Wake up call
Most of you will have heard of the ongoing bankruptcy in Detroit, Michigan. While it is no surprise to many, the consequences to all involved are dire. The danger of contagion is very real and all of us would do well to reassess our own hometowns and muni bond holdings. The overall balance sheets of many public entities are in horrific shape and unless we address the issues now, Detroit’s fate will become reality in many parts of the country and for that matter, in the industrialized world. Moody’s downgraded Chicago’s bonds last week stating that “its negative outlook is based on the dramatic spike in annual pension payments scheduled to take effect in the 2015 budget year.” Moody’s said it expects the payments “will place material strain on the city’s operating budget.”…Illinois lawmakers are struggling to solve the state’s own $100 billion unfunded pension crisis, forcing local pension problems to the sidelines. Continued failure to enact pension reform has helped push Illinois’ credit ratings to the lowest level among U.S. states.”
How do you feel about buying Chicago or Illinois bonds at rock bottom interest rates? Real estate?
Take a look at the many similarities of Chicago and Detroit below and judge for yourself if there is a problem(click to enlarge).
Reform needs to happen one way or another. Given that higher taxes are only feasible on higher wages, stagnant wages that we observe are not the solution to the issue at hand. Furthermore, overall wealth is in decline as you can see in the chart below. It is quite stunning to see that America only ranks #27 in the world in median wealth per adult.
From a financial point of view, it is clear why high quality stocks are surging while bonds are lagging. The inherent risk of owning bonds is simply not rewarded due to low-interest rate policy. The remedy to our problems lies in structural reform. No matter what the Federal Reserve might want to achieve, they cannot solve a problem of solvency with liquidity.