Clyde’s Problem
Clyde, Texas – a town of fewer than 4,000 – acted responsibly in the blistering summer of 2024, imposing a Stage 3 drought restriction that cut daily water usage by 30%. And the community followed orders – only to discover in short order that each gallon of water saved reduced the revenue earned by the town’s water and sewage utility to service the town’s municipal debt. This resulted in a default that led finance types to view the good stewards of Clyde as good stewards of nothing!
One can see both sides.
On the one hand, you have the ratings agencies downgrading poor Clyde (I love it when a town has a personified name) from A- to D citing the town’s “lack of willingness to pay an unconditional debt” with creditors scrambling for recovery. On the other, the townspeople were suffering through genuine hardship to keep their taps running because without H2O, a town really isn’t much of a town.
A problem that seems to be becoming more and more apparent is capital allocators settling for prospective returns that ignore – or underestimate – the risks baked into their deals. Is this because they think nothing will go awry or is it because their incentives don’t reward worrying about downside so long as there is a chance things can go right? Either way, it creates an artificially low cost of capital to finance overtly risky ventures such as water systems in the desert, luxury real estate below sea level, and any number of other things that leave creditor and borrower alike holding the bag when risk worm turns.
This isn’t to moralize, but rather to point out that sometimes your counterparty isn’t only the person on the other side of the deal. Instead, it might be Mother Nature, an Act of God, or plain Bad Luck (there are a lot of names for things you hate when they happen). Risk is risk because you can’t anticipate or control it, so at least be compensated for taking it.
– Tim
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