CBO Recommendation to Munis – Default!

Bruce Krasting's picture

You hear a lot about the states that are facing a financial wall.
California, NY and Il are on top of the list. But that is a 2010 story.
The 2011 story will shift toward the nations municipalities. There are
36,000 cities, towns, villages and boroughs across the land. They all
are facing problems. This chart from the CBO (pdf LINK) describes the problem:

As you can see the local munis get the lions share of their revenue from
three sources; direct payments from the State (30%), local property
taxes (26%) and other revenues (22%). A total of nearly 80% of the muni
revenue stream is now suspect.

If you are living in a hard up municipal area (who isn’t?) you know that
the fees you pay for everything has increased in the last year or so.
Building permits, licensing fees, transportation fees, library cards,
speeding and parking tickets, you name it have all doubled. There is a
limit to this. I think it has already passed. Nickel and diming
residents and having the cops turned into a revenue source is just not
going to fly much longer. We are at the point where if some town wants
to raise the price for garbage collection they are going to run into a
wall. Don’t look for this source of revenue to bail out the munis in

Property tax revenue is also a risk. At the end of the day there is a
relationship between the value of a property and the taxes that the
property pays. With housing in the dumps now for two years (and with no
prospect for any improvement) the tax base is falling apart.
Where I live price are down about 40% from the 06 levels. One after
another neighbors are petitioning the local authorities for relief based
on lower values. RE agents who represent sellers tell their customers
to go forward with the process before the house is listed. If the
listing price is less than the value on the books, tax relief is
granted. This process will accelerate. This is what the CBO had to say
on the prospects of property taxes actually falling:

decline in house prices implies that (tax) collections will probably
fall in the coming years as local governments gradually update property
tax assessments to reflect lower market values. On average, collections
of property tax revenues lag behind changes in house prices by three
years. Even small declines in collections could cause fiscal stress when the cost of providing public services is growing.

The largest contributor to Muni budgets is the states themselves. We
know that the states are broke and have to cut costs, so this source of
revenue has to be reduced.

Here is a (surprising to me) chart of both state and municipal revenue
for the past few years. Of no surprise is the sharp drop off of revenue
at the state level. But the municipal revenue has continued to increase.
Given the foregoing discussion on the sources of muni revenue it would
seem certain that their income is going to decline in 2011.

A few factoids on local munis tells the importance they play in our economic picture.

-90% of all cities have cut backs in spending scheduled for 2011.

-Approximately 14 million people are employed by local munis (not state
workers). That is 11% of the entire work force. Do the math. A 15% drop
in employment translates to 2.2mm jobs. That would come to 175,000 per
month. By itself this would add 1.7% to the unemployment rate. We would
be pushing 12% UE as a result.

-Muni spending is 9% of total GDP. A 10% cutback translates into a drag
on top line GDP by 1%. The estimates for growth range from 2-3%. If
local governments are forced into cuts (they will) a better estimate for
GDP is 1-2%.

-When looking for places to cut, munis always go to capital projects
first. Roads, sewer, water hospitals, schools are not going to get built.
What does this do for the private sector construction industry?

What are the options for a cash strapped muni? Unlike state borrowers,
munis can go bankrupt. (more than half have laws on the books permitting
a chapter filing - including key ones). The CBO report provided an
excellent set of reasons for munis to default:

Benefits of Bankruptcy


key advantage of bankruptcy is the “automatic stay,” which is issued by a
court and prevents creditors from taking action against the
municipality and its officials without approval from the court.


important advantage of bankruptcy is that courts can implement a
restructuring plan without the consent of every creditor.


bankruptcy process may also allow a municipal government to reduce its
labor costs by facilitating the con- sent of employee unions to changes
in labor contracts.


-While a stay is in place, bondholders cannot force municipal officials to raise taxes in order to make debt-service payments.

Over the past 30 years of the 18,400 muni borrowers only 54 have
defaulted on their debt. An admirable track record. One that is unlikely
to be continued over the next few years. Not a pretty picture for a
muni investor. To top it off BABs (the last pillar of support for munis)
is gone. I wouldn’t be at all surprised if some big Muni became the
Greece of America in the near future.

Disclosure: Very “underweight” in long term munis.

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Dan Duncan's picture

Bruce.  Thanks for the informative article. 

You might get a kick out of the following...about the calPERS Aristocracy:

Dangerous Liasons, calPERS style.  It's pretty damn funny. 




tradewithdave's picture

Excellent post as usual.  Here's a link to a video on the North Dakota State Bank.  I believe it's the only one of its type in the nation.  There are plenty of critics of the model and in some instances rightfully so, but it is working out very well for the state's residents and the bank.  See for yourself: http://tradewithdave.com/?p=4138

Dave Harrison


Mad Mad Woman's picture

Harrisburg PA will be filing for bankruptcy in near future, it has no other choice. It'll more than likely happen in January.

More cities will be doing that in 2011. Looking like a bad year shaping up for everyone in 2011.

junkhand's picture

legalize first=legalize best.


weed, that is.


i'll also add this:  friend of mine just purchased sewer bonds in indiana for 8%.  supposedly guaranteed by insurance company against default.  to me, that seems like "junk bond" type interest rates - at least in this rate environment.


if the bonds are earning 8% after taxes for the holder, that means the state is paying probably 10% to borrow once the insurance and tax costs are included. 

how is that sustainable in a weed free environment?


don't shake my junkhand.



Smu the Wonderhorse's picture


Any explanation as to why municipal revenues have been up so strongly through 2010?  I agree with your piece but, could this point to some weird countertrend that your analysis misses? 

Bruce Krasting's picture

I think transfers were up, these are revenues to the muni, but an expense to the State of the Feds. It's all debt someplace.

Agent P's picture

I think it's at least partially due to how property taxes are calculated and paid. 

State revenues are mainly income and sales tax related...both down in the recession.

Muni revenues from state transfers (up as you suggested, or at least flat/yet-to-be cut) and property taxes, which are paid one year in arrears (lag effect) and are not automatically lowered by the county collector to reflect lower property values unless contested by the homeowner (at least that's what I've seen first hand).  Also, property taxes are due even in a foreclosure scenario(bank pays), so the revenue source is more recession resistant than income and sales taxes. 

Given all this it would make sense that muni revenues continued to climb while state revenues turned south.

Amish Hacker's picture

Thanks, Bruce, for another great post. 

Any chance for a last minute stick-save of the BAB's? Without some kind of fed bailout of the states, I don't see how this ends happily. (Writing from California.)

Bruce Krasting's picture

As of now BABs is dead. Could they save it at the last minute? Yes, but I think this die is cast. The Republicans don't want it. I think when they gave in on the extension of unemloyment and the SS tax deduction the got the death of BABs in return. They want to kill the three big blue states, Ca, NY and Il.


erik's picture

This is the most important point for 2011 in my opinion.  The Republicans are dead set against BABs because of the blue state issue.  They will stamp out every attempt in the House to extend BABs.

Now that solvency revolves around a sector that is a divisive political issue, unlike the banks (both Dems and Reps liked banks), are we going to see states/municipalities going bankrupt?

The only way Republicans will relent on BABs is a major market dislocation and their subsequent fear making the decision.

Good stuff, Bruce.

SmittyinLA's picture

There's a reason the federal govt hasn't written the terms for state bankruptcy, they dont have the authority, we're still legally a union of sovereign states, each state has the sovereign authority to write their own terms for bankruptcy.

Make no mistake the people of CA will eventually have to takeover their state's financial affairs and when we do unsecured debt holders WILL GET NOTHING.



Gordon Freeman's picture

While it's nice to think "it's all going to come to a head!" sometime in 2011, I think history shows us that viewpoint is naive.

The sad fact is that the govt tax-funded cabal will be the LAST thing that goes down.  They will literally try ANYTHING to keep that ship afloat, more's the pity...

Temporalist's picture
This has already begun in some places:


FDNY To Charge For Emergency Services

Starting next summer, the city plans to bill drivers in accidents that require an emergency response.

The so-called “crash tax” works like this: A car fire or accident with injury would cost you $490. A car fire without injury, $415. And any vehicle accident without injury will run you $365

Don’t worry. If you are an illegal alien driving without a license or insurance, there will be no way they can collect from you. (Plus you get your medical care for free.)

The FDNY says: “We want to relieve pressure on the taxpayer and place it on those at fault and their insurance. Right now if you’re at fault at an accident or a vehicle fire, you get a free ride. And that should not be borne by the taxpayers.”

But under the plan, you’ll get charged even if the accident isn’t your fault



Drivers Beware of Crash Tax

Local Governments Charge YOU Additional Fees for Police and Fire Services




There are going to be new and creative ways for govts. to screw the taxpayers.  Too bad hope and change don't pay the bills.

MachoMan's picture

The biggest problem I see with excise taxes for traditional functions of local governments is that they effectively gut the reasoning for alternative taxation.  Meaning, if you are going to charge me each time I utilize your services, why do you get to additionally tax me on my property and purchases?  Further, how do you appropriately set the amount of excise tax when you have to account for the government's monopoly on these services and, inherent, inefficiency?  [what happened was some asshole said, "we need X amount of money to make up the short fall" and then said asshole went looking for ways to generate it].

Of course, the genius politicians don't understand that these increased costs will be paid by all through higher premiums...  It's neat to stick local taxes to faceless multinationals, but in the end, there is no escape to reckless spending...  eventually you run out of cubby holes from which to steal money.

RossInvestor's picture

Bruce, very good article, but your scope is too limited.  There are over 88,000 municpalities (http://wiki.answers.com/Q/How_many_municipalities_are_in_the_US).  The total number of muni issuers could well be higher when you included school, water, Melo-Roos, etc. districts.  The problem is HUGE.

the grateful unemployed's picture

by huge, you mean big, too big, too big too fail? perhaps?

DR's picture

D. Goldman chimes on the same theme:


Get out of Muni Bond Funds Now

"I’ve been warning for months that a few state and municipal bankruptcies (actually, a few states and a great many city bankruptcies) will be required to slay the beast of government-union pension liabilities."


Governments restructering will push the US economy into another recession. Good or bad for treasuries?

the grateful unemployed's picture

hmmm. Munis are more attractively priced, buyers leave UST and buy Munis? Or people see risk in Munis, and push the flight to safety eject button once more? Bernanke puts some Muni's CDS? under his Christmas tree (balance sheet) which causes GOP backlash if he buys blue state paper. but what can they do? What's going on in Jeff County, Miss these days? (my thought that in the end it will be a political football, for those municipalities which are well represented, kudos, for the rest, pathos) What would Huey Long have done?

the grateful unemployed's picture

i love a good pie chart as much as the next guy, but washington has the ability to  pass stimulus money to the muni's through the state. there is no other explanation for how California's redevelopment funds keep percolating through, even while these cities and counties act broke.  a neighboring city actually turned in a surplus this year, ( they claim due to good management.) If i was going to buy muni bonds, i think you can do it on a case by case basis, if you perform due diligence. i don't think housing values are as bad in CA, existing housing in a good location has held up better than exurbia (as the fellow used to say about Hawaii, but land there, they're not making anymore) exurbia is cold in the winter, hot in the summer and miles away from anything. consequently the corporate consumer franchise were built into these projects, starbucks, etc. which is one reason the stocks of these franchises are still going. they were subsidized, like fire and police to provide a service, using tax dollars. one can guess they continue to draw the benefits even while the business in these ghost towns has fallen off, but i am not sure exactly how it works, i just see money coming out the other end, and i figure out ways the goose is being stuffed. Christmas rally analogy.

if i wanted to buy munis i would crawl around in the cities sewer system, check their water pipes, and their highways. also check their sales tax, do they have room to bump it up another notch. and property values in some areas have held up well, but if you're just buying paper, or etfs, (the wall street wisdom is that diversity papers over the occasional default) i would say don't do it, buts that a contrary position. of set up some kind of spread long the individuals short the fund. 

Milestones's picture

Excellent post. Was unaware of the local gov'n's ability to go the bankrupcy route. So the guy in the middle (state) takes it in the butt.

"The game of history is played by those at the top and the bottom over the heads of those in the middle."  Eric Hoffer  "The True Believer"    Milestones

cdskiller's picture

+1000 Cutting edge post, Bruce.

monopoly's picture

Well done, as usual Bruce. Got it.

Rainman's picture

....agree. Good job, Bruce, especially the part about the municipal revenue lag behind the States. That has confounded me. 

Old School's picture

Remember, California printed up a bunch of IOUs recently. So, while they can't print FRNs, they can print as many IOUs as they want. (I don't believe there were any legal questions regarding this. I could be wrong.) I can see CA and other states printing more IOUs in the very near future.

TruthInSunshine's picture

How many California IOUs does breast augmentation cost these days?

And what's the exchange rate on the Zimbabwean dollar?

TBT or not TBT's picture

There is some text in that Constitution thingy regarding authority to create money, I heard.   Not sure that the Constitution applies everywhere though.  Take your right to keep and bear arms...in NJ or IL for example.

kaiserhoff's picture

Let's create a CDO based on state IOUs.  Imagine the possumbilities.  To infinity and beyond.

But seriously, the CBO on the side of the angels?  Vat gifs?  They must read election results a lot better than Obummer.  Somebody must have whiplash from that 180.

the grateful unemployed's picture

exactly, and then BB can put them on his balance sheet and misstate their real mark to market value. 

kaiten's picture

When CBO starts recommending the federal government to default, you´ll know the end is near. 2012? 2013? Who knows?

gwar5's picture

I've been concerned about this for some time. All levels of government are brokeback mountains and everybody is going to get screwed. What's next? --- Toll roads? Toilet paper tax? Double the property taxes on the houses not abandoned?

Maybe we should we just press the restart button before Jerry Brown comes to DC in Birkenstocks on the shoulders of 3 million illegal aliens from Bell, California asking for a $150 billion bailout of green utopian socialism.

One big, high profile, Muni default (think LA) will break the ice. The rest will follow. Maybe that's the way to clear the shit pile. If congress can also pass a bill (they're thinking about it) allowing states to go bankrupt we can disappear public unions the way they have disappeared the taxpayers.

Agent P's picture

"Maybe we should we just press the restart button before Jerry Brown comes to DC in Birkenstocks on the shoulders of 3 million illegal aliens from Bell, California asking for a $150 billion bailout of green utopian socialism."

Let me help with directions...1) march straight East; 2) turn left at the Atlantic ocean; 3) turn right at the pier.

Alternate directions...same as above, just skip steps 2 & 3.

DosZap's picture

No, the only salvation for Kali, is taxpayers,property owners leaving the state.

You cannot continue to spend if the revenue sources are completely GONE.

kaiserhoff's picture

Great post.  Kick the can gets more entertaining every month with more and bigger cans.  Paging WB7...


The Pierogi King's picture

I was at a ratings agency conference over the summer and they stated that State Muni's could not default under the CH 9 laws which required states to restructure cash flows and make good on them - is this so? Any Bankruptcy lawyers out there?

Shameful's picture

Under law the states do not have an avenue for bankruptcy.  So unless the law is changed in the event of a default the creditor could take the state to court and force them to make good.  But I'm not a bankruptcy lawyer, might be more knowledgeable people out there as to the specifics.

This is why states are stuck and may ultimately fold to the Fed.  The locals can default and the Fed Gov has Bennie and the Ink Jets, the states have no way out.  Well short of leaving the union...

Widowmaker's picture

This topic is more real than many realize, and also pounding the drum for a Constitutional convention shortly down the road.

Really, are Texas and Alaska going to be the only stars on the flag?

As soon as that door is cracked, out pops many genies gutting the [former] U.S. populous to 3rd world status from every angle.  You can bet your ass there are a few on a short list of Constitutional "to-do's" ...  "Kaleefornia, no problemo."

kaiserhoff's picture

Private currency appears to be legal.  I've read about several local attempts to create currency (accepted at a few dozen places of business).  These always fail due to lack of broad convertability, but a currency good anywhere in California....?

Desperate times...

ouchtouch's picture

Private notes are certainly legal, but they are not currency.  The only thing that the states can make "legal tender" is gold and silver.  They cannot make any of their IOU's legal tender for debts.  U.S. Constitution, Art. I Section 10.

ouchtouch's picture

Private notes are certainly legal, but they are not currency.  The only thing that the states can make "legal tender" is gold and silver.  They cannot make any of their IOU's legal tender for debts.  U.S. Constitution, Art. I Section 10.

Shameful's picture

But it's not good in CA.  IIRC their IOUs weren't even good enough to pay state taxes.  So could create a situation where they dump IOUs on a vendor then hit him with taxes and demand a different form of payment.  Actually happened in the late Roman Empire.  Would pay out coins that they would not accept in taxes because they knew the coins were bad.

kaiserhoff's picture

So print on thousand dollar notes "Good for all debts public and private, in the State of California."  The point is to capture the profit from seigniorage and push the limits of state's rights. 

Collect underpants - result - chaos.

I don't seriously want it to happen.  It would just be more kick the can, but Governor Moonbeam will come up with diverse and worse ideas. 

MachoMan's picture

It works IF you have your financial house in order.  Simply create a state bank that can convert state notes to whatever currency you want.  The state notes will compete on the open market with all the other currencies.  If the federal government continues printing dollars, then, conceivably, we could get a situation where dollars depreciate faster than state notes...

However, the problem with creating an alternative to Ben's printing press is that you necessarily create one of your own.  Ultimately, the allure of printing is far greater than our discipline to defend against it.  And, like the federal government, the magical state island of currency responsibility will eventually be overtaken by the same disease.

Regardless, the correct way to view the predicament, is that practically speaking, it is easier for us to participate in the political process in local matters.  As a result, the control of the printing press is best left to more local hands, regardless of how shaky, given our federal counterparts offer no greater discipline.  If the localities are not respected in this regard, the union will ultimately be threatened (as it is now...  no one wants to talk about it though).  Absolute power... 

Of course, without this power, the union is impotent.  In the end, this simply exemplifies that humans (especially americans) have yet to stumble across the secret formula for responsible governance.  Some people may call this the constitution, but it too is easily enough corrupted...  Or that the elimination of the FED and imposition of Congress will cure what ails us (it wont)...  but, we're just arguing about things that have been argued since the dawn of civilization...  still hoping for an answer.

kaiserhoff's picture

It works IF you have your financial house in order...

In a better world, yes.  But the FRN gets most of its value from the mountain of debt already expressed in dollars.  The real barriers for any sizable state doing this might be only these:

1 Is it somewhat convertible into FRNs?  The Black Market would take care of that.

2 Will it be accepted in payment for debt expressed in FRNs.  Maybe or maybe not, but see number 1.

MachoMan's picture

The FRN gets most of its value from being backed by the standing army of the united states and, ultimately, being utilized in oil transactions...  although we are off the gold standard, we've effectively hopped onto the oil standard.  If a state issues fiat currency at this point in time, it will be no different than if I issued my own currency with reckless abandon...  the state, by being part of a union that prints money, may not unilaterally release the hounds to prop up its state currency.  In short, there is little in the way of traditional government function that can give "value" to a note issued by a state.

The only way currency printing works as a money making enterprise is to be desired and, if not, then capable of being forced on others to use as a medium of exchange.  Needless to say, a state is not constitutionally capable of forcing everyone to use its currency (aside from practically via military strength).  The only way to get rational actors to convert is to: (A) have your financial house in order; and (B) have some type of commodity/non fiat backing.  The trick is to find a backing that people value but yet don't care to hoard/convert...  [not sure that's possible].

Needless to say, any attempts by states to issue their own currency will likely fall the same way california's IOUs did...  at this juncture, the converting entity (banks) will not accept the conversion risk...  you could have a state bank that would do so...  but if you have to create your own bank to convert your currency, I'd say that would kind of defeat the purpose (and exemplify that the currency was worthless).

Maybe the analysis will change post bankruptcy filing...  but, then again, states are incapable at this juncture.

the not so mighty maximiza's picture

They leave the union by being liquidated, ceasing to exist.

NotApplicable's picture

Not according to Lincoln. Unions are insoluble.

Hell, he liked the power obtained from centrally controlled states so much he made one all by himself, so that he could further increase his majority.

Uncle Remus's picture

Wait, it's different this time...

TruthInSunshine's picture

A wee bit of topic, but hasn't local government public sector employee growth outstripped EVEN federal employee growth by a wide margin for 30 years+ now? - there's no small feat in that.

Whenever I pass a high school that is being built today, that would have made some 'colleges' of 20 or 30 years ago look modest by comparison, or a 25 million dollar city hall (which 'serves' the needs of a city of 80,000), I just shake my head in amazement.

There's so much fat, waste, fraud and inefficieny in government that is boggles the sane mind.

RKDS's picture

TruthInSunshine, I feel as though you and other posters must live in a different America than I do.  Pennsylvania has held a coveted statistic for many years, that of 49th highest ratio of state employees to citizens (in other words, only one state has fewer state employees per citizen).  Yet, somehow, the cry out here is exactly the same as it is in California or New York (state government is too big, fire 50% to start, pensions are unfair and the only cause of bankruptcy ever, etc).  It makes it extremely difficult to take any anti-public-sector slogans seriously.  I don't really assign malice per se to Joe Sixpack, but I suspect that the elites are manipulating him into envying the imaginary advantages of an easy scapegoat.

Thanatos's picture

Hey, the High School and the City Hall both sound very familair to me.

I got the exact same situation here where I am.