Minyanville professor Kevin Depew made some important observations in a Buzz late in the day yesterday that I think are worth sharing with everyone.

Summer of Municipal Discontent



With fiscal years for states beginning on July 1, this summer could very well bring a host of unwelcome headlines for financial markets. Miraculously, Illinois has managed to surpass California in terms of fiscal distress.



Fine, we all know that fiscal woes are coming. But here's the nut of the thing: Who owns this muni debt?



Well, consider this round two for American households.



According to page 91 of the Federal Reserve Flow of Funds report, there is $2.8 trillion in muni debt outstanding. Here's the order of ownership:



Households ­ $1 trillion

Banks ­ $220 billion

Insurance companies ­ $350 billion

Mutual funds ­ $500 billion

Money markets ­ $370 billion

Broker/dealers own just $40 billion.

My friend Conor observes that, "for the cynical folks who think bailouts only happen if Goldman Sachs (GS) stands to benefit..." Well, that belief will likely be put ot the test.



Even worse, consider the fact that households make up a significant portion of holders of muni debt indirectly though the banks, insurance companies, mutual funds and money markets above. The $1 trillion ownership figure is actually much higher.



And still worse than that, over the last three quarters the household sector has bought 80% of all flows into munis.

Federal Reserve Flow of Funds

Warren Buffett recently declared he was nervous about insuring any muni debt, a business he eagerly took on in 2008.



I would further note, given the reality of unfunded liabilities, mostly pensions, and the state of financial markets and continued declines in tax revenues - specifically in terms of property taxes - there is every opportunity for municipalities to default in great numbers.

Moths to a Flame

will

should

Sovereign Default Risks