This is not an op-ed about the state of Illinois’ credit.
As a progressive, I am holding out for the election of a Democratic president who will usher Medicare-for-All. I think the U.S. economy will take on a new golden age as the federal government increases infrastructure spending by trillions, with the consequent impact being vastly improved state and local credit quality. Wages will increase. Debt will recede with inflation.
This is an op-ed about something fishy brewing in the municipal industry that is not discussed openly and frequently enough.
Market manipulation.
As a long-time follower of the rather sleepy municipal market, the past five years have seen a torrent of interest and publicity like I have never seen before. The reason? Puerto Rico.
Was the financial press concerned about the past administrations’ financial shenanigans, maybe. Did analysts from Nuveen and Blackrock contemplated the destruction of lives and livelihood in America’s “51st” state, perhaps?
In conference after conference, webcast after webcast, one came away with the unspoken conclusion on why Puerto Rico was so relevant and interesting: the Commonwealth’s restructuring was going to be (and became) the single biggest cash generation machine the municipal industry has ever known.
From lawyers who have racketed tens of millions of fees, to trustees who were no longer bound by fee caps. And the biggest sharks of all – hedge funds who purchased Puerto Rico bonds at 10 cents, waited three years and got out at 60 cents. Any surprise municipal high yield funds increased their AUMs by 600% over the past five years?
When the roulette is easy enough to win and generates so much return, it’s worth spinning the wheel.
Last month, a hedge fund filed a lawsuit claiming that $16 billion of Illinois General Obligation bonds were issued illegally. The petition was highly aggressive, seeking a full injunction from paying principal and interest on the contested bonds. Illinois bond spreads widened 30 basis points immediately. In Muniland, 30 basis points translates to a juicy 10% return differential, adjusted for leverage.
Yesterday, Fitch Ratings upgraded its outlook on Illinois. The rating agency cited the states’ on-time passage of its FY2020 budget as well as a $1.5 billion tax windfall due to changes in federal tax law.
Count on more good news in the coming months. Like a faulty faucet, there will likely be more upgrades–from rating agencies and sell-side houses–and there will be a “return to grace” as Illinois is declared a miracle state and bondholders are made whole again.
Not quite. Not the retail bondholders that panicked and sold after the lawsuit was filed. Not issuers saddled with a higher borrowing cost because risk was artificially inflated. Not taxpayers who pay the ultimate price.
As every woman who knows her kitchen knows, the easiest way to clear the stench of fish is to turn up the fans, open all windows and give it some time.
The only way to counter market manipulation that is not quite illegal, but wholly unethical – is to open the windows that allow the sun to shine in. The Bloombergs and the Wall Street Journals of the world need to continue to shine a light at this important “cottage industry” that is the U.S. municipal bond market.
Contact Lisa Lopez at LLopez@buymuni.com.
