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Municipal Bonds: Will Increased State and Local Bond Defaults Lead to More Chapter 9 Bankruptcies?

On Behalf of | Sep 9, 2020 | Bankruptcy, Debt, Firm News, Municipalities

Effects of COVID-19 Pandemic on Municipalities

By: Laura Day DelCotto

The pre-2020 collective wisdom was that municipal bonds were as good as gold, solid and basically without much risk. Investors in tax-free bonds get a greater bang for the buck with the tax savings. There are many great bond-fund salespeople hawking bonds to individual investors.

Enter 2020.  According to data from Municipal Market Analytics, there have been 10 municipal bond defaults in May 2020 and another 10 in June. This is off the charts and not widely reported in mainstream media.

Enter 2020.  According to surveys taken in April by the National League of Cities and the US Conference of Mayors, 90% of cities are projecting budget shortfalls. 90%. Of course they are. The fallout from the extreme drop in tax revenues is catastrophic to local budgets. Due to the pandemic, pretty much every single aspect of state and local revenues have been disrupted: sales tax, payroll tax, hotel and other tourism tax, income tax.

Origins and Misconceptions of Chapter 9

Enter 1934.  Congress enacted chapter 9 of the Bankruptcy Code to permit local governments to file for bankruptcy. This would enable them to rehabilitate their affairs. It’s totally understandable that no one wants to talk about bankruptcy since it’s been pitched by lenders, their lobbyists and our culture as some kind of moral failure. The bond market acts like not paying a bond payment when due is some kind of Armageddon. In the real world Detroit has proven otherwise.

Chapter 9 cases are very different from corporate reorganizations in many ways. Cities cannot be forced to “liquidate” assets for creditors as in other types of bankruptcy cases. The process is a pure rehabilitation and organized payment plan. While costly and full of creditor battles, it must be considered and understood as an option since 2020 is bringing local government back in time to 1934.

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