A Well-Earned Rant and My Call on Muni Issuance

Categories: Commentary |

May 19, 2014

Over the past months, I have refrained from any rants or glass half empty views. I decided to step back and see how things shake out for a bit. Simply point you, the reader, to data that can tell the story around the municipal market – the haves and have nots, if you will. For those that know me well, you can only imagine there is a bit bottled up. Well, I feel I’ve earned one part of a commentary to let off a bit of steam and provide some of what I think. What spurred me? Europe, the Fed, a number of articles I read this week, policy changes being discussed and a few other factors. Yes, this week’s commentary will contain more opinion than usual and no maps, charts or tables.

A Well Earned Rant

Last Thursday’s Wall Street Journal contained an article highlighting the fact that State tax receipts for 1Q 2014 came in unexpectedly below budget for many States and, in some States, opening a gap in the income projections for the year (in other words, requiring spending reductions – thankfully the States have to balance their budgets). I can’t say that I am terribly surprised. Recall that in the first quarter of 2013, when tax receipts ballooned, this commentary (and others) highlighted the fact that the expiration of the Bush tax cuts had caused many to take capital gains at the expiring, lower rate, thereby boosting State income tax receipts.

I am not here to toot my own horn but to point out that it is critical to look to the assumptions used to arrive at budgets. In the case of income tax, a component for many States is capital gains and dividends as is wages. If folks took advantage of expiring lower rates to take capital gains, one can certainly surmise that this can be treated as a one-time accretion to tax receipts that, at a minimum, needs to revert to the mean over time (as opposed to build off the base of an inflated year of tax receipts). Now, you can argue that 2013 saw spectacular gains in the equity market and, as a result, capital gains should not really suffer. Unfortunately, the actual tax receipts do not support this argument – at least to date (and some believe won’t happen once the equity market corrects). Time will tell but I am not particularly confident that the equity markets will continue to reach new highs despite the Fed’s continued efforts to inflate asset prices (more on this in a moment). Even if they do, will people cash out (take gains) or fear they will miss more upside?

The other factor I find disconcerting for State tax collections is around wages. As I pointed out several weeks ago, wages in the US are not rising all that much. Please take a look back at our May 5, 2014 and March 24, 2014 commentaries click here.

Next up, monetary policy. I was struck by word that Germany was on board with doing what is necessary to goose the European economy. As one person put it, “Germany finally fell in-line with the rest of the EU.” As I reminded this person, they should look at which European economy had the best growth and the most fiscal restraint. So far, accommodative monetary policy – be it here in the US, Europe or Japan (ask them how the 20+ year experiment is going) – doesn’t seem to be doing the trick. You may say, but Gregg, the Fed is tapering its bond buying program. Things have to be getting better. I disagree and here’s why. Despite near zero rates for years and an unprecedented bond buying program, the Fed has not been able to get the economy growing (recall that GDP growth is about 2%, we hope) nor is the job market and job growth near where it needs to be (despite a declining unemployment rate – you’ve heard me on this point so I will simply refer you to prior commentaries on the subject). I surmise that, despite weak economic data (why else would the Fed continue to promise low rates for as long as needed), the Fed has concluded that the bond buying program was not working. I base this on two simple facts: the economy and where rates are today.

Along these lines, I came across two quotes from William White, former chief economist of the Bank for International Settlements, as reported in Mauldin’s Thoughts From the Frontline, April 27, 2014, that I thought were worth sharing.

In the past, monetary policy has always succeeded in pulling up the economy. But each time, the Fed had to act more vigorously to achieve its results. So, logically, at a certain point, it won’t work anymore.

The second quote is worth reading before you move to the next paragraph.

It all feels like 2007, with equity markets overvalued and spreads extremely thin.

With that as a backdrop, I turn to one other factor that scares the bejeebers out of me. If you didn’t see the headline in Wednesday’s WSJ, here it is: “U.S. Backs Off Tight Mortgage Rules” and the sub-headline read “In Reversal, Administration and Regulators Push to Make More Credit Available to Boost Housing Recovery.” Holy housing crisis Batman! Haven’t we seen this before and don’t we know now how it ends?

You may argue that such a maneuver could benefit municipalities over time by virtue of rising house prices, associated assessed values and, therefore, increased property taxes. Come on. Recall the insane bailout required the last time we relaxed credit and documentation standards and concluded it was every American’s right to own a home. So here we are, despite historically low rates, the housing market is not where the government wants it to be so they suggest, relaxing credit standards. Perhaps, just perhaps, this is a short-term solution to get things going … Wait, heard that before too. You get my point, I am more than worried. As John Mauldin periodically comments, “a fly in search of a windshield.”

Municipal Issuance – Going Out on a Limb

I want to turn to the subject of municipal issuance. A subject that, until now, I have refrained from offering any opinion. In short, I think we may be experiencing – at least for a few years to come – a new normal in muniland. As we know, many States and municipalities have taken steps to reduce or better manage debt loads and expenses. The reason are far and wide but they come down to the economic well-being of those municipalities, pension and OPEB obligations, less and less real dollars coming from the Feds and the notion that fiscal management had room for improvement. Whatever the reason, better managing debt and expenses is a good thing.

So why do I think we may be in a new era with regard to issuance? Lets start with the obvious – rates have been artificially low (yes, I said artificially) for many years. As a result, issuers have had the opportunity to take advantage of relatively cheap funds. Many have done so vis-à-vis refunding and otherwise accessing the markets prudently. Despite rates where they are, issuance is down. So long as rates stay low, there may be room for a bit more refunding but one has to surmise that most of that was taken care of as most market experts predicted rates would rise this year – in other words, get it while the gettin’s good (for the record, I was in the same camp with regard to rates gradually increasing in 2014). From here, we have three scenarios. Things get better, they get worse or we continue with an anemic and uneven recovery. In the first case (things get better), rates will rise as the Fed takes its foot off the gas. Rates rise, cost of borrowing rises. The question for many to consider after such a long slog (recovery) will be, is this for real? Should we start borrowing again? Will the revenues (income, property and sales tax) receipts be there or will we need to cut expenses again after a false start? At a minimum, one should contemplate a healthy level of skepticism before sounding the all clear.

In scenario two, rates stay low, tax receipts fall as the economy falters (not a prediction just a scenario) and one simply doesn’t see debt burdens rising. In scenario three, well, we’re living that one. So, there you have it. My perspective regarding issuance. I won’t put a number on it – I leave that for those of you more inclined to do so – but I am on the record with my view that issuance will be at current or lesser levels (add to that the reality that issuance has been goosed this year by that small Puerto Rico deal). The last factor to throw in the mix is how the Detroit saga ends – what do bondholders end up with? Might that have an impact down the road? Perhaps or maybe folks have short memories (see the paragraph above re the housing market).

Oh happy days. I feel so much better now with that off my chest. Looking forward to your feedback and comments and, if you permit, will gladly publish the same in next week’s commentary.

On the Road: This week, Mike and Pete will be in our nation’s capital for the annual FINRA conference and Gregg will be in NYC on Tuesday. We also are pleased to announce the addition of Mark Harries to our Sales team.

Have a great week.

Gregg L. Bienstock Esq.

CEO & Co-Founder, Lumesis, Inc.

Data Released Last Week:

  • # of Unemployed, Unemployment (%) and Unemp. Rank Change, State, Apr 2014
  • Job Growth, State, Apr 2014
  • Labor Force and Labor Force Change, State, Apr 2014
  • # of Employed and Employed as % of Population, State, Apr 2014
  • Foreclosures, State, County, Apr 2014 o=
  • Weekly Initial and Continued Jobless Claims, State, 05/03/2014

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