Stories about the financial troubles of states and localities have been legion in the past several months.
Now, Congress is considering whether to let states declare bankruptcy.
"Some [members of Congress] have embraced the bankruptcy option, which would allow states to sort out finances and renegotiate contracts with public employee unions, as an alternative to sending in federal aid."
Reuters, January 25
In so many words, some Congressmen are saying "No more bailouts!"
Before the financial debacle began in 2007, who could imagine that Congress would have to decide whether to spare states from bankruptcy?
Almost no one. But please note -- the key word is "almost."
Here's what EWI's Robert Prechter wrote in Conquer the Crash (2nd ed., p. 255), before the municipal bond crisis became obvious:
"U.S. investors today own billions of dollars worth of municipal bonds, thinking they are getting a great deal because the bond income is tax-exempt. This tax break may be a bonus in good times, but like so many seemingly great deals, this one will ultimately trap investors into a risky position...the risk of default in a depression is huge."
Even so, some say the muni-crisis is overblown. A top financial magazine points to Arkansas defaulting in 1933, the Orange County, California bankruptcy in 1994, and Harrisburg, PA missing a bond payment in 2010. It says investors were made whole in all three instances.
And famed financial analyst Meredith Whitney has been chastised roundly for her prediction that several major municipalities will default in 2011.
But is this time different?
We do know that some municipal bond investors are angry that municipalities have apparently failed to provide all the facts about their financial condition:
"...angry investors are finding themselves blindsided by bad news. Those concerns are reflected in a forthcoming study that shows that public issuers routinely file information about their financial health well beyond the date they promise to bondholders, if at all. This weak disclosure is raising anxiety in the $2.9 trillion market..."
Wall Street Journal, January 26
We also know that some investors are flocking out of municipal bonds:
"Slightly more than $25 billion has flowed out of mutual funds that invest in muni bonds in the last two months..."
New York Times, January 21
Are investors sensing that the words "safety" and "municipals" no longer walk hand-in-hand in this environment?
"The more municipals borrow, the less likely their debts will be paid. Now that the public is up to its neck in muni debt, some of the smarter creditors must have started to sense that the paper they own is no good."
Elliott Wave Theorist, November 2010
If financial safety cannot be had in municipals, where can you find safety?