In the case of medical contagion no conscious actions need to take place to spread the malady. Alternatively, financial contagion does require some conscious and positive actions on the part of interested parties to spread the contagion.

Many in the municipal market have pondered whether events in Puerto Rico are raising the stakes for contagion elsewhere. Even though it is quite convenient to view events in Puerto Rico through the prism of a one-off, it is true that the Commonwealth and its agencies, authorities, and localities have been and continue to be part of this municipal market that we work in and invest in every day

John Hallacy
John Hallacy Bloomberg News

The recent plebiscite in Puerto Rico has pushed the margin supporting statehood to an all-time high but the vote is being viewed as compromised due to the low turnout. Statehood is not a panacea, but many on the Island believe that the change would lead to a windfall for the Island because programs would have to be on parity with Mainland levels. However, Congress would consider transition rules that would probably include a ramp-up if Congress ever approves admission as a state. The thorny issue of debt has not been addressed at the front end. Would the debt be “repatriated” or would it just be left to the forces prevailing at the time. No one knows for certain but there would be a great deal of speculation and positioning before any clarity emerges.

Whether contagion has been having a very direct effect is challenging to discern. But, I have witnessed more open speculation about the topic than I have in some forty years in the business.

A case in point is a discussion by an esteemed law professor at a prestigious Ivy League law school of whether the bankruptcy code should be modified to permit states to file. This notion is blasphemous to any of the practitioners in the business who acknowledge the importance of the role of the state in public finance on many levels. A weakened or significantly altered legal underpinning for states may have untoward consequences.

Most Mayors who take the fateful step to file for bankruptcy know it portends the end of his or hers career. Does it stand to reason that a Governor would view a theoretical filing in the same light? We really cannot predict the outcome. One material point is that we now have a “King of Bankruptcy” as President. Does that matter? Bankruptcy as an option may have less stigma than before.
Clearly, bankruptcy in a corporate context is viewed more as a tool for ultimately preserving some kind of value. Municipal bankruptcy has always been somewhat different. The governmental entity finds that it just cannot continue to function in terms of providing citizens critical services given the weight of financial obligations extant

As we have come to realize over the last decade or so that the incidence of municipal bankruptcy is real and is on the rise. The gatekeepers of market access such as rating agencies and municipal practitioners need to be asking more than ever the incisive questions about financial integrity of the name in consideration. It is no longer good enough to shrug your shoulders and just say that it is “money good.”

We do not believe that we are facing a wall of worry at this point. However, we all are aware of where the major hot spots are at this moment. What will be more difficult to call is where are the other hot spots that will emerge when this expansion inevitably comes to an abrupt end. That is precisely one of the times when the analysts get to prove their worth. Stockton and Vallejo were a lot less visible than Detroit and Puerto Rico.

It is troublesome that given record employment and low unemployment that we are so focused on the slowing of revenue growth. The pending actions of the federal level have increased the state and local fiscal uncertainties to new levels. Not that federal largesse has ever solved all of the challenges at the state and local level. The federal programs, grants, and aids have made the delivery of projects and services much more timely than they would otherwise be at any given point in time barring regulatory and permitting aspects. New approaches to municipal finance with the inclusion of other kinds of financing mechanisms are welcome but should be examined for any other potential outcomes. Will private sector solutions potentially lead to more bankruptcies? The possibility exists.

It is true that stronger economic growth may eliminate some of these reservations. However, many pundits are questioning whether 3% or 4% growth is even possible in the fully employed gradually increasing wages environment that we are in today.

I do not believe that we are facing a pandemic in regards to contagion in the municipal market today. We just need to be ever diligent about asking the probing questions and securing complete answers so that the market may continue to function in exceptional manner as it has been doing for a long time. Many thought we lost our way in 2008 and we have come back stronger than before. Let’s work towards ongoing resiliency and reliability in the municipal market. None of us benefits when it is just too easy or convenient to walk from important debt obligations.