Municipal Bond Market

[lmrhoades]

Henry and others
Is there a big problem with the muni bond market. On cnbc this morning they were talking about it as if it could lose big money. I know bill gross is investing big into the muni bond market and it's done well this year thus far.
Is there a problem that you know of or is it just continued speculation?
_________________
LMR

[rffrydr]

Vallejo faces BK. What was Spitzer saying about "good and bad" bonds?


http://www.cnbc.com/id/23385758
_________________
Today is the Tomorrow you worried about Yesterday!

[anti]

Thanks Henry....

Interesting stuff... Wish I was a lawyer... They're going to have a field day with the fiduciaries, Rating agencies and originators..........

[mildred]

[HenryTo]

Anti,

An older article which gives you some kind of idea of CDO exposure in DB pension plans:

http://www.bloomberg.com/news/marketsmag/pension.html

Note that the Texas Teachers Retirement Plan had a policy constraint of 1% for all CDO investments. Corporate pension plans only need to disclose their asset allocation once a year per FAS 158 - but only in broad terms. We will get more updated funding levels sometime in the next few months as analysts start compiling the new end-of-year 2007 numbers.

Henry

[mildred]

[anti]

One thing that has me concerned, is that although many banks and other institutions have written down CDO's and swaps....We really haven't heard much from Pension plans.. Corporate or Governmental

Since banks were for the most part syndicators and conduits for these structured products... Most of them were not held... But SOLD..

If they reside in pension funds and are still held as investment grade, what happens when the downgrades occur??

Maybe those funding levels come more inline with Ford and GM .....

One thing for sure,,, ultimately the taxpayer will be forced to swallow hard and pick up the tab.....................

[HenryTo]

Okay, I went back and dug up some numbers from an Abby J Cohen presentation that was given back in November.

According to Goldman Sachs, the amount of unfunded health care obligations on the corporate side is about $290 billion, with 25% of that attributable to GM and Ford.

On the governmental side, this amount is about US$1 trillion (under the GASB 45 rules) - with about $40 to $70 billion coming from California, $50 billion from New York, and $30 billion from Michigan. Note that many government entities are still in the midst of disclosing them (since the GASB 45 rules are very new) - so the $1 trillion is simply an estimate. We will get a better idea of what the number should be in probably 6 to 9 months.

[HenryTo]

Mildred,

Here is one of my more recent commentaries on the federal government debt and on households' net worth:

http://www.marketthoughts.com/members/z20080203.html

You can find other articles on savings and corporate cash/debt levels by doing a search in our archives:

http://www.marketthoughts.com/commentary_archive.html

At some point, we will get it better-organized.

Best regards,

Henry

[mildred]

Interesting article from a guy in the trenches : go to feb 14th column


http://www.technologyinvestor.com/index.php

[mildred]

[mildred]

I hear you Henry ....... the facts are the facts, no doubt. But I've learned over the years to trust my intuition at times and not rely on the facts especially when the facts are being published by any level of gov't. I live and breath the costs of gov't and when I see the domino effect that our current credit crisis can have it worries me.

I see gov't workers kicking and screaming about paying 2% into their healthcare plan.

I see gov't workers being hired at a much higher pace than the private sector.

I see gov't waste at a time when the private sector is lean and mean.

I see gov't workers recieving pension plans at bloated salaries and living alot longer than actuaries probably accounted for.

I see gov't salaries coming into line with non specialized private sector salaries.

What I don't see is anybody trying to contain the cost of gov't. There is no sense of urgency IMO and when bueracrats don't sense the urgency this credit crisis can wreak havoc in a hurry.

I go with the facts when they make sense within the context of what we're talking about. I've been reading these forums for a couple of months now and highly respect everyones knowledge and sources. But I believe when it comes to gov't balance sheets the public is being led around with a blindfold.

I'm not talking about municpal defaults of any consequence ( well, maybe California lol), but my point is that I believe people are thinking about the POSSIBILITY of municipal default and that will lead to higher costs to the municipalities.


Re my comment on unprecedented levels of leverage ....... I will go back and look up the discussions you pointed out.

Re my comment on pensions ..... my concern is not what the value WAS , but what the value WILL BE if the credit markets continue to erode and the equity markets have steep declines.

Re healthcare costs and how they're measured ....... that's scary.


It's a pleasure reading your posts along with the others in this forum and I must say I learn so much from you guys. Keep up the good work.

[HenryTo]

mildred,

I have to respectfully disagree with your statement regarding the "unprecedented leverage" in the U.S. financial system. We have previously discussed this with regards to the federal government, corporations and U.S. households, so we will just focus on state and local governments (and municipalities) here.

According to the latest Census, total state and local government debt grew by a nominal rate of 5.8% over the 15-year period to the last census conducted in 2001/2002 (note that these were bear market years), or to $1.7 trillion. A 5.8% annualized rate is hardly of concern - given that it is lower than nominal GDP growth over that 15-year period (table 1). On a debt-to-personal income basis, the amount of state and local debt is about 19% of annual income of the constituents on an aggregate basis (Table 2).

http://www.census.gov/prod/2005pubs/gc024x5.pdf

In terms of pension funding levels - at least count - the state governments, local governments, and municipalities have funded about $1.7 trillion of their total $2.1 trillion obligation. If we use the same actuarial accounting/assumptions as corporate pension plans, this obligation rises to $2.5 trillion. An underfunding of $800 billion is not peanuts, but given that U.S. households' net worth now total $58 trillion (rising by $20 trillion in the last 6 years alone), an $800 billion underfunding condition is hardly of concern either, given the various governments' power to tax their citizens. In total, we are looking at approximately a $2.5 trillion liability for the state and local governments, as well as the various counties and municipalities, taking pension obligations into account.

The healthcare obligations cannot be measured accurately, but many munipalities and counties are now starting to fund their health care obligations under the GASB 45 rules. Note that health care obligations are simply predictions - nothing better than a crystal ball - those can err on the upside as well as on the downside going forward.

Best regards,

Henry

[rffrydr]

You're absolutely right, there is a new level of risk. None more apparent than here in sunny California--where the spending is done by "alogrithym."

Yet they'll keep coming back to 1%default rate and OC full payout. They're sure writing alot more tickets in Hollywood right now.

Of course the investment houses don't have to worry about that--they are but "conduits." But when there is no market there is no market. It'll really be something if the Commissioner gets his separate market and still they don't come. Right now there are insured (Ambac) munis selling for higher yields than the same....uninsured!

A "ten-billlion" letter of credit? Get 'er done before we're done.
_________________
Today is the Tomorrow you worried about Yesterday!

[mildred]

My guess is that muni bond risk is not priced right. We all believe that municipalities can't fail because of the power to tax .... but today's credit crisis brings a whole new set of concerns to the equation.

Think about the debt loads of the municipalities and their pension and healthcare obligatons in the future. I believe the risk of municipal default has entered the equation now and investors are not buying into the old adage of "municipal safety".

I've never seen a confluence of financial unravelings that have taken place as of right now. The leverage in our financial system is unprecedented .... The debt load in the system is unprecedented .... The amount of under priced risk is unprecedented ... I can go on, but you get my point.

I've watched the Fed come out shooting bullets out of both barrels with no apparent success outside of short unsustainable equity rallies. I've come to believe that the present cancer in our credit markets must be worked thru on their own merits. It will be painful but no more quick fixes like in the past. Seeing the safe haven of the munipal market shaken has proven that to me. I believe the problem is bigger than the insurers. The problem is low interst rates and somewhere somehow we better start getting used to the inevitable outcome of higher interest rates.

[HenryTo]

Len,

I understand your frustrations with the markets but this is what typically occurs near the final stage of a liquidity crisis. There are always "unknown unknowns" out there that no-one has planned for - and liquidity/credit crises such as the one we are currently experiencing typically expose the weak link in our system. We have had similiar episodes in the past - the plot is familiar but the actors and settings are slightly different. In the early 1980s, it was emerging market debt that plunged the American financial system into a crisis. As then-Citibank Chairman Walter Wriston remarked, sovereign countries do not default. It was not supposed to happen, but it did.

In the early 1990s, it was the S&Ls. In 1998, it was Russia. The thinking was that sovereign countries would never default in debt that were denominated in the local currency, but it did.

Again, a liquidity/credit crisis exposes and kills the weak link in our financial system, and this time, it was the mortgage orginators, the monoline insurers, and anyone that were overexposed in the U.S. housing industry. This is to be expected. Also, this is not pretty, but this too, shall pass.

We decided to cover our short position on our DJIA Timing System in early January because we finally got assurance from the Fed that it will act swiftly and decisively to bring an end to the current crisis. So far - short of an act to socialize much of the mortgage losses - the Fed, the Administration, Congress, and the regulators are being as active and pro-active as they can. If push comes to shove, there are many agencies, such as the FHA, not to mention the U.S. Exchange Stabilization Fund, that can step in and reliquify the system relatively quickly. The ESF provided $20 billion to Mexico in 1995 - against much political backlash - and given the current crisis, there will definitely be no political obstacles preventing the ESF from doing this again.

http://www.treas.gov/offices/international-affairs/esf/history/

Again, if the Feds fail to announce something by the end of this month, and should the market become short-term overbought by that time, then I will most likely go neutral. But for now, we are still in waiting mode.

Best regards,

Henry