The Muni Mess

by: Karl Denninger

Janet Tavakoli has chimed in on the muni mess....

In previous posts, I've mentioned serious fiscal problems that need to be addressed at state and local levels. This varies by region and some issues are potentially solvable.

I live in Illinois, which is ground zero for fraud, corruption, underfunded pension funds and general fiscal mismanagement. It's an example of one of the worst fiscal messes in the United States. This year Illinois hiked personal income taxes from 3% to 5%, and increased corporate taxes. We'll be slammed with hidden tax increases in utilities, purchases, and more. When now Mayor Rahm Emanuel left his post as White House Chief of Staff to run his election, the Chicago mayoral race centered partly around steps, including budget cuts, needed to solve Chicago's serious fiscal issues: See "Third World America: Drowning in Debt and Choking on Lies," Huffington Post, June 24, 2011, and 'Fast-Tracking to Anarchy;" August 25, 2010.

On December 19, 2010, I was (at first) happy to see 60 Minutes highlight fiscal problems of states and municipalities. It explained how Illinois was late on payments to service suppliers, and it's a huge problem for people doing business with the state. The state's pension fund is underfunded and although 60 Minutes didn't mention it, state pension funds are the prey of Wall Street cronies that stuff them with losses and then propose fee-loaded leveraged financial products that are bets to make up the shortfall. Then 60 Minutes went completely off the rails by suggesting that these problems would lead to widespread defaults on municipal bonds in 2011. You can still view the segment, "State Budgets: Day of Reckoning," on the CBS web site.

She goes on to talk about Merideth and her (now disproven) call that there were going to be disastrous defaults (on an imminent basis) in this market.

The problem isn't that Merideth's look at the financial implications is wrong. That look wasn't wrong -- but the timing was, in a bad way.

At its root the biggest problem with public pensions is that there's no way to keep the promises made. There's been plenty of looting of various forms too, but an 8% return (which many if not most have modeled) is beyond ridiculous. We "got away" with it from the 1980s by doing this:

(Yes, I know, that damn chart keeps showing up!) There's no way that can continue on a forward basis, and this had to be known to the so-called "actuaries" at the time.

Nonetheless we continued down this road, and embedded in the problem is the 9% (actual) annual growth in medical expenses -- on all sides (public and private) that has gone on since 1980 as well, and which gets really bad when one starts allowing public employees to "retire" at 50, as many municipal systems do for police and fire.

So now what?

Well, let's look at what Janet has to say:

Bloomberg is also the financial news service that has done great early work on fraud and related municipal bond defaults, because that's a worthy story. Municipal credit issues are granular and the severity of the problem -- or non-problem -- depends on the specific situation.

Yep; that's been my point as well. The problem with "granularity" is that few people bother to look at the actual granularity of what they're talking about! The little Jefferson County fiasco is just one example -- not only is there an issue of outright fraud (bribrery certainly falls into that category in the general and specific sense) but in addition Alabama has a secondary issue of "warrants" .vs. "bonds", and along with it whether the so-called "full faith and credit" issued by a subunit of state governments can actually raise taxes if necessary to make good on the promise.

As is often the case promises are made and accepted by people without actually looking at whether they can be kept. That is a problem.

At the end of the day there are serious issues with municipal finance, but that's not the same thing as saying that they're all going to blow up tomorrow. As we've seen repeatedly the looting and games will go on for much longer than anyone expects, and whether the market should discount something (and mark it way down) doesn't bear on whether it will.

Illinois in particular has one of the most-intractable issues in this regard and it's not new. Paying late (sometimes VERY late

when it comes to suppliers isn't new either -- I fought with that crap when we had the library contract at MCSNet, with the City of Chicago trying to play "let's see how many days we can delay" more times than I can count. More than once I shut off service in order to drive home the point that since the City would never let me "extend and pretend" on my parking tickets, I was sure as hell was not going to do so when the shoe was on the other foot. This (I'm sure) was eventually part of why they walked, but in the end there's never a purpose in providing service to someone who isn't going to pay you in a reasonable amount of time -- no matter who it is.

It would have been nice if Whitney's call had led to the wholesale recognition of the problems in these issues (and obligations) and some sort of resolution. It didn't. Instead people stuck their heads in the sand after the initial sell-off, people bought into the decline, and then when values recovered everyone pointed and screeched. Ok, fair enough -- when you predict an event and a time you have to get two things right instead of one, so on a simple arithmetic basis your odds are one in four, not 50/50, and by any measurement you wish to use this was a big, big "miss."

So be it.

Now when are we going to start discussing and resolving the actual issues on the table related to municipal obligations? That's the question -- will it be before or after these funds default? The problem with "after" is that due to the nature of these funds if you wait until that point the problem will be impossible to solve without haircutting retiree benefits for already-retired people by enormous amounts -- like by 75% or something similar. We would do much better to deal with it now the increase employee contributions, reduce benefits and increase retirement ages for eligibility to where the pain, while still immense, will be manageable.

But you know we won't do that, right? Especially when it comes to places like Chicago.

Do you live in Illinois? If so, after all the warnings and articles I've written on the cesspool of corruption there, I have only one question remaining: Why?