We knew too well about how the recent discussions of the next phase would unfold. We are now beyond the 11th hour without a plan. While much of the debate has centered around the continuation of the Unemployment Insurance supplement as it should, there has been much less discussion about state and local support in the bill. The democratic side of Congress has proposed almost a $1 trillion in their release. The republican side started from a standpoint of zero. Treasury Secretary Mnuchin has suggested some willingness to increase the offer to $200 billion for states and localities. Although, I have read some conflicting reports that it may be $150 billion. Despite the relative opposition to the idea of providing more support, it is good to see there is some acknowledgement of reality.
The downdraft in revenues and the increase in safety net spending is quite causally linked to the Covid-19 pandemic. All state and localities are affected no matter what party is dominant in a specific location. All are seeking relief in various forms. If the federal government is not forthcoming with more assistance, many issuers may have to incur more debt than planned.
Carving out pension payments from eligibility for application of federal aid should be a relatively easy measure to accomplish. Most recognize that it has taken decades to develop some of the severe underfunding that exists out there. It has and will take decades to address. One recent positive is that the pension funds regained some ground in the second quarter with the equity market rallies. One quarter certainly does not solve the underfunding of the plans, but it helps. Even with the positive performance, few issuers were able to match their actuarial returns in the 7% range.
Despite some positive news on the hiring front, many remain unemployed. There is much speculation about whether all the available workers will ever be reabsorbed fully in the labor market. Many older workers who lost jobs are being forced into early retirement. Given people are living longer without referring to the pandemic, this outcome is not the best path for the economy. Resorting to an Executive Order to extend benefits to the end of the year has some merit. However, an overly complex funding arrangement will not help to ease administration by the states. That is the primary reason the $600 supplement level was selected in the first place.
The healthcare coverage also becomes a key concern for many. The thought about lowering Medicare eligibility to 60 years may have some merit, but we know that it is an expensive proposition. How the funding would be provided is an open consideration.
The four primary revenue sources for states and localities are the income tax, sales tax, corporate income tax, and the property tax. Income tax receipts are challenged by the high unemployment. Some capital gains may be a greater part of the status towards the end of the year. Retail sales are accelerating including online sales and car purchases after a bit of a hiatus. Sales taxes will show the improvement. The corporate tax is a bit of an unknown but will most likely be lower given the losses, write offs and credits. Property taxes should remain steady unless we see a real increase in foreclosures that take time to be processed. The sharp decrease in income taxes and sales taxes must be offset in the budgets. In the absence of federal aid, solving the imbalances will involve much more pain.
In the meantime, the municipal market is functioning quite well. Positive flows to the mutual funds have persisted for weeks. The persistent decline in yields has not kept investors on the sidelines. Some like to say that the reason is TINA (There is no alternative.). There is always competition for investments. Equities are clearly commanding a bulk of the attention; but many still seek the relative safety of municipals. We have not had any very damaging headlines in the municipal market of late. There has been some uptick in bankruptcy filings of smaller credits. I remain hopeful that we will get to the other side unscathed. My instinct and experience suggest otherwise not that I wish for such an outcome.
In the meantime, we may all enjoy the low yields and the gains that have benefitted existing holdings. The primary market will continue to function well if supply remains in the manageable to lighter range.
John Hallacy
John Hallacy Consulting LLC
Recent Comments