The news for unsecured creditors of Vallejo, California's municipal bonds is in, and it is not good. They will only receive 5 to 20 cents on the dollar under a reorganization plan the city filed Tuesday in federal court.
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The city regrets that it cannot pay a higher percentage,” Vallejo officials said in the court filings. “The city lacks the revenues to do so while maintaining an adequate level of municipal services, such as the provision of fire and police protection and the repairing of the city’s streets.
It has been a long time since investors were overly concerned with losing their principal on municipal bonds. The last time there were a substantial number of municipal defaults was during the Great Depression. By 1935, 15.4% of municipal debt was in default. During our most recent downturn we have not seen those levels of default, but there are serious potential cash flow problems for states and cities alike. Vallejo is certainly going to be one of the worst cases, but investors should be prepared for a very tumultuous 2011. Muni yields in general are not yet nearly high enough to compensate for the risk.
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