There's a growing sense that municipalities - from the largest cities to the smallest towns - may be the next to fall in the ongoing financial crisis that shows no signs of easing. Reason magazine recently opined:
Since 2000 the total outstanding [US] state and municipal bond debt, adjusted for inflation, has soared from $1.5 trillion to $2.8 trillion. The recession didn’t slow the spending.
One reason for the increase in demand for these bonds is that in times of crisis, investors tend to abandon high-risk, high-return assets for safer investments. The presumed reliability of municipal bonds — only U.S. Treasury bonds are considered safer — have made them very attractive. From 1970 to 2006, the default rate for municipal bonds has averaged 0.01 percent annually. And the average recovery rate for those few municipal bonds that have defaulted is also notably high, about 60 percent. In comparison, corporate bonds’ recovery rate is about 40 percent.
Municipal bonds are perceived as safe investments because, like U.S. Treasury bonds, they are backed by the full faith, credit, and taxing powers of the issuing governments. Investors know that states and localities can always raid taxpayer wallets to pay off their debts.
But in the last two years tax and fee hikes have faced greater public opposition. Last year, for example, Jefferson County, Alabama, was unable to raise sewer fees to meet its sewer bond obligation. Since governments are generally unwilling to cut spending either, the result of resistance to new revenue raising has been substantial increases in states’ and cities’ debt levels. Detroit and Los Angeles have announced that they may have to declare bankruptcy, as have a number of smaller cities.
Usually, as a borrower becomes a riskier prospect, lenders start pulling away. At the very least, worried about the prospect of losing their investment to default, they don’t increase the amount they lend.
But municipal bonds have not yet lost their low-risk reputation.
. . .
More important, investors believe cities and states — especially states, which can’t legally declare bankruptcy to escape debts — will resort to anything to avoid reneging on their obligations. And if they default anyway, investors assume the feds will bail them out. Washington already has bailed out the banks, the automobile industry, homeowners, and local school budgets; it isn’t unreasonable to assume that it will decide the states and cities are also too big to fail.
. . .
The parallels with the housing bubble are worrisome. Prior to the meltdown, mortgages were perceived as very low-risk investments. Banks were encouraged through government policies to lend large amounts to people, whether they could afford it or not, and borrowers were encouraged to spend more than they should. Both lenders and borrowers had faith that nothing would go wrong — and that if anything did go wrong, Washington would save the day.
. . .
The state and municipal debt crisis could culminate in a request for the third near-trillion-dollar bailout of the last two years. That much federal borrowing on top of the current debt could very quickly have an impact on interest rates and on the dollar. And at that point, we can just forget about the recovery.
There's more at the link. Bold print is my emphasis. The article's arguments are well-researched and -argued, and I can find no fault in its reasoning.
The Guardian has come out with a similar article from a European perspective.
Meredith Whitney, the US research analyst who correctly predicted the global credit crunch, described local and state debt as the biggest problem facing the US economy, and one that could derail its recovery.
"Next to housing this is the single most important issue in the US and certainly the biggest threat to the US economy," Whitney told the CBS 60 Minutes programme on Sunday night.
"There's not a doubt on my mind that you will see a spate of municipal bond defaults. You can see fifty to a hundred sizeable defaults – more. This will amount to hundreds of billions of dollars' worth of defaults."
New Jersey governor Chris Christie summarised the problem succinctly: "We spent too much on everything. We spent money we didn't have. We borrowed money just crazily. The credit card's maxed out, and it's over. We now have to get to the business of climbing out of the hole. We've been digging it for a decade or more. We've got to climb now, and a climb is harder."
American cities and states have debts in total of as much as $2tn. In Europe, local and regional government borrowing is expected to reach a historical peak of nearly €1.3tn (£1.1tn) this year.
Cities from Detroit to Madrid are struggling to pay creditors, including providers of basic services such as street cleaning. Last week, Moody's ratings agency warned about a possible downgrade for the cities of Florence and Barcelona and cut the rating of the Basque country in northern Spain. Lisbon was downgraded by rival agency Standard & Poor's earlier this year, while the borrowings of Naples and Budapest are on the brink of junk status. Istanbul's debt has already been downgraded to junk.
Whitney's intervention is likely to raise the profile of the issue of municipal debt. While she was an analyst at Oppenheimer, the New York investment bank, in October 2007 she wrote a damning report on Citigroup, then the world's largest bank, predicting it would cut its dividend. She was criticised for being too pessimistic but was vindicated when the bank was forced to seek government support a year later. She has since set up her own advisory firm and is rated one of the most influential women in American business.
US states have spent nearly half a trillion dollars more than they have collected in taxes, and face a $1tn hole in their pension funds, said the CBS programme, apocalyptically titled The Day of Reckoning.
. . .
"Cities are on their own. Governments won't come to their rescue as they have problems of their own," said Andres Rodriguez-Pose, professor of economic geography at the London School of Economics. "Cities will have to pay for their debts, and in some cases they will have to carry out dramatic cuts, such as Detroit's."
Again, more at the link - and, once more, bold print is my emphasis.
Both articles tend to agree on most points except that of a central government bailout of municipalities. I hope and pray that Professor Rodriguez-Pose is correct in the Guardian article when he says that this won't happen. We simply can't afford to pile more debt on the back of Federal taxpayers. If municipalities can't pay for their own debts, they must declare bankruptcy and go to the wall - and yes, this means that their residents will undoubtedly suffer, but that's the way the cookie crumbles. I'm sorry if that sounds cruel or unfeeling, but that's the reality of the situation. After all - why should the entire national economy be imperiled because a few dozen, or a few score, or even a couple of hundred cities and towns spent their way into oblivion? Better they endure the inevitable consequences than that they be allowed to drag the rest of us down with them!
Peter
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