Detroit Increases Municipal Bond Rates?

Detroit's bankruptcy filing may cause interest rates to spike for municipalities around the country. Many municipal bonds are backed by insurers, who stand by ready to make payments to bondholders should the municipality default. In Detroit's case, Assured Guaranty is backing $1.8 billion in sewer and water bonds and $300 million in general obligation (GO) bonds. Even though the $300 million in GO bonds is relatively small, the disposition of these bonds in bankruptcy will be crucial to municipal financing going forward. GO bonds are backed by ability of the municipality to levy taxes. Although there are only a limited number of legal precedents, GO bonds have generally been treated as secured debt, not unsecured. The difference is that if Detroit's GO bonds are considered secured debt, they must be repaid entirely. If Detroit's request to treat the GO bonds as unsecured debt goes through, the bondholders will likely not receive the full amount due. This could mean that future municipal GO issues are charged a higher insurance fee, and a higher interest rate.