Saturday, January 5, 2008

Municipal Bonds at Risk?

"Dozens of states, counties and cities across the nation will enter the new year facing deep and unexpected budget holes as the widening mortgage crisis cuts sharply into tax revenue. ... We're talking about a pretty tough fiscal environment for the next four or five years,' said Christopher W. Hoene, the director of policy and research for the National League of Cities. ... The 10 most affected states, including California, Nevada and Arizona, will lose a combined $6.6 billion in tax revenue next year, according to a report prepared for the U.S. Conference of Mayors. ... The most obvious victim is property tax collections. ... Even more distressing to budget planners is the decline in sales tax revenue. ... The fallout has been most severe in California, where officials are grappling with a $14-billion gap. ... 'Education and healthcare are usually politically untouchable, but we have to put those things on the table now. We have to include just about everything, really,' [Arizona state senator Bob] Burns said. 'If we don't make some serious moves in '08 and '09, we'll be out of savings. And out of gimmicks'," Stephanie Simon at, 31 December 2007.

"You didn't have to be a rocket scientist, for example, to see that a collapsing housing market would spell pretty bad news for municipal finances, which would, in turn, have nasty spillover effects. Yet it seems as though that concept kind of flew right over the heads of those who supposedly knew what was going on", Michael Panzer (MP) at, 1 January 2008. MP gives his 2007 "Groupthinkus Asininous Award" to "clueless regulators, strung-out Wall Street economists, pinheaded pundits, and sundry 'experts'--that the housing-bust-cum-subprime-meltdown would remain 'contained'." I second MP's award.

Supposedly muni bond holders are paid before recipients of public services, police officers, prison guards, schoolteachers, retirees, etc. Most times. With large impending budget gaps will this still be true? Do you remember the NY Daily News large type headline, when Gerald Ford refused NYC a "bailout", "Ford to City: Drop Dead", 30 October 1975? Will Bush introduce new aid to states and localities, or will Helicopter Ben monitize their debt since they lack their own Feds? Will California, home of a "three strikes" law, release some of its 172,000 prisoners because it can't afford to feed and house them? Will the California prison guards' union protest? Will California, home of Proposition 98, which requires spending 40% of the state budget on education, tell its localities, "tough, we can't pay. Do something"? Will we see a reintroduction of the 1930s farm debt moritoria, when states and localities "Just said no", and prevented farm foreclosures?

Lest you doubt contracts can be abrogated at the state's pleasure, read Home Building & Loan v. Blaisdell, 290 US 398 (1934). That's the Supremes opinion, not Independent Accountant's. "The act provides that, during the emergency declared to exist, relief may be had through authorized judicial proceedings with respect to foreclosures of mortgages, and execution sales, of real estate; that sales may be postponed and periods of redemption may be extended," 416. "The state court upheld the statute as an emergency measure. Although conceding that the obligations of the mortgage contract were impaired, the court decided that what it thus described as an impairment was, notwithstanding the contract clause of the Federal Constitution, within the police power of the state as that power was called into exercise by the public economic emergency which the Legislature had found to exist", 420. "In Von Hoffman v. City of Qunicy, supra, a statute which restricted the power of taxation which had previously been given to provide for the payment of municipal bonds was set aside", 432. "Not only is the constitutional provision qualified by the measure of control which the state retains over remedial processes, but the state also continues to possess authority to safeguard the vital interests of its people", 434. "The policy of protecting contracts against impairment presupposes the maintenance of a goverment by virtue of which contractual relations are worth while-a government which retains adequate authority to secure the peace and good order of society. ... And all contracts are subject to the right of eminent domain", 435. "The Legislature cannot 'bargain away the public health or public morals'," 436. "The states retain adequate power to protect the public health against the maintenance of nuisances despite insistence upon existing contracts. ... The economic interests of the state may justify the exercise of its continuing and dominant protective power, notwithstanding interference with contracts. ... This power, which, in its various ramifications, is known as the police power, is an exercise of the soverign right of the government to protect the lives, health, morals, comfort, and general welfare of the people, and is paramount to any rights under contracts between individuals", 437. If it serves the "public interest", muni bond interest will be paid after more pressing state business. Again, we seek the Chairman's counsel, "Political power grows out of the barrel of a gun". How many guns have the muni bond holders?

Franz Pick said, "Goverment debt certificates are certificates of guaranteed confiscation". "Classes struggle, some triumph, others are eliminated. Such is history; such is the history of civilization for thousands of years. To interpret history from this viewpoint is historical materialism; standing in opposition to this viewpoint is historical idealism. In class society, everyone lives as a member of a particular class, and every kind of thinking, without exception, is stamped with the brand of a class", Mao Zedong, Little Red Book, Chapter 2.


fabianflaque said...

I'm curious would you recommend ranking muni's by their budget deficits/revenues

Independent Accountant said...

You could use that as a "risk proxy". I can't recommend it, but have nothing better. I would ignore the ratings. More importantly, if you hold an undiversified muni bond portfolio, diversify now. "But they're double-tax free" if say you live in a state with an income tax like NY or CA. So?