Not everyone is as worried as I am about the fiscal condition of America’s states and municipalities and the impending wave of defaults on government debt. A case in point: In “Default Position: Why we needn’t worry too much about municipal bankruptcy,” Annie Lowrey with Slate argues that the problem is genuine, but not as bad as it appears.
If this is the best case, the “What, me worry?” side of the debate can muster, it’s probably time to sell all your municipal bonds. Right now. Lowrey is not very persuasive — indeed, she’s so unconvincing that it’s scary.
There is roughly $2.8 trillion in outstanding U.S. municipal debt, Lowrey notes. That sounds like a lot but never fear: The default rate is about 1/3 of one percent, far lower than the rate for corporate bonds. Citing Moody’s data, she says that municipalities have defaulted on Moody’s-rated debt only 54 times between 1970 and 2009, and all but three were incurred by riskier “non-General Obligation” bonds to entities such as hospitals, housing projects or various other entities with a quasi-public purpose — not municipalities themselves.
Recent trends have shown improvement. She writes:
“The National League of Cities notes that there have been at least 72 defaults this year, down from 204 in 2009 and 162 in 2008. Considering the thousands of bonds issued in the last decade by the 50 states,19,000 cities, 4,000 counties, 15,000 school districts, and tens of thousands of individual projects — that’s not too bad.”
Lowrey acknowledges that Harrisburg, Pa., has become a poster child for fiscal irresponsibility. The city of 50,000 borrowed $125 million for improvements to an incinerator, tens of millions of dollars for a Civil War museum, millions more for parking garages and baseball stadium — and even $125,000 to purchase a gun once owned by Doc Holliday for a Wild West museum that never materialized. But Harrisburg, she assures us, is a “mismanaged outlier.”
She reassuringly quotes a report from Standard and Poor’s:
“We believe the crises that many state and local administrators find themselves in are policy crises rather than questions of governments’ continued ability to exist and function. They’re more about tough decisions than potential defaults. This is because, for the states in particular, debt service generally holds a priority status relative to other obligations.”
The problem isn’t so bad, in other words, because the only thing standing between local governments and fiscal rectitude is the political will to make hard choices. And even if local politicians can’t muster the will to balance their budgets, she argues, states will stand behind their municipalities as Pennsylvania has for Harrisburg.
Lowrey is honest enough to recognize, however, that state/local budgets are a shambles, and that if vulnerable states like California, Illinois or New Jersey falter, public employee unions may not prove cooperative in getting them off the hook. But that’s OK. The federal government could stand behind the states. Lowrey quotes Warren Buffett as saying, “It would be hard in the end for the federal government to turn away a state having extreme financial difficulty when they’ve gone to General Motors (GM) and other entities and saved them.”
Bottom line: Don’t worry, the states will stand behind the municipalities and the feds will stand behind the states. Talk about the ultimate, bottomless moral hazard — Uncle Sam will act as the final backstop for $2.8 trillion (and climbing) in state and local debt. Wow. And what happens if a Republican-dominated Congress refuses to bail out California, Illinois and other financially reckless blue states for fear of massive retribution at the hands of their red-state constituents? Lowrey concedes that conservatives like George Will are already warning against bail-outs of “beggar states.”
As her column drags to a conclusion, she sounds none too comfortable about the argument she has just advanced:
“Pension liabilities, in particular, loom large. And even if a total muni crisis is not around the corner, fiscal problems, in all their horrible variety, will be with the United States for a long time.”
Lowrey is not a foolish woman — she sees the warning signs. I wouldn’t be surprised if some editor at Slate assigned her the story with a preconceived things-really-aren’t-so-bad narrative and this is the best she could muster. If this is the bullish case for municipal bonds, I need say no more. I rest my case: Defaults by municipalities and states will pave the road to the ultimate U.S. default.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.