Subprime Finds New Victim as Muni Defaults Triple

Commentary by Joe Mysak

May 30 (Bloomberg) -- The amount of municipal bonds that have defaulted this year is already more than triple what it was for all of 2007.

And who could doubt there's more bad news on the way?

So far this year, $736 million in municipal bonds have defaulted. That doesn't necessarily mean they didn't pay investors; they may have just drawn down reserves. That's what happens just before they stop making payments to bondholders.

During all of 2007, only $226 million in municipal bonds defaulted, according to the May edition of the ``Distressed Debt Securities'' newsletter, published in Miami Lakes, Florida.

That $736 million is nowhere near the record for municipal bond defaults, to be sure. The record year, if you're counting, was 1991, when almost $5 billion went bust. That's still small potatoes compared with what happens over in the corporate-bond market, where $36.6 billion blew up in 2006, and almost $24 billion in 2007.

But wait a minute: Municipal bonds never default, do they? Or at least this is how they are perceived by individual investors, right?

We're probably going to see a lot more munis default this year and in the years to come, because of the subprime crisis and maybe, just maybe, because of the high price of a barrel of oil.

New Residents

The hangover from the collapse in real-estate prices is going to be a boom in so-called dirt-bond defaults.

These are bonds sold by municipalities to build the infrastructure for housing developments, and are backed by the taxes paid by all the new residents who are going to move in. If no residents move in, or too few do, the bonds aren't repaid.

Of the 30 bond issues that have defaulted so far this year, more than half are from issuers in two of the states that have figured prominently in all tales of the housing bust: 10 in Florida and seven in California.

Consider the $50 million in special assessment bonds sold by the Monterra Community Development District in Broward County, Florida, for example. On May 7, the district disclosed that it had tapped its $1,279,200 reserve fund for $1,211,727.11.

You can just stop right there and know that this story is bound to be a sad one.

These particular bonds were sold by the district in 2006 in a limited offering. The bonds were unrated, and sold in minimum denominations of $100,000. The bonds carried a 5.125 percent coupon due in 2014, and were priced to yield 5.198 percent.

Remember Colorado

The Monterra development is located in Cooper City, which is about 20 miles north of Miami and has a population of almost 30,000. Of the 10 Florida bonds that defaulted this year, all were sold by community development districts, and all within the last four years.

The big jump we are going to see in the number of such municipal bond defaults this year won't be limited to Florida and California, but will include all those places where the high tide of real-estate mania has now receded.

This isn't an uncommon phenomenon after housing busts. In the past, the damage was usually confined to certain states where the boom was craziest, such as Colorado in the 1980s.

More bondholders are going to be affected this time around because the housing collapse is more national rather than regional or isolated, and because of the relatively recent development of so many ``exurbs,'' as chronicled, for example, by New York Times columnist David Brooks in his 2004 book, ``On Paradise Drive.''

Three-Hour Commutes

These are the suburbs beyond the suburbs, where Americans have moved to enjoy the good life, commute (usually) be damned. Not too long ago, the newspapers seemed to be filled with stories about people who gladly commuted two and even three hours each way for affordable real estate. Most people knew actual examples of such hearty souls. I wonder how much gasoline at $4-plus a gallon will dent the growth, and tax base, of such communities.

It's not just the price of gasoline that is going to make the nation's many far-flung communities less attractive. On May 28, Bloomberg carried a story detailing how the increase in the price of jet fuel was causing airlines to curtail service throughout the country.

Maybe we'll have to reconsider this whole flight-from-the- coasts idea that got such attention a few years ago.

(Joe Mysak is a Bloomberg News columnist. The opinions expressed are his own.)

To contact the writer of this column: Joe Mysak in New York at jmysakjr@bloomberg.net

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