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Wednesday, October 12, 2005

Snow Throws Cold Water on Katrina Bond Bailout

In Louisiana and Mississippi there will be default on municipal bonds if federal or state authorities do not step in to help. However, the cities are being told not to expect help from the federal government. The question is whether hurricane damage of this type is a social risk to be borne collectively as with other consequences of the disaster, or an individual risk borne solely by those involved in the transaction. The article claims that if there is default it won't spillover to other cities and will not affect the ability of non-defaulting cities to issue bonds in the future.  Even so, if it is more difficult for cities that default doesn't the potential harm extend beyond the investors holding the municipal bonds that are in default - aren't all the residents of the cities affected?  Or is that just part of the risk of living in a city and approving a bond issue at the ballot box?  I'm not convinced this is a social risk that requires the federal government to intervene with a bailout or a guarantee. Are there good arguments against that position?:

Katrina Bond Bailout No Sure Thing, Snow Reminds Us, by Joe Mysak, Bloomberg: Everyone who thinks the federal government is going to bail out municipalities that can't make their debt service payments because of Hurricane Katrina have another thing coming. The White House opposes guaranteeing state and local debt, Treasury Secretary John Snow told the Senate Finance Committee last week. ... This means the Bush administration opposes a federal guarantee of new bonds, as well as the billions of dollars in bonds sold by Louisiana and Mississippi localities. And this means that, unless the state governments somehow come to the rescue, bondholders can expect defaults in MuniLand. Even if half of the bonds that default are insured, ... This is a big problem .. Investors haven't had this kind of scare since the Great Depression, which means, for most of them, never. They have come to depend on municipal bonds  ... Some of them ... even ... only buy general obligations -- those that ... promise to increase taxes to whatever level is needed to repay debt. That cold comfort may not help the bondholders very much if those tax bases have been destroyed, or if most or all of the taxpayers have moved away. In the days following this disaster, ... Somehow, many of those in the market came to believe that Congress would include bondholders in the federal largess they are throwing at the problem. Now, it seems, the sudden socialization of credit risk in the municipal market is not a foregone conclusion. A lot can still happen ... but the argument being made by the market for a bailout is ... Widespread defaults by Gulf Coast issuers will, 1) make it impossible for issuers in those states to borrow money, and 2) raise borrowing costs for all municipalities. This argument is open to debate...Even if issuers in Louisiana and Mississippi default, there is no evidence that other issuers in those states will have a hard time selling their bonds, let alone issuers in other states. There's another argument to be made against a federal bailout, and it isn't so subtle. Consider the constituency. Almost from the beginning, commentators have said Katrina, or the government's response to it, was all about race and class. You can make the argument that helping municipalities pay debt service bails them out. More people are likely to see it as a bailout of bondholders -- a very small, elite club. ... These weren't the people taking refuge at the Superdome or the Convention Center in New Orleans.

    Posted by on Wednesday, October 12, 2005 at 01:11 AM in Economics, Financial System | Permalink  TrackBack (0)  Comments (4)

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