Europe Continues In Disarray, Stocks, Euro Plunge

Stocks have given back 100 points of Wednesday's misguided gains

The Euro sinks to a new low

Headlines from FT:

Germany Rejects Larger Bailout Fund
The German government has rejected any suggestion of an increase in the size of the €440bn European financial stability facility – the eurozone rescue fund established by European Union finance ministers in May to help debt-laden members of the common currency zone.

“It really is a non-issue for the German government right now,” said Steffen Seibert, the government spokesman. “We have never been approached in any way about this. All conversations are taking place within the framework of the existing facility.”

Berlin’s approach - and that of the European Central Bank - to handling the eurozone crisis has come under strong attack from Peter Bofinger, economics professor at Würzburg university and an independent adviser to the German government. Without a profound change of strategy there was a “major risk of an unraveling of the euro area,” he has said.

A “dangerous” adjustment process is being forced on eurozone countries he told a Financial Times/Credit Suisse conference in Frankfurt. The weakest spot is Greece, which faces rising unemployment and debt levels. As a result, political opposition to euro membership would grow, according to Prof Bofinger. “Sooner or later we will have a discussion in Greece: ‘why not leave the euro?’” A new currency could then be devalued and much of the government’s debt cancelled out. Once Greece had left, others would follow.

IT'S GETTING WORSE, NOT BETTER:

Europe’s proposed “permanent crisis resolution mechanism” is aptly, if rather ironically, named. Trying to resolve a permanent crisis seems to be what the continent’s leaders have been doing all year and will no doubt be doing for some time yet. (One presumes they really mean a permanent mechanism for crisis resolution – the final language may well be different).

Whatever the final shape of the mechanism, designed to allow eurozone countries to default in an orderly manner, Europe seems little closer to resolving its debt crisis. To the financial markets, bail-outs for Greece and now Ireland are clearly insufficient, no more than plasters placed over gushing wounds.


U.S. Munis Sink Still Lower


Investors withdrew another $2.3bn from funds that buy US municipal bonds in the latest week, capping a sell-off that has taken about $5.4bn from the sector, according to Lipper, the fund tracker owned by Thomson Reuters.
The latest outflows from mutual and exchange traded funds for the week ended November 23 follow redemptions of $3.1bn in the previous week, the largest outflow since Lipper began compiling weekly data in 1992. The combined weekly outflows accounted for 1.5 per cent of the assets managed by the muni funds that Lipper follows.
Investors have cashed out of muni bonds this month after a rise in yields on benchmark US Treasuries and against a backdrop of warnings that the financial problems of local governments and municipalities will lead to a rise in defaults. The selling also came amid record amounts of new issuance into the end of the year.
The latest round of outflows from funds occurred even though the $2,800bn municipal bond market, where states, cities and other public entities raise money, had rebounded in the last few days.

More Trouble Over California Debt

from Financial Times:

The US state of California on Wednesday said it would restructure upcoming bond issues as it tries to raise $14 billion in the middle of a sell-off in the municipal bond market.

The decision to shift more of the sale to a government-subsidized market for municipal bonds would lower the cost of the new debt. This follows other local borrowers who have delayed or downsized bond deals in a market downturn that has produced some of the largest one-day rises in yields on “munis” since the height of the financial crisis.

At the heart of the gloom is both the recent rise in US Treasury bond yields and the looming expiry of the Build America Bonds (BAB) program, which has buttressed the $2,800 billion market where states and municipalities have raised money since the financial crisis.

Most munis offer tax breaks that make the bonds attractive largely to wealthy US individuals. In an effort to ease credit to muni borrowers after the crisis, the federal government introduced the BAB program to subsidize taxable debt to attract a wide range of institutional investors.

The BAB program expires at the end of the year. This has resulted in wave of issuance and concerns about how the traditional market will fare under the renewed weight of the full borrowing needs of states and municipalities at a time when local governments are still under pressure from the recession.

 California’s latest spate of borrowing – it is the largest issuer of state debt in the US – started a week after news of new projected budget deficits of more than $25 billion in this fiscal year and the next

The state on Wednesday said it would cut the size of a sale of traditional tax-exempt bonds by $750 million to $1 billion, shifting the borrowing to a planned sale of taxable debt, which will price on Friday. Of the $2.75 billion of taxable debt it is now selling, some $2.5 billion will be BABs. The tax-exempt bonds price next week.

Tom Dresslar, spokesman for Bill Lockyer, the state treasurer, said the tax-exempt municipal bond market was a “a cold, cold world right now for issuers and taxpayers”.

“In an environment where tax-exempt yields keep rising, it’s in taxpayers’ best interest that we cut the tax-exempt offering and increase the savings we can achieve with subsidized BABs,” he added.

Due to market conditions, California also scrapped a $267.3 million tax-exempt lease revenue bond sale it planned to price next week.

The state also said it has received orders for $6.06 billion, or about 61 percent, of a $10 billion sale of revenue anticipation notes, or Rans, after it extended the marketing period to retail investors by one day. 

California attributed the delay to a lawsuit filed on Tuesday that challenges a plan to sell and lease back from private owners 24 state buildings, threatening to rip a $1.2 billion hole in the most recent budget.

The sale of Rans is an annual event that allows California to bridge the gap to its spring tax seasons. Last year’s sale of the short-term notes, which are due in May and June, drew retail orders topping 75 percent of the $8.8 billion sale.

“Given the hostile market forces, 60 percent-plus retail demand is pretty impressive,” Mr Dresslar said.

The Ran sale opens to institutional investors and prices on Thursday.

I Guess the Fed Can't Save Asset Values After All!

Stocks Crash -- Dow down 200

Treasuries Crash

Bond Markets Crash - munis led to the slaughter, but corp bonds too

The Muni Bond Bubble

from Mish Shedlock:

In New Jersey, governor-elect Christie opposes (and rightfully so), the state going deeper in debt but that is not stopping the current administration of Jon Corzine.

Please consider N.J. to Borrow $200 Million Amid Incoming Governor’s Opposition.

New Jersey, the third-most indebted U.S. state, will sell more than $200 million in bonds today to finance voter-approved capital projects a week after Governor- elect Christopher Christie said he opposed borrowing more money.

The state will issue $209.1 million of bonds, including $205 million of tax-exempt securities, the largest such competitively bid offering in the market today, according to Bloomberg data. Christie, a Republican who defeated Democratic incumbent Jon Corzine last month, said he opposed new bond sales after the state last week detailed $2.7 billion in borrowing it plans for the remainder of the fiscal year, which ends in June.

The state’s bond sale today will finance clean water and open-space preservation projects, according to a preliminary official statement. The state is also planning to sell $1.4 billion of bonds for transportation and $1.1 billion for school construction before June 30, according to a Nov. 30 report.

Christie, 47, a former U.S. attorney, told Bloomberg News last week that New Jersey “can’t have any more debt” and that any projections for borrowing will be “rendered meaningless” when he takes office on Jan. 19.

New Jersey has $36.5 billion of gross tax-supported debt, the third highest of the 50 states, according to a report released in July by Moody’s Investors Service. Moody’s rates the state’s bonds Aa3, the fourth highest ranking. California has the most, at $75.2 billion.

New York City is leading the municipal market this week as issuers seek to borrow more than $10 billion, according to Bloomberg data. New York, the largest borrower among U.S. cities, is selling $1.4 billion of taxable and tax-exempt securities, including $616 million of Build America Bonds. By yesterday, the city had taken orders from individual investors for $440 million of the tax-exempt bonds, and for $20 million in Build America Bonds that it expects to finish pricing on Dec. 10, according to Ray Orlando, a spokesman for the city Office of Management and Budget.

Yields on conventional 20-year municipal debt fell to an eight-week low of 4.24 percent, down 1.34 percentage points from a year ago, according to a weekly Bond Buyer index.

New Jersey Perspective

New Jersey has $36.5 billion of gross tax-supported debt.
California has $75.2 billion of gross tax-supported debt.
New Jersey has a population of 8,682,661.
California has a population of 36,756,666.

Let's do the math.
New Jersey has 23.6% of the population of California and 48.5% of the tax supported debt.

Municipal Bond Bubble

It is not just New Jersey going nuts, California clearly did as well, and cities like New York are in deep trouble.

The city of Vallejo, California fired a huge warning shot by declaring bankruptcy. However, that warning shot has largely been ignored.

Given there is no realistic way for this debt to be paid back, municipal bonds are in a bubble.

People are chasing municipals because of tax exempt status but they are not compensated for for the risk. Please consider the following table courtesy of Investing Bonds



Assuming a 28% tax bracket, the effective yield on a 4% yield muni is 5.56. 20 year treasuries are yielding about 4%. A lousy 1.5% is all you get for the additional risk that a municipal bond blows up. I hardly see how it can possibly be worth it.

Although there is no provision for states to declare bankruptcy (there should be), cities, municipalities, and counties can.

I expect several counties in Florida to default. Major cities like Houston are a distinct possibility as well. Please see City of Houston is Bankrupt (So are California, Oregon, and Pension Plans in General) for details.

When counties and counties start declaring bankruptcy, municipal bond yields are going to soar across the board.

If there is little to no compensation for this risk (and there isn't), then why take it? As with the "free lunch" of Asset Backed Commercial Paper, investors are going to learn the hard way once again.