Friday, May 6, 2011

CalWatchdog Sizes Up California's Municipal Debt

Wayne Lusvardi brings us this intriguing piece on CalWatchdog regarding municipal debt in California. While many analysts are anguishing these days over the possibility of epic-scale muni bond defaults, Lusvardi is actually much more sanguine. Sort of. He doesn't predict widespread defaults in California, but he expects bond payments to quickly crowd out all other forms of government spending. Which might not feel much better.

Lusvardi draws his conclusion from the fact that California muni bond rates are actually going down these days, as opposed to the upward trend you might expect from securities carrying a non-trivial default risk. The reason for this? Governments at all levels in California have stopped borrowing in recent months; as such, the constrained supply of these bonds has sustained their prices. With interest rates staying reasonably low and a constitutional mandate to make bond payments above all other obligations, default is thus unlikely. Lusvardi argues that trouble in the state will come rather from its basic insolvency with respect to budgetary and pension promises, as well as the chilling of economic growth by increasingly tight environmental laws and green-energy mandates, as well as the higher taxes introduced to help governments adjust to life on a pay-as-you-go basis.

We think Lusvardi has a good point; those expecting the state's demise to come in the form of widespread defaults might be disappointed by how far cities and counties are willing to go to avoid that outcome. We do think he's being a bit optimistic; given the recent default in the Madera County town of Chowchilla, the looming default in Montebello, and, of course, the default-ridden bankruptcy of Orange County in the mid-1990s, governments statewide may be more willing to pull that trigger than he realizes. More to the point, the situations in Chowchilla and Montebello illustrate a flaw in his argument: what if the local government in question is so grossly mismanaged that spending cuts or municipal tax increases simply can't be implemented quickly enough for payments to be made on time?

Nonetheless, the picture Lusvardi paints is a grim one. If Californians are paying the same or higher taxes and literally getting nothing in return apart from subpar public schools and interest payments on government debt, and the state's economy continues to stagnate, civic life will not be pretty.


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