Tuesday, April 14, 2015

SUPER WARNING Fed Official: The Detroit and Stockton Bankruptcies are Signs of Widespread Problems in America

By Robert Wenzel

This is likely the most important item you are going to read this year about the current state of finances in the government sector.

The municipal bankruptcies in Detroit and Stockton, California, may foretell more widespread problems in the United States than is implied by current bond ratings, the powerful New York bank president William Dudley said today in a speech in New York City.

"While these particular bankruptcy filings have captured a considerable amount of attention, and rightly so, they may foreshadow more widespread problems than what might be implied by current bond ratings,"  Dudley said at the Chapter 9 and Alternatives for Distressed Municipalities and States Workshop sponsored by the Federal Reserve Bank of New York.

Unfunded pension liabilities are estimated to be as high as several trillion dollars, Dudley said.

"At a certain point, the debt service burden clashes with maintaining a sufficient ongoing provision of services to forestall people from voting with their feet," he said.

"This may occur well before the point that debt service capacity appears to be fully exhausted," Dudley added. "In other words, the prioritization of cash flows to debt service may not be sustainable beyond a certain point."

TRANSLATION: More bankruptcies in various jurisdictions are coming and they may be coming sooner rather than later. A warning like this from such a top official is not done without careful consideration. The Fed will soon start raising interest rates and this is going to put even greater debt service burdens on various jurisdictions. Clearly, Dudley is trying to get out in front of the crisis the Fed sees developing, especially given that interest rates will climb.

He even brought up the financial crisis of New York City as an example of the problem of government borrowing, especially to cover an operating deficit:
One example of this was New York City in the 1960s and early 1970s, where annual operating deficits were repeatedly financed with short-term debt, until the fiscal crisis exploded in 1974-1975. 
What he is saying here is pretty clear: Imagine financial crises all over the country comparably to the the NYC crisis. The New York Daily News, October 30, 1975:

Dudley continued (my bold):
 Indeed, using debt to finance current operating deficits is equivalent to asking future taxpayers to help finance today’s public services. When this occurs, it means that the fiscal surplus offered by the jurisdiction in the future will be diminished by the value of these additional debts.  That is, in the future, the cost of servicing this debt will drive a wedge between the taxes paid by households and businesses, and the current services provided to them.  Of course, within the U.S., households and businesses can react to this wedge by choosing to locate elsewhere.  And because the tax base of any jurisdiction depends on the level of local economic activity, this out-migration can lead to ever-higher tax rates or ever-diminished services for those who still remain—typically those with fewer opportunities or resources to relocate. 
This is not the time to own municipal debt securities, especially long term debt. A combination of rising interest rates and municipal crises could very well cause panic out of the muni-bond market, even in municipalities that are not terribly exposed to default. And debt of exposed municipalities will get crushed. It will be the equivalent of a financial merger between 1975 NYC and current day Greece.

You have been warned, no less than by one of the most powerful bankers in the country, William C. Dudley.

Robert Wenzel is Editor & Publisher at EconomicPolicyJournal.com and at Target Liberty. He is also author of The Fed Flunks: My Speech at the New York Federal Reserve Bank. Follow him on twitter:@wenzeleconomics


  1. But you can bet that some scumbag at Merrill Lynch will be pitching muni's to Grandma tomorrow.

  2. Meredith Whitney was destroyed in the press for being around 60 months early in her prescient warning concerning the inevitable ruin of many bond holders.