Although the underlying strength in the fixed-income market still exists, the market is in bad need of a shot in the arm for the rally to continue. The market has expected to receive that added boost in the form of a discount rate cut by the Federal Reserve. For two weeks the cut has been anticipated, but since it has not occurred, it has been most difficult for the market to advance. This has been especially true in light of the large $13 billion Treasury refunding and an unusually large supply of new municipal issues that, surprisingly, were rather easily absorbed.
Over the past several years there have been billions of dollars worth of tax exempt power-authority revenue bonds sold. While many of these issues have no credit problems, there is a large segment of this market that does. Specifically, several large joint action authorities that have issued bonds secured with "take or pay" contracts seem to be on shaky ground and should be carefully examined. Basically, these authorities are formed to build huge facilities, mostly nuclear, and to manage the output of their power. In turn, several project participants agree to purchase power from the authority on a "take or pay" basis. The participants must pay a fixed amount to the authority to cover its operating expenses plus the debt service on the outstanding bonds. This revenue for the participants comes from the fees charged to their customers even though the plant may not be completed.
In several instances, cost overruns, inflation and mismanagement have raised the cost of these projects to astronomical levels. Accordingly, several of the projects have become economically unsound in today's environment, and realistically should either not be undertaken or perhaps even completed.
The most striking example of such mismanagement and excessive construction costs is the Washington Public Power Supply System in the state of Washington. The construction of nuclear plants No. 4 and No. 5 was halted almost a year ago and they probably will never be completed. In one case involving the Springfield Utility Board, the courts have ruled that the Springfield group did not have the authority to issue debt or obligations on a "take or pay" basis. In another instance, the Wyoming Public Service Commission ruled that rural electric authorities (REA) do not have to make good on their "take or pay" contracts. This all means that even though we are in the early stages of the litigation process for these "take or pay" types of bond issues, the courts have been ruling against the power authorities in enforcing the "take or pay" contracts. As a result, bondholders of such debt should feel very uncomfortable at this turn of events.
Some analysts feel the WPPSS No. 4 and No. 5 nuclear plants and their $2.25 billion of outstanding debt could easily go into default. This would then focus the market's attention on the problem. Other power authorities that should be examined are the Massachusetts Municipal Wholesale Electric Co., the Intermountain Power Authority of Idaho, and the Southern California Public Power Authority, plus several other authorities with large expenditures yet to come. Alternatives for owning such issues before the storm breaks would be other utilities like the South Carolina Public Service Authority or good A-rated hospital bonds that are currently returning 11 percent or more.
The Treasury will offer a two-year note on Wednesday in minimum denominations of $5,000. They should return 9.85 percent.