Municipal Bond Forum

Assessed values have dropped significantly in many communities, as you point out. However, in many areas, the property tax has become less relied upon by local governments than it once was. The increasing use of fees and assessments to provide funding for services where the specific benefit a citizen receives can be measured and priced has become a major source of revenue. Fees for sanitation, fire services and other traditional government services have replaced the property tax as that tax has become increasingly unpopular. So, the lessening role of property taxes also means that there is greater insulation from any volatility associated with that tax, and the impact of lower valuations has been somewhat reduced.

Despite this change, local governments everywhere are feeling the pinch from reduced revenues in this period of economic difficulty. Nevertheless, as local governments wrestle with out-of- whack budgets, debt service remains a high priority and is rarely, or never, targeted for cuts.

Those communities hardest hit are likely to see bond rating cuts and decreased service levels for their citizenry. But, defaulting on bond obligations, and the ramifications it would bring, still is a major taboo in local government finance.

Prof. Roubini has been a leading bear during the recent market turmoil, but we believe his negativity on the municipal market is misplaced. There are numerous differences between the municipal market of the 1930s and that of today. For one, investors had fewer tools at their disposal in the 1930s by which to gauge credit risk. Few muni issuers produced adequate financial statements for either internal or external use. So, judging the health of a muni issuer was far more difficult in the age of "cash" accounting. Second, sophistication in the management of public and non-profit entities was far behind modern practice. Today, better accounting systems, revenue and expense measurement techniques and the availability of outside financial advisors has provided a much stronger hand to those who must manage public organizations.

As a result of these and other changes, muni issuers (for the most part) are more experienced at managing cash flows, establishing "rainy day" funds and preparing for financial downturns. Finally, many issuers, such as California, require the payment of debt service as a priority in managing their budgets. These and other reforms since the 1930s have served to improve the state of public financial management and debt repayment administrations yielding the very low default rates the municipal market has seen over the last half century.

Bond insurance is supported by a combination of hard capital on the books of the bond insurers, as well as other forms of credit support, including re-insurance, lines of credit and other support traditional to the overall insurance industry. Bond insurers are regulated by state insurance regulators, who set the capital requirements necessary for the insurers to do business within their respective states.