Some investors fear collapse of municipal bonds across nation

TALLAHASSEE - Investors have fled municipal bonds in recent weeks, leading to rising fears about investments in state and local government debt and increasing the potential for higher rates for when governments look to borrow money.

But those involved in the bond market differ on how long the volatility will last and how much of an effect it might have on Florida, which has preserved its high credit rating throughout the economic downturn.

The market for municipal bonds, or munis, is pegged at around $2.8 trillion nationwide. It includes bonds sold for everything from sewer projects to college buildings to transportation infrastructure. Those investments have often been thought to be safer than other assets, largely because states cannot legally go bankrupt and because most governments do almost anything to avoid default.

No state has defaulted on its debts since the Great Depression, when Arkansas did so, and even in the midst of the current economic downturn, only three governments - Harrisburg, the state capital of Pennsylvania, a city in California and a transportation project in Las Vegas - have defaulted.

But with state budget shortfalls soaring, investors are getting skittish about the securities. Some investors have even raised the prospect of a crisis in state bonds, with investment guru Warren Buffett warning this summer that the federal government might eventually have to bail out some states or localities.

"I do think the bear market in bonds has begun," said Marilyn Cohen, founder of Envision Capital Management, an investment company in Los Angeles. A bear market is when a majority of investors are selling, causing prices to fall.

Cohen said the focus of the problem is concentrated on other states, including California and Illinois, where policy makers "glommed debt over more debt" to avoid tough budget decisions. But the fallout from investors' nervousness about those states is rippling through the market, pushing up interest rates across the board - even for states such as Florida.

"You will be hurt less than if you were a California resident or an Illinois resident. … They have not spared Florida," Cohen said.

Florida has not been devoid of defaults. But they have largely been confined to the debts of community development districts around the state, which are classified as municipal bonds.

"They got caught up in, 'You build and they will come,' " said Ben Watkins, who oversees Florida's state bonds.

Because the bonds were supposed to be paid off with taxes on homeowners, when the housing boom collapsed the districts often started defaulting.

Even Cohen, who is skeptical about the muni bond market, said surprisingly few local governments anywhere have defaulted.

"You would have thought you would see some by now," she said.

For now, Florida has largely avoided the highest interest rates by finishing its bond sales for the year before things reached their worst, Watkins said. The last sale happened earlier this month, when a project at the University of North Florida got an interest rate of 4.45 percent. And while that is higher than rates the state had been getting recently, Watkins and other observers point out that rates were hitting lows that hadn't been seen in decades.

"When things are so good, and they back up some, then people say, 'Oh my God, they're so bad,' " Watkins said.

Watkins said rates could continue to rise, but the situation in the bond market is "nothing catastrophic at this point."

Officials including Watkins are not alone in brushing off the idea that a muni bond crisis is looming. James Klotz, president of FMS Bonds, said those sounding the alarm are getting too far ahead of themselves.

"The people who are the Cassandras in this instance don't really have a track record in this field," he said.

Part of the problem is caused by the nearing expiration of the Build America Bonds program, offered under the federal stimulus package. Those bonds used federal subsidies to try to hold lending rates down for state and local governments - but the program is set to end Jan. 1, and the recent tax deal between President Barack Obama and Republicans has not been extended. That's led to a flood of new bonds as governments try to beat the clock.

"Every issuer's trying to push every issue they can through the door," Klotz said.

But Klotz conceded that a massive sell-off could continue to send rates higher, but he says doomsday scenarios are still overblown.

"If there was a legitimate scare and everybody started selling their bonds at once, of course," Klotz said. "That scare is not going to cause a default."

brandon.larrabee@jacksonville.com, (678) 977-3709