A small city unable to pay off a jumbo-sized debt hasn’t shaken the muni market.
Despite eye-catching headlines recently over Harrisburg, PA’s bankruptcy filing, the news barely fazed investors, but the still-unfolding story reinforces some time-tested lessons.
A mess over trash
Harrisburg’s financial woes stem from an incinerator originally built in 1972. Plagued with operating problems from the start, the city nevertheless decided to expand and retrofit the plant in 2003, taking on $125 million in debt. The initial contractor on the job went belly up, which led to more borrowing and debt that mushroomed to $310 million – a daunting sum for a city of 49,000 residents and a total municipal budget of less than $60 million.
Ultimately, the city filed for bankruptcy, which the state is currently challenging in court.
Bonds insured
Although Harrisburg’s move was unusual, the market hardly took notice. Harrisburg is not a significant issuer of bonds, and its financial plight has been well documented. A good portion of Harrisburg’s overall debt is insured, and many of the bonds associated with the incinerator are secured by Assured Guaranty, which made some payments the city previously missed.
We are all aware other cities and municipalities face strained finances, but few, if any, are confronted with challenges similar to Harrisburg’s.
Defaults continue to be extremely rare. Last year, municipal defaults totaled $2.65 billion, an 8.6% decline from 2009. So far this year, defaults total $1.1 billion, according to Lipper Research Services, a small fraction of the $2.93 trillion in outstanding municipal bonds.
In the meantime, a judge placed Harrisburg’s bankruptcy on hold for a month, enabling bond insurers to file briefs in the case while state lawmakers are pushing to take over the city’s finances. Soon after Harrisburg filed for bankruptcy, the state sued, concurring with the mayor’s opposition to the filing. Harrisburg’s City Council voted three times over the summer to reject a financial recovery plan under the state’s program for distressed communities. All the decisions were carried by a 4-3 margin. The measure on October 12th to file bankruptcy was approved by the same 4-3 margin.
Lessons for muni investors
The lessons from Harrisburg reinforce what generations of successful investors already know. Municipal bonds are bought to generate a steady stream of tax-free income. Look for quality and avoid excessive risk. Munis should comprise the part of your portfolio that helps you sleep at night, not the portion that keeps you glued to the financial channels and subject to night sweats.