California Creamin’ (the muni market)

You think today was ugly in the equity market take a look at what is happening with, MUB,  the Municipal Bond EFT (see chart below).   The California Legislative Analyst’s Office released their state fiscal outlook on November 10th and projects a $100 BN cumulative shortfall for the next five years (see chart).  Governor-elect Jerry “all the leaves are ” Brown certainly has his work cut out.   The Analyst’s Office has this caveat on the projected shortfalls,

Projections Likely Understate the State’s Fiscal Woes. We believe that our projections probably understate the magnitude of the state’s fiscal problems during the forecast period. First, our forecast generally assumes no cost–of–living adjustments or inflationary increases in departmental budgets. Second, by including only current–law expenditures, our forecast does not include funding to address a number of large liabilities that pose a risk to future state finances, as discussed below.

Massive Liabilities Growing. Unfunded actuarial accrued liabilities in pension and retiree health funds for state employees, teachers, and university employees now total $136 billion. (Possible upcoming actions by the state’s two largest pension systems to lower their assumed annual rates of investment return would expand this number.) The California State Teachers’ Retirement System (CalSTRS) estimates that it needs billions of dollars more per year in contributions—not included in our forecast—to retire its unfunded liabilities within about 30 years and continue operations past the 2040s. Similarly, there are no funds assumed in our forecast to begin retiring the University of California Retirement Plan’s (UCRP) growing unfunded liabilities. State retiree health liabilities continue to grow, driving upward the associated General Fund expenditures. The Legislature took action earlier this year to modify state pension programs, providing some budget relief now and greater relief in the future. The unfunded liabilities of state retirement systems, however, loom over the state’s budget prospects. Left unaddressed in the near term, costs to service CalSTRS, UCRP, and retiree health liabilities will only grow, burdening future Californians more and more and requiring even harder decisions about taxes and services. The state should look for ways to address these problems soon, to avoid passing these huge obligations to future Californians.

California is not an isolated case as many other states are experiencing similar fiscal difficulties.   We were surprised and concerned the long-bond did not rally during today’s massive commodity sell-off and weak equity market.   Coupled, with what is happening in munis and PIIGs, it looks like “the chickens may be coming home to roost”  and 2011 could be shaping up to be a year of public debt crises. Stay tuned!

Related Articles
Super-sized pensions, and a doomsday scenario – MSNBC
Teachers’ $500 Billion (and Growing) Pension Problem – Time
Municipal Bond Market Shudders – NY Times
Calif. Market Close: Tax-Exempts Finish Weaker – Bond Buyer
Municipal Bonds Get Crushed – Bespoke

And saving the best for last……………

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One Response to California Creamin’ (the muni market)

  1. David Jones says:

    Yes, CA has severe financial problems. However, there are additional factors that separate the closed end muni funds from most open end funds. The closed end funds use leverage which magnifies their returns in both directions. The closed end funds often have lower rated bonds than the plain vanilla open end funds. The NAV of the open end funds is internally calculated and may not be as responsive to market movements. That said, most plain vanilla muni open end funds barely budged Friday which may be an opportunity to get out at artificially high prices or may be an indication that the muni market is not as bad as the closed end funds indicate.

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