Home > Economy, Politics, Trends, Uncategorized > Muni Bond Sell-off Fuels Insolvency Controversy

Muni Bond Sell-off Fuels Insolvency Controversy

January 16, 2011

Will upwards to 100 U.S. cities default on their municipal debt and declare bankruptcy? I reported last month that there are trillions of dollars of outstanding municipal debt and many cities and states are on the verge of causing an across the board default scenario. The ripple affect would severely damage the bond market and drive up the cost of borrowing further hamstringing business and delaying the economic recovery. It is a scary scenario. American business could be on its knees for years – maybe a decade.

BAB, Buy American Bonds, has ended. The stimulus has ended. Where will the money come from? That would be tax revenue, and without a significant uptick in job creation tax revenues will remain anemic and the debt will remain unserviceable — this sets the stage for default. Could there be another trillion dollar Federal government bailout? Highly unlikely and this means lots of pain. The other problem is a political one as many of the worst problem states are ‘Blue’ states…. CA, FL, NY, IL; if the Democratic base is economically decimated further, it spells big problems for 2012. This is not a wait and see situation. The whole thing is playing out right now.

January 14, 2011 Reuters reports: Richmond Federal Reserve President Jeffrey Lacker spoke to those worries on Friday, saying the potential for insolvency among some municipalities was worrisome and that the $2.8 trillion muni market’s problems could have broad implications.

“I think there’s some potential for broader distress there,” he said in response to a question at an event. Lacker did not elaborate.

For the third time in as many months, munis are caught up in a sell-off that has sharply increased tax-free interest rates and lifted borrowing costs for local governments considering issuing new bonds.

“The psychology has certainly turned negative to say the least,” said Brian Musielak, senior portfolio manager on the Commerce Bank National Tax-Free Intermediate Fund.

The Muni-Bond Controversy
Analyst, Meredith Whitney presented a doomsday scenario starting in May 2010 and projected over the following 12 months. Doomsday appears to have arrived. Before I agree or disagree with her predictions let me lay out what she has said and provide some context.

May 17, 2010 the Wall Street Journal Ms. Whitney writes:…”over the next 12 months, disappearing state and local government jobs will prove to be a meaningful headwind to an already fragile economic recovery. This is simply how the math shakes out. Collectively, over 40 states face hundreds of billions of dollars in budget gaps over the next two years, and 49 states are constitutionally required to balance their accounts annually. States will raise taxes, but higher taxes alone will not be enough to make up for the vast shortfall in state budgets. Accordingly, 42 states and the District of Columbia have already articulated plans to cut government jobs. ”

What is happening today? States are raising taxes and laying off workers. California may be laying off as many as one million state workers. Governors of California and Illinois, the two states with the most severe debt problems, have stated taxes alone will not solve their fiscal problems. Thus, state programs are being slashed to avoid massive municipal bond defaults.

Whitney is the same article states: “So the burden on the private sector to create jobs becomes that much more crucial. Just to maintain a steady level of unemployment, the private sector will have to create one million to two million jobs to offset government job losses.”

That is actually a low estimate, as the Federal Reserve stated last month, 5-6 million jobs are needed to return the nation to pre-crash levels. Labor stats last week stated a little more than one million jobs were created in 2010. The Fed also has stated – and we posted on this blog – we will not achieve that level of employment until 2020. Additionally, we have 26 million unemployed or underemployed (part-time or temporary work). Let’s say we create 6 million new jobs over the next few years, that leaves 20 million unemployed or underemployed. So, indeed, small business will need a great deal of help, but also the creation of new businesses is critical.

Whitney is right on track saying those millions of new jobs will need to come from the small business sector: “Unless real focus is afforded to re-engaging small businesses in this country, we will have a tragic and dangerous unemployment level for an extended period of time. Small businesses fund themselves exactly the way consumers do, with credit cards and home equity lines. Over the past two years, more than $1.5 trillion in credit-card lines have been cut, and those cuts are increasing by the day. Due to dramatic declines in home values, home-equity lines as a funding option are effectively off the table.”

Bottom line, small businesses needs credit to hire and expand. Ms. Whitney assesses correctly this critical need…. “Right now we need banks, and particularly community banks, more than ever to step in and provide liquidity to small businesses. Interest-rate caps and interchange fees will more likely drive consumer credit out of the market and many community banks out of business. ”

As Ms Whitney points out in this MSNBC interview, it is Muni brokers who are contesting her analysis as they stand to lose.

Here is Meredith Whitney on CNBC January 13th the day after Illinois passed a major tax bill to increase personal state income tax by 67%.
http://www.msnbc.msn.com/id/21134540/vp/41037735#41037735

December 27, 2011, Michigan News story in the NY Times:
Yet with anemic property tax revenues and forecasts of more dire financial times ahead, some experts and elected leaders fear that more localities may have to at least consider bankruptcy.

“There could be many cities in this position next year,” said Summer Hallwood Minnick, director of state affairs for the Michigan Municipal League, who added that in this state, cities had already struggled with billions less than expected in state revenue sharing. “All our communities have done is cut, cut, cut. They’re down to four-day workweeks and the elimination of parks, senior centers, all of that. So if there’s anything else that happens, they will be over the edge.”

Within this recent article the Mayor of Hamtramck says….. “We can make it until March 1 — maybe,” Mr. Cooper said of Hamtramck’s ability to pay its bills. Beyond that? The political leaders of this old working-class city almost surrounded by Detroit are pleading with the state to let them declare bankruptcy, a desperate move the state is not even willing to admit as an option under the current circumstances.

“The state is concerned that if they say yes to one, if that door is opened, they’ll have 30 more cities right behind us,” Mr. Cooper said, as flurries fell outside his City Hall window. “But anything else is just a stop gap. We’re going to continue to pursue bankruptcy until the door is shut, locked, barricaded, bolted.”

That’s 30 cities alone in one state. You do the math. It seems not so far fetched to think 50-100 cities could declare bankruptcy.

Advertisements
%d bloggers like this: