Thursday, December 06, 2007

no reason.....

Today is the anniversary of the largest municipal bankruptcy in the United States when Orange County, California filed for Chapter 9 Bankruptcy in federal court on December 6th, 1994. You can watch more on that thanks to youtube where someone uploaded a lot of the contemporaneous news coverage:

The causes and effects of the Orange County bankruptcy are too much to get into here, you can look up the details if you want. But the bottom line is that like a lot of the big hedge funds that all but collapsed in the past, Orange County had invested in ways that were very sensitive to interest rates. When interest rates moved different from they way they bet they would, their entire investment portfolio had a big cash crunch forcing default.

Because the Orange County case was pretty unusual, it has little direct analogy to anything that could happen here, but it still is an important precedent. In reality, I have said in the past that Orange county entered bankruptcy in better financial strength than say the City of Pittsburgh would if it were to complete and exit a bankruptcy process. Their problem was highly leveraged investments that arguably were inappropriate for a public sector investor. If there is an analogy directly, it is in how interest rates are really the key. The city has scheduled large balloon payments in much of its bonded debt which isn't abnormal. It just means that large chunks of debt will need to be refinanced at some point. Thus far municipal interest rates are not shooting up, but things like higher oil prices, a weakening dollar and inflation in general have the potential to push up interest rates which would then make the refinancing costs of the all such debt a lot more painful at some point in the future.

Which reminds me of a quote from the early years of the Clinton administration. When he was learning how the economy and Federal government really operated, it was probably Robert Rubin who explained to the new president how most everything depended on keeping interst rates low so to keep the costs of the Federal governments debt manageable. Even before he took office the quote from Clinton himself was: "You mean to tell me that the success of the economic program and my re-election hinges on the Federal Reserve and a bunch of %^&^% bond traders?". I have to wonder if that will be the discussion up on the 5th floor someday.


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