MuniLand

Alarm bells are ringing across muniland because the discussion about capping the municipal bond tax exemption at 28 percent has surfaced again. Bloomberg reports:

“If and when there is a serious attempt to make substantial reforms to the tax code, I think that there’s a risk that the [municipal bond] tax exemption could be curtailed or eliminated,” said Decker, the co-head of SIFMA’s municipal securities activities.

The possibility of municipal-bond income losing its exemption from tax is as great as any time since 1986, when major tax reform was ushered into law during the Reagan administration, said George Friedlander, Citigroup Inc. senior municipal strategist.

Municipal bonds losing their tax favored treatment “is a very real threat,” said Mike Nicholas, chief executive officer of the Bond Dealers of America.

These industry leaders are echoing concerns that have been bouncing around muniland for a year and half. But the only specific proposal made by a government official came in President Obama’s 2013 budget proposal. Reuters reported in February, 2012:

The worst performing public service in the aftermath of Superstorm Sandy was the Long Island Power Authority. There are a lot of different estimates floating around, including 2.1 million of LIPA’s electricity customers were without power; some for up to 3 weeks. It was a public health disaster of epic proportions as households had to face late October and early November weather with no way to heat their homes or turn on the lights. The latest LIPA fiasco followed years of criticism of the organization.

New York State governor Andrew Cuomo ordered a swift investigation into the slow response of LIPA after Sandy. His Moreland Commission delivered its interim report on Monday.

According to Reuters (emphasis mine):

The commission recommended a complete overhaul of LIPA and the system by which power is delivered on Long Island…It recommended that a private utility buy LIPA.

The municipal bond market is one of the smaller corners of the bond market. It is dwarfed by the U.S. Treasury, government-sponsored organizations, mortgage and corporate bond sectors. Yet, muniland is larger than the equity market, as the data above (2011 and 2012 3Q year to date) shows, and it probably has more issuers than every sector combined. Muniland is a hopping place.

Thomson Reuters released its 2012 summary of municipal bond issuance data. Here is how it looked:

US municipal bond volume in 2012 reached $366 billion, a 32 percent increase over last year, but still behind 2010′s record setting underwriting volume of $430 billion by 14.8 percent.

Everyone in Washington is fighting over tax cuts, spending limits and the debt ceiling. But the real problem is the fat in all levels of government spending that must be slimmed down. A quick media survey uncovers poorly monitored and misspent government funds at every level of the system.

One of the most commonly reported spending issues is welfare fraud. When Massachusetts was sued to reach more citizens on welfare to get them registered to vote, 19,000 of the welfare recipients were not living at their listed addresses. The state, like most states, distributes welfare benefits electronically so that the benefits can be retrieved anywhere. If all these welfare recipients were illegally receiving support, that would be at least $138 million annually that Massachusetts has overspent. The Boston Herald had the story:

“The fact that 19,000 of these came back undeliverable tells me DTA has no idea where these people live, obviously, and is not doing the background checks they should be doing,” O’Connell said.

The majority of pundits and market observers have only tuned into the effectiveness of the SEC as financial market regulator since 2008, when the financial system nearly collapsed. So far, criticism has been relatively shallow. But when one of the most influential securities attorneys in America, Columbia University’s John Coffee, weighs in on the effectiveness of the SEC’s enforcement actions, we should all take note. Coffee’s SEC biography gives some background on his preeminence:

According to a recent survey of law review citations, Professor Coffee is the most cited law professor in law reviews in the combined corporate, commercial, and business law field.

And what does Professor Coffee have to say about the efforts of the SEC to prosecute financial market lawbreakers? He wrote on the CLS Blue Sky Blog:

The governor of New Jersey, Chris Christie, held a press conference on Wednesday in which he excoriated the U.S. Speaker of the House, John Boehner, and other Republicans for failing to hold a vote on Sandy relief this week. With a tone that is rarely heard in national politics, Christie accused the Congressional leadership of his own party of “duplicity” and “selfishness,” according to The New York Times. Meanwhile, New York governor Andrew Cuomo and New York City Mayor Michael Bloomberg delivered more tempered comments.

Was Christie’s tirade just common speech for Jersey, or are there other pressures on the governor? New Jersey state revenues are far from the projections that Christie’s administration made. Many, including myself and rating agencies, have said Christie’s revenue projections for fiscal year 2013 were overly optimistic given the economic climate. Meanwhile, Christie barnstormed around the state on his “New Jersey Comeback” tour for months until it was clear that the state was not experiencing a jobs boom. State revenues were already weak. Then Sandy flattened many tax and fee streams.

Here is New Jersey’s year to date report (July 1, 2012 – November 30, 2012) from the state treasurer (in $1000’s):

Regardless of the outcome of the negotiations between President Obama and Congress, the government’s budget is seriously out of balance. Here is a fiscal picture for the federal government from February in a simple form:

* U.S. Tax revenue: $2,170,000,000,000

* Fed budget: $3,820,000,000,000

* New debt: $1,650,000,000,000

* National debt: $14,271,000,000,000

* Recent budget cuts: $38,500,000,000

Let’s remove eight zeros from these figures and pretend it’s a household budget:

* Annual family income: $21,700

* Money the family spent: $38,200

* New debt on the credit card: $16,500

* Outstanding balance on the credit card: $142,710

* Total budget cuts so far: $38.50

The only brake on the spending of the federal government is the debt ceiling. Congress has been willing over and over to raise the limit on the amount of debt issued by the U.S. Treasury. This debt is transferred to the Federal Reserve, which sells it to financial markets, but it has been buying it back as part of its quantitative easing program. Unless Congress finds some fiscal discipline, this process will likely continue for decades, or until some external shock or technology development drives real productivity and growth.

The Federal Reserve is in the middle of a third round of bond buying that is commonly called quantitative easing (or QE3). The goal is to suppress interest rates, and it was the main monetary policy tool that the Fed began using in December 2008 to support the financial system during the credit crisis. The financial system has returned to racking up record-breaking profits, and the Fed has shifted the purpose of QE to propping up the housing system and the general economy.

By some measures though, the housing market may be showing bubble-like properties again from the broad efforts of the Fed. Rather than potentially fueling a new bubble, the Fed should turn to buying infrastructure bonds to rebuild America’s energy grid, bridges, roads, rail systems and ports. This would be a direct investment in the public sector of the nation, rather than the personal assets of households. If the Fed invested in America’s hard assets, it would create jobs and put in place the necessary framework to truly spur economic expansion.

The efforts of the Fed to prop up the housing market may be entering bubble territory in select markets (see Phoenix) as housing values rise more quickly than household incomes. From the blog Dr. Housing Bubble (emphasis mine):

States on average derive about 49 percent of their revenue from sales taxes, so holiday shopping results are important for state treasuries. Unfortunately, the early read on holiday retail sales looks pretty bleak. Reuters reports (emphasis mine):

As the U.S. holiday season winds down, retailers are left to hope that post-Christmas sales can help salvage their worst performance since 2008, preliminary data showed.

Holiday-related sales rose 0.7 percent from October 28 through December 24, compared with a 2 percent increase last year, according to data from MasterCard Advisors SpendingPulse.

New Jersey Governor Chris Christie recently berated Congress for its lack of progress on funding recovery monies for Hurricane Sandy. He made the argument that New Jersey and New York are net contributors to the federal treasury and they therefore deserve the funds that they requested. Yet, it is members of Christie’s own party who are slow-walking the legislation that would authorize spending. Republicans have raised some concerns – among them the amount of the original request and the need to budget for it.

The Republicans are right. More study should be performed into how states and communities are reimbursed for hurricane damage. Senator Charles Schumer of New York and others who are pushing for the funding cite the speed and largess of the federal government toward the affected Gulf region after Hurricane Katrina. But a study conducted by the Federal Reserve Bank of New York determined that the economic costs of Katrina were over-compensated to a level of 125%:

In hurricanes prior to Katrina, the [federal government reimbursement] rate was generally between 75 and 90 percent. However, beginning with Katrina, state and local governments often received 100 percent reimbursement. With this expansion of federal disaster assistance, payments from private insurance companies and the federal government exceeded the total economic cost of events since Katrina by about 25 percent.