Roubini's Guide To The Muni Crisis That Will Hammer The Economy


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Roubini doesn’t think we’re going to see a massive wave of muni defaults. His consulting firm predicts a relatively mild $100 billion in losses spread over five years.What really worries Dr. Doom is the collapse in state and local spending that will define the coming era.

RGE analysts David Nowakowski and Prajakta Bhide say austerity measures like job cuts will be a “major drag on U.S. economic activity,” reducing GDP by over 1 per cent.

PART ONE: The Cassandras Have Got It Wrong

We're NOT going to see hundreds of billions of defaults over the next year

Without mentioning Meredith Whitney by name, Roubini's report says 'Cassandras' have overblown the risk of a systemic muni crisis.

The report concludes that (1) the muni market can withstand severe downturns surprisingly well; (2) widespread defaults occur only in extreme recessions; and anyway (3) strong legal protection and high recovery values will mitigate investor loss.

Source: Roubini Global Economics

At worst we'll have $100 billion in losses, spread over five years

In other words, the Cassandras and the Pollyanas are wrong:

'Comparing the outlook for defaults in the muni universe with the widely cited Moody's study covering 1970-2009 is Pollyannaish; GDP growth averaged nearly 3.0% and inflation was 4.4% over that time period. Yet comparing budget woes to loss-making corporates is not apt: Governments cannot be liquidated, can raise revenues and cut most spending at will (though finding that willpower can be a challenge), and cannot be forced into bankruptcy.'

Investors should also remember that muni assets have an 80% recovery value, which will minimize loss.

Source: Roubini Global Economics

Muni spending growth was a problem -- but not as out of control as you might expect

The decline in revenues was a problem -- but again not the most significant problem

The elephant in the room is pensions -- total costs and unfunded liabilities are exploding

Unfunded pension liabilities amount to over $7 trillion for state and local governments, the report estimates, citing a study by Robert Novy-Marx and Joshua Rauh.

Roubini says this will be biggest challenge.

Source: Roubini Global Economics

PART TWO: The Real Crisis

Muni governments will massively reduce spending TO AVOID default

Austerity measures to close budget gaps will sap 0.75% from GDP

Austerity measures will include higher taxes and fees, layoffs and investment and spending cuts.

The burden will be greater as Federal funds run out.

Source: Roubini Global Economics

Making good on pension shortfalls will cost another 0.5% of GDP

Or higher if state governments don't take action soon.

Source: Roubini Global Economics

CONCLUSION: A Major Drag On U.S. Economic Activity

'Whether or not we have a new financial crisis worse than the last one, or even a depression, state and local finances will continue to be a major drag on U.S. economic activity. This is not because of defaults; rather, to avoid default and pay for past promises, spending will be constrained, employees will be laid off and taxes will rise. State and local spending is US$1.8 trillion or one-eighth of U.S. GDP; and employs over 19 million individuals, almost 15% of non-farm employment. Some 268,000 government jobs have been lost at the state and local level in the past year, despite federal assistance.'

Source: Roubini Global Economics

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