terça-feira, 8 de dezembro de 2009

Coming Collapse of Municipal Bonds; States, Cities Dig Deeper Holes

Coming Collapse of Municipal Bonds; States, Cities Dig Deeper Holes

In New Jersey, governor-elect Christie opposes (and rightfully so), the state going deeper in debt but that is not stopping the current administration of Jon Corzine.

Please consider N.J. to Borrow $200 Million Amid Incoming Governor’s Opposition.
New Jersey, the third-most indebted U.S. state, will sell more than $200 million in bonds today to finance voter-approved capital projects a week after Governor- elect Christopher Christie said he opposed borrowing more money.

The state will issue $209.1 million of bonds, including $205 million of tax-exempt securities, the largest such competitively bid offering in the market today, according to Bloomberg data. Christie, a Republican who defeated Democratic incumbent Jon Corzine last month, said he opposed new bond sales after the state last week detailed $2.7 billion in borrowing it plans for the remainder of the fiscal year, which ends in June.

The state’s bond sale today will finance clean water and open-space preservation projects, according to a preliminary official statement. The state is also planning to sell $1.4 billion of bonds for transportation and $1.1 billion for school construction before June 30, according to a Nov. 30 report.

Christie, 47, a former U.S. attorney, told Bloomberg News last week that New Jersey “can’t have any more debt” and that any projections for borrowing will be “rendered meaningless” when he takes office on Jan. 19.

New Jersey has $36.5 billion of gross tax-supported debt, the third highest of the 50 states, according to a report released in July by Moody’s Investors Service. Moody’s rates the state’s bonds Aa3, the fourth highest ranking. California has the most, at $75.2 billion.

New York City is leading the municipal market this week as issuers seek to borrow more than $10 billion, according to Bloomberg data. New York, the largest borrower among U.S. cities, is selling $1.4 billion of taxable and tax-exempt securities, including $616 million of Build America Bonds. By yesterday, the city had taken orders from individual investors for $440 million of the tax-exempt bonds, and for $20 million in Build America Bonds that it expects to finish pricing on Dec. 10, according to Ray Orlando, a spokesman for the city Office of Management and Budget.

Yields on conventional 20-year municipal debt fell to an eight-week low of 4.24 percent, down 1.34 percentage points from a year ago, according to a weekly Bond Buyer index.
New Jersey Perspective

New Jersey has $36.5 billion of gross tax-supported debt.
California has $75.2 billion of gross tax-supported debt.
New Jersey has a population of 8,682,661.
California has a population of 36,756,666.

Let's do the math.
New Jersey has 23.6% of the population of California and 48.5% of the tax supported debt.

Municipal Bond Bubble

It is not just New Jersey going nuts, California clearly did as well, and cities like New York are in deep trouble.

The city of Vallejo, California fired a huge warning shot by declaring bankruptcy. However, that warning shot has largely been ignored.

Given there is no realistic way for this debt to be paid back, municipal bonds are in a bubble.

People are chasing municipals because of tax exempt status but they are not compensated for for the risk. Please consider the following table courtesy of Investing Bonds

Assuming a 28% tax bracket, the effective yield on a 4% yield muni is 5.56. 20 year treasuries are yielding about 4%. A lousy 1.5% is all you get for the additional risk that a municipal bond blows up. I hardly see how it can possibly be worth it.

Although there is no provision for states to declare bankruptcy (there should be), cities, municipalities, and counties can.

I expect several counties in Florida to default. Major cities like Houston are a distinct possibility as well. Please see City of Houston is Bankrupt (So are California, Oregon, and Pension Plans in General) for details.

When counties and counties start declaring bankruptcy, municipal bond yields are going to soar across the board.

If there is little to no compensation for this risk (and there isn't), then why take it? As with the "free lunch" of Asset Backed Commercial Paper, investors are going to learn the hard way once again.

Mike "Mish" Shedlock
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Mike "Mish" Shedlock is a registered investment advisor representative for SitkaPacific Capital Management. Sitka Pacific is an asset management firm whose goal is strong performance and low volatility, regardless of market direction. Visit http://www.sitkapacific.com/account_management.html to learn more about wealth management and capital preservation strategies of Sitka Pacific.

Morgan Stanley: Fed to Raise Rates in 2nd Half of 2010

Morgan Stanley: Fed to Raise Rates in 2nd Half of 2010

In a research note titled: "The Fed Will Exit in 2010", Morgan Stanley's Richard Berner and David Greenlaw forecast that the Fed will raise the Fed Funds rate in the 2nd half of 2010 to 1.5%.

They are forecasting GDP to increase 2.8% in both 2010 and 2011, and for unemployment to peak in Q1 2010 at 10.3%, and decline to 9.5% in 2011.

The GDP and unemployment rate forecasts are consistent with each other (see my post:Employment and Real GDP), but the real question is why do they expect the Fed to raise rates in the 2nd half of 2010 with a sluggish recovery?

The reason is they expect inflation expectations to pickup, and the Fed to react by raising rates (to 1.5% by the end of 2010, and 2.0% by the end of 2011). That would be unusually since the Fed historically waits until sometime well after the unemployment rate peaks.

The following graph is from I post I wrote in September: Fed Funds and Unemployment Rate

Fed Funds and UnemploymentClick on graph for larger image in new window.

This graph shows the effective Fed Funds rate (Source: Federal Reserve) and the unemployment rate (source: BLS)

In the early '90s, the Fed waited more than a 1 1/2 years after the unemployment rate peaked before raising rates. The unemployment rate had fallen from 7.8% to 6.6% before the Fed raised rates.

Following the peak unemployment rate in 2003 of 6.3%, the Fed waited a year to raise rates. The unemployment rate had fallen to 5.6% in June 2004 before the Fed raised rates.

Here is more from Paul Krugman: When should the Fed raise rates? (even more wonkish)

Goldman Sachs recently forecast that the Fed will be on hold through 2011:
The key features of our 2011 outlook: (1) a strengthening in growth from 2.1% on average in 2010 to 2.4% in 2011, with real GDP rising at an above-potential 3½% pace in late 2011; (2) a peaking in unemployment in mid-2011 at about 10¾%; (3) extremely low inflation – close to zero on a core basis during 2011; and (4) a continuation of the Fed’s (near) zero interest rate policy (ZIRP) throughout 2011.
Although there are other considerations - such as inflation expectations, I don't expect the Fed to raise rates until late in 2010 at the earliest - and more likely sometime in 2011 or even later.

A crônica de uma alta anunciada

A crônica de uma alta anunciada

A equipe econômica do presidente Lula está convencida de que há um movimento no mercado visando forçar um aumento de juros na segunda reunião do Copom (Comitê de Política Monetária) em 2010. Reunião programada para março do próximo ano. Poderia ser a última com o presidente do Banco Central, Henrique Meirelles, no cargo, caso ele decida mesmo sair candidato para disputar algum posto na eleição. Na avaliação da equipe de Lula, seria uma forma de tentar antecipar uma alta dos juros que todos consideram inevitável, mas que teria de vir apenas no segundo semestre de 2010. Qual a lógica dessa pressão do mercado? Facilitar a vida e reduzir pressões sobre aquele que viria a substituir Meirelles no comando do BC. O nome mais cotado hoje é o de Alexandre Tombini, um funcionário de carreira respeitado e que conta com a simpatia do Palácio do Planalto. Mas que não teria a mesma autonomia do atual presidente do banco. Ou seja, Meirelles teria muito mais poder e liberdade para iniciar esse movimento de alta dos juros antes de sua saída do cargo, pavimentando o caminho para os necessários ajustes na política monetária diante da forte retomada do crescimento da economia no início do próximo ano. A vida de seu substituto ficaria muito mais fácil. Bastaria a ele dar continuidade a um processo leve e gradual de alta dos juros, visando manter na meta não a inflação de 2010, mas a de 2011, no primeiro ano do sucessor do presidente Lula. Leia mais (08/12/2009 - 20h51)

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