High tax rate state Muni Bonds ... legal tax shelter for the 'rich' or a ticking bomb
(snip)"Huge Flaw in Municipal Bond Assumptions
Everyone plowing into municipal bonds on the assumption the federal government will bail out the states may have another thing coming says Herbert Gold at Institutional Risk Analyst.
Please consider The Great Contraction Coming in State Finances
Back in August, the U.S. House of Representatives took a break from its recess to pass legislation giving $26 billion to the States for education and healthcare. This $26 billion is a stealth bailout for States on the verge of default. As such it is a band-aid that prolongs the crisis while sending a false signal to the markets. In the event of a State default Washington will not rescue the States.
The municipal debt crisis is well known. California by some measures has the world's 8th largest economy, yet it faces the prospect of once again issuing IOUs to its creditors as its government continues to struggle to pay its bills. Illinois, America's fifth most populous state, is running nearly half a year behind on meeting many of its obligations. New York and New Jersey, the latter despite some bold political moves by Governor Chris Christie, are similarly situated. Indeed, according to the Center on Budget and Policy Priorities only four states have avoided budget shortfalls this year.
Despite these conditions the market for State debt remains placid. Municipal securities continue to trade at favorable rates even though the larger economy has shown no solid signs of meaningful growth. The reason for this lies both in the fact that States historically don't default, and the belief that Washington will provide funding in the event of a true crisis.
The market continues to assume the federal government would not let a big issuer like California default. But this theory has a huge flaw: absent a vote from Congress there is no easy mechanism for the federal government to rescue the States. And after the political backlash from the TARP vote it is safe to say Congress will be loathe to issue any more blank checks to bail out the states.
It's unlikely the Fed would be inclined to bailout a State in distress given the political backlash the institution would face after another open-ended program that told the world (yet again) the US was ready to simply print its way out of its problems.
The market remains convinced that, in the worst-case scenario, Congress would not risk the disruption that would follow a State default. But countering this idea is the role federalism plays in our political system as well as an appreciation of the damage done to politicians who supported TARP.
Senator Bob Bennett (R-UT), a highly respected member of the Senate, was unceremoniously dropped from the ballot in the Republican primary in Utah in large part because of his vote on TARP. At least five other sitting officeholders have lost in their own party primary this year for the same reason, to say nothing of the large- scale losses likely to occur this November. Any politician interested in keeping his or her job would be very wary of voting for a State bailout. And this does not account for the role the States play in America's governing system. Ask a citizen of Oregon to bailout California, or a citizen of Michigan to bailout Illinois, and you are likely to get the same cold silence.
Treasury prefers to allow Illinois to borrow at low rates for as long as possible in the hope that somehow they will stumble through this crisis. From Treasury's perspective it is a free option, but the real price of this false confidence will only become clear after it is too late.
The genius of the American system is its flexibility, allowing States to be responsible for their own governance and finances. If some must bear the burden for reckless spending it should be the citizens of those States. Washington won't bail out the States and the market should be prepared for defaults. But just remember that it won't be the first time that an American state has defaulted on its debt."(snip)
from
Arguably, this situation has three resolutions ...
- the US Congress votes for a bailout of bankrupt states ( led by California, Illinois, Pennsylvania, New York, New Jersey, Michigan ) which winds up being a stealth subsidy extracted from the federal taxpayers in non-bankrupt states ( like Texas, Missouri, ND, SD etc.).
- there is no federal bailout and the bankrupt states are forced to enact MASSIVE state tax increases in order to make principal and interest payments on the muni bonds they have already issued ( many of which are owned by uber-rich state residents )
- there is no federal bailout and the bankrupt states seek bankruptcy protection ... thus stopping future principal and interest payments on existing muni bonds ( thus handing existing bondholders i.e. uber-rich state residents major losses )
Re: High tax rate state Muni Bonds ... legal tax shelter for the 'rich' or a ticking
Austerity is coming, whether anybody likes it or not.
Z
Re: High tax rate state Muni Bonds ... legal tax shelter for the 'rich' or a ticking
^^^ obviously nobody that is actually subjected to austerity measures will like it. However, a larger question concerns how 'evenly' the pain from coming austerity measures actually winds up being distributed.
Re: High tax rate state Muni Bonds ... legal tax shelter for the 'rich' or a ticking
If you have the guts to bet your money on bailouts, well, good luck with that. There's a reason the yields trade above the risk free rate.