The MUNI- MELTDOWN THAT WASN’T. November 2014 SPONSORED BY 11.25.14 www.bloombergbriefs.com Bloomberg Brief | Muni Meltdown 2 Front page | Previous page | Next page 11.25.14 www.bloombergbriefs.com Bloomberg Brief | Muni Meltdown 3 MUNI MANIA: A TIMELINE FEBRUARY 2009 “If a few communities stiff their creditors and get away with it, the chance that oth- ers will follow in their footsteps will grow.” – Warren Buffett APRIL 2009 Moody’s assigns the U.S. Local Govern- ment Sector a negative outlook SEPTEMBER 29, 2009 “Dark Vision: The Coming Collapse of the Municipal Bond Market” – Frederick J. Sheehan, published DECEMBER 2009 by Weeden & Co. “Are State Public Pensions Sustainable?” – Joshua D. Rauh MARCH 30, 2010 “State Debt Woes Grow Too Big to Camouflage” – The New York Times APRIL 4, 2010 “Once a few municipalities default, there is a risk of a widespread cascade in defaults.” APRIL 15, 2010 – Richard Bookstaber, blog “This isn’t capitalism. It’s nomadic thievery.” – “Looting Main Street,” by Matt Taibbi, Rolling Stone SPRING 2010 “Beware the Muni Bond Bubble: Inves- tors are kidding themselves if they SUMMER 2010 think that states and cities can’t fail.” “How to Dismantle a – Nicole Gelinas, City Journal Muni-Bond Bomb” SEPTEMBER 2010 – Steven Malanga, City Journal “The Tragedy of the Commons” – Meredith Whitney OCTOBER 5, 2010 “Cities in Debt Turn to States, Adding Strain” NOVEMBER 16, 2010 – The New York Times “California will default NOVEMBER 29, 2010 on its debt.” “Give States a Way to – Chris Whalen to Business Insider Go Bankrupt” DECEMBER 5, 2010 – David Skeel, The Weekly Standard “Mounting Debts by States DECEMBER 19, 2010 Stoke Fears of Crisis” “Hundreds – The New York Times DECEMBER 24, 2010: of billions” “I can’t make the numbers work. If you look at the 10 largest – Meredith Whitney, on 60 Minutes cities and the 25 largest counties in the country, that’s $114 bil- JANUARY 20, 2011: lion in debt outstanding. So you gotta basically have New York, “Misunderstandings Regarding State Debt, Pensions, Chicago, Phoenix, Los Angeles — these cities start to default.” and Retiree Health Costs Create Unnecessary Alarm” – Ben Thompson, Samson Capital, on CNBC – Center on Budget and Policy Priorities 21-page white paper AUGUST 2011: “[I don’t care about the] “stinkin’ municipal bond market.” – Meredith Whitney to Michael Lewis Front page | Previous page | Next page 11.25.14 www.bloombergbriefs.com Bloomberg Brief | Muni Meltdown 4 INTRO An old-media kind of guy, I still keep file folders of stories, blog Inside entries, clippings, messages and reports printed out and more or less sorted. Back in early 2009, I started a file labeled “Hysteria’’ In the Beginning to hold the physical evidence of what I thought the most unusual Particular and Specific .....................5 and even outlandish claims being leveled against an asset class I have spent 33 years writing about — municipal bonds. The Undiscovered Country Just Look! .........................................8 Over the next couple of years, the file swelled. I started another. And another. I didn’t even include Meredith Whitney. She got an entire file of her own. The End of Something Splendid Isolation No More ..............9 I collected so much material that I decided to use it as a presentation to the Bond At- torneys Winter Workshop one year. Even then I only got to use the high-points, or low ‘Dark Vision’ points, if you prefer, entering each exhibit into evidence. I considered this clever. Bombs Away ..................................10 “Show me a revenue stream and I’ll show you a bond issue,” is an old banker’s axiom. The writer’s equivalent is probably, “Show me a box of research and I’ll show you a book.” The Coming Collapse Or, in this case, a special supplement. And so here we are. In Sum ............................................11 In 2010, municipal bonds, hitherto known only as secure, boring investments, if some- Into the Abyss times a little weird, were front-page news. It was stated with some confidence that the ‘Dump Munis’ ..................................12 entire market was going to go bust. Public Pensions Of the Great Municipal Market Meltdown – so confidently predicted for 2010, 2011, 2012, and so on – I think we are now finally able to say, “That didn’t happen.” As it was being We Have a Problem ........................13 predicted, I observed that the reason it wasn’t happening was because “that doesn’t hap- pen.” In other words, the various “experts’’ then weighing in about state and local govern- Media Frenzy ments’ coming mass insolvency and/or repudiation didn’t know what they were talking Everyone’s Meltdown ......................16 about. That didn’t stop what I termed their “Inexpert Testimony” from being offered. And widely (and unfairly, I thought) quoted. The Market Responds to Its Critics First Responders ............................19 I define “meltdown’’ here as its proponents did: widespread default or outright repudiation of municipal bonds. There were a number of (non-muni) analysts and observers eager to Oh, Meredith forecast just this possibility. Others contented themselves with stoking hysteria in regard ‘Hundreds of Billions’ ......................23 to public pensions. One even expressed outrage over Wall Street’s underwriting and banking relations with Main Street borrowers. The blowup to come, we were assured, After ‘Hundreds of Billions’ was going to be almost operatic. Victory Lap .....................................24 The more I leafed through these bulging files — in retrospect, and recollected in tranquil- ity, as the poet says — the more I asked, How did this come about? Why were so many Returning Fire people who were little more than tourists in MuniLand taken so seriously? That’s Enough! ................................26 Why was the opinion of those who did know what they were talking about so heav- What Happened, Lessons Learned ily discounted? What lessons can investors learn from this? Because lots of investors, Age of Twitter ..................................27 especially after Meredith Whitney made her famous call on “60 Minutes” in December of 2010, sold both muni mutual fund shares and individual bonds, sometimes at fire-sale Appendixes prices. They wanted to get out at any price. Panic was in the air. To the Foregoing Work ...................30 There’s no one answer. There are lots of answers. There’s no one answer. There are lots of answers. Front page | Previous page | Next page 11.25.14 www.bloombergbriefs.com Bloomberg Brief | Muni Meltdown 5 I: In the Beginning Our story begins in 2009. There may have been hysterical commentary about the condition of the municipal bond market before this. There probably was; I just don’t recall it. Maybe it lacked a certain intellectual heft, and so had little impact on me as I read it. More likely, it was sub- merged in the round-the-clock hysteria then surrounding nothing less than the state of capitalism in the free world. The recession that had begun in late 2007 and accelerated in 2008 still had a way to go. Faced with Wall Street firms going bust, municipalities were just about to embark mass firings, the housing price collapse on a borrowing binge, spurred in part and 401(k) plans evaporating as the stock by the threat, real and imagined, of tax market plummeted, it was hard for munici- reform that would prohibit them from pal bonds to make the front page. financing certain things with tax-exempt They tried. Two events in particular had securities, and then by a decline in inter- rocked munis in 2008. In February, the est rates that sparked a wave of refinanc- $330 billion auction-rate securities market ing, and finally by a boom in what we may Source: Nick Ferris/Bloomberg froze after Wall Street banks stopped term bankerly creativity. I’m sure the rise Joe Mysak providing backstop bids for the stuff. The of suburbs beyond the suburbs and their I became so convinced that a national market had long relied on a convention concomitant needs for infrastructure like meltdown was unlikely. We’re not talking the Street could no longer afford – instant streets and sewers and schools was part about dozens or scores of issuers, but liquidity. The result: Investors in many of it, as was the later urban renaissance. tens of thousands. auction issues could see their money, but Analysts could take cold comfort in the The Census of Governments done by couldn’t lay their hands on it. It would take fact that the insurers didn’t lose their AAA the U.S. Census Bureau every seven years to remedy the situation. ratings because of anything they’d done years shows that there are just over in the municipal market. Their sin was 90,000 governmental entities in the U.S. It Rise of the Insurers expanding into asset-backed securities, has been estimated by the Municipal Se- a move inspired as much by stockholder This was damaging enough to the mar- curities Rulemaking Board, the market’s interest in returns as demanded (well, ket’s psyche. Even worse was the down- self-regulatory organization, that perhaps almost) by the ratings companies, which grade of most of the AAA-rated municipal 50,000 have borrowed money in the mu- urged the insurers to expand into more bond insurers. Bond insurance was per- nicipal market at some time or other. lucrative areas of business. haps the most successful franchise in the They have done so with serial and term And here it might be appropriate to say municipal bond market, originating in 1971 bonds, with notes, with variable- and the why commoditization was so welcomed in and reaching a peak penetration of 57 aforementioned auction-rate securities, this market. As investor Paul Isaac once percent of the new issue market by 2005.