The bankruptcy of Detroit has been met with a big yawn except for the folks whose fates are dependent on the outcome - creditors, bondholders and public sector unions. States and cities do not have a printing press like the Federal government. While Fedzilla may have at least a temporary capacity to print its way out of overspending, municipal debt is an entirely different issue.
Much to the chagrin of the states and especially public sector unions, all bankruptcies are governed by federal bankruptcy laws. There is no such thing as state bankruptcy laws. It doesn't matter if the debt is personal, corporate or municipal, federal bankruptcy laws have consistently held to the premise that secured creditors get paid first and the unsecured creditors are left scrambling for the crumbs which are frequently non-existent.
Municipal bankruptcy is emerging as especially problematic because it's been historically so rare that there is practically no case law governing such bankruptcies.
Generally speaking, municipal debt falls into 2 categories:
Revenue Bonds: these types of bonds are fully secured with real estate, plant and/or equipment. They are generally used for revenue generating projects like water plants.
General Obligation Bonds: GO bonds are not legally defined as secured but they do carry the full faith and credit of the issuing municipality which means that General Obligation bond investors believe that they are in the drivers seat because 'full faith and credit' translates to the government entity having the absolute power to tax until the debt is paid. Therefore, GO bondholders are convinced that they have the absolute right to demand that taxes be increased to pay them. That's the definition of 'full faith and credit'.
Enter - Public Sector Unions The primary reason for municipal bankruptcy is that the municipal entity can no longer afford to pay the pension/benefit packages promised to public employees. While many state constitutions include a clause specifically stating that the states are obligated to pay pension and benefits to public sector workers, it's difficult to enforce, especially when legislative bodies fail to adequately fund those benefits. Politicians are notorious for promising the sun, the moon and the stars to public sector employees in exchange for their votes. Public sector employees are not aware that those same politicians never funded their promised benefits.
Public section unions have now entered the municipal bankruptcy fray claiming that they are indeed senior secured 'lienholders' and their superior lien position trumps that of the revenue and general obligation bond holders.
This is truly a nightmare of a legal situation that is destined to be played out in many cities and states across the nation but the battlefield will be the Bankruptcy Court. Municipal bonds have always been considered very safe and low risk investments. Now that paradigm is being severely challenged. State and cities have borrowed and borrowed for many years for all kinds of things including issuing Pension Obligation Bonds to fund public pension. According to Forbes, outstanding municipal debt totals $2.9 trillion, here. However, The Economist pegged municipal debt at debt at $3.7 trillion, here.
As noted by The Guardian, many other cities and states are "skirting the edge of disaster – unless they find a solution to their pension problems".
Detroit, tip of a vast pensions liability iceberg
Although Detroit is getting all the attention because it's a major city as well as the largest municipal bankruptcy in US history, other cities are apparently in bad financial shape, if not worse shape than Detroit.
20 Cities In Worse Financial Shape than Detroit
1. Compton, Calif. Compton has teetered on the brink of bankruptcy after it accrued a general-fund deficit of more than $40 million by borrowing from other funds, depleting what had been a $22 million reserve.
2. East Greenbush, N.Y. A New York state audit concluded that years of fiscal mismanagement — including questionable employment contracts and illegal payments to town officials — left East Greenbush more than $2 million in debt.
3. Fresno, Calif. Fresno had the ratings of its lease-revenue bonds downgraded to junk-level by Moody's, which also downgraded its convention center and pension obligation bonds due to the city's "exceedingly weak financial position."
4. Gulf County, Fla. Fitch Ratings warned that Gulf County's predominately rural economy is "narrowly focused," with income levels one-quarter below national averages and economic indicators for the county also comparing unfavorably to national averages.
5. Harrisburg, Pa. Harrisburg is at least $345 million in debt, thanks largely to municipal bonds it guaranteed in order to finance upgrades to its problematic waste-to-energy trash incinerator.
6. Irvington, N.J. Irvington has a violent crime rate six times higher than New Jersey's average, with Moody's citing "wealth indicators below state and national averages and tax-base and population declines due to increased tax appeals and foreclosures."
7. Jefferson County, Ala. Jefferson County, home to the city of Birmingham, has been dealing with the collapse of refinancing for a sewer bond. It filed for bankruptcy protection in 2011 over a $3.14 billion sewer bond debt.
8. Menasha, Wis. Menasha defaulted on bonds in 2007 it had issued to fund a steam plant which has since closed and left the city permanently in the red and, as of 2011, had $16 million in general fund revenue, but had $43.4 million in outstanding debt.
9. Newburgh, N.Y. Newburgh was cited by Moody's for "tax base erosion and a weak socioeconomic profile," with 26 percent of its population below the poverty line and its school district facing a $2 million budget gap.
10. Oakland, Calif. Oakland is trying to get out of a Goldman Sachs-brokered interest rate swap that is costing it $4 million a year. According to a recent city audit, Oakland has lost $250 million from a 1997 pension obligation bond sale and subsequent investment strategy.
11. Philadelphia School District, Pa. Philadelphia's school district, the nation's eighth-largest, faces a $304 million deficit in its $2.35 billion budget, and is seeking $133 million from labor-contract savings to prevent further cutbacks.
12. Pontiac, Mich. Pontiac, where the emergency manager has restructured the city's finances, was downgraded by Moody's, reflecting the city's history of fiscal distress and narrow liquidity.
13. Providence, R.I. Providence, rumored to be filing for bankruptcy for more than a year, experienced consecutive deficits through fiscal 2012, has a high-debt burden and significant unfunded pension liabilities, as well as high unemployment and low income levels.
14. Riverdale, Ill. The credit rating for Riverdale is under review by Moody's because the city has not released an audit of interim or unaudited data for the year that ended April 30, 2012.
15. Salem, N.J. Salem is under close fiscal supervision after it issued bonds to finance the construction of the Finlaw State Office Building, which was delayed by construction issues, and its leasing revenues are not enough to cover the debt payments and the maintenance fees.All of the above cities and counties did something monumentally stupid and fiscally irresponsible. Illinois and Chicago have pretty much been dubbed 'walking bankruptcies' by many informed financial pundits. Even Time wrote a piece titled Why Illinois is Going Bankrupt, Squeezy the Pension Python has its grip around the Land of Lincoln.
16. Strafford County, N.H. Strafford County regularly borrows money to cover its short-term cash needs after it spent two-fifths of its budget on a nursing home, which lost $36 million from 2004 to 2009.
17. Taylor, Mich. Taylor has a large deficit and is vulnerable due to significant declines in the tax base, limited financial flexibility, and above-average unfunded pension obligations.
18. Vadnais Heights, Minn. The Minneapolis suburb of Vadnais Heights had its debt rating downgraded to junk last fall by Moody's after the city council voted to stop payments to a sports center financed by bonds.
19. Wenatchee, Wash. Wenatchee defaulted on $42 million in debt associated with the Town Toyota Center, a multipurpose arena, and has ongoing financial issues due to the default.
20. Woonsocket, R.I. Woonsocket faces near-term liquidity shortages necessitating an advance in state aid, a high-debt burden and unfunded pension liabilities, with Moody's citing the city's continuing difficulties in making spending cuts because of poor management and imprecise accounting.
Public employee unions are a powerful force in heavily Democratic Illinois, and they have not only clout but the law on their side. The contracts that grant retirement benefits to public employees are guaranteed by the state constitution, the unions argue. Such promises must be kept.Many US cities and states will become "Greece" - meaning out of cash, out of credit and out of taxpayers to plunders. When that happens, it's the bankruptcy courts that will be making the decisions on who gets paid and who gets stiffed. Such decisions are not decisions that any bankruptcy judge will welcome, especially since municipal bankruptcies are far more painful than routine "I want to stiff my creditors and walk away from my debts because I'm broke", the typical corporate or personal bankruptcy triggers.
Meanwhile, in Detroit the drama intensifies as the first order of bankruptcy business is for the court to rule whether or not Detroit is eligible for bankruptcy protection because bankrupt absolutely includes a legal discharge of debt. This quite naturally has incurred the wrath of creditors.
Creditors face deadline in Detroit bankruptcy case
Banks, bond insurers, employee pension systems and others standing to lose big if a federal judge declares Detroit insolvent are expected to legally file their objections to the largest municipal bankruptcy in US history.....Whatever the outcome of Detroit's fiscal nightmare, the only certainty is that there will be more Detroits. There's just way too much easy money debt that has grown into mountains that are chasing the ever dwindling ability to pay it.
A multi-day hearing on the eligibility question is scheduled to start on October 23.
Image credit: http://blogs-images.forbes.com/daviddisalvo/files/2012/03/bankruptcy.jpg