Up until now, investing in municipal bonds has been a calm experience. Politicians and credit raters have assured the public that munibonds are safe. But tremors are appearing.
The State Budget Crisis Task Force released a July 17 report showing how six heavily populated states (California, Illinois, New Jersey, New York, Texas and Virginia) are in fiscal turmoil."The trajectory of state spending, taxation, and administrative practices cannot be sustained," said the report.
The task force listed threats to the fiscal health of these states and others, including growth of Medicaid spending, underfunded retirement promises, narrow and eroding tax bases, the impact of federal deficit reduction, stresses on local governments, and state laws and practices that mask imbalances.
State and local governments spend $2.5 trillion annually and employ over 19 million workers, which is six times as many workers as the federal government. Is the munibond market the next crisis?
Case Study: California
California is home to 37 million Americans and is a case study in fiscal insanity. On Nov. 16, 2011, the Office of Legislative Analyst released a report forecasting a budget deficit of $3 billion at the end of 2011-12 and an operating shortfall of $9.8 billion by 2012-13.
Today, California's actual budget deficit is now a $16 billion headache (up from $9 billion in January) and the state's cities are going bankrupt. (See Mammoth Lakes Stockton and San Bernadino).
Instead of buckling down, California lawmakers approved a $68 billion project to build a high-speed train connecting Los Angeles and San Francisco. (A flight from L.A. to S.F. takes about one hour and costs around $100 one way.) Interestingly, the approval allowed the state to collect $3.2 billion in federal funding that would've otherwise been rescinded. The federal government rewarded California for needless spending projects, leaving U.S. taxpayers on the hook.
California's experimental plan for cutting its massive budget holes involves increasing taxes.
Gov. Jerry Brown (D.) wants California voters to approve "temporary" tax increases on the highest income earners along with the sales and use tax rate by 0.5%. The vote is set for November 2012 and informed observers know that there's nothing more permanent than a temporary tax increase.
