I think I feel a pulse….
Janney Montgomery Scott released its Municipal Bond Market Monthly newsletter and had these sobering words to say about the country’s economic horizon: “The U.S. economy is seemingly at a crossroads, and questions about its ability to continue to expand, even at a snail’s pace, are being countered not with satisfying answers but usually with more questions.”
OK, let’s not totally ruin your week. First, analysts (and just about everyone else) have been decrying for more than a year the uncertainty that has marked this post-recession recovery. Also, there’s nice news: for one, Janney notes, if the economy “keeps on trucking along,” the end of this year would mark the sixth longest expansion since World War II. We also get marks for resilience. “It shook off the Sequester cuts in 2013, for example,” the newsletter says. “A true test will be whether it can shake off the last few months of noise from the bad weather and then, most importantly, find a way to rejuvenate a structurally challenged labor market.”
But here are some of the worrisome bits: most economic indicators are still below pre-crisis levels and structural unemployment problems loom. Also, analysts worry that we are headed for another housing price bubble as home price increases are starting to outpace income growth. It’s the same trend we saw before the last housing bubble burst.
Harrisburg, Pennsylvania’s financially troubled capital, is poised to emerge from receivership on Mar. 1 after years of not being able to pay its bills. Harrisburg first defaulted in 2009 on its General Obligation guarantee of debt incurred by The Harrisburg Authority to build the city's trash incinerator plant. The city then defaulted on its own GO debt in 2012.
Moody’s Investors Service estimates that investors holding Harrisburg’s GO debt will receive an average of about 75 cents on the dollar. There are three main points in the credit agency’s analysis:
1. That 75 percent level of recovery is consistent with an overall trend of lower recovery rates following U.S. government defaults. Historically, rates have averaged as high as 96 percent, even during the Great Depression.
2. The recovery rate for the GO-guaranteed debt, which was supposed to be backed by the city if the Harrisburg Authority was unable to make payments, is actually lower than the city's own GO debt. This “suggests that GO-guarantees could have weaker recoveries in future municipal default situations,” Moody’s says, even though cities have the same legal obligations for both kinds of debt.
3. Even within the GO-guaranteed creditor group, recovery rates varied, ranging from 39 percent to 75 percent. This suggests a “growing pattern” of widely varying recovery rates in municipal defaults, Moody’s says.
All in all, Harrisburg paid creditors a total of $325.3 million of the $435.5 million originally promised to them.
Hands off my muni bonds!
Worried about the new proposed tax reform on Capitol Hill? Chris Mauro, director of municipal bond research for RBC Capital Markets, says you shouldn’t be. He is calling the proposal by House Ways and Means Committee Chairman Dave Camp “nothing more than a temporary distraction for the market rather than a legitimate near-term threat.” The reform would tax interest earned on municipal bonds by people with more than $450,000 in taxable income. It would also eliminate the tax-exempt status of private activity bonds, repeal the Alternative Minimum Tax and eliminates the deductibility of state and local taxes for individuals.
Mauro notes that the proposal has incited dismissals from both sides of the aisle. Both the House majority and minority leaders said the proposal has no chance of passing this year (albeit for different reasons). “Accordingly we expect this proposal will be quickly forgotten and that any legitimate debate on this matter will be pushed to 2015, after the mid-term elections, or potentially to 2017, after the next presidential election,” Mauro writes in his analysis.
Even with all the poo-pooing, Mauro’s review does contain this caution: the mere fact that Camp’s proposal includes some municipal provisions underscores the notion that the tax exempt status of municipal bonds is an item to be considered in reform. “Therefore when legitimate tax reform discussions begin in earnest, whether that’s 2015 or 2017,” he says, “municipals will, without a doubt, be part of the conversation.”