Bankruptcy: Coming To A Municipality Near You

Central Falls, Rhode Island

Don’t believe the hype. America’s cities are hurting.As we all know by now, Monday’s market meltdown – a long-overdue market reaction to the we-knew-this-coming-a-month-ago-but-decided-to-panic-now S&P downgrade of America’s debt – drove investors to the treasury market, a seemingly safe investment haven in times of financial trouble and turbulence.  

This, in turn, has convinced major market players that municipal holdings are “safe,” and should weather this economic storm relatively effectively (you know, because Wall Street is so ahead of the policy curve. 

Or intellectually lazy and completely ignorant to the ways of government spending and policy.  You know where my vote stands…).

In short, as Suzy Khimm writes in “S&P’s real victim: cash-strapped cities?,” “On the surface, municipal-bond watchers seemed relatively confident about the near-term health of the $2.9 trillion municipal market, where bond yields have remained low — a key indicator of investor confidence.” 

This, along with other commentaries, suggests Wall Street believes our municipalities, on the whole, are safe. There’s no reason to panic….or look more than 3 months down the road.

Once again, Wall Street, please get your collective head out of your as$.  Look at the facts.  America’s municipalities are in trouble.  No amount of market or financial or political manipulation or spin will change that fact.

Last month, and pre-U.S.-downgrade, S&P put out the notice – to not much effect, of course – that a downgrade of 7,000 American municipalities was in the works.  And while S&P’s announcement yesterday that these downgrades weren’t “guaranteed” (that is, some municipalities will escape S&P’s wrath), some ARE coming.  It may not be 7,000.  But there will be a significant number of them.

Yesterday’s crash, precisely – and the debt ceiling debacle of 2011, broadly – put into sharp focus what this means for these counties and cities.  After all, as Khimm explains, “During the last sharp downturn in 2008, the federal government provided a short-term stimulus to state and local governments that help prop up the muni market. This time, there’s little expectation that it would be willing or able to do the same.”  In short, the federal government is going to push many of the spending cuts dealt out in the debt deal onto municipalities, which, when combined with higher borrowing costs due to the impending downgrades, will dramatically cut into municipal financing across the board. 

Obviously, many of these municipalities targeted for downgrade will survive – or at least eek through by making the relevant and necessary spending and budgeting shifts, causing pain to both bondholders and citizens alike.

There are many municipalities, however, that will not.  And while Central Falls – the Rhode Island city of 20,000 – recent turn to bankruptcy seemed an extraordinary case, it is not.  Or won’t be, for long, anyway – for, with Jefferson County, Alabama already publicly flirting with potentially the biggest municipal bankruptcy in American history, Cedar Falls was simply the first in what will be a long and painful line of municipalities unable to service debt and provide for citizens. 

My final word/only advice to municipalities and, well, the world: don’t listen to what Wall Street has to say on this matter.  I know finance.  I know policy.  Neither side knows the intricacies of each other.  Municipalities do not exist to exclusively service debt obligations (a politically infeasible option).  Just as they don’t exist solely to guarantee retiree’s pensions. 

There’s a grey economic area here – one that’s both politically and economically feasible. We just have to find it.  And hopefully don’t lose America’s soul in the process.

Margaret Bogenrief is a partner with ACM Partners, a boutique crisis management and distressed investing firm serving companies and municipalities in financial distress.