Get Ready for Great Recession, Part 2

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Harrisburg files for bankruptcyThe capital of Pennsylvania just fell into bankruptcy. What? You didn't hear? Neither did the financial markets -- yet.

Crippled by a $300 million-plus debt burden taken on to fund a municipal incinerator, Harrisburg, Pa., filed for bankruptcy protection earlier this week. According to its city council, the only alternative to bankruptcy would have been to sell off the city's few remaining cash-generating assets -- parking garages and parking meters, for example -- to raise funds to pay off its creditors. Worse, once those assets were gone, the city would have been even more strapped for cash, which probably would have necessitated a bankruptcy filing "in three to five years anyway." So rather than procrastinate, Harrisburg bit the bullet -- and bit the big one.

The Shocking Reaction -- Yawn

The day after news of Harrisburg's bankruptcy broke, the Dow Jones Industrial Average (^DJI) barely trembled, while the Nasdaq (^IXIC) actually rose 0.6%.

And what about the one company that you would think would have been slammed by the news, Assured Guaranty (AGO) (whose subsidiary insured part of Harrisburg's debt and will now almost certainly be asked to pay up in the bankruptcy proceedings)? Its stock didn't even budge!

Clearly, most investors don't think the city's bankruptcy is a big deal. But two of the smartest investors in the room disagree.

The Woman Who Saw This Crisis Coming

On Oct. 31, 2007, Oppenheimer analyst Meredith Whitney became instantly famous when she broke the conspiracy of silence on Wall Street and warned investors that Citigroup (C) was on the verge of insolvency.

Derided for her pessimism, Whitney was all too quickly proved right, as America's banking establishment imploded, and the nation descended into the Great Recession.

Late last year, Whitney -- now running her own shop -- gave the gong of doom another sharp rap when she predicted the next big crisis. Appearing on CBS' 60 Minutes in December 2010, she predicted the U.S. would see anywhere from 50 to 100 local and municipal governments default on their bond offerings in 2011, causing "hundreds of billions" of dollars worth of losses for bond investors, and for shareholders in the multiple private companies that have insured the muni bonds.

Happily, this so far hasn't happened. According to Lipper Research Services, only $1.1 billion worth of America's $3.7 trillion in municipal bonds have defaulted this year.

But that doesn't mean we're out the woods yet. At least, not according to one oracle.

Guess What Keeps Warren Buffett Up at Night?

Warren Buffett was asked to opine on future risks to the U.S. economy when he appeared before Congress last summer to give testimony on the role that Moody's (MCO) and McGraw-Hill (MHP) subsidiary Standard & Poor's played in the financial crisis.

Would you care to guess whom Buffett named as Public Enemy No. 1 to the U.S. economy? That's right: The municipal bond market. Here's what the Oracle of Omaha had to say about it:

If you are looking now at something where you could look back later on and say, "These ratings were crazy," [municipal bonds] would be the area. I don't think [Moody's or S&P] or I can come up with anything terribly insightful about the question of the state and municipal finance five or 10 years from now except for the fact there will be a terrible problem and then the question becomes: Will the federal government bail them out?

Burned once by criticism of its TARP bailouts, and more recently by taxpayer outrage over government grants to failed solar panel producer Solyndra, the odds of the federal government bailing out desperate municipalities look doubtful. I suppose it could happen, if the situation turned grim enough. But Buffett has never been one to leave investments to chance.

Weighing the risks, his Berkshire Hathaway (BRK-A) (BRK-B) has been ratcheting back its exposure to municipal bonds. In 2008, Berkshire insured nearly $600 million worth of new municipal bond issuances. By 2009, Berkshire backed just $40 million of new issues.

What's got Buffett feeling so moody about munis? Take your pick. Runaway entitlement spending. Massive unfunded liabilities in public pensions. It all adds up to state, local, and municipal governments that are in hock up to their eyeballs, and ready to follow Harrisburg down the rabbit hole when and if another economic shock hits.

How Big Is the Risk?

Could this happen in time to produce Meredith Whitney's "hundreds of billions" of dollars of losses this year? It's hard to say.

On the one hand, municipal bonds today are paying interest rates about 20% higher than U.S. Treasury bonds. This suggests the market has priced in the risk. On the other hand, with the U.S. economy not exactly out of the woods, but at least no longer in free fall, you don't hear much in the media lately about the risk of muni defaults. (Aside from, you know, stories about the occasional mid-Atlantic state capital filing for bankruptcy.)

But it could be there are other trees out there in the forest, just waiting to fall -- and we just haven't heard about it yet.

Motley Fool contributor Rich Smith does not own shares of any companies named above. The Motley Fool owns shares of Citigroup and Berkshire Hathaway. Motley Fool newsletter services have recommended buying shares of Moody's and Berkshire Hathaway and writing puts in Moody's.


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351 Comments

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thewtt

Any City or state that files for bankruptcy instaead of implementing a temporary 1 cent sales tax, or something like that, is being run by a bunch of idiots! Come on, people will pay the 1 cent if they believe it is to insure fiscal stability and trust their leaders to remove it when it is not necessary. WOW! The people we have running things are amazing in thew worst way.

October 20 2011 at 1:07 PM Report abuse rate up rate down Reply
2 replies to thewtt's comment
warrenbent

Trust their leaders to remove it when not neccessary?

LOL!

October 21 2011 at 8:51 AM Report abuse +2 rate up rate down Reply
1 reply to warrenbent's comment
savemycountry911

I have noticed in our area that taxes are NEVER removed. They are still collecting on a building tax 50 after the building was completed.

October 21 2011 at 3:23 PM Report abuse +2 rate up rate down
joefromphilly

Remove it when necessary? Ha ha ha ha!

October 21 2011 at 9:18 AM Report abuse +5 rate up rate down Reply
rparis8241

this rescission will never get better till housing turns around.

October 20 2011 at 12:54 AM Report abuse +2 rate up rate down Reply
Dave

don't give a carpetbag bit of difference who the president is , can't do jack anyhow , get rid of the good old boys in the house and senate and soon as they realize how it is to keep a job they will start making some for everybody else after all no work no job , that should be the rule for everyboy ...

October 19 2011 at 1:28 PM Report abuse -1 rate up rate down Reply
tevroc143

The article says you don't hear much in the media - really? The problem with the corporate-owned media is that they cannot speak the truth. This is exactly alternative media is growing by leaps and bounds. Real Journalism will continue, but not in the main stream news.

Our economy will not recover without jobs. The middle class who bought most of the goods will not recover without jobs and decent wages. Tax cuts do not create jobs, workloads in need of more employees create jobs. A decade of more trickle-down has proven it is a failed economis policy. Jobs have not been created by the "job creators". Revenue for local, state and federal government will continue to decline as well. This will bring more bankruptsies for public and private sectors. It doesn't take a rocket scientist to know America is in decline.

October 19 2011 at 12:18 PM Report abuse +3 rate up rate down Reply
sfamilyent

If states and local municipalities rely heavily on property taxes for revenue, and property values have fallen significantly because of foreclosures and short sales; then, we'll certainly see some defaults on bond debts.

I guess my only surprise is that we haven't seen a rash of municipal bankruptcy filings to date...

October 19 2011 at 7:42 AM Report abuse +8 rate up rate down Reply
dabrownman

Well, the CLYDE's (crazy, libtard yahoos, demanding entitlements) protesting on wall street came up with another CLYDE Manifesto addition. This time the announcement was made after noon of all times, when they are normally sleeping or exposing themselves. It states - White Supremacist Racists like Herman Cain will not be allowed to use numbers like 9-9-9 to make them look stupid and insane. He must use the New CLYDE Alphabet instead where only g's, double t's and negative -v's are allowed. Also they demand free designer, haute couture prescription sunglasses with free shipping, for those that need them, want them or demand them.

Herman Cain's reply was gtt-vttg-v-v-vgtt.

The Clydes were unimpressed but praised Herman for his nearly instant learning ability and masterful use of the New CLYDE Alphabet but still claims he was an Evil Jew like Whoppie Goldberg before he became a gospel singer in their Messiah's Flash Mob Glee Club. Obama said he supports his treasured Flash Mob in all of their endeavors but warns Americans that you do have to be a totally insane, capital murderer on the Messiah's command to become one and receive everlasting life at the place of his choosing.

He also added; gtt-vttg-v-v-vgtt repeating Herman's claim saying it sounded much better coming from a a real black man even if he was only half black but fully racist.

October 18 2011 at 5:31 PM Report abuse -1 rate up rate down Reply
2 replies to dabrownman's comment
Terry

dabrownman please put down the coloring book and take your finger out of your nose, its time now for group.

October 19 2011 at 9:51 AM Report abuse +3 rate up rate down Reply
1 reply to Terry's comment
savemycountry911

I see the lunatic left loves to high rate the idiots.

October 20 2011 at 8:09 PM Report abuse +2 rate up rate down
savemycountry911

You know you have the truth when the lunatic left low rates you. GOOD FOR YOU BROWNMAN.

October 20 2011 at 4:38 PM Report abuse +2 rate up rate down Reply
mlpnola

A city of around 50 thousand residents takes on 300 million dollars in debt to fund an incinerator. What is the rest of the story?

October 18 2011 at 5:04 PM Report abuse +4 rate up rate down Reply
2 replies to mlpnola's comment
dabrownman

You can't fix stupid CLYDE's high on free; dope, beer and whisky.

October 18 2011 at 5:30 PM Report abuse +2 rate up rate down Reply
joefromphilly

That works out to $6,000 per resident.

October 21 2011 at 9:17 AM Report abuse rate up rate down Reply
dabrownman

Fire a CLYDE before it too late and the coming ICE AGE turns us all into popsicles - or worse.

October 18 2011 at 12:47 PM Report abuse +2 rate up rate down Reply
dabrownman

It is time for employers to unite, fight for what is right and teach the CLYDE's a lesson that they will never forget. We need to have a Fire a CLYDE Day every day - forever. Then they might understand that ingratitude and biting the hand that feed you are all very, very bad things.

October 18 2011 at 12:37 PM Report abuse -1 rate up rate down Reply
1 reply to dabrownman's comment
dabrownman

I forgot they are unemployable and don't have jobs. OK ,then fire their enabling Mommies and Daddies who let them smoke free dope, drink free brews-skies and shots, eat free pizza and expose themselves in the basement .

October 18 2011 at 12:41 PM Report abuse rate up rate down Reply
savemycountry911

More correctly it should be called: Obama's Geat Depession.

October 18 2011 at 12:29 PM Report abuse +3 rate up rate down Reply