Debts Hit the Max; Denninger

 

Subject: Debts Hit the Max; Denninger

 

{AND THIS, while America`s and Europe`s Production and wage structures are continually cut down or shipped elsewhere. The SKY FALLING? It will seem so for many. You certainly don`t want to live where your high taxes can be raised even more.}

 

 

 

Told Ya So (Municipal Borrowing)   https://market-ticker.org/akcs-www?post=230766

I've had people in the so-called financial industry, and their captive media, scoff at me when I explain exactly how the so-called "economic growth" we've posted up over the last 30 or so years has been a scam -- and more-importantly, why it cannot continue.

To recap the reason for all of this (and the ramp in the markets over the same 30 year period) is this:

Rates are at 10%.  You can borrow $1 million as long as you can come up with $100,000 in interest every year.  Note that the expectation is that you would pay off said bond when it matures, so if you're going to do that in five years (a 5-year bond, not an amortized loan) you'd need to come up with $1,500,000 -- $1 million in principal for the bond 5 years hence and and $500,000 for the five years of interest payments (the latter typically being paid out quarterly.)

But if rates are generally declining on a secular (long-term) basis you can cheat, and this cheating is both very seductive in the short term and extraordinarilydestructive over the longer term.

In the short term if the rate of interest declines on a secular basis in five years it looks awfully attractive to roll over that bond instead of pay it off, as the interest rate has gone down.  Much more-dangerously, however, it also looks attractive to keep the interest payment the same and borrow however much more you can by writing an even bigger bond!

So let's assume that in five years the rate of interest is 5% instead of 10%.  You have had $500,000 over that five years in sunk interest cost.  But now you roll over the debt instead of paying it off, and since you do so at 5% you borrow another million dollars by writing a second bond, both of them five years in duration.

Note what happened here -- your original expectation was that you'd have to lay out $1 million to retire the bond.  Instead you kept it and added another million to it.  This is a net $2 million you can spend that you otherwise would not be able to; an utterly enormous "windfall" that appears to literally come from the sky.

So long as this trend continues so does the scheme.  When the $2 million is due if rates have fallen to 2.5% you can now borrow not 2 million but $4 million, and so you do.  The swing in your municipal budget is not $2 million (since you otherwise would have had to lay out the $2 million, but rather $4 million dollars, and all you have to do is keep coming up with that $100,000 a year to keep the scheme going.

That is exactly what has happened in the municipal finance game, in the Federal Government finance game and in the corporate and personal finance game.  It has continued through all of the last 30 years including the 2008 crash!

What happens, however, when rates stop going down?  You suddenly have a problem.  If they don't rise but simply flat-line then while you may be able to roll over that bond you can't borrow more.  So if you had $4 million out you still do and the net "gain" that was magically appearing in your municipal budget stops showing up.

This is what has happened here:

One reason for the lack of borrowing: officials at local governments that were stung by budget shortfalls after the recession have been leery of taking on new debt. Instead, they’ve been seizing on low interest rates to refinance higher-cost bonds. About two-thirds of the $312.5 billion issued through Sept. 30 has been for that purpose, Bank of America Merrill Lynch data show.

Got it?  The state, county and local governments have been refinancing --but they cannot keep borrowing more, they instead must keep refinancing in order to keep the interest payments manageable.  Note that nowhere is ever mentioned paying off the principal on any of these bonds because that almost-literally never happens.

We have backed ourselves into a corner with ponzi finance and scam in the government sector across the board.  This problem is not limited to the Federal Government; it also exists at the state and local level and in fact in many ways its far worse there than on the federal side, since the exposures there are often not subject to simple legislative action.  Many of the baked-in-the-cake expenditures have managed to grab state constitutional protection which, absent an amendment to same, is virtually impossible to slough off.

This is going to blow up in our faces folks, and I've been warning about it for a long time.  It is an irrefutable mathematical fact that these leverage levels are unsustainable -- and there is nothing that can be done about it now other than living with the relative privation that will and must come in this regard.  The people responsible, including especially the folks at the big banks and other financial outfits that did the book-running for these deals, should be prosecuted for running a ponzi scheme and tossed in prison with the assets of their firms sold off and used to plug the holes to the extent possible, but you know that won't happen any time soon either.

There is no such thing as a free lunch and if you believe you've found one what actually just happened is that you got scammed.