Government debt defaults more frequent than thought

California state capital. Photo: prayitno via Flickr

Government debt isn’t as safe as once thought.
At least that’s the message from research released Wednesday by economists at the Federal Reserve Bank of New York.
The stigma that municipal bonds are the more secure investments, along with federal tax exemptions, make them enticing to household investors, the economists said in the study. Individual investors in the U.S. hold $1.879 billion in municipal debt, which is more than half of the $3.7 trillion market.
“Although the low default history of municipal bonds has played a key role in luring investors to the market, frequently cited default rates published by the rating agencies do not tell the whole story about municipal bond defaults,” Fed economists said in the study.
The economists say the rating agencies like Moody’s and Standard and Poor’s only report defaults of bonds they have rated. Between 1970 and 2011, Moody’s reported 71 defaults while S&P listed 47.
These reports miss the bond market’s unrated portion, which contains more than 2,500 defaults versus Moody’s over the same 31-year span. S&P had 2,366 defaults between 1986 and 2011, while its rated market only shows 47.
For municipalities, a bond rating is a voluntary step in selling debt. Some choose to opt out of a rating if receiving a poor score is likely.
It may be hard to get a good rating on a bond if the risk of default is too high, according to the report.
Revenue bonds, or bonds backed by revenues generated, make up 60 to 70 percent of new issuances since the mid-1990s and experienced the most defaults. These bonds can be risky if backed by volatile revenue streams, like fees from nonessential services.

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