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In the aftermath of a hard-hitting recession, states and localities are still feeling the heavy pressures of decreased revenues, and as a result, many have raised fears of being unable to alleviate operating deficits in order to maintain a balanced budget for the 2012 fiscal year. High rates of unemployment have only worsened the problem. Particular municipalities, including California and Illinois, have gained increased attention lately for their more extreme budgetary deficits. Such attention in the press has understandably generated anxiety for municipal bond holders.

Essentially, there is concern that some states and municipalities will be unable to make interest payments on their bonds in 2011. Experts seem to agree that we will see an increase in municipal bond defaults in the near future, but on a fairly narrow scale[1]. The consensus seems to be that the severity of the situation has been blown out of proportion; even if the bond default rate were to unexpectedly triple, it would still remain under one percent, within a reasonable historical range[2].

Recently, former Speaker of the House of Representatives, Newt Gingrich, announced that he believed Congress will soon see the introduction of legislation that would allow states to file for bankruptcy. Gingrich and some other lawmakers regrettably foresee the possibility of states looking to the federal government for bailouts[3]. This legislation would protect against such measures by giving states another opportunity for dealing with budget problems. The bankruptcy option, constitutionally forbidden to states because they are considered sovereign, would implicitly allow states to break pension promises and other contracts with state workers and retirees, for a period of debt relief[4].

Although Gingrich cannot be disagreed with in his view that the operating budget deficits are clearly problematic and something to necessarily deal with, this legislation is unlikely to garner much momentum, as it already seems to face a lot of opposition across both parties and among many economists. It appears unlikely that even if the bill were to pass, any state would default on its bonds and choose to utilize the legislation. Realistically, states still have many other options and measures available to them in dealing with their operating deficits. States can focus on raising revenues through budget and taxation changes, while allowing the cyclic nature of economic growth after recession to ensue[5]. The bankruptcy bill as a solution does not seem to be very viable—especially when it comes with the enduring risks of shattered state credit ratings and a loss of trust from bondholders[6]. It seems like it would have too large a negative impact on the trajectory of typical recovery after economic recession.

Howe & Rusling has a history of rigorous research, analysis, and constant review of municipal bonds in order to insure against these warnings and concerns that began intensifying a few years ago. We take a close look at the demographics of almost every municipality we invest in, and save for a few rare, compelling cases, we avoid credits rated below A2 or A by either major credit agency, since historically, defaults have been much more likely in unrated securities of non-established issuers[7]

Howe & Rusling has actively incorporated state diversification for clients worried about their home states.  We also use state tax exempt agencies in many accounts as another hedge against weaknesses in the municipal markets. Our portfolios have almost no exposure to California, and we avoid exceptionally large allocations to those other states with the greatest budgetary problems, including Illinois, Nevada, Arizona, Michigan, Florida, New Jersey, Rhode Island.  On the rare occasions that we do allocate to these states, it is generally a careful position at the short end of the curve to generate returns in an otherwise un-risky portfolio. Furthermore, Howe & Rusling has actually tried to capitalize on opportunities in those states we consider safe, including Iowa, Texas, Missouri, Virginia, certain segments of Pennsylvania, and Utah.  Iowa and Missouri, which we believe are often ignored by our counterparts, have brought us notable success.

Additionally, with the knowledge that most municipal bond defaults have been due to problems with individual projects, as opposed to local governments[8], Howe & Rusling does not purchase many of such project finance bonds, and instead tends to favor relatively rural and small-city suburb general obligation bonds (which require less taxation than cities) and revenue bonds. Revenue bonds, which are serviced by revenues of the specific entity, such as waste, water, transit, or another vital public operation, can offer special protection against municipal bankruptcies, especially lately, as they do not depend on voter approval of unpopular tax levels. Since 2009, Howe & Rusling has begun to carefully add several very high quality hospitals, as to further diversify our portfolio. Generally speaking, Howe & Rusling takes a very thorough and diverse approach to analyzing the municipal market, providing the necessary insulation against the market’s potential weaknesses.


[1] Cohen, M. (January 8, 2011). Gauging Those Tremors in Municipal Bonds. The New York Times. Retrieved from http://www.nytimes.com/2011/01/09/business/mutfund/09muni.html?pagewanted=1&_r=1

[2] Ibid.

[3] Lambert, L. (January 21, 2011). UPDATE 2-U.S. state bankruptcy bill imminent, Gingrich says. Thomson Reuters. Retrieved from http://www.reuters.com/article/2011/01/21/usa-states-bankruptcy-idUSN2115727620110121

 [4] Walsh, M.W. (January 20, 2011). A Path Is Sought for States to Escape Their Debt Burdens. The New York Times. Retrieved from http://www.nytimes.com/2011/01/21/business/economy/21bankruptcy.html?_r=3&hp=&pagewanted=all,

 [5]Lav, I. J. & McNichol, E. (January 20, 2011). Misunderstandings Regarding State Debt, Pensions, and Retiree Health Costs Create Unnecessary Alarm. Center on Budget and Policy Priorities. Retrieved from http://www.cbpp.org/cms/index.cfm?fa=view&id=3372

[6] Lambert, L.

[7] Cohen, M.

Lav, I. J. & McNichol, E.