Municipal & State Financing? Bad.

Broken CityAnd about to get really, really bad.

I write about economics.  A lot.  And lately there’s been a whole lot to write about especially when it comes to financing cities, towns, counties and states.  Unlike the federal government they operate under some draconian conditions as they generally can’t either run a deficit or print money.  What they have been able to do though, is borrow money cheap.  Really cheap.  From the “municipal bond market.”

Munis have been the vehicle of choice for heaping debt on future generations because they have been historically easy to get and cheap.  The reason they’ve been cheap and easy is because no muni bond holder has ever lost principal on their investment.  Ever.

At this point, if you need some perspective, you can catch up here…

Things are getting tough in the Muni market.  The Bankruptcy Court just certified Stockton’s bankruptcy filing this month.  San Bernardino’s filing is still under review, but even if they aren’t certified the result will be really ugly.

What’s happening in California right now is really the unthinkable.  There is a war on that will most likely end in the Supreme Court and no matter who “wins” municipalities and states that are dependent on muni bonds for financing (and that would be all of them) are going to end up being the losers.

The battle being waged right now is the question of who takes the hit.  Most cities biggest creditors are their employee pension funds and the holders of the bonds they’ve used to finance everything from roads to shopping malls to overdue pension payments from earlier days.

The bondholders think that the pension funds should take a hit and needless to say, the pension funds – and public employees – heartily disagree.  In addition, many states have either laws or language in their state constitutions that render pension funds inviolate.  Based on the recent Stockton ruling the Bankruptcy Court is likely not to agree with that position and in my non-lawyer opinion the Court is on very solid ground.

What’s a virtual certainty is that bondholders are going to get hammered and the only question is, how big is the hammer.  San Bernardino is getting set to start paying into Calpers again and they have no plan to pay any other creditors, including bondholders.

Nearly a year after it halted contributions to America’s biggest pension fund, San Bernardino will resume payments to Calpers at the start of the new fiscal year – but continue to not pay other creditors, according to the budget.

San Bernardino will not make interest and principal payments on $50 million in pension bonds issued in 2005, according to the new budget. …

Both San Bernardino and Stockton are considered test cases in the titanic battle over whether municipal bondholders or current and retired employees will absorb most of the pain when a state or local government goes broke. …

Calpers is opposing San Bernardino’s quest for bankruptcy, the only city to have ever halted payments to the fund. Stockton kept current on its payments to Calpers and the pension fund did not oppose that city’s bid for Chapter 9 protection.

And on the bond side, Moody’s announced today that they’re looking at downgrading $12.5B in currently outstanding muni debt.

NEW YORK (MarketWatch) — Credit rating agency Moody’s Investors Service revised its methodology for analyzing municipal pension obligations Wednesday, in the process placing the credit ratings of $12.5 billion in municipal securities under review for possible downgrade. Those cities under review for downgrade include Chicago, Cincinnati, Minneapolis, Santa Fe, and Portland. Pension liabilities have been a key cause for concern in the $3.7 trillion municipal bond market, with the two most recent cities to file for municipal bankruptcy — Stockton, CA and San Bernardino, CA — both suffering from outsized liabilities.

In other words, the price of borrowing is going up.  I would also expect in the future bondholders will start demanding a lien on revenue streams instead of just hoping that they’ll get paid.

The world of local government is changing and I seriously doubt that the politicians, the unions and the taxpayers are going to be really happy.




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