They expect moderately more bankruptcies, and that any that occur will continue to be idiosyncratic. However, they break down the common red flags for recent cases:
Common bankruptcy drivers:
- Unusually high unemployment
Areas that have defaulted tended to have higher than average unemployment prior to the recession, and rose more sharply during the downturn. Unemployment levels above 16 per cent are consistent with the level of stress that may cause a default.
- Shocks to the tax base
Property taxes are a huge source of revenue for local governments. A sharp decline in housing prices can seriously harm the tax base. In Stockton, for example, house prices declined by 71 per cent.
- A high/rapidly growing liability burden
Recent examples of default saw their debt burdens increase at a much higher rate than the broader market.
- A weak or diminishing reserve cushion
Diminished reserves leave municipalities less able to respond to negative shocks. A big warning sign is a high fixed cost burden combined with a diminished cushion.
- High or rising pension and benefit costs relative to budget
These sorts of long term contracts are much more difficult to restructure than other liabilities, and can quickly deplete reserves. These factors are elevated compared to the past, but there are still relatively few cases that are extreme enough to merit worry. By way of example, here’s a chart of unemployment rates for local governments:
Photo: Morgan Stanley
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