Municipal Bond Failures. This Would be a Real Crisis.

[chipwich]

A pretty good opinion piece about Muni Bonds on Bloomberg today.

Meredith Whitney Overreaches in Muni Default Call: Joe Mysak

There will be between 50 and 100 “significant” municipal bond defaults in 2011, totaling “hundreds of billions” of dollars.

So said banking analyst and new municipal bond expert Meredith Whitney on the “60 Minutes” show on Sunday, in perhaps the boldest, most overreaching call of her career.

Hundreds of billions of dollars? The one-year record, set in 2008, is $8.2 billion. You can see how an estimate of “hundreds of billions” would get people’s attention.

There are a lot of reasons to be doubtful about the health of the municipal market right now, as elucidated by “60 Minutes” correspondent Steve Kroft. Tax revenue is down, public pension and health-care liabilities are up, the federal government’s bailout money to the states is running out and the chances that those funds will be replenished are remote.

And yet -- hundreds of billions of dollars in default? The number is in the realm of the fabulous. If pressed, I would say that we might see between 100 and 200 municipal defaults next year, maybe totaling in the $5 billion or $10 billion range.

Whitney doesn’t believe the states will default. That leaves us with local governments and authorities as the ones failing to pay debt service on their bonds, which makes this an even bolder call.

Most defaults in the modern era aren’t governmental or what we might call municipal at all. The majority are corporate or nonprofit borrowings in the guise of some municipal conduit -- nursing homes, housing developments, biofuel refineries -- so they could qualify for tax-free financing.

Whitney’s Vision

And those are the ones I think will still comprise the majority of defaults in 2011.

This isn’t the Whitney scenario. No, she envisions between 50 and 100 -- or more -- counties, cities and towns making the choice to renege on their bonded debt.

My question is: Why?

Why would a governmental entity go out of its way to provoke or alienate its best source of finance? In the old days you might say that bondholders were a distant class of banks and plutocrats mainly centered in the Northeast. That’s no longer true, and hasn’t been since at least the passage of the Tax Reform Act of 1986, which made bonds less attractive for banks and insurance companies, among other things. Today, a city’s bondholders might live in the municipality itself, and almost certainly reside within the state.

Debt Service

Why would a governmental entity choose to default on its bonds, especially if they make up a relatively small proportion of its costs?

“Debt levels for U.S. local and state governments are relatively low, with annual debt service representing a relatively small part of budgets,” Fitch Ratings said in a special report in November.

Entitled “U.S. State and Local Government Bond Credit Quality: More Sparks Than Fire,” the report said, “The tax- supported debt of an average state is equal to just 3 percent - 4 percent of personal income, and local debt roughly 3 percent - 5 percent of property value. Debt service is generally less than 10 percent of a state or local government’s budget, and in many cases much less.”

The lead analyst on the report was Richard Raphael, who has been covering municipal finance for 31 years. He is not one of the analysts “who got everything wrong in the housing collapse,” in the words of correspondent Kroft. In his report, Raphael said, “debt service is a relatively small part of most budgets, so not paying it does not do much to solve fiscal problems (particularly as compared to the costs of such an action).”

Headline Grabber

What irks me about this Whitney call is that it generalizes about a market that resists generalization, a market that is particular and specific to a remarkable degree. And it doesn’t answer the question “Why?” It is instead an assertion aimed at getting attention.

Whitney made headlines in 2007 when she predicted Citigroup would lower its dividend and that it was time to sell bank stocks. She made headlines in September when she said she produced a report on 15 states’ financial condition, and said the federal government might be called upon to bail them out. Whitney only let clients see the report, so I don’t know if her conclusions are supported. She said it was 600 pages long and had taken two years to produce.

Perhaps Whitney should stick with bank stocks.

(Joe Mysak is a Bloomberg News columnist. The opinions expressed are his own.)

[Glenn VL]

I'm so glad that you posted that Bloomberg opinion piece Chipwich, as I read it today and it basically summed up my beliefs and was more or less what i mentioned a couple of days ago in this topic.

I respect the hell out of Meredith Whitney as an analyst in the financial sector, but I believe she is way off on this one, and it's the type of goofy 60 Minutes type piece that tries to do the impossible (describe the municipal bond landscape in the time it takes to fold a load of laundry) and completely misses a lot of huge points, specifically as I mentioned a few days ago and as the Bloomberg piece pointed out today, that the municipal market is so incredibly diverse and segmented that no one thing (including state budget deficits) can sink it.

The Fed absorbed 1.8 trillion dollars worth of illiquid asset backed debt as QE1. If the prediction I made and the Bloomberg piece makes of at most 10 billion in defaults comes true, or if Whitney's non-denominated opinion of 50-100 defaults (we'll call it 100 billion) comes true, it's a complete drop in the bucket compared to what we've been through. It may cause some pain and set us back a bit, but it is no way a crisis the likes of anything we have seen lately (ie the credit crisis or even the European debt crisis). In addition, aside from Build America Bonds, tax incentives make it unfavorable for absolutely nobody (foreign countries, every day Americans, pension funds, corporations etc) to actually own Municipal bonds except individuals in high tax brackets.

Stephendare, I would love to hear in your own words your opinion on the subject. From what I read of the first few pages (albeit they were from 2008), you basically presented yourself as an expert on the subject ("I would go into it further for you, but I don't have the time") and made fun of a forum member for pointing out some very basic points about municipal bonds that almost anyone who follows the market could tell you and asked him for proof, and when I question the relevance on some of the articles you have posted (for example, using archaic failures for ARS auctions as evidence of a Municipal crisis when that hasn't even been on the radar for two years), your only response is copying and pasting more opinion pieces. 

[ChriswUfGator]

The fallout from munibonds is likely going to land on the taxpayers through the fed bailing out bond insurers, if the past 3 years has taught us anything. The main problem if mass-scale defaults start happening will be local governments being essentially locked out of borrowing money for a period of time, when they have become almost fully dependent on borrowing to keep the lights on. That should get interesting at a local level.

And yeah PVBGuy and RG were idiots, LMAO at those memories of 2007/2008 when they said the recession would be over in 6 months and real estate would be higher than before. Genius.