Most people have no doubt seen the headlines by now: Detroit, an iconic American city that was at one point the fourth largest city in the nation, has officially gone bankrupt. In many ways, the filing is simply a formality, the roots of the Motor City’s economic woes go back a long way.
One of the biggest problems facing officials in Detroit is the issue of teetering municipal bonds. When you raise money through bonds—whether it is on a local, city or statewide basis—and you get into these circumstances where you have essentially made more financial promises than you can keep, what is that debt worth? At this point in the municipal bond crisis, you are in danger of not being able to recoup the principle—let alone the interest payments.
You don’t need a financial advisor to tell you that it’s pretty worrisome when municipal bonds on the city and state level becoming high-yield, or, for lack of a better term: junk. And while city leaders and civic officials in Detroit might be tearing their hair out over this, individual investors need to be equally alarmed. Many retirees and pre-retirees have these municipal bonds in their portfolio. If you hold those bonds, what are you going to get back— pennies on the dollar? That’s obviously more than a little concerning.
Here is the really unwelcome news: Detroit may be the face of this problem, but it is far from the only place suffering from these same structural economic difficulties. In fact, it’s really just the tip of the iceberg. Harrisburg, the state capital of Pennsylvania, has declared bankruptcy, and a number of towns and municipalities in California are dropping like flies. This is happening everywhere, and it’s a real concern. The only real solution for investors (especially retirees and pre-retirees) is to do your homework on the municipalities that you have (at least indirectly) invested in: be cautious and strategic with respect to municipal bonds.