Greece coming to America?

To say the last couple of weeks have been interesting is an understatement. The Greece problem boiled over, necessitating a bailout costing almost $1 trillion. Some of that money comes from the International Monetary Fund (IMF), of which the US is the largest contributor. America’s portion of the bailout is now over $50 billion. Some people are concerned that this could happen in the US. In our opinion, if it does hit, it will first hit the states and municipalities. For this reason, municipal bonds (as a whole) may be one of the most risky investments available today.

We are all aware of the problems that states and municipalities are having with their budgets. In Greece, the state unions are striking and protesting their austerity measures. In the US, public unions are fighting such measures in court. For example, in New York this week, the public workers union took Governor Patterson to court on his plan to reduce the state’s budget deficit by forcing workers to take a one day unpaid furlough. A judge put a temporary halt to the plan, ruling that that the furloughs violated collective bargaining agreements and would cause “irreparable harm” to workers. “In California, 18 lawsuits have been filed by public unions to stop Governor Schwarzenegger’s furlough program. In a time when many – including all employees at THOR – took pay cuts to help save jobs, it is unconscionable to think that the public unions are not doing the same. These actions only increase the risk of bankruptcy and defaults within the municipal bond market as it becomes tougher for states and municipalities to balance their budgets by reducing costs. Adding even more pressure to the states is the additional Medicaid spending they will be required to make because of the recently passed health care legislation.

If fear does hit the municipal bond market, it could be devastating to investors holding those securities. One has to be very careful about which municipal bonds they own and what assets secure such bonds. Our concern is that if we see any fear in this market, even strong municipal bonds will get hurt – just as strong mortgage backed securities suffered along with sub-prime mortgages. Other aspects of the municipal bond market add additional risks that most investors are not aware of:

• Liquidity Risk – The municipal bond market is a very highly fragmented market. In the “good-ole-days,” brokerage firms held municipal bond inventories which provided liquidity in the market. Currently, there is little liquidity in the municipal bond market.
• Accounting Risk – There currently is no uniform accounting standard for municipalities. This results in very little transparency.
• Disclosure Risk – Not only is there a lack of full disclosure in many municipal bonds, but it can take as long as 6 months after the end of their fiscal year for municipalities to provide financial reports. In many instances, the information comes much too late to react and bond holders suffer the consequences.

We applaud those brave politicians that are trying to reduce spending. Individuals and corporations have tightened their belts. It is time for municipalities, states and the federal government to do the same.

Sincerely,

Your THOR Team