Stating the obvious.
For the record, I have not read Meredith Whitney's much-hyped report on how the states will present the next bailout-inducing credit crisis. I've only seen her interview on CNBC.
Meredith Whitney is obviously a very good bank analyst and has earned her popularity. But it is not difficult to tell that here she has wandered outside her bailiwick. Somehow she goes from complaints about disclosure in the muni market (which would be very valid complaints in another context) to predicting massive bailouts. It actually is not difficult to find information on state budgets. Most states produce volumes of information about their spending habits. The problem with disclosure in the muni market is with smaller issuers (who consider preparing financial statements an onerous activity), and this is complicated by the diverse types of borrowers in that market and the diverse types of revenues pledged. Muni analysts and the SEC have been trying to increase disclosure in the market for many, many years.
Whitney also criticizes the subjectivity involved in muni credit analysis. It impossible to avoid some level of subjectivity in analyzing government credits, because every spending decision a government makes is fundamentally a political decision. (She even makes highly subjective statements herself in the interview in talking about why Texas is a superior credit "â?? it's a "small government"? state.) There is a big difference between modeling how a bank's loan portfolio performs under certain economic circumstances and the level of services policymakers choose to provide.
Beyond that, the distinction between state and local governments can be of limited use when it comes to evaluating the financial impact of policy decisions. States split the services provided (and the taxes that support them) very differently between the state and local levels of government "â?? this is very important to consider when you are trying to figure out the debt burden that a specific population can support. Some states have centralized taxation and spending. For some it is almost entirely at the local level. The budgets for some local governments in this country dwarf those of many states. While the state may have some discretion to ignore the financial distress of smaller governments, that would be nearly impossible with a larger entity or an entity that provides essential services for a large local government.
If you pay attention to the interview you will see that the "defaults"? Whitney is talking about are on "social contracts,"? things like reducing spending on education, transportation, health care, etc. (Debt service is not breaking states. It is actually a relatively small percentage of budgeted state revenues. The problem with debt service is that it is a fixed cost that cannot be changed when revenues underperform. The immediate operational stresses on states derive from programs, not debt.) That is a cheap definition of default, and if by bailout, she means "Congress providing states with money so they do not have to make politically unpopular decisions about spending"? "â?? um, that's already happened, twice. It's just that we like to call it fiscal stimulus or federal aid and not a bailout. It will probably happen again if policymakers get loud enough.
Something that most people do not realize "â?? something that is completely lost in discussions of the amount of muni debt outstanding "â?? is that the federal government and the Federal Reserve have already passed up a number of opportunities to backstop municipal bonds in the face of outright market dysfunction and failure. Take a look at what happened to variable rate debt in the market during the financial crisis. The muni market was the only sector that did not get some sort of liquidity backstop. And it was not for lack of political pressure.
I have to say that the most amusing aspect of the sky-is-falling talk is that Whitney could not provide any actual investment advice. I'm sure we'll be suffering through many people suggesting credit default swap plays in the virtually non-existent muni CDS market, however.
If California has a top income tax rate of 11%, and Texas has no state income tax, it might be logical to argue that Texas has more resources on which to call in the event that the state budget were to become distressed.
Furthermore, if the defaults being discussed are on â??social contracts,â? and Texasâ??s social contract is more minimal than Californiaâ??s, then it seems less likely that Texas will default on it.
Would you make the same argument about Florida? Nevada?
The fact that states would likely change their spending priorities (â??default on social contractsâ?) rather than lose market access is a strength from the muni investorâ??s standpoint, not a weakness.
Unfortunately in the case of NV and FL I think the dynamics are different (obviously). Those two states are run in a Ponzi fashion, in which business activity associated with newcomers moving in supports an unsustainably high level of government services. Not to mention the fact that the culture in Texas is pretty self reliant whereas the culture in NV and FL is more that people expect a high level of services but just donâ??t want to pay for it.
Bondgirl I think you may be missing the forest for the trees. While the specific comments you make are accurate, and while Whitney can be over the top in her assessments, the basic message that there is a financial train wreck coming in the states is accurate. Whether that train wreck inflicts more damage on bondholders or claimants to the various streams of money from programs and the benefits due to former state employees remains to be seen of course.
While debt service may not constitute a unmanageable burden, it is worth considering how debt holders might fare in an era in which a) most state legislatures are dominated by public employee unions (which did not exist during the last period of municipal distress in the recession) and b) politically connected groups such as the UAW have managed the leapfrog the well established rights of priority in bankruptcy procedings to receive a preference in liquidation that was unimagninable two years ago.
It is also instructive to look at the response of legislatures in some of the biggest basket case states to the financial stress they face (CA, IL and NY in particular). They have ranged from the â??just say no defenseâ? of IL and just ignore the bills of various vendors to the state, to the passage of fantasy budgets combined with massive borrowing in CA, to a close your eyes and pretend the stimulus money will be there forever approach in NY. None of these states have even pretended to take a stab at restoring structural balance and the unions in each have acted as if they never heard of the crisis (in NY, they wonâ??t even discuss a pay freeze, never mind a cut).
A day of reckoning is fast approaching. The unions have enormous influence at the state level and to date have not even paid lip service to the need for changes in comp and benefit plans. The taxpayers have figured out that they are the patsies in a zero sum game with the unions. They have funded a workers paradise in most state governments with pay and benefits that the private sector guy could only dream of for comparable work. The rise of the Tea Party is not an accident in this environment.
How the debt holders fare in all this is by no means certain. Who are the big holders of muni debt â?? rich people and banks â?? hardly sympthetic victims. It is not hard to imagine a political deal being cut to address the situation that balances the books at least in part by taking a piece out of the hide of bondholders whether that is appropriate according to all norms of contract law and commercial convention. Particularly with the current resident of the White House who doesnâ??t â??stand withâ? hedge funds and speculators who happen to own distressed securities. Some thing tells me he isnâ??t going to stand with banks and fat cats when the muni market hits the fan.
Finally, itâ??s worth considering what Buffett had to say about all this:
June 2 (Bloomberg) â?? Warren Buffett, whose Berkshire Hathaway Inc. has been trimming its investment in municipal debt, predicted a "terrible problem"? for the bonds in coming years.
Sure. But it is less about who is holding the bonds than preserving market access, and it always has been in the muni market. The unsympathetic can stick it to the fatcats that purchase the bonds to shelter their income, but who is going to provide a means to finance aging infrastructure going forward? Or even to lend the government money short-term to mitigate the irregularity of tax receipts within a fiscal year? Governments are not companies; they do not just go away. That creates a powerful incentive to honor obligations to bondholders at the end of the day that should not be underestimated.
Just a thought, but the non-fatcats should probably care about superfluous fear-mongering. To the extent that it could temporarily increase governmentsâ?? borrowing expenses, wellâ?¦ Who is paying for that?
Well, this is the proposal to deal with the bondholders in the biggest bankruptcy of this cycle so far â?? 50 cents on the dollar:
http://blog.al.com/spotnews/2010/09/jefferson_county_sewer_plan_ha.html
Perhaps market access isnâ??t their highest concern.
Jefferson County is in receivership, not bankruptcy.
Iâ??m not sure why everyone holds Jefferson County up as an example of some forthcoming wave of muni defaults. That was a case of outright fraud. People are in prison for it. Hardly typical. (PS â?? Who holds most of the bonds? JPM. Who provided the county with the problem swaps? JPM. Cry me a river.)
The fact that people can count, and moreover, name the defaults in the muni space supports my argument there, I think.
The distinction between receivership and bankruptcy is a immaterial to someone getting 50 cents on the dollar.
Letâ??s check back in a couple of years and see how things look. I think weâ??re only in the first inning of this game. In fact, they may not have played the national anthem yet. Iâ??d be careful about hanging that Mission Accomplished banner from the bridge of the ship at this point.
The fact that JPM would receive even a cent on deal designed for no other purpose than to steal money from taxpayers should blow anyoneâ??s mind, I think. They should be putting those bankers to work in a wastewater treatment plant until theyâ??ve paid off what they cost the county so far.
Sure, but that is hardly what I am doing by saying that I am skeptical that a muni meltdown is around the cornerâ?¦
And thanks to both of you for the very thoughtful comments.
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