Muni Bonds

"As this critical domino chain of local governments in China’s credit risk situation begins to wobble, there could be significant ramifications for broad financial market stability. Such a chain reaction seems to have begun."

While China is rather proud of the fact that it hasn't yet implemented outright QE, Beijing has now put in place a bewildering hodge-podge of hastily construed easing measures that can't seem to get out of their own way.

China has officially doubled the quota on a critical local government bond swap program designed to help provincial authorities crawl out from beneath a debt pile that amounts to some 35% of GDP. Participating banks can pledge the newly issued muni bonds for cash, but with four policy rate cuts already on the books this year, it isn't clear that more liquidity is the answer when it comes to boosting credit creation. 

China may raise the quota on a critical debt swap plan by as much as CNY1 trillion, underscoring how important its success is both in terms of kicking the can for the country's heavily-indebted local governments and in terms of jumpstarting the credit creation machine. Meanwhile, an effort to encourage ABS issuance is sputtering amid rising NPLs.

China has pitched its local government debt swap program as a way for heavily-indebted provinces to deleverage. Now that the program is officially off the ground, what are the implications for banks and for the PBoC?

"China is reversing course on a major effort to tackle its hefty local government debt problem, marking a setback for a priority reform aimed at getting its financial house in order," WSJ reports. The abrupt about-face by Beijing, which will now allow local governments to once again tap shadow banking conduits for high interest loans, comes as the PBoC gets set to ramp up an LTRO-like program designed to essentially monetize trillions in local government debt. The interplay between the debt swap program, Chinese-style LTROs, and the decision to drop the ban on LGFV financing could set the stage for a dramatic increase in the country's already massive debt pile.

According to Fitch, nearly 40% of credit in China is outside bank loans, meaning that between forced roll-overs, the practice of carrying channel loans as "investments" and "receivables", inconsistent application of loan classification norms, and the dramatic increase in off balance sheet financing, the 'real' ratio of non-performing loans to total loans is likey far higher than the headline number.

China has officially entered the realm of "unconventional" monetary policy, joining the Fed, the ECB, the BoJ, and a whole host of other global central banks in an attempt to bring the supposedly all-mighty printing press and the unlimited balance sheet that goes with it to bear on subpar economic growth. We suspect the results will be characteristically underwhelming (at least in terms of lowering real interest rates, although in terms of boosting risk assets, the results may be outstanding) meaning it's likely only a matter of time before LTRO becomes QE in China just as it did in Europe.

Following an Illinois Supreme Court ruling that struck down a pension reform plan aimed at closing a $100 billion funding gap, Moody's downgrades Chicago to junk, giving the city the dubious distinction of being the only major city "in recent history" to carry such a low rating other than Detroit. Chicago now faces accelerated payments to creditors of more than $2 billion.

If you want to know where the next bear market is, look around at the people who are enjoying unimaginable wealth. Mr. Market has a habit of correcting things over time. My guess is that you won’t be paid $200K/year to drive trucks in North Dakota for much longer. The best thing about capitalism is that everything is temporary. The last time around, people had the stock, could have sold it, and didn’t. Nothing lasts forever.

More than originally estimated, apparently...

Puerto Rico muni owners who never saw the Barron’s story or the rating firms’ downgrades are better off than those who kept up with the financial news.

Wall Street can clean up junk well enough, but it can't make it go away.

Three days ago it was S&P that opened the can of Puerto Rico junk worms. Moments ago it was Moody's turn to downgrade the General Obligation rating of the Commonwealth from Baa3 to Ba2, aka junk status. We note this just in case someone is confused what the catalyst was that just sent stock to a new intraday high in the aftermath of today's disappointing jobs number which until this moment barely managed to push the S&P higher by 1%. From the report: "While some economic indicators point to a preliminary stabilization, we do not see evidence of economic growth sufficient to reverse the commonwealth's negative financial trends. Without an economic revival, the commonwealth will face difficult decisions in coming years, as its debt and pension costs rise. The negative outlook signals the remaining challenges facing the commonwealth."

• Fed’s $4 Trillion Assets Draw Lawmaker Ire Amid Bubble Concern (BBG)
• Ex-Goldmanite Fab Tourre fined more than $1 million (WSJ)
• EU Banks Shrink Assets by $1.1 Trillion as Capital Ratios Rise (BBG)
• Japan to bolster military, boost Asia ties to counter China (Reuters)
• China condemns Abe for criticizing air defense zone (Reuters)
• Insider-Trading Case May Hinge on Phone Call (WSJ)
• Republicans Gird for Debt-Ceiling Fight (WSJ)
• Mario Draghi pushes bank union deal (FT)
• German Coalition Plans More Pension Money (WSJ)
• Oil Supply Surge Brings Calls to Ease U.S. Export Ban (BBG)