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I Want My Cheese
Commentary on the News
Monday, February 21, 2011
Ed DeShields

Unions and their collective bargaining process has Wisconsin looking more like Cairo than a sleepy Midwestern state with old fashioned values.  The leftist kleptomaniacs from Madison, with their union officials representing state employees, have declared that the United Nations entitles them to claim their benefit packages as a basic human right.

Wisconsin is only the beginning of the revolt brewing here at home.  Forty-nine of fifty states are either insolvent or headed to the poor house.  And, their entitled are furious and will take their demands to the street. 

For the first time since the debt crisis began, economic pain is about to be passed down to the average citizen who is going to recognize it for what it is.   The government is going to pass the hot potato, and the burden of their mismanagement onto our backs.  It’s how government works. 

When state and local governments want to spend more than they collect in revenues, they issue bonds. But during the last decade they have spun out of control, as states and cities have increased their borrowing to indulge in more and more spending on new stadiums, schools, bridges, and museums. They have even started borrowing to cover their basic operational expenses.  

Since 2000 the total outstanding state and municipal bond debt, adjusted for inflation, has soared from $1.5 trillion to $2.8 trillion. The recession didn’t slow the spending because the ponzi-scheme is wrapped in a clever marketing package.

Municipal bonds are peddled as safe investments because, like U.S. Treasury bonds, they are backed by the full faith, credit, and taxing powers of the issuing governments. Investors know that states and localities can always raid taxpayer wallets to pay off their debts. 

But in the last two years tax and fee hikes have faced greater public opposition. Since governments are generally unwilling to cut spending either, the result of resistance to new revenue raising has been substantial increases in states’ and cities’ debt levels. Detroit and Los Angeles have announced that they may have to declare bankruptcy, as have a number of smaller cities.  Seattle and Dallas are closing schools and laying off thousands of employees causing contentious opposition.  In Dallas, a local city council member frustrated with citizen dissent, demanded that all the white people were to leave the meeting. 

Incredibly, municipal bonds have not yet lost their low-risk reputation. Long-term municipal bond sales increased by 785 percent since 2008.  Investment houses have lured investors into thinking that lending cash to bankrupted cities will be profitable while their trading desks shorted the same bonds.

More important, investors believe that cities and states—especially states, which can’t legally declare bankruptcy to escape debts—will resort to anything to avoid reneging on their obligations. And if they default anyway, investors assume the feds will bail them out. Washington already has bailed out the banks, the automobile industry, homeowners, and local school budgets. 

Recently, things have taken a bad turn. A recent poll reported that 90 percent of the restructuring experts believe that major U.S. municipalities will default on their debt.  Even in the best-case scenario, a municipal debt crisis looms in the near future.

The parallels with the housing bubble are worrisome. Prior to the meltdown, mortgages were perceived as very low-risk investments.  Both lenders and borrowers had faith that nothing would go wrong—and that if anything did go wrong, Washington would save the day. 

Now some investors are betting against the borrowers.  Time reports that some of them “are jumping to bet against cities, towns and states.” That’s a clear warning sign that people are effectively starting to short the muni market.”

The state and municipal debt crisis could result in the third trillion-dollar bailout in the last three years. That much federal borrowing on top of the current debt could very quickly have an impact on interest rates and on the dollar. And at that point, we can just forget about the recovery and get ready for a smaller slice of the cheese.

About Ed DeShields

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