WEBVTT - Interview With Michael Zezas: Masters in Business (Audio) 0:00:00.160 --> 0:00:02.440 The future may not be clear, but our commitment is 0:00:02.600 --> 0:00:04.440 so when you sit with an advisor at Merrill Lynch, 0:00:04.519 --> 0:00:07.160 will put your interests first. Visit mL dot com and 0:00:07.240 --> 0:00:09.640 learn more about Merrill Lynch, an affiliative Bank of America. 0:00:09.760 --> 0:00:12.039 Mery Lynch makes available products and services offered by Merrill 0:00:12.080 --> 0:00:14.440 Lynch Pierce Veneran Smith Incorporated or Registered Broker Dealer remember 0:00:14.560 --> 0:00:19.880 s I PC. This is Master's in Business with Barry 0:00:20.000 --> 0:00:25.880 Ridholts on Bloomberg Radio. This week. On the podcast, I 0:00:26.000 --> 0:00:28.640 have Michael Jesus. You may not have heard of him, 0:00:28.680 --> 0:00:33.879 but he is Morgan Stanley's chief strategist for public policy 0:00:34.360 --> 0:00:38.360 and municipal bonds. If you are at all an investor 0:00:38.600 --> 0:00:43.199 in the fixed income portion of assets, if you're curious 0:00:43.240 --> 0:00:48.320 as to what goes into the bond buying decision, how 0:00:48.360 --> 0:00:53.160 how the by side actually thinks about tracks and makes 0:00:53.720 --> 0:00:58.800 allocation decisions, you will find this conversation fascinating, as did I. 0:00:59.760 --> 0:01:02.080 It's a little wonky, it's a little in the weeds. 0:01:02.160 --> 0:01:05.960 It's very very specific, but you would be amazed at 0:01:06.000 --> 0:01:10.680 how many different subjects have to come under the data 0:01:10.720 --> 0:01:15.320 set that muni bond investors look at. Everything from politics 0:01:15.319 --> 0:01:21.160 and public policy, to credit quality, to local economics, to 0:01:21.360 --> 0:01:25.200 macro economics. It's really as well as the federal reserve 0:01:25.280 --> 0:01:27.560 and interest rates, which we didn't even touch on. I 0:01:27.560 --> 0:01:30.680 think everybody has heard enough of that. Obviously, if rates 0:01:30.680 --> 0:01:34.880 are going up or not, it becomes a fairly significant question. UM. 0:01:34.920 --> 0:01:39.000 All told, Mike is a really knowledgeable guy about these things. Obviously. 0:01:39.080 --> 0:01:43.200 Morgan Stanley is a giant firm UH, both in equities 0:01:43.240 --> 0:01:47.279 and UH fixed income and muni bonds. UH. The muti 0:01:47.280 --> 0:01:51.400 bond market is almost four trillion dollars in the United States. 0:01:51.760 --> 0:01:56.600 Other countries have their own version of municipal bonds. UH. 0:01:56.640 --> 0:01:59.919 It's it's really very interesting and it touches on areas 0:02:00.040 --> 0:02:03.200 you might not have been aware of. So, with no 0:02:03.320 --> 0:02:09.359 further ado, here is my conversation with Michael Jesus. This 0:02:09.800 --> 0:02:13.880 is Masters in Business with Barry Ridholts on Bloomberg Radio. 0:02:16.400 --> 0:02:20.600 My special guest today is Michael Zesus. He is Morgan 0:02:20.720 --> 0:02:26.560 Stanley's chief US public policy and municipal bond strategist. He 0:02:26.680 --> 0:02:29.640 joined Morgan Stanley about a decade ago in the role 0:02:29.760 --> 0:02:34.120 of head of credit analysis for their US investment group. 0:02:34.880 --> 0:02:37.960 Previous to that, he worked at Fitch Ratings as a 0:02:38.000 --> 0:02:42.040 credit analyst, and he began his career focusing on the 0:02:42.120 --> 0:02:46.800 public sector capital budgeting and economic development. He comes to 0:02:46.919 --> 0:02:50.840 us with a b a. From Georgetown and a master's 0:02:50.840 --> 0:02:53.960 of Public Affairs from the lb J School of Public 0:02:54.280 --> 0:02:58.160 Affairs at the University of Texas at Austin. Michael Jesus, 0:02:58.240 --> 0:03:00.799 Welcome to Bloomberg. Hey, thanks for having so. We were 0:03:00.840 --> 0:03:03.880 just in Austin. What a fantastic town. Every time I'm 0:03:03.720 --> 0:03:06.600 I'm in there, I'm like, wow, this is really Someone 0:03:06.639 --> 0:03:09.600 described it to me as the blueberry in the middle 0:03:09.720 --> 0:03:12.680 of the Texas raspberry pie. Which or the or the 0:03:12.720 --> 0:03:16.760 third coast, the third Coast, Yeah, definitely, definitely not Dallas 0:03:16.800 --> 0:03:20.359 or Houston the least. You have a really interesting background 0:03:20.400 --> 0:03:24.679 and the transitions that you've gone through are really quite fascinating. 0:03:25.040 --> 0:03:29.120 How do you go from looking at public affairs and 0:03:29.160 --> 0:03:34.240 analyzing credit to running a muni bond portfolio? I would 0:03:34.240 --> 0:03:38.640 say by accident, inadvertently for the most part. So the 0:03:38.680 --> 0:03:42.000 public policy, public affairs was sort of my first intellectual love, 0:03:42.080 --> 0:03:45.360 so to speak. Um through let's say, kind of a 0:03:45.400 --> 0:03:49.760 series of experiences, work experiences, both in college and afterwards 0:03:49.800 --> 0:03:53.840 where I decided and really like the pace um of 0:03:54.120 --> 0:03:58.440 public policy a little too slow, a little yeah, not 0:03:58.520 --> 0:04:02.240 much competition. Um. There were a lot of smart people 0:04:02.240 --> 0:04:04.520 who worked in those areas, but I think the sort 0:04:04.520 --> 0:04:08.520 of pace of bureaucracy, um, it just just wasn't what 0:04:08.560 --> 0:04:10.520 you would want if you were a very ambitious person. 0:04:10.600 --> 0:04:13.120 Let's not say it's not worthwhile work, but it's it's 0:04:13.160 --> 0:04:16.000 kind of academic and slow as opposed to market based 0:04:16.160 --> 0:04:19.719 and and it sort of fall fell into the markets 0:04:19.760 --> 0:04:22.560 based work when I was in grad school or try 0:04:22.600 --> 0:04:24.320 to make a little extra money working for one of 0:04:24.320 --> 0:04:26.920 the credit rating agencies that worked for Fitch down in Austin. 0:04:27.600 --> 0:04:29.360 And that was kind of my first taste. Even though 0:04:29.520 --> 0:04:31.800 rating agencies are not terribly fast placed to work, it 0:04:31.839 --> 0:04:33.280 was my kind of my first taste of kind of 0:04:33.320 --> 0:04:36.000 translating public policy because I was working in munies then 0:04:36.600 --> 0:04:41.279 translating public policy into kind of market based analytics. And 0:04:41.320 --> 0:04:43.200 I got hooked. I got hooked. I stayed there. I 0:04:43.200 --> 0:04:46.640 didn't go into government like I intended to, and you know, 0:04:46.680 --> 0:04:48.400 one thing led to another. I ended up on the 0:04:48.440 --> 0:04:51.800 by side within Morgan Stanley and a couple of years 0:04:51.880 --> 0:04:53.839 later in the role that I have now which is 0:04:54.040 --> 0:04:56.400 running a research and strategy team for munis and now 0:04:56.400 --> 0:04:59.320 public policies. So so let's talk about when you joined 0:04:59.360 --> 0:05:02.640 Morgan Stan Like, you start pretty much right in the 0:05:02.680 --> 0:05:05.720 midst of the credit bubble. You're on a buy side, 0:05:05.880 --> 0:05:10.240 your meaning you're not on the brokeren side selling individual 0:05:10.279 --> 0:05:14.800 bonds to investors, your buying bonds on behalf of investors. 0:05:15.040 --> 0:05:17.839 What was it like to start right in the middle 0:05:17.839 --> 0:05:22.960 of that storm. It was it was scary. It was well, first, 0:05:23.000 --> 0:05:26.360 there's the shock of having a responsibility of managing other 0:05:26.360 --> 0:05:29.880 people's money, which to someone who at the time was 0:05:30.560 --> 0:05:34.240 pretty broke. Um, it felt this kind of huge burden 0:05:34.680 --> 0:05:38.240 that uh, you know, it didn't really completely understand or 0:05:38.279 --> 0:05:40.520 was having trouble grapple with. On top of that, you 0:05:40.520 --> 0:05:42.360 had this kind of big crisis that was just getting 0:05:42.360 --> 0:05:46.720 bigger and bigger. Oh seven. Yet really the very early 0:05:46.839 --> 0:05:50.280 stages of the housing market rolling over, early stages of 0:05:50.720 --> 0:05:53.960 the default starting on on mortgages in some prime starting 0:05:54.000 --> 0:05:57.039 to pick up. Markets were still going higher. You stock 0:05:57.080 --> 0:06:00.440 markets were going higher, as we're bond markets. At what 0:06:00.640 --> 0:06:04.520 point in that baptism of fire did you say, hey, 0:06:04.560 --> 0:06:08.280 this is really an unusual set of circumstances. I was 0:06:08.320 --> 0:06:11.080 initially focused just on Muni's when I was there, so 0:06:11.440 --> 0:06:13.440 we saw some of the telltale signs, were able to 0:06:13.520 --> 0:06:15.720 identify some of them early in the sense that when 0:06:15.760 --> 0:06:19.360 you see corporate credit markets starting to show signs of weakness, 0:06:19.800 --> 0:06:23.920 because there's a lag effect right where government revenues tend 0:06:23.960 --> 0:06:25.920 to kind of trail the real economy. You know, if 0:06:25.920 --> 0:06:28.960 you think about it, if you go buy something at 0:06:29.040 --> 0:06:31.120 your drug store, the sales tax you pay on it 0:06:31.200 --> 0:06:33.320 might not make it into the state's coffers for a while, 0:06:33.400 --> 0:06:35.960 or effectively be spent for a while, So not on 0:06:36.000 --> 0:06:40.560 income tax takes forever. So yea. So the point there, 0:06:41.080 --> 0:06:43.159 we could kind of see what was happening in corporate 0:06:43.200 --> 0:06:46.120 credit markets and it was appropriate to kind of be 0:06:46.200 --> 0:06:49.520 more defensive. So from that perspective, it was easy for 0:06:49.600 --> 0:06:52.080 us to be a little bit defensive. And then that environment, 0:06:52.120 --> 0:06:54.160 you weren't getting paid too much to take a lot 0:06:54.160 --> 0:06:57.839 of credit risk anyway, So so you were buying bonds, 0:06:57.839 --> 0:07:02.680 primarily MUNI bonds primarily for their tax for yields. Was 0:07:02.720 --> 0:07:05.560 that the thinking back then? I mean, yeah, boring, So 0:07:06.160 --> 0:07:09.160 it was a boring approach, but design it's bored, right, 0:07:09.160 --> 0:07:10.800 I was gonna say it's boring, but they're bill to 0:07:10.840 --> 0:07:14.480 be boring. And how big is the muni market in 0:07:14.480 --> 0:07:17.400 the United States. It's tremendous three point seven trillion dollars. 0:07:17.600 --> 0:07:19.720 If you want risk, you can find it in that market. 0:07:20.240 --> 0:07:22.280 Just that wasn't that wasn't the That wasn't the place 0:07:22.280 --> 0:07:24.200 at the time where we went looking on purpose or 0:07:24.200 --> 0:07:25.960 by accident. I mean, we could talk about we can 0:07:26.000 --> 0:07:28.280 talk about Illinois, we could talk about Puerto Rico. Or 0:07:28.360 --> 0:07:30.960 do you mean there's risk that people are wholly unaware 0:07:31.000 --> 0:07:35.720 of because of inflation, credit risk, duration, etcetera. I guess 0:07:35.720 --> 0:07:37.960 I would say all of the above. What you're saying, 0:07:38.200 --> 0:07:40.760 uh there, I mean in any market, there there are 0:07:40.800 --> 0:07:44.200 investors taking risks they don't completely understand, and you know 0:07:44.240 --> 0:07:47.640 that that's what kind of makes them interesting. The muni market. 0:07:47.640 --> 0:07:50.440 The most misunderstood risks that I think are now beginning 0:07:50.520 --> 0:07:55.040 to be better understood are the risks of basically sovereign 0:07:55.080 --> 0:07:59.640 political risk. Right Puerto Rico, Illinois, These are places they 0:07:59.640 --> 0:08:01.960 tell you that the same type of sovereign political risk 0:08:02.040 --> 0:08:05.640 that exists in other countries they exist in the MUNI market. 0:08:05.680 --> 0:08:09.080 Also So what was your take on on the very 0:08:09.120 --> 0:08:13.920 famous Meredith Whitney claim that we're gonna see hundreds of 0:08:13.920 --> 0:08:18.440 of muni bond default state cities, etcetera. That really rocked 0:08:18.480 --> 0:08:21.040 the muni bond market for a while. I I'd say 0:08:21.080 --> 0:08:25.120 that she was right in spirit, but really wrong in magnitude. 0:08:25.600 --> 0:08:27.320 And when I say right in spirit, what I mean 0:08:27.440 --> 0:08:30.600 is that there are some very meaningful long term credit 0:08:30.680 --> 0:08:34.400 challenges to the muni market that, uh, if they're not 0:08:34.480 --> 0:08:38.280 addressed politically, uh, they're going to express themselves in a 0:08:38.320 --> 0:08:41.400 meaningfully negative way, you know, over the medium term, let's 0:08:41.400 --> 0:08:43.080 call it kind of five cent years from now, or 0:08:43.120 --> 0:08:47.200 maybe if they're catalyzed with a big recession. But she 0:08:47.320 --> 0:08:50.080 was wrong in magnitude and timing, and that means a 0:08:50.080 --> 0:08:52.480 lot in market for sure, to say the least. Take 0:08:53.240 --> 0:08:55.760 if you give a forecast. The old joke is you 0:08:55.800 --> 0:08:58.280 could give a dollar level or a date, but never 0:08:58.320 --> 0:09:01.040 both at the same time. Coming up, we continue our 0:09:01.040 --> 0:09:05.280 conversation with Michael Jesus Morgan, Stanley's chief muni bond strategist, 0:09:05.760 --> 0:09:11.520 discussing investing in municipal bonds. I'm Barry Rehults. You're listening 0:09:11.559 --> 0:09:15.320 to masters in Business on Bloomberg Radio. My special guest 0:09:15.360 --> 0:09:19.520 today is Michael Jesus. He is Morgan Stanley's chief Muni 0:09:19.559 --> 0:09:23.520 bond strategist. Let's talk a little bit about the bond world. 0:09:23.840 --> 0:09:27.839 Why do people say the bond market is the smart money. 0:09:28.160 --> 0:09:31.719 I think that there's this kind of romantic romantization. I'm 0:09:31.760 --> 0:09:34.200 not sure if I'm saying it right, but of kind 0:09:34.240 --> 0:09:37.079 of the contrarian right of the person who can kind 0:09:37.080 --> 0:09:41.280 of see risks before they develop and see disasters before 0:09:41.320 --> 0:09:45.080 they develop. And I think bond investors, generally speaking, are 0:09:45.160 --> 0:09:48.000 kind of always looking for that because they've got the 0:09:48.040 --> 0:09:52.760 same price incentive positive price incentive that a stock investor has. 0:09:52.800 --> 0:09:54.439 You know, if you want to see stock prices go up, 0:09:54.480 --> 0:09:56.360 you tend to kind of ignore looming risks. If you 0:09:56.400 --> 0:09:58.120 want to see bond prices go up, you tend to 0:09:58.120 --> 0:10:00.760 focus on those looming risks as you're focused on whether 0:10:00.800 --> 0:10:02.600 or not you're gonna get paid back. It's basically like 0:10:02.640 --> 0:10:06.880 making a loan. So I think in the times that 0:10:06.960 --> 0:10:09.720 the that markets around risk markets take a downturn and 0:10:09.760 --> 0:10:12.360 bond investors look smart, there is this kind of you know, 0:10:12.480 --> 0:10:15.640 lionizing of the bond investor. But the problem is if 0:10:15.640 --> 0:10:17.960 you kind of give in to that kind of perma 0:10:18.000 --> 0:10:20.280 bearish view, you end up losing a lot of money 0:10:20.280 --> 0:10:22.360 in the interim. You know, the opportunity costs of being 0:10:22.360 --> 0:10:25.480 permanently bearish is negative. So I'd say early in my 0:10:25.520 --> 0:10:27.679 career and yesked earlier about what it meant to kind 0:10:27.679 --> 0:10:29.599 of start in the middle of the financial crisis and 0:10:29.679 --> 0:10:31.880 say that was kind of hammered into me just by 0:10:31.880 --> 0:10:34.720 market conditions early that being bearished was kind of the 0:10:34.800 --> 0:10:36.920 right thing to do. It took a while for me 0:10:36.960 --> 0:10:39.320 to kind of unwind that view and embrace a more 0:10:39.400 --> 0:10:42.000 risk taking view, which I think is more having a 0:10:42.000 --> 0:10:44.040 more balanced and sort of flexible approach. It has to 0:10:44.080 --> 0:10:48.520 be more appropriate. So so let's address that perma bear attitude. 0:10:49.200 --> 0:10:51.720 We see it in stocks, but we've been seeing it 0:10:51.760 --> 0:10:55.120 in bonds for forever. I can't count how long I've 0:10:55.160 --> 0:10:58.680 been told we're in a bond market bubble. Interest rates 0:10:58.679 --> 0:11:02.359 have nowhere to go but up. I've heard that literally 0:11:02.440 --> 0:11:06.280 for decades, pretty much my entire career. Uh, this is 0:11:06.320 --> 0:11:09.240 as low as yields are gonna go, the bondbill market 0:11:09.320 --> 0:11:11.719 is over, when in fact it's thirty two years in 0:11:11.760 --> 0:11:14.560 the making, and I don't think we can officially say 0:11:14.559 --> 0:11:19.120 it's ended yet. Yeah, I mean there are mathematical reasons, 0:11:19.600 --> 0:11:22.600 uh to sort of to discount that argument, and then 0:11:22.640 --> 0:11:25.640 there's kind of fundamental economic reasons. You know. The mathematical 0:11:25.679 --> 0:11:29.400 reasons are basically bond investment. You're clipping a coupon. You've 0:11:29.400 --> 0:11:32.720 got some cushion against negative price movement. History tells you 0:11:32.760 --> 0:11:37.080 that if you're underweight bonds, or you're you just own 0:11:37.240 --> 0:11:41.080 very short maturity bonds within a balanced portfolio, that is 0:11:41.120 --> 0:11:44.960 the riskier choice as opposed to something longer that's a 0:11:44.960 --> 0:11:47.520 good credit rating or a good credit risk that you 0:11:47.520 --> 0:11:49.719 could hold to mature. The income you give up by 0:11:49.760 --> 0:11:52.360 doing that in order to make it up later. You 0:11:52.440 --> 0:11:56.480 have to be really right, really fast about bond yields 0:11:56.480 --> 0:12:00.200 going up. And it's not typical that that happens. There 0:12:00.200 --> 0:12:04.480 are the obvious exceptions throughout history. You got your late seventies, 0:12:04.480 --> 0:12:08.160 early eighties, but those are exceptions to the rule. So 0:12:08.160 --> 0:12:12.240 that's kind of mathematical reason. Fundamental reason is unless there 0:12:12.320 --> 0:12:16.120 is some type of exogenous shock to the economic system 0:12:16.400 --> 0:12:18.480 that kind of shocks us into a higher growth rate, 0:12:18.920 --> 0:12:22.320 we're still looking at real growth rates and inflation that 0:12:22.360 --> 0:12:27.120 are relatively low. So the fundamentals don't necessarily support real 0:12:27.160 --> 0:12:30.680 bond yields meaningfully higher from here. And so you know, 0:12:30.760 --> 0:12:32.959 the the big debate this year and sort of the 0:12:33.000 --> 0:12:34.960 end of last year after the election, was where we're 0:12:34.960 --> 0:12:38.000 going to get that exogen a shock because President Trump 0:12:38.040 --> 0:12:40.600 and Republican Congress we're going to deliver a big tax cut, 0:12:40.880 --> 0:12:44.800 big expansion of infrastructure spending. And so if that happens, 0:12:44.840 --> 0:12:47.560 then sure, I think it's valid to say that bond 0:12:47.640 --> 0:12:50.600 yields are are going to go up, But um, you 0:12:50.679 --> 0:12:52.720 have to have a lot of confidence in that view 0:12:52.800 --> 0:12:55.000 and a lot of evidence behind it. Right now we 0:12:55.040 --> 0:12:57.880 don't see either. I can't say I disagree. Let's let's 0:12:57.920 --> 0:13:02.120 fast forward to the current circumstance. I want to pull 0:13:02.160 --> 0:13:05.800 a quote from one of your recent UH notes. The 0:13:05.920 --> 0:13:09.560 prospect of a FED taper to its balance sheet raises 0:13:09.720 --> 0:13:15.599 obvious questions about long term rates. Justice tax reform threatens 0:13:16.080 --> 0:13:19.440 long end MUNI rates, Exactly what you were just discussing about. 0:13:19.840 --> 0:13:23.160 Explain why that is. What is it about tax reform 0:13:23.679 --> 0:13:26.160 that impacts the muni rates, and what is it about 0:13:26.720 --> 0:13:31.120 um the Feds taper that's going to affect shorter term rates. 0:13:31.160 --> 0:13:33.600 So so this this is kind of two components of 0:13:33.640 --> 0:13:36.640 what we call the Trump triple threat to Muni's what 0:13:36.800 --> 0:13:40.040 what's the third threat? So it's fed it's tax reform, 0:13:40.120 --> 0:13:42.480 and well there's basically there's two components of tax reform. 0:13:42.559 --> 0:13:44.800 One is lowering the tax rate, the other is changing 0:13:44.840 --> 0:13:48.960 the tax exempt treatment of MUNI bonds. And is that 0:13:49.080 --> 0:13:52.720 legitimately on the table. We think so? We think so. 0:13:52.760 --> 0:13:55.480 It's not part of any formal plan right now, but 0:13:56.360 --> 0:13:59.320 it's been part of previous formal plans like the Dave 0:13:59.400 --> 0:14:02.920 Camp Plan. It was part of almost every single one 0:14:02.960 --> 0:14:06.679 of Barack Obama's budgets. The not the idea of eliminating 0:14:07.000 --> 0:14:10.559 tax exempt interest, but capping it for high income individuals, 0:14:10.840 --> 0:14:13.679 meaning you can't just buy billions of dollars worth of 0:14:14.040 --> 0:14:16.439 munies and expect to get that income tax. Right there, 0:14:16.480 --> 0:14:19.720 there's basically, without boring you the death on the details, 0:14:19.720 --> 0:14:23.080 you would have to pay staff. Well, think about it 0:14:23.120 --> 0:14:26.400 this way. If you have let's let's look at Barack 0:14:26.400 --> 0:14:29.440 Obama's original plan on this. You want to cap itemize 0:14:29.480 --> 0:14:33.000 deductions and exclusions for high in commuters. So it wasn't 0:14:32.840 --> 0:14:37.160 that what dollar amount. So his proposal was based on 0:14:37.480 --> 0:14:39.840 the tax rate that you pay, so and it was 0:14:39.880 --> 0:14:42.120 for everything. It wasn't muni focus. But think about this way. 0:14:42.160 --> 0:14:44.640 If you are earning a hundred thousand dollars of muni 0:14:44.680 --> 0:14:47.880 interest and you're in the h thirty five percent tax bracket, 0:14:48.120 --> 0:14:50.720 but he wanted to cap the way the amount you 0:14:50.720 --> 0:14:52.720 could enjoy that just the same as someone in the 0:14:52.720 --> 0:14:57.080 twenty percent bracket. Right, hundred thousand dollars muni interest THTC. 0:14:57.200 --> 0:15:00.160 Tax bracket, you're shielded from a thirty five thousand dollar 0:15:00.240 --> 0:15:02.800 tax liability. But if instead they said we want to 0:15:02.840 --> 0:15:06.520 cap you at PENT and you're only shielded from a 0:15:07.080 --> 0:15:10.040 thousand dollar liability, that's seven thousand dollar differences attacks you 0:15:10.120 --> 0:15:14.640 have to pay. So I said, differently, less attractive. Yeah, 0:15:14.720 --> 0:15:17.280 so there's still very much a tax preference in that 0:15:17.320 --> 0:15:19.760 scenario because you're still being shielded from twenty eight thou 0:15:19.960 --> 0:15:22.440 dollars at tax, but there's some level of tax that 0:15:22.480 --> 0:15:24.680 you have to pay, and that's a that would be 0:15:24.800 --> 0:15:27.960 very different to the market where you had something that 0:15:28.120 --> 0:15:30.640 felt purely tax free before. Now there's some level of 0:15:30.680 --> 0:15:33.440 taxation applied to it. But That's just one example. I mean, 0:15:33.480 --> 0:15:36.000 and our view of the reason it's hypothetically on the 0:15:36.040 --> 0:15:41.160 table is because there is a drive to make tax reform, 0:15:41.440 --> 0:15:44.800 to push tax reform as a republican only plan through 0:15:44.840 --> 0:15:51.000 budget reconciliation. Right, that's the procedure by which you can get. Right. 0:15:51.560 --> 0:15:54.600 In order to do that and make the tax cut permanent, 0:15:55.160 --> 0:15:57.360 you have to raise a bunch of money to offset 0:15:57.360 --> 0:16:00.640 the money you're losing by lowering tax To explain that, 0:16:00.800 --> 0:16:03.720 you can do it on a simple majority, if it's 0:16:03.760 --> 0:16:07.320 revenue neutral, if it actually course revenue you need sixty 0:16:07.400 --> 0:16:10.680 votes or is that correct, or if you allow it 0:16:10.800 --> 0:16:14.640 to sunset, so you think about the Bush tax. So 0:16:14.920 --> 0:16:17.080 what you have here is a plan at least the 0:16:17.080 --> 0:16:20.200 one that Paul Ryan is following right now, which he 0:16:20.280 --> 0:16:22.560 claims his revenue neutral based on the assessment, and it 0:16:22.640 --> 0:16:25.400 got from the Tax Foundation, which is a conservative leaning 0:16:25.480 --> 0:16:28.560 think tank. Coming up, we continue our conversation with Michael 0:16:28.640 --> 0:16:33.400 Jesus Morgan, Stanley's chief UNI bond strategists, discussing public policy 0:16:33.760 --> 0:16:37.760 and tax reform. I'm Barry Hilts. You're listening to Masters 0:16:37.760 --> 0:16:40.800 in Business on Bloomberg Radio. My special guest today is 0:16:40.840 --> 0:16:45.080 Michael Jesus. He is chief strategist at Morgan Stanley for 0:16:45.320 --> 0:16:49.440 Municipal Bonds and Public Policy. UH. Previous to that, he 0:16:49.520 --> 0:16:53.200 was a credit analyst at Fitch Ratings. Let's talk a 0:16:53.240 --> 0:16:56.760 little bit about the prospects for tax reform. One of 0:16:56.760 --> 0:16:59.920 your recent notes did something that I don't think you 0:17:00.120 --> 0:17:02.320 guys have done a whole lot in the past. You 0:17:02.440 --> 0:17:07.600 put some fairly specific probabilities on the odds of of 0:17:07.720 --> 0:17:13.200 tax reform actually passing. Tell us about that. So I'm 0:17:13.280 --> 0:17:16.760 always very reticent to put specific probabilities on things because 0:17:17.560 --> 0:17:20.560 what what I worry about is that it implies a 0:17:20.600 --> 0:17:24.159 kind of false precision. Um the old joke about economists 0:17:24.240 --> 0:17:27.199 using two decimal places, it's just to show they have 0:17:27.200 --> 0:17:31.320 a sense of humor. Yeah, exactly. So Yeah, I would 0:17:31.320 --> 0:17:34.480 say two things. One, Investors really kind of demand that 0:17:34.560 --> 0:17:38.120 from us um and too. I sort of understand that 0:17:38.200 --> 0:17:42.880 because what probabilities, as long as they're well defensed and logical, 0:17:42.880 --> 0:17:45.159 will help you do as they help you build some 0:17:45.200 --> 0:17:48.680 logic into your portfolio, into your portfolio strategy. And if 0:17:48.720 --> 0:17:50.880 you have that type of consistency with how you build 0:17:50.880 --> 0:17:55.239 probabilities of different event risks, Um across your portfolio. Then 0:17:55.280 --> 0:17:59.320 whatever story you're trying to tell as an investor is coherent, 0:17:59.680 --> 0:18:02.120 and then the easier to manage risks. So that that's 0:18:02.160 --> 0:18:04.159 the rationale for why we do it. I'd say the 0:18:04.200 --> 0:18:08.560 way that we try and keep our probabilities sane um 0:18:08.840 --> 0:18:11.920 is we you know, we we try and we whatever problem, 0:18:11.960 --> 0:18:15.800 whatever event we're trying to to to forecast here, we 0:18:15.960 --> 0:18:18.919 first try and establish what are the rules of this event, 0:18:19.000 --> 0:18:21.320 like really what how far can this go one way 0:18:21.400 --> 0:18:24.240 or another? We try and established data that kind of 0:18:24.280 --> 0:18:27.399 help us measure kind of prior probabilities, and then we 0:18:27.440 --> 0:18:30.800 try and iterate on those prior probabilities. So you know, 0:18:30.800 --> 0:18:34.800 if you take tax reform for example, um, the sort 0:18:34.800 --> 0:18:39.040 of operative um uh, you know, the the the the 0:18:39.080 --> 0:18:42.480 operative theme that we had to focus on was what's 0:18:42.520 --> 0:18:47.280 possible through budget reconciliation, which is the process that would 0:18:47.280 --> 0:18:52.240 allow Republicans to basically ignore Democrats. And then on we 0:18:52.280 --> 0:18:55.600 had the layer on top of that, given the current 0:18:55.600 --> 0:18:59.040 political conditions, how likely is it that a president and 0:18:59.200 --> 0:19:03.879 the same party can actually execute on their policy priorities. 0:19:03.880 --> 0:19:06.440 So we had to go back and reconstruct data. We went, 0:19:06.680 --> 0:19:09.119 we looked all the way back to presidential elections, going 0:19:09.160 --> 0:19:11.880 all the way back to World War Two. We catalogued 0:19:12.280 --> 0:19:15.240 UM what the main promises were of each candidate eventually 0:19:15.240 --> 0:19:17.400 one and what was the execution rate in their first 0:19:17.440 --> 0:19:20.119 year on office. It was about six, and so we 0:19:20.119 --> 0:19:24.240 were able to iterate UM above and below six based 0:19:24.240 --> 0:19:28.600 on other conditions party agree on on the goals, etcetera. Yeah, 0:19:28.600 --> 0:19:31.560 and I'm simplifying it a bit, and I'm a big 0:19:31.560 --> 0:19:34.479 fan of using kind of too sanity check ourselves. I'm 0:19:34.520 --> 0:19:36.879 a big fan of using Bayes' theorem. I'm also a 0:19:36.880 --> 0:19:38.600 big fan of just kind of asking some of the 0:19:38.600 --> 0:19:41.800 other smart people that we work with UM to find 0:19:41.840 --> 0:19:44.280 base theorem for listeners who may not have a mathematical 0:19:44.440 --> 0:19:47.399 or statistical background. So, I mean, Bayes' theorem is just 0:19:47.480 --> 0:19:50.960 a way of calculating the probability, or at least the 0:19:50.960 --> 0:19:52.760 way we use it, it's the way of calculating the 0:19:52.760 --> 0:19:57.760 probability of an event given given uh the sort of 0:19:57.840 --> 0:20:02.200 prior baseline probability, then relating it to new evidence. So 0:20:02.400 --> 0:20:05.119 if if in any given year, knowing nothing else, the 0:20:05.160 --> 0:20:09.520 probability of a tax reform was five percent, based on 0:20:09.720 --> 0:20:12.280 just how many years you've got the tax reform divided 0:20:12.320 --> 0:20:16.119 by how many years we've been in existence, um, and 0:20:16.160 --> 0:20:18.560 then you sort of iterate for new information, Well, what's 0:20:18.560 --> 0:20:21.840 new information here? New information is that Republicans control the 0:20:21.840 --> 0:20:23.760 White House and both Houses of Congress, and we know 0:20:23.840 --> 0:20:25.520 that sixty percent of the time they can ext you 0:20:25.560 --> 0:20:29.960 on their top priorities. We know that, um, they that 0:20:30.119 --> 0:20:32.600 the reforms they want to pass can go through the 0:20:32.640 --> 0:20:35.800 reconciliation process, so that ups the probability and on and 0:20:35.840 --> 0:20:37.840 on and on. So let me let me throw a 0:20:37.840 --> 0:20:42.000 curve ball at you. What did the failure of Obamacare 0:20:42.080 --> 0:20:46.919 repeal and replace due to your probability stick studies on 0:20:47.119 --> 0:20:50.159 corporate tax reform? So you know, a part of this 0:20:50.280 --> 0:20:53.800 for US is defining a timeline to UM in the 0:20:53.840 --> 0:20:58.520 sense that we think that a failure to pass a 0:20:58.600 --> 0:21:02.320 tax reform and timely fashion this potentially is disappointing to 0:21:02.400 --> 0:21:06.880 investors as just an outright failure. So better late than never, 0:21:07.040 --> 0:21:10.679 but sooner was much better than Yeah. So what happened 0:21:10.960 --> 0:21:13.320 after the kind of let's call it the hereto for 0:21:13.480 --> 0:21:17.840 failure to repeal and replace Obamacare was, uh, it was 0:21:18.040 --> 0:21:19.879 it's sort of failure to pivot on the part of 0:21:19.920 --> 0:21:23.320 the Republicans right, we said they need to fisher cut bait, 0:21:23.359 --> 0:21:25.040 whether or not the fish or cut bait, and moved 0:21:25.080 --> 0:21:26.600 to tax reform. Is going to tell you a lot 0:21:26.600 --> 0:21:29.520 about the timing of tax reform and the content of it, 0:21:30.080 --> 0:21:32.479 and they appear to have tried to do both. They 0:21:32.480 --> 0:21:34.560 said they're going to focus on tax reform, but they 0:21:34.560 --> 0:21:37.960 haven't given up on the legislative process, and so that 0:21:37.960 --> 0:21:41.320 that pushes the timing of tax reform back. They've also, 0:21:41.760 --> 0:21:46.120 in our view, tried to overcorrect for what happened um 0:21:46.160 --> 0:21:48.879 in A c A by opening up the process. So 0:21:48.920 --> 0:21:51.399 now they're gonna have hearings. Now they're going to engage 0:21:51.440 --> 0:21:54.280 Democrats in at least try a bipartisan or at least 0:21:54.280 --> 0:21:55.800 they say they're going to try a bart who knows 0:21:55.840 --> 0:21:58.240 what they really want to do. All of that adds 0:21:58.280 --> 0:22:01.240 time to the clock. All of that rolls the possible 0:22:01.280 --> 0:22:05.000 details of tax reform. None of it improves the probability 0:22:05.000 --> 0:22:08.920 of success, but because it pushes back timing, the probability 0:22:08.920 --> 0:22:11.320 of success within a timely manner has gone down in 0:22:11.359 --> 0:22:14.320 our view. Coming up, we continue our conversation with Michael 0:22:14.560 --> 0:22:20.119 Jesus Morgan Stanley's chief muni bond strategist discussing the municipal 0:22:20.200 --> 0:22:23.680 bond market. I'm Barry rid Helts. You're listening to Masters 0:22:23.680 --> 0:22:27.639 in Business on Bloomberg Radio. My guest today is Michael Jesus. 0:22:27.840 --> 0:22:31.840 He is Morgan Stanley's chief strategist for municipal bonds and 0:22:32.000 --> 0:22:35.120