Saturday, February 1, 2014

The State of the States: Post-Bernanke Bellum

Frederick J. Sheehan is the author of Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession  (McGraw-Hill, 2009) and "The Coming Collapse of the Municipal Bond Market" (, 2009)

            One can almost imagine ex-chairman Bernanke shaking his head in disbelief. (For the record, I cannot conceive of Simple Ben possessing the capacity for what follows, so this is an indulgence in creative writing.):

            "I gave them every opportunity to get out of the mess they had created. Here we were, after the bust in 2009, a generation of irresponsible and sometimes criminal municipal management was obvious. States and cities had spent money like a ship full of drunken sailors, who then sold the ship to keep drinking. They built the most unnecessary monuments to satisfy contractor payoffs, union shakedowns, and school-board extravagances." [Bloomberg, January 24, 2014 - "Engineers spotted 'hundreds' of cracks in welds on parts produced for the San Francisco-Oakland Bay Bridge in 2008 and were encouraged to stay quiet rather than delay the $6.4 billion project.... 'This is the first time in my career the engineering wasn't allowed to be done right,' said Douglas Coe, a former Civil Engineer for the California Department of Education."]

"The phony housing boom had mushroomed property tax receipts, but even these temporary handouts had not been enough to balance their budgets. I have done my best to keep property-tax receipts at such an inflated level ["Home prices in 20 cities climb by most in seven years" - Bloomberg, December 31, 2013], but only a fool could think the central bank can keep prices for 100 million houses rising forever. The huge increase of income tax, sales tax, and capital-gains receipts had also increased beyond belief. This once-in-a-century transfer could not sate these spendthrift governments.  

            "We at the Fed ignored the preposterous 8% earnings rate assumption made for public-pension assets. This assumption extends into the hereafter. All I could give them was through 2013. I produced 8% rates-of-return across markets for four years! This was their chance to get their affairs in order; to whittle down the rate-of-return for the future when markets are bound to regress. [As I said, this goes well beyond Ben's potential imagination. - FJS] To stop spending as if the Fed could QE their pleasure palaces without losing the world's trust in the dollar. To stop building professional football fields when consumers could not possibly continue their animalistic buying, with incomes falling.

            "We worked every contrivance to keep them doing so. Such as: Financial Times - January 24, 2014: 'In Vegas, a panel on securitizations of subprime auto loans - made to riskier borrowers who want to buy cars - was standing room only. Investor demand for the higher-yielding securities has led to intense competition to originate and bundle the auto loans.... 'At some point there will be a failure [of a subprime auto lender]. There will be some consolidation,' said Chris D'Onofrio, of rating agency DBRS." [Not mentioned in the story, but you may have gathered from the "intense competition," most subprime auto loans now being made are to buyers (sort of) whose credit is so poor, they do not even have credit scores.  - FJS] 

            "I offered an opportunity to municipal bond markets: for ratings firms and bond managers to read the fine print. To understand municipalities had started (by 2009) to borrow for operating expenses, even the operating expenses they were forecasting, two or three years in the future. All of this is illegal and remains unspoken.

            "We at the Fed thought [sic - FJS] municipal bond managers would pick and choose through the wheat and chaff. Yet, today, almost every municipal bond fund has at least one percent of its assets in Puerto Rican bonds. I knew the average mind at the FOMC was senile, but what gives with these managers? Their funds are often leveraged. And the rubbish being sold is as revolting as the justification for these issues. For example, from Bloomberg, December 17, 2013: 'Phillips Academy, the oldest incorporated boarding school and one of the most exclusive, is tapping the municipal bond market for over $80 million this week in new money and refunding debt....The school has an endowment of $869 million. The fall, 2013 enrollment was 1,129. Only 13% of the applicants were admitted.... 'These schools need to compete for students and invest in their facilities,' said [Susan] Fitzgerald, [senior vice president at Moody's].'

"She's a senior vice president? I can get away with not knowing what I am talking about before a bunch of senators, but she has a real job. Or, maybe not."

"And now, reading the Wall Street Journal from January 31, 2014: "DETROIT - This bankrupt city is proposing to favor pension funds at roughly double the rate of bondholders to resolve an estimated $18 billion in long-term obligations..."

            "Et cetera, et cetera."

For those not up on Bernanke's limited verbal energy, see "The Professor Who Did Not Save the World."

            Note: The question of pensions vs. bondholders will probably wind its way to the Supreme Court, even though there are many jurisdictions. In the meantime, there will be plenty of reasons for municipal bondholders to run, the Puerto Rican holdings being immediately pertinent.