The Fed Report is a Canard

Meredith Whitney’s Muni Prediction Gets No Boost From Fed – Bloomberg.

This article is correct about the Fed report. Those IDBs are not as creditworthy as revenue or general obligation bonds and are usually not considered in the context of municipal defaults. IDBs are extra bonds that a local government may issue in support of an industrial project in its jurisdiction. The issuer is usually a development agency that is a distinct entity separate from the municipality. As such, investors know that only the agency is liable for the bonds, and that a tax increase to bail out a struggling agency is not in the cards. These bonds offer higher returns to offset the extra risk.

Meredith Whitney is being criticized for getting the timing wrong for municipal defaults. Pundits seem to think that just because there have not been defaults yet means that they are not in future. Let’s look at this map of unfunded pension liabilities courtesy of ZeroHedge:

The states are trillions of dollars in the hole, and these unfunded liabilities are based on 7% stock market returns. Large numbers of baby-boomer retiring means that the demand for stocks will fall just as these boomers are trying to sell the stocks to fund retirement. The states will have to pay for these liabilities somehow. This means tax increases and service cuts in the future.

Or, one can follow the California plan. Municipal governments do not have the political power to say no to unions. Stockton, California is attempting to stiff its bondholders while its retired and current workers retain their pensions and benefits. Ultra-low interest rates for municipal debt have priced in the Fed’s ZIRP, but these rates do not reflect the fact that bondholders are now junior to state pension funds. Rates will have to rise to offset the increased risk of  a subordinated debt position, especially in California. Warren Buffet has already figured this out:


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