Defaults in the bond markets portend an ugly future.

Posted by Ian Smith | Jul 15, 2020 | 0 Comments

Red Storm Rising in the Municipal Market.

Forbes published an interesting article yesterday.

I have been wondering about the knock on effect of the coronavirus for months now. While the media and the stock market seem to be focusing on a supposed "V-shape recovery." The underlying economic fundamentals have decidedly pushed this theory aside. The U.S. economy is suffering unemployment in numbers not seen since the Great Depression. Corporate earnings are coming out this week and banks are sharing that they have reserved billions of dollars in anticipation of a wave of loan defaults. Revenue at major corporation has been slashed in half compared to the same period last year. All of these factors would make one assume that the recession we find ourselves in could be rather serious.

The stock market isn't reflecting economic reality. The rally in equities over the past couple months is a perfect example of a true decoupling of economic reality and financial speculation and optimism. The Fed has pumped trillions of dollars into the US economy in hopes to stave off a massive financial calamity. The fed has essentially stymied many listed company's bankruptcies through it unprecedented programs. While this seems to have temporarily assuaged the financial markets, Covid-19 and its repercussions are still being felt evinced by the bankruptcies of many large companies like Neiman Marcus, J. Crew, Brooks Brothers, to name just a few. But, Covid caused bankruptcies will not end with companies, they will surely effect individuals, and more frighteningly even municipalities and states.

One place where the financial hardships from Covid-19 are becoming more apparent by the day is in the municipal bond markets. States and local governments are increasingly asking congress to help bail them out of the precarious position they find themselves in regards to their bond offerings. The importance of municipal bonds is that they are often the equity financing for big projects that create infrastructure and jobs. These bonds are often attractive investments because they offer relatively high rates of return and generally have a lower risk profile. 

However, data compiled by Forbes comparing last July to this July is alarming. Forbes amassed all the bonds that have either defaulted on payments to bond holders or failed to make payment obligations to a bond trustee. Their findings are in the graph at the bottom of the article. The numbers sum it up though, in July '19 there were 16 defaults on $1.7 billion. In July '20 there were 59 defaults on $3.8 billion! That's nearly a 400% increase in defaults with a more than 100% in net money being defaulted.

What does this mean for bankruptcy in the United States? The Covid-19 recession has brought bankruptcy upon the American economy. The first wave has been the large corporate companies with the means to higher expensive lawyers to restructure their businesses under Ch. 11. These municipal bond defaults point to a structural problem that is much larger than the private and publicly listed companies that make up the stock market. If municipalities and states begin defaulting then the U.S. will enter a brave new world in regards to bankruptcy.

About the Author

Ian Smith

Ian Smith was born and raised in Jackson, Wyoming. His parents were NOLS instructors so his childhood was filled with outdoor adventuring across beautiful Wyoming. He spends his free time in the outdoors; fishing, hunting with his father, skiing, mountain biking, and camping. Ian spent his twentie...

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