New Jersey, one of the richest states in the nation, is nearly broke.
Starting next week the Garden State could be unable to pay its bills unless it secures a short-term loan of $2.25 billion, which it is reportedly close to doing with JPMorgan Chase. New Jersey’s fiscal year starts July 1st. Usually it has a fair amount of money left over from the year before. But this year, New Jersey’s excess reserves aren’t enough to cover it in the first few months of its fiscal year. The state plans to do a late summer bond offering, which will shore up its cash problem. But until then, the Garden State is what you would call cash poor. So New Jersey is going the unusual route of getting a bridge loan from J.P. Morgan.
New Jersey’s economy does appear to be in pretty poor shape. In May, at a time when unemployment around the country continues to rise, albeit slowly, state unemployment in New Jersey fell by 400 jobs, and the unemployment rate rose to 9.4%, which is slightly higher than the rest of the nation. And I think Chris Christie’s effort to scare the state into agreeing to cut its municipal workforce is doing more harm than good. Nonetheless, I don’t think today’s news about New Jersey’s finances signals a new round of trouble in the muni bond market. Here’s why: Earlier this year, municipal bonds were seen as one the biggest risks in the market. A number of prominent analysts predicted that state and local governments could default on their debt in record numbers, causing a mini-financial crisis. But so far this year, those defaults have yet to materialize. In fact, muni bonds have turned out to be one of the better investments around this year, with prices up nearly 7% on average through late June. Why is that?
First of all, the New Jersey news is not as bad as it seems. In a way it’s a sign of improvement. Two years ago, when California and Illinois needed cash they couldn’t get a bank to lend them money. We were still in the middle of the financial crisis cash crunch, and banks weren’t about to lend to troubled states. Instead, California and Illinois started issuing IOUs. That understandably made it much tougher for those states to borrow more money. Illinois had to raise its state income and property taxes. That has temporarily helped the problem there. But California is still facing higher borrowing costs because of the IOUs.
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There days, banks are reaching out to make loans to states and other muni governments. The interest rate JPMorgan is giving New Jersey at least initially is an extremely low 0.56%. That rate goes up to 9% if the loan is not repaid in the next six months, but still that seems like a rate you grant a healthy borrower, not one on the brink.
Second, economic research firm IHS Global Insight reported today that state and local tax revenue rose 4.7% in the first quarter of 2011. That was six straight quarter that state tax revenue rose, and the result is that states and local governments are now pulling in more than they did just before the recession started, and they are doing so at a time when property taxes are still falling. Also today New Jersey’s government enacted a pension reform measure that will raise the retirement ages and lower the cost of the states retiree benefits. While surely bad for future retirees, pension reform is something the states must do. And if New Jersey is the start of nationwide cutbacks, that will also be good for the muni bond market.
Daniel Loughran, a muni bond portfolio manager at Oppenheimer Funds has long said that the fears of credit problems in the muni market are overblown. He says today’s news reinforces that. “The credit fears that were widespread seem to have abated,” says Loughran.