Municipal Bond Failures. This Would be a Real Crisis.

[civil42806]

you mean that right wing and "nazi" arent the same thing.

Neo Nazi means nazi like.

But it is imaterial to the discussion which is about the bond failures.

Neo-nazi only means what the individuals talk about.   Very few understand that the national socilast party was originaly not percieved as right wing   Many of FdR staff admired attributes of the nazi party.  We are talking about the government taking a stake in the manufacturing sector, the banking sector, mandatory health care, and numerous other issues.   The basic problem is that fascism has been confused with Nazism, and anti semitism.  Though I think that the whole anti -semitism on the left is being  embraced as anti zionism.   

[Midway ®]

And it would be "as the article says" not "like the article says", and "as I thought", not "like I thought".


You are riversidegator junior with bad grammar.

Ooooh the grammar police!!

Pardon me for interrupting your orgy of illiteracy.....Now back to the fun....

[BridgeTroll]

orgy of illiteracy

Stop with the grammar morality.  Consenting nouns, verbs, adverbs, and punctuation marks should be able to cavort about as they like.  They are hurting no one...

[Midway ®]

So you oppose government regulation of grammatical morality?

[chipwich]

The US is now under watch by Moody's to possibly loose its AAA credit rating.  As times get better, the smart money is becoming less risk averse and moving away from US bonds.  The 10yr note hit 3.56% today which is around 40% higher than it was  selling for just two months ago.  With more loose money, tax cuts, and credit worthiness, it is a hard sell to think that the US will not have to pay significantly more for their debt.  Probably a third to half of municipal bonds are basically ticking time bombs and I have my doubts that all of those will be bailed out by cash strapped states or a national government that is just bleeding cash (and having to may more for it too).

[chipwich]

PS: I don't think the US is any immediate danger of loosing its AAA credit rating right now, but two more years of lackluster growth and high debt could undermine the AAA status and cause us to finally loose it.

[Glenn VL]

To say that we are now, or were in 2008, on the verge of a municipal crisis due to declining property values, and hence, declining property tax revenues, is to over simplify and largely misunderstand municipal bonds in the first place.

The initial poster was correct. Less than half of all municipal bond issues are General Obligation bonds. G.O. bonds are backed by the taxing power of a municipality and historically incredibly safe. They are safe because a) if you don't pay your property taxes, the state will make your life miserable, and b) most come with the promise of assessing additional taxes on the community or placing a larger lien for debt service on gross tax revenues if the municipality can't service the debt. I will gladly offer a source for this (the S&P Annual Municipal Bond guide), but it is common knowledge to almost anyone in the securities industry.

The remaining 50-55% of municipal bonds are backed by revenue sources besides property taxes - usually things tied to sustenance of life like power, water and sewage. If you combine these "traditional" revenue bonds with the above mentioned General Obligation (tax backed bonds) the historical default rate is 0.20-.25% (Fitch's annual study of Municipal Defaults). The number is even lower for the property tax backed bonds on their own. People talk about the Orange County crisis of the 1990's as the benchmark for municipal debt gone wrong, but holders of those dreaded tax backed bonds came out of it receiving 100% of their principal back plus interest. When California was handing out IOU's for almost every expense they had, they were still sending out interest payments to bondholders. Additionally, many of these bonds are also insured (albeit by insurers who are in rough shape), and most likely implicitly backed by the US Government in the event of a muni bond pandemic. As a backstop, if Big Ben was ok with absorbing nearly 2 trillion dollars of MBS's, I'm sure there is room on the Fed balance sheet for another couple hundred billion dollars worth of distressed debt from the 3 trillion dollar muni market.

If you look at the Case-Shiller home price index, we've had some significant corrections in the housing market over the last 100 years, but we haven't had sweeping defaults in the municipal bond markets as a result.

Municipal bonds like Industrial Revenue Bonds and Non Essential Public use bonds are and have been exponentially more likely to default (literally > 50x more likely according to the Fitch's studies) than the stereotypical property tax backed bonds that the original post makes mention of, but that's more a function of a poorly planned individual project here or there than some sweeping epidemic.

We might see defaults in muni bonds go up a couple of percentage points due to specific types of bonds issued by specific states having problems, but I completely agree with the original poster that the sky has never been falling, and that there are too many backstops and too much diversification in the market to keep it from happening, and that the original post was a tad sensational.  

[chipwich]

Wow, Great post Kevin!  I think you are right on the money.

I do however think Stephen's post does raise good concern regarding the solvency of many of the municipal bonds out there and furthermore, the solvency of future debt obligations (worker pensions, retirement, future needs) that many of these municipalities do have.  At the very least, it seems that more and more municipal bonds will indeed be forced into some degree of default.  The consequences will ultimately affect everyone by forcing bonds rates higher and thus  increasing tax rates/ user rates on citizens and further reducing the amount of future projects that can be bonded.

In regards to the Fed's ability to purchase muni bonds, I agree with you.  Whether it be in the form of QE3 or 4 or so on, I can definitely see it happening to some degree eventually.  However, for now, it is the US government that has picked up the tab in bailing out struggling states ($26 billion in August).  I think we will definitely see more and similar moves by government before we see the Fed getting involved.  If that scenario occurs (continues really), then I think we will begin to see bond vigilantes begin target US treasuries to a degree that not even the Fed can buy enough to keep rates from going up several basis points....and that is what I fear could eventually drag us into another recession.  

Lastly, in regards to these bonds being insured, I think you said it best by saying insurers are in rough shape.  As we saw from the last recession, I have a hard time believing many counter-party investors will actually make good on their CDS'....leaving the Fed to come and backstop it anyways.

So, yes, I agree completely that the sky is not falling, but I think this problem is enough to cause on-going concern that will stifle future growth and possibly lead to another downturn in which the US cannot simply monetize and sweep under the rug.

[Glenn VL]

That testimony literally has nothing to do with a default crisis with municipal bonds, never mind the fact that it is dated by 2 and a half years, nor does it prove that municipal bonds were ever in a meltdown stage. It's a super specific testimony on a very, very small slice of the municipal market, auction rate securities.

At their absolute peak, ARS's made up around 4-6% of the total municipal bond universe. Since this (again, severely dated) testimony, brokers and investment banks have taken about 65% of the bonds off the table. So really, you are looking at around 30-50 billion in outstanding ARS securities, which is a mere drop in the bucket and a minor headache for those stuck holding them more than any major financial catastrophe. These securities haven't "defaulted" at all, rather the auction system that allowed an investor (usually institutional due to the high price tag) to transfer the bond to another investor. When the credit market dried up, the buyers stopped showing up to these auctions and some investors got stuck with them longer than they wanted.

This mechanism, again, is contained and has absolutely nothing whatsoever to do with collection of property taxes.

[Glenn VL]

Wow, Great post Kevin!  I think you are right on the money.

I do however think Stephen's post does raise good concern regarding the solvency of many of the municipal bonds out there and furthermore, the solvency of future debt obligations (worker pensions, retirement, future needs) that many of these municipalities do have.  At the very least, it seems that more and more municipal bonds will indeed be forced into some degree of default.  The consequences will ultimately affect everyone by forcing bonds rates higher and thus  increasing tax rates/ user rates on citizens and further reducing the amount of future projects that can be bonded.

In regards to the Fed's ability to purchase muni bonds, I agree with you.  Whether it be in the form of QE3 or 4 or so on, I can definitely see it happening to some degree eventually.  However, for now, it is the US government that has picked up the tab in bailing out struggling states ($26 billion in August).  I think we will definitely see more and similar moves by government before we see the Fed getting involved.  If that scenario occurs (continues really), then I think we will begin to see bond vigilantes begin target US treasuries to a degree that not even the Fed can buy enough to keep rates from going up several basis points....and that is what I fear could eventually drag us into another recession.  

Lastly, in regards to these bonds being insured, I think you said it best by saying insurers are in rough shape.  As we saw from the last recession, I have a hard time believing many counter-party investors will actually make good on their CDS'....leaving the Fed to come and backstop it anyways.

So, yes, I agree completely that the sky is not falling, but I think this problem is enough to cause on-going concern that will stifle future growth and possibly lead to another downturn in which the US cannot simply monetize and sweep under the rug.

I would agree with you on most of this as well, thought I don't know who Kevin is .

Bondholders are paid as close to first as the specific bond allows. There is such a diverse collateral system for municipal bonds (property taxes, "sin taxes", revenue from essential things like power and water, revenue from non essential things like airports and hospitals), and all 50 states issue their own unique bonds, that no one thing or problem is going to bring down the market, barring a complete collapse of the US economy.

State's tax receipts were up 3.9% from Q3 2009 to Q3 2010, which is a good sign for bondholders.

I completely agree that borrowing costs are going to go up for municipalities, particularly in states like California, Illinois, New York and New Jersey with huge CDS spreads and bond prices that have suffered, but I think the more likely outcome to this is that states are going to have to make some unpopular decisions and get their budgets under control, because defaulting on their bonds is historically always the very last resort because debt financing is (unfortunately) the oxygen that keeps out states able to turn the power on in the morning.

[JC]

Well this will certainly be an interesting year, wont it?  I am curious if this does what she says, if things get worse than they are what changes will come?  Could be huge....  We also cant forget about the commercial real estate market which is destined to tank soon too. 

[ricker]

I've been reading this thread from the original post including all posted links. for hours.
worrisome.
sorta wish I was medicated like the rest of the sleeping naysayers.
what are they on if they think all is swell.
oh and don't drink the water_until you test your tap for chromium6.
thanks for posting and maintaining eventhough I feel more angsty.

[Dog Walker]

"Angsty"  Good word.

I have a couple of friends whose entire holdings and entire income depend on municipal bonds and I fear for them.

All of their bonds are insured and general obligation bonds which might mitigate some of the damage and they have avoided California, New Jersey and Illinois, too.

It is probable that the courts would put the claims of the pension beneficiaries ahead of those of bond holders in cases of municipal default.  There ain't enough insurance in the world if that house of cards comes down.

[CS Foltz]

Been saying it for quite a few years now..............public spends more than what is available, there are problems! I see no reason why government at any level should be any different! City of Jacksonville will be something like $58 Million Dollars in the hole next budget cycle...........what is next? Hard to make up for that kind of money, but current Administration continues to spend what we don't have! Not very smart nor fiscally responcible!

[mtraininjax]

Can't wait for the next round of taxpayer funded shortfalls. Gotta hand it to the invisible mayor, stating to publicly avoid asking for the union support. Really wonder where Hogan's head is at for wanting the union support, and thankful Audrey has enough sense not to ask for it. Unions are going to be a huge issue headed into the election as well. Good article by Littlepage in the TU on it.