CA Tax Free Municipal Bonds

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ChrisVarick's picture
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How safe are CA tax free municipal bonds/bond funds? What happens if our state does go bankrupt? I'm looking into putting some non-qualified money into muni bond funds. If interest rates do shoot up, will they drastically affect the bond prices inside funds? What are you advisors doing for your clients in non-qualified money right now?

shantom1's picture
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Joined: 2009-10-28

States cannot go bankrupt (municipalities can)...
 
Stick with CA state GO's and diversify with a national portfolio....

today1's picture
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chris sound like you are trying to get free advice.  maybe you should go hire a financial advisor.

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No, he's definitely in the business.  Does mostly insurance I think, so he's probably prudently trying to learn the product before peddling it.  Very commendable.  

buyandhold's picture
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States can go broke. Several states have gone down to the wire recently to keep from spending more than they take in, and only stimulus money saved several of them. Just a few weeks ago, California asked for federal money.I could see California defaulting on some of its debt. I realize their constitution says debt payments are second in line, but if the citizens of the state are asked to cut education or raise property taxes I could see them voting to change that.Also, we saw last year that high yield debt can be very volatile, so make sure your clients would be comfortable seeing their bond fall 25 percent in a political or economic crisis.

shantom1's picture
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Wrong, a state cannot declare chapter 9.  Period.  It has nothing to do with a vote, there is no provision in the federal bk code to allow for a state to file.  The code was specifically written to prevent states from filing.  At the end of the day they are required by law to pay their teachers then interest on debt.  Period.   

buyandhold's picture
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shantom1 wrote:Wrong, a state cannot declare chapter 9.  Period.  It has nothing to do with a vote, there is no provision in the federal bk code to allow for a state to file.  The code was specifically written to prevent states from filing.  At the end of the day they are required by law to pay their teachers then interest on debt.  Period.    Well, and California had law that said gay marriage was legal .... then it wasn't .... then they had a Constitutional amendment .... then it was overturned by a judge ....Point being you can't trust their constitution or their lawmakers. If any state runs out of money to pay pensions or entitlements or even basic services they might consider defaults.

shantom1's picture
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You are missing the point. At the FEDERAL level a state CANNOT go BK. PERIOD. It has nothing to do with voters. We are not talking about gay marriage here, if you are going to give advice, please make sure it is accurate....

LockEDJ's picture
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shantom1 wrote:..., if you are going to give advice, please make sure it is accurate....
thank you.

buyandhold's picture
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LockEDJ's picture
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Holy toledo.
OK ... keep reading political writers from The Atlantic and using that as the basis for informing your clients. Very impressive.

shantom1's picture
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buyandhold wrote:http://meganmcardle.theatlantic.com/archives/2009/05/is_california_too_big_to_fail.phpDifferences of opinion make markets.

Seriously?  Your rebuttal to the fact that we are talking about an unchangeable FEDERAL law is that article?  Seriously? 

ChrisVarick's picture
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Joined: 2008-09-04

I am definitely not a consumer. Just an insurance guy trying to learn more about investments to do the right thing by my clients. Thanks for the responses.

buyandhold's picture
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Joined: 2008-09-23

You guys are seriously missing the point. If California runs out of money (i.e. more obligations than revenues, which is what's happening), you don't think that's going to stress the ability of the state or municipalities to pay the bondholders?You're going to tell your clients that California voters can't change their constitution? You're going to tell them that there is 'unchangable Federal law' that will protect them?Maybe I'm wrong, but you've got to imagine the possibilities and not deal in absolutes.Btw, Meghan McArdle of the Atlantic is a conservative economist.

Anonymous's picture
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B&H,
 
If CA can't pay their bondholders, they are OBLIGATED to raise taxes to pay them off.  The Federal law people are referencing is federal bankruptcy law, not some state law that CA has to protect bondholders. 
 
Suppose CA wanted to file for bankruptcy and screw their GO bondholders.  They would have to head to FEDERAL bankruptcy court; at which point, the court would say "it's no legally possible for you to do this - raise taxes, and pay your debts." 
 
Of course, CA wouldn't go to Federal court to try and do this, because they already khnow it's not possible. 
 
Now, what COULD happen, is that they fall short money-wise, and CAN'T make the coupon payments.  If that's the case, bondholders may have to wait for their coupons, but the GO holders WILL get their money. 

buyandhold's picture
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iceco1d wrote:B&H,
 
If CA can't pay their bondholders, they are OBLIGATED to raise taxes to pay them off.  The Federal law people are referencing is federal bankruptcy law, not some state law that CA has to protect bondholders. 
 
Suppose CA wanted to file for bankruptcy and screw their GO bondholders.  They would have to head to FEDERAL bankruptcy court; at which point, the court would say "it's no legally possible for you to do this - raise taxes, and pay your debts." 
 
Of course, CA wouldn't go to Federal court to try and do this, because they already khnow it's not possible. 
 
Now, what COULD happen, is that they fall short money-wise, and CAN'T make the coupon payments.  If that's the case, bondholders may have to wait for their coupons, but the GO holders WILL get their money.  Ice, I hear what you're saying, but let's run with your scenario in which a court tells the California it has to raise taxes or balance its budget (maybe by closing schools or prisons or some other unpopular action) but it MUST pay the bondholders, there would be a freakin' revolution. I can just picture the story: California closes kindergartens so it can pay off Wall Street.One lesson I've learned in the past two years is that when an institution runs out of money, all guarantees are irrelevant.

LockEDJ's picture
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"Megan holds a bachelor's degree in English literature from the University of Pennsylvania, and an MBA from the University of Chicago."
 
How, precisely, does that make her an economist? "A summer as an associate at an investment bank  an internship"? Is that it?? She started a blog, the blog got her onto the staff of The Economist magazine.
 
She's a writer, an acerbic one that gets people riled up. Good for her. She's not an economist, not by training, not by education. Simply writing what you think doesn't make you an economist.

shantom1's picture
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buyandhold wrote: You guys are seriously missing the point. If California runs out of money (i.e. more obligations than revenues, which is what's happening), you don't think that's going to stress the ability of the state or municipalities to pay the bondholders?You're going to tell your clients that California voters can't change their constitution? You're going to tell them that there is 'unchangable Federal law' that will protect them?Maybe I'm wrong, but you've got to imagine the possibilities and not deal in absolutes.Btw, Meghan McArdle of the Atlantic is a conservative economist.

Ok, I don't know why I am bothering, but here we go.

The Articles of Confederation (a pretty important document) defines the sovereign nature of each state:
"Each state retains its sovereignty, freedom, and independence, and every power, jurisdiction, and right, which is not by this Confederation expressly delegated to the United States". When the Articles were supplanted by the US Constitution, this provision was abbreviated to what we know of as the tenth amendment, a component of our bill of rights, "The powers not delegated to the United States by the Constitution, nor prohibited by it to the States, are reserved to the States respectively, or to the people."

Translated: The states are themselves sovereign entities who control ALL LAWS THAT ARE NOT SUPPLANTED BY A COMMON FEDERAL LAW.

Ok, here is where we start to put two and two together.

Before we had Chapter 9, a creditor only had one option when faced with a municipality unable to pay its debts: Mandamas. Mandamas, a word so unspoken of today that it is not even recognized by our spell checkers, was the action of forcing a municipality to raise taxes. Well, after municipalities could not raise taxes during the great depression, congress enacted the bankruptcy act in '34 but it was declared unconstitutional. So congress enacted Chapter IX (formerly Chapter X of the Bankruptcy Act) in '37; it stands largely in its existing form today.

Here is the written Chapter 9:
Only a "municipality" may file for relief under chapter 9. 11 U.S.C. § 109(c). The term "municipality" is defined in the Bankruptcy Code as a "political subdivision or public agency or instrumentality of a State." 11 U.S.C. § 101(40). The definition is broad enough to include cities, counties, townships, school districts, and public improvement districts. It also includes revenue-producing bodies that provide services which are paid for by users rather than by general taxes, such as bridge authorities, highway authorities, and gas authorities.

Section 109(c) of the Bankruptcy Codes sets forth four additional eligibility requirements for chapter 9:

1. the municipality must be specifically authorized to be a debtor by State law or by a governmental officer or organization empowered by State law to authorize the municipality to be a debtor;
2. the municipality must be insolvent, as defined in 11 U.S.C. § 101(32)(C);
3. the municipality must desire to effect a plan to adjust its debts; and
4. the municipality must either:
obtain the agreement of creditors holding at least a majority in amount of the claims of each class that the debtor intends to impair under a plan in a case under chapter 9;
negotiate in good faith with creditors and fail to obtain the agreement of creditors holding at least a majority in amount of the claims of each class that the debtor intends to impair under a plan;
be unable to negotiate with creditors because such negotiation is impracticable; or
reasonably believe that a creditor may attempt to obtain a preference

So you are now tired of the strangely worded writing, I get it. I will now connect the dots.

We know states are sovereign entities responsible for all laws except those that are expressly given to the federal government. Chapter 9 bankruptcy laws are federal laws and therefor cannot be amended or changed by the states. Chapter 9 laws relate to the restructuring of debt of a municipality of a state, it does not allow provision for the state itself to declare bankruptcy.

We will now go one step further. Since a state is a sovereign entity of the US, and it cannot declare bankruptcy, one would think case closed- but no, I have uncovered one possibility through my research.

A state in theory could attempt to rescind its statehood status returning to a 'territory'. As a territory a state could theoretically eliminate it's rights as a state, give up all seats in the senate and congress, forgo all federal benefits, and become the rest of the country's bitch. The actions are so inconceivable, that when California's director of finance, Mike Genest, actually went to Washington last year to attempt to research the possibility of Cali filing, he came home saying it is not a legally possible alternative.

At the end of the day California, and far more importantly Illinois, will be forced to make drastic cuts and raise taxes. It is the only choice afforded to them. Period.

I know of this because I research everything that is told to me to assure that my clients get the most accurate information possible. I do not take anyones word for any given fact.

So next time you feel the need to quote a sensational article from some journal as the reason the CONSTITUTION OF THE UNITED STATES OF AMERICA is just a worthless piece of paper you should turn in your license and find a job more fitting for your abilities.

Anonymous's picture
Anonymous

buyandhold wrote:
iceco1d wrote:B&H,
 
If CA can't pay their bondholders, they are OBLIGATED to raise taxes to pay them off.  The Federal law people are referencing is federal bankruptcy law, not some state law that CA has to protect bondholders. 
 
Suppose CA wanted to file for bankruptcy and screw their GO bondholders.  They would have to head to FEDERAL bankruptcy court; at which point, the court would say "it's no legally possible for you to do this - raise taxes, and pay your debts." 
 
Of course, CA wouldn't go to Federal court to try and do this, because they already khnow it's not possible. 
 
Now, what COULD happen, is that they fall short money-wise, and CAN'T make the coupon payments.  If that's the case, bondholders may have to wait for their coupons, but the GO holders WILL get their money.  Ice, I hear what you're saying, but let's run with your scenario in which a court tells the California it has to raise taxes or balance its budget (maybe by closing schools or prisons or some other unpopular action) but it MUST pay the bondholders, there would be a freakin' revolution. I can just picture the story: California closes kindergartens so it can pay off Wall Street.One lesson I've learned in the past two years is that when an institution runs out of money, all guarantees are irrelevant. As for the statement in bold - the outrage would actually be quite the opposite.  If I had to venture a guess, the biggest buyers of California municipal bonds, would be the residents of California.  I'm sure individuals from other states hold a great deal of Cali munis also.  So in fact, it wouldn't be "paying off Wall St.," it would actually be "paying off Main St."

today1's picture
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Joined: 2008-05-07

true and sad fact california currently spends more money on prisons than higher education. 
i see two solutions to solving the budget issues.  solution 1- legalize weed, fire 1/3 of the lazy state employees, and let people out of jail. or solution 2 get a bailout from the fed or the fed completely backs all CA paper so they can raise more capital to cover budget shortfalls.  both these scenerios i think would play out BEFORE CA defaults.  the ripples would be devastating if CA defaulted.   there are many states in the same situation as CA, i cant remember the exact number but i think it was at least a dozen.

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