Reflecting on the LA Fires from January

I was thinking of my family and everyone I knew who might be in the path of the fires while watching what was unfolding in LA. Amid the heartbreak, though, an unsettling question surfaced: What about the LA county bonds we’d put into client portfolios? What about those I’ve put into my own? 

Municipal bonds are a core part of Montcalm TCR’s investment strategy. With LA and the surrounding areas being the most populous region in all of California, municipal bonds directly funded by infrastructure and services use throughout LA, Malibu, Glendale, and Pasadena were in many Montcalm portfolios. 

While this was not the first natural disaster that caused us to re-run credit quality analysis and have temporary concerns about the solvency of a bond issuer, the scale of the destruction in LA and the direct implications it had on so many close to me made this one feel all the more like a catastrophic event that could shake our fundamental trust in the municipal bond market.

While I acknowledge the personal loss and the weight of the trauma felt by so many, the LA fires were also a keen reminder of why we held such a fundamental trust in municipal bonds in the first place and why they are our primary choice for low-risk, public investments when navigating global uncertainties and climate-related disruptions for US investors: 

Private property losses were enormous. Homes, businesses, and entire neighborhoods were scorched and likely rendered uninhabitable for years to come. Those structures represent living communities, which in turn need all sorts of infrastructure, like watermains and gas lines, school buildings and hospitals, roads and parking spaces, to make life possible in the modern era. As long as people are living in those communities and using those public services, there are revenue sources to fund all sorts of municipal bonds; revenues from property taxes, utility bills, leases of government property, sales tax, even parking meters. 

Everyone who lived or still lives in the neighborhoods affected, whether they know it or not, borrowed money from the public at large via municipal bonds to build the infrastructure that makes life in the modern era there possible. Investors provided the upfront capital necessary to build, for example, the Palisades High School. Not because it was a nice thing to do, but because it was an attractive investment: Municipal bonds come with layers upon layers of contractual and legislative protections that make their credit quality among the safest in the public security market. So, even if no one can live in a certain community going forward and use its infrastructure or services, municipal bonds that funded projects in that community are able to draw on revenues from other sources within the entire municipality to continue servicing its debt, uninterrupted. There are, of course, also tax incentives to make yields competitive in public markets.

Reflecting more energetically on municipal bonds, they represent a sort of beautiful social contract we sign when we choose to live where we do and participate in a system that provides public services to enable our communities to thrive. 

More often than most realize or care to think about, we agree that our taxes and participation in the local economy will fund interest payments to investors that provided the capital upfront to build the infrastructure we use every day. Through our interwoven municipal, state, and federal systems, we also agree that if our neighbors face localized disaster, our contributions to government coffers through their various avenues can ensure those neighbors won’t be forced to default on the debt that funded their infrastructure and be effectively barred from rebuilding. This is a mutually beneficial arrangement that allows for a larger, more stable economic system, and cheaper debt since your neighbors have also agreed to support you in return.

Our government and its branches and agencies at any level may spend our tax dollars inefficiently or in ways that we don’t always agree with, but putting that aside for a moment, there’s something fundamentally right about this. Something right about mutually agreeing to make our promise of future repayment plus interest so strong that investors from all over the world are willing to provide upfront the capital needed for projects that directly benefit only a localized community. 

That is part of the light I am choosing to see out of this recent disaster in LA. As we looked at the municipal bonds issued by the LA Unified School District, the Pasadena Public Finance Authority, and many more, we only saw bonds that were funded by such a broad base of revenue streams, had abilities to also draw from neighborhoods outside of the fire zones, various legislative obligations to draw on rainy day funds, and additional layers of support from state and federal emergency funding. 

The LA fires are projected to surpass Hurricane Katrina as the costliest natural disaster in US history and occurred simultaneously with a new presidential administration vowing to slash federal funding and punish sanctuary cities. It was uncharted territory, but the more we dug into the bonds potentially affected by the fires, the more confident I became in the resiliency of those bonds and ability to perform as expected. 

In the case of smaller municipalities, insurance proceeds and emergency aid usually fill the gap to avoid credit downgrades or missed payments, as was the case recently in Ashville, NC following Hurricane Helene, for example. Still, the LA fires validated our focus on diversification and bonds from larger issuers with more layers of financial support in times of natural disaster. Localized disasters such as this are tragic and heart wrenching, but they can also remind us of the social contracts we sign as neighbors, community members, and tax payers, where we’ve built our lives atop an intricate and interwoven set of societal and financial systems that certainly may not be perfect, but have allowed for tremendous growth, wealth, and a quality of life worth preserving through intentional and thoughtful decisions and investments - rather than speculation in zero-sum games.