From Senator Charles Schumer’s (D-NY) 1-16-08 Opening Statement to the Joint Economic Committee:

• [Ominous Subtitle:] “What Should the Federal Government Do to Avoid a Recession?”
• [Economic Fear-mongering:] The discussion of economic stimulus is no longer an academic exercise. In fact, real economic stimulus measures, enacted quickly, could be the last thing between us and a deep or protracted recession.”
• [Endorsement from Non-Endorsement:]On Monday I called Chairman Bernanke personally to get his thoughts on the economy. And he said that fiscal stimulus is certainly needed and he would be generally supportive of the Congress and the President enacting such a stimulus. He said that while he wasn’t going to endorse a specific plan, if an economic stimulus package was properly designed and enacted so that it enters the economy quickly, it could have a very positive effect on the economy.
• [Obligatory In-Hindsight Partisan Jab:] Because of presidential inaction to mitigate the effect of the subprime mortgage meltdown, the economy is now on the edge of recession.
• [Government > Free Markets:] An effective stimulus package, which includes both expenditures and tax cuts in combination with monetary policy, is the best way to avert a recession.
• [The Most Opaque Way to Say Deficit Spending:] On the question of pay-go – […] paying for stimulus now would take away from the economic boost we are seeking to create. The stimulus, by definition, must have a net of spending over income.
• [”Non-Partisan” Now Equals “Authoritatively Correct”:] Fortunately, because of the important work of economists across the ideological spectrum and most recently yesterday by the non-partisan Congressional Budget Office, we know what works and what doesn’t when it comes to economic stimulus.
• [I Simply Don’t Believe This Is True:] We know that extending unemployment insurance is one of the most effective stimulus proposals because we’ve deployed it successfully in the past and it gets a lot of “bang for the buck.”
• [Drawing the Line in the Sand:] Renewing the Bush tax cuts, which don’t expire until the end of 2010, should be off the table, because they will thwart any chance of passing a stimulus package.

And a somewhat more rationed take (though the first quote sounds like a joke) from the JEC testimony of Bill Beach, director of the conservative Heritage Founadation’s Center for Data Analysis:

• [If That’s What Congress Does “Best”… :] Congress should take this moment of slow growth to do what it does best: set broad economic policy.
• [I Thought Everyone Agreed About a Congressional Stimulus:] I am convinced the Congress is not the best policy making body for addressing the short run challenges of the economy. That role is better played by the Federal Reserve System.
• [Stepping Across Schumer’s Line in the Sand:] The decision makers in business and investment are watching Washington closely to discern the direction Congress will take in responding to this crisis. If that direction includes tax increases, then investors will find more favorable economies to support and business owners will, as much as they can, locate their expanded activities in places with more favorable tax regimes. […] For my part, I urge the Congress to make permanent the key provisions of the 2001 and 2003 tax law changes.

I’m guessing this will all work out to a compromised stimulus package that both extends Bush tax cuts and provides temporary subsidies for unemployment-extension/home-heating/food-stamps/state-aid. That would be a firm step in the opposite directions of both smaller and bigger government.  Perfect.  Good thing everyone likes to buy American Debt and US Dollars…

All this reminds me of the old adage about taxes: “Defer, Deny, Delay.” (ordering?)  The same goes for recessions, too.

The Wall Street Journal published “Insurer Woes Put Munis in Bargin Bin” today, echoing almost exactly what I said on 12-2 and 12-8 (and continuing the Journal’s own coverage on 12-8).  The article starts:

Bad news about bond insurers in recent days sent mutual-fund managers racing into the market - scooping up insured municipal bonds at a steal.

Just as predicted, more bond insurers are getting caught in the ’subprime’ mess and the prices of the munis they backed are dropping.   However, since munis rarely default, the lack of background insurance is battering their prices more than is likely justified.

I was excited - but ultimately disappointed - with the last section of the article entitled “Insurance Even Needed?” The WSJ could’ve made the case much more strongly that the insurance is redundant/unnecessary … but of course this is an article, not an editorial.

I’m still not jumping into the market until I feel bottom … and we’re not there yet.  None of the returns -at least for Massachusetts municipal bonds - look very appealing right now.  Of course some states are better;  maybe I should move to Maine or Wyoming or some other less affluent place without a well-off middle-upper class chasing tax-exempt interest on the same local bonds?  [That’s for another post…]

and fwiw: that my investment acumen was this accurate probably scares me more than it does you.

There’s a short WSJ article entitled Credit Crunch Provides Opening In Muni Bonds about yields rising (prices dropping) on muni bonds.  What are the reasons for the price shift?

The first is that investors have been selling anything not issued directly by the federal government — irrespective of the issuer’s credit-worthiness. That has included an aversion to debt issued by state and local governments.

Second, the municipal-bond market has been rattled by concerns about the financial health of companies that insure bond issuers against defaulting on their interest payments.

These insurers also guaranteed bonds backed by low-quality mortgages and are under pressure to back up those guarantees or face ratings downgrades.

That last paragraph about the private bond insurers not being strong enough to repay on default echoes David Einhorn’s take on municipal bond (under)ratings and bond insurance:

The misrating of municipal bonds directly benefits the friends of the ratings agencies on Wall Street, the banks who underwrite the deals.  A lower rating - means bigger underwriting fees.  Or alternatively, the excess cost can be shared with another great friend - I mean very large customer - of the rating agencies - the municipal bond insurers who effectively rebate some of the “overcharge” to the municipalities in exchange for a share of the savings through a scheme called “bond insurance.”  The municipalities purchase bond insurance to enhance their credits to AAA level.  Of course, since they are in fact, AAA to begin with, the insurance provides no true benefit.

I assure you that a quick peak at the balance sheets of any of these so-called AAA rated bond insurers will tell you that they are not likely to be there to pay more than a fraction of the claims they have insured in an environment where there are wide-scale defaults in the municipal bond sector.

So, what to do? Do you invest in munis even though you realize that the bond insurance is junk …. because you also know that the bond insurance wasn’t originally needed anyway … since the munis were underrated by the agencies? 

The big question is will they actually default?  The Journal reiterates the view of Einhorn, noting “that just 0.1% [of investment grade muni bonds] failed to make good on interest payments — a far lower rate than on corporate bonds.”  From my joe-citizen perspective, I’d also agree that default seems unlikely.  Municipalities probably won’t become fiscally sustainable anytime soon  … but, like most Americans, municipalities should be resourceful enough to find money to pay off their ever-mounting interest (at least for awhile).  Municipalities can raise taxes, sell off the local park, sell rights to run government services as legalized monopolies, or just ask the state/federal government for a bailout.  And that last option just means printing money, so I’d expect inflation before any of these municipalities really default.

But still, playing the markets is all about the timing your investments: if when the bond insurers get more bad press from their financial instability, muni bond prices could will drop even further and be an even better deal.  So all you have to do is time the market. Easy.