Beware the "GM Option"

From the 5 Minute Forecast:

Recall that the bankruptcy of General Motors and Chrysler two years ago was no ordinary bankruptcy proceeding. Hypothetically, bondholders were first in line among the automakers’ creditors trying to recover their investments.


After all, they lent money to the automakers at a relatively low rate… so if the worst happened, they stood the best chance of getting all their money back.
Then the politicians got their mitts on the deal… and handed out favors like Halloween candy to the unions and other favored constituencies. Bondholders were left holding the bag.

Now we have news that the State of California is in a fiscal state of emergency and that can only mean trouble for holders of municipal bonds.

See, unlike cities and counties, states can’t declare bankruptcy in federal court. So unnamed “policymakers,” The New York Times reports, “are working behind the scenes to come up with a way to let states declare bankruptcy and get out from under crushing debts.

“Proponents say some states are so burdened that the only feasible way out may be bankruptcy, giving Illinois, for example, the opportunity to do what General Motors did with the federal government’s aid.”

Just imagine the feeding frenzy that would result -- pitting holders of municipal bonds against the public employee unions seeking every last dime of their pensions and health benefits.
“They are readying a massive assault on us,” says Charles Loveless, legislative director of the American Federation of State, County and Municipal Employees. “We’re taking this very seriously.”
You don’t want to be around to see how this turns out.

“We expect muni funds will find a bottom at some point,” says Jim. “And then, just as quickly as they stabilize, they’ll fall again on actual news of defaults. It won’t take much in the way of a real scare to truly collapse these investments.

“Regardless of their future, the point is we’re entering into panic mode on some of the best-performing and hottest assets for pension plans, 401(k)s and IRAs. Pensioners are no doubt beginning to reel again.”