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After Detroit: Which muni bonds are riskiest?

How will Detroit pay back its debt?

The heretofore unsexy municipal bond has gotten a lot of attention since Detroit filed for bankruptcy.

Municipal bonds, or munis, are the workhorses of government financing at the local level. When your county or city government needs money for a new hospital, a rebuilt school or some other public project, they often issue bonds to pay for the expensive project.

Though not without risk, municipal bonds have long been considered pretty safe investments, for the simple reason that they are backed by taxpayers and tax dollars.

Detroit, and why munis are getting riskier

But then, look at Detroit. As people and businesses left the Motor City, the reliability of the tax base there shrunk dramatically, and now investors aren’t sure they’ll be paid back. Even before the city's bankruptcy filing, Fitch Ratings had been downgrading Detroit’s bond ratings, citing imminent default.

In June, Fitch assigned a ‘C’ rating to more than $600 million worth of Detroit’s general obligation bonds. A ‘C’ indicates “exceptionally high levels of credit risk,” where “default is imminent or inevitable.”

Sounds pretty bad, right? Well, just a few days after that, Fitch downgraded about $1.5 billion worth of Detroit pension debt to a ‘D’.

Munis: The new junk bonds?

Though Detroit is in particularly bad shape, The Washington Post reports federal regulators are increasingly scrutinizing municipalities’ disclosures about the health of their bonds.

In that spirit, we asked two ratings firms, Fitch Ratings and Standard and Poor’s, to send us some of their lowest rated municipal bonds. The bonds stretch from California to Rhode Island, from cities devastated by the housing bubble to financially-stable cities that made poor investment decisions.

These assets can't be measured on a purely quantitative scale: Each rating has a story.

For example, Central Falls, Jefferson County, Vallejo, and Stockton all declared bankruptcy too. Their grades are now ‘BB’ to ‘C’, according to Standard and Poor’s.

Littlefield, Texas: The looming bills

But the stories behind bond ratings can get much more micro than that. Take Littlefield, Texas, population 6,500.

Littlefield is a rural city, and the county seat of Lamb County. It decided to build a detention center. So in 1999, it sold about $11 million in CO's, certificates of obligation, to fund it.

The Bill Clayton Detention Center sprung up in a cotton field south of town and was operated by a for-profit company. For almost a decade it provided jobs and enough revenue to pay the debt service, according to Fitch. But then, other states started pulling out their prisoners, because of their own budget problems.

The for-profit operator left, the prison closed, and Littlefield was left with millions of dollars of debt to repay. Years later, the still vacant, city-owned detention center is a primary reason Fitch has rated Littlefield’s bonds at ‘BB+’, below investment grade.

Like Littlefield, and like Detroit, all these cities and municipalities have reasons and stories behind their debt. For residents, this means something -- possibly everything. But investors, who are worried about getting paid back, are probably more concerned about the bottom line.

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