The origins of the phrase ‘drink the Kool-Aid’ are tragic indeed.
On this day in 1978, the self-styled ‘Reverend’ Jimmy Jones led hundreds of his followers to their deaths at their commune in Guyana. 913 people tragically lost their lives that day after Jones, through sheer force of personality, convinced them of ‘the beauty of dying’ and told them to drink a cyanide-laced cocktail. The few members of the ‘People’s Temple’ who refused to drink the lethal mixture were either forced to do so at gunpoint or were shot and killed as they fled.
The phrase ‘drink the Kool-Aid’ has entered popular culture as a means to signify a firm, yet blind faith or belief in something, often in defiance of the evidence presented. It has become ever more familiar to those of us in the financial industry in recent years as the twin cultures of ‘extend-and-pretend’ and ‘kick-the-can’ have meant that, unless one was prepared to ignore some really nasty realities about the solvency levels of initially a few mortgage originators, then some rather large financial institutions and now some sovereign nations, one would be forced to face up to the fact that everywhere around us there are problems staring us in the face.
The mortgage originators were ultimately ‘saved’ by the banks (Countrywide, WaMu). The banks were then ‘saved’ by the sovereigns (Citi, Morgan Stanley, BoA), the sovereigns were then saved by other sovereigns (Greece and now probably Ireland, then Portugal, then…) and now those sovereigns at the top of the pyramid are watching the foundations get kicked out from underneath them.
The US Municipal bond market has been slowly climbing the proverbial wall of worry for the past year as talk of bankruptcy in cities such as Harrisburg, PA, Detroit, MI and the first to actually attempt to file this past week – Hamtramck, MI; counties such as Jefferson, AL and finally states such as Illinois, Arizona and the Daddy of them all, California, escalates in both frequency and severity.
In fact, as far back as January 2009, John Paul Mitchell estimated that 46 of the 50 Untied States could file for Chapter 9 bankruptcy (link) before the end of 2010. Things have hardly improved in the intervening 21 months and yet we are yet to see the first domino fall. The average change in revenue for the 10 States with the biggest mountains to climb (California, Arizona, Rhode Island, Michigan, Oregon, Nevada, Florida, New Jersey, Illinois and Wisconsin) in 2009 was -11.7% and that decline continued into 2010 until finally, in the second quarter of this year, the Rockerfeller Institute announced that overall state tax revenues increases 2.2% y-o-y.
(As an aside, each of the 50 states has its own business model and are reliant on different income streams although most states rely heavily on property and sales tax to provide the bulk of their revenue as this interactive chart from the NYT [click here] demonstrates)
In the past week, the rate of decline has quickened as several Muni funds have been battered with many of them losing almost a year’s gains in a matter of days. Throw in a Moody’s downgrade of the State of Philadelphia (link) and the City of San Francisco in the last 24 hours and the announcement that, as of Wednesday, the total amount of Municipal bond sales that have been cancelled or postponed this week alone amounts to over $3 billion (or more than 10% of slated issuance) with the likes of Orange County and the Cleveland public hospital system deciding that discretion was the better part of valor, and you have the makings of a Cygnus atratus that pretty much everybody must have seen coming but, after consumption of generous amounts of Kool-Aid, few seem to have taken took notice of – until all of a sudden they did.
The Municipal Bond market in the US is a $2.8trillion behemoth that relies on constant funding and any postponement or cancellation is not going away but will be forced to come back to market – potentially at a time when forced hands lead to unpalatable prices. The Build America Bond program, instituted in 2009 to help state and local governments issue bonds at favourable rates in difficult environments, provided $150 billion in subsidies but it will be up for extension on December 31st. So far this year about a quarter of all bonds issued by municipalities have been Build America Bonds. If the newly-Republican-controlled Congress doesn’t approve an extension for this program then the noose tightens a little further and, in June 2011, as another $150 billion of stimulus from the ‘Jobs’ bill passed last Summer rolls off, the noose may just tighten that little bit too far.
All of which brings us back to the sovereigns at the top of the pyramid.
The US now has a debt-to-GDP ratio of 60% (up from 40% a mere two years ago), the UK’s stands at 70% and everybody’s favourite credit risk, Japan, is currently second only to Zimbabwe with a staggering 181% debt-to-GDP ratio (up from a far more manageable 156% in 2008). But don’t worry.
Here, drink this.