(snip)"Muni Watch:
December 19 - Bloomberg (Michael Quint and Jeremy R. Cooke): "Wall Street's three-year love affair with debt sold by U.S. states and cities is over. Municipal bonds, whose returns trounced Treasuries and corporate debt from 2004 to 2006, are headed for their worst year since 1999, according to Merrill Lynch & Co. indexes. They may remain laggards after securities firms reduced their holdings at the fastest pace in at least 12 years during the third quarter, data compiled by the Federal Reserve show."
December 18 - The Wall Street Journal (Amy Merrick): "Falling home values and rising property taxes in many parts of the country are generating the loudest complaints about property levies since the 1970s, forcing state and local officials to address the outcry even as the housing-market slump eats into many sources of their revenue... In California, thousands of homeowners are having their assessments reduced under a decades-old state law, and lower tax revenue due to the weaker housing market is likely to force an emergency budget session. Falling real-estate prices and turmoil in the mortgage market are expected to reduce property values for U.S. homeowners by a total of $1.2 trillion next year, according to Global Insight Inc... Unless tax rates are changed, California could lose $2.96 billion in property taxes over several years because of the housing bust, the firm predicted. New York could lose $686 million; Florida, $589 million."
December 18 - Bloomberg (Henry Goldman): "New York Mayor Michael Bloomberg said a slowing U.S. economy will reduce Wall Street profits and real estate sales, creating 'worrisome' city tax shortfalls... 'The test of our character as well as our policies is how we handle any long-term downturn headed our way,' Bloomberg said. The mayor said that while he is optimistic about long-term prospects because of the city's fundamental economic strengths, 'We are going to have some very tough times.' In October, the mayor ordered budget cuts of 2.5% for the remainder of the fiscal year and 5% for the next year, which begins July 1. He sought to reduce the 2009 budget gap that had grown to $2.73 billion from $1.55 billion in June. The mayor said 'unfunded mandates' for public employee pensions and benefits and Medicaid had increased by $8.2 billion in the six years he's been mayor, costing the city 47 cents out of every dollar in the city's $59.4 billion budget."
December 20 - Bloomberg (Christopher Condon): "Nuveen Investments Inc.'s John Miller, the No. 2 ranked municipal bond-fund manager of the past five years, may post his first annual loss because he kept almost half his assets in unrated securities as prices sank. Miller invested 48% of the $5.1 billion Nuveen High Yield Municipal Bond Fund in non-rated bonds that finance projects such as schools, hospitals and water-treatment plant... The strategy backfired this year when investors fled all but the highest-rated government bonds as subprime mortgage losses mounted.""(snip) from
Please understand that for decades the Municipal Bond market has been a 'stealth' partnership between state / local politicians and the very rich. Under their status as gov't entities, state and local politicians have been able to raise tons of extra money at 'low cost' to continue their gov't spending habits. Since these Municipal Bonds are triple tax free, the very rich have been able to shield their interest earnings from the tax increases on the rich that that the politicians typically call for via the purchase of Muni Bonds. This meant that gov'ts could sell Muni Bonds at a below market interest rate (like 3% versus 6% market rate) to raise additional money, and also meant that very rich investors could get a 3% tax free return (= up to a 6% taxable return depending on fed / state / local tax rates) with essentially zero risk of loss.
Historically, very few Municipal Bonds have gone belly-up resulting in extremely few actual losses for Muni Bond investors. This is because state / local gov'ts were able to buy cheap 'insurance' from a third party company like AMBAC who would pay off the investors in the unlikely event that the state / local gov't went 'broke'. But the big bond insurers have already started to take big losses on corporate and mortgage bonds. As a result they have re-evaluated the actual financial risk of state / local gov'ts going 'broke', and have jacked up bond insurance cost to sky high levels that most states / localities cannot afford to pay.
You're probably wondering 'so what ... I'm not rich enough to buy muni bonds, so why should I care ?". This is why you should care ... and I'll pick the specific example of California since their numbers have been all over financial news lately. California has just announced that it has an unexpected $10 billion dollar shortfall in the state budget. Since states cannot run an unbalanced budget, California has three choices. They can cut spending by $10 billion, meaning huge layoffs for state employees, cutbacks in state social benefit programs, cutbacks in road maintenance etc. They can raise taxes by $10 billion, by a combination of jacking the sales tax rate up to 9-10% plus increasing the state income tax by 20%+ plus enacting / increasing 'sin' taxes. Or they can issue new Municipal Bonds worth $10 billion. During last year's 30 billion shortfall, California opted to issue a shitload of new Muni Bonds rather than cut spending or increase taxes (much), which they were able to do at a 3-4% interest rate, and which very rich Californians quickly snapped up. California taxpayers of course have to pick up an extra 3-4% interest cost in their future income / property taxes in order to pay interest to the buyers of these Muni Bonds - but this is a whole lot more politically palatable than seeing their tax rates jacked up 20% immediately.
However, things are different as a result of the recent developments with AMBAC etc. If California tries to sell another $10 billion in Muni Bonds, and these new bonds cannot be insured such that there is now a very real risk that Muni Bond buyers could lose part of their investment, in order to sell these new bonds the state / local gov't must now pay interest rates which accurately reflect this risk. If they don't, then the very rich investors will seek out 'safer' tax advantaged investments such as bonds of foreign countries, or will seek out tax loophole investments that involve similar risk but also offer huge potential earnings in exchange for that risk, such as Cayman Island private equity funds. This means that if California wishes to sell $10 billion in new, uninsured muni bonds to balance this year's budget deficit without huge tax increases or huge cutbacks in public spending, they're going to have to pay enormous interest rates in exchange for increased risk of default ... probably on the order of the 11% Citibank paid to the Oil Sheiks.
If this is the route chosen, and if California can actually find buyers for new Muni Bonds, California taxpayers will potentially wind up having to pay $10 billion * 11% or $1.1 billion in new Muni Bond interest every year for the next 20-30 years ON TOP OF an average 1/2 billion per year in new Muni Bond principal ON TOP OF the Muni Bond interest and principal due on existing bonds ON TOP OF money that California needs to spend immediately every year to pay for social welfare benefits, teacher and police paychecks, road repairs etc. This is versus a bloated 2007 total California budget of $145 billion with a $10 billion shortfall against $135 billion in estimated tax revenues. Ultimately, this will require huge state and local tax increases in the long term because these Muni Bond interest payments don't go away for decades.
However, if California is NOT able to find willing buyers for new Muni Bonds, then federal law requires that the State achieve a balanced budget by tax increases or spending cuts. While some spending cuts will take place ( check out this proposal to release 28,000 prisoners early ! ... ) , big tax increases in the short term will be inevitable.
Either way, California's state / local gov't spending habits can no longer be sustained by borrowing and spending via 'cheap' Muni Bonds. And for very rich California investors who are willing to take some risk, buying new California Muni Bonds paying a tax free 11% will equal the after tax return on taxable investments paying 16-22%, which will be a huge windfall for them. As usual, the 'middle class' will take the brunt of the bad news in the form of higher California tax rates that, unlike the very rich, they will actually have to pay !
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