Municipal Bond Forum
GO defaults extremely rare
Q
I’m a client and read your article, “Moodys: Muni Default Rate to Remain Low.” You said that only one general obligation issuer, out of the 9,700 rated by Moody’s, defaulted. I thought GOs couldn’t default? Also, I thought states, like California, can’t file for bankruptcy and default on their GO bonds. Correct?
A
James A. Klotz responds:
General obligation bonds can default but rarely do. Usually, a GO bond default would occur if a city filed for bankruptcy, but this, too, is rare. In fact, many states prohibit bankruptcy by units of local government. Bond ratings on local governments indicate vulnerability to potential default, and if default was not possible, they would all be rated “AAA.”
A major strength of general obligation debt is that debt service for such bonds is a small percentage (usually 5% or less) of annual expenditures. Since local governments need to maintain access to the capital markets, they will cut other areas before debt service. To do otherwise would have grave consequences for their ability to fund future capital projects.
As far as states defaulting: Theoretically, a state can default. However, only one state has defaulted since the Civil War, and that was during the Great Depression.
California, the state you mention, has constitutional protections that require debt service to be paid on general obligations after school aid has been paid, and before any other expenditures. Many other states have similar legal provisions.
States are rated higher than virtually any other class of credits due to state sovereignty, broad diverse economies and a multitude of revenue streams that can be accessed to pay state GO debt obligations. As a result, the average state GO rating is “AA.”
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