Bloomberg is reporting Subprime Finds New Victim as Muni Defaults Triple.

The amount of municipal bonds that have defaulted this year is already more than triple what it was for all of 2007.

And who could doubt there’s more bad news on the way?

So far this year, $736 million in municipal bonds have defaulted. That doesn’t necessarily mean they didn’t pay investors; they may have just drawn down reserves. That’s what happens just before they stop making payments to bondholders.

My Comment: This is peanuts, at least so far. However, Ambac (ABK) and MBIA (MBI), both of which are the equivalent of the walking dead, are staring at more nails in their coffins should municipal bond debt head south in a big way.

During all of 2007, only $226 million in municipal bonds defaulted, according to the May edition of the “Distressed Debt Securities” newsletter, published in Miami Lakes, Florida.

That $736 million is nowhere near the record for municipal bond defaults, to be sure. The record year, if you’re counting, was 1991, when almost $5 billion went bust. That’s still small potatoes compared with what happens over in the corporate-bond market, where $36.6 billion blew up in 2006, and almost $24 billion in 2007.

But wait a minute: Municipal bonds never default, do they? Or at least this is how they are perceived by individual investors, right?

We’re probably going to see a lot more munis default this year and in the years to come, because of the subprime crisis and maybe, just maybe, because of the high price of a barrel of oil.

My Comment: There is no maybe about this. Jefferson County Alabama alone might account for $3.2 billion in defaulted bonds. See Fraud, Antitrust Investigation Involving JPMorgan, Jefferson County.

In addition there are at least two counties in Florida that are likely to go bankrupt according to Mike Morgan at Morgan Florida. I will mention one of them: St. Lucie County. This topic came up in my last phone conversation with Morgan about a week or so ago.

The hangover from the collapse in real-estate prices is going to be a boom in so-called dirt-bond defaults.

These are bonds sold by municipalities to build the infrastructure for housing developments, and are backed by the taxes paid by all the new residents who are going to move in. If no residents move in, or too few do, the bonds aren’t repaid.

Of the 30 bond issues that have defaulted so far this year, more than half are from issuers in two of the states that have figured prominently in all tales of the housing bust: 10 in Florida and seven in California.

The big jump we are going to see in the number of such municipal bond defaults this year won’t be limited to Florida and California, but will include all those places where the high tide of real-estate mania has now receded.

Vallejo California

Municipal bonds were not the issue in Vallejo, but if cities, counties, or municipalities start heading south, there is bound to be significant potential exposure to bond failures as a result. With that in mind, please consider Hardball In Vallejo, No Balls In D.C.

Failures like we saw in Vallejo are going to spread. In turn, municipal bonds and the ratings of those bonds are also about to change in a major way. There is no way Ambac (ABK) or MBIA (MBI) van survive such an onslaught.

Mike “Mish” Shedlock
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