For an economy to run smoothly, two players must coexist: A willing and able lender and a well-qualified borrower to pay said lender back, with interest. Take either one away, and the system goes -- as my grandma used to say -- "Plotz!"
Case in point: the "muni-bond malaise" of early 2009. At the time, the collective source of municipal funding had melted like a snow cone in the Sahara. Topping the list was insurers. 58% of the total pool of muni bonds in early 2009 was covered by monoline insurers like Ambac and MBIA, both of which saw their shares plunge 90%.
Also, private equity, hedge funds, college endowments, and local governments ALL saw their investments liquefied. (See: Vallejo bankruptcy, the first California town to go insolvent since 2001).
That was then. In the spring, the search for a willing and able lender ended with none other than Uncle Sam and his Build America Bonds (BABs). They are: taxable muni-bonds that provide a handsome federal subsidy equal to 35% of total interest costs. So, higher yields today translate into larger rebates later.
And -- since their April debut, BABs have raised more than $50 B-B-Billion; that number is expected to exceed $90 billion by the time the program expires in 2010 (if it isn't extended, that is). What's more, according to recent data, November 2009 was the third most active month in muni-bond history. For the mainstream, the healing touch of BABs can not be overstated, as this November 17 Time Magazine observation makes plain:
"BABs have stabilized the muni bond market. It's the biggest thing to hit [Munis] in a generation. It's clearly been a success as a means of stimulating the economy."
We beg to differ.
While the muni market may have found a willing and able lender in the federal government, the other end of the equation is still absent: A well-qualified borrower to pay that lender back, with interest.
State and local governments can offer more debt because they have better access to borrowing, NOT because their quality of credit has improved. Last check: Municipal liabilities, including bonds, loans, and payables negative at the end of the second-quarter 2009 exceeded assets by $319.26 Billion -- the biggest gap ever.
In essence: States are borrowing their way through their budget problems, AND now Uncle Sam is giving them more rope to hang themselves with.
Also, because of the "torrid volume" of BAB issuance, the supply of tax-exempt municipal debt has dwindled. As a result, prices have risen even as credit worthiness has fallen.
And, as a final strike against the long-term viability of a BAB-inspired recovery, the November 19, 2009 Elliott Wave Theorist presents the following close-up of state tax receipts since Q1 of 2004.
As Theorist editor and EWI president Bob Prechter writes: "The basis of states ability to pay interest -- tax receipts -- is evaporating. The goose -- the poor overdriven taxpayer -- is dying and the production of golden eggs is falling."