It would appear that the demise of the U.S. Treasury Market as a safe haven asset was sorely exaggerated. Two years ago when financial markets trembled as the United States Treasury was stripped of its AAA, riskless rating by Standard & Poor’s uncertainty reigned as market losses mounted.
Since that date, The S&P 500 is up 49%, U.S. Treasuries have remained a safe haven asset during time of market volatility and U.S. bank credit spreads are at or close to their post 2008 tights. This is to say nothing of the relative out-performance of U.S. markets relative to their developed market counterparts… and nothing of the improving U.S. employment data.
Maybe Standard & Poor’s was a bit overzealous in their assault on the credit worthiness of the world’s reserve currency. Unfortunately, they were not. They had the right church, but the wrong pue. as risks remain to the credit-worthiness of the U.S. Government. The risk however, is NOT to the federal government’s ability to pay principal and interest – we have technology and FIAT currency status to address that. The credit issue the United States is facing lies closer to home – in our states, municipalities, towns and villages (SMTV) in the form of growing, unfunded mandates.
The fiscal strain of pension, benefit and compulsory spending placed on SMTVs has been coming to bear. While the U.S. did NOT default on any of its debt obligations over the past three years, the scope and frequency of municipal bankruptcies has escalated – punctuated by Detroit’s Chapter 9 filing last month – the largest Municipal filing in U.S. History.
There are many structural reasons why the fiscal stress will continue to manifest itself in the SMTV layer. First, as opposed to the Federal government which is not compelled to balance their budget every year, state and other municipal governments must balance their budgets annually which provides a potential catalyst for a filing – or at a minimum, cutting services, which was Detroit’s initial reaction. In addition, SMTVs lack a critical piece of technology the Federal government possesses – a printing press – a tremendous differentiator when it comes to making interest and principal payments.
Our research into the financials of several seemingly ‘fully-funded’ state pensions has unearthed evidence of financial engineering reminiscent of the Federal Government’s $6 trillion raid on social security years ago. Specifically, one state satisfied their mandated multi-billion healthcare obligation with an inter-agency note. Essentially an IOU that will never be paid.
For these and other reasons, we believe folks like Meredith Whitney are correct in focusing on the fiscal viability of our States and local governments as these stresses directly impact investment opportunities for the foreseeable future. Specifically, the increased SMTV tax load combined with declining services will reduce consumer disposable income – a direct hit to GDP and by extension, equity earnings.
Below is the Bloomberg Radio interview from August 5th 2013 where Mark Connors discusses with Pimm Fox the necessity to triangulate with Market, Credit and Economic analysis to identify today’s investment opportunities.
[single_audio_player mp3=”[single_audio_player mp3=”http://www.riskdimensions.org/wp-content/uploads/2013/08/0805.mp3″ ogg=”http://www.riskdimensions.org/wp-content/uploads/2013/08/0805.mp3″ title=”Mark Connors on Bloomberg Radio”]” ogg=”[single_audio_player mp3=”http://www.riskdimensions.org/wp-content/uploads/2013/08/0805.mp3″ ogg=”http://www.riskdimensions.org/wp-content/uploads/2013/08/0805.mp3″ title=”Mark Connors on Bloomberg Radio”]” title=”Bloomberg Interview – Aug 5th 2013″]