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Municipal Bonds

August 17, 2012 – 5:34 pm

The default rate of a muni bond is much higher than anyone thinks. You just don’t hear about it much of the time. When defaults occur on General Obligation bonds for a city, county or state that makes for wide spread news because it is rare. However, defaults of Revenue Bonds are much more common and many times these bonds are not rated so they are not followed closely. A Revenue Bond is a bond issued by a city, county or state that is backed by a specific revenue generating source in those entities such as sewer, water, or a power generating plant. Since they are not a General Obligation bond in which taxes are used to repay they are reliant on the specific project to generate cash and repay the bond holder.

The problem lies in that while essential services such as sewer and water or reliable income generators others are not. A new trash to energy electrical plant could lose money and if there are other sources of power the plant could be shut down thus the bonds issued to build that plant may not be repaid.

As a result, two thirds of the municipal bonds that go under are not General Obligation bonds but rather Revenue Bonds. In that case the official default rate is about 30% higher than reported.

What kind of bonds do you have?

Good Trading
Steve Peasley

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