The Municipal Bond Crisis: Why Stock Market Investors Should Pay Attention


Investing in municipal bonds is like being kissed by your grandmother; it's comforting, but not particularly exciting. Lately, however, thanks to extraordinary media attention, the subject of municipal bonds has become a decidedly uncomfortable subject for many investors. Recent headlines in renowned national newspapers include such disastrous headlines as "Mourn the Muni Market", "Dire Headlines Unsettle Muni Bond Investors", and "Mounting Debts by States Stoke Fears of Crisis". And the list continues.

Is the municipal bond market facing a real crisis here, or is it really journalistic sensationalism? Perhaps a more important question: what are the consequences if you are a municipal bond investor or a stock market investor? For reasons that I will briefly review, I think stock market investors may miss the big picture and may in fact risk losing more from the municipal bond crisis than real bond holders. In 2008, many stock market investors suffered huge losses as they focused only on the stocks themselves and generally did not pay attention to the ongoing problems in the day to day bank loan markets. the day. Likewise, the lingering problems in municipal bond markets should be followed closely by stock market investors, due to the anti-growth and taxation policies and spending that are being implemented across the country.

Let's start with the municipal bond market itself, and then turn our attention to the broader financial implications for the stock market. Recent media reports suggest that there may be 50 to 100 municipal defects in the next year. Although this is a historically high number, even if it is true, it is a very small percentage of the total. Specifically, the state and municipal bond market is approximately $ 2.8 trillion in size with approximately 60,000 different bond issues. So even if 100 shows default next year, that would only represent 0.2% of the total. In addition, according to a recent Wall Street Journal article, in the past 40 years, there have only been 54 cases of municipal debt default rated Moody's. Among them, 78% were in autonomous housing and health care projects. (Wall Street Journal: "New risks are emerging at Muni", November 10, 2010). Given the large number of existing individual bond issues, this is an extremely low historical default rate and shows that cases of real default at city, country and county and even state are extremely rare.

Media likes to mention Vallejo, California, and Harrisburg, Pennsylvania – two cities with serious tax problems – but nothing is said about the thousands of cities, counties, and various government agencies that never miss a only payment to their bondholders. As mentioned in Moody's data, most of the municipal bond defaults come from project-specific revenue bonds. These are do not general obligations, guaranteed by the full faith and the taxation powers of the issuing municipality. There is no doubt that the vast majority of general municipal bonds will remain highly creditworthy and remain a safe investment for fiscally sensitive investors in need of income.

However, as suggested earlier, even if our worst fears prove to be true, municipal bond investors are probably not the ones most at risk – stock market investors risk losing more in this crisis. Why? First of all, we need to understand that 1 in 7 workers across the United States actually works for a municipality, including state, county and city governments, transportation authorities, Law enforcement agencies, school districts, etc. That's right, 15% of all workers in this country work for a municipal government or a state agency. Collectively, this means that "Municipal America" ​​is by far the largest employer in the country, and the employer faces a dire financial situation. Additionally, 13% of the total US economic output (ie, gross domestic product) comes from municipal spending. This means that municipal spending represents the second largest component of the overall US economy; consumer spending is the largest. Therefore, the real risk to our financial system is not the potential of dozens of municipal bond defaults, the real risk is that thousands of municipalities will be forced to lay off or lay off hundreds of thousands of 39; employees and dramatically cut spending and benefits, tipping the fragile US economy into recession. It turns out that such developments have already started.

Indeed, state and local governments have reduced their payroll at an accelerated rate in the past 12 months, with approximately 250,000 jobs lost in 2010 alone, in addition to 130,000 jobs lost in 2009. Even more interesting: since January 2008, the U.S. economy lost 7.2 million jobs, but the total number of jobs in states and municipalities has only decreased by 225,000 in the 3 last years. Since the latter group accounts for 15% of total employment, one would expect that a proportional share of these jobs would have been lost here, but this has not been the case. If that were the case, state and municipal agencies would have lost around 1.1 million jobs to date. Since municipalities only started cutting wages in large numbers a year after the recession started, it is reasonable to think that substantial losses are now heavy for us, and we might have up to 1 million additional jobs to be cut from state and local government payroll in the coming years.

Yet even that underestimates the total economic impact of municipal austerity, as it only counts jobs lost, excluding employees who have simply experienced holidays, salary freezes, reductions in benefits, etc. A recent NY Times editorial, "The Looming Crisis in the United States," said that "government spending fell 3.8% in fiscal 2009 and 7.3% more in during fiscal year 2010 ".

If you happen to work for a municipal agency, it is likely that you have recently seen a hiring freeze, a wage freeze, restrictions on hours of work, etc. In addition, many of the projects funded by the American Recovery and Reinvestment Act of 2009 will soon end, and municipalities are not committing to significant spending on new infrastructure projects. This will result in a significant reduction in construction-related expenses. Finally, if you happen to reside in one of the states without tax resources, like Illinois, you will soon pay much higher tax rates and benefit from reduced services. Illinois recently increased its state income tax from 3% to 5%, which will cost the average family of 4 about $ 1,000 more a year. Likewise, newly elected California governor proposes $ 12 billion in tax increases more $ 12.5 billion in spending cuts for the coming year, with cuts in health care, welfare, community colleges, universities, services for the disabled, wages for state employees, etc. This is all good news for Illinois and California bond holders, but bad news for just about every resident, worker, and business in the state, as well as companies doing business with the state.

Municipal governments will continue to face painful choices in 2011 and 2012, but most face their problems in the only logical way: financial austerity. This is good news for investors in municipal bonds. But if the trend continues, as it almost certainly will, it further diminishes the prospects for a broad economic recovery in 2011 and 2012, which means that the municipal bond crisis could be more troubling for the stock markets than most investors don't think so. Certain types of businesses will obviously be hit hard, including construction companies, information technology and services. Municipalities will cut back on new construction projects and postpone systems and technology upgrades for another year or more. Service companies that depend on contracts with the state and local agencies will also be affected.

Recalling the lessons of 2008, stock market investors are advised to pay attention to the current crisis in the municipal bond markets. Financial austerity in all state and municipal agencies will make the years 2011 and 2012 very difficult for many national businesses and will create considerable downward pressure on consumer spending and corporate profits.

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