Regular Via Meadia readers are by now well versed in the perils of state and municipal finance. Simply put, vast unfunded liabilities (pensions and retiree health benefits) are bearing down on taxpayers who cannot afford to make up the shortfall. Consequently, a once placid and predictable market for state and municipal bonds is beginning to roil.
Yesterday, it roiled a lot, with the news that Berkshire Hathaway, under the direction of legendary investor Warren Buffett, announced its departure from the state and municipal bond market.
Discerning signal from noise isn’t easy in the cacophony of financial markets, but there was no mistaking this particular signal. It was front-page news. Everybody got the message.
In early 2011, Meredith Whitney famously told the CBS News program 60 Minutes that the state and municipal bond markets were headed for disaster. She predicted defaults and bankruptcies. Tens of billions of dollars would be lost, she said, over the course of the year.
In the event, there were a few declarations of bankruptcy and a few defaults, but the state and municipal bond market, as a whole, rebounded nicely from the mini-panic that followed Ms. Whitney’s prediction. The market for state and municipal bonds finished the year strong.
So it was that Ms. Whitney was denounced as a fraud and a charlatan. Anyone who defended her (like me, for instance) was deluged with emails and comments unfit for family viewing. The state and municipal bond chorus was both righteous and vengeful. They wanted this heretic burned at the stake.
Although Ms. Whitney’s timing was off, her arithmetic was inarguably correct. Take the municipal bond market as an example.
Municipalities have two ways to raise revenue: property taxes and sales taxes. There is as well a mind-numbing array of “fees” that have been concocted for cushion, but property and sales taxes account for the vast majority of municipal revenues.
According to a study by the Joint Center for Housing Studies at Harvard University, the amount of equity Americans have in their homes has been cut by more than half in the last six years. In 2006, home equity stood at nearly $15 trillion. Today, it stands at $6.2 trillion. You can’t raise property taxes on people whose property is worth less than half as much as it was 6 years ago.
As for sales tax revenue, it’s better than it was in 2009, but it’s not nearly as robust as it needs to be to keep feeding the municipal debt beast. Nor will it soon be. Middle class Americans are tapped out. At the same time, they are deleveraging (paying off home equity loans, student loans, etc). Higher taxes aren’t just politically difficult. They’re all but impossible on middle class Americans.
Unless you live in energy-boom North Dakota or the Silicon Valley or a few other selected “hot spots,” this combination of depressed property values and diminished retail activity is the new normal. It will be the new normal for some time. It couldn’t come at a worse time.
An aging work force is preparing for retirement. There aren’t nearly enough people in back of them to help pay the taxes that will keep retirement benefits flowing. Immigrants, in theory, could make up the difference, but immigration trends have recently reversed. Mexicans, for example, are no longer coming to America. They’re staying in or going back to Mexico.
Over the course of the last four decades, public employee unions have been the only segment of the union “movement” that has seen membership growth. In their negotiations with local and state governments across that time span, public employee unions consistently swapped out sharply higher wage increases for ever-more generous retirement benefits. The deal being that politicians could claim credit for holding the line on present costs, union leaders could claim credit for much richer retirement benefits and no one would have to pay for it any time soon.
Those public employee retiree health and pension benefits, once so far away, are now upon us. They get more and more expensive as the baby boomers age. And the money to pay for all those benefits simply isn’t there.
What about the state and local pension funds? Didn’t they kill it over the length and breadth of the great bull market of the last 30 years? Well, yes they did. And then they didn’t. They now struggle to make half of their promised (8%) rate of return.
To make matters worse, the accounting that was used to describe assets and liabilities, was, shall we say, suspect. So much so that Moody’s recently announced that given new and stricter accounting rules for state and local pensions, it was tripling the size of the total unfunded liability, from roughly $700 billion to $2.2 trillion. In one day.
Further revisions (upward) are expected. Which is one reason, no doubt, why Mr. Buffett chose to make his exit.
There are serious students of state and municipal debt who believe that the actual size of the total unfunded liability is closer to $4 trillion than it is to Moody’s $2.2 trillion. Whatever the real number is, it will eventually require (and sooner would be better than later) that all involved take some kind of haircut. There is simply no way, barring the discovery of the fountain of youth and the erection of a state and muni bottling plant next to it, that these gigantic unfunded liabilities can be made whole.
Mr. Buffett saw that nearly 20 months after Ms. Whitney. He got out while he still could. It will be hard, if not impossible, for the state and municipal bond chorus to call him a fraud and a charlatan.
[Image provided by Wikimedia Commons.]
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