Tuesday, September 20, 2011

Investors Surprisingly Unwilling to Loan California Municipalities Money

For a few days now, the powers that be in Sacramento have been trumpeting the low interest rates that the market gave California for its most recent issue of short-term debt. For people like Governor Jerry Brown, the willingness of investors to lend the state money at low interest is a sign that our habitually broken finances are on the mend. We beg to differ, of course: in our view, the favorable interest rates reflect the low-risk nature of a nine-month loan and the anxiety being created by the sovereign debt crisis in Europe. (We also think the Governor is seizing on any pretext for higher government spending, but that's another discussion.) And it looks like some people agree with us: the LA Times reports that investors' response to a new issue of longer-term municipal bonds has been tepid.

According to Treasurer Bill Lockyer, California's brokerage network has taken orders for $640 million in general obligation municipal bonds since Friday, against a total issue of $2.5 billion. In contrast, Wall Street bought almost $1 billion in similar bonds last November, when interest rates were considerably higher. This time around, the tax-free yields on these bonds are over 1% lower, for both the 10-year and 30-year issues, and investors are wary. Some of their reluctance may stem from President Obama's proposal to cap the amount of muni bond interest that high-earners exclude from their taxable income. But it's unlikely that the proposal will move forward; if nothing else, it would have the effect of driving up interest rates on this debt, which no one in government wants to contemplate. To us, this news is a sign that lenders aren't entirely willing to trust the solvency of California's governments. And really, between the shaky budgets of many of the state's cities and counties, the potentially disastrous pension crisis on the horizon, and Sacramento's decision to balance its budget on the backs of the cities, can you blame them? We have a hard time believing that many municipal bonds issued in the Golden State will be paid with interest in 10 years' time, let alone 30 years' time.

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