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Capital Markets

Are munibonds at risk of default or a sure-fire investment?

Outstanding debt issued by state and local governments in the US now runs at $2.8 trillion. With pension costs increasing, revenue streams reduced and state budget shortfalls at about $192 billion for the fiscal year 2010, doubts about the likelihood of municipal debt being paid off are increasingly being raised. In the markets’ view, the risk of default for Illinois and California debt against default is in line with Portugal or Ireland.

The concern is understandable, and echoed by such investors as Warren Buffett, who predicted "a terrible problem" for municipals bonds when he spoke in June this year at the Financial Crisis Inquiry Commission.

But are state-issued bonds really at risk of defaulting? It seems that the risks have been greatly exaggerated. State bonds (general obligation bonds or GO bonds) rarely default. State voters pledge to meet debt service requirements by levying a tax or cutting costs to meet the obligation. Furthermore, debt servicing payments are only a fraction of annual revenues. California’s state treasurer, Bill Lockyer, points to the figures to dismiss any questions about risk. He says a comparison with Greece is "absurd". California’s revenue for the fiscal year 2009/10 will be $82 billion.

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