Another Warning on Muni's

Munis, Bank Layoffs, and Anti-Bailout Fervor

September 8th, 2010
By David Goldman
 
Full disclosure: I just unloaded a large part of my municipal portfolio. I am restricting my holdings to bulletproof bonds with ring-fenced revenue streams. New York City, my home town, went bankrupt once in my lifetime, and with financial industry employment vaporizing and real estate values falling, the Apple is lookng pretty wormy. Meredith Whitney yesterday forecast what everyone in financial industry management has been saying private for weeks: mass layoffs are coming in the banking sector. The banks simply can’t make money with a still-shrinking loan book, a flattening yield curve, and stupid-tight mortgage spreads (thanks to the Fed’s purchasing program).

A great deal of Obama’s $800 billion stimulus went to cover state and local budget gaps. It was political life-support for the hard core of the Democratic party political base, the public employee unions whose generous pension deals have turned into an estimated $3 trillion underfunding gap. As bond yields remain depressed and equity returns remain non-existent that gap will grow.

And we are about to get a Republican Congress populated by candidates who ran on a promise of no more bailouts. In a deep and prolonged recession, the voters simply won’t approve new taxes (or new deficits) to bail out public employees who have it better than most employees in the private sector. The drumbeat against government employees sounds nightly on Fox News.

From the Republican vantage point, the state and local government crisis represents a generational opportunity to burn out the base of the Democratic party. The cure for the crisis is to break the public employee unions. It’s as simple as that. Layoffs, salary and pension givebacks, hiring of non-union employees, and so forth will enable cities and states to adjust to the misery of their circumstances. I wouldn’t own Illinois state debt on a dare. Obama’s home town can’t expect mercy from the Republicans.

It has to get ugly. Police, firemen, transit workers and teachers will fight for what they have. The tug of war over scarce funds will take cities and states to the brink of bankruptcy and in a few cases, over it.
As for the banks: they were no more clever in 2009 than they were in 2007. After the huge bounceback in bank profits (as banks scuppered up cheap assets which then appreciated), bank management assumed that happy days were there again and begin hiring. By the second quarter of 2010, banks figured out that no such rosy scenario would ensue and began laying off. Ms. Whitney’s 80,000 number is pulled out of thin air. It could easily be more. The one way that banks can make profits is to reduce compensation costs. Instead of the old 80/20 rule (80% of profits are made by 20% of bank employees), it’s more like 99/1. “All the banks need is one guy to make sure that the firehouse is attached to the pump at the Fed, and a couple of guys to point the other end into the swimming pool” of bank assets, says one senior manager. How many credit officers do you need to NOT make loans? And how many salesmen do you need when ten customers account for 90% of your turnover?

The unraveling of financial industry employment and the end of the federal lifeline will conspire to make life rough pretty rough in New York City. Investors are well advised to stay out of the line of fire.