April 17, 2012 / 8:42 PM / 8 years ago

More U.S. cities set to enter default danger zone

April 17 (Reuters) - America’s swelling ranks of fallen municipal borrowers have been blamed in the past year on ‘what-were-they-thinking’ causes, be it a Taj Mahal sewer system in Alabama or an overpriced trash incinerator in Pennsylvania’s capital city of Harrisburg.

But the next series of major cities and counties in danger of defaulting on their debt can hardly point to one single decision for their malaise. Whether it be Detroit, Miami or Providence, Rhode Island, their problems have a lot more to do with financial policies that put them on course to live well beyond their means.

Municipal defaults have shot up since 2007 and are on pace for another high year in 2012, according to Richard Lehmann, publisher of the Distressed Securities Newsletter.

Many failures will be due to local politicians’ willingness to give unionized local government workers lucrative pensions and health care benefits when times were good. For others, the housing bust was enough to destroy their real estate tax base. They almost all share the failure to prepare for a rainy day.

Now, belt tightening by state and federal governments is adding to the pain - as contributions to governments at city and county levels get squeezed. Many of the places in the worst condition are in the Northeast, Midwest, California and Florida.

The new tide of defaults may worry some investors in the $3.7 trillion municipal bond market who have so far shrugged off the fiscal crises of local governments and yield cuts in local government services.

“This is a lagging process,” said Richard Ciccarone, managing director at McDonnell Investment Management. “Capitulation may not come for years. In the crash of 1929, the defaults did not come until 1934 or 1935. The marginals hang on as they can.”

Take a look at Miami. The city just added a futuristic baseball stadium to its skyline and is gaining prominence as a global business center even as Miami’s exposure to declining housing values, low reserves and high pension obligations worry some bond buyers.

The long-running housing crisis threatens Miami because drops in city property values are only now strongly hurting tax payments, according to institutional investor Chris Ihlefeld of Thornburg Investment Management.

“Miami was dealt a pretty big blow following and during the recession in terms of property tax revenues,” he said. “Part of the smoothing process implies that when you had a problem two years ago, it’ll show up now.”

Ihlefeld said his firm had concluded that Miami, which is wrestling with a budget shortfall nearing $40 million, had relatively high debts and other credit negatives.

Detroit, where the long decline of the region’s car-making industry and $300 million a year in pension costs may help lead to a state-government takeover, also suffers from weakened tax collections, along with many other local governments.

Administrators of Chicago’s vast public schools system face a $700 million budget gap created by shrinking federal funds and widening debt, pension and other costs. Chicago’s mayor warned last week that property taxes in the city would have to be hiked 150 percent if government-workers pensions are left as they are.

One of New York’s wealthiest counties, Suffolk County on Long Island, in March declared a financial emergency and reported worryingly low liquidity and a projected three-year deficit of $530 million blamed partly on overspending.

Twenty three villages and cities in Ohio, as well as five school districts in the state with a slowly expanding economy and a history of heavy home foreclosures, are in fiscal emergency, according to the Ohio state auditor’s office.

Badly hit by the burst of the property boom, California’s Stockton, with 292,000 people and east of San Francisco, has endorsed defaults on $2 million of debt payments and may file for municipal bankruptcy if it cannot reach deals with creditors. The California ski resort, Mammoth Lakes, is also bargaining with creditors in a bid to avoid bankruptcy.

By far the most populous state and issuer of muni bonds, California suffers from sagging home prices, with values in Los Angeles and San Francisco off 40 percent in the five years through January, according to data reported by Standard & Poor’s/Case-Shiller.

Declining property values that result in lower property tax assessments are likely to continue since property assessments trail by years falls in market prices.

“Over the next year or two, there is a big risk of more Chapter 9 filings in certain parts of the country: California, Rhode Island and the Midwest,” said municipal bankruptcy lawyer David Dubrow of Arent Fox.

In California, in addition to Stockton, Monrovia and Pomona could find themselves in crisis, according to an analyst who sees low liquidity, excessive debt loads and outsized pension liabilities as key warnings.

In Rhode Island, where the governor backs legislation to reduce operating costs for distressed local governments, cities such as Providence and Pawtucket are seen as possible candidates for bankruptcy. Afflicted by underfunded pensions, the state’s Central Falls is bankrupt.

Despite the growing list of potential defaults, it is still a relatively rare occurrence for issuers to miss scheduled bond payments in America’s $3.7 trillion municipal debt market.

Still, such failures have ballooned in the past years.

Bond defaults were $25.355 billion in 2011, or nearly five times the value of defaults in 2010, according to Lehmann. In 2012’s first quarter, defaults totaled $1.245 billion, or more than double the $522 million of last year’s first quarter.

Municipal bankruptcies, such as last November’s landmark, $4.23 billion Chapter 9 filing by Alabama’s Jefferson County mainly because of its excessively expensive sewer system mocked as a Taj Mahal project, have picked up, too.

Chapter 9 municipal bankruptcy filings doubled to 13 in 2011 from six in 2010, but still remain rare among the more than 60,000 issuers, with only 49 of the 264 cases since 1980 being towns, cities, villages or counties, according to James Spiotto of Chapman and Cutler LLP. States are ineligible for Chapter 9.

Outsized pension-deficit payments and other liabilities, as well as depressed local economies or failing government projects such as Harrisburg’s trash incinerator, often herald crises, according to Ciccarone.

Many local governments struggle even as broad, if muted, economic gains lift revenues for states and some local governments, which reported to the U.S. Census that overall revenue rose in late 2011 to a 23-year quarterly high of $387.2 billion.

That was a ninth consecutive up quarter for local government and state revenue and solidified 2011 as the best-ever year with total revenue of $1.35 trillion..

That broad snapshot obscures often crushing pension deficits and other dogged problems that individual local governments face.

Persistently high jobless rates and reductions in state and federal aid, as well as round after round of government layoffs, service cuts and fee increases in recent years, leave mayors and other local officials with few ready remedies, according to Moody’s Investor Service Managing Director Naomi Richman.

At an industry conference last month in Philadelphia, Richman said, “A lot of the easy fixes are gone.” (Reporting By Michael Connor in Miami; additional reporting by Joan Gralla in New York and Hilary Russ in Philadelphia; Editing by Andrew Hay)

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