A Quick Thought on Municipal Bankruptcy

By: Michael Ashton | Wed, Jul 24, 2013
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On CNBC today, analyst Meredith Whitney commented that "everybody loses" from the Detroit declaration of bankruptcy.

If that is the case, then why in the world are they seeking bankruptcy? If everybody loses, then it means nobody wins from declaring bankruptcy, and if that's the case then it would be truly idiotic to seek it.

But of course, this is nonsense. There is no wealth being either created or destroyed in a bankruptcy proceeding; it is merely being forcibly reallocated. In this case, the winners are the taxpayers of Detroit. More to the point, it is the future taxpayers of Detroit, who were on the hook for a bunch of liabilities that they were going to have to figure out how to pay someday, but are not now going to have to pay. Those folks win big. And it's a good thing, too, because Detroit needs more of these future taxpayers to move to Detroit.

The losers are many in number. Bondholders will lose a lot. Pensioners will, unfortunately, lose a lot. Many of the public service unions will lose a lot as their contracts are rolled back. But their losses are equal in magnitude to the gains of the future taxpayers.

Another prediction that Whitney made is on firmer ground. She said that this bankruptcy would touch off a wave of other municipal bankruptcies. I think there is a very good chance of that. I am not saying that because I have analyzed the balance sheets of many municipalities in great detail, as Whitney have (although I have seen enough, in trying to persuade some of them to hedge their post-employment medical liabilities, to be concerned). I say it because we have seen such phenomena before in industries which were overburdened. Consider telecommunications in the early 2000s. Once one big telecom company declared bankruptcy, it suddenly had a big cost advantage over its rivals, and could underprice them until its rivals followed the same path. We've also seen this in airlines. It seems to me that it is entirely possible that, if Detroit is able to lower taxes and reinvigorate the economy once it no longer needs to service these overwhelming liabilities, and begins to attract migrants from high-tax neighboring cities and states, then it makes the finances of places like, say, Chicago that much worse as their taxpayers leave.

 


 

Michael Ashton

Author: Michael Ashton

Michael Ashton, CFA
E-Piphany

Michael Ashton

Michael Ashton is Managing Principal at Enduring Investments LLC, a specialty consulting and investment management boutique that offers focused inflation-market expertise. He may be contacted through that site. He is on Twitter at @inflation_guy

Prior to founding Enduring Investments, Mr. Ashton worked as a trader, strategist, and salesman during a 20-year Wall Street career that included tours of duty at Deutsche Bank, Bankers Trust, Barclays Capital, and J.P. Morgan.

Since 2003 he has played an integral role in developing the U.S. inflation derivatives markets and is widely viewed as a premier subject matter expert on inflation products and inflation trading. While at Barclays, he traded the first interbank U.S. CPI swaps. He was primarily responsible for the creation of the CPI Futures contract that the Chicago Mercantile Exchange listed in February 2004 and was the lead market maker for that contract. Mr. Ashton has written extensively about the use of inflation-indexed products for hedging real exposures, including papers and book chapters on "Inflation and Commodities," "The Real-Feel Inflation Rate," "Hedging Post-Retirement Medical Liabilities," and "Liability-Driven Investment For Individuals." He frequently speaks in front of professional and retail audiences, both large and small. He runs the Inflation-Indexed Investing Association.

For many years, Mr. Ashton has written frequent market commentary, sometimes for client distribution and more recently for wider public dissemination. Mr. Ashton received a Bachelor of Arts degree in Economics from Trinity University in 1990 and was awarded his CFA charter in 2001.

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