Senate Majority Leader McConnell yesterday was reported by Bloomberg News as saying that he "would certainly be in favor of allowing states to use the bankruptcy route” rather than giving them a Federal bailout. This reminded us of 2010 when Meredith Whitney, a noted bank analyst, predicted that there would be hundreds of billions of dollars of municipal defaults in 2011. She caused lots of market damage and outflows from municipal bond funds before sanity resumed and yields moved lower than they had been before she made her remarks. The Senator is trying to take a page from her playbook.
Cumberland wonders what the majority leader had in mind, in that his statement is at best disingenuous and at worst inflammatory at a time when both houses of Congress, the administration, and the Federal Reserve are all engaged in the business of helping all parts of the economy get through the economic downturn caused by Covid-19.
We did not notice any market reaction on Wednesday April 22, in the wake of McConnell’s statement, apart from a drop in price that was consistent with the drop in US Treasuries. This doesn’t mean that he cannot cause damage with ill-considered remarks.
There are also two legal problems with McConnell’s position. First, it is not possible for states to declare bankruptcy under current law. This means that laws would have to be changed. That is unlikely given the current makeup of Congress, especially when they are concentrated on getting the economy over the hump of the virus.
Secondly, to meet conditions of insolvency, states would have to prove they have exhausted all other means to satisfy debts. Those would include reducing their workforce, selling state-owned property, etc. In other words, the states could not prove they were insolvent.
Given the fact that the Treasury has committed to helping the municipal bond market by a purchase program and that the Federal Reserve has committed to buying notes out to two years issued by states, counties, and cities, the Senator’s remarks seem particularly counterproductive, given the need to restore economic stability to individuals, private businesses, and state and local governments.
If the muni market had any substantial sell-off based on these irresponsible remarks, it would be yet another opportunity to buy longer paper at extremely attractive yields. We will keep our readers informed of developments.
John R. Mousseau, CFA
President, Chief Executive Officer & Director of Fixed Income
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