Investing in the High Yield Municipal Market: How to Profit from the Current Municipal Credit Crisis and Earn Attractive Tax-Exempt Interest Income

Default Record for Rated Bonds

Since the fourth quarter of 2010, there has been intense interest in the default and bankruptcy record of the tax-exempt market, thanks to the predictions of widespread defaults from a few market pundits with little prior experience in municipals. Historically, the largest and best-known municipal defaults occurred in the 1970s and 1980s: New York City in 1975, Cleveland in 1978, and the Washington Public Power Supply System (WPPSS) in 1982. There is one notable exception: Orange County, California, in late 1994. Each was a seminal event in its own right, although the factors leading up to each default were quite different. At the risk of oversimplification, one could say New York and Cleveland were victims of structural budget deficits and socioeconomic factors, WPPSS of nuclear construction risk, and Orange County of financial mismanagement.

Since the mid-1980s, with the notable exception of Orange County, the municipal credit landscape has remained remarkably calm. Between 1986 and 2010, the default rate on bonds rated investment grade by S&P was virtually nil, averaging literally 0.00 percent. The worst year for the credit markets to date, 2008, still showed a default rate of only 0.03 percent. In contrast, over the same period, the default rate on what S&P calls “speculative grade” (i.e., below investment grade) averaged 1.55 percent, with a peak of 5.26 percent in 1992, still very modest by corporate bond standards.

For the period from 1999 ...