At the same time that Moody's concluded that retirement costs have been vastly underreported, the Government Accounting Standards Board (GASB) was introducing new accounting rules for municipalities to increase transparency and reduce that underreporting. Significantly, last September, a report by the U.S. Senate's Joint Economic Committee (JEC) estimated that underfunding to be as high as $3.5 trillion.

Artificially low interest rates have a lot to do with pension underfunding. If actual pension plan investment returns are lower than the actuarial return assumptions, there won't be sufficient assets to pay the retirees. In July, Moody's reduced the return assumptions for CALPERS from 7.5% to 5.5%, causing the funding status of CALPERS to fall from 82% to 64%.

As you can imagine, the new studies and reporting rules are playing havoc with the interest rates that municipalities must pay. Much of the recent rise in rates in the muni markets have been blamed on Federal Reserve Chairman Ben Bernanke's "tapering" pronouncements, which had a huge impact on the Treasury yield curve. But there can be little doubt that much of the recent increase in Muni-Treasury spreads was the result of the Moody's study and the new GASB rules.

Although a financial meltdown was avoided in 2009, the crisis clearly isn't over. State and local budget issues are going to have a significant impact on economic policy going forward. Their recognition may even delay the start of the Fed's "tapering" program.

Muni investors, be forewarned: There is volatility ahead in the marketplace. As it turns out, the much maligned pronouncements on the health of state and local government finances by Meredith Whitney in late 2010 were actually prescient. Even the JEC agrees with her conclusions, as they reported that "some state pension funds will run out of assets in as little as five years."

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.
Robert Barone is a partner, economist and portfolio manager at Universal Value Advisors, an investment advisory firm in Reno, NV.

He previously held positions as an economist for Cleveland Trust Company and as professor of finance at the University of Nevada. During his tenure at Comstock Bancorp in 1996 he became a Director of the Federal Home Loan Bank of San Francisco, serving as its Chair in 2004.

Barone also served as Director of AAA of Northern California, Nevada and Utah and a Director of its associated insurance company. He currently serves on AAA's Finance and Investment Committee. Along with his son Joshua, he founded Adagio Trust Company in 2000. Barone received a Ph.D. in Economics from Georgetown University.

This commentary comes from an independent investor or market observer as part of TheStreet guest contributor program. The views expressed are those of the author and do not necessarily represent the views of TheStreet or its management.

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