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Fed’s Dudley Warns about Wave of Municipal Bankruptcies
Wolf Richter www.wolfstreet.com www.amazon.com/author/wolfrichter
It has been a persistently growing, ugly list of municipal bankruptcies: Detroit, MI; Vallejo, San Bernardino, Stockton, and Mammoth Lakes, CA; Jefferson County, AL. Harrisburg, PA; Central Falls, RI; Boise County, ID.
There are many more aspirants for that list, including cities bigger than Detroit. Detroit was the test case for shedding debt. If bankruptcy worked in Detroit, it might work in Chicago. Illinois Gov. Bruce Rauner wants to make Chapter 9 bankruptcies legal for cities in his state, which is facing its own mega-problems.
“Bankruptcy law exists for a reason; it’s allowed in business so that businesses can get back on their feet and prosper again by restructuring their debts,” Rauner said. “It’s very important for governments to be able to do that, too.”
His plan for sparing Illinois that fate is to cut state assistance to municipalities, which doesn’t sit well with officials at these municipalities. Chicago Mayor Rahm Emanuel’s office countered that balancing the state budget on the backs of the local governments is itself a “bankrupt” idea.
Puerto Rico doesn’t even have access to a legal framework like bankruptcy to reduce its debts, but it won’t be able to service them. It owes $73 billion to bondholders, about $20,000 per-capita – more than any of the 50 states. If you own a muni bond fund, you’re probably a creditor. Bond-fund managers use its higher-yielding debt to goose their performance. But now some sort of default and debt relieve is in the works. The US Treasury Department is involved too.
“People before debt,” the people in Puerto Rico demand. It’s going to be expensive for bondholders.
That’s the ugly drumbeat in the background of New York Fed President William Dudley’s speech at the New York Fed’s evocatively named workshop, “Chapter 9 and Alternatives for Distressed Municipalities and States.”
“We at the New York Fed are committed to playing a role in ensuring the stability of this important sector,” he said, referring to the sordid finances of state and local governments. But he wasn’t talking about future bailouts by the Fed. He was issuing a warning to municipalities and their creditors about “the emerging fiscal stresses in the sector.”
It’s a big sector. State and local governments employ about 20 million people – “nearly one in seven American workers.” The sector accounts for about $2 trillion, or 11%, of US GDP. And its services like public safety, education, health, water, sewer, and transportation, are “absolutely fundamental to support private sector economic activity.”
The problem is how all this and other budget items have gotten funded. There are about $3.5 trillion in municipal bonds outstanding. So Dudley makes a crucial distinction:
When governments invest in long-lived capital goods like water and sewer systems, as well as roads and bridges, it makes sense to finance these assets with debt. Debt financing ensures that future residents, who benefit from the services these investments produce, are also required to help pay for them. This principle supports the efficient provision of these long-lived assets.
“Unfortunately,” he said, governments borrow to “cover operating deficits. This kind of debt has a very different character than debt issued to finance infrastructure.” It’s “equivalent to asking future taxpayers to help finance today’s public services.”
In theory, 49 states require a balanced budget every year, but it’s easy enough to “find ways to ‘get around’ balanced budget requirements” and cover operating expenses with borrowed money, he said, including the widespread practice of “pushing the cost of current employment services into the future” by underfunding pensions and retiree healthcare benefits for current public employees.
The total mountain of unfunded liabilities remains murky, but estimates for unfunded pension liabilities alone “range up to several trillion dollars.” With these unfunded liabilities, employees are the creditors. That would be on top of the $3.5 trillion in official debt, where bondholders are the creditors.
And eventually, high debt levels and the provision of services clash as in Detroit and Stockton, he said, and render public sector finances “unsustainable.”
But cutting services to the bone to be able to service the ballooning debt entails a problem: citizens can vote with their feet and move elsewhere, thus reducing the tax base and economic activity further. To forestall that, municipalities may alter their priorities and favor the provision of services over debt payments. “This may occur well before the point that debt service capacity appears to be fully exhausted,” he said.
In other words, the prioritization of cash flows to debt service may not be sustainable beyond a certain point. While these particular bankruptcy filings [by Detroit and Stockton] have captured a considerable amount of attention, and rightly so, they may foreshadow more widespread problems than what might be implied by current bond ratings.
That was easy to miss: foreshadow more widespread problems than what might be implied by current bond ratings. Dudley in essence said that current bond ratings – and therefore current bond prices and yields – don’t reflect the ugly reality of state and municipal financial conditions.
It was a warning for states and municipalities to get their financial house in order “before any problems grow to the point where bankruptcy becomes the only viable option.”
It was a warning for public employees and retirees – in their role as creditors – to not rely on promises made by their governments concerning pensions and retiree healthcare benefits.
And it was a warning for municipal bondholders that their portfolios were packed with risky, but low-yielding securities that might end up being renegotiated in bankruptcy court, along with claims by public employees and what’s left of their pension funds. And it was a blunt warning not to trust the ratings that our infamous ratings agencies stamp on these municipal bonds.
Some states are worse than others. Even with capital gains taxes from the booming stock market and startup scene raining down on my beloved and crazy state of California, it ranks as America’s 7th worst “Sinkhole State,” where taxpayers shoulder the largest burden of state debt. Read… The 10 Worst “Sinkhole States” in America
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Fuck the William Dudley. Like his hands are clean...
If Detroit is their model, it's a mega fail, Detroit is stuck buried in bad debt which can never be discharged and a Socialist parasite majority voter base.
Detroit aint fixed, it's gonna get a lot worse. even with the firehoses of state & federal money
Another Liberia experiment?
“Bankruptcy law exists for a reason; it’s allowed in business so that businesses can get back on their feet and prosper again by restructuring their debts,” Rauner said. “It’s very important for governments to be able to do that, too.”
But not students, I presume?
Unlike the fucking sociopaths making bullshit decrees from the safety of D.C. or Wall Street. I know where the fuck all my local representatives live. Go ahead, fuck shit up at the local level motherfucker. I double dog dare you.
So, politicians, mostly left of center?, use unsustainable promises to munincipal unions to get elected, then dump the whole problem on taxpayers, who leave the city, and finally the promise to the unions is broken through bankruptcy.
Rinse and repeat.
"State and local governments employ about 20 million people – “nearly one in seven American workers.” The sector accounts for about $2 trillion, or 11%, of US GDP."
The absolute root of the problem right there.
That's easy; they'll raid pension funds, raise taxes, and cut services.
The problem is in many communities the real estate taxes and sales taxes are already very high - in a lot of cases the property taxes are a higher expense than a mortgage which is an unprecedented condition in such massive numbers in so many communities
they will hammer the retirees payouts and pension contracts for those still on the job first since they can hire people quickly cheaper since there are no jobs.
then they will go for many other categories - Puerto Rico is a disaster since they had muni tax free status across the USA so the bankers loaded the boat beyond any rational basis
imagine - oil and gas HY / HY gen corp / emerging markets / muni's / all way over leveraged - plus the exposure from rates rising across the board
the entire bond market is a tinder box!
I have a well and pump real water. Is a five gallon bucket of water worth a dollar ... a silver dollar? I guess that depends on how thirsty you are. Same as all the rest of this virtual reality we live in. Someday a fellow will say I don't want your paper for my real product and then all hell breaks loose. Not if but when.
“Bankruptcy law exists for a reason; it’s allowed in business so that businesses can get back on their feet and prosper again by restructuring their debts,” Rauner said. “It’s very important for governments to be able to do that, too.”
Wrong, politician breath.
Get the Fed to print. Seriously. It seems the scam is capable of going on for ever as far as I can see.
At this point, I'm in full agreement. But, it's only because I have a very morbid sense of curiosity.
I can tell you from personal experience, look at the maintenance cost for all the security camera systems the Municipalities have been putting up for "security and "safety". Sure you might of got a grant for the capital purchase of the equipment or floated a bond but the maintenance is all yours and a operating expense. Public safety for example in many municipalities is redundant to the police and the town commissioners think they are running a swat team to battle ISIS. Total waste of money total scam.
"nearly one in seven American workers"
That's alot of non-productive people but more to the point as jobs were offshored a way to soak up the unemployed so nobody realised.
Dudley in essence said that current bond ratings – and therefore current bond prices and yields – don’t reflect the ugly reality of state and municipal financial conditions.
Really? Rating companies lie? Golly, what is their incentive to lie? Oh, right, money, money, blowjobs and money.
Don't forget the downgrade clauses written into the derivatives - interest rate swaps, especially.
No Greece here as their special and special ptb don't have to live by the rules of reality!
Don't worry, it is not as bad as it seems, as these municipalities have access to SWAT teams that can seize all the property needed to keep their treason and tyranny humming along for some time longer.
"The Zionist banksters need paid, so I'm going to choke you to death."
The banksters need to repay us.
https://s-media-cache-ak0.pinimg.com/236x/28/dd/88/28dd889827a2f5aedf8b7...
http://cdn.newsday.com/polopoly_fs/1.5113025.1366541578!/httpImage/image.JPG_gen/derivatives/display_600/image.JPG
More chaos and high treason,
brought to you by the Federal Reserve.
This just in!: Governments not able to budget.
They do budget, just in different terms. While most people have to follow "earn and spend," they follow, "seize, spend, seize more."
The banksters need to repay us.
Ferguson, MO derived over 20% of their budget from fees and fines on their subjects.
ANOTHER giant turd circling in the bowl.
Meredith Whitney being repped?
Chicago in bankrupty would be very entertaining just for the giant chorus of sewer rats that would be demanding their share of the booty and LA is in the warm up box. We're on the slide now and everybody will have their chance at panic and destruction....
Rahm knows what to do with a good crisis. Hell he probably helped engineered this whole financial crisis. I credit him and Obama with helping me create my nice foil hat.
Tiny Dancer may help in engineering the bankruptcy but it was the Daley clan that rang up all the debt.
They can take City Hall. And the primary occupant. Please.
And just leave the seat empty. I think we'll fare better, regardless.
That's nice! BTFD
You know the status quo is doomed when shaming your leaders into doing the right thing no longer works.
Sociopaths have a sense of shame?