Defaults on Municipal Bonds Eric Thammavong & Natalie Hooper

Overview Historical default rates (Munis vs. Corporates) Robert Citron – Orange County Default Washington Public Power Supply System (WPPSS) – Whoops!

Municipal Bonds Municipal Bonds High ratings Long history of repayment 1970s: municipal bonds have exhibited significantly lower risk of default than similarly rated corporate bonds

Default Rates: Munis vs. Corporates

Default Rates: Munis vs. Corporates Standard & Poor’s Study (2001): “A” rated municipal bond less than 1/10th as likely to default as A-rated corporate bonds

Recovery Rate: Munis vs. Corporates Money recovered from defaulted municipal bonds: 66% of face value FULL recovery 75% - 100% of par Money recovered from defaulted corporate bonds: 42% of face value

Orange County Bankruptcy December 6th, 1994 Robert Lafee Citron Only Democratic Politician to hold office at the time 1970-1994 (24 years in Office) Controlled the General Fund, Investment Pool, and the Treasury Commingled Pool ($7.6 Billion) 9% annual return

What led to the financial crisis? Orange County FY94 12% of revenue came from Interest 3% of revenue from interest for Other Counties Proposition 13 Lowered property tax by 57% Proposed FY95 FY95 budget: Interest would account for 35% of county’s general fund revenue

The Scheme

Investments Federal Reserved raised interest rates from 3.5% to 5% What goes up must come down $2 borrow for $1 dollar deposited

Warnings John Moorlach Republican candidate “It doesn’t bother me he’s a Democrat. This is a person who has gotten us millions of dollars. I don’t know how the hell he does it, but he makes us all look good” Then-Chairman of the Board of Supervisors

Bankruptcy November - $1.64 Billion $7.6 Billion (county funds) County government, school districts, transportation, water, and sanitation agencies $13 Billion (borrowed) Total Loss $20.6 Billion Robert Citron Asked to resign in December 1994

Washington Public Power Supply System (WPPSS) Created in 1957 Expected demand for electricity would double every ten years. Plan to construct 5 nuclear power plants

WPPSS Projects 1,2, and 3 supported by net billing Bonneville Power Administration (BPA) Net billing: pledged BPA’s revenues towards repayment of WPPSS borrowings made the plants expected energy into a regional resource which spread the risk among all BPA’s customers priced expensive new nuclear power below its marginal cost

WPPSS Projects 4 and 5 financed through tax-exempt municipal revenue bonds 88 regional public utilities signed participants’ agreements for shares “take or pay” agreements: Commitment to pay for their share whether or not the plants ever generated a WATT of electricity

Skepticism Demand began to decline due to increased energy costs 1972 oil embargo Conservation High energy costs = conservation Slowing economy Electric growth rates fall 1% to 2% per year

Three-Mile Island 1979, nuclear plant accident in Middletown, PA, changing direction of entire nuclear industry. Public confidence eroded New safety requirements implemented Nuclear Regulation Commission (NRC) devised list of 6,000 steps to improve plant safety

The Downfall Construction delays, increased costs to meet safety standards, and mismanagement of the process drove the cost of the project to 3 and 4 times the original estimates. Costs soared to $24 billion NW population of 10 million, $2,400 burden on every man, woman, and child

Mismanagement Mismanagement by WPPSS was the biggest cause of delays and cost overruns no experience in nuclear engineering or projects of this scale unable to develop a unified means of choosing, directing, and supervising contractors For example: a pipe hanger was built and rebuilt 17 times Delays were not widely reported

Whoops!

Whoops! Construction of projects 4 and 5 was terminated January 1982 1983 WPPSS defaulted on $2.25 billion in principal and approximately $5 billion in interest 88 participating utilities were faced with repayment Washington and Idaho Supreme Courts invalidated obligations of those utilities

Question 1 What was the name of the treasurer who caused Orange County bankruptcy? Robert Citron

Question 2 What was one of the causes of the WPPSS default? Construction delays Cost overruns Mismanagement of project

Question 3 What type of agreement did the 88 public utilities enter into that committed them to pay whether or not the WPPSS plants ever generated a WATT of electricity? Take or Pay

Question 4 What suggestions do you have that could help prevent future municipal crisis?