MuniLand

There has been so much talk in muniland about massive defaults, but so far there has been very little discussion about the actual mechanism of default and municipal bankruptcy. Public entities generally try everything before resorting to default or bankruptcy. The video above is an excellent primer on the many choices that can be made leading up to the end game.

Bond defaults can happen with or without a bankruptcy. Here is Wikipedia’s definition of default:

In finance, default occurs when a debtor has not met his or her legal obligations according to the debt contract, e.g. has not made a scheduled payment, or has violated a loan covenant (condition) of the debt contract. A default is the failure to pay back a loan. Default may occur if the debtor is either unwilling or unable to pay their debt.

If a bond issuer doesn’t make a scheduled interest or principal payment on time (though there is usually a thirty-day grace period), then the bonds are considered in default.

The most common investor concern you hear in muniland is “willingness to pay.” One way to think of this would be if you managed the family budget and had to make a choice between feeding your children or paying your credit card bills. For a muniland bond issuer like a city, the comparable choice is between paying your bondholders before your employees.

Excellent chart from Barry Ritholtz’s The Big Picture. He uses data from the Federal Reserve’s Flow of Funds Accounts to map credit flows. State and local governments have become negative borrowers in the first quarter as the amount of bonds that have matured and the amount of principal that has been repaid exceeded new bond issuance. States and municipalities are making the hard fiscal choices and restraining borrowing and expenditures. It’s painful, but it must be done.

Delaware opens the procurement kimono

From Governingpeople.com:

Delaware has launched a new website to make it easier for entrepreneurs, small businesses, and other employers to do business with the State of Delaware. The new website will serve as a resource for companies interested in bidding for State contracts. The Governor hopes that the site will make the bidding process easier and more transparent for business owners so they can create jobs in the state easily…

…The public will also be able to see state spending trends and details of contract usage. The public can also access business development tools, customer satisfaction surveys and “I Found it Cheaper,” which allows individuals to submit suggestions on how the State can procure goods for less money.

Bloomberg covered an interesting story today about the bonds which financed the parking garages at Yankee Stadium in New York. The $237 million of securities are “revenue” bonds issued by the Empire State Development Corporation. They have no guarantee and no rating, and it looks likely that the bonds will default.

The main reason that the bonds face default is that attendance at Yankee games is off about 10% from last year. I don’t follow baseball so I’m not sure why that is happening (if you have ideas please leave in the comments below). But the revenue for these parking garages has declined much more steeply than baseball attendance. Bloomberg says this about the garage revenue:

Revenue from the garages and parking lots managed by the nonprofit is almost 40 percent below projections as the facilities face competition from public transportation and other parking at a mall near the stadium.

I had really hoped that Meredith Whitney had gone back to analyzing banks and trying to interpret how the new Basel 3 liquidity ratio would be phased in. Unfortunately, she is back touring the mainstream financial media with another shrill message for muniland.

Muniland’s loudest harpy threw out some real doozies yesterday on CNBC and in a Fortune interview. The most outlandish claims Ms. Whitney made related to the proportion of state’s budgets that were going to service their debts. The substance of her statements were expertly demolished by Nicholas Johnson of the Center on Budget and Policy Priorities:

Whitney wildly exaggerates what states are spending on interest, claiming for instance that “debt service absorbs half of Nevada’s budget.”

How does $775 billion of bonds go missing?

There is a sleeper story in muniland about a big pile of just-discovered municipal bonds. The story has some odd twists and turns. John McDermott of FT Alphaville scooped the details yesterday:

FT Alphaville typically estimates the size of the muni market at $2,900bn, based on year-end 2010 data from the Federal Reserve. The FT uses the same figure, occasionally rounding up to $3,000bn.

But the Fed is underestimating the size of the market by nearly $800bn, according to analysis by Citigroup’s municipal bond team.

Several of my Reuters colleagues sent over this graph. My editor said “it’s nice but doesn’t give much historical context.”

So let’s start with the big picture.  From Publicbonds.org:

In 1988, a study by Enhance Reinsurance Co. looked at historical patterns of municipal defaults from the 1800s to the 1980s and concluded that municipal defaults usually follow downswings in business cycles and are also more likely to occur in high growth areas that borrow heavily.

Following the 1873 Depression, when more than 24 percent of the outstanding municipal debt was in default, the greatest number of defaults occurred in the South, the fastest-growing region at the time.

It’s a glorious spring day in America and everything continues to bounce along. A little progress here and some fall back there. Oh and that unpleasant negative ratings watch on United States debt from Standard & Poor’s. Yeah that is not good. Welcome to a new week in muniland.

The sun sets over a pond in Rogers, Arkansas, November 8, 2009. REUTERS/Lucy Nicholson

Increasing the muni investor pool:

Marketwatch has an article which frames the proposed Wyden and Coates federal legislation for muni tax-exemption as having the effect of shrinking the investor pool.