30 California Cities Warned About Credit Rating Cuts

credit ratingIn case you thought the municipal debt crisis was over, here is a newsflash for you:

Credit rating agency Moody’s Investor Services is looking to downgrade the credit rating of 30 cities in California. Should that happen, you can add another $14.3 billion in municipal bonds at risk of defaulting. (Source: Bloomberg, October 10, 2012.) This time around, cities like Santa Clara, Santa Monica, and Oakland are the ones facing a rigorous credit rating cut if they don’t get their act together.

The epidemic of defaulting on municipal bonds is certainly on the rise. I will not be shocked to see those 30 cities (under credit rating review) start to default on their municipal bonds if their credit ratings are downgraded.

San Bernardino, the city that filed for bankruptcy on August 1, is now once again planning to skip payments on its municipal bonds (Source: San Francisco Chronicle, October 17, 2012). The city skipped municipal bonds payments in July to a total of $5.6 million.

Though credit rating downgrades and municipal bonds defaults look to be escalating in California, other cities and counties around the U.S. are struggling as well. The municipal bond market is in trouble territory and certainly not a safe place.

Since the start of the recession, cities across Michigan State have struggled. They are in a downward spiral and are considering desperate measures to get out of the mess. Seven school districts and communities in Michigan are operating under emergency managers. (Source: Detroit News, October 15, 2012). Cities cannot keep up with falling revenues, rising budget deficits, and spending.

In New York State, multiple counties including Cortland County are encouraging the state government to let them raise property taxes, because they are facing severe hardships, as their current tax revenues are not enough for the counties to survive. (Source: New York Now, October 11, 2012.)

Cities across the U.S. are suffering, and municipal bonds default looks to be the new norm. The news of more credit rating cuts by Moody’s doesn’t bring anything good to the table. The bottom line is we are going to see more cities and counties struggling and defaulting on their debt.

We are only seeing troubles in municipal bonds right now, but if defaults continue to increase, individual states will have to come to the rescue. A new crisis emerging at the state level? Tell me it can’t be true.

Michael’s Personal Notes:

No matter where you go, political debates, or mainstream media, everyone seems to be talking about how our economy is doing. Some say the economy is improving. Others, like me say, take artificially low interest rates and money printing out of the equation, and see the economy is doing terribly.

Regardless of where you sit with your opinion, the majority of us do seem to agree that, for the economy to improve, the housing market needs to improve. So the question is: is the housing market really recovering?

As we all know, the housing market was the main culprit of the Great Recession that started in 2008. Here are some important facts about housing today. At the end of the second quarter of 2012, housing market prices were still down more than 30% from 2006. A total of 22.3% of all residential properties with mortgages on them had negative equity at the end of the second quarter—the equivalent of 10.8 million residential properties with negative equity. (Source: Core Logic, September 12, 2012.)

In a recovering housing market, what you want to see is overall market conditions improving. This means existing home sales improving, not just prices going up marginally; but first-time home buyers coming into the housing market, inventory of distressed homes decreasing, and obviously a continued rise in housing starts. You also want to see improve mortgage lending and the willingness of homebuyers to borrow. None of this is happening!

U.S. housing starts in September increased 15% over August, to an annualized rate of 872,000 units. In September of 2011, housing starts were running at annualized rate of 647,000 units. Hence, housing starts are certainly moving in the right direction. But they don’t draw a clear picture of what’s really happening in the housing market.

Big banks like JPMorgan Chase & Co. (NYSE/JPM) and Wells Fargo & Company (NYSE/WFC) are earning higher profits over last year partly due to more mortgage lending. But the fact is that, in 2011, residential mortgage lending reached the lowest level in 16 years, while mortgage interest rates were historically low.

My point is that, yes, the housing market is witnessing some good things, but from a bigger point of view, it still has long way to go. With one in five homes with mortgages on them underwater, it will be a long, long time before we get back to a normal housing market, and a long time before we see national house prices rising again.

Where the Market Stands; Where it’s Headed:

This has to be the worst earnings season I have seen in years. Just look at some of these names…

Google Inc. (NASDAQ/GOOG) reported its third-quarter earnings yesterday afternoon and missed both analysts’ profit and revenue expectations. The stock fell eight percent to under $700.00 a share.

After the close, Microsoft Corporation (NASDAQ/MSFT) reported that its third-quarter sales and profit were below analyst expectations and its stock dropped almost three percent in after-hours trading.

Philip Morris International Inc. (NYSE/PM) said it made less money than expected in the third quarter, as eurozone smokers cut back on cigarette consumption (sales down 15% for the company in the European Union in the third quarter). This stock fell four percent.

I’ve been warning that it would be a very poor third-quarter earnings season. How much longer before the stock market pays attention to the falling profits of the companies that trade in it?

What He Said:

“Bonds could now be a buy: Bonds rise in price when interest rates fall, as their return makes them more valuable. After a bear market in bonds that has lasted for months, the action in the bond market, as I read it, indicates the bear market in bonds could be over. I’ve always preferred quality when buying bonds, going with government bonds over corporate bonds. If you have some cash lying around, bonds could be a great deal.” Michael Lombardi in Profit Confidential, July 24, 2006.The yield on 10-year U.S. Treasuries fell from five percent in the summer of 2006 to 2.4% in October 2011, producing spectacular profits for investors in the bonds Michael recommended.