It’s worth remembering here that most municipal bondholders are individuals, rather than sophisticated institutional investors. If your aunt Sally put her savings into state bonds, she is not going to be happy if she can’t get her money back, and she is certainly not going to be mollified by talk of lower deficits in future. The deficits are what allowed her to buy the bonds in the first place; she doesn’t particularly want them to go away. But there’s no way she’ll stand for a haircut. And, of course, she votes.
The fact is that states are not going to declare bankruptcy, and they’re not even going to be allowed to declare bankruptcy. So the worst thing that can happen, for the municipal bond market, is that people continue to talk about municipal bankruptcy for the next couple of years. Let’s take the option off the table, once and for all, rather than taking it seriously and thereby only making it harder for states to borrow the money they need.