A Trillion Reasons to Cry

The June 20^th Washington Post: “The obligations of state and local governments have doubled in the past decade, to $2.4 trillion, according to a recent Federal Reserve report, a figure that excludes more than $1 trillion in unfunded pension and retiree health-care liabilities.” Back in January of 2008, long before the world’s economy melted, the Government Accountability Office described the pre-crash problem in seemingly gentle terms: “Still, many [state and local] governments have often contributed less than the amount needed to improve or maintain funded ratios [for retiree benefits]. Low contributions raise concerns about the future funded status. For retiree health benefits, studies estimate that the total unfunded actuarial accrued liability for state and local governments lies between $600 billion and $1.6 trillion in present value terms. The unfunded liabilities are large because governments typically have not set aside any funds for the future payment of retiree health benefits as they have for pensions.”

And then the state and local property tax, income tax and sales tax base blew up as home values collapsed forcing many into foreclosure, unemployment and economic contraction pulled back income and people just stopped buying! While some states – like Arizona – have begun changing the retirement benefits for current workers (which will become the rule across the nation in the near term) by extending the retirement age, for those fractured cities and states dealing with workers who have already retired with vested benefits, the only exit may be bankruptcy. And the situation is only getting worse; on April 19^th, the Franklin Center for Government & Public Integrity figures that by 2013, that $1 trillion of unfunded state and local benefits pushes out to $1.2 trillion. And when bankruptcy hits, there are a lot of pensioners (happy with the defined benefit retirements plus cost of living escalators) in for a very rude shock, a betrayal on the order of magnitude faced by a Bernie Madoff investor.

We’re going to see cities, towns and states hit walls a few at a time… until there is a flood. The signs are out there. A few have already fallen recently: Pontiac, Michigan, Vallejo, California, Central Falls, Rhode Island and even Jefferson Country, Alabama’s largest county. Since 1980, there have been 245 Chapter 9 (municipal) bankruptcy filings. An example of one more that is about to trickle is the insolvent capital of Pennsylvania, Harrisburg. “The debacle is pushing the 150-year-old state capital toward default. The fiscal crisis has shaken the city, which over the past decade has spruced up its riverfront downtown and created tourist attractions in large part through low-cost financing afforded by municipal bond sales. In one notorious example, former mayor Stephen R. Reed spent nearly $8 million from the public authority tha t owns the incinerator to buy wagon wheels, rifles and other memorabilia for a Wild West museum that never opened. And like a homeowner who binged on cheap financing, this city is underwater financially. ‘The truth is, we are already insolvent,’ City Controller Dan Miller said.” The Post.

They have a $68 million loan due at the end of the year, a sum that exceeds the entire city budget for the year, and no clear path to find a substitute lender. They borrowed to spruce up the city, pay for a new garbage incineration system that went way over-budget… well they acted like lots of Americans who could only see a rising economy as far as the eye could see. Even with massive tax and service fee increases and tons of layoffs and cutbacks, Harrisburg is unlikely to survive without filing for some kind of official bankruptcy or insolvency protection.

But the bigger picture is what happens to municipal bonds in general. Picture a few defaults and how investors, who have always thought tax free munis were safe and efficient, will react. What happens to the ability to place school and infrastructure bonds? What happens to the ability of state and local government to construct new and replacement roads, bridge, dams, mass transit, senior housing, parks, libraries, playgrounds… well the list is endless? Paying off bondholders has been sacred; failure to honor those debt obligations could easily spell the end of a state’s ability to build larger, longer term projects.

Even where cities have gone under, states have stepped in to make the bondholders whole: “In the past, the bond market's importance motivated officials to do all they could -- including raising taxes and cutting services and personnel -- to make payments. If cities miss payments or show severe fiscal stress, their bond ratings are cut, significantly increasing borrowing costs and making it more difficult to emerge from debt. Even when municipalities file for bankruptcy, ‘the tradition is that bondholders get paid in full,’ said James E. Spiotto, a Chicago lawyer specializing in public financing. ‘The reason is that without access to the bond market, cities can't function.’ When municipalities couldn't help themselves, their states usually stepped in. Cleveland defaulted on more than $15 million in bonds in 1978 but was able to refinance them not long after. Also in the 1970s, New York was lifted from a financial hole with state help. More than a decade later, Pennsylvania bailed out Philadelphia.” The Post. But today, there are 39 states with their own deficits to bear; the luxury of paying off the debts of a defaulting city may no longer be in the cards.

As we look out the window and warily eye European defaults and a moribund domestic real estate market, as we watch the unemployment needle staying in place and the future job picture focus on the lower paying end of the employment spectrum, it’s easy to miss the elephant in the room: the rapidly deteriorating state and local economic options. The feds can increase the money supply (print money); the states and local cities just go under. The impact can shatter any hope for a foreseeable recovery, and only the federal government has the tools to begin to deal with this mega-crisis.

And when you read this little ditty on the federal government that appeared in the June 22^nd Los Angeles Times, you’ll feel so much better: “As the Senate scrambles to scale back a $140-billion recession relief bill, the poor, the elderly and the unemployed are bearing the brunt of the squeeze. But NASCAR track developers, movie producers and other special interests are likely to escape unscathed… Those businesses stand to gain $32 billion in tax breaks as part of the bill, which has been stalled for weeks because of rising complaints about deficit spending.

“In the hunt for ways to cut costs, neither party has proposed curbing the panoply of narrow tax preferences, which Congress has routinely extended each year… Instead, Senate leaders have proposed a $25 cut in weekly unemployment benefits; temporarily allowed a 21% cut in Medicare fees for doctors; and are planning to withhold or scale back $24 billion in payments many states expected to help pay for Medicaid for the poor.” Yeah, I didn’t think so!

I’m Peter Dekom, and sometimes the obvious can kill you.