Behind The Looking Glass: Municipal Debt And The US Economy

I have been of the opinion for a number of years that what we see in the media is exactly what “they” want us to see, no more and no less. With very few exceptions, if we see it on TV it’s because they want us to see it and it is meaningless. If by chance you do see something bad on TV it’s because it isn’t what it appears, or the censors slipped up. Most of what appears to be bad is simple misdirection intended to distract your attention away from what really matters. This week was no exception as we are subjected to the monotonous drone of employment numbers, earnings reports and whether or not the market has topped. None of that matters, at least not in the way it is being presented to us.

So what are we missing when we listen to Bloomberg? On Friday the city of Detroit said it would default on a payment due to creditors due that same day, setting the stage for last-ditch talks to avert the largest municipal bankruptcy in US history and push through a financial restructuring plan that would cut benefits to workers and payments to some bondholders. Kevyn Orr, the emergency manager appointed by the State in March to lead the city out from under its estimated $17 billion in long-term liabilities, invited creditors to Detroit to unveil his 128-page presentation. In the plan Mr. Orr deemed Detroit “insolvent”, and called for “shared sacrifices” to save it from bankruptcy.

According to Mr. Orr “financial mismanagement, a shrinking population, a dwindling tax base and other factors over the past 45 years have brought Detroit to the brink of financial and operational ruin.” He went on to say the city would not pay the $39.7m due on Friday to holders of pension-related certificates of participation. These were among the bonds downgraded on Thursday by Moody’s, which gave them a credit rating of Caa3, the agency’s third-lowest rating. Caa3 means the agency views the bonds as being of poor standing and subject to very high credit risk. Mr. Orr also proposed issuing $2bn in notes to pay unsecured creditors on a pro-rated basis, as well as cuts to city worker and retiree healthcare and pension benefits. The plan would also include an oversight board to ensure reforms are enacted and sustained, and $1.25bn to restore services and repair the city.

More than one hundred participants, including insurers, bondholders, unions and swap counterparties, will weigh the offer. Initial discussions are scheduled to start on Monday. Mr. Orr has previously taken a hard line with creditors and last Monday he said at a public meeting the city faced a 50-50 chance of Chapter 9 bankruptcy. If such a step were taken, the claims of bondholders and workers are treated equally. Detroit isn’t the only city suffering these days as Philadelphia, Cleveland and a host of others spread across the rust belt are feeling the effects of decades of globalization, i.e. the shifting its core manufacturing jobs overseas and the shrinking of its population and tax base. In Detroit’s case the population fell from 1.8m in 1950 to 700,000 today. The city has an accumulated budget deficit of $375m.

In March, Dan Snyder, governor of Michigan, took the unusual step of declaring Detroit in a state of fiscal emergency and appointed Mr. Orr, a restructuring specialist with the law firm Jones Day, to manage its finances. The appointment gives him broad powers to bypass the City Council – which had gone to court to block his appointment – to void collective bargaining agreements and to declare bankruptcy. There are limits though as he had suggested he was considering selling parts of the multibillion-dollar Detroit Institute of Arts collection to cover a portion of the debt, though the state senate later voted to prohibit the move. In a note accompanying its downgrade on Thursday, Moody’s cited the growing likelihood of a bankruptcy filing or a major debt restructuring. The one-notch rating cut pushes the bonds deeper into Moody’s “highly speculative” category. “Should default or bankruptcy occur, the recovery levels for bondholders could potentially be quite low based on recent municipal recovery rates for other distressed local governments,” Moody’s analyst Genevieve Nolan wrote.

Debt at the city, municipal and State level is staggering and yet we almost never hear anything about it. As these governments cut back more people become unemployed, lose their homes, their benefits and their pensions. I can understand losing your job and even your benefits, but how do you lose your pension when both you and the entity you work for have made payments into it for years? If you manage a small company and fail to keep up with your workers pension contributions, you’ll go to jail. Yet State and local governments around the country have mismanaged hundreds of billions of dollars of your money and it doesn’t even rate a discussion. If by some odd miracle the topic does see the light of day, commissions are appointed and manned by individuals friendly to the thieves.

There is an old saying that a country is only as sound as its currency, so with that in mind I want to take a look at the plight of the US dollar. We’ll begin by looking at an historical monthly chart of the US dollar:

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