This article originally appeared in Business Insider
August 11, 2011
By David Johnson, ACM Partners
Bloomberg has an article today testifying to how calm municipal bond investors have been. Unsurprisingly, demand was strong on the 9th, with buy orders outstripping sell orders by a 2.5 to 1 ratio. Frankly, on August 9th municipal bonds were certainly not the worst place to store your money in the short-term.
There continues to be a paucity of realistic thinking on the underlying quality of municipal credits in the investor community. Howard Cure of Evercore Wealth Management advocates a focus on the bonds of providers of essential services. In light of the severe haircut holders of Jefferson County’s sewer bonds are facing, that advice is, at a minimum, in need of an adjustment based on recent events.
Moody’s comments on the strength of the municipal market hardly inspire confidence. A Reuters article yesterday quotes Timothy Blake of Moody’s as noting of municipalities: “some may face significant stress if hostile market conditions emerge.”
It is a fairly established principle in turnaround and restructuring circles that a debtor who lives by the market can (and often does) also die by the market. With revenues still below pre-recession levels, the need for state and local governments to rationalize both their cost structures and their outstanding liabilities is paramount. “Hostile market conditions” are upon us, as fear of continuing sovereign debt instability in the euro zone, emerging market reactions to inflation and U.S. economic weakness provide the markets with a veritable buffet of threats.
While financial professionals remain disturbingly sanguine, state and local government officials have been increasingly pressing the panic button. A representative sample:
- Karen Grande, Rhode Island’s municipal finance counsel, recently stated that the logic behind a recent Rhode Island law giving precedence to bondholder claims was “so that other municipalities and Rhode Island itself would not be adversely affected by one going bankrupt.”
- Gina Raimondo, Treasurer of Rhode Island, has called on the state to enact pension reform.
- Milwaukee County Supervisors Joe Sanfelippo and Johnny Thomas have argued that the window for tackling their county’s $51 million operating deficit is quickly closing.
- Illinois governor Pat Quinn is advocating a debt restructuring and recently sued the state’s largest employee union after it won a $75 million wage increase in an arbitration award.
- An analysis of a 2010 Rhode Island Auditor General’s report on municipal finances indicated that eight municipalities other than Central Falls were paying facing annual required contributions (ARC) for their pension and healthcare benefits in excess of 25 percent of their tax levy. By this measure Central Falls is not the sick man of Rhode Island; that honor goes to Pawtucket, with its 2009 ARC at nearly 59 percent of that year’s tax levy.
State and local government has reached a crossroads. Government leaders have recognized it, and eventually the market will catch on. Until then I comfort myself by paraphrasing Barry Goldwater: Extremism in the defense of reality is no vice. And moderation in the pursuit of falsehoods is no virtue.