America is now officially worried about a municipal bond meltdown. In a piece called "Day of Reckoning," CBS 60 Minutes showcased financial analyst Meredith Whitney’s bold prediction that we will see “50 to 100 sizable [muni] defaults...more. This will amount to hundreds of billions of dollars of defaults.” It’s a frightening forecast.
Another sign that the muni issue has captured America’s attention: the number of people searching for the term ‘municipal bond’ on Google has spiked in the last week.
Even Goldman Sachs and Citigroup analysts rushed out notes in the days following the broadcast, assessing the likelihood of Whitney’s doomsday scenario.
“The public debate on the subject of municipal credit is terrific and Whitney has helped to energize it even more,” says Ben Thompson, who oversees $7 billion in tax-exempt debt for Samson Capital.
Not one to ignore the structural problems in the municipal market, Ben was early to alert CNBC's "Strategy Session" to these issues back in June. But he’s quick to question the scope of Whitney’s call: “I disagree with the conclusion that the market is facing imminent defaults of the magnitude she described.”
So should you be freaked out?
According to Thompson, the solution to fixing the state balance sheets isn’t fun—but it is manageable:
“This is not like the family who lived beyond their means for years by borrowing money they couldn’t likely pay back. This is the family that lived generally within their means in the good years and didn’t run up the credit cards, but now faces the prospect of lower wages for an extended period of time and has to adjust their lifestyle accordingly,” he said.
Here are three key questions about the so-called "muni meltdown" that seems to have taken center stage overnight —and answers from Thompson.
When will this problem come home to roost?
“It is not a near-term crisis,” says Thompson. But he's quick to add that “pensions and post-retirement health care benefits will become a crisis within 10 years if not addressed soon. Solutions are just beginning to be discussed but we are in the early stages of fixing it, so there is much work left to be done.”
Is the muni crisis the next "subprime crisis" or the next "sovereign debt crisis"?
Thompson says "munis = subprime" is an apples-to-oranges comparison: “The subprime collapseresulted from a new universe of hyper-leveraged, synthetic securities—all dependent on home prices going up forever. In contrast, U.S. municipal finance is at least 200 years old and still functions on the basis of the same inputs and outputs that it always has.”
As for "munis = sovereign debt," Thompson points out the scale of the debt burdens for nations is much, much greater than states:
“Greece’s debt burden is 130 percent of GDP and expected to rise to 150 percent. The U.S. government debt burden is over 50 percent of GDP and rising. In contrast, the largest state debt burdens are around 7 percent (Connecticut, Massachusetts and Hawaii) and the majority are below 5 percent of Gross State Product. Even including pension liabilities, the most challenged large state, Illinois, is only about 16 percent of state product.”
What if the federal government stops payments to the states?
Thompson emphasizes that it’s important to make clear exactly what kinds of payments are happening here:
“Yes, the federal government transfers money to the states, but the majority of these payments are for 'human resources' (like Medicaid) and the result of mandated programs where the state matches federal payments. The federal government cuts payments, the states cut funding and the programs get smaller unless the state elects to make up the difference. This is certainly an example of painful belt tightening but not a causal event for bond defaults.”
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