Taxpayers Soon to Bailout Failing US Cities

Some down-and-out US cities are on the cusp of defaulting on their debt, which means financially encumbered states and taxpayers alike, will have to pay dearly. It was recently projected by the National League of Cities, municipal governments will most likely generate $56-$83 billion, between now and 2012, paying for decades of “binge spending.”

Municipal bonds, which are utilized to fund public projects (roads, public buildings), “have historically been seen as one of the safest places to invest, which is why 80% of municipal bond holders are individual households and mutual fund investors,” said Jeffrey Cleveland, a municipal bond analyst with Payden & Rygel Investment Management.

And while municipal defaults are steadily on the rise—the trend is expected to continue. Last year alone, 183 borrowers, most of them “risky” municipal issuers such as suburban developers in Florida, failed to make $6.4 billion of payments. This is, according to Distressed Debt Securities, a far cry from 31 defaults on $348 million only two years prior. And while only one city has actually defaulted within the past year, according to Matt Fabian, Municipal Market Advisors’ managing director, this could easily increase thanks in large part to unemployment, extremely low consumer spending, bad choices made by city officials and underfunded public pensions.

Presently, the cities hurting most financially include Jefferson County in Alabama, Detroit and Harrisburg in Pennsylvania. Jefferson County is roughly $5 billion in debt in large part, due to its 2003 refinancing of fixed-rate bonds and its corrupt local government. The city may soon file for Chapter 9 bankruptcy. To make amends for its 2010 budget shortfall of $280 million, the city of Detroit issued $250 million of 20-year municipal notes back in March. This issuance followed city officials’ warning—without financial improvement, Detroit may have to declare bankruptcy. Earlier last year, Michigan took over the Detroit Public School System, which faced a budget deficit greater than $300 million.

Meanwhile, Pennsylvania owes $68 million in bond interest payments this year, roughly $3 million more than its entire annual budget. The Harrisburg Authority has been unable to make payments and the county government, which paid a hefty $775,000 swap fee last year, is presently suing for the funds. And while the mayor of Harrisburg has said the city won’t declare bankruptcy, the governor has vowed not to bail Harrisburg out.

There is currently no standard operating procedure whatsoever for a city or county default. In some cases bankruptcy may not be the best option. For example, the city of Vallejo, in California, has been in Chapter 9 bankruptcy for two years.