Since as early as mid-2008 we’ve been talking about problems with municipality finances. Our concerns stemmed from the effect of the recession on tax receipts, and that was compounded by what are now common stories about public pension problems.
Our concerns arose from a couple of items that the Williams Inference Service folks raised. Here’s a recap.
Fourth quarter of 2005 – file titled, “Local Debt” – featured rising local taxes and efforts to cap them. Finished with excerpt from Money Chronicles:
“[b]ut the really serious local debt crisis nobody is talking about yet is . . . local government debt . . . Take the states. Out of 50, 43 of them are close to bankruptcy.”
Alarmist? sure, but it caught one’s attention.
Fourth quarter of 2008 – file titled, “Main Street” – talked about the pension issue (“perhaps the bigggest time bomb of all is something that remains a secret . . . “), declining sales tax revenues (“And states, unlike households and business, have few reserves set aside for a rainy day.”)
First quarter of 2009 – file titled, “Firemen’s Pensions”
“Thee Federal government is focused on the bailout package . . . This leaves pension obligations as an afterthought. This ticking time bomb will have repercussions far into the next decade.”
Between and since these events stories about municipality troubles have begun migrating from page 16 to page 1, the point at which the problems should be widely discounted and the end of the trend may be near. Well, you can’t get more page 1 than a TIME magazine cover story like this one.
Meanwhile, our Strategas service recently pointed out several datapoints that are bullish for municipal finance in a report titled, “STATE(S) OF CONFUSION: DISPELLING THE MYTHS ABOUT STATE & LOCAL GOVERNMENT FINANCES.”
An ideal situation would have been for municipal bond yields to have risen over this period. Then we could look for a peak and an opportunity to back up the truck, as they say, and buy muni bonds. In fact, yields have largely declined over this period, as can be seen below. Also on display is the breakout through the downtrend in yields, so yields are on the rise.
While rising yields aren’t evidencing the increased fear/awareness, what might be is the way municipal bonds have lagged the rally in Treasuries. If the fears are at a peak it might suggest that munis have some catching up to do. Even without the ultra-low yield on display in Treasuries, it makes sense to sell Treasuries and buy munis.
Make no mistake: there will be trouble with municipalities. They’ll include communities affected by the oil spill and those in trouble with pensions. You’ll read stories like this one:
Tough times: The city of Maywood, California, is laying off all city employees and hiring contractors for police work and all other essential business, the Los Angeles Times reports. Having been bankrupted by financial incompetence, the City Council decided to fire all 100 city workers. It will contract police services from the LA County Sheriff’s Department and get street maintenance, finance, and administrative services from a neighboring city. Full story here.
These anecdotes, however, shouldn’t be used to paint an entire asset class, and, indeed, with the press featuring such a story on the front page, it suggests the fever pitch should be approaching an end. We would use any yield spikes as an opportunity to buy solid municipal bonds.