MuniLand

The Christie discount

The media is reporting that New Jersey Governor Chris Christie will announce that he is not running for the Republican presidential nomination this afternoon. That’s probably wise given that the credit markets’ opinion of New Jersey would undercut any claim candidate Christie could make to being a responsible budget manager.

If you look at the Markit municipal credit default swap chart above you can see that credit markets think that the financial condition of New Jersey is pretty bad. It ranks only behind California and Illinois as a poor credit risk. It would be very hard for Governor Christie to tell the story of his fiscal successes in his state given the data. To be a credible candidate for the presidency he needs to develop real improvement for his state and reverse the Christie discount.

Here is the real muniland story

From the blog Credit Writedowns:

US states and local governments cut their debt by 3.2% in Q2 and 4.2% in Q1. This year looks to be the first year since 1996 that local governments in the US reduced their indebtedness.

Muniland’s dog eat dog

From Stateline (emphasis mine):

It may not quite be every level of government for itself, but many states are showing far less willingness to share revenues, even revenues that local governments consider theirs. They are forcing localities to streamline by limiting their ability to raise money, as with legislatively mandated property-tax caps in New York, New Jersey and Indiana, or Nebraska’s moves to keep Omaha from taxing the vehicles of suburban commuters and restricting cities’ ability to tax telecommunications.

States are setting out to reshuffle responsibilities up and down the governmental ladder — along with the funds that go with them — as California Governor Jerry Brown decided to do in this year’s budget. They are forcing local governments all over the country to reconsider long-established ways of doing business. And they are compelling local officials to rethink their relationship with state government.

Our nation is overdue for an overweight leader. President William Howard Taft, seen at left, was a heavy man who had accomplished a lot when he completed his term in 1913. His successes laid the groundwork for exceptional economic growth for the century. Wikipedia says:

His domestic agenda emphasized trust-busting, civil service reform, strengthening the Interstate Commerce Commission, improving the performance of the postal service, and passage of the Sixteenth Amendment.

The 16th amendment allowed the federal government to assess an income tax without apportioning it among the states or basing it on Census results. The big man had impressive results in his term of office.

The small town of Collingswood, New Jersey is facing some rough sledding in the next 90 days as it attempts to raise cash to pay off loan guarantees it made on behalf of a local condo and commercial development.

The private project, The Lumberyards, originated in 2006 with funding from TICIC, a consortium of New Jersey banks that provided $18,000,000 in construction loans to Lumberyard Condominiums. After completing about one third of the project the developers encountered weak demand when the housing market and economy softened following the 2008 financial crisis. The developers are now broke and have turned to the town of Collingswood, their municipal guarantor, to repay the loan to TICIC.

Moody’s downgraded the town six notches due to its weak financial position and the difficulty it will face in repaying the loan to TICIC. Moody’s picks up the tale:

Public pensioners everywhere should be worried today. There is devastating news from Central Falls, Rhode Island as the city’s receiver has cut the monthly pension payments to retirees. From WPRI.com:

Central Falls slashed one in three of its retirees’ pension checks by more than half this month, with the majority of the city’s former public-safety workers set to lose tens of thousands of dollars a year.

Receiver Robert Flanders reduced 48 of the city’s 141 police and fire pensions by 50% or more, with all but three of those cut 55% from their original amount, according to financial records obtained by WPRI.com.

Irene has come and gone. She was a big girl but fortunately she didn’t cost a lot in terms of economic damages. The biggest toll was the 25 lives she claimed. I mourn those deaths and know their loss is incalculable to their families.

Local, county and state officials responded to the disaster admirably. Local newspapers and television stations are full of stories of families evacuated and emergency measures taken. New Jersey and New York City preemptively evacuated millions of people and shut down mass transit and other infrastructure systems. Given the scale of potential damage the losses have not been that great.

The economic loss of Hurricane Irene has been estimated at approximately $3 – 4 billion. Measured against a gross domestic product of $14 trillion Irene will ding the economy for about 0.214% of its annual output. Some have suggested that this will give the construction industry a boost, but it’s not significant. Irene’s damage, on its own, is not a substantial blow to the U.S. economy, but nine other “weather disasters” have caused more than $35 billion in damages this year, according to the National Climatic Data Center at the U.S. Department of Commerce (hat tip Empty Wheel).

Hurricane Irene, an enormous storm of unimaginable power, is bearing down on the east coast. Although there could be loss of life and substantial property devastation, America has more than enough resources to meet her and survive mostly intact. Unlike third-world countries we have the people, equipment and money in reserve to clean up. But it maybe the human locusts that follow in her wake that are hardest to battle against.

Irene is expected to make landfall in North Carolina, but it is the northeastern states that have made extraordinary efforts to evacuate the population and shut down public transportation systems. The corridor stretching from New Haven, CT to Atlantic City, NJ is one of the most densely populated areas in America; 55 million people are currently preparing for this large natural disaster.

Cities, counties, states and utility companies are on standby. Funds have been reserved to respond to emergencies and the federal government has a large department, the Federal Emergency Management Agency, ready to provide local assistance. The public sector is ready to go.

The debt of the United States was downgraded by Standard & Poor’s several weeks ago, but the price of U.S. Treasuries have skyrocketed since then. This confuses many people because a baseline relationship in the fixed-income markets is that lower-rated, less-creditworthy bonds will be relatively cheap and investors will demand higher interest rates to compensate for additional risk.

To see this bond market truism, it’s much more instructive to look at the downgrade of the debt of New Jersey. Fitch lowered the state’s credit rating Wednesday citing heavy debt and benefit obligations. This followed downgrades by Moody’s and S&P earlier in the year. Municipal bond and credit default swap markets didn’t like this third downgrade and did what you would expect them to do: they required more yield in the case of cash bonds and more payment in the case of credit default swaps.

The graph above charts muni CDS prices for New Jersey (data supplied by Markit). You can see the move up in CDS prices began in June when Governor Christie and the state legislature made the final run to their agreement on the fiscal 2011 budget, which began on July 1. The uncertainty and contentiousness of the process must have spooked investors and dealers.

New Jersey downgraded again

Yesterday Fitch joined Moody’s and S&P in downgrading the state of New Jersey to AA-, the fourth lowest investment-grade rating. This places New Jersey in the lowest 10% of states in terms credit quality and deflates the story of Governor Chris Christie’s repair of the state’s unfunded pension liabilities. From Bloomberg:

A bill putting more of the pension and health-care burden on employees, signed by Governor Chris Christie in June, won’t prevent the need for increased state contributions, Fitch said yesterday in a report. Other negatives were a weak economic recovery, persistent deficits and high debt, the company said.

Christie, a 48-year-old Republican, signed a $29.7 billion budget in June in which he vetoed about $1 billion in spending added by Democrats who control both the state Senate and the Assembly. The spending included a pension payment of about $480 million, below the $3 billion recommended by actuaries. The state hasn’t made full payments into its pension system for most of the past decade.

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.

Every family encounters times when bills are due and they don’t have money. If this happens to a state or local government, they go to the municipal bond market where they can borrow short- or long-term. In the current market they are likely to find a lot of willing lenders.  These lenders will lend at very reasonable interest rates, and the terms of the borrowing will be made public so taxpayers can see what their obligations are.

Since there is so much demand in the muni bond market I was surprised to see that the State of New Jersey was going to set-up a “bridge loan” with J.P. Morgan Chase, one of Wall Street’s biggest banks. The specific details of the borrowing have not been announced, but tidbits released in the media suggest that the lending rate from the bank will be twice the rate from the muni bond markets.

The consumer analogy would be using a neighborhood payday lender rather than taking a cash advance on a credit card. The payday lender would charge you 10% and the credit-card company would charge 5% for the same loan. These are made up examples, but give a glimpse into the most important variable when comparing the state’s borrowing choices.