Words of wisdom from an investment adviser: When it comes to municipal bonds, the ones you want you can’t get, and the ones you can get you don’t want.
Assured Guaranty and other large holders of bonds issued by the city of Stockton, Calif., got a sharp reminder of that on Monday when a federal judge ruled that the city was entitled to file bankruptcy under federal law to gain protection from bondholders and other creditors. The bondholders’ suit was probably never going to stand up: The city is plainly insolvent. Faced with a choice between screwing its bondholders and reneging on the pension benefits it owes to union goons, Stockton’s leaders clearly calculated that at this point they have little to lose by shortchanging bondholders — its credit rating is already so low that it’d have a hard time financing a used Hyundai with $5,000 down — and that while creditors may sue, complain, and caterwaul, they do not get to vote. Moody’s responded by downgrading the credit on the pension-obligation bonds of nearby Solano County.
Pension-obligation bonds fall under a special class of idiocy. Municipalities with large unfunded liabilities for employee pensions wipe those obligations off the books by selling municipal bonds, investing the proceeds in stocks or other investments in hopes of earning a spread that will make the whole thing work out for them. Noted bond speculator Jon Corzine once called the maneuver “the dumbest idea I ever heard.” Make a note: Too stupid for Jon Corzine is a rarified kind of stupid.
But even if large losses are imposed on other creditors, Stockton, like many cities and states, probably cannot afford to meet its pension obligations. Down the road a bit, the fools and miscreants who run the city of San Bernardino, Calif., have stopped making their payments to CalPERS, the state’s public-pension giant.
The situation presents a few interesting problems. California law says cities have to meet their pension obligations. Federal law says cities may seek bankruptcy protection. Math says that no matter what the law says, there probably isn’t enough money to honor the pension obligations. What will happen is anybody’s guess.
But relatively speaking, the cities’ cases are straightforward, because there exists such a thing as bankruptcy law for municipalities. There is no bankruptcy law for states. The state of California, like the criminal state of Illinois, also has obligations that it almost certainly cannot afford to discharge. But there is no legal provision for them to do so.
There are a few obvious conclusions to be made: States and municipalities bet big on the real-estate bubble; they succumbed to the rosiest of expectations about their investment earnings; they promised their unions far more than they could actually afford to pay; and they will continue to do so until they have completely depleted their resources. For an approximate model of the method of operation at work here, I recommend this short discussion: “Evolution from a Virus’s Point of View.”
Illinois and New Jersey before it are unusual in that the states were in fact indicted for their crimes, with the SEC charging them with specific instances of securities fraud, for misleading investors about the true state of their finances. But the unindicted governments are largely indistinguishable from criminal organizations, too. People sometimes joke: “If I ran my business like the government does, I’d be in jail.” The thing is, that’s not a joke: Businesses are expected to account for their liabilities. Lying about your liabilities is a crime. You can go to jail for that. Government at every level lies about liabilities, from the halls of power in Washington to third-rate burgs such as Stockton and San Bernardino. But as somebody once said, “When the president does it, that means it isn’t illegal.”
Some investment professionals have suggested to me that bondholders are fools for entrusting their money to the likes of Stockton and San Bernardino. I agree. But the bondholders at least had a choice in the matter. If they’re fools, what does that make taxpayers?
— Kevin D. Williamson is National Review’s roving correspondent. His newest book, The End Is Near and It’s Going to Be Awesome, will be published in May.