MuniLand

California gets a little lovin’

The state of California received some good news this week when credit rating agency Standard & Poor’s upgraded the state’s long-term rating to “A” on its $73 billion in general obligation (GO) bonds (a single A rating is four notches below AAA). It’s certainly a feel-good moment for Governor Jerry Brown and other public officials. The municipal bond market has been anticipating the state’s improving credit position for the last year, as you can see in the chart above. It shows that the extra interest cost (over the AAA gold standard) on the state’s bonds has declined in the last year. The Golden State is getting some sunshine in muniland.

A single “A” rating is not great for a state, especially one as large as California, which has substantial debt to service and relatively volatile tax receipts. Among the positive praise that Standard & Poor’s gave the state, there were also reminders of the risks that the state faces in achieving real fiscal stability. These risks include lawmakers loosening their fiscal restraints and restoring the social spending that had been cut during the fiscal crisis. Translation: Politicians will revert to promising more than they can afford. S&P explains (requires free registration):

But another part of the answer likely rests with state lawmakers. Given that fiscal restraint has been a crucial ingredient to the state’s strengthening financial position, we think the budget process itself contains some risk.

After implementing significant program cuts in consecutive years, we anticipate there could be political pressure to restore services that would entail higher costs and could undermine the state’s nascent fiscal balance. We also believe there is potential for windfall-like PIT [personal income tax] collections through the early months of 2013, reflecting robust capital gains from 2012. Initial January tax receipt data suggest a surge of PIT collections may already be underway. A temporary flood of revenue could embolden lawmakers that may already prefer to add back to state programs.

The California budget is now balanced on a knife’s edge and the general economy must keep growing for it to remain in balance. U.S. Fourth quarter 2012 GDP growth of negative 0.1 percent is not supportive of keeping the California budget stable. S&P again:

America’s military is “lender of last resort”

America is slowly awakening from its long debt-induced slumber. It has conducted two major wars, a bailout of banks and a major stimulus program without raising taxes to pay for them. Because the Federal Reserve kept interest rates low, it was easy for politicians to continue to raise the debt ceiling and spend without making reductions in other areas of the budget. But those days have ended, the punch bowl has been removed and a new sobriety has rolled into our national capital.

Even with its massive deficit problems, America has been providing security for its global allies for decades at no cost to them. This resulted in spending 4.8 percent of GDP on U.S. military in 2010, which was ramped up from 3.0 percent in 2001, according to the Stockholm International Peace Research Institute. In contrast, you can see that European countries spent 1.73 percent of total GDP on military in 2010, which declined slightly from 1.99 percent in 2001.

America has been subsidizing European military needs largely due to its role in the NATO alliance. The Council on Foreign Relations explains the new problems with this arrangement:

Are sales taxes more ecological?

There is a growing cadre of Republican governors who are considering lowering or eliminating income taxes in their states (Louisiana, Nebraska, Kansas, Oklahoma, Missouri, and Indiana). The revenue they would forego by eliminating the income tax would be made up by increasing state sales taxes. There are several strong arguments in favor of this change for the way it would increase personal savings and lower tax rates on small business owners who usually run their business expenses and profits through their own income statements. So by eliminating state income taxes, more profits are left with small businesses to possibly expand.

But there is also an overlooked ecological advantage that comes from increasing sales taxes. It reduces consumption, because people pay higher prices for goods and services. Reduced consumption leads to less ecological damage. For example, since the economy has remained weak since 2008, gasoline consumption has declined and remained substantially below its peak in 2007. This has created an economic drag, but has also been an enormous boon in reducing air emissions.

America is crazy about consumption. Our houses, closets and garages are stuffed with junk. An important national sport at a certain time every year is to go out and shop for more. The Center for Sustainable Systems at the University of Michigan has some facts on U.S material consumption:

How muniland sees cities

Alisha Green of Sunlight Foundation is working on a project to identify the ways that different types of data are used to describe cities. She put up a great post that sketches out a number of ways to view a city demographically, including population density, unemployment and housing. She asked me recently to write about how I personally view cities. I think of cities almost entirely as cash flow machines that collect taxes and provide social services. That is muniland. Here are Alisha’s questions and my answers:

1. From your point of view, what is a city?

Cities are legal entities that are incorporated to provide essential services; especially police, fire, education and water and sewer systems. Depending on the state, cities have legal authority to enter contracts, collect specific types of taxes and maintain judicial systems. Many cities also provide more expansive social services including care of the elderly and disabled and maintenance of parks and hospitals.

2. How have cities changed over the last 10 years?

Many cities saw strong revenue growth from the real estate bubble that began about 10 years ago. Then revenues flat-lined as housing prices plummeted. Generally, about half of local revenues come from property taxes, so budget adjustments have been widely necessary. Also, pension payments have become an increasing drag on city budgets, so other spending has been curtailed. Some well-positioned cities like San Francisco have seen great growth, while others like Cleveland have seen a lot of emigration. Cities are living, breathing entities which evolve in many ways. I think cities are becoming increasingly attractive places to live and work, compared with suburbs or rural areas.

Illinois on the downward slope

The state of Illinois was placed in the lower investment grade class last week when Standard & Poor’s downgraded the state to A- with a negative outlook.

Fitch

Moody’s

Standard & Poors

A  [negative watch]

A2  [Negative outlook]

A -  [Negative outlook]

On a market-based scale, the Fitch (A) and Moody’s (A2) ratings for Illinois are considered equivalent, while Standard & Poor’s is considered one notch lower. But more importantly, all the raters have a “negative watch or outlook” on the state. This means that it could be downgraded again. The ship is taking on water.

There are several reasons why raters view Illinois so negatively. The state’s spending is way out of line with its revenue and its deficit is about 25 percent of its annual budget. Unlike the federal government, Illinois cannot endlessly issue new bonds to cover annual shortfalls. Instead, the state simply delays paying its bills from year to year. From S&P’s rating action:

The big cliff that Nate Silver didn’t see

Nate Silver of the New York Times weighed in with his substantial analytical skills on the growth of government spending. For a data source, he used usgovernmentspending.com, and most of the federal spending he analyzed appeared to be in line with the general consensus. But there was one area that has been very contentious, the federal debt, which is where his data source did not serve him well. Here is how he describes America’s debt:

Another surprise is how little we are paying in interest on the federal debt, even though the debt is growing larger and larger. Right now, interest payments make up only about 6 percent of the federal budget. In addition, they have been decreasing as a share of the gross domestic product: the federal government spent about 1.5 percent of gross domestic product in paying interest on its debt on 2011, down from a peak of 3.3 percent in 1991.

 

The interest payment total that Silver uses, saying that U.S. debt interest payments are “only about 6 percent of the federal budget,” seems to be $247 billion. But the Government Accountability Office said in their GAO-13-114  Schedules of Federal Debt (see chart above) that total interest expenses on the federal debt were $432 billion, or 11.4 percent of the federal budget.

Calling New York State Comptroller DiNapoli

Late in 2012, New York State Comptroller Thomas DiNapoli launched the Fiscal Stress Monitoring System, an early warning system for municipal entities in the state that were suffering financial stress. The program’s purpose was described this way in a webinar:

To identify both local governments and school districts that are in fiscal stress, as well as those nearing fiscal stress.

To identify for local officials the need to take actions in a timely manner that change their financial trends for the better.

Assured should seek a new credit rating

Moody’s released it’s long awaited opinion of Assured Guaranty’s creditworthiness on January 17th. Moody’s analysts were not feeling good about the subsidiary that insures the bonds of municipalities. They pushed the rating down three notches from Aa3 to A2. The Bond Buyer noted that “fundamental challenges inherent in the business model make a return to the Aa rating level unlikely.” Zap and you are dead.

In the municipal bond insurance space, firms make money by insuring (or wrapping) bonds of communities or public entities that have lower credit ratings. This saves money for the entity issuing the bonds because it has a lower cost of borrowing and the insurer is guaranteeing that they will repay investors if the bonds default. It also benefits the investors who know that they will be made whole if the issuer cannot make payments on their bonds.

However, when a bond insurer’s rating is lowered, that means the pool of bonds it can insure shrinks because many new bonds have higher credit ratings. Assured now has a lower credit rating than most bonds being brought to market.

Are private toll roads a losing idea?

President Obama and others have called to create a “national infrastructure bank” that would leverage the credit backing of the U.S. to fund more privatization of public assets – also known as public-private partnerships. In other words, a federal bank to fund the selling off public assets with loans or guarantees provided at low interest rates. But is control of public assets a successful business model for the investors? Actually, it seems to be a disaster. Let’s look back at private toll roads over the years.

An academic paper “Is there ‘value for money’ in transportation PPP’s?” looked at the efforts of the Australia infrastructure firm, Macquarie, in building private toll roads in the United States. The paper, published in 2007, included this table of Macquarie’s U.S. projects. The record for these projects is abysmal.

Two of the projects declared bankruptcy. The assets of one, Pocahontas, were written down to zero by its new owner, and two were bought by the government jurisdictions where they were located. Another is in negotiations to be bought by the state of Virginia. None of these projects fulfilled their initial plans to operate successfully as profitable, private companies. Macquarie’s most substantial U.S. project, the Indiana Toll Road project, is near insolvency and attempting to restructure its loans.

The end of muniland interest-rate swaps for Pennsylvania?

Pennsylvania may have suffered more damage from municipalities using interest rate swaps than any other state in America. Many cities and school districts were sold these “hedging” instruments after former governor Ed Rendell pushed legislation allowing their use in 2003. The fallout for the state has been devastating.

Small communities, large cities and school districts have suffered substantial losses from their use. Bloomberg reported in March 2008 how a school district suffered deep losses:

James Barker saw no way out. In September 2003, the superintendent of the Erie City School District in Pennsylvania watched helplessly as his buildings began to crumble. The 81-year-old Roosevelt Middle School was on the verge of being condemned. The district was running out of money to buy new textbooks. And the school board had determined that the 100,000-resident community 125 miles north of Pittsburgh couldn’t afford a tax increase. Then JPMorgan Chase & Co., the third-largest bank in the U.S., made Barker an offer that seemed too good to be true.

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