Just as with American state and local governments, not much, except that bondholders don’t get a haircut in the EU. However, the populations whose government is being bailed out will see their locks on the floor.
Ireland is insolvent, and would be unable to pay its creditors. Except. The European Union, along with the International Monetary Fund, cobbled together a rescue package to prevent its default, in the process making its bondholders more or less whole.
Ireland has a bit fewer people but a bit larger economy than does the state of Alabama in the United States. Greece, which defaulted this year around the beginning of summer, has about the same population and a bit smaller economy as Georgia in the United States. (Both comparisons are based on the 2008 CIA World Fact Book, and use per capita income to compare economies.) Now both have been bailed out by the European Union, the issuer of the Euro.
Which is where the muni-bond market in America is heading: Federal government (the EU and IMF rolled into one) bailouts of state and local governments. It will probably start with the states, California comes to mind, and then spread to local governments that can’t service their debt.
Unlike the bailout of Ireland and Greece (and likely Portugal and Italy, etc), the holders of local government bonds in the US will lose. Instead of protecting bondholders from loss, US bailouts will be focused on protecting public employees and retirees. The EU doesn’t mind inflicting pain on the people of Ireland and Greece. The populations of Ireland and Greece don’t vote in any meaningful way so far as the EU is concerned, and besides, it wasn’t so long ago that inflicting pain across the continent was done with bullets instead of balance sheets. But American public sector employees vote. The more public sector employees are likely to be affected by a muni-bond default, the more compelling will be federal government intervention. This will hold true regardless of which party is in power. Votes are votes, and public sector employees are far greater in number than are bondholders, and often leverage their votes with union membership.
Like the GM/Chrysler bailouts, it will be far more important to understand the political calculus of government intervention than it will be to understand the underlying economic fundamentals of the entities being bailed out. GM and Chrysler were bailed out because of their employees, specifically, because of the political power of their union, the United Auto Workers. By comparison, California state employees, like their civil service compatriots in locales all across the land, know a thing or two about the powers of unionization. State and local governments can’t possibly make good on their pension and health care promises to their employees and retirees. Sound familiar? Indeed, GM and Chrysler could never have met their pension and healthcare obligations to their unionized employees and retirees, so the union masterfully engineered a big dollop of federal aid while cajoling the government into inverting ordinary creditor priorities in bankruptcy to give them precedence over secured creditors.
Bankruptcies will be rare. Not because the state and local governments aren’t insolvent, but because resolving their fiscal problems in bankruptcy would be politically unpalatable, as it would often require adjusting the entity’s obligations to its employees and retirees. When bankruptcies do happen, the GM/Chrysler model of running roughshod over established bankruptcy rights and obligation will be the norm.
Notwithstanding their profligate spending, the West and Japan spent the last half-century accumulating massive wealth, making bailouts such as these inevitable when the wealth-creation machine faltered, causing tax receipts to decline. Unfortunately, bailing out profligate spenders does nothing but encourage their profligacies. In the EU, the bailed out bondholders will swimmingly return to lend at more generous terms with even a whiff of better economic times ahead. The memory of pain inflicted on the EU populations may act as something of a check on the politician’s profligate tendencies, but the politicians didn’t suffer pain–the people did–and political memories never extend backward further than the last election cycle. In the US, public sector unionism, shown to be a political juggernaut capable of steamrolling any opposition to its gold-plated salaries and benefits package, will see an increased rate of growth and consolidation until virtually every public sector employee works under a standardized union contract. Public sector unions will effectively own the state houses and local governments, making insolvencies and defaults common, which means the federal government will ultimately underwrite all the bonds issued by state and local governments, just as it does now with residential mortgage securities issued by Fannie Mae and Freddie Mac.
Sovereign defaults in the EU and state and local government defaults in the US are just a symptom. The disease, or condition, from which they arise (and the financial system crisis arose) is the underlying demographic implosion. Aging and dying populations don’t have vibrant, growing economies. The time-honored strategy of growing out of debt-servicing issues will not work for the West this time around. There will be pain. In the EU, immediately, with the austerity programs all but required of deadbeat sovereigns. In the US, the pain won’t come until the Treasury is bled dry. Then the pain will be severe, perhaps even testing, like the Europeans will, the limits of reason for remaining in a union.