Municipal Bonds—When Full Faith and Credit Falls Flat

Why we don’t invest in uninsured general obligation bonds from the state of Illinois and the city of Chicago.

Franklin Templeton Fixed Income Group

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Once upon a time, US municipal bonds were generally considered less risky than corporate bonds. Backed by the full faith and credit of state governments, investors had confidence they would receive their principal plus interest without fail. Times have changed. For some states and local governments, decades of financial mismanagement and massive pension liabilities are threatening to upend the full faith and credit pledge.

In this article, we explain why we don’t invest in uninsured general obligation bonds from the state of Illinois and the city of Chicago. As municipal bond analysts, assessing pension risks hinges partly on the willingness of elected officials to implement tangible pension reforms. Absent that, large pension obligations can significantly degrade budgets, credit quality and eventually impair bondholders. Here’s the good news: after excluding some local bond exposures, like Chicago’s, that still leaves well over 85% of the general municipal market available for investment. In some instances, we think essential-service revenue bonds offer more stability than general obligation bonds.