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ChrisGraley (29.87)

Soon is the Winter of our Discontent.

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December 21, 2010 – Comments (23) | RELATED TICKERS: AM.DL2 , CRIS

46 States face major budget shortfalls in 2011 and the possibility of bankruptcy.

Tax revenue is falling as new jobs aren't being created and borrowing costs are increasing due to the end of Building America Bonds and investors fleeing the munis.

The FED is hamstrung as it can only buy very short term municiple obligations. Illinois is already paying about 2% above average for it's munis. Arizona is sold off it's buildings including the Capital building. Pension funds are exerting a huge strain on most State budgets.

The only thing missing at this point is a panic moment to send a contagion event through the country. (Why a state selling off it's capital building wasn't a panic moment, I do not know!)

Moodys recently reported that banks can not sustain a double dip. They still have unrealized losses on their books and the shock of a double dip will be too much for them. Real Estate definately can't handle a double dip at this point and double dip would be certain if contagion sets in.

So what happens? A double dip followed by a huge QE3 is what I think happens.

Does anyone else have a different take on the munis or on the Fed response?

Please post here as I have been thinking about it a lot lately.

23 Comments – Post Your Own

#1) On December 21, 2010 at 12:20 PM, Option1307 (29.95) wrote:

Alstry, is that you? :)

Arizona is sold off it's buildings including the Capital building.

That certainly was surprising to read about. It will be interesting to see going forward how many more states take a similar path.

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#2) On December 21, 2010 at 1:01 PM, Jbay76 (< 20) wrote:

Hi Chris!

Always happy to read your posts!  I think we are in for some heavy sh$t becuase of this issue.  States have known of this for the past year but for some reason haven't done anything about it.  The time to act on the unpopular decisions, i.e. cutting pensions, reducing everyone public workers' salary, has been upon many states for years now. If its not bad enough to follow on those actions now, I'd hate to see how bad it needs to get.

 

My wife and I were thinking of moving back to CA, but now intend to stay where we are and finish paying off our school loans first.  Although, in retrospect, given the financial crisis our states are leading us into, and the chasm it will create, I wonder whether I should pay off my loans anyways (aside from the ethical/moral implications).

I also wonder about investments in REIT's.  Will the upcoming catastrophe encourage Benny to keep IR's low?  Will REIT's be able to generate their dividends and increase shareholder value.  I think that NLY will do fine as they are branching out to begin creating loans for small businesses, thereby diversifying their business model.  Increasing investments in PM's and their miners will also be clutch!

 My one solace is that states budgets are seperate from the federal budget (i.e the feds can print money to get their way out of debt, or so they think, states can not).

And on a side note, that was very desparate and overall stupid of AZ to sell off its capital onyl to rent it.  They had been discussing that option all year.  I swore there was someone intelligent enough to realize the stupidity in that deal. Another bum deal for the public...hopefully this doesn't set a precedence for other states.  It would be interesting to see the private investors who own the capital house kick out the state government when they can't pay rent.....

 @option1307

Interesting enough, I am surprised to not have heard from Alstry.  I guess he really stuck to his word this time and is blogging on a different site 

My ramblings for the moment! 

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#3) On December 21, 2010 at 1:11 PM, ChrisGraley (29.87) wrote:

That's funny option, after I posted it, I thought I sounded like Alstry too.

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#4) On December 21, 2010 at 2:24 PM, ChrisGraley (29.87) wrote:

Jbay, I like your stuff too.

AZ is just trying to kick the can a little further hoping for a miracle. It won't end well.

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#5) On December 21, 2010 at 2:33 PM, eldemonio (98.64) wrote:

I just dropped off the kids at Taco Bell Elementary and then proceeded over to The Home Depot Justice Center for jury duty.

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#6) On December 21, 2010 at 3:41 PM, Melaschasm (56.36) wrote:

While a serious double dip could occur, QE2 (3,4, whatever it takes) is designed to create stagflation.  If successful, the State may avoid technical default, while inflation eats away at the wealth of the people.

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#7) On December 21, 2010 at 4:16 PM, ChrisGraley (29.87) wrote:

Is that lose/lose scenario Melaschasm!

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#8) On December 21, 2010 at 6:10 PM, outoffocus (23.26) wrote:

Combine that will the possibility that QEII may have popped the Treasury bubble, we have one huge ugly smelly shoe that maybe dropping within the next year that could make 2008 look like paradise.

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#9) On December 21, 2010 at 6:17 PM, davejh23 (< 20) wrote:

"Combine that will the possibility that QEII may have popped the Treasury bubble, we have one huge ugly smelly shoe that maybe dropping within the next year that could make 2008 look like paradise."

I agree, but I think the Fed will do everything in their power (enough?) to prevent a double dip.  Another stock market crash at this point would probably take us much lower than the March '09 lows...people would panic (3rd crash in 10 years) and nothing the Treasury/Fed/Congress did would calm their fears...everyone would rush for the exits just like last time, but they'd never return.  They'll try to protect stock market gains at any cost.

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#10) On December 21, 2010 at 6:40 PM, rfaramir (29.31) wrote:

High inflation expectations make people do things that would be deemed stupid under better conditions. Selling the Capitol building and renting it back transfers the risk of inflation to the buyer. If they're right, the buyer gets stuck with an asset paying a (presumably) fixed amount of depreciating dollars.

I'd be worried about what the state is using the present money for, though. Sure, their future obligation will wither away with inflation, but are they spending the money wisely? Not likely.

One positive is the small possibility of this catching on in general. States devolving government operations (and assets) to private entrepreneurs who might actually do something useful with them, creating wealth instead of redistributing it and skimming some off the top like government does. Again, not likely, but one can hope.

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#11) On December 21, 2010 at 8:55 PM, rd80 (98.03) wrote:

Illinois is already paying about 2% above average for it's munis.

It's worse than that.  Illinois is trying to arrange deals where Wall St. firms buy the accounts receivable from vendors to the state.  Those bills are past due and have late fees of 1% per month, so IL is basically trying to set up financing for its past due bills at about 12% annual interest. 

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#12) On December 21, 2010 at 10:24 PM, whereaminow (24.43) wrote:

LOL, I didn't know about the Capitol building. That's too funny. Do they get kicked out if they don't pay the rent?

States could fix their problem if they just exercised their monetary sovereignity :)  Just reject Fed money and print their own money to pay off their debts.  The only thing stopping them is their own political will.  (Well, that and the United States Army.)

Wait a second...

David in Qatar

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#13) On December 21, 2010 at 11:09 PM, ChrisGraley (29.87) wrote:

@outoffocus I was trying to keep a short blog post, but the Treasury bubble was definately on my mind as well as a huge European contagion reaction to any US weakness.

@davejh23 Well, I agree that the FED will do everything that they can to prevent it, but our laws dictate that they can't directly buy munis (which would be the proper response) and they will be slow to respond. The State governments don't just lie to their voters, they lie to their sugar daddy as well.

@rfaramir Well, inflation would suck for them too. The building that they sold will be worth far more than when they sold it.  States are supposed to be more stable than being perpetual rentors. If they want to buy it back, (and if they don't they will be a joke among other states) They not only will pay the same inflated dollars, they will pay it after paying a rent that they shouldn't have needed to pay in the first place. They will pay that inflated price only after financing it with more debt.

@rd80 You wouldn't happen to have a link for that one would you buddy? I did not hear that one and would be very interested in that article. I think that Illinios is the next Greece. I could really use the info if you have it.

@WheretheheckdidIwakeupthismorningandwhatwashernameagain?

Thanks for the chuckle. Most people wouldn't see the reference to the Euro. As far as the US Army goes. I was a member of the US Army and can assure you that we were(are) highly trained individuals capable of accomplishing things that most people would think impossible. That being said, we used to take orders from the Pentagon, and now the Army takes orders from NATO and Congress. Arkansas could print their own money and the Army could succeed in the invasion, only to find out that we accidently invaded Texas because Nancy Pelosi couldn't think of a good comeback to Ron Paul.

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#14) On December 21, 2010 at 11:22 PM, rd80 (98.03) wrote:

Here's a link to a WSJ article and a quote from the piece.  I was doing some research and couldn't find this outside the WSJ, although a Google on Illinois, vendors, and (I think) invoices turns up some info from the state.  They started this on a trial basis back in Oct. 

Sounds kind of like inviting a loan shark in to rip you off.  Of course, any investors considering buying in should ask themselves, 'if the state can't pay the vendors, how are they going to pay me.'

http://online.wsj.com/article/SB10001424052748703727804576011644076639916.html

“The Illinois approach works like this: Investors take over the delinquent bills owed by the state to its vendors. Those vendors are due a 1% penalty each month after the state falls behind by 60 days. The financial investors make the vendors whole and are entitled to 1% monthly penalties until the state pays the investors back.”

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#15) On December 22, 2010 at 12:32 AM, ChrisGraley (29.87) wrote:

Thanks rd80!

"That isn't what the state says. Among the program's main selling points: "Illinois cannot declare bankruptcy and constitutionally must pay its obligations," according to investor materials."

That was about all I needed to read.

"Ms. Kraft said the program was largely inspired by complaints from vendors, who were being solicited to sell their debts at significantly less than face value. Some were being offered as little as 20 cents on the dollar, a person familiar with the matter said."

That was icing on the cake!

It's much worse than I thought!

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#16) On December 22, 2010 at 6:39 AM, cthomas1017 (97.48) wrote:

Can anyone identify the 4 states that do not face major budget shortfalls in 2011 and the possibility of bankruptcy?

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#17) On December 22, 2010 at 9:43 AM, cthomas1017 (97.48) wrote:

Found it... ND, AK, AR, MT

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#18) On December 22, 2010 at 10:13 AM, silverminer (30.68) wrote:

ChrisGraley,

I am 100% aligned with your concerns, and the clear inevitibility of further quantitative easing as the default response. The looming crisis is of large enough scale, furthermore, to spark another major bank failure or something of its ilk ... with all the associated repercussions for systemic risk, uncontrolled deleveraging, etc.

It's reported we came within a few hours of complete financial devastation in the wake of Lehman. Will we be so fortunate on a second time around? For all of our sake, I hope we manage to avoid such a perilous precipice, because the fall from these heights after all that has been done would be truly unthinkable in scope.

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#19) On December 22, 2010 at 11:36 AM, rd80 (98.03) wrote:

Hi Chris,

No problem on the link.  I'm surprised that story isn't getting more coverage in the financial press.

I also liked the "cannot declare bankruptcy" quote.  True enough, but it could default. 

I hope I'm wrong, but suspect it won't be too much longer before we learn what happens when "must pay its obligations" meets "can't pay its obligations."

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#20) On December 22, 2010 at 11:47 AM, AlexanderAkhavan (< 20) wrote:

I have a few questions, that I hope someone can answer.  Why cant the state of Illinois declare bankruptcy?  Is it a state law?  If so, why couldn't they change it.  Thanks.

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#21) On December 22, 2010 at 12:41 PM, ChrisGraley (29.87) wrote:

Alexander, It's just a little political hogwash stated to make people less nervous.

as rd80 pointed out, they sure can default.

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#22) On December 22, 2010 at 6:16 PM, rd80 (98.03) wrote:

Why cant the state of Illinois declare bankruptcy?

My understanding is because there is no provision in the bankruptcy code for a state to file.  There are chapters that apply to individuals, companies, cities, and counties, but not states.

I'm not a lawyer, but suspect that's because a state is a sovereign entity and would not fall under the jurisdicition of a bankruptcy court. In the event of a default, the difference is any settlement would be determined by state law rather than in a bankruptcy court.

As a practical matter to a bond holder, it doesn't make much difference - if there's a default, the bonds go to zero or, at best, pennies on the dollar either way. 

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