Issue 83 - August 21, 2012


Summer Time Slows but the Lawyers are Busy

It sure feels like August – typically the quietest time of the year when markets around the world mark time. Volumes and ranges are low and tight. Daily economic data remains solidly mediocre and reported corporate earnings were once again broadly undistinguished. But these trends are nothing new. They have been with us for some time, periodically improving only to fade back again, with the further passage of time frustrating investors and pundits alike. However, despite the treadmill like feel of things, global market indices have found a path forward. We might call it the “Voltaire” market, where waiting for the perfect has been the enemy of accepting the good. Economic performance which is not quite a recession and is yet far from full potential is leading to respectable gains in broad global indices. Two steps forward and one and three quarters back is still progress. This is the world we are in and it makes things very tough for those who will not focus beyond the immediate short term.

Whatever it Takes

The short term is currently dominated by central bankers and politicians around the world. As Jim Bianco noted in his August 9th conference call regarding the comments by Mario Draghi, the president of the ECB:

“And I know that there are some strategists that are saying that the market has got this obsession with macro and well, it should because that is what is driving it. We could waste our time on earnings calls in figuring out what all these companies are doing, come to the conclusion that it is not good, and then (Mario) Draghi says three words – “whatever it takes”- and the market is up.”

Here in the US, the debate as to whether there will be further accommodation, known as “Quantitative Easing”, provided by the Federal Reserve has reached a stalemate at least until Mr. Bernanke makes his report at the annual Jackson Hole summit in late August. Arguments for and against further open market purchases have been strongly made by Boston Federal Reserve Bank head Eric Rosengren (for) and Dallas Bank head Richard Fisher (against). With consensus in short supply, Bernanke will be challenged to make a strong case in either direction.

These macro interventions, potential or otherwise, create short term distortions which are the Achilles heal of short term players. A one off headline can be devastating to a wrong footed hedge fund and as such many funds have chosen the safety of the sidelines and have missed much of the overall rally. On the other hand, the investing advantage clearly goes to those with a longer term horizon. This is nothing profound, but it certainly feels especially true at this juncture. The best parts of the current economy are those trends which pay longer term dividends. Qualities such as balance sheet strength and historically low long term borrowing costs bear fruit over many years and are not the stuff of “sexy” quarterly reports. Our last newsletter discussion of the rapidly emerging natural gas advantage here in the US is another example of a long term thesis. Even the municipal market has benefited from modest improvements in local finances and a more honest accounting of future liabilities. The battle around “honest accounting of future liabilities” now has the potential to bring us through what has been one of the most contentious bottlenecks in all of municipal finance: the problem of unfunded public pension liabilities.

Heavy Weight Fight

We have historically purchased only those municipal bonds which also carried credit enhancement provided by either a state guarantee fund such as the Permanent Fund of Texas or a well know insurer such as Assured Guarantee or MBIA. Our thinking was two fold. One, credit enhancement on high quality essential service issuers was a bit of belt and suspenders which was not properly priced into the market and secondly, the insurers would ably represent investors’ interests in the unlikely event of any bankruptcy as they would be on the hook for the timely payments of interest and principal.

In June, the city of Stockton, California filed for bankruptcy under chapter 9 of the Federal code. The city cited a $26mm deficit for its next fiscal year and listed as their single largest creditor the California Public Employee’s Retirement System (CalPERS) with a $147.5mm claim for unfunded pension costs. This filing suspended $10.2mm in debt service for a variety of outstanding bonds (for which MBIA and Assured Guarantee are liable) and another $7mm in savings would come from cutting retiree medical benefits for one year. The city did not however attempt to negotiate the pension claims with CalPERS. The city managers felt and probably rightly so, that fighting a claim against the behemoth retirement system would be long and costly.

Stockton’s challenges are not particularly unique. California cities are facing the daunting prospects of trying to reconcile the claims of 4 very different constituencies. There are the current employees, current vendors, bond holders, and retired employees. With dropping real estate values and sales tax revenues, cities have struggled with vastly diminished budgets, but it is the pension obligations that are the elephant in the living room of creditors. CalPERS has taken the position that the obligations owed to their retirees are senior to unsecured creditors and bondholders and that the California Constitution bars any reduction of what is owed. Essentially CalPERS has stated that they are not going to be part of any solution.

However, this past week saw the lawyers representing the bond insurers enter the fight. This certainly levels the legal playing field with CalPERS. Both MBIA and Assured Guarantee filed objections to the Federal Bankruptcy petition. The insurers argue that since the city of Stockton made no attempt to negotiate with its single largest creditor, their overall negotiations were effectively made in bad faith as was their chapter 9 filing. Saving $10mm in debt service and other modest cutbacks does not begin to address what is owed in total. Essentially; the bankruptcy filing solves nothing without CalPERS at the table.

Both CalPERS and the bond insurers have a great deal on the line in this case. Since the Stockton filing, there have been two more filings in California and the whispers of many more. The legal arguments pit California state law against the Federal chapter 9 protection which will certainly be interesting to those with legal knowledge. Importantly though, a ruling in this case which allows municipal bankruptcy proceedings to allow for the impairment of contracts akin to what the private sector allows would be a big step forward in the process of getting all the parties to the negotiating table. This is exactly what Rhode Island Treasurer Gina Raimondo was able to accomplish outside the walls of the bankruptcy court. She was able to partner with the Governor and State legislature to introduce legislation that balanced the need for security and affordability in pensions for all parties. The Rhode Island Retirement Security Act passed in 2011 by large margins. With or without the courts, pension reform will be a significant boost to the credit outlook of a large part of the municipal bond market.

We will continue to follow these developments as well as the many other “interesting times” that are currently influencing our markets.

Best Wishes,

Jen & Patsy


In this Edition

  • Summer Time Slows but the Lawyers are Busy
  • Whatever it Takes
  • Heavy Weight Fight

Huntington Steele

925 4th Avenue
Suite 3700
Seattle, WA 98104



Past Issues

82 - 08.21.12
Half Time 2012/ 19 Euro Summits - A Tiger by the Tail/ The Crystal Ball

81 - 06.11.12
Next Chapter/ Election Lessons/ A Gentleman's C/ Opportunities

80 - 05.10.12
Choices/ Texas Hedge/ Outcomes

79 - 04.09.12
13,000 x 1,400/ Lessons Learned/ It's Not Insider Trading When Congress Does It/ Crystal Ball

78 - 03.21.12
Goldman's Casablanca Moment/ Mr. Macy meet Mr. Gimbel/ The Fiduciary Standard - The Gold Standard

77 - 03.05.12
Punxsutawney Greece/ Foaming the Runway/ "The Euro Crisis is Behind Us/ Healing Hoopla/ What Price Income?

76 - 01.09.12
2012 - The Continuum/ Europe - Working in the Injury Time/ "Risk On - Risk Off"/ The Road Ahead

75 - 12.05.11
The Problem/ What Could Go Wrong/ Compound Interest/ Germany or Bust/ The Cavalry/ Stress Tests/ Next Chapters/ MF Global

74 - 09.29.11
Broken Transmission/ Chickens and Eggs/ Where to?

73 - 08.29.11
The Confluence/ The ECB/ US Economy - Distinction without a Difference/ A Different Kind of Exit/ Gold as a Thermos/ Where to Now?

72 - 06.28.11
Sovereign, Central, Commercial/ Why we call them "Banksters"/ "Extended Period" just got a lot longer/ Forward.

71 - 05.24.11
The Question is... How Many Years?/ "Unexpected" Housing Weakness/ P.I.G.S. Can't Fly/ Stages.

70 - 04.11.11
Inflation for thee, but not for me/ On the Other Hand .

69 - 04.05.11
Implications - A Bevy & A Wedge/ Implications - Quantitative Easing 2.0/ Implications - Rules Rules Rules/ Catching Up with the Can.

68 - 03.03.11
What Ever Happened to Housing?/ Where Do Loans Come From?/
Where Do Loans Go?/ The Last Straw/ The Path Forward/ Equity/ Clearing Mechanism/ Restart Your Securitization Engines.

67 - 01.10.11
Curiosity of the Federal Reserve/ Complacency & Fragility

66 - 11.12.10
Phew/ Taxes and Employment/ Quantitative Easing Returns/ Incentives & Unintended Consequences/ Dear Mr. President

65 - 09.28.10
Progress in the Absence of Milestones/ Changing Nature/ Correlations & Valuations/ Synthetic Securities

64 - 08.18.10
A Tricky Diagnosis/ Traditional Treatment/ Bad Medicine/ New Age Medicine/ Homeowners/ The Banks/ Pension Plans/ Bull Flattening

63 - 06.17.10
Hip & Groovy/ The Trouble with Zombies

62 - 05.24.10
Next Sequel/ 2012

61 - 05.04.10
Intensity/ Principles versus Rules

60 - 04.01.10
Grand Isle to Lincoln
/ Mile Post 312/ Mile Post 353/ Mile Post 399/ P.I.G.S. are a Problem

59 - 02.17.10
Surprise, Surprise, Surprise/ P.I.G.S. Matter/ Leverage vs. Debt/ Going Forward



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Market Highlights



6/29/12 3/30/12 12/30/11 12/31/10 12/31/09 12/31/08 12/31/07
12,880 13,212 12,218 11,578 10,428
S&P 500 US


1,362 1,408 1,258 1,258 1,115
Nasdaq US
2,935 3,092 2,605 2,653 2,269
EAFE Int'l Equity
1,423 1,553 1,413 1,658 1,581
5 Yr Treasury .84 .75 1.07 .85 2.02 2.71
5 Yr AAA Muni .78 .86 1.03 .94 1.75
10 Yr Treasury
1.73 2.28 1.96 3.38 3.92
10 Yr AAA Muni
2.05 2.24 2.08 3.44 3.26
30 Yr Treasury 2.92 2.78 3.33 2.914 4.325
30 Yr AAA Muni 3.33 3.56 3.72 3.82 4.9
EUR Currency 1.23 1.26 1.33 1.29 1.34
JPY Currency 79.53 79.49 82.08 77.36 81.32
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