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Bond Crisis?

The Coming Municipal Bond Crisis?
By Dennis Tubbergen

Recently, researcher Meredith Whitney appeared on 60 Minutes and predicted 50 or 100 municipal bond defaults nationwide. Whitney recently published a report that discussed the financial condition of many municipalities and the possibility of default by some. While the research report didn’t make a prediction as to the number of defaults, when on 60 Minutes Whitney boldly predicted 50 or 100 defaults nationwide.

Taking the other side of the argument is PIMCO’s Bill Gross. Fox News is reporting that Gross is waging an all out war to make certain that the masses view Whitney’s report as not credible. Of course, it’s not surprising that he would take that position, PIMCO makes money selling bond funds.

And, to be fair, Whitney may sell a lot more reports if she makes some big predictions.

So who is right? Is the sad financial condition of many states and municipalities leading to a certain default on some municipal bonds?
George Soros thinks it’s a possibility anyway. He recently stated that the muni-bond crisis would be 2011’s “big drama”.

Here’s what we know.

Many municipalities are using very optimistic return assumptions when doing their pension accounting, some as high as 8%. That assumption is simply not a good one.

While getting an 8% return in SOME investments sporadically over the past several years COULD happen, it hasn’t been a regular occurrence. If I were required to choose a more accurate assumption for pension plan growth rates, I’d probably use 4%.

Assuming a municipality uses an 8% asset growth assumption when the actual asset growth that occurs is 3% – 4%, the municipality’s pension fund will ultimately have a day of reckoning and that day of reckoning is here for some municipalities.

For example, it has been recently reported that the City of Philadelphia’s pension fund will be out of money in 2015; not short on funds, not facing a funding shortfall, just plain out of money. At that point, from my perspective, only one of two things can happen.

One, since the pension is now a hand to mouth system, pensions get cut and funded only to the extent that funding exists which would be significant given the fact that most municipalities have been very generous with their benefits to retirees. Retirement at age 50 with generous benefits has been the norm rather than the exception. Two, taxes in these municipalities go up – a lot. This is already occurring. While real estate values plummet in virtually every area of the country, real estate taxes have been rising. This trend will continue.

As a result, people will begin to move out of these areas leaving fewer to shoulder the debt burden. This trend will intensify like a snowball rolling down a hill, getting larger as time passes.

 

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