I recently wrote a piece on Illinois’s debt spiral (located here). In it I discussed the state’s out-of-control pension system, incompetent political leadership, and how to avoid owning the state’s debt.
The State of New Jersey is in a remarkably similar situation. It finds itself completely broke despite proximity to the economic engine of New York City and an extremely high rate of taxation.
The State is rated A3 and has been downgraded 11 times since Governor Chris Christie took office. Future downgrades are virtually guaranteed as the state refuses to reform. (Sound familiar?)
As I write this, the state is entering a shutdown due to its inability to govern itself and pass a budget.
In this piece, I will review the current status of NJ, what to look for in your investments, and some personal predictions regarding the Garden State.
Debt, Pensions, and Out-Migration
The Mercatus Center at George Mason University does a great job of ranking the fiscal condition of US states.
They provide the following snapshot of New Jersey:
NJ is ranked #48 among all US states and Puerto Rico.
Debt is high, unfunded pension liabilities are high, and debt-to-state personal income is above the national average.
We can zero in on the pension problem by using data from Bloomberg. According to their calculations, NJ is actually the worst state in the country.
This has resulted in an extremely high rate of taxation (discussed in the next section) and a high rate of domestic out-migration. The only thing keeping the state’s population steady are births and international migration.
A recent report shows Millennials are leaving NJ in record numbers:
(Source: NJBIA) (PDF File)
High profile corporations are joining citizens and leaving the state as well. Mercedes-Benz made headlines when they announced they were moving their headquarters from Montvale, NJ to Atlanta, GA.
Extremely High Taxation
Perhaps the problem in NJ is low taxes! Maybe it doesn’t bring in enough revenue to pay for its expenditures?
You’d be wrong if you believed that. According to the Tax Foundation, NJ’s State-Local Tax Burden is #3 in the nation.
(Source: Tax Foundation)
New Jersey’s property taxes are what drives their total ranking so high. They have the highest property tax burden in the nation. As of 2016, NJ’s average annual property tax bill is $8,549.
(Source: Tax Foundation)
To recap: NJ has some of the highest taxes in the nation (including the highest property taxes) and is still totally broke.
Sure, the situation is serious. But the state’s politicians are on the case. They must have serious, practical solutions to the problems at hand.
The state’s response to this fiasco is to use lottery money (not making this up) to fund public worker pension funds.
Christie is not blameless in this, but he is dealing with a Democratic legislature that is guaranteed to keep their seats regardless of how bad the problems get. They’ve shown zero interest in real reform.
Seeking Alpha is not a political forum, but it’s important investors understand the structure of a state when investing in muni bonds. Politicians in these states will favor local constituencies over muni holders.
Not compensated for the risk
The next logical question to ask is: Are investors compensated for the risk of holding New Jersey municipal bonds?
Some may look at spread over US Treasuries or yield of benchmark GOs to determine this. I decided to look at what a “typical” investor might receive when investing in NJ munis.
To do this I pulled up the income characteristics of the Fidelity New Jersey Municipal Income Fund (FNJHX) and here is what I found:
A 2.38% yield and a 4.46% tax equivalent yield are not adequate compensation for a state using the proceeds of scratch-off lotto tickets to fund pensions.
Know what you own
Closed End Funds are a popular alternative for muni investors.
I looked at the Top 10 National CEFs by size and calculated the exposure each one has to New Jersey:
Many of these funds have a double-digit percentage allocation to “problem states” when you add in Illinois. (We haven’t even gotten to Connecticut yet!)
The problems of NJ are serious for both investors and residents. Investors are giving their money to a state that is in terrible financial condition while residents are being fleeced by high taxation.
My predictions for NJ are similar to those of Illinois due to the low chance of turnover in the legislature:
1) The state will make no effort whatsoever to reform itself. Instead, it will increase its already high taxes.
2) This will lead to population loss and companies fleeing.
3) The state will then raise taxes even more in an attempt to make up the difference.
4) The financial condition of the state will worsen.
5) Either Congress allows states to declare bankruptcy and/or the Federal government starts taking direct control over these states
Of course, in a QE world, none of the risks I’ve stated are reflected in NJ’s bond yields. The fact that NJ, IL, CT, and the others are able to borrow at such low rates is a failure of our bond markets.
It’s up to you to make smart decisions when investing in this sector.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.