MuniLand

An increase in the minimum wage and universal pre-kindergarten education were part of the centerpiece of Barack Obama’s State of the Union address this week. These proposals address both income inequality and low academic achievement. Expanding pre-k education would benefit all states that would be willing to participate. According to the Council of State Governments:

Today, 39 states provide funding for 4-year-old kindergarten. Nine states plus the District of Columbia offer pre-K to all 4-year-olds. No state provides universal pre-K programs for 3-year-olds, although 26 states provide pre-K for some 3-year-olds, according to the National Institute for Early Education Research.

This provides a good foundation to build on. What is gained by educating four-year olds? From the Council of State Governments again:

That question was the subject of a research study published in a 2005 edition of The Policy Studies Journal, a product of the academic research group Policy Studies Organization. Researchers tested four-year-olds entering pre-K and a similar-aged control group that had not attended preschool. The study revealed 4-year-olds who had completed a year of preschool scored 16 percent higher on language tests than children who had not attended preschool. The results varied widely, however, according to race and economic background.

White children showed no significant increase in test scores, while Hispanic children’s scores increased more than 50 percent. Low-income children’s scores also increased significantly, including a 31 percent increase in cognitive skills and an 18 percent increase in language skills. The research concluded children enrolled in full-day pre-K programs outperformed those enrolled in half-day programs.

The need for more infrastructure must be brought back to center stage. Creating middle-class jobs “must be the North Star that guides our efforts,” President Obama said in his State of the Union address on Tuesday. More improved bridges, tunnels, ports and other shared infrastructure would be a great way to boost the economy, create jobs and improve the hard assets that support business and public activities.

Many infrastructure projects are taking place under the radar, guided and funded by state governments. These projects are usually designed and driven by states with some funding from the federal government as well as municipal bonds and toll or user fees. The bridge that carries I-75 and I-71 traffic over the Ohio River between Ohio and Kentucky is a perfect example of a joint project. This is a bridge in Senate Minority Leader Mitch McConnell and House Leader John Boehner’s districts that President Obama stood in front of last year to sell his $467 billion jobs bill. The bill was never approved by Congress. The bridge highlights the difference between the two parties on funding infrastructure. Bluegrass Politics blog covered the story:

Obama joked that it was “just coincidental” that he came to the bridge in the backyards of McConnell and Boehner.

In 2012, municipal debt issuance totaled $367 billion, just shy of the 10-year average ($381 billion) and a level last seen in 2003 ($378.5 billion). The blue line in the graph above shows that about 65 percent of this debt was issued to refund previously-issued debt (to get a better interest rate or other term). The balance, about 35 percent, was “new money” debt issuance to fund projects that previously had not been funded. The market sees a slight increase in issuance for 2013. According to SIFMA’s 2013 Municipal Issuance Survey, volumes are expected to be $393 billion.

New York outpaced all other states in the amount of debt issued for 2012. Of New York’s $48 billion in debt, $11.6 billion went to general obligation bonds and $36.7 billion went to revenue bonds. (See the full list of debt issuance by state on page 7 – PDF).

Here is part of a SIFMA chart that shows the amount of debt that is outstanding for each state government and the other public entities that issue debt within that state (page 13 – PDF). If you add up the “Due in 13 months” column you can get an idea of how much debt will need to be issued this year to re-issue that debt if it is not being paid off.

Muniland ground rule number one: Never use the state of Rhode Island as example of national issues. The state has been poorly managed and dominated by union interests for decades. Rhode Island is a high school dropout when it comes to fiscal management. The underfunding of its public pensions is exhibit one.

Josh Barro of Bloomberg has broken muniland’s number one rule and used Rhode Island’s public pension system to argue about systems nationwide. He writes:

This lack of attention has meant that local plans are much more likely than statewide plans to have become deeply underfunded. Of the 110 statewide pension systems covered by the Public Funds Survey, the worst-funded is the Illinois State Employees’ Retirement System, with a funding ratio of 35.5 percent. Sixteen of Rhode Island’s 36 local plans are worse funded than Illinois SERS.

Texas Watchdog.org explains how Texas is mounting the transparency pony:

A quartet of the most powerful legislators in Texas filed bills Thursday to make available to the public detailed financial information from most local taxing entities and pension systems across the state.

Senate bills 14 and 13 and their identical House counterparts establish, at the request of state Comptroller Susan Combs, new requirements for the posting of public debt, unfunded liabilities, borrowing and project costs on websites maintained by state and local agencies.

This new legislation, if passed and signed by the governor, has the potential to set the gold standard for public accounting of spending and taxpayer liabilities. The legislation would require the posting of all tax rate information:

Congress and President Obama are at it again, fighting over taxes and spending cuts. It seems like a bad television show – the same story keeps getting repeated without any hope of a proper ending. In essence, there is too much spending and not enough revenue. The amount of spending currently in dispute is about $80 billion. It is this $80 billion, which needs to be reduced, that is the centerpiece of Washington’s fighting.

The fighting in Washington is always about overall spending and never about the efficiency or productivity of the spending that we do have. It is like a spigot turned on full blast; it has no controls for fine tuning. The Government Accountability Office cannot render an opinion on the 2012 consolidated financial statements of the federal government because of “widespread material internal control weaknesses, significant uncertainties, and other limitations”.

Maybe part of the $80 billion that is currently being fought over could be found by searching for more efficiency in the current budget. If we identified efficiency or productivity gains of 1.5 percent on the $2.6 trillion of annual U.S. spending (read: the budget minus Social Security) we could save approximately $40 billion, or half of what the Congress and president are fighting over. The Labor Department calculates that the productivity change in the non-farm business sector between 2007-2011 was 1.8 percent. Achieving slightly less in government productivity should be possible.

The long awaited prosecution against a U.S. credit rating has finally arrived. The Department of Justice filed a civil suit this week alleging that Standard & Poor’s committed mail and wire fraud and defrauded investors with ratings of residential mortgage backed securities (RMBS) and collateralized debt obligations (CDOs). These securities are known in regulatory and market parlance as “asset backed securities” because loans or bonds are bundled into larger, more complex securities. Until this market collapsed in the 2008 financial crisis, it was the source of great profits for banks, investors and credit rating agencies. It also accelerated the collapse of the financial system as the securities were sold around the world to increasingly less sophisticated investors.

At the core of the allegations against S&P is that the ratings agency loosened its methodology to get more market share from Moody’s and Fitch, the other dominant raters. Bloomberg writes:

In 2004, S&P discussed changing its rating criteria as executives internally raised concerns about losing deals to competitors.

Members of Congress approved spending $198 billion during fiscal years 2012 and 2013 on the war in Afghanistan, according to the Center for Strategic and International Studies. In contrast, in fiscal year 2012, Congress allocated only $37 billion to the Federal Highway Administration for transportation infrastructure. About $23 billion of this spending on highways, bridges and mass transit comes from the 18.4 cents of federal tax Americans pay on a gallon of gasoline. This tax – instituted in 1993 – has not been adjusted (even for inflation) since it was put in place. From McClatchy:

It’s been 20 years since Congress raised the gasoline tax. The 18.4-cents-a-gallon tax has lost a third of its buying power to inflation and rising construction costs.

The tax feeds the federal Highway Trust Fund, which long has paid for a portion of highway construction and repairs in all 50 states.

It is extremely rare to see a muniland market professional pitch a specific bond to the public. In fact, I’ve never seen an analyst or a portfolio manager do it in the general media. So I was more than a little shocked to see Alexandra Lebenthal pitching a newly issued unrated bond on Maria Bartiromo’s show on CNBC.

Unrated bonds inhabit a dark corner of muniland. An August 2012 study by the Federal Reserve Bank of New York highlighted that default rates for unrated bonds have historically been 36 times higher than rated bonds. Here is how the New York Fed puts it:

Our findings raise the question, what causes such markedly different default frequencies between rated and unrated municipal bonds? Our answer: Not all municipal bonds are created equal. Different types of municipal bonds are secured by very different revenue sources with varying levels of predictability and stability. Furthermore, we believe that rated municipal bonds tend to be self-selected: issuers are less likely to seek ratings if their municipal bonds are not likely to achieve investment grade ratings.

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.