In a bygone era when this author still did international live radio, I penned a piece titled “Municide” which outlined how the housing crisis was going to lead to a disaster in the municipal bond market. ti was such a popular phrase, it joined the financial jargon lexicon as the crash accelerated in 2008 and many of us did not think the Fed would buy everything in sight to bail out the nation.
My one and only appearance in the New York Times unless of course the world goes to hell in a hand basket domestically and then all bets are off.
The reason I bring this up again is that a chart appeared on HedgeIn’s twitter feed which brought back new flashbacks to 2007-2008:
This brought about a new, more frightening version of Municide which I did not consider in 2008 due to the threat of a deflationary collapse which was under way at that time; what if the inflationary fire is not extinguished and interest rates begin exceeding historical norms, such as those seen in the early 1980’s?
The results of the high interest rates in the early 1980’s was the creation of the Rust Belt (see Gary, In) and the inability of many communities to fund basic operations. Thus the northeastern US saw a population decline as many formerly industrialized towns found difficulty in providing basic services, much less jobs for the residents there.
While most economists have acknowledged that the additional increase in rates across the US Treasury curve has impacted the US budget deficits and debt, what about the local ability to raise money at higher interest rate levels?
The impacts based on the current economic structure created since the 1990’s will be devastating. Many communities are already experiencing a massive decline in the quality of living and ability to provide for its citizenry, now add inflation and higher interest rates on top of that and all bets are off.
Think about a typical AAA muni now yielding 4.75% for a GO (General Obligation bond) over five years. Now make that number 9.75% or 12% in less than two years. There is no validation yet that Jay Powell has the stomach to raise interest rates to keep pace with inflation much less suppress it, thus investors are going to demand higher and higher yields from municipalities to keep ahead of inflation.
Why would any investor buy a 5.50% note from Sarasota, FL when they could get 8.25% from San Jose, CA? Granted the risk is higher in California but as long as investors feel the Federal Reserve will eventually buy them out at the higher price, why not gamble on the riskier yield?
In the end, the actions by the Fed over the past decade may indeed trigger the deflationary collapse they were trying to avoid by creating an interest rate environment where communities can not afford to finance basic operations, much less desperately needed infrastructure improvements. The current Fed is just too incompetent to pull this off, much less a soft landing, so the collateral damage from their current blunt instrument policy may have impacts far beyond the consumer and “reigning” inflation in.
Just like the policies which almost wiped out the US economy in 2008-2009.