Saturday, July 22, 2017

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Bailouts and Municipal Bonds

City Journal‘s Steven Malanga writes at RealClearPolitics about the possibility of a municipal bond bailout on the horizon. The canary in the coalmine is the SEC’s cease-and-desist order to New Jersey for misleading investors by omitting key information in their bond offerings between 2001-2007. Specifically, the SEC charges that New Jersey misrepresented the state’s pension liabilities. The state indicated it was taking actions to ensure the solvency of its pension funds when in fact pension deferrals were frequently undertaken.

What’s interesting is that the day after this announcement, New Jersey easily sold an offering of short-term notes to banks. The state didn’t have to pay a premium to attract investors. Why aren’t investors more cautious? And why wasn’t New Jersey fined?

As Malanga noted earlier this week in the Wall Street Journal, for years states have been hiding the true size of their fiscal problems behind a range of fiscal manipulations (for a catalog of those, see my latest paper on Fiscal Evasion). Yet the signal sent by the SEC is that there is no penalty or risk for bad behavior. The question Malanga asks: do politicians and muni bond holders simply expect that in the event a state can’t pay its bondholders a federal bailout will pick up the tab?