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The cup is half empty at Janney
A new research note this week from municipal credit analyst Tom Kozlik issued a dire warning about the future of the municipal market that may make state finance officers uncomfortable. Despite mostly high ratings and a years-long economic recovery, all is not well with states' credit quality, Kozlik wrote in a May 28 report for Janney Montgomery Scott. “Truth is, that there has been a long and slow recovery, but the magnitude has been weak, and revenues have lagged [in] many U.S. state government budget plans,” he said.
The rating downgrade of Chicago earlier this month, he added, should put politicians and voters across the country on notice. Although it is a particularly severe case, Chicago is not alone in its problems with pension costs that are gobbling up budgets. “Lawmakers have not been paying close enough attention to the future costs of employee benefits. This lack of attention is going to be expensive,” Kozlik said. “The costs are so expensive, and possibility of reform so dire, that we will consider a solution to the funding of public employee pension plans, if and when it happens, among the top achievements of government.”
His conclusion? Political indecision should now be considered an actual risk in the municipal bond market, he said. His advice for investors is to start protecting themselves from that risk by adjusting their municipal bond investment strategies to “insulate themselves from political risk.” (That's another way of saying it's time to dump the potentially risky bonds now.) “This Research Note,” Kozlik concluded, “should be considered a warning alarm for municipal bond investors, they need to prepare for this fallout now.”
Breaking down Illinois' breakdown
Speaking of political risk, the Tax Foundation released a breakdown this week of what exactly is terrifying about Illinois’ financial trajectory. The state has had more people moving out than moving in each of the last 20 years; and in fact, since the early 1990s, Illinois has seen a net of 1,004,952 people leave the state. And since the early 1980s, the state has generally had a higher unemployment rate than the U.S. average. Another sour point: Its income tax rate is slated to fall, which could put further pressure on its revenue stream. The rate remained constant at 3 percent for the last two decades, before lawmakers passed a temporary rate increase to 5 percent in 2011. Rates dropped to 3.75 percent at the start of 2015 and are scheduled to drop further to 3.25 percent in 2025.
The fiscally conservative Tax Foundation released the study in partnership with the Taxpayers’ Federation of Illinois. The idea was to offer a broad perspective of Illinois’ taxes and help readers visualize some of the lesser-known aspects of its tax environment -- but also to push the point of overall tax reform in the state. “Illinois is at a turning point,” the press release said. “It currently faces a large volume of unpaid bills, a multibillion dollar budgetary shortfall, and the partial sunset of tax increases from 2011." These factors, and the state's inability to reform its pension system, mean that it's time for new policy solutions. "Budget, revenue, and structural proposals are all currently on the table, but tax reform needs to be part of the discussion.”
When disaster strikes
As Texas and Oklahoma battled severe floods this week that killed more than a dozen people, Moody’s Investors Service issued a report summing up how access to money plays a key role in how communities recover. In short, governments would really be up a creek without the feds. “On their own, state and local government issuers lack sufficient financial resources and borrowing capacity to fund post-disaster rebuilding of vital infrastructure and maintenance of core services,” the report said. “Without strong federal support for recovery from hurricanes, earthquakes, floods, tornadoes and other disasters, the credit quality of affected issuers would materially decline.”
In general, the smaller the government, the more vulnerable it is when it comes to disaster. Access to cash reserves is still key as local governments are typically the first responders in a crisis and must put up their own money until federal aid arrives. “Issuers expect their immediate costs will ultimately be defrayed by outside assistance, but the federal reimbursement time frame is still very hard to predict,” Moody’s said, adding that officials have to take detailed records of all expenditures to hope to secure their federal reimbursements.
But small towns and counties shouldn’t fret too much. Despite Congress’ inability to agree on much of anything these past few years, it still views disaster assistance as a basic federal government function. In 2014, disaster events in 34 states were declared eligible for federal assistance and Congress has enacted emergency supplemental funding measures in 12 of the last 18 federal fiscal years, Moody’s said.