Tuesday, February 26, 2008

Lies, Damned Lies and Bond Insurance

Credit insurance was born in the municipal bond business, to take advantage of a quirk: rating agencies apply different rules in assigning ratings to states and local governments than they do when rating corporations. In essence, they rate local governments against each other. If the State of Upper Anchovia is deemed worthy of a AAA based on its finances, then the State of Lower Anchovia with slightly lower financial strength gets a AA, even though it would be worthy of a AAA if it was judged by itself.

The demand for municipal bond insurance came entirely from individual retail investors who wanted the comfort of AAA-insured ratings, thinking them equivalent to Treasurys. Since municipal bonds rarely defaulted, monoline insurance companies made a pretty penny selling unnecessary insurance to unsophisticated investors. It was like selling snow damage insurance in the Sahara, or as P.T. Barnum said, there's a sucker born every minute.

But then the monolines got greedy and jumped on the structured finance bandwagon, insuring all manner of private, asset-backed bonds. There is nothing wrong with wanting to make extra profit, as long as you price the marginal risk/return properly. Clearly, the monolines did not, choosing instead to buy into the financial engineers' elevated assurances about the implausibility of multi-sigma events and the non-existence of black swans. Oh, and the elevated fees must have played a role, too..

So here's my suggestion: The federal government should guarantee all state and municipal bonds - at least those not tied directly to private-sector projects. It will cost next to nothing and save local governments billions in the process, in lower interest and insurance costs. This will leave the monolines with the weak structured finance part of their insurance book, and undoubtedly result in downgrades and large write-offs. But this is the private sector and it can take care of itself, one way or another. The public sector, on the other hand, must be protected from avarice.

Will there be conflicts from the constitutional separation of power between sovereign states and federal government? I imagine so, though I am not familiar with constitutional law. Nevertheless, there is no reason whatsoever to keep subsidizing private speculators through proceeds derived from duping the public in the name of government. The lucrative loophole that arose from mis-rating local government debt must be shut down, once and for all.

The nonsense of paying loan-shark rates (8%-20%) for adjustable-rate local government debt when T-bills are at 2% has gone far enough.

Update: Several readers objected to my guarantee proposal, mentioning that some local governments are badly mismanaged and thus should not have their debt back-stopped by the federal government. Here is a chart of the overall state and local debt as a percentage of GDP.

By comparison to the household and financial sectors, who have sent their debt soaring, local governments have been paragons of fiscal virtue. Cicero (see masthead) would have been proud.

Data: FRB


  1. Dear Hellasious,

    I couldn't agree more. The US Govt (taxpayers) should provide the backstop for these projects. We should not need the insurers for muni projects, period. Thank you so much for making this point. Power to the people.

  2. Why should a state or municipal bond be given a AAA rating by the Federal Government? Because the Federal Government can monetize debts and therefore can monetize the debts of states and municipalities when the insurance kicks in? To instill a level of confidence that is not justified by invoking the name of the almighty United States whose own fortunes are swirling down the drain at this moment? I don’t get it but an willing to learn.

  3. That is the worst possible solution imaginable. If the US govt backstops all municipal debt that means that all muni issuers will enjoy the exact same credit risk and interest rate. There will be no difference between the rate of interest charged to the City of Vallejo, which is going bankrupt, versus US treasuries because both will enjoy the backing of the full faith and credit of the federal govt. Munis would become the equivalent of treasuries. Why buy treasuries now that you can buy munis and get a tax break? Just hand over the Federal checkbook to city and state governments and throw out it any constraints left on local govt spending.

    Furthermore, this would ramp up Treasury rates and put a nail in the coffin of the private debt markets. Not to mention a dollar crash.

    I am disappointed with you. I thought you were smarter than to suggest this type of hair brained scheme.

  4. otoh
    he may have just identified our next bubble!


  5. I agree, and I am also of the opinion that the US government should be the single payer as it relates to healthcare services as well as campaign finances for public office.

    This is no time to be a dogmatic zealot.

    Call me "Old Fashioned" if you wish.


  6. Hell, fascinating post. Kudos!

    I am a big fan of yours, but this gets a decided thumbs down. I would much rather we just eliminate insuring debt all together.

    Investor eduction seems a whole lot cheaper, and a lot less risky.

    Again, nice posting

    PS-- of late I sometimes sense a prejudice against private sector debt creation over public sector debt creation (am I misreading you?). If this is the case, why? And if it is, may I offer the following links here and here on moral biases?



  7. Hellasious - I have come to enjoy reading the material on this site; it is one of the first I check everyday.

    A federal guaranty of state/muni bonds makes absolutely no sense though. Among many other reasons why this is a bad idea, please also consider the implication of a federal backstop for state and local budgets (too often states and local governments borrow to fund current expenses).

    Please figure out a way to retract this particular post (or at least the federal guaranty portion) gracefully, and keep up with the great work. Thanks.

  8. Gasparino was on CNBC a couple of weeks ago saying that muni insurance was unnecessary. His opponent "begged " to differ!

  9. 1st reaction: Cold shiver down my spine imagining the investment bankers/mortgage brokers/house flippers who got us into this current mess suddenly running for city council to tap into tax money for their nefarious projects which they claim are for the public good, but are really for enriching themselves.
    2nd reaction: Oh wait, this is pretty much happening already. Human nature seems to include a certain percentage of complete sociopaths which will infect every type of group endevour (gov, market, entertainment)unless the good people actively control them. Of course, the controller group will eventually be infected by the sociopaths too.... #$%^&#!!!!

  10. The US does defacto guarantee debt by the judicial power to force local and state governments to raise taxes. No kidding, they can and have done that to make sure that schools are funded, much less bond issues paid back.
    Depends on whether it's a general obligation or a secured loan. A secured loan can be defaulted on just by relinquishing the high school, sewage treatment plant, college dorm, whatever.

  11. Dear all,

    Notice I said that the guarantee should be given to those issues not related to the private sector, i.e. revenue and project bonds issued to build malls and "developments", etc. would be excluded.

    Second, as with all guarantees they would come with strings attached. For example, all guaranteed debt must be funded, i.e. the sources of debt service must be identified and appropriated in advance.

    Finally, I am not against private debt and pro govt. debt. The distinction I make is about debt USE: margin debt (i.e. leveraging existing asset prices) or borrowing to buy shoes is mostly bad, whereas borrowing to build a new energy regime is good.


  12. Don’t believe one optimistic word from any public figure about the economy or humanity in general. They are all part of the problem. Its like a game of Monopoly. In America, the richest 1% now hold 1/2 OF ALL UNITED STATES WEALTH. Unlike ‘lesser’ estimates, this includes all stocks, bonds, cash, and material assets held by America’s richest 1%. Even that filthy pig Oprah acknowledged that it was at about 50% in 2006. Naturally, she put her own ‘humanitarian’ spin on it. Calling attention to her own ‘good will’. WHAT A DISGUSTING HYPOCRITE SLOB. THE RICHEST 1% HAVE LITERALLY MADE WORLD PROSPERITY ABSOLUTELY IMPOSSIBLE. Don’t fall for all of their ‘humanitarian’ CRAP. ITS A SHAM. THESE PEOPLE ARE CAUSING THE SAME PROBLEMS THEY PRETEND TO CARE ABOUT. Ask any professor of economics. Money does not grow on trees. The government can’t just print up more on a whim. At any given time, there is a relative limit to the wealth within ANY economy of ANY size. So when too much wealth accumulates at the top, the middle class slip further into debt and the lower class further into poverty. A similar rule applies worldwide. The world’s richest 1% now own over 40% of ALL WORLD WEALTH. This is EVEN AFTER you account for all of this ‘good will’ ‘humanitarian’ BS from celebrities and executives. ITS A SHAM. As they get richer and richer, less wealth is left circulating beneath them. This is the single greatest underlying cause for the current US recession. The middle class can no longer afford to sustain their share of the economy. Their wealth has been gradually transfered to the richest 1%. One way or another, we suffer because of their incredible greed. We are talking about TRILLIONS of dollars. Transfered FROM US TO THEM. Over a period of about 27 years. Thats Reaganomics for you. The wealth does not ‘trickle down’ as we were told it would. It just accumulates at the top. Shrinking the middle class and expanding the lower class. Causing a domino effect of socio-economic problems. But the rich will never stop. They will never settle for a reasonable share of ANYTHING. They will do whatever it takes to get even richer. Leaving even less of the pie for the other 99% of us to share. At the same time, they throw back a few tax deductable crumbs and call themselves ‘humanitarians’. IT CAN’T WORK THIS WAY. This is going to end just like a game of Monopoly. The current US recession will drag on for years and lead into the worst US depression of all time. The richest 1% will live like royalty while the rest of us fight over jobs, food, and gasoline. Crime, poverty, and suicide will skyrocket. So don’t fall for all of this PR CRAP from Hollywood, Pro Sports, and Wall Street PIGS. ITS A SHAM. Remember: They are filthy rich EVEN AFTER their tax deductable contributions. Greedy pigs. Now, we are headed for the worst economic and cultural crisis of all time. SEND A “THANK YOU” NOTE TO YOUR FAVORITE MILLIONAIRE. ITS THEIR FAULT. I’m not discounting other factors like China, sub-prime, or gas prices. But all of those factors combined still pale in comparison to that HUGE transfer of wealth to the rich. Anyway, those other factors are all related and further aggrivated because of GREED. If it weren’t for the OBSCENE distribution of wealth within our country, there never would have been such a market for sub-prime to begin with. Which by the way, was another trick whipped up by greedy bankers and executives. IT MAKES THEM RICHER. The credit industry has been ENDORSED by people like Oprah, Ellen, Dr Phil, and many other celebrities. IT MAKES THEM RICHER. So don’t fall for their ‘humanitarian’ BS. ITS A SHAM. NOTHING BUT TAX DEDUCTABLE PR CRAP. Bottom line: The richest 1% will soon tank the largest economy in the world. It will be like nothing we’ve ever seen before. and thats just the beginning. Greed will eventually tank every major economy in the world. Causing millions to suffer and die. Oprah, Angelina, Brad, Bono, and Bill are not part of the solution. They are part of the problem. EXTREME WEALTH HAS MADE WORLD PROSPERITY ABSOLUTELY IMPOSSIBLE. WITHOUT WORLD PROSPERITY, THERE WILL NEVER BE WORLD PEACE OR ANYTHING EVEN CLOSE. GREED KILLS. IT WILL BE OUR DOWNFALL. Of course, the rich will throw a fit and call me a madman. Of course, their ignorant fans will do the same. You have to expect that. But I speak the truth. If you don’t believe me, then copy this entry and run it by any professor of economics or socio-economics. Then tell a friend. Call the local radio station. Re-post this entry or put it in your own words. Be one of the first to predict the worst economic and cultural crisis of all time and explain its cause. WE ARE IN BIG TROUBLE.

  13. Hell, if they spent the money wisely building a new energy regime, I think everyone would agree. But just because voters say 'spend the money on new energy regimes' doesn't mean it actually will be-- this would still require people to study science, work hard, save, invest, delay gratify, etc... all terribly unpopular ideas when applied personally(regardless of political affiliation or income level).

    Japan built bridges to nowhere with their money. So did the state of Alaska (or did they settle for a ferry? I can't remember). Why would voter behavior suddenly change?

    And it is just as easy for local and state governments to hide bridges to nowhere in their books as it is for private companies to hide them in theirs-- take a look at Homeland Security's budget right now. Didn't Okielawyer remind me just the other day that the Bush administration is keeping The Iraq war 'off books'?

    We are not in this because 'greedy Wall Street' stole from 'honest public'. We are in this because 'greedy Wall Street' teamed up with 'greedy public' at the expense of brain dead investors. The same brain dead investors who said 'I want AAA', but don't read the package insert describing what AAA means.

    There is no Holy Grail to solve this. At least this is not it. You have great ideas, alas this is not one of them.

    PS-- I might remind you of your blog's own subtitle... "The national budget must be balanced. The public debt must be reduced; the arrogance of the authorities must be moderated and controlled. Payments to foreign governments must be reduced, if the nation doesn't want to go bankrupt. People must again learn to work, instead of living on public assistance." (Cicero, 55 BC)

  14. We are a fossil fuel eating brute and other nations are too. We must change our energy regime in order to survive. Changing our energy regime means that we will have to become a solar pansy. However, we cannot become a solar low-energy pansy until everyone else is also forced to do so. If we become a solar low-energy pansy first we are likely to get eaten by an herbivore or predator. If we stop eating fossil fuels before others do so we will weaken ourselves and become vulnerable.

    Other nations must be neutralized before we can have any hope of transitioning to an energy diet that is more rational and long-lasting. The United States must make sure that by foregoing our taste for oil and natural gas other nations are not provided an excess that will allow them to grow into competitive powers. Why should we sip sunshine while they continue to gorge and grow strong on the carcass of fossil fuels.

    It is a last man standing scenario. They must weaken before we do and only then can we begin meaningful transition. In this scenario there is a significant die-off and considerable turmoil. The only other strategy involves unprecedented diplomacy whereby a one-world and rather totalitarian government can impose hardship by degree and retreat from fossil fuels to avoid a cataclysmic ending for environment and civilization.

    I think long before we issue many solar bonds we will be issuing war bonds to pay for our encirclement of world energy resources and the girdling of our competitors.

  15. i have read [but cannot independently verify] that the monolines were forced to take on other lines of business to DIVERSIFY their income streams - this at the insistence of the RATINGS AGENCIES. [in a triumph of the capm and efficient market theory]. the ratings agencies said that without more diversified incomes, the monolines would be down-rated. ain't irony grand?

  16. H:

    Re: the Constitutionality of your proposal

    Having the federal government guarantee municipal bonds would be one of the easiest to justify on constitutional grounds. All Congress has to do is make a finding that the municipal bond business affects "interstate commerce." That's pretty easy as municipal bonds are bought across state lines all the time, I would expect. And any such law would be subject to the Rational Basis Test.

    I, for one, think that your proposal merits serious discussion. But it should not be done for free: the federal government should receive payments just like private insurers do now; and any such premiums should be properly rated according to the expected risk.


    Thai: I probably am, in fact, the one who told you that much of the cost of the Iraq War is "off budget."

  17. So presumably that means you would have the federal govt guarantee the City of Vallejo's muni obligations?


    And their pension obligations too?

  18. Well done, Hellasious, with the proper refinements and restrictions, what you suggest makes sense, and apparently, according to Okie lawyer, is legally well within the realm of the possible. Are you listening Congress?

    And whoever wrote the verrrry long rant against the vastly unequal concentration of wealth, I agree that Brangelina and their kith and kin in the "entertainment" industry are far more of a problem than not. Goodness gracious, the carbon footprint alone of the aforementioned must be gargantuan.

  19. Hel,

    Your point about muni bond insurance premiums inappropriately being used to provide cover to writers of CDS contracts is very valid. However, I respectfully disagree about need for the Federal government to insure munis.

    Several studies have shown that investment grade munis (BBB or above) have extremely low default rates (about 10% of investment grade corporates), going back to 1926 and covering the most severe recessions in America. The biggest beneficiaries of muni insurance are the writers who pocket the premiums, knowing that many municipalities cannot declare bankruptcy (unlike the lucky bastards in the corporate world). The municipalities who buy insurance do so just so they can get a lower interest rate and issue more debt instead of being a little more prudent, not buying insurance and making sure the payment streams are covered by taxes. In fact, about 70% of munis issued recently (the past 25 years or so) are not paid for by taxes but rather by use fees.

    Should the Feds insure such bonds? Also, many states have been issuing munis to cover generous pension plans with absolutely no intent to obtain revenues to pay for these. Should the Feds cover these too? With respect, I say, I don't think so.

    The reality is that if there was no muni bond insurance for funding many essential services such as water, sewer, power, education, it would matter not a whit. Most people know these are things they can't live without and will pay for them with taxes. No need for the Feds the get involved here.

  20. Anonymous @ 3:55:

    I don't know if you are talking to me or Hellasious. But in regard to pension obligations, I have already written in regard to my idea of how to solve the pension problem. Currently, the Pension Benefit Guaranty Corporation (PBGC), a federal agency, is already responsible for guaranteeing pensions when companies go bankrupt. The problem with the current setup is that it creates a readily known and visible moral hazard for American corporations to raid and deliberately underfund retirement obligations since it allows corporate management to personally benefit from harming workers and shareholders.

    Therefore, I think that pension obligations should be guaranteed in a way that cannot be taken away. In classical business theory, workers take lesser compensation and retirement benefits because they are not supposed to take the risks of capitalization. In reality, our perverse system now makes the workers take the risks and allows corporate management to reap the rewards at the worker's expense.

    This is a result that is as unjust as one could create.

  21. Anonymous @ 6:07:

    Municipalities most certainly can file bankruptcy. It may be very rare, but they most certainly can do it.

  22. Follow up to my comment above ...

    The proper response is for the Feds to hack the bond insurers into two, the safe muni part and the trash.

    Further, we need legislation that enforces all insurers to receive 100% of their compensation in the CDS part.

  23. okielawyer,

    We are talking about city and state pension obligations not corporate. My question was addressed to Hellasious. He hasn't addressed whether he also recommends the federal govt should backstop these muni pension obligations too since they are often financed by muni debt issuance rather than tax increases.

  24. Okielawyer, why the double standard on private pensions vs. public pensions? Being the trust officer of a rather large retirement plan with many participants (a position I take VERY seriously), I kind of resent the double standard.

    Governement can be every bit as irresponsible as corporations with its money-- easy to spend someone else's money, especially when it tends to get you re-elected.

    My own state of Maryland just spent slotmachine proceeds in their latest budget, despite the fact that voters haven't even approved slots in Maryland.

    Federal guarantees on munis would create the same moral hazard the PBGC does with corporations. It would dramatically increase 'systemic risk' (much like Buffet has warned us with Freddie and Fannie). A 10 billion dollar company guaranteeing the State of California is a joke-- a federal government guarantee is not.

    Why must we have this insurance in the first place? Last time I checked, insurance was a 'bad deal', that is why insurance companies get into the business in the first place. If it were a 'good deal', insurers would loose money and cease to exist. A 'good deal' for a state means a 'bad deal' for the federal government. You will never convince me they would 'price this right'. And even if they priced it right today, the moment a state changed its behavior, the federal governement would still be on the hook for old debt, even if they refused to insure new debt.

    Insurance works ONLY when the consequences of something is simply too disasterous to accept (read dead parents, 4 small kids, no assets, etc...). Muni default is not in the same league.

    A well diversified portfolio should minimize the impact of muni 'blow up'. Most university endowments seems to do this quite well, why can't most pension funds? Who was stupid enough to require only AAA designation? Why did they constrain their managers hands? If they don't trust him, they should get a new manager. You can't get away from integrity, no matter how much you try legislation as a substitute.

  25. Hell, You are a commie as always. So, the solution of a problem created by the government has to be more government.

    Even the Wall street journal gets it right, and you do not.


    It is the government mandating money market and bond funds to buy AAA that creates the problem.

  26. Hellacious:
    Grow up. No "strings" will ever be enforced because of political considerations. I usually agree with you, but here agree with anonymous. No guarantees. Period.

  27. Instead of LESS government, we should be asking for BETTER government.

    It is astonishing how effective extremist movement Republicans have been in convincing many otherwise informed and astute people that the best government is one that can be drowned in a bathtub.

    Democracy and freedom CANNOT function without excellence in government. But fascism can, and did in the past. And this includes communist fascism, if I may twist the terms around a bit..

  28. But it should not be done for free: the federal government should receive payments just like private insurers do now; and any such premiums should be properly rated according to the expected risk.

    At a minimum. Otherwise you just introduce a new dimension of 'moral hazard', as other comments have rightly mentioned:

    Update: Several readers objected to my guarantee proposal, mentioning that some local governments are badly mismanaged and thus should not have their debt back-stopped by the federal government.

    There is also a case to be made that with such low default rates insurance is not really needed at all. Given the tax advantages of owning muni debt, the market should sort things out, i.e. separate the wheat from the chaff. And if the market softens for some issuers, then maybe they should pause and take a look at what they are doing and why they are doing it -- perhaps it is not a good time to be taking on more debt.

  29. I agree with the vision of Hellasious.

    Western countries do not need less government, but better one.
    Fascism, nazism, communism, they all started from a failure of the government in managing vital issues for the citizens (mostly security and economic issues).

    Fascism took power in Italy in a illegal way (no election) because of the failure of the king of Italy in managing the after WWI social issues.

    I would take it further than Hellasious.
    Free market, invisible hand etc. they are only ipothesis on an economy 101 text book, there is no such thing like a free market.

    Because of this, and because of the nature of the current human being, citizens should not mandate to the free market the fundamental social issues, such as medical assistance, education, security.

  30. The Government is a reflection of the people who elected it and hence the culture of a nation. Democrats wouldn't have policed this mess any better than the Republicans. In the UK you have a left wing government which has overseen the financial industry with pretty much the same results as in the USA.
    What do you expect from a modern western culture which basically values looking after number one at all costs. The bankers are looking after themselves, the homeowners are looking after themselves as are the politicians: No one is looking after the country. A greedy, corrupt and worthless society has bought this pox on themselves.

    You can't get a good government when the majority are rogues and knaves or at best simpletons.

  31. "By comparison to the household and financial sectors, who have sent their debt soaring, local governments have been paragons of fiscal virtue."

    Great, so you now you want to lift off all the restrictions on state and local governments so they can run deficits as high as consumers and the federal government. More debt. Brilliant!

    While you're at, why not just give them their own printing presses.

  32. DUH.... What's happening to the dollar....?


  33. Italian,
    I agree that there are fundamentals that shouldn't be left to the whims of the market. I recall Maslow's Hierarchy of Needs; you need to have bodily safety (sufficient police, natl health care, sustainable environment) before the mind can be improved (education). I don't think the free market is inherently evil, but then neither is government. Balance.

  34. Durable Goods and New Home sales sucked. Fannie Mae sucked. Plus all of the economic releases yesterday sucked... and the market breaks UP, on a technical break of a Triangle formation.

    Check out these simply insane facts, figures and charts.

  35. Okielawyer
    The Pension Guaranty Benefit Corporation or whatever just was given government permission, or perhaps instruction, to invest in CDO tenth mortgages.
    Kiss goodbye to the union pensions. The Republicans finally have their revenge on the United Coal Workers, the United Steel Workers, the OCAW, UAW, Teamsters, etc.

  36. Italian,

    It is a simple fact that medical expenditures in EVERY country in the world follow fractal patterns-- small minority spends the majority of money.

    In American, 4% of patients represent 70% of healthcare expenses.
    The costliest 4% of these 4% represent something like 70% of 70%.

    You do the math... 50% cut on costliest 1% frees 20-30% of healthcare expenditures... something like 3-4% of GDP in the US. Added benefit of being politically easy since only effects 1%.

    This is why national healtcare systems work, plane and simple.

    Public healthcare delivery is NOT more efficient than private healthcare delivery. Productivity differences between similar public and private institutions FOR EXACTLY THE SAME ILLNESSES are often shocking.

    Wrapping 'healthcare is too important to trust to the free market' in airs of morality is as hypocritical as Republicans claiming they are for 'fiscal restraint'.

  37. Thai:

    My previous response got wiped out by blogger (maintenance just as I was posting). So I will try again more briefly. I don't think my position is a double standard. I think retirements accounts should be treated like trusts, wherein the trustee has a fiduciary duty to the principles.


    I heard about this policy change last week, I think. It is a horrible policy.

    The PBGC already pays less money than what workers were contractually promised. I would analogize this new policy to a financial planner selling an elderly person a risky variable annuity (wherein the financial planner gets a fat commission). (This happened to my late father. Fortunately, I was able to fix the situation before the stock market tanked a day afterward.) Retirees need to be in safe investments.

    This is especially true of workers who are received reduced pensions due to corporate bankruptcies.

    But I think your analysis is correct. The Bush Administration has routinely appointed ideologues that take actions to try to prove that government doesn't work.

    I agree with Hellasious. We need better government, not less government. In fact, it is the lack of oversight that has allowed fiends to get away with their financial schemes to the detriment of workers who lack political and legal bargaining power.

  38. Okie, my heart goes out to you. I know what that is like.
    Regards ;)

    Also, EVERYONE agrees we need better government. That sits on top of the list which includes motherhood, apple pie, In n Out Burgers and surfing. But as only Lord Arnold has tamed this beast-- being beyond the skills of other 'girly men', and he can't run for Pres, what are we to do? fail. If Lord Arnold's knights faily to find the Holy Grail of better governement, maybe The Singularity will be our backup plan

    Hell, Okie, others, voters are the issue! You, me (well not me), the neighbors (again yours more than mine). I don't think the majority of voters are rogues and knaves, as my fellow physician The Socialpathologist suggests, but I do agree there are just enough out there to casue mischief and they are waiting to vote... (choose the political party, no the other party-- with the bad ideas and the even worse leadership. Yah that one!)

  39. Local and State fiscal responsibility in action:

    For some financially strapped cities, pension-fund liabilities -- the National Association of State Retirement Administrators estimates that public pension funds have $3 trillion in assets but unfunded liabilities of $440 billion -- aren't even the biggest problem. That is clear in Vallejo, Calif., a town of 120,000 residents located 30 miles north of San Francisco, where the city council is expected to vote today on filing for bankruptcy protection from municipal creditors under Chapter 9.

  40. I think the biggest cause of the problem is that the ratings agencies have no skin in the game, not counting the possibility of class-action lawsuits by investors which the supreme court seems determined to prevent to the point of making the shocking claim that collusion in fraud does not create any liability on the part of third parties because investors did not rely directly on the fraud even if they did rely on it indirectly, i.e. higher share prices or bond ratings than otherwise possible absent the fraud. Well, no s__t Sherlock, fraud by its nature is covert and no one other than its perpetrators would be privy to it. IMO the easiest solution is to disband the ratings agencies and transfer that function to the bond insurers; they would at least have an incentive to rate securities more realisticaly and price risk accordingly. As long as there was no monopoly or oligopoly in the market, competition would prevent any company from unfairly gouging a credit worthy issuer. And as insurance providers they would be subject to inspection and oversight by commissioners of insurance, whether at the state or federal levels. To all the anti-regulation free marketeers out there I would say that the cost of govt regulation is usually a small fraction of the fraud or injury inflicted by unregulated markets.

  41. Okielawyer
    I think that the destruction of the Pension Benefit Guaranty Corporation is not for ideological reasons, I think it is just to keep the markets up for one more week before the hammer comes down.
    Why do people try and put off the inevitable? Damned if I know. I did it myself when I was using credit cards to live on while using my salary to make minimum payments on credit cards.

  42. wkwillis:

    I think it may be a corollary to Starve the Beast neo-conservative ideology.

  43. Short clip from Mason and Rosner's May 2007 paper, Where Did the Risk Go? How Misapplied Bond Ratings Cause Mortgage Backed Securities and Collateralized Debt Obligation Market Disruptions:

    Since the 1970s, largely due to issuer demand for ratings as a way to increase investor confidence, the rating agencies revenues have increasingly been generated by issuers of securities. 8 In the past few years, these revenues have been increasingly driven by ratings for relatively newer structured finance products. As a result rating definitions have undergone significant changes to their meaning as well as the manner in which they are employed. These changes and their implications to the integrity of the rating process are significant.

    In an effort to meet market demands for investment grade assets with higher yields, the rating agencies created new models and approaches to rating these assets. Given the limited number of Nationally Recognized Statistical Rating Agencies (NRSROs) and requirements directing certain investors to purchase only “investment grade” rated assets, their move to rate newer asset classes strengthened their market power, 9 or in the words of one rating industry executive, their “partner monopoly”. 10 As highlighted by the table below, structured-financial products became a major growth opportunity for the ratings industry and has become an increasing proportion of their revenues.

    "Partner monopoly" that transformed into a corrupt interdependency between agencies, issuers, investors, govt{s), all seeking to perpetuate evidently fictitious values.

  44. Okielawyer, you seem like a compassionate person, why view this with such a partisan lens?
    To quote Brad DeLong... "grasp reality with both hands".

    Very good people of all political affiliations see controlling government spending as a 'tough love' for a societal spending addiction infecting all political parties and socioeconomic groups.

    I might point you towards Chile, where a socialist prime minister is pacifying riots from workers intent on spending the national surplus she wants to save.

    Spendaholics/uber consumers will call themselves anything/do anything if it gets them more money. If calling themselves liberals gets money, they will sign up. If calling themselves conservatives gets funding, they will do that.

    wkwillis had the integrity to see this addiction in himself, I certainly admit it in myself, why the need to view this in 'neo-conservative' partisan terms?

  45. Hell,

    one more thing Cicero forgot to remind you of when you posted the graph on state and local debt as a % of GDP...

    The revenue of all the combined states is much smaller than the revenue of the federal government, yet looking at your graph, from 2000 to 2007, states increased debt share from 12% GDP to just under 16% despite the fact they have something like 1/3-1/2 the revenue of the federal government-- and this on a GDP artificially inflated by increasing consumer and federal i.o.u's

    Relative to their smaller budgets/lower starting point, my read of your graph is that states were actually worse stewards of their resources than the federal government, i.e states took debt market share from consumers and the federal government (a small number growing faster on a larger number).

    Even drunken sailor Bush only increased gross federal debt from 60% to 70% of GDP from 2000 to 2007.

    Am I reading this incorrectly?

  46. Spendaholics/uber consumers will call themselves anything/do anything if it gets them more money. If calling themselves liberals gets money, they will sign up. If calling themselves conservatives gets funding, they will do that.

    wkwillis had the integrity to see this addiction in himself, I certainly admit it in myself, why the need to view this in 'neo-conservative' partisan terms?


    We were talking about the PBGC, which is a federal taxpayer-funded department that picks up the cost of retired workers pensions when corporations go bankrupt. Those retirement funds, set aside for workers, end up in the pockets of corporate executives instead of the PBGC. As a result, workers end up being deprived of the retirement that they were contractually promised; and not because there was a lack of funds to cover them.

    That's not "tough love." That's excessive greed. And it is the result of a moral hazard that has been built into the legal and economic system.

    As for being partisan, my "being partisan" (if you insist on putting it that way), is in response to a stated partisan official policy by the neo-cons. Have you ever read my post Seven Years of Bad Luck?

    Things are OK for me now; but it is in spite of the Bush Administration's "tough love" policy, not because of it.

  47. @anonimous "Wrapping 'healthcare is too important to trust to the free market' in airs of morality is as hypocritical as Republicans claiming they are for 'fiscal restraint'."

    Maybe morality is what is needed.
    Here (Italy) you (almost) do not directly pay for healthcare, and heathcare is at a (almost) good level for (almost) everybody. That is partly why our tax level is at 43%. Everybody pays for everybody else, this is a moral duty.

    Inefficient? easy to fraud? of course it is! But I do not see any better solution.

    Time will tell if this "mos" is better than your "mos".

  48. Okie, I am truly sorry.

    @Italian-- do you understand fractals? Your response kind of implies you do not.

  49. thai mcgreivy
    Not an addiction. A bad investment plan.
    I went to college to upskill from being a security guard to being a programmer. This was because security guards were having their salaries devalued by unskilled immigrants from less developed countries.
    So in 1989 I started taking computer science courses. Ithought I would get a job and pay back my debts. Bad move in hindsight, but not at the time.

  50. You do realize that after the U.S. Gov't is finished guaranteeing munis, all $12T residential mortgages (including illegals' FL investment condos), health care, strip malls, the dollar will be worth a peso.

    That's the punishment that those financially responsible savers deserve, for their savings to be burned to the ground to protect the irresponsible.

    Welcome to Weimar Germany folks.

  51. we all know muni debt never goes bad. you know, just like house prices never go down.

  52. wkwillis, I misunderstood, my apoligy. But the truth is spenging has almost become gluttonous.

    How much stuff do we all need? Why does it always need to be 'better'?

    I thought Michelle Singletary's article in The Washington Post
    described the problem nicely today.

    Stewardship in truth is not a 'family' value; not at home, not in government (why would it be, the politicians are elected by the same people?).

  53. There are all kinds of municipal debt, and I'm not sure which kinds you're considering to be public vs. private. Private 501(c)(3) nonprofit organizations finance capital facilities through municipal issuance, often backed by bond insurance. Are you including these as "public"?

  54. In the UK the bond market is a little different, and I'm trying to learn about it - could anyone point me in the right direction? I need bond insurance for my home, I have found these mortgage bonds but not sure how they work...

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