The nightmare scenario?
In interviews I’ve conducted in the last year there’s been a fear on the lips of finance and government experts.
Their worst-case scenario fear is this: staggering under an unpayable burden of bond debt, municipalities around the country will begin to stream to bankruptcy court, and the bond insurers will go broke.
With Detroit’s bankruptcy filing you have to wonder if this fear is now playing out.
Is a stigma against municipal bankruptcy lifting? Will other large and small distressed municipalities across the country follow Detroit’s example?
Government-based observers understand the deeper problem.
For the last decade we’ve seen a debt-hobbled federal government push obligations and debt down the pipe to state government. The state governments in turn have pushed these service and debt problems downstream to local governments.
Harrisburg, like other local governments, turned to the bond market to plug holes in its general fund budget so taxes wouldn’t be raised.
Often the state all too willingly helped to pass the debt burden off to the local governments.
“As the states were pushing the costs to the local governments, the states were also approving these (bond) borrowings,” one public-private partnership expert points out to me.
“The state was also instrumental in removing all obstacles so that these borrowings could happen. The states played a much bigger role in these municipal problems than the general public realizes, or that the states want the public to realize.”
At hearings last fall in Harrisburg, for example, Pennsylvania Department of Community and Economic Development officials testified about how they essentially ignored red flags while they approved questionable bond borrowing again and again for Harrisburg.
We’re now seeing this spigot of funds drying up from the bond market. Local tax bases are dissolving, and it’s obvious local taxpayers can take no more of the burden.
The risk now is that municipalities will be rushing to bankruptcy court in droves to free themselves from the resulting bond, salary and pension debt obligations that were pushed on them, often, by the state and federal governments.
Why should we be worried?
For years the municipal bond market operated on several predictable assumptions.
Municipalities would never default on their bonds.
General obligation bonds, backed by the full credit and taxing power of the municipality, could and would always be paid, simply by raising taxes.
Municipal bonds, sold and bought under these assumptions, were thought to be safe and predictable investments, the old reasoning went.
With Detroit in bankruptcy court, and other municipalities, including perhaps Harrisburg, PA, not far behind, those old assumptions are going out the window.
In many ways, Detroit’s bankruptcy and Harrisburg’s insolvency represents a brave new world for specialists in public finance, and governance.
It’s population and tax base shrinking, its debt and unfunded pension obligations growing, Detroit’s problems in many ways are unique.
But in other ways, its problems aren’t so unique to other cities and localities.
Now the unspoken fear is starting to bubble up in the press, at least in passing:
“Officials in other financially troubled cities may feel encouraged to follow Detroit’s path, some experts say,” reports The New York Times today.
“Bankruptcy Bodes Ill for Market,” the industry broadside The Bond Buyer’s headline read yesterday. “The implications for the muni market appear potentially ominous.”
The Wall Street Journal today writes, “Muni-Bond Investors Wary, Not Surprised, by Detroit Bankruptcy: Treatment of General-Obligation Issues Rankles.”
“Bond investors are particularly rankled that the city appears poised to seek significant cuts on general-obligation bonds, which are backed by a municipality’s taxing authority,” the WSJ reports. “Previously, this debt has been considered one of the safest types of munis.”
The bond insurers and sellers and buyers obviously hoped bankruptcy judges would see things their way. But it’s becoming obvious no judge will ask a poor resident of Detroit, or Harrisburg, to pay more taxes.
The real-world concern is that bond insurers now must pick up this slack, and pay the stiffed bond investor the difference.
The question is this: how deep are the pockets of the bond insurers if suddenly dozens of municipalities rush to bankruptcy court?
Last month, on June 17, The Bond Buyer published an article titled, “Detroit Default Shines A Light on Bond Insurers.”
“The fiscal condition of the insurers could play a role as negotiations play out over the next month, market participants said,” The Bond Buyer wrote.
I’ve been asked whether Detroit’s bankruptcy filing may make it easier for Harrisburg’s receiver to seek concessions from Harrisburg’s creditors, especially its bond insurer, Assured Guaranty Municipal (AGM).
Those with knowledge of Harrisburg’s financial predicament suspect just the opposite is true.
For AGM’s managers, recent developments have to be scary.
The smart play of the bond insurer might well be to throw itself on the mercy of a bankruptcy judge, and point out there’s a finite amount the bond insurers can pay, without going broke itself.
Meanwhile, local government debt continues to grow.
“Could this be the next debt bubble that plays havoc with the broader American economy?” one financial expert recently wondered aloud to me.
“Could this growing municipal debt problem cause the next stock market crash?” this expert asked. “Could it throw (Fed Chairman Ben) Bernanke off his chair? I could see these things happening.”
While all this plays out, we’re left to ponder the wisdom of those who continue to do the same-old thing, as if there is no problem.
Does it really make sense for the Lancaster County Solid Waste Management Authority to float upwards of $150 million in bonds to buy the troubled Harrisburg incinerator, in essence throwing good money after bad?
As NewsLanc has reported, the state recently approved a new municipal bond program, “The City Revitalization and Improvement Zone,” which communities like Lancaster seem to be clamoring to join.
How wise is that?
Perhaps now is a good time for local officials to step back, and stop borrowing money like there’s no tomorrow.
