Fed Report: Muni Bond Defaults More Frequent Than Reported

Investors have flocked to municipal bonds over the past 18 months, as cities and states have generally avoided financial meltdowns.

But new research from the Federal Reserve Bank of New York indicates the safety of municipal bonds is more tenuous than has been reported.

That’s because when rating agencies report defaults, they look only at the universe of bonds rated by the agencies. And only the safest bonds are rated, according to The New York Times.

Editor's Note: Unthinkable Haunts Investors: Evidence for Imminent 90% Stock Market Drop.  

When unrated bonds are included, there were 36 times as many defaults from 1970 to 2011 as were reported by Moody’s Investors Service, according to the Fed economists who compiled the report.

They found 2,521 defaults compared with the 71 recorded by Moody’s. The Fed’s data showed a 4 percent default rate compared with 1 percent for Moody’s, The Times reported.

“[T]he municipal bond market is complex, and defaults happen much more frequently than most casual observers are aware,” the economists wrote.

Rating agency officials didn’t dispute the study’s basic conclusions. “The lion’s share of the defaults occur in the unrated market, and they have for many years.” Steve Murphy, managing director of Standard & Poor’s, told The Times.

Whatever the risk, Morningstar analyst Miriam Sjoblom doesn’t see the muni rally abating anytime soon. One key reason is near-record low interest rates, she writes on Morningstar.com.

“Individual investors' hunt for yield remains a key driver of flows into muni funds.”

Editor's Note: Unthinkable Haunts Investors: Evidence for Imminent 90% Stock Market Drop.