For months the argument over the financial distress of municipalities throughout the U.S. has raged. On one hand, Meredith Whitney, Nouriel Roubini, Jamie Dimon and others have looked at the rising debt service levels and declining revenues of municipalities and suggested that an inflection point is coming. In opposition to this view a number of veteran fixed income investors have taken to repeating the twin mantras of historically low municipal default rates and the taxing authority of municipalities. The fact that the later group’s argument seems eerily reminiscent of the logic that savaged the returns of real estate investors has been politely ignored.
The saga in Jefferson County, Alabama is highlighting the weakness in the argument of those who would deny that we are going to see widespread municipal distress. Jefferson County has $4.2 billion of debt (comprised of general obligation, school and sewer debt). The county has put forward a plan that envisions sewer rate increases of 8 per cent per year. Creditors have proposed sewer-rate increases of up to 25 per cent per year.
Restructuring cases are contentious, but restructuring professionals working with troubled governments must strive to improve their understanding of political reality. With sewer rates up fourfold between 1997 and 2008, Commissioners have good reason to maintain that any plan calling for increases over 10 per cent will be rejected.
Governments do not exist for the sole purpose of fulfilling financial obligations. When meeting financial obligations begins to inhibit a government’s ability to provide services to its citizens, politicians will tend to err on the side of citizens and not creditors. Jefferson County may serve as a very costly lesson in this principle for fixed income investors.
About the author:
David Johnson is a partner with ACM Partners, a boutique financial advisory firm providing due diligence, performance improvement, restructuring and turnaround services to companies and municipalities. He can be reached at 312-505-7238 or at [email protected].