The Federal Reserve has done a study that says municipalities are defaulting at higher and faster rates than investors realize. The sample for the study was much broader than the slim segment that is rated by ratings agencies. When such unrated bonds were included, the default rate over the last 40 years jumped to 36 times what conventional wisdom suggests.
Moody’s, a popular bond rating agency, says that from 1970 to 2011, only 71 municipalities defaulted. According to the Fed survey, there 2521 defaults over that period.
The study also shows that less than 1% of bonds rated by Moody’s defaulted. Over 4% of the bigger pool of municipal bonds went into default. Individual investors tend to invest in rated bonds. The largest segment of bonds that defaulted were industrial development bonds. The bonds least likely to default were general obligation bonds.
The study also observed that corporate bonds have more defaults during a recession while municipal bonds default more during economic downturns. Moody’s has restructured its ratings criteria to apply more equally to corporate and municipal debt.
The study can be useful in helping investors understand the risks inherent in unrated debt as they search for higher income in a low interest rate environment.
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