States legally can't default on munis?

I read or heard somewhere that certain states are required by their constitution to make interest payments on any munis they may issue. They would have to sell assets if they don’t have the cash. I assume this would apply to paying back the principle as well.

What’s the straightdope? And if true then which states are bound by this?

If true then this also begs the question, why would a state bond offer higher interest rates then a Treasury with the same maturity?

‘Munis’ is short for municipal bonds, i.e. those issued by municipalities (cities). Why would a state government be responsible for the actions of a city? So I doubt that this is accurate.

As for the second question, all bonds, state, municipal, federal treasury, or corporate, pay an interest rate based on the rating of the issuing body. That rating depends on their history of paying back bonds, and estimations of their current financial status and the likelihood of them paying back bonds in the future. It can vary widely from one city to the next, from one state to the next, etc. Given the level of the national debt right now, it’s quite possible that some state bonds might be rated higher than federal treasury bonds. Especially as some state Constitutions require a balanced budget, unlike the federal government, with its large deficit.

States would be authorized because states create cities via the laws for incorporating them. That doesn’t mean that they would be liable, but there could well be a law in some state saying they are.

Recall that while states can raise taxes, they can’t print money.

Muni rates have been collapsing over the past couple of days. Equivalently, prices shot up today.

Municipal money market funds were paying in the 4-5% range a little while ago. This was an anomaly, related to the credit crunch. Luckily the spreads between corporate and Treasury debt are finally narrowing.

Recall also that the muni insurers are in trouble: Ambac had its rating cut to below AAA. I understand that an Australian concern made noises about entering the muni insurance market earlier this week.

Maybe somebody more informed than myself can drop by and explain the oddness in recent bond pricing.

I was doing some research on municipal bonds when I came across this interesting little bit of info somewhere. It just seems to good to be true that you could buy a bond which didn’t require paying taxes, yield more then Treasuries, AND had no chance of defaulting. I know there is no such thing as a free lunch so I thought maybe I had misread somewhere. Some of these tax rules can be really frustrating to understand.

Munis rally as Demand Roars Back. Prices and yields move in opposite directions, so yields fall as prices rise.

Price rises/yield declines set new records today, beating the previous record set… on Tuesday. Admittedly the data series started only in 1984.

No, it isn’t. Federal bonds aren’t rated, because they are considered free of default risk. They are the standard against which other bonds are measured.

And what if they don’t have enough assets? No constitutional guarantee can make state and local bonds completely risk-free. Cities and states have gone bankrupt in the past. (See New York and Cleveland during the 1970’s, and many states during the late Nineteenth Century.) They have less ability than the federal government to tax with impunity (because people and businesses can more easily relocate to a neighboring state than a neighboring country), and they don’t control the money supply.

Most general obligation munis are very low risk, and they may well be underpriced right now, but they are not risk-free.

That’s why I’m asking if this is true. Although since states have gone bankrupt in the past that would explain why state munis pay more then a similar Treasury. 1970’s is a little before my time. :slight_smile:

The most shocking, more recent municipal bond default occurred in 1994, when Orange County, California–a perfectly prosperous suburban county–suddenly went belly up. Its country treasurer had been speculating on exotic derivatives on the county dime, and got burned (pdf).