The Muni Bond Market Signals Danger Ahead

The fears in the “overall” muni market are over done, yes.

In specific issues, and specific states, however, there’s plenty to fear. Too many people think that all muni debt is the same - they look at the rating some bunch of dipsticks at an agency has put on it, and they look at the tax treatment of the issue, and that’s about it.

That’s, I’m sure you’ll agree, seriously stupid and risky now.

And buying paper which isn’t GO and backed by a taxing authority results in many people taking on more risk than they understand.

There are nuggets under the pile of poop, which I’ve been buying here and there all along... but there’s entire states which I won’t search too hard for issues, (eg, Illinios) because they’re being run by a clown posse.

There are states where I’ve been plenty comfortable holding paper (eg, the Dakotas, Montana, Wyoming), but many other people won’t look at bonds from outside their own state due to the tax issue. Living in a state where there is no income tax makes me disregard the tax efficiency and look at only the cash flow behind the bond.

30 states?

That’s a good deal larger than my universe when I look at their books. I’m down to about 12 who have cash flows that I see as remotely sustainable.

The state/local level structural deficits in the US are huge, and to date, I see only a very few governors (NJ, IN, WI, possibly TN) who appear to be serious about taking on the problems. Moon Unit Brown in CA is talking a good game, but I suspect that he’ll never accomplish much because the legislature is so wholly controlled by public employee unions. In NY Cuomo is also talking a good game, again, I expect nothing to come of it.

There are some cities where leaders are more than talking a game: Providence RI has just authorized the layoff of all their teachers, San Jose CA is laying off about 25% of their cops and firefighters, etc. As you’d expect, there are screams and howls of indignation from the unions...

The numbers out there are really pretty grim, and what I think is going to make it worse is that a lot of people have been fooling themselves about how quickly home valuations are going to return. One thing I’m starting to see here in Wyoming is a growing realization that, yes indeed, what happened in CA helped pare back real estate valuations even here, where the population growth rate is very, very low (compared to the southern tier states). People are starting to gain an appreciation that prices might not go back up... so... they’re starting to ask for re-assessments of their property. A re-assessment that comes back with “Yes, we admit your property has dropped 25% in value” is a pretty big hit on ad valorem tax streams when (not if) this practice catches on.

I don’t see how the ad valorem tax base remains even near what it is today if people finally start accepting that the current valuations might be around for years to come... because the Fed’s efforts to re-inflate the housing market, I think you’d agree, have amounted to “bup” and “kiss.”

The few states I like for muni paper have tax revenue streams that are based, in part, on natural resource extraction, sales taxes, ag, etc. Stuff that isn’t tied as much to the valuation of real property... but that’s me. eg, here in Wyoming (where it will be -15F tonight, so I sorta envy your Florida weather at times), we tax coal extraction, gold extraction, uranium extraction, wind power generation, etc. Stuff that ends up going out of state, isn’t terribly optional and isn’t tied to real estate valuations. That stabilized our tax revenues somewhat in this mess.

One more thing I’ve looked at: the retirement wave of boomers. In some states, it will be a crushing wave (eg, CA). There still seems to be little recognition of the numbers of retirements coming in the federal or some of these state workforces, modulo those four states I mentioned previously. Even here in WY, the administrators and elected officials don’t seem to “get” the upcoming wave of retirements that are going to put a whole bunch of drawdown on these pension plans in the next 10 years. When I attend public meetings and look at the muni/county/state employees in attendance, they all appear to be in their late 40’s to late 50’s. I see very few young faces in county and state government offices...

"I see very few young faces in county and state government offices..."

...same in the state just to the south of you. There's are other considerations. In rural areas during the next few years, retirees (much of the rural population here), will not likely be able to afford their heating (nearly all propane), food and transportation fuel costs. They are suburbanites by nature (not frugal or agricultural). Also, some service and retail businesses in small towns have already closed. Others will probably follow. Tourism will be less attractive due to fuel and other increasing costs. That will take a bite out of local government revenues. Some rural residents would rather move than do without the services, furthering the decreases in revenues.

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