Municipal bankruptcies have historically been rare for a number of reasons – including the states’ determination to preserve their credit ratings, their access to cheap funding and the stigma of bankruptcy. But, these days, things are very different in the world of municipal finance.
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At the root of the problem is the incentive system that elected officials used to face. For decades, across the US, local leaders ran up tabs for future taxpayers; they promised pensions and other benefits for public employees that have strong legal protection. That has been a great source of patronage for elected officials: they can promise all sorts of future perks to loyal supporters (state and local workers) with very little accountability on the delivery of those promises.
Today, we are left with the legacies of this waste. The bill for promises past is now so large for some cities and towns that it is crowding out money for the most basic of services – in the case of Detroit, it could not even afford to run its traffic lights. Across many American cities, cuts to basic social services have already been so deep that they have made the communities unpleasant places.
This is, in part, because of a strange legal position. Over the past decade,
US states’ finances have run deficits in more years than they have not. But, of the 50 states, 49 are constitutionally required to balance their budgets; quick cuts to social services were largely used to bridge the gaps. This meant delays in infrastructure projects, delays in basic maintenance of roads, bridges, and schools, cuts to school and higher education.
This type of cut is allowed by state constitutions. But, under the same laws, cuts to pension and benefit costs or debt service payments are often not permitted. In other words, education and public safety tend not to be safeguarded by constitutions but pensions and repayments on municipal bonds are. So, over the past several years, basic social services have steadily eroded, and in most cases home values have declined, crime rates have soared and education has suffered.
Rotten public services take a toll on home values and business investment alike. After all, what makes one neighbourhood worth more than another is the perceived value advantage of its schools, safety, public parks and libraries. Cuts in services happen even when taxes go up; the combination acts to drive out businesses and other taxpayers from the area. This sets off the negative feedback loop from hell.
So leaders across the country cannot continue as they have. They must choose sides because there is simply not enough money to go around. Will they side with taxpayers, unions or the municipal bondholders? If they back residents, money will be directed to underfunded public services at the expense of pensions and bondholders. If they side with the unions, social services will continue to be cut and the risk to bondholders will increase considerably. If they side with bondholders, social services and pensions are at risk.
Up to this point, it has taken either an incredibly daring elected official to stand up for taxpayers or, in the case of Detroit, an appointed official (read “unelected”) whose mandate has been the “emergency management” of the city. After decades of near-third-world conditions in the richest country in the world, the city finally stood up and said enough was enough. Officials could raise taxes further and cut social services deeper but leaders are finding these once “go-to” measures to be counterproductive. They are destructive to the very sustainability of the city.
Since the credit crisis, taxpayers have paid most dearly in terms of reduced social services while paying the same or often higher tax bills. Increasingly, unions are being asked to make concessions on pensions and benefits. And – now – bondholders, who up until last week thought they would be protected in almost any scenario, are being forced to make a contribution to the fiscal problem. Elected officials, for the first time in a very long time, are siding with residents. This is a new precedent that boils down to the straightforward reality of the survival and sustainability of a town or city.
There are five more towns like Detroit in Michigan alone. There are many more municipalities across the country in similar positions. Detroit’s decision last week paves the way for other elected or non-elected officials to make decisions to save their cities and towns, decisions that probably involve politically unpopular actions that may secure their long-term viability.
The writer is author of ‘Fate of the States’
It seems that the system (like most political systems) is corrupt, ineffectual and inefficient - to see it in graphic full colour, watch the TV series Brotherhood.
precisely. Even a broken clock shows the correct time twice a day
Firstly, the actuarial accounting for pension solvency is a complete joke. Local governments are given far too much leeway in investment return assumptions (8% pa for a bond fund, hello?) and mortality profiles, which have allowed solvency problems to remain under the surface. The bizarre part is the hidden problem has also resulted in fund managers investing in far too risky investments, such as private equity, structured credits and other deals that were nothing more than a "Hail Mary".
Interestingly, the old actuarial method was abandoned for corporate schemes around a decade ago, when US accounting standards started to move towards an international standard. The big problem is that making the shift will send shock waves through the Muni markets as people wake up to the real size of the problem.
The second part is that if you raise taxes and cut spending on the young, people will leave and take their Dollars elsewhere, communities will die and the city will become nothing more than an insolvent nursing home. If you are cutting school classes, closing schools in order to pay pensions to school administrators that retired at 55 on a $200k pension, then your city is going to die a slow, miserable death.
Workers have suffered from the onslaught of neo-liberalism for the last 40 years.
It started before Thatcher & Reagan, but their policies of attacking unions, privatising & ending capital controls broke the back of social democracy.
With China opening up, finance capital was only too happy to take advantage of cheaper production costs & to deindustrialise the West. The buying up of US T-Bills by the Chinese & the Arabs in particular has enabled the West to live on credit & prolong US imperialism.
All on this has its origins in the over-issue of US $'s in the post-war period, culminating in the decoupling from gold in 1971 & the beginnings of fiat money & the growth of finance capital as financialisation took off. It was this material basis that underlies the neo-liberal political ideology.
But the West can't live on debt forever. When the crisis struck in 2008 Western governments had to bail-out finance capital. How? Largely by buying back the debt they themselves sold to the banks. Private sector debt has been deleveraged & public sector debt has more than replaced it. Total debt in the developed countries has actually increased since 2008.
It is now evident that all the government & other bad debts bought by central banks cannot be sold back to them without another credit crunch, financial panic & recession. Even the threat of a slow-down in QE sends tremours through the money markets.
QE can't continue forever otherwise the world's currrencies will be debased. Commoditiy inflation caused by QE can cause revolutions, as we have seen in the Arab world.
Try as they may to avoid a depression, it will have to come eventually. This is the only way a crisis of overproduction can be resolved. By postponing it with ever increasing amounts of debt the scale of the adjustment (depression) only increases.
It is admittedly hard to calculate, but it could be that world GDP may reduce by 50% as a result of the necessary deleveraging. Capitalism may not survive that.
sub-prime debt was once AAA, alas . . . . . . .
much of the 1st world is like drunken doped out zombies.
The major thing to watch is, like Obama with the auto industry, how much will politicians try to vitiate the Rule of Law in favor of political expediency ?
Where's the beef?
Oh come on .Just have Ben hit the print button and bail everybody out of everything. Personal responsibility? Not in America. I mean why should the banksters get all that ZIRP money alone?
1000 year municipal bonds anyone? Cmon bond salesman. Get out of the strip clubs and start selling.
I wish she would of named the other towns.
Real debt of the US is 200 TRILLION . Prof. Kotlikoff,. Get on with the default already
This seems particularly true of politics in the US.
We all know that where you can't cut expenses any further, revenue raising is how income shortages are solved.
Revenue raising isn't even whispered as a possibility anywhere in the world, never mind the US.
To make costs affordable, you therefore reduce spending somewhere, you thus take circulating spending money out of a state by reducing costs. Next, the profit making businesses don't have so much spent with them, as a result not so much profit, so state income revenue deteriorates further, next thing, and finally, is bust.
This happens not only in America but is one problem in the EZ. in that debt problems in the indebted nations has not been covered by increased revenue.
Exponentially deteriorating revenue, leads to exponentially decreasing spending, leads to riots, and in the end leads exponential deflation all the way to Zimbabwe, where because money making resources have been so destroyed, the only thing you have left is a tiny money pool, huge unemployment, and inflation as pointless as your grannies false teeth.
I wonder when we in the UK will soon experience the point of no return as well, as GB is doing what Detroit has attempted to do, and what Greece is doing, from what I read, except only voluntarily.
They are not different, the problem is inability, either by politicial choice or by economic choice, to not raise income by taxation to cover costs so you end up with a whirlpool of money going down the drain to a bl;ack hole somewhere.
Shylock would have been proud of the world.
I know the ConDems will be proud, until they recognise that their own wealth, being dependent on spending, in a fountain-up way, the opposite of trickle down.
Fountain-Up Effect works like this. Those on the bottom, with increased benefit instead of cut benefit, that is to say the unemployed, buy socks, the shop they buy the socks from makes a profit, the shop moves into more expensive premises because of the profit, the company makes more profit, stocks go up when socks are pulled up, and also because of higher rents, the landed gentry also start to see their property folios and then land portfolios increase.
But at the moment we have the circulating money reduction effect.
Cashing checks at taxpayer expense, modern politicians have been voting themselves into office via public unions not caring, along with union members, that one day there had to be a total collapse of the system. Problem is, it's happening sooner and faster than anyone expected. Happy thought for babyboomers: Nothing but IOUs coming their way; money's gone, gone, gone.
Though there is one more solution: Throw up another bond issue and see what comes.
"Almost all +50,000 US communities are receiving comparable services to pre-2008."
Where I live in Philadelphia the school system, facing a deficit of $304m, has laid off 20% of school staff this year. What an improvement to get rid of these 3,800 individuals all just bloating the municipal budget, don't you think? Fancy coming here to educate your kids? Thought not.
It seems to me eventually bankruptcy and court rulings, possibly legislation, must establish some hierarchy of priorities among different claims. For example, I would say that a voter-approved bond issue should have a higher priority than a legislatively-approved arrangement. Voter-approved contracts should have higher standing. But maybe not.
If adjustment is going to disproportionately fall on bond holders, then future infrastructure investment is going to be constrained. That will create winners and losers among local government entities. And most of the time that is how American society works. Well-to-do local governments are going to be advantaged over less prosperous entities. But that is also true today, which is why Detroit is in bankruptcy.
Will there be widespread municipal defaults? Most likely not. Will municipal finance enter a new era? That is almost certainly the case.
Sadly there is no data in this piece only cherry picked anecdotes.
Crime is declining in the US even with the fiscal distress since 2008:
http://www.disaste.../crime/uscrime.htm
US property values, after troughing in 2011, are increasing:
http://www.zillow.com/local-info/
For pension reform communities have three choice: litigate, negotiate or go bankrupt. 99.99% of communities are litigating or negotiating.
http://blogs.reute...te-or-go-bankrupt/
My own view is that state and local governments never got on the efficiency train and are generally bloated. A period of tight revenues allows reassessment and remaking of service provision. Almost all +50,000 US communities are receiving comparable services to pre-2008.
As for the nations biggest muni expense, education, time will tell if learning increases or not with tighter budgets. US is not likely now to adopt something like Australia's Gonski program but many have suggested realigning spending out of higher ed to primary/secondary and vocational education. This would be done through state budgets which provides much of the funding.
Does Detroit presage a wave of muni defaults? No -- but hopefully it will scare local and state legislatures to buckle down and do the hard work of balancing budgets (cutting expenses or raising taxes).