MuniLand

Atwater, California voted at a special meeting on Wednesday to declare a common-law fiscal emergency. This is the first step toward filing for municipal bankruptcy. It makes Atwater the fourth city in California to publicly declare fiscal distress. The city must now go through a 90-day mediation period with its creditors, public employees, bondholders, trade vendors and CalPERS, the statewide pension provider.

The bankruptcy process is well established, but very little cost benefit analysis has been done to evaluate whether the benefits of bankruptcy outweigh the costs. Vallejo, CA spent $13 million on bankruptcy costs and Jefferson County, Alabama’s  large and very complex Chapter 9 case still has enormous legal costs to contend with. Jefferson County Commission President David Carrington explained what the county faced:

“People look at our side in the courtroom and see five or six lawyers, which seems like a lot,” Carrington said. “It is, but the other side has 45, 46 lawyers over there working against us.”

Lawrence LaRose, a bond insurer lawyer and partner at Winston and Strawn who has been actively involved in the Stockton, Harrisburg and Jefferson County bankruptcy cases, said at a recent conference that bondholders are “lawyered up and organized” during bankruptcies. The forces facing Atwater officials in bankruptcy will be strong.

Standard & Poor’s did an analysis of the costs and benefits of the Vallejo, CA bankruptcy, and found that bankruptcy was not a cost-effective strategy given what the city has gained (emphasis mine):

Puerto Rico is drowning in debt. It is now in the process of leasing its Luis Munoz Marin International Airport to a Mexican firm Aeropuertos del Sureste (Aerostar). The airport (LMM) is the largest in the Caribbean, and it could become an international gateway to Central and South American cities. The lease deal lasts 40 years. However, studying the financial terms of the deal, it is not clear that Puerto Rico will really benefit much financially from privatizing the airport.

ASUR, a Mexican airport operator with concessions to operate, maintain and develop several airports in the southeast of Mexico, is doing the deal in partnership with Highstar Capital, an American infrastructure investment firm.

Looking at the financial data, which is sparse and hard to find, the deal is unlikely to generate any substantial cash for Puerto Rico. From the FAA application (page 9):

Yesterday I attended the always great municipal finance conference held by Bloomberg:

The Bloomberg State & Municipal Finance conference will convene public sector policy makers, labor leaders, pension fund managers, institutional investors and issuers for a full-day program covering current issues central to state and municipal finance and evaluate opportunities for investors and participants in the municipal bond market.

If you are not familiar with Twitter, this might give you a better idea of how it works. This micro-blogging format fit the form of the conference, which had 3-4 speakers on each of its fifteen panels. I tweeted from several of them:

Kamakura Corporation, a risk management firm in Honolulu, Hawaii, has updated their analysis of the volume of trading in municipal credit default swaps (CDS). Here is what they say:

On January 11, 2012, we looked at weekly credit default swap trading volume for subsovereigns and municipals among 1,090 90 reference names that had traded in the 77 weeks ended December 30, 2011.  We found, unfortunately, that (in the words of Gertrude Stein) “there is no there there.” In this blog,  we update our CDS volume analysis for subsovereigns and municipals for the 103 weeks ended June 29, 2012. Alas, our conclusion is unchanged.

Kamakura documents that there is very little volume in muni CDS trading, and most of it is done between dealers. Essentially it’s an artificial market with very few trades outside the dealer community.  Kamakura, in their analysis, strips away the trades that dealers are doing between themselves:

SEC Commissioner Elisse Walter spoke at the SIFMA Municipal Bond Summit yesterday, and her message came across loud and clear. She said that despite enormous advances in technology, decentralized muniland trading is still too hard to understand from the outside. She said that although 75% of municipal bonds are held by retail investors through direct ownership, money market funds, mutual funds and closed end funds, retail investors are still “afforded second class treatment.”

Walter led a two-year effort to assess the hurdles that retail investors face in the municipal bond market. The SEC held three field hearings on the municipal market over the last two years, and Walter said one thing that struck her were the retail investors who said that they couldn’t get pricing for their municipal bonds. Walter seems dedicated to fixing that problem. Transparent bond pricing – the bedrock of a stable and fair market – has been unavailable to investors for decades in muniland.

Walter’s statements echoed the findings of the SEC muni report (summarized by the law firm Bingham):

A wave of innovation is sweeping American cities. Hard fiscal times and inexpensive technologies are prompting many governments to develop new and innovative programs. New York City’s mayor, Michael Bloomberg, and Harvard University’s Ash Center for Democratic Governance and Innovation are leading nationwide competitions to showcase innovative public programs, while two other states have rolled out tools for their cities and taxpayers. Righting the muniland ship will require stabilizing budgets and creating innovative ways to deliver public services.

Last week I wrote about local officials needing governance resources, and this week two of the largest states, Texas and New York, rolled out a few. The Houston Chronicle reported on the efforts of Texas State Comptroller Susan Combs to inform taxpayers about how much local debt they are responsible for:

Local governments are loading down Texas taxpayers with debt without providing them enough information about the amount already owed for roads, schools and other public projects, State Comptroller Susan Combs contends in a report released Wednesday.

The SEC caught a big fish in muniland that was clearly breaking the “pay-to-play” rules. Pay-to-play is when municipal bond underwriters give contributions to politicians to win underwriting business. Reuters has the story:

Goldman Sachs Group Inc will pay more than $14 million to settle federal and state charges after it violated “pay-to-play” rules, in a case involving campaign contributions to former Massachusetts gubernatorial candidate Timothy Cahill.

Neil Morrison, a former vice president in Goldman’s Boston office, worked extensively on Cahill’s 2010 campaign while also soliciting underwriting business from the Massachusetts treasurer’s office, the Securities and Exchange Commission said. Cahill at the time was Massachusetts state treasurer.

Last Friday, New Jersey Governor Chris Christie proposed to levy a $10,000 fine on anyone who leaked the state’s fiscal data ahead of official announcements. Politicker NJ quoted New Jersey state Senator Barbara Buono (a Democrat from Middlesex):

“Governor Christie came into office promising ‘fiscal transparency’ and signed an executive order [in 2010] requiring his Treasury Department to issue revenue reports on the 10th business day of each month,” Buono noted. “But now that revenues are coming in below the governor’s wildly optimistic projections, revenue numbers are suddenly a state secret and the governor wants total control over the flow of information.”

“Whether New Jersey taxes are coming in as expected should not be kept secret from New Jersey taxpayers and it should not be kept secret from New Jersey legislators who are responsible for ensuring that the state budget remains in balance. Like the United States Constitution, the 1947 New Jersey Constitution established a government with three equal branches. It did not establish an imperial governorship.”

The retail investor is king in muniland, holding about $1.81 trillion of municipal securities in the second quarter of 2012, according to the Federal Reserve Flow of Funds report. But where are the other big players in the municipal bond market, and what are their investment objectives? Here’s a quick rundown of the different parts of the financial business that held $1.789 trillion in muni bonds in the second quarter of this year.

Securities dealers

Big bank dealers like Citi, JP Morgan Chase, Bank of America Merrill Lynch, Morgan Stanley and Goldman Sachs held a relatively small amount of municipal bonds this year, with $31 billion in the second quarter. But they play an outsized role in muniland. The dealer banks underwrite a vast majority of new municipal bonds, they write derivative contracts to municipal issuers and they control the flow of trading between market participants. Their basic advantage comes from knowing who bought bonds in the underwriting process, and who might be willing to trade old bonds out for new ones. Bank dealers hold their bonds typically as trading inventory. Securities dealers have decreased their holdings, down from $51 billion in 2006.

Government-Sponsored Enterprises (GSEs)

The GSEs held a tiny amount of municipal bonds, $19 billion in the second quarter. This number only seems tiny because the bonds somehow snuck onto the $6.351 trillion portfolios of GSEs. It makes me wonder if some traders there just made a mistake when choosing which bonds to buy.

In Atlantic Media’s newly-launched financial vertical, Quartz, they have included a section entitled “low interest rates.” It caught my attention because I’ve never seen a financial publication that baked an assumption about the direction of interest rates into their format. That is like assuming oil or grain prices would always be low. A post, No, Ben Bernanke’s goal isn’t to reduce grandma to abject poverty, suggests that someone has to lose in executing monetary policy, and it is savers who must bear the most pain:

“But what about the savers?” That cry went up yet again when the US Federal Reserve promised, earlier this month, to keep interest rates at zero at least until 2015. The Fed, of course, was trying to perk up the American economy, but in monetary policy there are always winners and losers, and—with the Fed’s interest rate target having already been at or near zero for more than four years—the losers are people with savings. Yields on CDs (fixed-term deposit accounts) have collapsed. The yields on safe bond investments, like US Treasuries, is so low that after a few years of inflation, returns on those investments are almost certain to be worth less than what investors first put in.

Ben Bernanke, the Fed chairman, took the somewhat unusual step of acknowledging some of these concerns. In an attempt to assuage them, he pointed out, “low interest rates also support the value of many other assets that Americans own, such as homes and businesses large and small.”