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Is Connecticut Bankrupt?

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This article on Yahoo finance really got my attention. It’s about how the state of Connecticut is about to run out of money. It’s interesting because many states are in dire financial straits, but most people are, as usual, blissfully unaware.

Recently I did some research about bonds, and was interested in purchasing some. I discovered that municipal funds are supposed to be among the safest bonds that you can buy! I thought, “Isn’t that funny. Many states and cities are going bankrupt, but people think these bonds are very safe.” It sounds like the same game the ratings companies have been playing for decades: give the bond a AAA rating even if it is risky.

Why are municipal bonds more risky in this financial environment?

I can just imagine what is going to happen. There will be a wave of municipal bankruptcies or near-bankruptcies, and the bond holders will get screwed. Then there will be people on the news saying, “Everyone thought that municipal bonds were safe. This has never happened before.”

During “normal” times, municipal bonds were safe for at least 2 reasons:

  1. Cities and states are big players. That means that if a certain industry turns down, or if there are other changes in the economy, it may not make a big difference for an entire state. It could wipe out a company, but have only a limited effect on the city or state.
  2. Municipalities have the ability to generate large amounts of money without doing any work. How? By raising taxes. Whenever they need money, they just change the law and millions or billions of dollars flow in. People and companies are slow to change where they live or do business, so it works great in the short term.

However, in these uncertain times the above benefits actually become liabilities. The municipality can be adversely affected in a big way if there is a wave of bankruptcies and foreclosures. When people stop paying taxes, the money stops flowing. And in times of financial chaos people stop paying taxes.

Also, since the economy is so weak, raising taxes can make the situation worse. Since that would worsen the city’s finances, they may not be able to do this. Their #1 method of getting money may be ineffective.

Connecticut is the first of many states and cities that are going to have massive financial problems. I believe that we are just starting to see a wave of defaults and near-bankruptcies on the municipal level. The federal government can try and step in, but I think that doing so will only push the problems further out into the future.

The post Is Connecticut Bankrupt? appeared first on The Online Investing AI Blog.


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