Barney's Bad Idea

Barney Frank’s proposal for the Federal government (you and me) to insure municipal bonds is no less than astounding, as you will see from the first and last paragraphs of a column in today's today’s Wall Street Journal:

Barney Frank's track record as a financial analyst is, shall we say, mixed. The House Financial Services Chairman said for years that a collapse of Fannie Mae and Freddie Mac would pose zero risk to taxpayers. For most people, a mistake of that magnitude would trigger introspection, if not humility. But not the sage of Massachusetts. He's cooking up another fantastic subsidy -- and like the last one, he swears taxpayers won't feel a thing. In his words, "it would cost the federal government zero." Uh oh. 

One Fannie Mae debacle ought to be enough for any career, but Mr. Frank wants taxpayers to double down on his political guarantees. There are currently some $1.7 trillion in municipal bonds held by the public, and Barney thinks we can insure them at "zero cost." Considering the source, and the potential size of the bill, someone in Congress needs to sound the alarm. 

The column describes Mr. Frank's proposal for an "FDIC-like federal insurance program for municipal bonds,"  and goes on to quote from Warren Buffet's latest Berkshire Hathaway shareholder letter on the dangers of the municipal bond insurance business.  Mr. Buffet compares it to insuring against natural disasters, where many loss-free years can be more than wiped out by one devastating experience.  

Considering the financial difficulties afflicting city and state governments, including enormous health care and pension liabilities, severely reduced tax receipts, excessive spending on ever-expanding social welfare programs, and the rigid demands of their employee unions, there is a lot of risk to go around on municipal bonds.  That risk has been reflected in the decision last week by Moody's to assign a "negative outlook to the creditworthiness of all local governments in the United States... the first time it had ever issued such a blanket report on municipalities."  On top of all the systemic risks, many states and cities are attempting to balance their near-term budgets on the back of billions of dollars in federal "stimulus" money (i.e. on the backs of our kids).  When that money runs out then what?

Recalling New York City's 1975 fiscal crisis and the Orange County, CA 1994 bankruptcy, and considering the current precarious financial situation of states like New York and California, it is hard to believe that a United States congressman, even a Barney Frank, would assert that muni bond insurance "would cost the federal government zero."

After digesting the Frank proposal, sit down and consider the implications of the federal government taking over a bankrupt state.  I will allow the reader to speculate on his or her own on the implications of that one.

Oh, and I almost forgot this part.  In an interview published in the New York Times last month, Mr. Frank was asked how his 401(k) is doing, and he had this to say:

Overwhelmingly, my money is in Massachusetts municipal bonds. I long understood that the corporate world charges municipalities an unfairly high risk premium. Full faith and credit general obligation municipal bonds are very safe. I am heavily invested in bonds that have been paying me a steady 4 1/2, 5 percent, for years and suffered no losses.

What a guy.
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