Opinion

A muni meltdown?

The municipal-bond market is in crisis, with prices fall ing and investors running for cover — and for good reason.

Munis — bonds sold by states, cities, counties and other localities to finance government operations — are in trouble because the Ponzi scheme of Big Government is coming unglued. The markets are merely reflecting this reality, as they always do.

The $3 trillion muni market was once regarded as the safest of all investments because the bonds are backed by government taxes. Now it’s showing all the earmarks of the 2007-08 meltdown.

That mess began with investors fleeing from bonds tied to the housing market — and ended with the collapse of the financial system. Mortgage-backed bonds were considered super safe because the housing market “always goes up,” and any remaining default risk was covered by “super-sophisticated” securities.

So banks held tons of those securities, earning huge returns on their “risk-free” investments. The feds used Fannie Mae and Freddie Mac to keep the market booming by buying up tons of mortgages, leaving the banks with more cash to initiate more mortgages — ensuring that even the riskiest borrowers could play.

As it turned out, the housing-bond market was a Ponzi scheme not all that different than what Bernie Madoff pulled off for so long. Eventually, the cash couldn’t flow in fast enough to keep inflating the bubble. Once the folks who couldn’t afford their mortgages could no longer flip out of the market, the whole thing burst.

The municipal-bond market’s assumption is that cities and states won’t default on their debt because they need to keep selling bonds to build roads and bridges. Investors will keep buying munis because they think the state will always make good on its obligations (and with the added incentive that these bonds are free of state, local and federal taxes).

But suppose taxes are so high that people leave cities or states in droves, depleting the pool of revenue need to pay bondholders? Suppose these states have so many other obligations — from federal mandates, massive “guaranteed” pensions to government workers and more — that they can’t or won’t make the vast cuts needed to keep paying on their bonds?

Investors are now including that worry in their calculations of risk and price; the places where government has choked off the private economy and tax revenues the most — such as New Jersey, California and New York — are suffering the worst. The states in which the private economy flourishes have little trouble issuing debt even in this turbulent market.

Sure, a huge degree of paranoia is sweeping the muni market. The Securities and Exchange Commission has launched a wide examination of whether states and cities are properly disclosing budget issues to investors in municipal debt.

That review is prudent because even a few defaults would hit average investors hard. Munis, more than other bonds, are overwhelmingly held by individuals, not institutions.

Prominent banking analyst Meredith Whitney (who accurately predicted the banking crisis in late 2007) recently warned that 50 to 100 municipal-bond defaults will happen over the next year, likely amounting to more than $100 billion in defaulted debt.

Analysts I speak to are skeptical. Nothing like that happened even the worse years of the Great Depression, and with the economy improving, it’s hard to see such a doomsday materializing.

But the fear is there — even if it is overblown at the moment. Just last week, after an off-hand remark by Gov. Chris Christie that mounting pension costs would eventually “bankrupt” New Jersey, the state had to cut back a municipal-bond sale because investors were too spooked to bid.

In fact, Christie is a big reason that buyers should have faith in Jersey’s bonds. He’s the rare public official who understands the need to expand the tax base, rather than constrict it through higher taxes, and the need to slash the size of government — all of which would leave more revenues to pay off bond holders.

Still, while the gloom in the muni market may be tough on governments looking to borrow and on the investors and Wall Street firms looking to make money by helping governments stay fat and unmanageable through the sale of more and more debt — it should be celebrated on Main Street.

For decades, many of our biggest cities and such states as New York, New Jersey and California have grown mindlessly — running up ever more debt and routinely hiking taxes on business and entrepreneurs. The market’s now saying that the game will have to end.