D.C. Duo

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CBO on $2 Trillion deficit cut -

"Blowing in the wind"

Senators Kent Conrad (D-NDAK) and Jeff Sessions (R-AL) asked the CBO to “score” (link) the consequences of a $2 T ten-year deficit reduction package. The results of the work by the good folks at the CBO blew my mind. $2T over ten years barely moves the needle.

The CBO report assumes that there is a phased in package that starts with a reduction of the deficit by $100b in 2012 and grows to a cumulative $2t over time. A graph that the CBO used:

CBO produced three sets of results. This looks at their ‘base case’:

Note that the CBO concludes that there will be very minor changes in interest rates as a result. Only 1/8% of a percent (on average) for the ten-year bond. Note also that they think there might be a reduction in short-term rates.

These potential changes in interest rates are actually not measurable. This is pure guess work on the part of the CBO. I found it amusing that they think the first year consequence will be a reduction in 3 month bills by 41 basis points. Given that bills are now comfortably trading around 5 BP this looks a bit silly.

I would agree with the CBO on their projections for GDP. They assume that broad economic activity will actually decline directly as a consequence of the belt tightening. They see the fiscal drag lasting four long years before any payback to the economy is realized.

One thing clearly wrong with the CBO analysis is that they assume that a deficit reduction package will kick in during 2012. That is not the case. Any deficit reduction plan will start in 2013. 2012 will see more big deficits and no cutbacks. (No sense in raining on the parade during an election year)

My take on the CBO report is that we are dealing with very big numbers. We think that a $2T reduction in the deficit is a very important step. That it really should make a difference in our debt profile and the sustainability of our financial system. Actually, $2 Trillion is a drop in the bucket. It doesn’t move the needle.

I wonder what Conrad and Sessions are thinking about looking at the CBO report. They might just conclude:

“It doesn’t matter what we do. We’re screwed either way”

GASB gets religion -

a decade late

The Government Accounting Standards Board (“GASB”) has produced some new rules that, if adopted, would drive a stake into the muni bond market. While this move toward better disclosure is welcome, it comes at a very bad time. Munis sat on the bench for the first half of the year and did not issue debt (50% YoY reduction in the last six months). Now they will have to come forward with new paper, lots of it. I find it amusing that that the GASB is doing their level best to muck up that process.

From the (normally subdued) Bond Buyer: (Sticker shock??)

The exposure draft would require state and local governments to report unfunded pension liabilities on their balance sheets, creating "sticker shock" and potentially raising concerns from politicians, rating agencies, and others (AKA: Investors) about how the liabilities will be funded in the future.

Imagine that! Munis would have to report their unfunded liabilities. That would be a sticker shock to muni bond buyers. They are just trying to get their money back and a lousy 3% interest. That's not much incentive to take risks. Clearly there are risks.

It gets worse. There are proposed “penalties” to those Munis that have unfunded accounts (pretty much all of them). Once a pension account is determined to be underfunded the entire pension plan must be restated using a risk free interest rate. That act alone will kill almost every muni out there.

GASB recommends that pension plans use a historic rate of return — typically 7% to 8% — only to the extent the plan has sufficient assets, set aside in an irrevocable trust, to make projected benefit payments.

BUT:

When a plan reaches a point of no longer having sufficient assets set aside in a trust for long-term investments, it would have to shift to a lower, so-called risk-free rate of return pegged to a tax-exempt, high-quality, 30-year municipal bond index rate, typically 3% to 4%.

Munis across the country have been running pension plans that have had monster "hidden"deficits for years. GASB knows that, so you have to give them an "A" for pushing for more accurate disclosure. But the timing of this could not be worse. Nearly every bond indenture will have the Emperor’s clothes torn off. The nakedness of gigantic unfunded liabilities will be exposed.

Does it matter if it is finally in ink? I think so. (The press will have a field day) There will be a (new) giant red flag that says, “We’re busted!” Who in their right mind would want to buy that paper?

 Debt, Debt and more Debt