February 21, 2008
How the Suicidal Fiscal Behavior of Government at every level, Federal, State and Local will Crash the US Financial Markets
“….In a report to the City Council last week, City Manager Joseph Tanner said the city faces a $10.1 million general fund operating deficit for the current fiscal year and a negative available fund balance of $5.9 million on June 30, 2008.
“Based upon the updated financial projections, the current estimate for insolvency is late April 2008,” Tanner said.
“It may become necessary for staff to recommend that the City Council consider filing and pursuing Chapter 9 bankruptcy in the event the city is unable to meet its existing obligations with its existing revenues,” Tanner said in the report.”
From “Vallejo Fears Bankruptcy; Solutions Sought” KCRA TV Channel 3 –
The news headlines in the last six months have a nasty tendency to “speak for themselves” yet few Americans have opened their ears to the deafening din of economic destruction impacting our shores. Tonight’s headlines are no different with the Financial Times screaming “The Monoline Clock is Ticking” and the mainstream media starting to pick up on the story of Vallejo, California possibly going bankrupt, it would appear that we are getting ever closer to two plus two equaling four again and everyone figuring out how our government, at every level, will be the final death knell to this economy and will initiate the final crash which destroys the United States financial markets. The absurd spending projects from sports stadiums to aquariums, butterfly colonies, ant farm research facilities or Malibu tennis courts are indicative of the extraction mentality inherent in almost every level of government. The consequences of this behavior have a price. I call it “Municide” and after my usual historical reference points and theories on how they apply to our current dilemma, the definition will become crystal clear.
During The Great Depression of the 1930’s home ownership dropped then recovered considerably by 1939 in most of the nation, as had median income for the average worker. After the 1940 census, home ownership for the nation as a whole was only down 4.2% from the 1930 pre-depression peak. The problem was that housing values were down 48.6% in the same time period and would take considerably longer to recover (Source: US Bureau of the Census 1943 and The Origins of Modern Housing Finance: The Impact of Federal Housing Programs During the Great Depression-September 2001-Price V. Fishback, William C. Horrace, and Shawn Kantor University of Arizona). While the affordability of housing was a boom for the average citizen as the economy crawled out of it’s depths with no thanks to the socialist interventionism of FDR, the dilemma the housing crash created during that time period wiped out many towns throughout America and helped to contribute to the mass migration of citizens from town to town looking for work and an affordable place to live. This mass migration had the effect, along with the economic consequences of the depression, of wiping out the fiscal health of the cities, counties and states which suffered population drops and substantial job losses. This trend would continue until World War II began and revitalized the economy, but for many now non-existent communities it was too late.
I am not going to review with any in-depth analysis of the problems with towns defaulting on their debts during that time period because the creation of Chapter 9 bankruptcy was a child of the Great Depression and for the purposes of this paper would make research a far more considerable task than this writer has time for at the moment. Considering it took until 1978 for the first town to threaten to default on it’s debt obligations, the new system installed by the Keynesian theorists until that time seemed sound and functional. Mayor Dennis Kucinich (that’s right the UFO guy who keeps running for President for some reason) screamed at a city council meeting:
“This is the politics of insanity!” he shouted at the city council in his high-pitched voice. “You participated in the murder of the city.”
–“Dennis Defaults”, Time Magazine, December 25, 1978
Yes, old Cleveland, Ohio almost defaulted on $15.5 million in notes that came due, but they were able to avoid filing for Chapter 9 bankruptcy reorganization thanks to massive intervention. As we all know, the 1970’s ended with such a resounding economic thud that the stagflationary times are still referenced and feared in current economic commentary. The news from Vallejo, CA should not come as any shock to the average reader or my readers who have paid attention to the warnings that I have been posting. To get some idea of just how dangerous a point in time we are in, we have to review the monoline insurance crisis, housing crisis and ineptness of government at every level to see how America is about to commit “Municide.”
2004-2007: The Seeds of Destruction are Planted
“Real Estate Never Declines”
Ah the mantra we got beaten over the head with over and over and over again this decade as prices accelerated and the obvious problems began to appear to even the casual observer. While I am not a Yale economist like Professor Shiller, the stories about illegal aliens obtaining no-doc loans from banksters in Denver hit the papers and it was a screaming siren of pain on the horizon. I was unfortunate enough to have been invited to participate in the bubble when one of my former business associates established his own mortgage brokerage office, for example. The office was nice and the two friends he persuaded to participate with him enjoyed their work sitting in front of computers set up in his converted “garage office” sipping beer and cold calling candidates who had decent FICO scores and had huge equity parked in their homes after making payments for over ten years. I disagreed with my former friend’s ethics which caused a rift, but if you think about it, just how many hundreds of thousands of other folks set up operations like this in home offices throughout the nation? Ugh. On second thought, I don’t want to know as it would upset my stomach.
So with the ease of lending money to every Tom, Dick, Harry and Jose accomplished through the ignorance and bliss of Greenspanism (defined as the act of blowing bubbles regardless of consequence for the purpose of future book sales) and friends like mine able to make the connections, people realized they could easily buy more home than they needed or could ever afford and what the heck as “real estate never declines.” This bubble blowing extravaganza led to a cooperative effort that expanded beyond the financial realm as the restrictions on creative financing options were removed and the towns which suffered in the 2000-2002 economic decline saw one of those once in a lifetime opportunities. In communities from Northport, FL to Tucson, AZ local planning commissions and zoning boards were pitched the idea of expanding their cities and tax bases to grow, grow, grow. Unfortunately to accomplish this the annexation policies were abused to absurd levels. This was no problem thanks to cheap, free and easy money, and the issuing of municipal bonds to willing investors also became a common practice which allowed the development of infrastructure for these expansions. The willingness of cooperative developers to write their own land-use plans for these expanding locales all but guaranteed rapid sales, accelerated property tax revenues and of course donations to political coffers at every level. As long as the good times were rolling, why not expand beyond any comprehensible level or logic and at the same time who cared because the bonds were “insured” and rated as AAA the majority of the time.
After the infrastructure was laid into place, the developers went into action creating community after community, each one more expensive and expansive allowing the cities and counties to claim more tax revenue for themselves. The missing part of the equation, industrial expansion or “job creation” was a concern that solved with the theory that when people moved into these communities they would bring the jobs with them. Thankfully that theory held true for quite a while and the demand for illegal aliens to perform yard work and build those houses helped to occupy the older homes that were on the markets that the buyers in the new communities left behind. Huh? Well, don’t worry, I’m sure the millions of new homeowners all spoke Mandarin Chinese and worked as importers or WalMart inventory specialists. Or maybe not so much….as we shall see later on in this editorial.
Amazingly the monoline insurers were apparently given incentives to insure the AAA derivatives of the Residential Mortgage Backed Securities (RMBS) as well as the Commercial Mortgage Backed Securities (CMBS). This gave the insurers a huge opportunity to expand their operations and grow their companies that usually insured only the safe, mundane municipal bonds issued for things like libraries, hospitals, roads and utilities (etc…). This rapid growth has been well documented and the crisis we find ourselves in is now the huge ticking time bomb which has everyone terrified that their demise or crash will destroy the financial markets. According to a news report the largest insurers, MBIA and Ambac, would both need $30 billion each to become fully capitalized and thus the flurry of activity from Bill Ackman and Warren Buffett to perform nature’s role as vultures except this time they want the carcass still warm, not dead cold and frozen. The theories proposed in the mainstream financial media about the “good bank, bad bank” split seem viable only to sustain the illusion of solvency just a bit longer while denying the underlying rot. This is akin to calling the tilt of the deck on the Titanic a “feature” to enable skateboarders to have more fun as it slipped under the icy waters. There is a hope that foreign investors can be taken to the cleaner just one more time to bail out the financial houses of horror which have yet to mark to market the garbage being protected by the various insurers and rating agencies, both of which will be destroyed should the derivatives be forcibly revealed to the investing world.
What is the rot you ask? Let’s go back to the concept of “good bank” versus “bad bank” which is so patently ridiculous it’s beyond the pale. The idea was to shove the bad paper or derivatives into the “bad bank” and capitalize with shares from the “good bank” which would hold the municipal paper. In theory this is sound as who ever heard of cities and counties being unable to service their notes or pay their bonds off as taxpayers can handle it according to liberal politicians and investment banksters. Unfortunately the Vallejo, California story is just the tip of the iceberg. I live in a county where the word “foreclosure” is a daily utterance and the signs are posted everywhere. This same county has the earlier referenced “Northport” as part of it’s realm. This town is basically one giant snapshot of the real estate crisis with literally thousands of homes for sale for years now, thousands of vacant lots for sale for years now, and businesses failing on a weekly basis. I may not be an expert but I have stayed at a few Holiday Inn Expresses lately and the last time I checked, people in bankruptcy or foreclosure, empty houses, vacant lots, bankrupt businesses and empty office parks do not provide what I would call “steady streams of income” to finance the city or the county. And believe it or not, it took until this past December for these morons to reduce the “impact fees” on new homes and businesses built there because they noticed no one wanted to build due to the high taxes! Ah yes, but why do they have high taxes? Hmmmm. Could it be to service the municipal bond debt payments?!?!?!?!?!?!!!!!
You see, this problem is ignored just like the pinheads on Wall Street ignored the problem of falsified ratings for communities, derivatives and creative financing. These idiots think that in a period of declining economic activity where the falsified job numbers give the indication of “continuing strength” in some areas will not put a burden on the average taxpayer to meet their obligations. Well, guess what sparky? The average homeowner prefers to feed their children, buy medicine for them, and shockingly remain employed if possible with as many jobs as possible to try to keep their homes. But when a home is falsely appraised at $505,000, an ARM is written which resets in November of 2007, and the payments skyrocket problems (wow) start to occur. Under the government sponsored cancellation of private contract project of the week, usually code-named project HopelifelinesaveourbuttspleasesoIcankeepmyStJohnscondo that the banksters all endorse as opposed to a FBI investigation, the desperate homeowner contacts the customer service representative in New Delhi, who instructs the homeowner to go meet with the banksters in person anyways, in the hopes of refinancing the home. Of course the refinancing goes swimmingly until the appraiser arrives on the scene and says “I appraised this at $505,000 last time? I must have been drunk. It’s only worth $250,000” This closes the books as far as the banksters are concerned and they can blame it on the homeowner in the government’s eyes and be done with this until foreclosure proceedings begin. Because the homeowner, now very jaundiced, remembers Cramer’s advice back in August of 2007 to just “walk away” from upside down real estate thus the increase in “Jingle Mail” back to the banksters. The bottom line is that unemployed or underemployed individuals or households can not afford the same payments they had in 2005 now, much less the reset payments or re-financed ones being promoted as the “savior” now.
While all that is happening, the pinheads deny reality while sipping Pina Colada’s in the USVI and lower level schmucks keep warning and warning until they are laid off for annoying upper management with facts. In the mean time, the lobbyists come back to the local governments all tanned, rested and ready with the “what’s in your wallet” question of the day to which the local governments reply “nothing, which is what is being paid on our debt service next quarter if it doesn’t turn around soon.” The lobbyist leaves and calls New York or the Cayman’s (one and the same really) and reports “hey boss, we could have problems on the horizon.” But the “Horizon” is just a golf course project they are working on in China and something they will worry about “tomorrow.” In the mean time, localities and counties are considering closing libraries, hospitals, schools, road repair projects, utility improvements, etc. as the money runs out which eventually leads to Vallejo, California and many other cities raise their hands to the on staff legal team to ask “is Chapter 9 really that bad?” After a quick call out to Orange County, California (the biggest Chapter 9 to date), the legal time replies “Chapter 9 is not so bad. Heck, Orange County even has it’s own show about the housewives there.”
False Economic Assumptions Based on a False Economic Reality
This brings us back to the problem we are encountering now. For several years now the false economic assumptions that “real estate never declines” and “homeowners would never walk away from their homes” built the derivatives up, up, and up on RMBS and allowed the risk to spread out the world over. The mathematical models assumed that it was beyond any reality to assume a default rate above 1.5% or so and the political assumption was that the Federal Government would never allow it to get that bad.
Now that it is officially worse than “that bad” and those assumptions are obviously blown to smithereens, let’s take a look at the false economic reality which is impacting this side of the equation:
1. Wages are increasing. While that sounds nice, concise and easy to perceive it’s complete, utter and total nonsense. The BLS statistical reports have demonstrated flat to declining net income levels for years now.
2. Inflation is under control and reasonable. And hedonically speaking I’m the Pope.
3. Real Estate valuations fluctuate but never experience long term declines. I guess these folks ignored the 1930’s. Along with the 1830’s. And many other time periods of stagnant prices in the real estate markets.
4. Governments will never let everyone fail. The problem with that theory is what if government is the preeminent cause of all the failures?
5. Unemployed people will always find a way to pay their bills. No comment necessary.
The attempts to micro manage our economy at the state and federal levels has been an unmitigated disaster but statistically speaking we are not in a recession yet. Of course the NEBR has stated that the data they receive is garbage and they often have to wait months or years to determine the exact time frames when one begins and ends, so get your cardboard to build your Hooverville home now and beat the rush. The inexactitude of the data is not only creating a Fantasy Island themed economy but distorting investment decision making from the household level right up to the corporate board room. And this dissonance, desperately created by the politicians to maintain power, will be our downfall. The falsification of economic reality is contributing to the poor investment decisions we see by municipalities and individuals alike. And that distorted view of reality did not help the rating agencies nor monolines in their decision making process either. This is where the complications of their upcoming failures will destroy our financial markets completely in my opinion.
The “good bank” theory would hold up oh so well if the economic situation were traditional and valid in the current day and time. We are not creating new industries or new jobs. The government has over-burdened our society with such a myriad of rules, regulations, fees and taxes that the hassle of creating sustainable manufacturing or any type of industrial base is almost impossible besides unprofitable. Thus with declining net incomes, the evaporation of disposable income, the implosion of local budgets thanks to the housing collapse, and the imposition of the inflation tax by our central bank the future is very bleak for the average citizen or municipality. These counties and cities are engaged in a service cutting frenzy lopping off the softball instruction classes and janitors in a weak effort to meet the budget. But the phrase “municipal bond default” is slipping into the modern American lexicon and that is where the rules change.
Pension plans, conservative investors, and many millions of other souls have piled billions of dollars into supposedly safe, insured and low-yielding municipal bond funds. The idea that the valuations of these instruments changing in a drastic manner never even crossed the minds of anyone (well exclude myself and a few others), as there seemed to be a huge gap in the River of Denial where the disconnect between the “subprime crisis” and the solvency of the cities involved was huge. Well, the connection was finally made when the Auction Rate Security markets went off the scale recently. With failed auctions resulting in some communities seeing back breaking 18 to 20% yields, the idea of issuing new paper or starting new projects will fade quickly. And that reduces employment opportunities in those cities. As well as impacting the investors, be they pension plans or just a bankster in the Caymans, to shun this market and fly for safety in tangible assets. That is why the stories about declining home sales, falling building permit applications and small to medium sized business bankruptcies are starting to scare the dickens out of the investors domestically and overseas. What happens if the monolines have to start paying out on defaulting municipal bonds? What happens if the “good bank” becomes as insolvent as the bad one, reducing the capitalization of the “bad bank” with it’s devalued shares? And what happens when the Municide kills the insurers causing a massive write down of actually worthless assets by the largest banks in the United States? These questions are ones that they do not want to have answers to, but the Federal Reserve has to be aware of this pending implosion.
Unfortunately for all of us, the failure to project future revenues and growth does impact everyone in the U.S. The decline in sales tax receipts, property tax receipts, and other fees originally projected from an expanding economic base as well as healthy real estate market, will eventually lead us to city after city, county after county, defaulting on various securities once thought or perceived to be the safest in the nation. As the resets continue this year and next, even more over-valued real estate which will force property tax revaluations and appraisals to be evaluated lower and lower, feeding the vicious cycle downward even more so. Asset devaluations with accelerating commodity inflation will eventually destroy the average American citizen’s standard of living. Add in the starting wave of HELOC and second or third home equity defaults and you have a formula for a banking crisis on top of the municipal bond crisis to come. The result of this economic contraction along with the forced decline in government spending on the state and local level will leave huge revenue gaps that will result in either default or increased federal intervention.
In the long run, I can foresee the Northern Rock solution being implemented. There is a “too big to fail” mentality in this nation as there is in the U.K. which results in a very low pain threshold on a political level. The natives are restless and if the government fails to prevent a total collapse of the system, they will be held accountable during this election season. Thus the inflationary solution, the most damaging and damning one, shall be implemented. Municide will have the consequence of destroying the retirements of millions, the standard of living of many more, and re-introducing the dominance of Washington, D.C. into our lives on a scale unseen in over half a century. To think all of it could have been avoided by cities and counties setting up rainy day funds, maintaining cash reserves and not supporting inane projects like bike paths to honor dead Mayan Gods that don’t even know where Podunkville, Arkansas would have been located on a 912 B.C. map.
God help us.