Ever since Meredith Whitney unveiled a study forecasting a wave of defaults by cash-strapped state and local governments last fall, investors have been pulling money from municipal-bond mutual funds. It’s no surprise — the Wall Street analyst famously (and correctly) predicted Citigroup’s
2008 dividend cut and the shaky finances of the banking industry. But while investors sell off munis, everyone from bank analysts to government officials have blasted Whitney for crying wolf.
It was no different at a conference this week about state and municipal finance hosted by Bloomberg. Though investors and economists didn’t directly blame Whitney, they say the doomsday speculation of widespread defaults are overplayed. Whitney could not be reached for comment because she was traveling, but as CNBC anchor Maria Bartiromo noted in USA Today, the analyst seems to have softened her initial projections: “Every day things get better because politicians are addressing the fiscal challenges more aggressively. Since November you’ve had more governors take strong austerity measures,” she tells Bartiromo.
Defaults could certainly edge up some this year, many analysts agree, but not to the alarming scale suggested by Whitney on 60 Minutes last year. Richard Larkin, director of credit analysis with Herbert J. Sims & Co., says defaults will probably be “a little less than 1%” this year.
And as Jerry Webman, senior investment officer and chief economist at OppenheimerFunds, said during a panel at the conference: “I’d rather be a muni bondholder than a public school teacher.”
To be sure, this isn’t to downplay the mess that has become of government finances. Though the Great Recession officially ended nearly two years ago, municipalities and households are still recovering from the scars of the financial crisis. Tax revenues, closely tied to property values, are down. Public pension and health care liabilities are way up. And as the federal government’s stimulus package wanes with little chance of another round of funding, bailout money to states (which generally trickle funding down to city and counties) is running dry.
This year will be the toughest budget season in at least two decades as municipalities face annual budget shortfalls of as much as $83 billion by 2012, according to the National League of Cities.
But tough as it may be, it won’t be doom and gloom everywhere. Here are three reasons why any defaults on government loans will likely come in ripples — not waves.
It’s not worth missing debt service payments. Needless to say, when governments pay interest and principal payments on loans to build everything from civic centers to public schools, it’s far different from the average consumer trying to pay down credit card debt. Whereas the average consumer might miss a few payments here and there, this rarely happens with governments as local charters and other rules often put such payments at the top of list. Fitch Ratings notes that debt service makes up “a relatively small part of most budgets” and that not paying would not solve fiscal problems.
Historically, defaults are rare. It’s not entirely implausible that large-scale defaults could arise, but history has proven that’s unlikely to happen. Since 1970, there have been 54 bond defaults — the majority, 42, were standalone housing and health-care projects while just three involved general-obligation debt, according to a report by Moody’s Investor Services. Indeed, the pains following the latest recession are unprecedented and governments are scrambling to plug budget gaps. But if history continues to play out, the wave of defaults that Whitney predicts won’t likely happen.
Governments have the power to tax and cut spending. Governments rarely if ever resort to loan defaults to balance their budgets. The short and long-term impacts are often unfeasible — defaulting damages government credit, leading to higher borrowing costs on any future bonds. Besides, governments have several options to plug budget gaps, since officials have the power to cut spending and raise taxes and fees. In what’s perhaps one of the more controversial cuts, Michigan’s new Governor Rick Snyder is pushing to eliminate a popular tax credit that has allowed more than 100 movies to be filmed in the state over the past three years.
Indeed, one of the indicators calming muni bondholders is the scale of budget cuts that have already happened. In a survey looking at fiscal conditions across American cities, the National League of Cities found that 79% of cities cut personnel in 2010, 69% canceled or delayed infrastructure projects, 44% made cuts in services other than public safety, and 25% cut public safety. And while layoffs since the height of the financial crisis have stabilized in the private sector, state and local governments have been cutting jobs.
Now the question that Whitney and other skeptics have is whether governments have enough political will to cut deeper.
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