Stay Away From Muni Bonds
I’ve been warning for months that a few state and municipal bankruptcies (actually, a few states and a great many city bankruptcies) will be required to slay the beast of government-union pension liabilities. The total size of the muni bond market is about $2.4 trillion. Unfunded pension liabilities (calculated with a realistic discount rate) are almost as high, according to one study. Now comes James Pethokoukis of Reuters to tell us of a “secret GOP plan” to bankrupt local governments and crush the government unions.
Congressional Republicans appear to be quietly but methodically executing a plan that would a) avoid a federal bailout of spendthrift states and b) cripple public employee unions by pushing cash-strapped states such as California and Illinois to declare bankruptcy. This may be the biggest political battle in Washington, my Capitol Hill sources tell me, of 2011.
That’s why the most intriguing aspect of President Barack Obama’s tax deal with Republicans is what the compromise fails to include — a provision to continue the Build America Bonds program. BABs now account for more than 20 percent of new debt sold by states and local governments thanks to a federal rebate equal to 35 percent of interest costs on the bonds. The subsidy program ends on Dec. 31. And my Reuters colleagues report that a GOP congressional aide said Republicans “have a very firm line on BABS — we are not going to allow them to be included.”
In short, the lack of a BAB program would make it harder for states to borrow to cover a $140 billion budgetary shortfall next year, as estimated by the Center for Budget and Policy Priorities. The long-term numbers are even scarier. Estimates of states’ unfunded liabilities to pay for retiree benefits range from $750 billion to more than $3 trillion.
I’m not going to trade in Capitol Hill rumors, but whether there is a secret plan or not, the US federal government is in the same position that Germany is with respect to Greece — the creditors (in this case public employee pensions) have to take a massive haircut for the numbers to add up. The delayed effect of the real estate collapse (which is still getting worse) is going to hit local revenues next year due to massive downward adjustment in tax assessments. This is the killer.
It’s cities, not states, that live off real estate taxes. Local government was riding the real estate boom along with everyone else but it takes a couple of years for the price collapse to work its way through tax assessments. What’s going to happen is two, three, many Harrisburg bankruptcies. The cities will collapse and the states will push them over the edge (like NY State with NYC in 1974). They’ll make a horrible example of a couple of states — California and Illinois — others will hold the line as the cities go down like ninepins.
There are nearly 11 million local government employees (not counting 3.56 million part-time), or a full-time equivalent of 12.2 million. Full-time equivalent for states is only 4.4 million. So most of the savings (and union-busting) has to come from local governments in the first place.
There’s a limit to how far they can take this: banks and insurance companies together have about $700 billion of munis. You can wipe out mom and pop (did so already with the auction securities market) but a 40% haircut would take out about $300 billion of financial institutions’ capital — not pretty. And that’s not to mention the spillover effect on other markets. That’s yet another reason not to own the banks’ common equity.
| Individuals | Mutual Funds1 | Banking Institutions | Insurance Companies | Other | Total | |
| 2010 | ||||||
| Q1 | 1,034.3 | 959.1 | 269.2 | 444.4 | 137.6 | 2,844.6 |
| Q2 | 1,033.3 | 955.2 | 255.5 | 444.1 | 145.0 | 2,833.1 |
| 36.5% | 33.7% | 9.0% | 15.7% | 5.1% |
My best guess is that two states go down — Illinois and California — and lots of Democratic city machines. In lots of states, Republican governors and state legislatures will actually win support by running against the machines.
If you have to own munis, own the better-quality states – in fact, own bonds that have first claim on revenues rather than general obligation debt. The municipal bond funds are loaded with School District of West Squashbug and the general obligation bonds of Death Gulch. Even if you own bullet-proof munis (and I own some myself) be prepared to take a big mark to market hit as the crisis plays out.
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Comments (21)
Yeah, some entities can't declare bankruptcy. So? If they can't pay their obligations, they can't. So the difference is what? Oh, the lack of the bankruptcy system to apportion what's left fairly. How again is that a good thing?At the very best, they will threaten, then do, laying off of all the parts of local government that actually provide any services to us -- cops, firemen, teachers, while keeping their nice buildings and bureaucrats and perks fully intact. I've seen this movie before.Could be sloth rather than unions (though I have zero sympathy with unions myself). If the place you're going to work needs one -- don't work there, dummy. The having of two bosses, one of which you have to pay, in an adversarial environment just isn't worth it to anyone with any sense of having a good life. If it's the only job you could land -- get your skills up so you can get a good job instead.Ever wonder why the fed unions didn't kick up a big fuss when Obama "froze" their pay at historically high levels, when cuts are truly in order? Jobs AND pay, cuts. At no time in previous history have government jobs that amount to advanced secretarial work paid so often in the 6 figures and up -- we are at an all time high (and you can take that backwards adjusting for inflation). Not to mention job security -- the Civil Service is utterly out of control and in far too much control over us (TSA comes to mind on that, but it's a tiny example considering the total bucks involved, just a funnel of money to contractors who make nudie scanners and so on).I found here that our government puts up a big fight when you try to get your taxes lowered to some assessment that has something to do with current land values -- based on actual sales, because guess what -- there aren't many to go by....and is talking about the alternative of raising rates. Like the banks, they're going to find out that winding up owning a bunch of unoccupied homes doesn't do much good for them when people can't/won't pay. Their sense of entitlement is undented at the moment, disgusting.Good luck on your munis, you're going to be needing it. Or your increased local taxation is going to eat any money they do make you, not much of a choice.How again can I go short these guys? TBT and TMV on the fed side are doing nice for me just now....for example.
With this bunch in office, expect the worst.
2-Young gun Repubs, Paul Ryan, tells Jerry, tough luck, but??
3-Ryan might say, fix pensions, cut salary's and head count, and freeze spending for a decade, and pay back your fed loans, then maybe DC will send a few $$.
4-my opinion, having lived in CA for 60 years, this would be a great moment for CA. Even with Jerry (moonbeam) Brown at the helm.
5-i'm not sure where the Muni's get a hair cut in this picture?
