Local Governments Declare Bankruptcy- Is Yours Next?

3p is proud to partner with the Presidio Graduate School’s MPA Curriculum on a blogging series about “Sustainable Development.” This post is part of that series. To follow along, please click here. By Ben Horowitz The Occupy Wall Street protests now dwindling in most states look pretty tame in comparison to the kinds of riots sweeping across Europe.  Few would argue this point.  The real fear is that the Occupy movement may be just the beginning, and that violent responses to severe fiscal austerity measures may not be far off in some American cities, either.  After all, while the Eurozone debt crisis is absorbing the lion’s share of media attention these days, there is a similar crisis quietly brewing right here in the U.S. that is just now beginning to surface. Last month Jefferson County, Alabama,  or Jeffco, as bond-market analysts call it, filed for Chapter 9 bankruptcy protection, the largest such municipal claim ever made.  Shortly thereafter, Harrisburg, Pennsylvania,  did the same. Although the high-profile Jeffco case is still pending, the judge in Harrisburg threw out the case, ruling that the city council member who filed the claim lacked the authority to do so, according to the NY Timess. Governments and financial stakeholders across the country and the world are closely watching these court proceedings, as what happens in Harrisburg and Jeffco will likely become a litmus test used to guide municipal debt-restructuring elsewhere in the U.S.  However, no matter the resolution and no matter how each city chooses to address its fiscal woes, the prognostication is not good:  Jeffco, for instance, buried in more than $4 billion of debt, has been forced to lay off thousands of public employees while indiscriminately cutting programs and services across the board. It should come as no surprise that local governments are in trouble.  Indeed, many more besides Jeffco and Harrisburg are trapped between a fiscal rock and a hard place. Much like many debt-ridden European governments, too many state and local government balance sheets are also egregiously messy.  Only eight states were able to float a budget in 2011, with the remaining 42 contributing to a $13.8 billion shortfall, according to the National Association of State Budget Officers.  Despite the outlook for 2012 indicating a return to a possible $27 billion dollar shortfall, the situation has vastly improved since 2010 when at the height of the financial crisis state budget gaps totaled more than $150 billion nationwide. In an era of widespread debt, it bears stating that it wasn’t as if European nations and U.S. state and local governments suddenly stumbled into these fiscal crises.  For years they’ve been on an unsustainable trajectory, marked by declining revenues and soaring debt obligations to truculent bond-holders.  Lately, however, thanks to the Eurozone debacle, it’s become too easy, even fashionable to write-off government debt holders as heartless and unruly repo-men – “bond vigilantes” as the venerable Paul Krugman calls them. Yet for Jeffco and Harrisburg, the forces and the individual actors responsible for pushing these municipalities towards bankruptcy may simply be an example of Muni bonds gone horribly wrong - an aberration in an otherwise pure market.  After all, as a financial tool, most Muni bonds are safe and highly effective ways for local governments to responsibly leverage the power of markets.  Issuing bonds offers a state or local government an inexpensive way to finance its expenses and fund critical infrastructure projects to provide water, electricity, and regional mobility options. The key is to issue Muni bonds prudently, and then subsequently make disciplined investment decisions with the capital raised. Admittedly, that’s not what happened in Jeffco and Harrisburg, which is why many market analysts have concluded that the bankruptcy filings coming out of these two municipalities  are nothing more than anomalies in a relatively thriving sector of the market economy.  They say those two city governments, aside from the outright criminal fraud in Jeffco, simply placed bad bets on public works projects in their counties, and are now just paying the price. For example, in Jeffco, multiple city officials there are facing criminal suits and jail time for their role they played inflating a sewer project from $300 million to $1.2 billion while personally rewarding themselves for having done so.  In Harrisburg, city officials sprung for a $300 million waste incinerator.  Bad call.  Paid for through bond issuances, real revenues from the facility are amounting to a fraction of what was projected, rendering the city insolvent. Negligent city officials failing to protect the public interest may appear the sole cause of these local governments' economic woes, but other market watchdogs aren’t so sure. Some are cautioning that these two municipalities are instead just the beginning, and that like Europe, an equally perilous degrees of systemic risk in the Muni bonds market may simply be a ticking time bomb in the still fragile U.S. economy. Time will tell how safe Muni markets really are.  Some cities, however, don't want to wait to find out.  In the aftermath of the latest financial meltdown and as a by-product of the Occupy Wall Street movement, a growing number of communities are urging their city governments to altogether free themselves from the whims and liabilities of unstable global financial markets.  Like residents in Boulder, Colorado, for example, who are pressuring city officials to seek investment-financing from more benevolent institutional investors, or, better yet, none at all. [Image credit: wallyg, Flickr]