MuniLand

Muniland holds steady

Municipal bond ownership has remained relatively steady over the past year, according to the Federal Reserve’s latest Flow of Funds data, which was released yesterday (Fed’s L.211 Municipal Securities and Loans page 92). The data paints a different picture than the one we typically hear from the media of large outflows from retail investors and mutual funds following Meredith Whitney’s prediction of massive municipal defaults. Essentially the whole municipal bond market has increased slightly in size, growing from $2.842 trillion in 2Q 2010 to $2.886 trillion in 2Q 2011. Ownership for all categories has remained pretty steady.

The puzzling part is that the Federal Reserve continues to maintain that muniland is about $2.8 trillion in size. Back in June my colleguage Daniel Berger of Thomson Reuters Municipal Market Data kicked up a dust storm when he began to question the overall size of the municipal bond market. George Friedlander of Citigroup got on the story too and wrote the following:

After considerable conversation with Federal Reserve staff and recalculation based upon separate sources, we have concluded that the Fed’s data dramatically understates the amount of outstanding municipals. We now estimate that there is a sum total of roughly $3.7 trillion in state and local debt outstanding, in comparison with the $2.925 trillion reported by the Fed for year-end 2010. While the Fed may modify its data at some point, we felt that it was important to present this modified picture of the size and mix of holdings on a timely basis.

It would be useful if the Federal Reserve was able to verify the size of the muni bond market, especially as President Obama and the Congress make proposals to alter the tax treatment of these bonds. It would certainly help policy-making if there were accurate baseline data.

Moodys: Defaults and bankruptcies to remain “rare”

Reuters reports that the rating agency Moodys continues to see stress on state and local government finances but predicts few defaults or bankruptcies for municipal bonds. From Reuters:

Municipal bonds are not just for rich people

This Bloomberg interview with John Miller, co-head of fixed-income at Nuveen Asset Management, is a good overview of the current state of muniland although I disagree with his comment that “many, if not most municipal bond holders are in the highest tax bracket”.

Actually IRS data tells us that about 75% of filers who claim exclusion for tax-exempt municipal interest earn less than $200,000 per year. As with all financial assets the richest own the most by quantity but municipal bonds are held pretty broadly. It’s not just a rich persons asset class.

Further: Citibank: US Municipal Strategy Special Focus

Big, big day for Jefferson County, Alabama

The Jefferson County Commission will hold a meeting today to determine whether to accept their creditors proposal for settlement of defaulted sewer bond debt or declare bankruptcy. My opinion is that they will settle and creditors will take a haircut of about 33 cents on the dollar. This will be a very important precedence for muniland workouts. Stay tuned. Here is some of the coverage:

Supporting less prosperous brethren

There are many financial linkages between various levels of government in muniland but everyone eventually has to stand on their own. It’s like the cousin you grew up with but don’t see much now other than holidays. When your cousin loses their job and their mortgage is being foreclosed you want to help but in a limited way. You want the cousin to get a job and cut a deal on their mortgage or do a short sale. You don’t want them moving into your home or having access to your bank account. It’s the same between the federal, state and local governments. They are cousins. But not that close.

My fellow Reuters blogger, Felix Salmon, said yesterday that states are considered too-big-to-fail by the financial markets:

There’s certainly a general understanding, in the markets, that California is too big to fail: if push came to shove, the federal government would bail it out rather than let it default.

The middle sadness

The middle sadness

Paul Mason, the economics editor of the BBC’s Newsnight program, recently retraced John Steinbeck’s footsteps during America’s Great Depression.  What he found was a broad swath of sadness as he observed many citizens who have lost jobs and homes. It’s the invisible America. From the BBC:

I drop down into Albuquerque, into Joy Junction, which in the red dusk looks like a scene from Steinbeck. There are 300 homeless people staying here, all families.

Jeremy Reynalds, an expat Brit who runs the place, tells me frankly that the mainstay of the place are people with drug, alcohol and domestic violence issues. But as the years of crisis have dragged on, there is a new phenomenon – the homeless middle-class.

Continuing wills for the United States?

The theatrics in Congress concerning the debt ceiling, now in their seventh month, have sent increasingly strong shock waves throughout the U.S. and global financial systems. The debt ceiling is the legislatively-imposed limit for the nation to issue debt to fund its activities. It’s been stalled at the same level of $14.3 trillion since May 16. The U.S. Treasury has been scrambling to find extra monies, including borrowing internally from the federal government workers’ pension plans, so that they can continue to pay the nation’s obligations. They say the cash drawer is near empty.

The United States borrows or issues debt for 40 cents of every dollar that it spends — that is a lot to borrow. The federal government turns around and distributes this borrowed money, along with taxes collected, to Social Security and Medicare beneficiaries, states and local governments and defense contractors. It also returns some of it to bond holders as interest payments. The federal government is so massive that this flow of payments equals about 24% of the gross national product. If this flow stops, substantial parts of the economy will stop.

Organizations that oversee, or participate in, the financial system are rightly concerned. One positive benefit of these long, drawn-out Congressional deliberations is that there is time for extensive planning and analysis. Credit rating agencies have particularly been concerned with the downstream effect on state and local governments. Today Moody’s issued a press release that affirmed the strong AAA rating of 400 local governments while saying it would review the AAA rating of 162 other local governments (emphasis mine):

Markets hold the whip, but are they rational?

There has been a lot of discussion over the past few days about whether the United States deserves a triple-A rating. The weak and meandering attempts of the Congressional leadership and President Obama to reach a consensus on raising the debt ceiling has prompted this storm of confusion. The political theater is painful.

Most of the talk about ratings revolves around whether the level should be lowered one or more notches. But in The Telegraph today Ambrose Evans-Pritchard goes further and says it’s not really that important whether the United States retains a triple-A because the credit rating agencies don’t have the credibility to strip the rating to the world’s largest sovereign debt issuer (emphasis mine):

Yes, the US may be stripped of its AAA by Standard & Poor’s. A nice one-day story, but otherwise irrelevant. Global bond vigilantes are quite able to make their own judgement on the substantive default risk of the US. The rating agencies are out of their league on this one.

Relying on the rich uncle

State and local governments earn their “wages” primarily by collecting taxes, although states get significant “flow-throughs” from the federal government for Medicaid and other social entitlements. Every state varies in where they draw tax revenues from. For example, states that are highly dependent on tourism will see substantial revenues from hotel and sales taxes.

New York and New Jersey are two well-to do states that have historically relied on sharing in the largesse of their rich uncle from Wall Street. The Federal Reserve Bank of New York published an interesting paper last year that talked about how these two states were heavily reliant on tax revenues from the financial sector and were especially affected by the financial crisis of 2007-2009. Wall Street revenues rebounded sharply in 2009 and 2010 but are now sputtering and projected to decline going forward due to financial reform and the slow pace of recovery.

One recommendation of the Federal Reserve’s research staff was to have a reduced reliance on personal-income taxes, which fluctuate with the economy, and a greater reliance on sales taxes, which tend to be more stable. Unfortunately, sales taxes tend to be regressive and place a heavier burden on the poor, who spend the bulk of their income on consumption.

“To win the future, we must dream big and build big”

America’s Interstate Highway System celebrates 55 years

This is the best example of how public infrastructure can really anchor tremendous economic growth. We can learn from history and use this time of economic challenge to conceive of equally profound infrastructure goals. From Fastlane, the blog of U.S. Secretary of Transportation Ray LaHood:

As President Obama has said, to win the future, we must dream big and build big. One of the best examples of dreaming and building big in our nation’s history is America’s Interstate Highway System, which marks its 55th anniversary today.

On June 29, 1956, President Eisenhower signed the Federal-Aid Highway Act of 1956, which established a program for funding and building the new system. This legislation has been hailed by historians as one of the top ten bills in American history, surpassed only by the Civil Rights Act and Medicare, and the Interstate Highway System has been called the greatest public works project in history.

The global spiderweb of debt

If you are not familiar with the municipal bond market, you may think that muniland is nothing more than states, municipalities and school districts offering plain bonds that mature on a set date and offer a fixed interest rate. That is the textbook description.

Actually the municipal bond market is a murky tangle of odd bond structures, variable-rate debt, multiple layers of issuers and bank guarantors. The lack of standardization of bond structures and relationships is one of the main reasons that the asset class has never migrated to the internet for retail investors.

Often the odd bond structures can create much more exposure to the tides of global affairs than plain vanilla bonds. The biggest example now is the Belgian-French bank Dexia, which is a big guarantor of U.S. muni bonds.The WSJ reported in an excellent article that investors are selling off muni bonds that Dexia insures:

Is the taxpayer backstop the root of pension problems?

Public workers have been protesting against the reduction of their benefits in several states. It got a more than a little testy in Wisconsin this winter, which has led to several recall elections for legislators there.

It is the right of public workers to push back when they believe they have been treated unfairly. But it is also the responsibility of public workers, and especially their union leaders, to help create a realistic, sustainable benefit scheme for themselves. Too often union leaders insisted on more and more benefits and lower contributions while ignoring the damage done to the viability of their pension plans.

Maybe they didn’t worry because they knew that taxpayers would have to make up shortfalls in underfunded pension plans. Maybe the guaranteed taxpayer backup is the root of our fiscal problems. It has placed all the responsibility for fiscal prudence on elected officials who often are easily swayed by well-organized constituent demands.

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