Political subdivision debt in the US is not sub prime
Image via WikipediaMore than 100 American cities could go bust next year as the debt crisis that has taken down banks and countries threatens next to spark a municipal meltdown, a leading analyst has warned.I think most people recognize that Detroit is a special case where a shrinking population base means there are fewer tax and rate payers available to service the debt. And while many cities including prosperous ones like Houston, Texas have pension fund problems, that does not mean they have problems with their bond debt.
Meredith Whitney, the US research analyst who correctly predicted the global credit crunch, described local and state debt as the biggest problem facing the US economy, and one that could derail its recovery.
"Next to housing this is the single most important issue in the US and certainly the biggest threat to the US economy," Whitney told the CBS 60 Minutes programme on Sunday night.
"There's not a doubt on my mind that you will see a spate of municipal bond defaults. You can see fifty to a hundred sizeable defaults – more. This will amount to hundreds of billions of dollars' worth of defaults."
New Jersey governor Chris Christie summarised the problem succinctly: "We spent too much on everything. We spent money we didn't have. We borrowed money just crazily. The credit card's maxed out, and it's over. We now have to get to the business of climbing out of the hole. We've been digging it for a decade or more. We've got to climb now, and a climb is harder."
American cities and states have debts in total of as much as $2tn. In Europe, local and regional government borrowing is expected to reach a historical peak of nearly €1.3tn (£1.1tn) this year.
Cities from Detroit to Madrid are struggling to pay creditors, including providers of basic services such as street cleaning. Last week, Moody's ratings agency warned about a possible downgrade for the cities of Florence and Barcelona and cut the rating of the Basque country in northern Spain. Lisbon was downgraded by rival agency Standard & Poor's earlier this year, while the borrowings of Naples and Budapest are on the brink of junk status. Istanbul's debt has already been downgraded to junk.
Whitney's intervention is likely to raise the profile of the issue of municipal debt. While she was an analyst at Oppenheimer, the New York investment bank, in October 2007 she wrote a damning report on Citigroup, then the world's largest bank, predicting it would cut its dividend. She was criticised for being too pessimistic but was vindicated when the bank was forced to seek government support a year later. She has since set up her own advisory firm and is rated one of the most influential women in American business.
US states have spent nearly half a trillion dollars more than they have collected in taxes, and face a $1tn hole in their pension funds, said the CBS programme, apocalyptically titled The Day of Reckoning.
Detroit is cutting police, lighting, road repairs and cleaning services affecting as much as 20% of the population. The city, which has been on the skids for almost two decades with the decline of the US auto industry, does not generate enough wealth to maintain services for its 900,000 inhabitants.
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There are general two revenue streams for debt of political subdivisions in the US. Revenue bonds are paid from the flow of funds provided by certain government enterprises, such as providing water or sewer services. When the bonds are issued there is a promise to keep rates at levels adequate to meet the debt service payments. The other types of bonds are those backed by the taxing power of the issuer. Some are limited tax bonds, while general obligation bonds are a pledge to level what ever tax is necessary to pay the debt service.
Most US cities do not have a shrinking tax base like Detroit. There are also cases where local authorities have acted on advice that did not foresee market changes in floating rate securities. Jefferson Country Alabama has had that experience which has put it in a desperate hole. Some states like California have been irresponsible in the handling of their debt. I suspect that New Jersey was in that category before Gov. Christi took over. Clearly, he is not content to dig the hole deeper and is working hard to solve the problem.
California my go the other way and send more of their tax base to Texas. Texas is still a high growth state that is adding to its tax and revenue base. It needs to deal with municipal pension problems, but I think its debt is not in doubt.
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