With great timing to follow up on Chuck's excellent series, "Dumb Money," the New York Times ran an article today titled: "Cost of Public Projects Is Rising, and Pain Will Be Felt for Years." It's worth reading the entire article, but here are the highlights:
States and cities across the nation are starting to learn what Wall Street already knows: the days of easy money are coming to an end.
Interest rates have been inching up everywhere, sending America’s vast market for municipal bonds, a crucial source of financing for roads, bridges, schools and more, into its steepest decline since the dark days of the financial crisis in 2008.
So, the money for horizontal infrastructure expansion is going to be harder to obtain, and the debt already incurred will be more expensive.
Gov. Pat Quinn of Illinois attributed the extra cost to the state’s failure to shore up its finances, particularly its rickety pension system. Illinois has the lowest credit rating of any state, and as interest rates rise they tend to rise fastest for the weakest borrowers.
It's unfortunate that Gov. Quinn isn't looking at the lifecycle return on investment for the horizontal infrastructure investments that these interest rate changes are going to have the most impact on. This is our great challenge at Strong Towns -- we're spreading the message as fast as we can but we still have a long way to go.
The sell-off in the municipal bond market has followed the general rout in the overall bond market, which was set off when Ben S. Bernanke, the chairman of the Federal Reserve, indicated that the strength of the economic recovery might allow the central bank to pull back on its $85 billion-a-month bond-buying program earlier than anticipated.
The Fed was not buying municipal bonds, but the market reacted anyway. Investors expected interest rates to rise, and because prices move in the opposite direction, the values of the municipal bonds they already held dropped.
Investors apparently started selling, not wanting to be the last one out. That caused a flood of bond sales. For the week ended June 19, $3.368 billion flowed out of mutual funds that hold tax-exempt municipal bonds, according to the Investment Company Institute. The outflow for the previous week was $3.236 billion.
Chuck has talked about "the last one out" phenomenon. When market conditions start shifting, and the carry trade is going to bust, there tends to be a scramble to get out. Those are the kind of conditions that, historically, have had a high risk of a panic and crash. Keep in mind, what we're seeing now is the movement based only on Bernake's comments that the Fed is "might stop buying bonds someday." It's not hard to imagine the news will be worse when the Fed actually makes a change.
Some local governments that had planned to issue bonds this week decided to wait and see whether the market improved. But Illinois was among those that could not afford to wait. It had been conserving money by delaying road maintenance and the building of new schools.
Abdon Pallasch, an assistant state budget director, cited in particular the risk of delaying reconstruction of the city’s commuter rail system in hopes of obtaining better rates on the bonds, which have a total value of $1.3 billion. He said service had been halted on the Red Line, Chicago’s oldest, inconveniencing 80,000 commuters a day.
Now, here's where this all comes home for the Strong Towns audience. In the Easy Money environment, Illinois was still facing a problem of too much debt. For a long time they've been deferring maintenance, and as we all know, transit is often the very bottom of the infrastructure barrel. So now they're running out of capacity to acquire debt, while the Red Line still needs work. The scariest part, this is the impact at the very tip of the iceberg, when the stimulus hasn't actually been pulled back yet, and interest rates have barely started to move. What happens when they eventually return to historical norms?