The Other Really Big Bubble.

 

 

Municipal Bankruptcy – What if every major city in America declared bankruptcy? Who would bail them out? What if the Student Loan bubble bursts in a few months, or if Congress fails to extend the low interest rates this coming July, or the US Banks are really over-extended in Europe? Interesting questions.

As I had posted earlier a few times, the future of American cities now hangs in the balance, as the truth starts to seep out and the predictions of street analyst Meredith Whitney — on 60 Minutes in December, 2010, that there would be 50 to 100 sizable municipal bond defaults — have started to become famous, because she was right. She may have been off a year or so, but her view is now coming true all over America. Mostly because of run-away pension costs, but also due to amazing acts of administrative stupidity: a $300+ Million incinerator program in Harrisburg, PA that the city had no funds to pay for, or a $4.23 Billion deficit due to un-funded infrastructure spending in Jefferson County, Alabama.

Her predictions came just at a time when federal stimulus money that helped states weather the recession was scheduled to end. States then started passing the fiscal pain down to localities by cutting aid to them. Meanwhile, localities had already been through several years of belt-tightening, with the worst yet to come: the likelihood that property taxes will decline in 2011 and beyond.

The culprit is a decade of over-spending by governments, especially on pension guarantees, and an economic slowdown that refused to flip into a robust recovery. The money just isn’t there. And it’s not going to be there even if local governments raise taxes while cutting employees and services to the bone.

Chriss Street was the treasurer of Orange County, Calif., from 2006-2010. And back in 1994, he warned that Orange County was headed for what would become, in November that year, America’s worst municipal bankruptcy. People didn’t listen then. They’re not listening now.

“State and local government revenues are taxes and fees on the private sector and housing,” Street said. “The bulk of this tax collection is subject by law to an approximately 18-month lag in collection. The recovery in real estate peaked out in November 2010 and economic activity peaked around April 2011. Both real estate and the economy are in substantial decline.” Therefore, tax collection will be falling all through the first half of 2013, and probably beyond.

“Most states, counties, cities and school districts have spent their cash reserves down to the legal minimum,” Street said. “When I speak at national conferences on municipal finance, I ask the question: ‘How many of you have made contingency plans for another 15 percent decline in revenue in the next year?’ I have never gotten a hand raised. Consequently, it is my belief that there is the potential for thousands of defaults in the 50,000 municipal bond issuers in the United States.  Most cities can cut spending, but they cannot cut principal and interest payments without default and bankruptcy.” And, why do you care? Maybe you own Bank stocks. Maybe you might look into your Bank’s position relative to Bonds and debt with munis. Just saying.

Do You Know The Way To San Jose.

An example of where so many cities are going is San Jose, Calif. Unlike some small cities facing bankruptcy, such as Central Falls in Rhode Island, San Jose remains highly prosperous. It’s not a dead-end rust-belt town. San Jose enjoyed the dot-com prosperity of the late 1990s, then the real-estate boom of the mid-2000s. The ensuing real-estate bust was milder there than in most places. It still prospers from being part of Silicon Valley, the epicenter of the world computer revolution that’s booming again, despite the global economic slowdown. Apple’s HQ is a stone’s throw away in Cupertino. Facebook is just a little further north in Palo Alto.

But San Jose officials have discussed bankruptcy as a possible option.

Its prosperity turned out to be its undoing. In the November 2011Vanity Fair, financial writer Michael Lewis wrote, “the city owes so much more money to its employees than it can afford to pay that it could cut its debts in half and still wind up broke.”

The problem for America’s 10th-largest city, population 1 million: “The Internet boom created both great expectations for public employees and tax revenues to meet them….  Over the past decade, the city of San Jose had repeatedly caved to the demands of its public-safety unions. In practice, this meant that when the police or fire department of any neighboring city struck a better deal for itself, it became a fresh argument for improving the pay of San Jose police and fire. The effect was to make the sweetest deal cut by public-safety workers with any city in Northern California the starting point for the next round of negotiations for every other city.”

This ratchet effect also struck areas throughout the rest of California and the United States.

According to Mayor Chuck Reed, a Democrat, “Our police and firefighters will earn more in retirement than they did when they were working. There used to be an argument that you have to give us money or we can’t afford to live in the city. Now the more you pay them the less likely they are to live in the city, because they can afford to leave. It’s staggering. When did we go from giving people sick leave to letting them accumulate it and cash it in for hundreds of thousands of dollars when they are done working? There’s a corruption here. It’s not just a financial corruption. It’s a corruption of the attitude of public service.”

While costs have been ratcheting up for San Jose, city staff levels have been ratcheting down. City staff has been cut from 7,450 to 5,400. The number of staff is the same as that of 1988, before the city added another 250,000 residents. By 2014, the number of city staff could be as low as 1,600. Reed warned, “There is no way to run a city with that level of staffing.”

San Jose’s fate could rest on the decision of voters. As Ed Mendel of CalPensions wrote in December 2011, “The San Jose City Council voted 6-to-5 … to place a pension reform measure on the June ballot that takes on what the Little Hoover Commission called ‘the elephant in the room,’ a way to reduce the cost of pensions promised current workers. As state and local governments face rising pension costs while a weak economy forces deep budget cuts, the San Jose council’s plan is the biggest and boldest proposal yet by elected officials to reduce pension costs widely believed to be legally untouchable. Mayor Chuck Reed had talked about declaring a fiscal emergency to reduce pensions earned by current workers in the future. Now he is talking about the city charter specifying minimum benefits provided by the city’s two independent pension systems.

With the economy still underperforming, there will be no rescue for public budgets. There’s no dot-com boom or real-estate bubble on the horizon. As we have seen, those booms were unsustainable anyway, and just encouraged unrealistic expectations about municipal revenues and portfolios.

What has happened is that at least 12 years of delusions finally are wearing off, and everyone is being forced to meet reality. For most governments, the easy fix, if one could do it, would be just to switch all future pensions for current employees to 401(k) plans. And for those facing bankruptcy, the additional fix would be to cut payouts to existing retirees, as Central Falls (Rhode Island) is trying to do. But employee unions, not surprisingly, are resisting any changes to current benefits.

This is the same discussion that is happening all across America in big and little cities and local municipalities. Bankruptcy doesn’t cure any ills for the cities and particularly for its residents. It simply postpones dealing with the reality for a while. And, in the meantime, your city turns into Vallejo, California, where when you call the Police, they tell you to fill out a form and mail it in. Either the administrators raise taxes or the unions cave on decades-old contracts. One of these things, or maybe both have to give and soon, or Meredith Whitney becomes the smartest guy in the room. And, your police and fire suddenly can’t protect you from harm anymore.

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About Steve King

iPeopleFINANCE™ Chief Operating Officer. Former CEO of Endymion Systems, Inc. a $36m Information Systems Services company. Co-founder of the Cambridge Systems Group, the creator of ACF2, the leading IBM Mainframe Data Center Security product; acquired by Computer Associates. IBM, seeCommerce, marchFIRST, Connectandsell alumni. UC Berkeley alumni. View all posts by Steve King

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