CHICAGO – State and local governments will need to muster attention on the federal threat to tax-exemption and should seize upon the sea change of public support to tackle tough issues like retirement benefit cuts afforded by the fiscal struggles of recent years.
Those were the assessments offered by a number of market participants during several discussions that focused on market risk and conditions at Bloomberg’s State and Municipal Finance conference in Chicago this week.
The “threat to tax-exemption is the greatest it’s been since 1986” and comes from both sides of the political aisle, said George Friedlander, senior municipal strategist at Citi, during a discussion on the subject of market regulation and oversight.
The threats are posed in the form of changes being floated to market access for 501(c)(3) organizations and private-activity bonds, debate over replacing tax-exempt bonds with tax-credit borrowing and from President Obama’s proposal in his fiscal 2013 budget to place a 28% cap on the value of tax-exempt interest to reduce the deficit by $584 billion over 10 years.
State and local governments will need to band together to fight the battle, said Friedlander, who worries that their attention may be diverted by other “things they may care as much about.”
“We have a tough fight ahead of us,” perhaps heating up in the first half of next year after the presidential election when attention will be focused on deficit reduction, he said.
In a separate discussion on market risk factors, participants weighed in on the potential for a resurgence of insurance and the role it could play for some borrowers, especially those dealing with wider credit spreads.
Buy-side market participants said demand for the product exists from retail buyers and from smaller investment management companies with limited internal analysts, said Eric Friedland, head of municipal research at Schroders.
Panelists suggested that insurance could help market liquidity, and though it’s not likely to enjoy the 50% market saturation it did in 2007 before the collapse of most monolines during the financial crisis, it could one day hit the teens. Insurance faces a tough road back, however, because of market distrust of the product’s value.
Most remaining insurers are still not wrapping new insurance and Moody’s Investors Service in April issued a report attaching a negative outlook on the industry. Analysts are expected to resolve the outlook in the coming months.
Adam Bergonzi, chief risk officer of National Public Finance Guarantee Corp., said insurance would re-emerge as a “niche” product for low investment-grade credits in the triple-B to single-A categories.
From a risk-conscious investment perspective, Bob Moore, president of Institutional Capital Management Inc., said he pays close attention to political and leadership risk and economic diversification in assessing potential risks. His advised a careful review of a local government’s top 10 taxpayers and sources of employment.
Participants on several panels honed in on the role of politics in assessing risk. Friedland called the political failure of Alabama to successfully intercede in Jefferson County’s financial woes and stave off its Chapter 9 filing a “huge red flag” for investment in other struggling Alabama communities.
“The supervising parent is the state,” James Spiotto, a partner at Chapman and Cutler LLP, said of the need for strong state intervention when needed.
Richard Ciccarone, chief research officer at McDonnell Investment Management LLP, gave credit to states like Michigan with strong intervention policies in distressed communities aimed at staving off bankruptcy.
Former Indianapolis Mayor Stephen Goldsmith, a senior strategic advisor at McKenna Long & Aldridge LLP, reflected on the shifting political landscape, where “the ability of vested interests … to paralyze reform is eroding.”
Reform supporters have been bolstered by Wisconsin Gov. Scott Walker’s victory in a recall election last week that was sparked by his move to curtail collective bargaining rights, and by pension reform mandates approved by San Jose and San Diego voters.