Municipal bonds are debt securities issued by state and local governments to finance a wide range of public projects, cover government operational needs and support private-sector projects through conduit financing that lowers private developers’ borrowing costs. Most of these issues are tax-exempt. The municipal bond market is smaller than the corporate bond market, but it is of vital importance for the state and local government entities that issue these securities.
As of the end of 2011, the latest year for which comprehensive data is available, the principal value of the roughly 1 million outstanding municipal bond issues totaled $3.7 trillion, according to the U.S. Securities and Exchange Commission. By comparison, there were about 50,000 corporate bond issues outstanding with a total principal value of $11.5 trillion. In 2011, there were 13,463 new municipal issues totaling $355 billion in principal value, according to the SEC. That was down significantly from 2010’s 16,848 issues with $499 billion in principal value. The municipal bond market has seen big growth over the years. In 1975, for instance, the total principal value of all outstanding municipal bond issues was just $235.4 billion.
Sellers and Buyers
The municipal bond market is very diverse, with bonds issued by 44,000 state and local government agencies and entities, according to the SEC. Issuers include states, counties, cities, towns, townships, villages and special-purpose entities such as economic development commissions, school districts and sewage authorities. About 50 percent of outstanding municipal bonds are held directly by individual investors, with another 25 percent held by individuals indirectly through mutual funds or money market funds. Individuals’ direct and indirect holdings totaled $1.9 trillion in principal or 52 percent of the total principal outstanding. The vast majority of municipal bond issues are exempt from federal tax and from state taxes for buyers living in the state where the bonds were issued. Some 91 percent of the municipal bonds issued in 2011 were tax-exempt securities.
Municipal bonds are marketable securities, meaning they can be bought and sold on the secondary market, although most municipal bond owners hold their bonds until maturity. In 2011, $3.3 trillion in municipal bonds were traded in 10.4 million transactions in the decentralized, dealer-intermediated, over-the-counter marketplace where municipal bonds are traded. Average daily trading volume in municipal bonds was $11.3 billion, compared to $20.6 billion average daily trading volume for corporate bonds. There is no central exchange for trading municipal bonds. As of 2011, the SEC reported that there were 1,800 municipal bond dealers making trades, but the 10 largest dealers represented about 75 percent of the bond value traded that year. Municipal bond dealers are regulated by the SEC, Financial Industry Regulatory Authority, Municipal Securities Rulemaking Board and state securities regulators.
Municipal bonds are relatively secure investments. Most issuers meet their principal and interest payment commitments. In 2011, there were $1.06 billion in defaults, compared to the $3.7 trillion in outstanding municipal bonds. Default occurs when the bond issuer ceases to make timely payments of principal and interest. Default rates can change with time and economic conditions. In 2009, for instance, there were $6.9 billion in municipal bond defaults.
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