The municipal debt
market is $2.8 trillion worth of risky debt.
However, according to a recent Wall Street Journal article, the debt
isn’t priced as risky. Why?
The June 14th edition of the Wall Street Journal
gave a good report at the health of the municipal debt market. What I found interesting was that municipal
debt was trading at 3.15% interest for the week ending June 11th and
was down from 3.3% in April. Lower
interest rates suggest that the debt is becoming safer, yet is this really the
case?
According to the WSJ, only .002% of municipal debt defaulted
in 2009, signifying that the municipal market appears to be stable. Despite this, investors, including Warren
Buffet are steering away from municipal debt in the latter half of 2010. Why?
Municipal governments have yet to stand on their own two
feet after being propped up from the federal stimulus over the past 18
months. As state and local governments
begin to lose federal funding, they will need to rely more on property taxes
and sales tax revenues in order to continue paying their interest payments.
Despite some optimism, we have to keep in mind that asset
prices are still low (therefore less property tax income), foreclosures are
still high, and there is still a massive amount of pension costs coming down
the pike. So, why are municipal bond
rates trading so low? I believe part of
this is because bond demand is still high in a shaky stock market.
We have to keep in mind, however, that municipal debt is a
problem we’ve kicked down the road and as the stimulus ends, defaults will
begin to rise and spread. Investors know
this, yet they continue to buy municipal bonds at low interest rates (which
means they are paying a high price for the debt). It appears for the time being, that investors
are expecting some type of future “bailout” from the federal government if
local governments begin to have a “Greece-like” mentality.
So, why am I sounding the alarm on municipal debt?
Keep in mind that as debt rates go up, municipal governments
have to pay more to service their current debt.
Therefore, if municipal governments begin having problems paying off
their debt, interest rates will rise and make the problem even worse. The essential “snowball effect” could have
devastating effects on our recovery.
Government layoffs will likely rise (making the employment
issue worse) and local governments will once again need to turn to the federal
government for help.
Do you think an austerity plan to cut these municipal costs
in 2009 would have helped more as opposed to “kicking the can” down the road
through the federal stimulus programs?