Sunday, July 22, 2012

Urban decay, urban bankruptcy, and fiscal reality

Remember Meredith Whitney?  She's the analyst who, in late 2010, predicted massive municipal defaults on their bonds, which in so many words implies municipal bankruptcies.  We mentioned her twice here.  Here's the interview with '60 Minutes' where she made her predictions.

At the time, she became a prophet without honor in her own country.  As Michael Lewis recalls:

Inside the financial world a new literature was born, devoted to persuading readers that Meredith Whitney didn’t know what she was talking about. She was vulnerable to the charge: up until the moment she appeared on 60 Minutes she had, so far as anyone knew, no experience at all of U.S. municipal finance. Many of the articles attacking her accused her of making a very specific forecast—as many as a hundred defaults within a year!—that failed to materialize. (Sample Bloomberg News headline: MEREDITH WHITNEY LOSES CREDIBILITY AS MUNI DEFAULTS FALL 60%.) The whirlwind thrown up by the brief market panic sucked in everyone who was anywhere near municipal finance. The nonpartisan, dispassionate, sober-minded Center on Budget and Policy Priorities, in Washington, D.C., even released a statement saying that there was a “mistaken impression that drastic and immediate measures are needed to avoid an imminent fiscal meltdown.” This was treated in news accounts as a response to Meredith Whitney, as she was the only one in sight who could be accused of having made such a prediction.

Well, guess what?  The bankruptcy filings of three California cities in the past few weeks - first Stockton, then Mammoth Lakes, and now San Bernardino - has ladled egg onto the faces of Ms. Whitney's critics.  As the San Francisco Examiner points out, "Basically the roster of California cities has become a game of dead pool to see which one will drop next".  Michael Lewis again:

What Meredith Whitney was trying to say was more interesting than what she was accused of saying. She didn’t actually care all that much about the municipal-bond market, or how many cities were likely to go bankrupt. The municipal-bond market was a dreary backwater. As she put it, “Who cares about the stinking muni-bond market?” The only reason she had stumbled into that market was that she had come to view the U.S. national economy as a collection of regional economies. To understand the regional economies, she had to understand how state and local governments were likely to behave, and to understand this she needed to understand their finances. Thus she had spent two unlikely years researching state and local finance. “I didn’t have a plan to do this,” she said. “Not one of my clients asked for it. I only looked at this because I needed to understand it myself. How it started was with a question: How can G.D.P. [gross domestic product] estimates be so high when the states that outperformed the U.S. economy during the boom were now underperforming the U.S. economy—and they were 22 percent of that economy?” It was a good question.

From 2002 to 2008, the states had piled up debts right alongside their citizens’: their level of indebtedness, as a group, had almost doubled, and state spending had grown by two-thirds. In that time they had also systematically underfunded their pension plans and other future liabilities by a total of nearly $1.5 trillion. In response, perhaps, the pension money that they had set aside was invested in ever riskier assets. In 1980 only 23 percent of state pension money had been invested in the stock market; by 2008 the number had risen to 60 percent. To top it off, these pension funds were pretty much all assuming they could earn 8 percent on the money they had to invest, at a time when the Federal Reserve was promising to keep interest rates at zero. Toss in underfunded health-care plans, a reduction in federal dollars available to the states, and the depression in tax revenues caused by a soft economy, and you were looking at multi-trillion-dollar holes that could be dealt with in only one of two ways: massive cutbacks in public services or a default—or both. Whitney thought default unlikely, at least at the state level, because the state could bleed the cities of money to pay off its bonds. The cities were where the pain would be felt most intensely. “The scary thing about state treasurers,” she said, “is that they don’t know the financial situation in their own municipalities.”

“How do you know that?”

“Because I asked them!”

All states may have been created equal, but they were equal no longer. The states that had enjoyed the biggest boom were now facing the biggest busts. “How does the United States emerge from the credit crisis?” Whitney asked herself. “I was convinced—because the credit crisis had been so different from region to region—that it would emerge with new regional strengths and weaknesses. Companies are more likely to flourish in the stronger states; the individuals will go to where the jobs are. Ultimately, the people will follow the companies.” The country, she thought, might organize itself increasingly into zones of financial security and zones of financial crisis. And the more clearly people understood which zones were which, the more friction there would be between the two. (“Indiana is going to be like, ‘N.F.W. I’m bailing out New Jersey.’ ”) As more and more people grasped which places had serious financial problems and which did not, the problems would only increase. “Those who have money and can move do so,” Whitney wrote in her report to her Wall Street clients, “those without money and who cannot move do not, and ultimately rely more on state and local assistance. It becomes effectively a ‘tragedy of the commons.’ ”

The point of Meredith Whitney’s investigation, in her mind, was not to predict defaults in the municipal-bond market. It was to compare the states with one another so that they might be ranked. She wanted to get a sense of who in America was likely to play the role of the Greeks, and who the Germans. Of who was strong, and who weak. In the process she had, in effect, unearthed America’s scariest financial places.

“So what’s the scariest state?” I asked her.

She had to think for only about two seconds.


There's much more at the link.  I highly recommend reading Mr. Lewis' article in full, not only to understand the mess in which California finds itself, but to understand what's happening in other union-heavy states - New York, Massachusetts, Illinois, etc.  New Jersey and Wisconsin have elected governors that are tackling the problem head-on.  They're meeting resistance, but their tough talk is getting results.  I'm willing to bet other states will soon elect governors with similar attitudes.

As for the spendthrift municipal governments?  Michael Lewis spoke to Mayor Chuck Reed of San Jose.

“How on earth did this happen?” I ask him.

“The only way I can explain it,” he says, “is that [the unions] got the money because it was there.” But he has another way to explain it, and in a moment he offers it up.

“I think we’ve suffered from a series of mass delusions,” he says.

I didn’t completely understand what he meant, and said so.

“We’re all going to be rich,” he says. “We’re all going to live forever. All the forces in the state are lined up to preserve the status quo. To preserve the delusion. And here [San Jose] is where the reality hits.”

Warren Buffett believes that more municipal bankruptcies are on the way.

Billionaire-investor Warren Buffet said on Friday bankruptcies by three California cities in three weeks are making traditionally objectionable Chapter 9 municipal bankruptcy filings more palatable to local governments in financial crisis.

"The stigma has probably been reduced when you get very sizeable cities like Stockton or San Bernardino to do it," Buffett said in a Bloomberg Television interview. "The very fact they do it makes it more likely.

. . .

"Once people find that the city works the next day, it makes it easier for the city council next time they have a problem with pensions -- or whatever it is -- just to say, 'Well, we'll declare bankruptcy,'" Buffett said.

There's more at the link.

That figures.  Spent your way into a corner?  Take the easy way out.  Declare bankruptcy so you can default on all your commitments and all your promises.  The fact that millions of your bondholders will lose the income on which they rely to fund their pensions is neither here nor there.

Folks, this is where the rubber of the economic crisis hits the road of reality.  When your trash is no longer picked up as often, because the city can't buy gas for its garbage trucks;  when your streets are no longer as well lit, because bulbs are too expensive to replace;  when crime soars, because police numbers have to be cut;  when fires burn a building to the ground, because fire stations have been closed, or are operated on staggered hours . . . all these are symptoms not only of financial ruin, but of the decay of the physical fabric of our society.  When that goes, the moral and spiritual fabric of that society often follows.  Remember the old Latin tag, 'Mens sana in corpore sano'?  It means 'A sound mind in a healthy body'.  It implies that one can't have a sound mind in an unhealthy body;  alternatively, an unsound mind will lead to an unhealthy body.  Basically, it says that balance is a good thing.  Disrupt the balance, and bad things follow.  Our cities are living proof of that.

The only answer I know that works in the real world - one that I've seen working in poverty-stricken areas all around the world - is for like-minded people to band together.  Get together with your friends, and bring in like-minded people whom they can recommend.  Form a small group whose members can help each other to sustain themselves.  Some can grow and/or cook food;  some can clean;  some can guard and protect;  some can earn money at their jobs to help others keep going;  some can repair clothes, or cars, or washing machines;  some can cut lawns, tidy up, and haul away trash.

By working together, we can all help ourselves.  If we stand aloof, we may soon not be standing at all.

Think I'm joking?  Tell that to the people of Stockton, California - 'the most miserable city in America', according to Forbes.  Tell it to the residents of San Bernardino.  Tell it to all those cities whose leaders are desperately looking for a way out of their troubles . . . and not finding one.

Urban decay.  It's almost certainly coming to a city near you - and when it does, its effects may well spill over into your neighborhood.  Start preparing yourselves now.



Anonymous said...

Well, bring it on. I cannot wait for it to distroy this state of mexafornia/kalifornia. Maybe some of this destruction will actually befall upon thoses that started all this crap in the first place. Then let GOD sort it out.

Peter said...

@Anonymous at 11:10 PM: Unfortunately, when it comes, it's going to affect the good and the bad alike. We're all going to suffer. That's why I'd rather not bring it on, if at all possible . . . but I fear it's inevitable by now.

Joe in PNG said...

And this is how the American empire falls. The badly managed bits slowly rot away while demanding money from the better managed bits. The smart people leave the poorly managed bits for the better managed bits.
Eventually the better managed bits get sick & tired of giving money to the bums and go for independance. Note, this takes a while, but is inevitable.

Frank said...

Enough with the hysteria. It's obvious you have no idea what you're talking about in terms of muni bonds and of course, neither did Meredith Whitney. Read a learned discourse on what a bond expert says about Michael Lewis and his misguided piece in Vanity Fair:

Sutor, ne ultra crepidam
by The Bond Girl 2011-09-29

Michael Lewis’ latest piece in Vanity Fair, “California and Bust,” begins with a lengthy defense of Meredith Whitney’s prediction that there would be a wave of defaults in the municipal bond market. I was not planning on writing a response to his article – frankly, defending Whitney’s call at this point is very much like defending Harold Camping’s prophesy on May 22nd, after even the most gullible people have realized that they euthanized their pets for nothing.

Whitney’s call for “50 to 100 sizeable defaults” totaling “hundreds of billions of dollars” has not even come close to materializing.

Lewis decides to test her assertion, at least as it pertains to California, which is the state Whitney says is in the worst position. Of course, Lewis does not interview Bill Lockyer, who is the state’s treasurer, but Arnold Schwarzenegger, the former governor. His rambling interview with Schwarzenegger, which takes place while the two ride bicycles along the beach, mostly covers the governor’s improbable ascent to political leadership and struggles while in office.

As I was reading Lewis’ defense of Whitney’s arguments, it struck me that he probably did not read Whitney’s Tragedy of the Commons report (as I have). If he had, it probably would have occurred to him that she mostly used data and analysis provided by organizations like the National Association of State Budget Officers (which publishes reports explaining the logistics of states’ individual budget processes and comparing state budget actions) and the Pew Center on the States (to name only a couple). She doesn’t really do any of her own analysis at all – her work reads like an incredibly verbose high school student’s book report. He also would have known that her opinions about local governments were not based on any specific analysis of local credits. She said there would be hundreds of billions of dollars’ worth of defaults in a sector of the municipal market that she had not even studied. And Lewis seriously wishes to defend this kind of reckless and irresponsible behavior?

Lewis makes two other undeveloped arguments in support of Whitney. The first is that her claims have been misrepresented. It seems fairly silly to say that her words have been misrepresented when they have been captured on video and repeated ad nauseam over the past twelve months. And much has been made of how Whitney conflates what she calls “defaults on social contracts” and what most rational people would consider a default, which is a failure to observe terms of the bond contract or a failure to make timely principal and interest payments. (That is not misrepresenting her views, but providing a legitimate criticism of her sense of what constitutes a credit event.) In interviews, Whitney has generally moved back and forth between the two as is convenient.

But “she was referring to the complacency of the rating agencies and investment advisers who say there is nothing to worry about,” Lewis offers. As I have already explained, until recently, the rating agencies inexplicably rated munis on a tougher scale than other kinds of credits, and most of the monetary defaults the market sees are on bonds that had junk ratings or were unrated when issued. Lewis would know this if he had actually researched credit events in the marketplace before writing his article.

People like Lewis and Whitney, who are trying to sell a canary-in-the-coal-mine version of the market, are doing investors a disservice.

Peter said...

@Frank: I don't think it's hysteria at all. I cited several sources (including Warren Buffett) who appear to agree with and/or confirm the position that increased municipal defaults and/or bankruptcies are highly likely. All you've done is cite one source that disagrees - akin to sticking a finger in a dyke that's about to burst.

Believe your source if you wish. My money's on the other side being right. So is that of most of the more authoritative economic commentators I know.

virgil xenophon said...

In tiny rural Grosse Tete La and outlying areas off La Hwy 77, some 20 mi outside of Baton Rouge near Bayou Blue they are cutting garbage pick-ups from twice/wk to once/wk come August. The State of Louisiana is making massive cuts in its heaklth and school budgets--cuts so big it may affect the accreditation of some hospitals and Universities. But why should I worry--I just escaped from Alice thru the Looking Glass California...FORGET the multibillion train to nowhere--wait until Cali's residential electrict rates start to reflect the new law that 33&1/3% (ONE THIRD!)of the States electric power comes from "renewable"/"alternate" (har har) energy sources by 2021.