Friday, October 26, 2012

In January of this year I predicted that Barack Obama would be reelected in a close race with Mitt Romney based on the fact that the US economy would be in some form of OK. I still believe that and we will find out in two weeks. Most people I know have already decided who they will vote for and cannot wait for the election to be over so we can get on with our lives. I have said before that who ever wins will be facing difficult choices and the decisions made will have significant impact on the economy in the next few years.

One of the markets I follow closely is the municipal bond market. There have been a number of municipalities that have filed for Chapter 9 bankruptcy protection in the last year and the resolution of these filings will have a huge impact on municipal finance. So far there has not been a clear pattern emerge concerning the discharge of debt, union contracts, employee benefits and a host of other issues. Once these issues start to be decided, municipal bond holders will be forced to reevaluate their holdings and look more closely at their standing in the court process. There are important differences between Chapter 9 and commercial bankruptcies (Chapter 11 etc.). This link outlines some of the considerations and criteria necessary for a filing for Chapter 9 protection.

Since the 1970's the use of the bankruptcy code by US businesses has been on the rise. If you are a bondholder in a bankruptcy you have seen your investment wiped out with the stroke of a pen. Sometimes in a large bankruptcy like GM 35 billion in debt is replaced with a very small amount of stock in the new company. Jack got a better deal than that for his cow when he swapped it for magic beans. If municipalities can successfully void interest and principal payment the politicians will drive a truck through that loophole rather than correct the long term problems of employee benefits and wasteful spending. Stay tuned.

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