A lot has already been written about the risk to municipal bond holders in the U.S., as a growing number of states face severe fiscal problems. But local government debt is an even bigger threat in Europe – where it could force governments to assume the debt, putting further pressure on sovereign bond spreads.
Because Europe has no bankruptcy regime for municipalities, EU countries would likely have no choice but to issue more central government debt and bail out any local governments facing shortfalls, according to Morgan Stanley economist Daniele Antonucci. Governments could use EU structural funds to further fudge the lines between funding deficits and financing specific projects, but the sums we are talking about are too big.
Interestingly, Germany and Spain have the biggest levels of local debt – and would in an open and honest world adjust their national debt burdens upwards accordingly. Meanwhile Greece has no local government debt; while, Ireland, Italy, and Portugal have lower levels of municipal debt than the rest of Europe.
Spanish debt could be riskier, therefore, than investors are currently assuming. Unfortunately, investors wanting to gauge these risks, would be better pulling out of European municipal debt altogether.
Timely data on non-central European government finances doesn’t exist. “Even when this information is available – after a considerable time lag – some of the accounting practices don’t seem fully compatible with the national accounts,” says Antonucci.