Beginning in 2013, the federal Bureau of Economic Analysis will measure all pension obligations using fair market valuation techniques, so GASB accounting will no longer align with official U.S. economic statistics. A change from GASB to fair market valuation would cause all U.S. public pension plans to fall from an average funded ratio of 75 percent to 41 percent, according to a recent report by Andrew W. Biggs. The most underfunded large state pension plan, belonging to the Illinois State Employees ystem, would falRetirement Sl from 36 percent funded under GASB to 18 percent under market value, Biggs estimates. You can read his full report here.

Note: In December, after the Biggs research was published, Kentucky announced that it had passed Illinois in the race to the bottom, with a GASB funded ratio of just 24.5 percent for its largest plan.

#7: Puerto Rico

In December, Moody's downgraded Puerto Rico's GO debt to Baa3 (the lowest investment-grade step) with negative outlook. S&P and Fitch currently rate Puerto Rico's GO debt BBB and BBB+, respectively. The Commonwealth's unemployment rate is 13.8 percent, and the current-year budget deficit is $1.6 billion. Real GDP growth has been negative for five straight years, and manufacturing jobs have fallen by 50 percent since the mid-1990s. The New York Times recently reported that Puerto Rico's public pension fund is only 6 percent funded and could run out of money as soon as 2014.

Despite its relatively small size (population 3.7 million), Puerto Rico is a big player in the muni market, due to triple tax-exempt interest everywhere in the U.S.  It has about $100 billion of total municipal debt outstanding, including $52 billion of tax-supported GO debt.

You can read an in-depth report on Puerto Rico's Challenge by Breckinridge Capital Advisors.

#8: Relocation and Population

High tax burdens are causing companies and jobs to relocate, which forces job seekers to move elsewhere in search of employment. The resulting population loss makes it harder for high-tax jurisdictions to escape economic holes. 

Among states with high per-capita debt burdens, unemployment rates are above the national average in Rhode Island (10.4 percent), California (9.8 percent), New Jersey (9.6 percent), Michigan (8.9 percent) and Illinois (8.7 percent).

In its latest population estimates, released in December, the Census Bureau estimated that U.S. population growth slowed to 1.7 percent over the two-year period 2010-2012. Rhode Island was the only state with a negative rate of growth, -0.2 percent. Michigan's and Vermont's populations were flat and populations of Maine, Ohio, and West Virginia increased just 0.1 percent. Puerto Rico again is in a class by itself, suffering a population loss of 1.6 percent over the two years.

www.census.gov/popest/data/state/totals/2012/tables/NST-EST2012-02.xls

#9: Rethinking Historic Defaults

The municipal market was mildly rattled in August when three Federal Reserve researchers released a report on historic default rates. Previously, S&P and Moody's had reported just 71 and 47 municipal defaults among rated bonds, respectively, from 1970 to 2011. The Fed's researchers looked at a broader swatch of the market, including thousands of unrated bonds, over a longer period – 1958-2011.

They uncovered a total of 2,521 defaults, the vast majority of which involved unrated revenue bonds. They concluded: "Until recently, investors could take some comfort from the fact that many municipal bonds—both rated and unrated—carried insurance that paid investors in the event of a default. But now that bond insurers have lost their AAA ratings, they no longer play a significant role in the municipal bond market, increasing the risks associated with certain classes and certain issuers of municipal debt."

The Fed researchers' initial summary findings are located here.

#10: Federal Financial Support

Municipal bond prices had a rough month in December as fears grew that the U.S. Government might topple over the fiscal cliff. According to one estimate, the federal budget cuts required under "sequestration" would have cost California half a billion dollars in federal funds and 200,000 jobs. 

The fiscal cliff controversy underscored how dependent state and local governments have become on federal spending, and how painful federal budget cuts could be at the state and local level.  School districts, transportation authorities, and health care facilities – all of which are active muni market participants – would be vulnerable to federal funding cuts.