Why NYC bondholders should be very afraid of 1970s-style financial crisis

New York Politics: A Clown Car of Instability and Financial Risk

The world of New York politics has always been a drama-filled arena, but the current state of affairs is particularly concerning. With Mayor Eric Adams struggling to maintain his position amidst scandal, the city teeters on the edge of political upheaval. The potential rise of far-left politicians, such as Public Advocate Jumaane Williams, to positions of power has significant implications for the city’s financial health and, by extension, the stability of its municipal bond market. While New York City has historically navigated financial crises, the confluence of political instability, rising debt levels, and a shrinking tax base paints a worrying picture for investors.

Municipal Bonds: The Unseen Pillar of the Economy

Municipal bonds, or "munis," are a cornerstone of the U.S. economy, often overlooked but crucial for funding public projects like roads, bridges, and schools. Issued by state and local governments, these bonds attract investors with their tax advantages, particularly for those living in the issuing municipality, where returns can be triple-tax-free. Despite their reputation as safe investments due to backing by tax revenues or government credit, municipal bonds are not without risk. Defaults, though rare, have occurred, and the financial health of the issuer plays a critical role in their stability.

New York City’s History of Debt and Fiscal Challenges

New York City’s history is marked by significant debt, driven by its expansive social programs and infrastructure needs. The city has weathered several financial storms, including the 1970s fiscal crisis that brought it to the brink of bankruptcy. Investors suffered losses as bond prices plummeted, a stark reminder of the risks associated with municipal debt. While the city is not currently in a crisis, the ingredients for one are present, including a reliance on Wall Street revenues, which are sensitive to economic downturns, and a political environment leaning towards increased spending and taxation.

The Shifting Political Landscape and Its Implications

The political landscape in New York City is undergoing a significant shift, with moderate voices like Mayor Adams being overshadowed by progressive figures. Public Advocate Jumaane Williams, a self-described socialist, is poised to take a leadership role. This change could lead to policies that expand government size and increase taxes, further eroding the city’s tax base as middle-class and high-income residents migrate to lower-tax states like Florida. This exodus, coupled with the relocation of Wall Street firms, poses a direct threat to the city’s revenue streams and, consequently, its ability to meet bond obligations.

Financial Risks and the Looming Specter of Default

The city’s financial outlook is troubling, with projected budget deficits of $4.25 billion by 2027, growing to $5 billion by 2029. These figures predate the potential ascendancy of progressive leadership, which could exacerbate spending and reduce fiscal discipline. While the city’s finances are currently stable, and rating agencies maintain a positive outlook, complacency is dangerous. History shows that rating agencies often underestimate risks, and the political will to prioritize bondholder payments over government expansion is far from certain. Investors should be vigilant, recognizing that while a default is not imminent, the risk is growing.

Guidance for Investors: Caution and Prudence

For investors holding New York City municipal bonds, the advice is clear: stay informed and cautious. While the current financial situation does not necessitate a panic sale, it is crucial to recognize the warning signs. EJ McMahon of the Manhattan Institute underscores that New York City is ever vulnerable to economic downturns, a risk amplified by the shift towards progressive policies. Diversification and careful monitoring of the city’s fiscal and political developments are essential. The city’s ability to manage its finances and withstand economic shocks will be critical in determining the future of its municipal bonds—and the returns for its investors.