Municipal bonds are supposed to be one of the safest investments, especially for small private investors saving for retirement or using the interest income for their living expenses. Unfortunately states and other local municipalities have borrowed more money than they can pay back.

Wall Street analyst Meredith Whitney says muni bond failures (i.e. a default on the bond obligations) are inevitable. The analysis by her and her team concluded there just isn’t enough income to pay back the principal and interest on all $3 trillion worth of muni bonds.

60 Minutes – State Budgets Day of Reckoning with Meredith Whitney

Meredith Whitney Predicts Billions of Dollars of Muni Bond Defaults on CNBC Squawk Box

Local governments have to decide, “do I default on debt investors or my constituents.”

Paraphrased: The federal government will have to bail out the states that have to bail out local municipalities. Will Texas citizens want their taxes used to pay off bonds for a water treatment project in Illinois?

Whitney on Bloomberg

Legally taxpayers are required to make up any shortfall in pension funds. Legally everyone’s going to be required to pay higher taxes.

Summary

There are two sides to the equation: income and expenses. The Great Recession reduced income, which exposed the muni bond issue. Governments borrowed more money than could be paid back with a reasonable margin of safety given fluctuations in the economy and tax revenue. Note on the second video Whitney agrees with PIMCO’s Bill Gross, who says “states” won’t default but municipalities below the state level probably will default or restructure.

One of the biggest drivers of annual expenses is obligations to retired government workers. This issue will continue to grow as more retirees draw income and medical benefits from all levels of government.

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