Where Will The New Trouble Rear Its Ugly Head?

The $700B Bailout Bill finally passed and as expected the stock market ran up on Friday morning in anticipation and came crashing down once it was likely to pass. As we have been saying it is a band-aid and the future will be driven not only buy the credit crunch and the financial sytem but by the economy. The economic truths were best displayed by last week's Institute for Supply Management's index of manufacturing which tumbled to 43.5% in September. This was the lowest reading since October 2001. A reading under 50 means manufacturing is contracting. We are in much worse shape today as October 2001 reflects 9/11 where all business in America came to a screeching halt but rebounded in Novermber. We shouldn't expect a sizable, if any increase, in this index in the near term. On Friday, the payroll employment number for September came out and there were 159,000 fewer jobs. This is not a pleasant number and I suspect the next few months could be worse. If the economy is not in a recession now, I would be shocked.



Just as it seems like all the bad news is out, Arnold Schwarzenegger, Governor of California, seems to be short a few pennies to pay the state's bills and payroll. He is now asking the Federal Government for a small loan of $7B. This is one of the next major problems facing the mighty America. I think Hank Paulson is waiting for the year to end quickly so he can hand off the baton to the next unlucky sole to take the position of the Secretary of the Treasury. The need for capital never seems to end in this crisis.



The municipal bond market, where all Cities and States raise money to fund their capital projects and supplement tax collection has come to a halt like many other credit markets. If the economy is sinking, then business will be softer, earnings will decline, and taxes will also shrink. City and State budgets are calculated with the expectation that their expenses will primarily be covered through the revenues generated by the tax base. Weakened companies pay smaller tax bills and since unemployment is rising, individuals will pay fewer taxes also. Where will the municipalities get the necessary revenue to pay salaries, bills, and pensions to the government workers? They might normally raise money in the municpal bond market but as I stated above, that market is not currently functioning as it should. There are two choices: slash costs as Governor Patterson of New York is attempting or go hat in hand to the Federal Government and ask for a loan as Governor Schwarzenegger is attempting.

If a plethora of Cities and States starts to run a deficit and need to turn to Mr. Paulson for a loan, this will be troubling. Not only is the government trying to fix the financial sytem, it will need to find billions more to keep the municipalities across America from defaulting. In 1979, New York City bonds yieded something like 14% and it looks like similar investment opportunities may be coming.