Muni Investors Beware: Detroit Is Tip of Iceberg
NEW YORK (TheStreet) -- When Detroit filed for bankruptcy protection last week, no one was shocked. It felt like it was inevitable. Now one has to ask whether analyst Meredith Whitney was correct but just early in her call in late 2010 on municipal defaults?
For Detroit, the real culprits in the bankruptcy were skyrocketing pension and health care costs, even though mismanagement and reduced state and federal aid also played a role.
Those same issues are at the root of most of the fiscal challenges faced by state and local governments. As I write, there is controversy over the legality of Detroit's bankruptcy filing because state law prohibits such a filing if it contemplates a reduction in pension benefits.
That said, there is no doubt that Detroit, with more than $18 billion of debt, cannot pay its creditors. Of that debt, the city owes $3.5 billion to its pension plans.The answers that Detroit will deliver to the marketplace regarding the distribution of its assets will be based on forthcoming judicial decisions that will determine which group of creditors skates and which ones get savaged. Detroit may well become the model for how the courts treat the creditors of future municipal bankruptcies. The credit markets are certain to take note, and there are certain to be reactions and price adjustments as a result. Detroit may be just the beginning of the spate of municipal bankruptcies that Meredith Whitney forecast more than two and a half years ago. In the last month, studies have shown that municipal fiscal problems are much worse than previously believed. Actuarial estimates of unfunded liabilities have risen, not only because governments have failed to properly fund the plans under the old guidelines, but because the guidelines have changed. A couple of years ago, Morningstar estimated the funding status of each state's pension program. The 2011 results ranged from 43.4% (Illinois) to 99.8% (Wisconsin). That study showed that only 30% of state programs were at least 80% funded. But now, those estimates have all changed as, in late June, Moody's introduced new measurement methodologies. Not surprisingly, Illinois was still at the bottom. What is significant is that Moody's found that the median state must now devote 45% of its annual revenue just to fund and catch up with its existing pension obligations.
Select the service that is right for you!COMPARE ALL SERVICES
- $2.5+ million portfolio
- Large-cap and dividend focus
- Intraday trade alerts from Cramer
- Weekly roundups
Access the tool that DOMINATES the Russell 2000 and the S&P 500.
- Buy, hold, or sell recommendations for over 4,300 stocks
- Unlimited research reports on your favorite stocks
- A custom stock screener
- Upgrade/downgrade alerts
- Diversified model portfolio of dividend stocks
- Alerts when market news affect the portfolio
- Bi-weekly updates with exact steps to take - BUY, HOLD, SELL
- Real Money + Doug Kass + 15 more Wall Street Pros
- Intraday commentary & news
- Ultra-actionable trading ideas
- 100+ monthly options trading ideas
- Actionable options commentary & news
- Real-time trading community
- Options TV