Fears are receding of immediate state and city budget crises, due to the double impact of federal spending and restored economic and revenue growth. But low interest rates and pent-up public spending needs are leading to a great deal of new state and local borrowing. Are states and cities taking on too much debt?
In 2020, falling revenues due to the Covid-19 recession led to significant new muni borrowing. In fact, 2020 saw municipal bond sales set a new record of $451.2 billion, up 11% over 2019.
2021 has seen continued issues from states and cities, “5% above the 5-year average” in June according to Blackrock. But muni supply is being swamped by demand, with large inflows of purchasing funds and less supply due to investors buying and holding munis.
Saying “muni trading hasn’t been this slow since the turn of the century,” a recent Bloomberg analysis found “the par amount of (muni) bonds traded has tumbled by 34%” in 2021, “a 22-year low.” At the same time,BNY Mellon says 2021’s volume of municipal bond purchases “looks set to shatter the previous record” set in 2019.
So investors are buying, but they aren’t selling. That’s one sign of a robust market for municipal debt. Why the buy and hold strategies? and what does that imply for servicing debt going forward?
First, the Biden Administration has (rightly) been saying it wants to raise taxes on the wealthy. Forbes contributor Howard Gleckman notes that almost all of Biden’s tax increases “would be. borne by the highest income 1 percent of households.” So wealthy investors are becoming more interested in tax-free returns, and munis are a central element in reducing taxes on their investment portfolios.
Second, the improved status of municipal finances is reassuring investors. Nuveen noted in July that “state revenues have been very resilient, outperforming virtually anyone’s expectations from one year ago.” President Biden’s American Rescue Plan has helped significantly, putting $350 billion into state and local governments. And if the Biden infrastructure and stimulus plans get enacted, that will be a further revenue boost to governments.
Third, personal income is keeping up with municipal debt. Michael Kahn, Director of Research for the National Conference on Public Employee Retirement Systems (NCPERS) recently calculated the ratio between twenty-year state and local outstanding debt and twenty year personal income. His calculations show a stable relationship of debt to personal income, with improvement after the 2008 Great Recession.
All of these factors make analysts comfortable with state and local debt levels, especially because there seem to be more funds eager to get into the muni market. And given the high level of recent bond activity, there are significant levels of redemptions coming to investors, which often are reinvested in the muni market. James Mann of RBC Wealth Management expects the “supply-demand imbalance” in munis “to continue for at least the next several months.”
Revenues should be sufficient to service state and local debt and even expand it. The National Association of State Budget Officers (NASBO) notes that 38 states reported FY2021 general fund revenues above initial forecasts. Many states are increasing spending on a variety of programs, including teacher salaries and K-12 education, health care and Medicaid, and many other programs.
So the markets and other analysts seem confident in state and local governments’ ability to handle their debt loads, and even increase them in the face of continuing high demand from investors. But this short-term outlook could be clouded by longer-term spending and tax plans.
In my next blog, we’ll look at the longer-term picture for state and city revenues in the face of economic and demographic change, pressures on pension and other spending, battles over tax increases and cuts, and whether long-term budget obligations are being funded with one-time revenue injections from the federal government.