Over the course of history, during world wars, pandemics, financial crises, and deep recessions, municipal bond defaults have been an extremely rare occurrence. There have been less than 700 rated municipal bond defaults in the over 100 years of public finance existence. As a point of comparison, we saw over 117 corporate defaults in 2019 alone. Moreover, roughly 90% of the total notional value of all municipal defaults, are tied to just four bankruptcies, which include Washington Public Power System (Whoops), Jefferson County, AL Water & Sewer, Detroit, MI, and Puerto Rico. Each of these defaults were predicted and identified by our deep credit research and, therefore, were avoided by our clients.
Throughout the span of modern history, municipalities, across the country, have successfully navigated prior economic recessions by applying powerful tools including cutting expenses, consistent with the reduction in revenue and tax collections they experienced. Ongoing payrolls and benefits of public employees represent the primary source of expense for most municipalities. Therefore, during times of recession, and in the absence of additional revenue, municipalities are forced to make the difficult choices which include the termination of public employees and other civil servants. Unlike corporations, municipalities have the unique flexibility to raise revenues through taxes and fees.
Is this time different?
As we re-open our economy and attempt to restore normalcy in our lives, we are faced with the grim fact that COVID-19 has exacted a deep cost resulting in over 100,000 deaths in the U.S, while, at the same time, pushing unemployment claims have surpassed 40 million since March. While it may be difficult to see through the fog of fear and uncertainty, and the risks associated with this crisis remain unknown in many respects, we believe there are key economic truths from which we can draw comfort and confidence.
The government policy response of closing the US economy to “flatten the curve”, to avoid overwhelming the US healthcare system with COVID patients, has resulted in deep economic contraction. Stay at home orders have had dramatic negative effects on our movement, employment, discretionary spending, and investment. Cities and states have been directly impacted as a result. The Congressional Budget office estimated that State tax revenue losses could approach $650 billion through Fiscal Year 2022. Having said that, the monetary and fiscal response, by the Federal Reserve and US government, has been on a scale and scope like nothing we have ever seen in our lifetimes. We firmly believe the swift action by the Fed, Congress, and the President will help offset many of the losses incurred to-date, while ongoing stimulus and Quantitative Easing by the Fed will continue to heal the deep wounds inflicted on the US economy by the current healthcare and financial crisis.
The measures taken to slow down the effects of this global pandemic are like nothing we’ve experienced in our lifetimes. Yet, there are important conclusions we can draw from prior periods of economic stress. In this regard, we will closely evaluate the powerful tools municipalities have used to manage through prior periods of extreme economic stress, which will help dispel many of the misconceptions about municipal default risk.