Meridith Whitney has made a fuss of late pointing out the (more or less obvious) insolvency of many State and local governments.
She seems to think this is the end of the world.
Maybe there will be a lot of defaults though if something like California defaults it will be by choice rather than by force. (California is plenty rich and has plenty of taxing power if they don't want to give it away in citizens initiated referendums...)
But that is irrelevant to the point I wish to make.
Ultimately I don't care if there is a wave of municipal defaults. I think it will have next to no economic effect. Here is why.
I like to draw a distinction between money lost by unlevered players and money lost by levered players.
Plenty of wealth was destroyed in the dot-com bubble. But it caused no systematic crisis because the wealth was lost by individuals and unlevered players. If you lost money in dot-com you probably spent less (there was a recession) but it did not destroy the system.
However when money is lost by levered players it leads to cascade effects. 50 billion lost by Lehman Brothers (not more than 200 billion anyway) had huge effects because Lehman was a levered entity that had its claws everywhere. It had widespread destabilizing effects - whereas a similar amount lost in dot-com like events has next to no effect (except on the losers).
Well muni-bonds are ultimately held by unlevered individuals usually for their tax advantage. They are not held by people with large mortgages or credit card debt and they are mostly not held by financial institutions.
In other words their default will have economic effects similar to dot-com rather than similar to Lehman.
And in fact they are held by the people with the most excess saving and the lowest marginal propensity to spend incremental income - so their default will have low wealth effects.
It won't matter. Meridith Whitney might be right - or she might be wrong - but unless you hold muni-bonds I can't see why you should care.
I don't think you are going to find a Goldman strategist who will say that muni-bonds are owned by rich people and you can f--k rich people and they won't spend any less and hence muni-default does not matter.
Nah - nobody from The Squid will say that.
So I will. Somebody has to.
Tuesday, July 19, 2011
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