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Whitney warns about ‘negative feedback loop from hell’ in muni market

Says higher taxes will force residents of some states to relocate; where’s the revenue going to come from then?

By Jeff Benjamin

Apr 29, 2013

Investing based on the economic and political realities facing individual U.S. states is offering an “incredible investment advantage,” according to banking analyst Meredith Whitney.

Speaking Sunday evening in Seattle at the start of the Investment Management Consultants Association annual conference, Ms. Whitney explained her December 2010 bearish call on muni bonds by suggesting there are long and short opportunities among individual states.

“You’ve got some states doing stupid things and some states doing incredible things,” she said. “Unemployment is more than twice as high on the coast as it is in the central corridor states.”

The chief executive of Meredith Whitney Advisory Group LLC has been working on Wall Street for 20 years, but made big news in 2007 with her call that a major financial credit crisis was looming.  That call was followed in late 2010 by an even more spectacular call for sweeping municipal bond defaults, which was broadcast during a 60 Minutes interview.

When asked about the negative muni prediction, which rattled the $4 trillion muni bond market and drew a lot of criticism from the bond market, Ms. Whitney said she the reaction surprised her.

“I first published the research from that [December] 60 Minutes interview in September,” she said. “That was an hour and a half interview, and it was not my intention to make any calls on the show, and I didn’t expect it to resonate as much as it did.”

As to whether her call on the muni market was premature or exaggerated, she clarified, “I said people would have to worry about it in 12 months because the stimulus money was running out.”

She still isn’t backing down on the level of risk she sees in the muni market.

“This is just the beginning, and this stuff will take a long time to play out,” she said. “This is not fun stuff to talk about; the fun stuff to talk about is all the good stuff that governors are doing around the country.”

Along those lines, Ms. Whitney laid out an investment theme that involves digging deep into state and municipal budgets that will tell the story of where and how money is going to be spent over the next few decades.

“People who don’t like the taxes in one state will move to another state and that creates the negative feedback loop from hell, and something has got to give,” she said. “The investment side of the issue is the demographic landscape of the United States is changing before our eyes and this is what is important for the next 25 years.”

In terms of what she worries about the most, Ms. Whitney initially paused saying she “didn’t want to be audited,” then acknowledged to witnessing “the worst political policies I’ve ever seen in my lifetime.”

She noted that “the jobs conundrum is not a conundrum, you’ve got to retrain and relocate people. The lack of political will scares me.”

President’s 2014 Budget Cuts State, Local Grants

GFOA News Letter

April 18, 2013

On April 10,  2013, the White House sent to Congress a $3.78 trillion budget proposal  for fiscal 2014, which included a combination of revenue raisers and  spending cuts designed to reduce the federal budget deficit by $1.8  trillion by 2023. The largest revenue increase proposed in the budget  would come from a reduction in the value of certain tax benefits,  including tax-exempt interest on municipal bonds.  Under the proposal a 28% limit would be imposed on the tax value of  specified deductions and exclusions from adjusted gross income earners  in the 33%, 35%, and 39.6% tax brackets. The administration estimates  that this policy would generate $529.5 billion over the next ten years.  The GFOA has consistently opposed any limitations on these provisions in  the tax code because of their potential costs to state and local  governments, and is encouraging our members to contact the White House  and discuss their opposition and concerns with this proposal. Our  Federal Liaison Center is providing a draft letter that members can use to send to the president on this issue.
Beyond  these harmful provisions, the proposal also reintroduces a new America  Fast Forward bonds program, which would provide 28% subsidies for  governmental financing. The bonds could be used for all purposes for  which tax-exempt bonds are currently eligible, including working  capital, refundings, and eligible 501(c)(3) and other private-activity  bond uses, subject to current state volume caps. New-money AFF bonds  issues in 2014 and 2015 for school and university construction projects  would be eligible for a 50% subsidy rate.
Regarding retirement  savings, the budget proposal would limit the total amount an individual  can accumulate for retirement in tax-favored accounts. In particular,  the president’s budget would cap such accumulated savings at the amount  necessary to provide the maximum annuity permitted for a tax-qualified  defined benefit plan under current law – currently an annual benefit of  $205,000 at age 62. The cap would apply to individual accounts such as  IRAs, 401(k)s, 403(b)s, and 457(b)s, as well as to defined benefit  accruals.
In other areas of note to state and local governments, the proposal would:

  • Exclude private activity bonds for water infrastructure from state volume caps.
  • Permanently extend the New Markets Tax Credit.
  • Reduce  funding for the b program, which supports housing and community  facility improvements in low income neighborhoods, from $2.8 billion in  the current fiscal year to $2.7 billion in fiscal 2014.
  • Reduce funding for Clean Water and Drinking Water State Revolving Loan Funds,  which provide low-interest loans to communities to finance water  projects, from $2.2 billion in the current fiscal year to $1.9 billion  in fiscal 2014.
  • Reduce funding for the Low Income Home Energy Assistance Program,  which assists low income families and individuals with heating and  cooling bills, from $3.2 billion in the current fiscal year to $2.9  billion in fiscal 2014.
  •  Changes to funding for federal programs designed to support state and local public safety. These programs include:
    • The Community Oriented Policing Service grant program, which enables state and local governments to hire additional police officers. Under the White House proposal, the COPS program would be increased by $241 million over current funding levels, for a total of $439.5 million in fiscal 2014.
    • Part of the COPS program, the $150 million new Comprehensive School Safety will develop school safety plans, improve equipment and systems needed to provide for enhanced school safety, and hire school safety personnel.
    • The Byrne Justice Assistance Grants, which provides states and localities with funding to support state and local law enforcement equipment, prosecution and courts, crime prevention, drug treatment, and other similar initiatives. The White House’s fiscal 2014 budget proposal would provide a $25 million increase over current year funding levels, for a total of $395 million in fiscal 2014.
    • The Staffing for Adequate Fire and Emergency Response grant program, which provides funds to state and local governments to hire firefighters, as well as the Assistance to Firefighter grants program, which provide funding to state and local governments for equipment, protective gear, emergency vehicles, and training. Under the administration’s proposal, each of these programs would experience a slight decrease from $338 million in the current fiscal year to $335 million in fiscal 2014.
  • Eliminate the State Homeland Security Grant Program,  which provides resources to state and law enforcement and emergency  response agencies to help fund equipment, training, and other needs to  respond to acts of terrorism. The proposal would also eliminate the Urban Areas Security Initiative,  which provides funding to address similar needs of first responders in  high-density population areas. These programs would be replaced by a new  National Preparedness Grant Program.
  • Reduce funding for Airport Improvement Grants  by $450 million to $2.9 billion in fiscal 2014, by eliminating formula  grants to large airports but allowing them to increase their own  passenger facility charges.
  • Provide $50 billion in new funding  for infrastructure repair and maintenance of existing roads, bridges,  transit systems, border crossings, railways, and runways. The proposal  also supports the funding levels included in the 14-month transportation  reauthorization law (MAP-21), which was enacted in  July 2012. In fiscal 2014, the budget would provide $53 billion for  highway, transit, and highway safety programs.

Take Five: Muni mavin Ronald Bernardi on the tremors from Stockton

Trader says bankrupcty will likely shake up tax-exempt landscape in California

By Jeff Benjamin

Apr 9, 2013

Ronald Bernardi, a municipal bond trader and president of Bernardi Securities Inc., puts the Stockton, Calif. bankruptcy in perspective.

For investors, he said, there is an upside to the growing list of defaults, and he thinks that municipal employees will ultimately be forced to share in the pain alongside bondholders.

InvestmentNews: Does the Stockton bankruptcy represent the start of a tipping point for municipal bankruptcies?

Mr. Bernardi: In California, perhaps. But even on that score, there’s still much to be determined. Nationally, we don’t see a direct correlation with the precedent-setting decision in Stockton.

Clearly, the decision [last week by U.S. Bankruptcy Judge Christopher Klein approving Stockton’s petition for bankruptcy protection] gives California municipalities an option in terms of walking away from their debt, but nationally we don’t view it that way because bankruptcy is handled differently in different states.

InvestmentNews: The California Public Employees’ Retirement System is listed as Stockton’s largest creditor but has so far not been asked to make any concessions. What is the message being sent to muni bond investors?

Mr. Bernardi: Reading what the judge said about the kinds of nontransparent pension benefits that workers received for decades, I have to believe CalPERS will be asked to make some concessions. And that will make the reorganization more palatable to bondholders.  The plan that ultimately is approved will be the defining moment for this and future bankruptcies for municipalities in California.

InvestmentNews: What larger message should muni bond investors take away from the Stockton bankruptcy?

Mr. Bernardi: As it relates to unsecured California municipal debt, investors need to be very wary. The judge gave Stockton permission to use monies in its general fund to pay operating expenses.

The reorganization that Stockton ultimately presents to the judge will greatly determine how market makers and debt issuers view Stockton and other California municipalities.

InvestmentNews: Is there an upside for investors to be gleaned from a municipal bankruptcy?

Mr. Bernardi: Most definitely, because bad news creates opportunities. California muni debt is trading at higher yields and lower prices than it was 10 days ago. The legal right of municipalities in California to file for bankruptcy has now been confirmed by a judge’s ruling.

InvestmentNews: From 1970 through 2009, municipal defaults averaged less than two per year, but there have been 16 defaults over the past three years. What does the trend suggest?

Mr. Bernardi: From a 10,000-foot level, an increase in defaults is certainly consistent with the economic crisis we went through. And secondly, it shows that the chickens are coming home to roost, in that too many nonessential bond issues have come to market in the last several years.

If it doesn’t work out, elected officials are more likely to walk away, because typically the officials in office when the issue was approved are no longer there. And the new officials have inherited a problem that taxpayers don’t want to pay for.

When I started in the business in late 1980s, you didn’t default on debt, period. But what we’re seeing now is consistent with what you’re seeing across the country — people walking away from their mortgages. You’re seeing those same lower standards trickle down into the muni area.

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