In December, Wall Street analyst Meredith Whitney began predicting that the municipal sector would be increasingly insolvent going into 2011 and that many cities would default on their bond obligations. The predictions seem to be chasing away some investors from the municipal debt market, which could increase bond issuance rates. In an effort to shore up the market, the Washington-based National League of Cities (NLC) is forming a new municipal bond insurance company while also trying to convince investors that their fears are baseless.

Whitney's predictions are unfounded, says Los Angeles Chief of Debt Management Natalie Brill, but they have been contributing to an investor panic. “There's been a lot of money that's been bleeding out of municipal debt over the last few months because of that fear,” Brill says. Los Angeles officials are concerned about the rates they may encounter when they pursue some regularly scheduled bond issuances this summer.

Since Whitney's predictions were first published, NLC Director of Research and Innovation Christopher Hoene has been assuring the investing public that the municipal bond market is stable. NLC also is moving forward with plans to create a new municipal bond insurance company that could reduce the cost for cities to issue bonds, says Cathy Spain, director of NLC's Center for Enterprise Programs.

The credit crisis caused by the recession has left only one company that insures issuers against default in the municipal bond market. That is particularly problematic for smaller cities that participate in NLC's municipal bond pool, which bundles bond issues from small governments to put on the market as one issue. Because the bundled issuers have different credit ratings, the bond pool typically buys a letter of credit or bond insurance for each issuance. “[Now,] bond insurance or letters of credit are either generally unavailable or not available at an affordable price,” she says.

Spain says it will take some more time to resolve the final details in forming the insurance company. In the meantime, NLC will concentrate on educating the public about the municipal bond market.

Layers of protection

NLC's proposed insurance company, as it is currently planned, would have three sources of capital. A private reinsurance company would pay the first loss on defaults to a set amount. NLC would have issuers invest some of the savings they get from issuing insured bonds back into in the insurance company to cover losses not covered by the reinsurance company and to pay back a possible loan from the federal government or another source.

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