December 22, 2010
Although politicians on both sides of the Atlantic are trying to reassure their respective electorates that the worst of the latest sovereign debt crisis is behind us, 2011 appears to shape up as the year when the municipal bonds bubble bursts. In the US, municipal long-term debt has jumped from 1.5 trillion to 2.8 trillion dollars today. Cities like Detroit and Los Angeles or states like Illinois, California and Alabama, for example, have racked up billions in debt and used the money to build stadiums, concert halls and to fund other projects with little, if any, economic benefit for the communities undertaking them.
As the casino capitalism mentality took hold, municipal and state politicians issued additional bonds and deposited the money in pension funds, using these as a legal vehicle to play the stock market. Their hopes of higher returns than the interest rates the bonds carried were dashed, however, as share prices stagnated or showed little increases for years. As a result, affected municipalities have instead made heavy losses and have seen their interest bills soar.
Municipal bonds were initially peddled as a safe haven for investors, much in the same way real estate was touted before as a sure bet . Municipalities, and especially states, are not known to default, as both have the ability, at least in theory, to increase the local or state taxes to make up for a shortfall in revenue. Moreover, the interest rates these bonds carry are usually, although not always, tax exempt, making them doubly attractive. Unfortunately, as the US federal debt or the sovereign debts of some European nations look less secure an investment instrument than ever before, the recklessness of local and state politicians in racking up too much debt to finance their projects is also coming under scrutiny. What makes matters worse is the fact that many taxpayers, like the ones in Alabama, are refusing to foot the bill via increased local taxes, making it hard to repay investors on the one hand and fund current local government expenses, on the other.
The 2008 decision of the Obama administration to pay a 35-percent share of the interest municipal bonds carry has, unfortunately, aggravated the problem. Thus, if in 2009 69 billion dollars worth of municipal bonds were sold, the figure jumped to 84 billion in 2010, adding to an already huge amount of muncipal and state debt issued since 2000. To be sure, the BABs (Build America Bonds) were intended to assist local and state governments to repair their infrastructure and thus reduce unemployment locally. As it happened, most of the new money generated as a result went into settling old debts , continued to fuel pension funds, or simply financed the day-to-day running of municipal councils.
The situation is so serious that in 2010, 90 percent of economic analysts in the States believed the “muni-bond bubble” was about to burst. According to Veronique de Rugby, senior research fellow at George Mason University, when this happens, the US federal government will be forced to spend an extra trillion dollars to bail out insolvent municipalities or states. This, in turn, will put the skids on the already sluggish and patchy US economic recovery, therefore bringing the country back to the situation it experienced in the days of the sub-prime crisis.
For centuries, credit instruments such as bonds have been used to finance the development of American cities – and they worked well. Defaults were rare or almost inexistent and investors as well as local communities were generally happy with their respective benefits. In the hands of neoliberal agents, however, these credit instruments – or others like promissory notes, bills of exchange and the like – have been put to massive use to erect Ponzi schemes, creating stock market, real estate and now municipal bond bubbles, which ultimately torpedoed the American and global economies.
Less dependent on municipal bond financing than their American counterparts, European cities are, as a rule, less exposed to such occurrences. Still, cities like Barcelona, Budapest, Naples, or regions such as the Spanish Basque country are on the watchlists of investors, as their debts have ballooned and it isn’t clear who is going to give them the money to cover repayments or operating expenses. The cash-strapped national governments, in the throes of the sovereign debt crisis, are unable to come to their rescue. This makes it likely that the hapless local communities will foot the bill, through a combination of higher local taxes and investing in newly-issued bonds themselves.
As expectations of a solid economic rebound are thus evaporating, we can only hope that 2011 will at least arrest the decline in industrial production, productivity and employment. (sources: The Wall Street Journal, The Guardian)Florian Pantazi