The mass protests from state workers in Wisconsin and the revolt by Democrats in the state Senate should set off alarm bells for investors in municipal bonds.
One of the strongest arguments against fears of a wave of muni bond defaults is that state governments will be able to reign in their need to accumulate debt before a crisis develops. That would require states to reign in spending—especially health care spending—and pension fund obligations.
This is what Wisconsin Governor Scott Walker has been attempting to accomplish. He has sought to pass a bill that would bring an end to collective bargaining for state workers. He also wants state workers to pay a larger share of their health care costs and contribute more to their pension funds.
To Walker, these measures seem “modest.” But they have set off a political firestorm. The Democrats in the state senate have effectively filibustered the bill by leaving the state on Thursday, delaying any vote by depriving the senate of a quorum.
Now even President Barack Obama has joined the side of the state-workers, describing the bill as “an assault on unions.”
Wisconsin is not in imminent danger of defaulting on its bonds. Although tax revenues dropped in the wake of the financial crisis, Wisconsin’s economy is healthier than many other states.
But a victory by the unions in Wisconsin could embolden state workers in states with far worse finances. Politicians worried about similar revolts might consider it better politics to force muni bond holders to accept haircuts. After all, hedge fund and mutual fund managers are not likely to fill the streets of the state capital or win the sympathy of members of the state legislatures.
Much of the bullish case for munis depends on the belief that states and localities will behave rationally and predictably when it comes to their debt payments. In Wisconsin, however, we’re seeing these assumptions fall apart. Political risk is alive and well.
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