“My city was gone…” The Pretenders

While the federal government’s debt, spending and money printing mania has received most of the attention in this blog, there is another serious problem — the large and growing municipal governments long-term debt . The recent news that Detroit will move forward in filing for bankruptcy in the next few days/weeks is a cautionary “canary in the coal mine”. To be sure, Detroit’s problems are unique in their severity having lost two-thirds of its population since the 1950s, operating at a $100 million per year deficit since 2008, with currently $19 billion in debt and an additional $3-5 billion in unfunded retiree pension and health liabilities. However, many other cities/towns are sure to follow in the next few years unless there are fairly drastic reforms in government pension and benefits for retirees.

Over the past several years, state and municipal debt and deficits have steadily grown with future pension liabilities becoming alarmingly large. Though the numbers are small in comparison to $17 trillion+ in federal debt and the prospect of $1 trillion per year deficits in the future, the ability to raise money to cover these shortfalls or to cut other expenditures is considerably smaller for states and particularly municipalities. Perhaps most importantly, cities and states do not have the power to print money that the federal government has been using to “monetize” the their debts.  For states and cities, the problem is real and now. Consider the following alarming facts and recent events in addition to those coming from Detroit:

• On July 18th, Moody’s downgraded the city of Chicago’s credit rating and says the future outlook is negative. Currently, the City of Chicago has $19 billion in unfunded pension liabilities. The problem is even more massive statewide with a total of nearly $100 billion in unfunded pension liabilities across Illinois.
• On July 17th, 80 of the 105 pension plans in Massachusetts received failing grades for their progress in covering billions of dollars in future pension obligations.
• In California, on June 13th, it was reported that pension changes from Moody’s, and separately the Governmental Accounting Standards Board, could result in Los Angeles, San Francisco, San Jose, Azusa and Inglewood joining fiscally troubled Stockton and San Bernardino, among others, as severe credit risks. It’s all largely due to soaring employee retirement costs, according to new analysis based on the methodology by Bob Williams and his team at State Budget Solution (SBS), a non-partisan organization that studies state budget crises. 

Total unfunded pension liabilities have literally exploded in the past few years and now exceed more than $4 trillion . While this doesn’t sound as menacing as the federal numbers consider that this represents only about a 41 percent funding based on “fair market valuation” (59 percent unfunded). Even “official” statistics using very optimistic rates of return for pension investments (on average about 7 percent per year) across the states still show significant underfunding -73 percent funded versus 27 percent unfunded. Not surprisingly, state and municipal bond debt has continued to grow now totalling more than $3 trillion or triple the levels a decade ago.

As dire as these numbers sound, consider how much worse they will be, if  the value of pension assets falls substantially due to a major selloff in the stock market and as interest rates continue to climb. With the market at very high valuations today, we could be facing pretty disastrous consequences for health and pension benefits for state and local government workers if this were to occur over the next couple of years.

What is clear is that state and local government leaders will have to push thru some painful reforms involving major reductions in future pension and health benefits and some additional taxes in order to remain solvent. However, past attempts to even cut benefits slightly or partially reduce collective bargaining rights for state and local unions on the part of Governor Walker in Wisconsin, led to strong opposition and an antagonistic and costly recall election. Thus, I find it highly unlikely that governors and mayors will do anything but fix only the most immediate of problems and let the longer term liability problems fester. I believe it is almost a certainty that many other cities and even some states will have to follow Detroit’s lead in just the next few years with Chapter 9 bankruptcy. Bankruptcy will likely mean be followed by pennies on the dollar settlements for pension and health care benefits along with unsecured bond holder payments, which will in turn destroy the municipal bond markets. Most importantly, the human toll of this all will be enormous.

Could it be avoided? Of course, but even in Detroit where the handwriting was clearly on the wall, the special city manager was unable to wring enough union and bondholder concessions to avoid Chapter 9. And even after the die was cast, the unions resorted to the Courts to block the bankruptcy filing. In other words, the unions are unlikely to concede much if past history is any judge.

How many other cities could be affected soon? In addition to Chicago and the California cities noted above, there are a number of cities that have a lower resident to employee ratio (and thus more unfavorable ratio) than Detroit’s current 60-1, which provides at least some indication of those that are in more serious trouble. Among larger cities, this includes Washington DC (25-1), New York (32-1), Baltimore (43-1), Denver (49-1), St. Louis (50-1), Philadelphia (51-1), Atlanta (51-1), New Orleans (52-1), Cincinnati (52-1) and Seattle (56-1).

It’s hard to predict when it all will happen BUT I am quite confident in saying that bankruptcy at multiple major cities WILL happen. Further, once we get a few additional bankruptcies, it will result in a major problem in raising money thru the municipal bond markets for virtually ALL cities, which will speed other bankruptcies.

What can any of us do? We can make our voices be heard and hope to convince our cities are dealing with these issues NOW rather than later. Otherwise, Chrissie Hynde and the Pretenders will be eerily prophetic.