Municipal bonds are in the news again. They took a long vacation during the Great Recession, due largely to the failures of municipal bond insurance companies which resulted from taking on credit default risk and straying from a lucrative but boring business of simply insuring municipal bonds.
Before the Great Recession, and during the Great Recession including the present time, municipal bonds are the same as corporate bonds, only different: Municipal bonds rarely default, unlike corporate bonds which default a lot more often. These comparative rates of default are not reflected in the cost of their insurance policies, however, as municipal bond insurers set high rates in a niche market. There just have not been many alternatives open to local government bodies that wish to obtain insurance to protect their bonds (and so give confidence to their bondholders).
Now, some call into question whether the very low default rate of municipal bonds is threatened by unfunded local government pension plans. See Tara Siegel Bernard, “Your Money / Municipal Bonds Not Really So Scary” p. B1, col. 3 (New York Times Nat’l ed., “Business Day” Section, Saturday, July 25, 2015).
What is scary is the spectacle of municipal bond insurance companies issuing policies to cover risks unrelated to their core business.
Please Read The Disclaimer. ©2015 by Dennis J. Wall, author of “Lender Force-Placed Insurance Practices” (American Bar Association 2015). All Rights Reserved.