Way back on October 13, 2011 I wrote about the coming wave of city bankruptcies.  I quoted several sources which predicted municipal defaults on a large scale.  If you’ve been keeping up with the news you know that the wave is starting to crest.

I.          Recent California City Bankruptcies

In just the last few weeks several California cities have filed for Chapter 9 bankruptcy protection, and many more are close to filing.

A.        Stockton

According to the June 28, 2012 issue of Reuters:

Stockton, California, became the largest city to file for bankruptcy in U.S. history on Thursday after years of fiscal mismanagement and a housing market crash left it unable to pay its workers, pensioners and bondholders.

And all over Stockton you can hear the cheering:  “We’re number one, we’re number one” because they’re the largest governmental entity to file for bankruptcy.  Whoops, not so fast Stockton.  Later in the article we read:

Stockton becomes the nation’s most populous city to file for Chapter 9 bankruptcy. But Jefferson County, Alabama, remains the biggest municipal bankruptcy in terms of debt outstanding, as it had a debt load exceeding $4 billion when it filed in 2011.  Stockton has about $700 million in bond debt.

How do you like that?  What a disappointment!  Beaten by a county in Alabama!  That’s gotta hurt.  I mention the Jefferson County bankruptcy because when I wrote my October 13, 2011 post, I stated that they had only defaulted on their municipal bond obligations, and had not yet filed.  But they came through with a subsequent bankruptcy filing.

By the way, if you read that October 13, 2011 post I hope you heeded my warning and divested yourself of any investments you may have had in municipal bonds.  As the wave of municipal bankruptcies continues, those instruments are going to drop in value pretty quickly.  Some of them already have junk bond status.

For example, the L.A. Times reported that Moody’s downgraded Montebello, California’s municipal bonds to junk status:

Some of Montebello’s municipal bonds have been downgraded to junk status, another blow to a city already teetering on the edge of insolvency.  . . . “This is a city in a heap of trouble,” said Raphael Sonenshein, a political science professor at Cal State Fullerton.  The general fund owes $16.8 million to the redevelopment agency, and is looking at a $1.2 million current-year budget deficit on top of that.  Additionally, the state controller’s office has announced it will audit the city’s finances amid allegations of inaccurate financial statements, and the U.S. Department of Housing and Urban Development has frozen funding to Montebello and demanded that it pay back as much as $5 million in grants due to issues with the handling of the funds.  City officials also are trying to sort out the full story of about $1 million in bond money that flowed through an off-the-books city bank account.

Hmmm.  Do we see a trend here?  Stockton’s bankruptcy was triggered, in part, by “. . . years of  fiscal mismanagement . . .” and Montebello has been cooking the books.  But there is also a systemic problem – other than the corruption that bedecks the public officials.  What is it?  I’ll discuss it later in this post.  For now, let’s go to . . .

B.        San Bernardino

The L.A. Times reported:

San Bernardino officially filed for Chapter 9 bankruptcy protection in federal court Wednesday, just two weeks after the City Council declared insolvency after learning the city would be too broke to make payroll this summer.

Would you buy bonds issued by San Bernardino?  No?  Nor would anyone else.  So what’s a poor city to do?  File for bankruptcy protection, of course.

And yet another California town has filed for Chapter 9 protection in just the last few weeks:

C.        Mammoth Lakes

On July 4, 2012 Bloomberg reported:

Mammoth Lakes, the High Sierra mountain resort, became the second California municipality in a week to seek court protection from creditors, filing bankruptcy to shield itself from a $43 million court judgment.

What a nice way to celebrate the Fourth of July!

II.        Potential Future City Bankruptcies

Here’s a prediction.  We’ve only just started to see what’s ahead.  Other towns that are heading down the road to Chapter 9 include:

A.        El Monte and Compton

According to the L.A. Times:

Faced with a crippling combination of low revenues, high labor costs and decreasing funding from the state, El Monte is moving to declare a fiscal emergency and seek a tax on sugary beverages sold within the city.  The moves come as the city attempts to stave off the financial problems facing a number of cities across California. So far this summer, three cities — Stockton, San Bernardino and Mammoth Lakes — have moved to seek bankruptcy protection, and Compton officials announced the city could run out of cash in a matter of months.

Sweet!  El Monte is going to sweet talk its way out of debt.  With those corrupt officials, I don’t think so.  California has Bell-like corrupt officials all over the state.

B.        Fresno

According to the Fresno Bee:

The recent bankruptcy filings of three California cities have U.S. investors worried that Fresno could be next to go down this road, according to a major Wall Street financial house.  Vikram Rai, strategist with Citigroup Inc., said bond investors are increasingly asking about the financial health of Fresno out of concern that the city will seek court protection from its debt obligations and that millions of investment dollars will be lost.  Stockton, San Bernardino and Mammoth Lakes have filed for bankruptcy protection this summer.  “Investors worry about contagion,” Rai told the Bee. “Many California cities are in a tough situation.”  Fears about Fresno in the trading world were reported in Citigroup’s investment strategy report, which this month said that “the harsh spotlight (of potential bankruptcy) has shifted to Fresno.”

And the problem is not just in California.

C.        Detroit

You knew this one was coming.  The only real question is whether Detroit will be able to afford the bankruptcy filing fee.  Detroit ceased to be a functioning city years ago, and is now a wasteland of human degradation, with its former mayor doing five years in prison.  Here’s what CNN Money has to say about Detroit:

Detroit automakers are back on their feet, showing their best profits in years. But the city of Detroit’s finances are worse than ever.  The city won’t have enough money to pay its bills by April, unless Mayor Dave Bing can get the council and municipal unions to agree to steep spending cuts he’s announced. By the end of its fiscal year in June, that shortfall will hit $45 million.  There is also the possibility that the state may take over the city, which would open the door for Detroit to file for bankruptcy.  That would make it the largest U.S. city ever to suffer that fate.

Take that Stockton!  Detroit is bigger and more corrupt than you are.  But Detroit isn’t the only fiscal disaster area outside of California.  There is also . . .

D.        Miami

I have a warm spot in my heart for Miami because my wife and I lived in Boca Raton for six years; Boca is about fifty miles north of Miami.  Unfortunately, Miami is giving serious heartburn to investors because its finances are in a mess.  Here’s Reuters’ July 28, 2012 take:

Miami officials declared “financial urgency” in a bid to get $40 million in labor concessions from police, firefighters and other union workers, using a Florida law that allows the city to unilaterally alter union contracts, according to media reports.

Financial urgency sounds like a précis of the conditions leading up to bankruptcy.

E.         Rockland County, NY

Huh?  “I’ve never heard of Rockland County,” you say.  Well, there’s a raft of New York localities that are teetering on the edge of bankruptcy.  Here’s the good news from the Times Union:

Athens on the Hudson.  No, not the town south of Albany. There’s a genuine risk of Greek-like financial problems overwhelming New York’s local governments. Yonkers, Rockland County, Newburgh, Nassau County, Suffolk County, Erie County and maybe Albany and a slew of upstate cities and counties are staring at structural budget gaps, deficit borrowing, control boards and bankruptcies. And if nothing is done, it’s going to get worse.  The culprits are known. For decades there’s been wide acceptance of budget gimmicks that come down to borrowing money or selling assets to pay for the day-to-day operation of government. Recurring expenditures are paid for with non-recurring revenues and borrowing. Call it pension smoothing, or certiorari bonds, or asset sales, or spin-ups, or privatization, it’s been the way we’ve done business.  It wasn’t sustainable, everyone knew it. But now the day of reckoning approaches. Just like in Greece, even the most irresponsible of bankers is not going to lend money any more.

There are lots of other cities on the financial skids.  For example, Google “Gary, Indiana’s financial mess”.  And . . .

Enough, already!  You get the idea.  U.S. cities are headed for insolvency in droves.  By the way, so are the states.  And don’t get me started on the federal government, which is a financial disaster area of epic proportions.

III.       The Causes

There are several key causes of the aforementioned messes.  I already stated the first:  corrupt politicians – how many politicians does it take to screw in a light bulb?  It can’t be done because the politicians are unavailable, since they’re already too busy screwing their constituents.

The second was also mentioned:  tanking real estate values have reduced tax revenues.

But the 800-pound gorilla in the room is the same thing that led GM into bankruptcy.  Absurd unfunded commitments.

I remember the regular strikes called by the UAW in the sixties.  (Yes, I remember the sixties, pace George Carlin’s well-known witticism.)  The UAW got amazing concessions from GM, so much so that a gag on the old TV comedy show, Laugh-In, went something like this:  Talks between the UAW and GM stalled this week when, after having successfully reduced the work day to fifteen minutes, the UAW demanded a fifteen minute coffee break.  While that joke was, admittedly, a bit of an exaggeration, it caught the gist of the problem.  GM was making what it viewed as short-term concessions, without making long-term plans to fund the obligations it was assuming.

GM agreed to golden retirement plans that included Rolls-Royce (not Cadillac?) medical benefits, without setting aside the funds to cover those future obligations.  Apparently, GM’s executives at the time had the Louis XIV philosophy:  “Aprés-moi, le déluge.”  Of course, those chaps were long gone by the time the financial chickens came home to roost.

And so it has been with the venal politicians who have given golden retirement plans to government workers without providing for those future obligations. I do not begrudge a hardworking government employee reasonable compensation for services rendered.  But when the city fathers and mothers commit taxpayers to pay large sums without making any plans for those future commitments, we are guaranteed the fiscal messes described above.

Here’s my prediction:  either we will see a huge wave of municipal bankruptcies during the next couple of years, or the federal government will try to bail out the municipalities and completely debauch the currency in the process.

What are you to do about this cheery news?  If you have a lot of debt, get rid of it, and don’t invest in municipal bonds.  Instead, invest in gold, which holds its value against any and all other standards.  If you have a lot of debt, hire a good bankruptcy attorney to help you clean the slate.

Stay tuned.