MuniLand

Estimates for the economic damage resulting from Superstorm Sandy are circulating from $15 to $50 billion in damage. No formal assessments have been completed yet, and it’s likely that these are “repair” estimates that reflect the cost of cleaning up and repairing infrastructure back to its former state. A repair bill is likely to be much lower than the cost of hardening and improving vital transport, energy and communication systems to withstand more storms like Sandy or worse. After Hurricane Katrina, architect Frederic Schwartz wrote:

The planning of cities in the face of disaster (natural and political) must reach beyond the band-aid of short-term recovery. Disaster offers a unique opportunity to rethink the planning and politics of our metro-regional areas…

I’m not advocating centralized economic planning, but instead the concept of having a clean slate to rethink a region’s needs and weaknesses. Much of New York’s infrastructure is over 50 years old and some parts of the subway system are over 100 years old. On top of these old and heavily worn systems have been laid new systems that support the regions modern economy.

A 2008 Critical National Infrastructure Report, performed by the Commission to Assess the Threat to the United States from Electromagnetic Pulse (EMP) Attack references the effects of an enormous external shock to the system:

The U.S. has developed more than most other nations as a modern society heavily dependent on electronics, telecommunications, energy, information networks, and a rich set of financial and transportation systems that leverage modern technology. This asymmetry is a source of substantial economic, industrial and societal advantages, but it creates vulnerabilities and critical interdependencies that are potentially disastrous to the United States.

Revel casino weathers storm, credit health remains in doubt, leveraged loan down 3 pts compared to pre-Sandy $ ow.ly/eWOIu #casino

— LCD News (@lcdnews) November 1, 2012

Hurricane Sandy made landfall near Atlantic City, New Jersey, but the damage did not set back the city’s gambling and hotel economy by much. Fitch Ratings reports:

Gaming operators in Atlantic City, NJ, and across the mid-Atlantic region appear poised to re-open properties affected by Hurricane Sandy relatively quickly, limiting the storms impact on cash flow. However, Fitch believes longer term effects on physical infrastructure and consumer sentiment in New Jersey and surrounding states could have a material impact on fourth-quarter gaming demand.

I’m not a big fan of municipal bond-related mutual funds because some of their structural features work the opposite way that municipal bonds work. Mainly, the value of muni bond funds decline as interest rates rise. The WSJ.com has a useful description:

Advisers and investors appreciate being able to obtain even the current 1.8% yield from 10-year U.S. Treasurys. But many likely don’t realize the effects when interest rates rise, said James Swanson, chief investment strategist at MFS Investments. With the 10-year Treasury at a duration of about nine years, an investor faces a 9% cut to principal if interest rates rise 1% over the next 12 months and an 18% cut if rates increase 2%, he noted.

Did you catch that? If interest rates rise 1%, an investor could lose 9% of the value of his/her mutual fund. This negates one of the prime reasons to own municipal bonds for the long term:  the preservation of principle. If you are looking for the highest returns and you are willing to rotate into and out of bond funds as markets move, you might not suffer any principal loss. But that requires paying close attention to market direction and timing. Retail investors who are choosing retirement funds or putting aside cash are not generally good market timers. If an investor makes a choice and then sticks with it, the investment principal may be gone before they realize it.

Hurricane Sandy blasted through New York City and left a swath of wreckage. The cost of repairing the region’s infrastructure hasn’t been totaled yet, but Joe Lhota, head of the Metropolitan Transportation Authority (MTA), said this:

As of last night, seven subway tunnels under the East River flooded. Metro-North Railroad lost power from 59th Street to Croton-Harmon on the Hudson Line and to New Haven on the New Haven Line. The Long Island Rail Road evacuated its West Side Yards and suffered flooding in one East River tunnel. The Hugh L. Carey Tunnel is flooded from end to end and the Queens Midtown Tunnel also took on water and was closed. Six bus garages were disabled by high water. We are assessing the extent of the damage and beginning the process of recovery.

The MTA currently has a fully committed 2010-2014 capital budget of $24 billion, which does not take into account any spending needs that arise from Sandy. Here is where the current funding comes from (page 15):

With Hurricane Sandy descending on the mid-Atlantic coastline, I looked back at what I wrote when Hurricane Irene was making landfall last August:

Hurricane Irene, an enormous storm of unimaginable power, is bearing down on the East Coast. Although there could be loss of life and substantial property devastation, America has more than enough resources to meet her and survive mostly intact. Unlike third-world countries we have the people, equipment and money in reserve to clean up…

… Cities, counties, states and utility companies are on standby. Funds have been reserved to respond to emergencies and the federal government has a large department, the Federal Emergency Management Agency, ready to provide local assistance. The public sector is ready to go.

The collective output of the U.S. has increased modestly in the most recent quarter, as Reuters reports:

Gross domestic product expanded at a 2 percent annual rate, the Commerce Department said on Friday in its first estimate of the third quarter, a pick up from the second quarter’s 1.3 percent pace.

This is positive news, but did the economy really expand? Or is it possible that the government just issued more debt that flowed into the economy and was picked up as “growth”? More reporting from Reuters:

Moody’s released a summary of its third-quarter rating actions today and the downgrade grinder continues to turn in muniland. Downgrades across U.S. public finance sectors totaled about $75 billion in the third quarter of 2012, with four issuers accounting for over 70% of the debt downgraded: The Port Authority of New York and New Jersey,  the Puerto Rico Sales Tax Financing Corporation, the Commonwealth of Pennsylvania and the Chicago O’Hare Airport Enterprise.

With the exception of heavily indebted Puerto Rico, the other three issuers are household names, and their weakening credit profile might surprise some people. Here is Moody’s rationale for downgrading the four issuers. You may start to see some patterns (emphasis mine):

Port Authority of New York and New Jersey – Consolidated bonds downgraded to Aa3/Stable from Aa2/Negative;  $18.2 billion of total debt affected.

When FIX – the industry electronic trading standard – was fleshed out for fixed income in 2003, municipal bonds were incorporated. I got a fresh look at FIX at the FIX Protocol Americas Trading Conference this week. All the major muniland alternative trading systems (ATS)  including Bonddesk, MuniCenter and Tradeweb, as well as the major dealers are already FIX compliant for the latest 4.4 version.

The SEC has tasked the Municipal Securities Rulemaking Board (MSRB) with several new pre-trade transparency initiatives. They are considering two projects:

1) Determining the “prevailing market price” for a municipal security.

Things are heating up in the Golden State as bankrupt San Bernardino has stopped making payments to CalPERS, California’s public employee pension system. CalPERS, of course, had something to say about it. Reuters’ Tim Reid reported:

“These [pension] payments are required to be made under California law,” Calpers said in an e-mail to Reuters. “If Calpers and the city cannot resolve the missed payments, Calpers will assert its rights and remedies available under applicable law.”

Calpers spokeswoman Amy Norris said in a telephone interview that if the payments were not made and continued to fall due, “we will pursue collection through legal action.”

The media is filled with reports and reviews of a book by former Goldman Sachs employee Greg Smith, which disparages his former employer. Smith alleges that traders on his London equity derivatives desk treated their clients harshly and would glibly refer to them as “muppets.” They secretly despised their clients as they ripped them off, according to Smith, especially the “muppet” clients that were mainly pension funds and non-profits. The Guardian reports (emphasis mine):

“Getting an unsophisticated client was the golden prize,” he told the [60 Minutes] programme. “The quickest way to make money on Wall Street is to take the most sophisticated product and try to sell it to the least sophisticated client.

“What Wall Street will do is they will approach one of these philanthropies or endowments or teachers’ retirement pension funds in Alabama or Virginia or Oregon and they’ll say to them: ‘We have this great product that is going to serve your needs’. And it looks very alluring to these investors, but what they don’t realise is that upfront they are immediately paying the bank $2m (£1.2m) or $3m because of their lack of sophistication.”