By Frank Keegan — It’s not how many. It’s which. That is the great unknown chilling municipal bond markets. Felonious accounting practices by state and local governments make it impossible for investors to determine the one factor that makes munis attractive: Bonds are supposed to be a sure thing.
A sure thing they are not anymore. They are not because for more than a decade politicians have hidden true costs of government off the books and deferred them to the future.
The future is now. Truth is finding its inexorable way out, and this truth is ugly with no hope of beauty for at least 50 years, according to the Government Accountability Office.
Fifty years is a long time for municipal bond investors.
Bond Dealers of America wrapped up a three-day huddle at the Fountainebleau Hotel in Miami last week figuring out how to “set the record straight” on “Municipal Market Health” after almost three years and increasing billions of outflows from bonds and bond funds.
They issued a statement: “The historical default rate for governmental debt is negligible. The average 10-year cumulative default rate from 1970 to 2009 for investment-grade municipal debt was only 0.09 percent with only 54 defaults on rated credits — and just three general obligation defaults. In the past four years and during the height of the recession, only seven municipal governments filed for bankruptcy, yet all bondholders were paid in full. By comparison, AAA corporate credits were three times more likely to default than BBB municipal credits. Further, municipal debt service is only about 3 percent to 5 percent of state and local budgets.”
True enough, but past performance is no guarantee of future results.
One big problem is state and local budgets represent only a fraction of true government costs because they employ accounting techniques that would be felonies if citizens or businesses used them.
For example, BDA claims: “Pension liabilities will be a challenge, but these are long-term liabilities upon which state and local governments are focused. Stock market declines of recent years have reduced pension assets, on average, to 75 percent of what is required. But that shortfall can be prudently addressed over a number of years. Accordingly, the current budget impacts of pension contributions are manageable.”
Actually, governments lie about how big their actual pension debt is, and then hide the lies off the books. Double deception.
Other calculations put assets, on average, at about 50 percent of what is required, and show some states having to increase taxes and cut programs equivalent to about a third to three-quarters of 2008 operating revenues just to write those guaranteed pension checks. Pensioners get paid before bondholders. That is why bondholders worry.
If unfunded pension obligations were the only hidden debt states and municipalities racked up, they might be able to dance past a fiscal event horizon beyond which there is no return.
But politicians use a wide array of deceptions ranging from borrowing for stock market gambles to deferring essential capital projects and shorting catastrophe funds to hide how deep in the hole they really are.
The Government Accounting Standards Board, the Securities and Exchange Commission and Municipal Securities Rulemaking Board are working on ways to force governments to be honest with investors, taxpayers and employees.
Efforts at openness include a proposed public employee pension transparency act that would deny federal tax exemption for interest on municipal bonds issued by governments that hide pension liabilities.
Until then, nobody can sort the overwhelming majority of solid bond issues from the few that are rotten.
The first, best answer of course is complete openness and fiscal transparency whether GASB, the SEC, MSRB and Congress require it or not.
As Carmen Reinhart and Kenneth Rogoff wrote in This Time is Different: Eight Centuries of Financial Folly, “We view the difficulties one experiences in finding data on government debt as just one facet of the general low level of transparency with which most governments maintain their books.”
They point out ominously, “… a highly leveraged economy can unwittingly be sitting with its back at the edge of a financial cliff for many years before chance and circumstance provoke a crisis of confidence that pushes it off.”
All bond investors want is honest answers from public officials about which state and local governments are how close to the edge of that cliff, and how deep the chasm really is.
Right now nothing forbids governments from being honest. Politicians just choose not to be for their own comfort and personal gain at taxpayer expense.
One thing our leaders can do immediately without any mandate is pass Truth in Accounting laws that consistently reveal to themselves, citizens, bond buyers and public workers the ugly reality of state and local government finances. That would free us all from the fear of uncertainty undermining municipal bond markets.
Yes the truth shall set us free, but nobody ever said truth would be cheap. Only the huge future cost of continued lies makes it a bargain now.
Frank Keegan is a national editor for The Franklin Center for Government and Public Integrity, watchdog.org and statehousenewsonline.com . Any disgusted public employee, journalist, activist organization or citizen watchdog who wants help exposing government waste, fraud and abuse may contact him at: email@example.com