The bones of Meredith Whitney’s failed municipal default prediction have been picked clean. Critics scoff, while defenders note she just had the wrong “D,” as municipal downgrades rose to precarious levels in 2011.
As wrong as she turned out to be, not everyone got off scot-free, and high profile defaults did occur, spooking markets and piquing analysts about where city governments went so wrong.
And as SmartMoney’s Real Time Advice blog notes, cracks in the muni space are once again beginning to show.
“Exhibit A: So-called lease bonds, which are backed by revenue from rental payments on city facilities, are now defaulting at almost 10 times the rate of traditional municipal bonds,” writes the blogger Jonnelle Marte. “Experts say many other types of revenue bonds that rely on income from city projects, such as a football stadium or retirement home, are also struggling to keep up with payments.”
She quotes Patrick Early, chief municipal analyst for Wells Fargo Advisors, when explaining that the problem is twofold: “The sluggish economy has made it difficult for many of these projects to generate enough revenue, and issuers of these bonds are limited in what they can do to make up for a shortfall. For instance, a transportation authority can raise a toll to help cover bond payments, but if fewer people drive on the bridge that charges the toll, the fee hike might still not be enough to cover debt. State governments, on the other hand, can take other steps, such as raising taxes or cutting services.”
Was Whitney’s prediction simply delayed, rather than dismissed? Fingers crossed as we look back at five recent municipal defaults to glean what we can.
1) On Nov. 10, 2011, Alabama wasn’t so sweet to those who call it home. Jefferson County, which includes the city to Birmingham, had defaulted on $4 billion of financial obligations—the worst municipal default in U.S. history at the time.
Noah Rothman, writing for political news site Politicology at the time, noted the county simply went in the sewer.
“The county voted to upgrade its failing sewer system in the late 1990s but, as municipal projects funded with state, local and federal tax dollars are wont to do, the costs ballooned and obligations skyrocketed …A deal with JPMorgan Chase to reduce the county's financial obligations though bond auctioning blew up along with much of the economy in the collapse of 2008.”
2) Rhode Island’s catchy marketing slogan, “The biggest little state in the union,” didn’t hold for Central Falls, its smallest city. Desparate to stave off bankruptcy, it fired all teachers at the city’s failing high school in an effort to renegotiate contracts, which garnered national headlines but little else. The trouble stemmed from an $80 million unfunded pension and retiree health benefit liability, nearly quadruple its annual budget of $17 million. However, as Moody's notes, Central Falls somehow muddled through, and continues to pay creditors on time.
3) Unlike neighboring Hershey, Harrisburg, Pa., left residents and investors sour on its bankruptcy last October, with the added embarrassment of being the state capital. It all stemmed from a newfangled trash-to-energy incinerator that didn’t fangle the way city leaders thought.
“This was a last resort,” Mark Schwartz, the city council’s lawyer, said at the time. “They’re at their wits’ end.”
Bloomberg noted that Harrisburg, as guarantor of the incinerator bonds, said it filed to escape lawsuits seeking to force it to make payments. In a “damned if you do, damned if you don’t” scenario, the bankruptcy attempt itself mired the city in expensive, and some said unaffordable, litigation.
4) There are failures, and then there are spectacular failures. What happens when you try to file for bankruptcy as a last resort and judge says no? Ask Boise County, Idaho.
The county that was hit with a $4 million verdict in December 2010 for violating the Fair Housing Act. It tried to duck the judgment by prophesying poverty, but the judge wasn’t buying it, concluding the municipality has “sufficient surplus moneys” to satisfy the judgment and continue services to residents.
All it took was some simple math; the county had excess funds totaling more than $3 million, which, added to $2 million that was immediately available from county trust accounts, provided $5 million.
Noting it was more than enough to pay up, the judge dismissed the county’s bankruptcy case.
5) It wasn’t all bad news in 2011, and a bright spot was the Northern California city of Vallejo—sort of. After declaring bankruptcy in 2008, the city finally emerged last November; however, it was not without pain. According to Capital Public Radio in Sacramento, the city of 120,000 had closed fire stations and cut funding to senior centers, libraries and public works to save money, and worked to find new sources of revenue.”
The author Michael Lewis described the situation as a microcosm of what ails California as a whole—public-sector pensions. Writing in Vanity Fair, Lewis noted, "Eighty percent of the city's budget—and the lion's share of the claims that had thrown it into bankruptcy—were wrapped up in the pay and benefits of public-safety workers."