Myths and Falsehoods About The Backstop

When the traditional media followed the lead of the Hooverists on the right and started calling California's desire for federal loan guarantees to secure short-term borrowing a "bailout," which it isn't, support for the measure collapsed. But not only was California seeking a solution to being gouged by bankers and investors, but other localities would like the option as well, putting the lie to the notion that California seeks "preferential treatment." In fact, other localities want a simple payback to cover losses to their municipal bonds from the Lehman Brothers meltdown, which would cost far more to the Feds than a loan guarantee program. Moody's has downgraded the ENTIRE muni bond sector, not just California, so the costs have gone up across the board. Overall, there is an acknowledgement that the recession has made borrowing costs too exorbitant, and backing from the Feds could save municipalities billions at no cost to the government.

All of the proposals are meant to help struggling state and local governments that are facing a cash-flow squeeze. The economic downturn has eaten into their tax bases as local businesses shut, houses are lost to foreclosure and there is a resistance to raising taxes. The risk to the federal government is that it could lose money if things get worse for municipalities and states. Although backing debt with a guarantee does not require an immediate outlay of funds, the federal government could have to cover losses if there are defaults — which could be substantial if the economy weakens or states and municipalities cannot bring their budget deficits under control. Nonetheless, these overtures by state and local officials reflect a sense — perhaps just a hope — that municipalities suffering from a downturn in revenues and creditworthiness may find some relief in Washington beyond the stimulus money the federal government already is spending.

Emphasis there on "could." Those who know the market and understand it admit that California, and all the other states, would certainly repay the bondholders. The state has never missed a payment in its history, and bond repayment has a stronger priority in the California constitution than most other states. All the bond analysts I've seen say uniformly "California's not going to default." Not to mention the fact that the savings from being rescued from out-of-control interest rates would leave more money available to aovid cuts.

"There's simply no better stimulus than guaranteeing state and local bonds, particularly those that are being used to get through the crisis and avoid layoffs," said Rep. Brad Sherman, one of 15 Democrats in California's House delegation who signed a letter earlier this month asking for the federal loan guarantee.

Plus, supporters of the idea note that Washington stands to make a profit from loan fees as it did after bailing out New York City in 1975, a move that brought the city back from the brink of ruin [...]

"We are not asking for a bailout," said state Assembly Speaker Karen Bass, a Los Angeles Democrat. "We're asking for the federal government to step in where commercial banks can't this year because of the crisis within the financial industry."

In other words, the state didn't create the economic crisis, they didn't create the financial crisis, and they shouldn't be unable to secure normal short-term borrowing because of either.

Also contrary to the myths in the media, the federal government has NOT foreclosed this option whatsoever. The Treasury has been somewhat noncommital on the specifics, but agreed in broad terms that the municipal bond market needs to work better than it does today. In addition, Tim Geithner had this warning for the wordsmiths on the right and in the media:

But, according to a Bloomberg News account of the speech, Mr. Geithner cautioned: “I wouldn’t use the word bailout.”