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Wednesday, May 20, 2015 1:07 AM

CNBC's Santelli and Mish Discuss Municipal Bonds; Egan-Jones on Chicago; S&P Blames Moody's; Message to Bondholders

Mish Moved to MishTalk.Com Click to Visit.

I was back on CNBC with Rick Santelli on Tuesday May 19. The topic once again was municipal bonds with a spotlight on Chicago. Here are a pair of videos.

Live Santelli Exchange

CNBC's Rick Santelli discusses Chicago's credit downgrade and municipal bond crisis, with Mike Shedlock, Sitka Pacific Capital Management.

Link if video does not play: Santelli Exchange: Illinois' unfunded pension liabilities

What's next for Chicago's debt crisis?

In an extended segment, CNBC's Rick Santelli discusses Chicago's municipal bond crisis with Mike Shedlock, Sitka Pacific Capital Management.

Link if video does not play: What's next for Chicago's debt crisis

The slides in the videos are courtesy of the Illinois Policy Institute. Santelli drew an amusing schematic of the 2011 tax hike showing where the money went. Here is the original chart.

John Cullerton: "Tax increase helped state pay bills and debt." October 28, 2014.

In the second segment, I mentioned Mike Madigan, Speaker of the Illinois House. I know full well Madigan is Speaker, but the words "House Speaker" did not come out of my mouth. I was thinking of mentioning John Cullerton, "Senate President", and those were the words that came out of my mouth.

In Illinois, Madigan and Cullerton are the two guys that control every bit of legislation.

Beware, the Tax Man Has Eyes on You

In case you missed it, please consider my May 4, article Beware, the Tax Man Has Eyes on You: Potential Hike for Illinoisans is Staggering.

Nuveen estimates that property taxes in Chicago will need to rise by 50% to bail out Chicago pensions. I believe the required tax hike would be much higher.

When Nuveen came up with the 50% property tax hike, it did not include tax hikes to bail out other Illinois pension plans. Nor did it address the $9 billion budget deficit for the state. Nor did it consider the possibility (I believe likelihood) of negative stock market returns for years to come.

For further discussion please see my April 23, article Seven Year Negative Returns in Stocks and Bonds; Fraudulent Promises.

Egan-Jones Chimes In

On Monday, I gave Sean Egan of the rating agency Egan-Jones a ring. I asked him how he would rate Chicago General Obligation bonds. Egan replied "deep in junk territory".

Here is a table I put together of how various agencies rate Chicago debt.

Rating AgencyDateRating LevelOutlook
S&P5/14/2015A-3 Levels Above JunkNegative
Kroll 5/11/2015A-3 Levels Above JunkStable
Fitch 5/15/2015BBB+3 Levels Above JunkNegative
Egan-Jones5/18/2015"Deep Into Junk"Negative

S&P Blames Moody's

Here's an amusing take on passing the buck courtesy of Pensions & Investments on the Debt Downgrades.
Chicago's problem now is that it faces “short-term interference,” S&P said. “That said, we recognize that the city has a diverse tax base and a management team that has good policies in place. These are an important foundation for any city that needs to address the challenges that this city is facing.”

Lois Scott, the city's chief financial officer, said in a statement: “The city of Chicago's financial crisis is real, urgent, and has been decades in the making. The downgrade by Moody's of the city's credit — a decision they say was driven by the Illinois Supreme Court's reversal of the state pension reform bill — has substantially magnified the city's challenges and will add real costs to Chicago's taxpayers. In fact, S&P noted Friday that its own downgrade is driven by the short-term pressures on the city's fiscal position that were created by Moody's actions earlier this week. However, unlike Moody's, S&P recognizes the city's efforts to not only address its legacy liabilities, but that it has the right tools in place to address the challenges it faces.
Rate Shop Whores

For a discussion of how the SEC is to blame for the current environment of Fantsayland bond ratings please see Rate Shopping Whores and Chicago's Bond Rating.

In that link I explain in detail how it is that one rating agency has Chicago "deep in junk" while others have Chicago rated "A-".

99% Haircut

The Bond Buyer reports San Bernardino Chapter 9 Plan Gives Bondholders Worst Cut of All.
San Bernardino, Calif. is now planning to give bondholders significantly worse treatment than they have received in any municipal bankruptcy to date, Moody's Investors Service said in a comment piece Monday.

The bankruptcy plan of adjustment city officials presented to the city council on Thursday "proposes to eliminate 99% of the principal value of its pension obligation bonds, while committing to pay 100% of its unfunded pension liability," Moody's credit analysts wrote.

"The implication of the ruling is that the use of POB proceeds to fund pensions is irrelevant to how the bonds are to be treated in bankruptcy, and therefore retirees are under no obligation to share losses with bondholders," according to Moody's.

"The ruling and the plan of adjustment are credit negative for San Bernardino's POB investors." Moody's wrote in the comment. San Bernardino proposed in its adjustment plan to only provide pension obligation bondholders with a 1% recovery.

In Stockton, POB holders received a roughly 41% recovery, while bondholder recovers in Vallejo were roughly 60%. Vallejo did not have POBs.

"By leaving pensions untouched, however, the city's financial operations will remain strained by rising pension costs," Moody's wrote about San Bernardino. "Under the city's projections, pension costs will nearly double over 10 years to nearly 19% of expenditures."
Bondholders and Taxpayers Screwed 

San Bernardino city officials made a purposeful decision to screw bondholders and taxpayers.

"By leaving pensions untouched, however, the city's financial operations will remain strained by rising pension costs. Under the city's projections, pension costs will nearly double over 10 years to nearly 19% of expenditures," says Moody's.

Moody's dramatically understates the problem because it did not factor in the likelihood of negative returns on stocks and bonds.

Conflict of Interest

Federal bankruptcy courts ruled four times that cities can cut pensions. So far, cuts have been token. In the case of San Bernardino, nonexistent.


The answer is "conflict of interest". City officials wanted to preserve their own ill-gotten and undeserved pensions. On that basis, U.S. Bankruptcy Judge Meredith Jury may have made a very bad ruling.

Message to Bondholders

The decisions in Detroit, Stockton, San Bernardino, and Vallejo send a clear message to bondholders:

Don't buy or hold municipal bonds in any municipality plagued by pension woes because you will be screwed if you do.

That is why I agree with a Chicago Tribune editorial by Henry J. Feinberg, says Pass a Bankruptcy Law, Give Taxpayers a Chance.

Pending Illinois legislation, Bill 298 will allow Illinois municipalities to go bankrupt, a badly needed measure. Feinberg's editorial seeks to amend House Bill 298 so people who hold Illinois bonds have a "secured first lien," the fancy words needed in the law to make sure bondholders are first in line to get their money back.

My concern is not for bondholders, rather it's for the taxpayers. In the great financial crisis bailing out the banks at taxpayer risk was precisely the wrong thing to do.

In this case, taxpayers are punished once again. They will have to pony up for inevitably higher borrowing costs. And the sorry situation is that none of the cities really solved any long-term problems.

In bankruptcy, the city could have at least done something to protect taxpayers down the road. Instead, corrupt and greedy city officials protected their own interests.

When the stock market takes another dive, and it will, San Bernardino pensions will again be deeply underfunded. 

Another Crisis Coming

Since no long-term issues have been solved anywhere, expect another pension crisis down the road in a number of already bankrupt California cities.

Meanwhile, I repeat my warning: Don't buy or hold municipal bonds in any municipality plagued by pension woes because you will be screwed if you do.

Mike "Mish" Shedlock

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