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One way that various government entities below the Federal level have tried to plug budgetary holes has been through the privatization of assets. Arguably, the leader of such efforts has been the city of Chicago, which has privatized the Chicago Skyway (a short toll road leading to Indiana), some municipal garages and parking lots, as well as its parking meters. An attempt to do the same with Midway Airport a couple of years ago fell apart.

Of course, Chicago isn't the only one attempting to use this technique to plug budgetary holes. New York city financed the construction of parking lots and garages around the new Yankee stadium via bonds issued by New York's Industrial Development Agency. "Vulture funds", such as Monarch Alternative Capital, LP., and Davidson Kempner Capital Management, LLC have been buying these bonds at $0.635 on the dollar, as they approach default, due to declining revenues.

It certainly can be argued that privatization is at best a band-aid, and a fairly expensive one, at that. The states and cities resorting to the strategy are trading an income stream for a one-time lump sum payment. Basically, it's a well than can only be visited once.

Now, however, it would seem that the Federal government is looking to get a slice of the privatization pie....at least if Sen. Dick Durbin (D-Ill.) has his way. He's introduced legislation that would require states and municipalities that received Federal funds for the construction and/or maintenance of transportation projects to repay such funds, as a condition of leasing them to private entities.

A few months ago, noted analyst Meredith Whitney rang the alarm bell over the potential large scale defaults in muni debt. She took her fair share of flack over her call from a variety of corners. So far, there's been only a smattering of relatively low profile defaults, but with the fiscal year ending at the end of June, it seems likely that the cracks in the muni debt structure are exposed, due to things like pension funding obligations rising faster than the revenues needed to fund them....often, such revenues are actually declining.

I must say that there's more than a bit of logic behind Durbin's proposal (yes..I can't believe that I actually said that...), but the last thing that states and cities need, at this point in time, is further crimping of income streams, from any quarter.

Municipal bonds, and the funds comprised of such holdings have been faring fairly well, lately, but the bloom may quickly leave the rose. I'd say that investors who have allocated assets to individual bond issues are most at risk, since they lack the diversification of a fund, but even funds may not escape unscathed, since many are state specific.

Sources: Bloomberg.com
Huffpost Politics
CNBC NetNet

Disclosure: I am long GIM, TEI.

Source: Are Munis in Trouble as Government Privatizes Assets?