Moody's, Others Worry About Municipal Bankruptcies to Come

Moody's, Others Worry About Municipal Bankruptcies to Come
July 24, 2012

Phil Britt

Phil Britt (spenterprises@wowway.com) writes from South Holland, Illinois. (read full bio)

First Stockton, then San Bernardino. Moody’s Investors Service worries more could be on the way.

Stockton, California, filed for bankruptcy in late June, followed less than two weeks later by another major California city, San Bernardino.

These recent municipal bankruptcy filings signal more cities may be losing their willingness to pay debt obligations, Moody's Investors Service said.

“The looming defaults by Stockton and San Bernardino raise the possibility that distressed municipalities -- in California and, perhaps, elsewhere -- will begin to view debt service as a discretionary budget item, and that defaults will increase,” Anne Van Praagh, a Moody's managing director, said in a published report.

San Bernardino became the latest municipality in California to seek court protection from creditors after the City Council voted for an emergency bankruptcy July 10. It joined Stockton, an agricultural center of 292,000 east of San Francisco, and Mammoth Lakes, a mountain resort town of 8,200, by entering bankruptcy proceedings. Stockton is the largest U.S. city to take the step.

More Defaults Predicted

Meredith Whitney, who runs her own financial advisory firm, predicted in December 2010 that 50 to 100 counties, cities, and towns in the United States would have “significant” municipal bond defaults starting in 2011, totaling "hundreds of billions" of dollars in losses.

Though the 2011 fallout didn’t occur as she projected, the recent filings could show that Whitney simply might have been early in her projection.

“There will be more [municipal bankruptcies], no doubt about it,” said Benjamin Y. Clark, assistant professor of public budgeting, finance and administration at the Maxine Goodman Levin College of Urban Affairs at Cleveland State University.

Government Causes Economic Pain

“One thing that seems to get lost in the national debate about the economy is that a good portion of the job losses or lack of growth we are seeing right now is coming from government. The American Recovery and Reinvestment Act helped keep a whole heck of a lot of states and local governments afloat for a few years. But ARRA has been almost completely wound down now. States, which were also supporting a lot of local governments through intergovernmental grants [often sourced from federal grants, including ARRA] are pulling back,” he said.

He added, “What this means for local governments is that they are now more reliant on their own source revenues. With property values declining, those own source revenues are going to fall -- and local governments across the US are very heavily reliant on property tax revenues, though the specific mix varies from state to state.”

Pension Costs Keep Growing

Pension obligations also have continued to grow while the investments designed to cover those obligations have performed far worse than expected, said Tom Estes, CEO of Covered Bridge Financial Partners, a company that helps restructure the distressed debt of institutions.

“Municipalities don’t have a lot of backstops,” Estes said, explaining that private firms have some financial options not available to municipalities. “Municipalities can’t fall back on the federal government. The largest single liability that municipalities have is the pension fund liability. These costs are growing every year.”

For example, the State of California recently reported an annualized return of 1.5 percent for its pension investments. To cover the obligations, the return needs to be closer to 7.5 percent, according to Estes.

Municipalities must begin to bring pension promises in line with investment realities and make investments that are in line with long-term pension obligations, Estes said. That means making longer-term investments that tend to have lower returns. So any future pension offers have to take these returns into account.

Estes added he agrees with Meredith Whitney that there are many more municipal defaults on the horizon.

Though the federal government has stayed out of the municipal pension issue, there have been some funds that could have been put toward it, according to Estes.

“Rather than putting $900 million into solar panels, the federal government should have put the $900 million into the pension funds,” he said.

Phil Britt (spenterprises@wowway.com) writes from South Holland, Illinois.

 

Phil Britt

Phil Britt (spenterprises@wowway.com) writes from South Holland, Illinois. (read full bio)