Obama should not chase CFTC-head Gary Gensler away

The Huffington Post’s Shahien Nasiripour brought news of the Obama Administration’s effort to run off the most effective financial regulator since Franklin Roosevelt signed the 1933 and 1934 Securities Acts into law:

President Barack Obama is poised to nominate Amanda Renteria, a former Senate staffer, to replace Gary Gensler atop the main U.S. derivatives regulator amid an intensifying fight between Gensler and the world’s major banks and regulators over cross-border transactions.

And why is Gensler being run off? Nasiripour writes:

Renteria’s elevation would end Gensler’s tenure as the nation’s top derivatives overseer. A former Goldman Sachs executive who was viewed skeptically by some liberal lawmakers when he was first nominated in 2009, Gensler has become perhaps Wall Street’s leading foe as he has sought to curb risk and expand transparency and competition in the previously opaque market for a type of derivatives known as swaps.

Gensler has transformed a once-unknown agency to one at the forefront of financial regulation as CFTC rules are shaking up a marketplace unaccustomed to government supervision. His rules threaten to decrease profits at the nation’s largest banks as formerly unregulated activities are forced to comply with provisions that help buyers compare prices and compel banks to stump up more cash to back their trades.

One of the administration’s longest-serving regulators, Gensler has clashed with the Treasury Department, foreign regulators from countries including the United Kingdom and Japan, dozens of U.S. lawmakers and the leading world banks over his efforts to impose stringent rules on a once little-regulated market that fueled the financial crisis and nearly toppled financial groups including AIG, the giant U.S. insurer.

Big muniland haircuts

Are muniland bondholder haircuts a growing trend? Actually, recoveries (the principal and interest that the bondholders recover in a default) have varied a lot, according to a Moody’s municipal default report published in May:

Recovery rates are high but variable. Historical ultimate recovery rates on Moody’s rated defaulted US municipal bonds are generally higher than those for unsecured corporate bonds. On average, the ultimate recovery for municipal bonds was about 60 percent for the period 1970-2012, compared to 49 percent ultimate recovery rate for corporate senior unsecured bonds over 1987-2012. However, municipal recovery rates for the relatively small subset of defaulted bonds are highly dispersed across individual bonds, ranging from full recovery to two cents on the dollar.

When you drill into Moody’s default data, there is only one local government bond default where the recovery was less than 100 percent – the Belfield Limited Tax General Obligation default in 1987 – where bondholders ultimately recovered 55 percent of their principal (page 14). There were also recoveries of less than 100 percent on non-general obligation bonds. The low recoveries were almost always associated with housing or hospitals projects.

The cost of defaulting on the 38 Studios bonds

The Rhode Island General Assembly’s House Finance Committee heard testimony last Thursday from Matt Fabian of Municipal Market Advisors – an independent research service with about 300 subscribers – about the cost and implications of the state defaulting on the 38 Studios moral obligation bonds. Committee Chair Helio Melo’s main line of inquiry was “Does it cost us more money in the long run” if the state were to default on those bonds?

At 29 minutes into the hearing Fabian says that it is unlikely that the state’s general obligation rating would be lowered below investment grade, but it could be knocked down one, two or three notches. He says “It could go down to a BBB, the lowest investment grade rating …  it is a scenario but not most likely.” This is the closest Fabian gets to predicting the cost.

Most members of the House Finance Committee wanted hard numbers to make a decision. Understandably, it seemed difficult for them to convert Fabian’s commentary into decisions for the state. reported:

Muniland’s balance sheet

There is always a lot of attention directed at muniland about the number of municipal securities outstanding when the Federal Reserve releases its updated Flow of Funds report (recently renamed the Financial Accounts of the United States report). This data gives a measure of how much municipal borrowing has expanded in the previous quarter. Reuters’ Lisa Lambert wrote about a small increase of outstanding muni debt and shifts in ownership patterns in the first quarter of 2013. Direct ownership of muni bonds by retail investors is declining, while institutions have increased their holdings.

More of interest to me is the macro picture for muniland’s financial assets. The Fed’s report lists the financial assets of municipalities in the same table as the financial liabilities. While muni debt has increased since 2007, financial assets, bloodied by the extra burden carried by state and local government during the Great Recession, have declined.

This decline in financial assets, when coupled with lower-funding of public pensions, paints a gloomy picture for muniland. Expect belt-tightening to continue.

Medicaid: The state budget crusher

Under the Affordable Care Act, all 50 states will have exchanges where individuals can buy healthcare insurance. But the second leg of the ACA, whether and how much to expand Medicaid, is every state’s choice. The Supreme Court gave states this right when it ruled on the Affordable Care Act last June.

The Center on Policy and Budget Priorities is mapping states’ decisions to expand their Medicaid program (as of June 4).

Many commentators presume that it is an ideological choice for governors to extend or not extend public support for the uninsured through the ACA. Pat Garofalo of US News writes:

Infrastructure land

The New York State Comptroller, Tom DeNapoli, issued a new report this month that discusses public private partnerships (P3s) and makes recommendations for municipal entities that are considering P3s for infrastructure projects. The report seems to be directed at the New York State Assembly, which had legislation that would have authorized P3s in the state without any limit on size or requirement for oversight. From the report:

Since that time, [New York] has authorized a number of agencies and public authorities to use a simple form of public-private partnership known as design-build contracting. The Thruway Authority’s procurement of the new Tappan Zee Bridge is being undertaken using design-build methods, with the expectation that this approach will streamline the project, shift some financial risk to private contractors rather than the Thruway and its users, and result in savings for the Authority.

Policy makers in New York are now considering whether to authorize more sophisticated types of P3s that depend on private financial investments. The State Fiscal Year (SFY) 2013-14 Executive Budget included a proposal for “design-build finance” P3s that would for the first time have given private firms the authority to finance public infrastructure projects.

Illinois: Driving into a ditch

The state of Illinois, which joined the union in 1818, has a state motto: “State Sovereignty, National Union.” The website Netstate says this about the motto:

Two months after Illinois entered the Union, the new Illinois General Assembly decreed, on February 19, 1819, that a permanent state seal should be obtained for use on the official documents of the state. A seal, modeled after the Great Seal of the United States, was created with some differences appropriate to Illinois as a state. Importantly, the ribbon held in the eagle’s beak was changed from E Pluribus Unum to State Sovereignty – National Union.

Now, almost 200 years later, with the state in wretched fiscal condition, chatter among municipal traders concerns the possibility of a federal bailout or a state bankruptcy for Illinois within five years. The medium-term fiscal situation is that bleak. Long-term fiscal balance is not achievable without substantial changes to the state’s pension system, which the state has struggled with since 2009. The latest effort to reform the pension system ended last Friday when no agreement was reached in the State General Assembly.

Meredith Whitney’s “Great Migration”

Since I write about muni issues every day, I couldn’t find where Meredith Whitney had covered much new ground in her book, Fate of the States: The New Geography of American Prosperity, which is released June 4. It felt like the book had been written over a year ago and was not in tune with current fiscal realities. For example, on page 117 Whitney says, “We have reached a breaking point for some states. There is no more money.” The only state that I know where that might apply is Puerto Rico. In fact, numerous states are seeing modest surpluses this year and some are rebuilding rainy day funds.

Bloomberg’s municipal columnist Joe Mysak drove straight to the heart of Whitney’s thesis:

We’re all moving to North Dakota.

Or South Dakota. Or somewhere out there in the middle of the country.

This is the thesis of Meredith Whitney’s “Fate of the States: The New Geography of American Prosperity.” The country’s “central corridor,” largely untouched by the housing bust, is going to drive the economy for decades to come.

Why SEC adviser rules are desperately needed

Stockton, California is in the early stages of their bankruptcy and a local grand jury polled current city council members about their understanding of public finance. Does the latest round of public servants have any knowledge municipal finance? No, sadly the San Joaquin County Grand Jury discovered that there was little understanding of the city finances that the council oversees and that they could easily repeat prior mistakes. Local ABC affiliate, News10, reports (emphasis mine):

It has been widely reported how Stockton mismanaged its finances into bankruptcy court.  The grand jury also questions the current council and council members’ ability to manage important financial issues.

“The Grand Jury’s concern is the limited grasp of municipal finances.  While a few [council members]) indicated they had taken college-level courses in finance, or attended workshops, none indicated they were proficient in the matter,” read the report.

America is not growing, it’s contracting

The Guardian’s Heidi Moore wrote an epic screed about the illusion of economic recovery and waded through a river of micro data to prove her point. She highlighted how the housing recovery was driven by banks withholding their foreclosure inventories from markets and how three large banks halted foreclosures, which slowed supply. Unfortunately, she only had anecdotal evidence to support these ideas. She berated consumers for their increasing confidence in the economy and called it unfounded. She blasted the federal government, Congress and corporate CEOs for doing nothing to revive employment and stimulate economic growth. Moore writes:

The reason to maintain skepticism of good times a-coming is that an economic recovery can – and is – used to package a lot of political snake oil. As long as people believe in a recovery, Congress can keep ignoring the unemployment and equality crises and enjoy ginning up imaginary problems like the plague of corporate tax rates.

Actually, Congress is doing a lot to address the economy and unemployment. You can see it if you look at the macro data; specifically GDP growth versus the amount of debt that the U.S. Treasury is issuing. In fact, total U.S. growth in Q1 2013 came from issuing Treasury debt; not an increase in economic activity ($339 billion of new debt issued from 1/2/13 to 3/31/13 while GDP grew only $140 billion in same period).

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