With Detroit going bankrupt some may think this could be the start of many municipal bankruptcies, while others would consider this an isolated event.
The problems in Detroit are certainly extreme, but many other cities have similar issues to a lesser degree.
Detroit’s unemployment rate is roughly double the national average. Its crime rate has ranked near the highest in the country for many years, with a murder rate approximately 10 times the U.S. average.
Detroit’s population has fallen from more than 1.8 million in the early 1950s to less than 700,000 currently, as many residents have fled to safer suburbs.
Detroit has lost a substantial number of auto related jobs in recent decades, and was unable to establish new industries.
Generous retiree pension and health care costs have kept expenditures high, while a declining population has decimated the tax base. Given all these factors it is not surprising that Detroit has gone bankrupt.
Looking at Los Angeles and Culver City the initial impression would be that we are so different from Detroit.
This is true to a large extent, as we have a diversified economy, a population that has grown, and crime, while a concern, has come down over the past decade.
However, there are some issues that we need to be cognizant about. The unemployment rate in Los Angeles County, while decreasing over the past year, is still significantly higher than both the state and national averages.
Public employee retiree pension and health care benefits are especially generous for Los Angeles and state workers overall.
It is questionable if investment returns from the various government pension plans will be large enough to meet these obligations without making additional demands on the taxpayers.
While the population of Los Angeles County has continued to grow, the school age population is actually declining.
We have seen a significant decline in enrollment at LA Unified in recent years, and this is backed up by census data. From 2000 to 2010 the under 10 population in LA County declined 260,000.
This would not be a near term concern, but in 10 to 15 years the working age population in our area could be declining.
In the future with the large baby boom population receiving retirement benefits, and less workers available to pay taxes there could be a potential problem.
For the municipal bond investor I do not expect that the Detroit bankruptcy mean that there will be a significant number of bankruptcies to follow.
Detroit is an unusual situation, and with the economy improving, most states and cities are seeing an increase in tax revenues.
yields are currently quite attractive, being slightly greater than those of U.S. Treasurys despite their tax-free status.
The credit risk for a diversified California municipal bond fund is relatively low. There certainly could be additional bankruptcies in this state, but an isolated one would have little impact on a portfolio.
For investors in taxable accounts, if you are at least in a 15 percent tax bracket I think municipal bonds are appropriate.
I would not purchase municipal bonds in a tax-exempt or retirement account. Also, I would purchase municipal bonds in a low cost fund, for better diversification versus individual bonds.
The more significant risk for a municipal bond portfolio, or any bond fund is interest rate risk. With interest rates likely to increase I would not recommend that anyone invest in longer term bonds, but keep maturities to the intermediate term or shorter.
The Detroit bankruptcy created a scare for municipal bond investors. In the near term I believe this is a one-time event, so I do not believe investors in California should be overly concerned with this, especially with our economy improving.
However, we could have problems longer term, but these are probably at least a decade off.
