Posts Tagged ‘fiscal stress’

The Illinois Comptroller’s April report  is scary reading.  The state is $4.5 billion in arrears on payments to vendors and others (like school districts and service providers) with no end in sight.  The Comptroller expects 2011 to be worse.  The following chart from the report looks to me like a deteriorating structural imbalance moving towards a delicate liquidity position.   

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As long as markets are willing to provide liquidity, the state will be able to continue on this trajectory.  As we learned from the New York City fiscal crisis in the mid 1970’s, not to mention the banking liquidity issues beginning August 2007 and later, those institutions that depend on short term market access for viability will freeze up (seize up?) when the markets don’t cooperate.  

The Civic Federation prepared a detailed analysis  and critique of the proposed 2011 budget.  In the report they graphically present the state’s roll-over of short term debt from 2009 to 2010.   In 2011 the state expects to issue $4.7 billion notes for “voucher payments.”  Where will the re-payments come from?  

So here’s some simple math.  The state’s debt service payments for 2011 jump from $1.6 billion to $2.8 billion.  Short term debt will be $4.7 billion.  The budget assumes $27.4 billion General Fund revenues in 2011, so it looks to me like debt service consumes a hefty 27.4% of that total.  Red flag.  Maybe there will be some roll-overs, some additional budget cuts, maybe some tax increases, maybe the economy will be good to the state and they will make it into 2012.  But the long-term problem here is huge.  

 Bondholders are feeling sanguine since, like California, payments go to debt service before other services.  As tax increases loom on the horizon, investors want that tax exempt paper.  As the Civic Federation described:  

As the State continues to issue more G.O. debt than it retires on an annual basis, the amount of General Funds committed to debt service payments will continue to rise. To make these payments the State pledges its full faith and credit to its bondholders and legally commits itself to transfer the debt service payment into the General Obligation Bond Retirement and Interest Fund (GOBRI) prior to paying any other bills or transferring funds for any other appropriations.

  

  

 

  
 
 

 

I’m putting on my public policy hat now (as opposed to financial analyst).  There’s no mechanism for bankruptcy or receivership at the state level in the U.S. which may be comforting from an investor’s perspective, but lousy public policy.   There’s no IMF and no process at the federal level to re-structure state finances other than handing out bailout grants or loans — which usually require increased borrowing or matching spending.   There’s no Board of Directors as in the private sector whose charge is to protect shareholders (substitute “taxpayers” for shareholders) even when painful actions are necessary.   So we are left with random taxpayer uprisings and the occasional vote for elected officials and the analysis of think tanks.  Maybe there will be a lawsuit by vendors or school districts to get the state to meet its obligations.  Maybe vendors and residents will vote with their feet.   The preferred approach would be an objective mechanism with authority and mettle to resolve the fiscal mess.   Someone please tell me that I am wrong …

An article about upstate New York town of Kingston and their discussion of fiscal stress, union contracts and the debate over Chapter 9 bankruptcy.

I just came across this blog from John Moorlach, Orange County.  Scroll down for a “five year lookback” on the discussion about San Diego, thought you might find it of interest.

The financial reform proposals, designed to eliminate systemic risk, could actually trigger another meltdown upon the bill’s passage.  This is due to the ratings notching approach that has given rating credit to government support since the meltdown.  A change in the expectation of support – both emergency and on-going would result in ratings downgrades for certain banks.  Standard and Poor’s for example, gives a three notch upgrade to the counterparty ratings of Bank of America Corp., Citigroup Inc and Morgan Stanley and two notches to Goldman Sachs and UBS AG.  Reverting to a lower stand alone rating could trigger collateral calls, terminations or other nasty events, not unlike what we have seen over the last three years.  My bank analyst colleagues are more sanguine about the likely outcome.  They suggest the banks would raise more capital, and by the time of passage, the underlying stand alone ratings could be improved.  But the House bill requires bondholders to take it on the chin before federal monies could be used.  And if the goal is to withdraw federal support, where would the capital come from?  While this issue may be better-understood by bank analysts I thought this should e brought to the attention of the municipal finance readership here.  Caveat counterparty.

I am adding a link to this article that updates Toledo’s fiscal situation.  (See prior post.)  The city is wrestling with a budget gap and trying to negotiate with unions over compensation.  Ohio is a state that has a fiscal emergency program and municipalities may not file for bankruptcy without going through the state.  The state’s oversight of fiscal emergencies is useful but does not give the oversight panel the right to cancel contracts or replace management.  The biggest clout is the panel’s ability to prevent borrowing — a severe but important hammer for any city in fiscal emergency that may be facing a cash flow shortfall.

The tables below are for contextual reference as state and local governments face draconian spending cuts.   The combination of public policy with the several bubble periods over the last twenty-five years has created a toxic brew.  Some state and local governments are valiantly trying to tackle the issues while other legislatures and councils are more interested in fist pounding.  For those involved in financial analysis (as well as taxpayers) a careful eye is called for. 

State and local spending grew dramatically during the post-Reagan years of the “Program for American Recovery”.  A historic devolution of responsibilities from the federal government to state and local government was coupled with overall economic growth during this period.  I have commented on this issue in prior posts and the presentation I gave at the recent analysts’ conference.  The following tables are expanded to include the 1982-1992 decade.  The first set of columns show dollar increases in 1982 constant dollars.  To account for population changes from migration, which naturally cause increased spending for schools, infrastructure, healthcare, etc. the second set of columns shows the constant dollar increase in per capita spending.   Embedded in these figures are a complex set of decisions on spending, and different approaches to governance, not to mention divergent demographic and economic profiles across the states. 

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click image for independent table

click table for independent image

click table for independent image

 

Florida and Nevada top the list in the 1982-1992 decade with spending increases of 105% and 108% respectively.  Florida’s population grew by nearly one-third during this time while Nevada grew by more than 50%.  Per capita spending in Florida increased nearly 58% while Nevada increased 36%. 

On October 19, 1987, Black Monday, the stock market crashed,  followed by the savings and loan crisis and the Gulf War which combined to hit state and local budgets hard.  Mid-term elections during the Clinton administration resulted in Republican control of Congress and the “Contract with America” which further devolved responsibilities to state and local governments.  Some governments slowed their spending increases in the 1992-2000 period.  On a per capita (constant 1982 dollar) basis spending actually declined in some places.  (Note that these are combined state and local figures from the Census Bureau — most other sources, such as Pew, Rockefeller and Center for Budget Policy Priorities focus only on the states.) 

Population growth figures allow some analysis of the changes.  For example, Nevada had nearly 50% population growth which helps to explain a 7% decline in per capita spending during the 1992-2000 period.  New Jersey, in contrast, hard hit by the recession, had only a 7% increase in population but had a nearly 2% decline in per capita spending over the period.

(For the detail oriented reader, there is a minor change in the numbers since I adjusted for 2007 population — the prior tables used 2008 population. Data source: Census Bureau and Bureau of Labor Statistics.  Note that spending includes current year payments for retirement and health benefits but not capital outlay.)

Here is an interesting clip from MLive about the debate over Flint’s dire finances.   Michigan has a receivership program that has been used a number of times so municipalities cannot just file bankruptcy in federal court without going through the state.  The article poses the sensible, if painful and difficult, questions of concessions on salaries and benefits compared with outright layoffs (in a city with 25% private sector unemployment) as well as collaboration with other municipalities on providing services (we applaud that approach).   We also note the exaggeration of county Commissioner Curtis, who said “cities across the country are going into Chapter 9 and getting relief from the contracts…”  Of the 89,000 municipalities in the U.S. there’s Vallejo, California and Prichard, Alabama.  Las Vegas monorail mentioned in the Wall Street Journal article last week  (you may need a subscription to access this) is in Chapter 11 which is the part of the bankruptcy code for corporate filings.  There have been a number of Chapter 9 filings by hospital districts, as well as numerous, small land-development-based special districts.  Then there’s Connector 2000 in South Carolina.  Harrisburg, PA has been discussed and of course, Jefferson County, Alabama sewer system,  but there has been more chatter on the wires since the Journal.  Connector 2000, the Harrisburg incinerator and the monorail have each been problem credits for some time, apart from the recession and credit market meltdown.

Looks like the city is making its best effort to try to resolve budget imbalance.  Ohio is one of the states that has a strong oversight/receivership program and municipalities may not file bankruptcy without approval of the state.  Local governments there do rely on income taxes, which is tough in the current economy, especially in auto and manufacturing which dominates the landscape.

Harrisburg, Pennsylvania can’t really afford to pay for the Resource Recovery bonds that it guaranteed.  Their recently adopted 2010 budget does not include debt service for this guarantee (see prior post with link).  It is accepted practice for rating agencies to rate municipally (or state) guaranteed debt off the credit of the guarantor.  Unlike bond insurance or any insurance for that matter there are no capital set-asides for guarantees by municipal governments.  Market analysts assume that the city or county would raise its taxes to the point of covering the debt.  Harrisburg is now testing that assumption. 

There has been some disagreement on the underwriting floors (at least in bond insurance, if not at the rating agencies) whether one should take into account the credit quality of the project being financed or simply “look through” to the guarantor’s quality.  I suggest a middle ground.  Assume that the Resource Recovery project was rated on its own merits as a project finance — what category would that be?  Then assume a contingent liability on the balance sheet of the guarantor of that lower credit quality.  If it is clear that the guarantor cannot afford the contingency the rating should embed this risk.  This thinking extends to “moral obligation” bonds whose ratings are automatically notched down from the state (or infrequently, local) rating.  Should a “white elephant” project backed by a moral obligation bear the same rating as one that is performing and essential?  (We don’t think so)   Affordability of obligations (add pensions, opeb, debt service to the list) is going to become an increasingly important risk factor as government wrestles with raising taxes, reducing expenditures and satisfying multiple constituencies — unions, taxpayers, retirees and service beneficiaries.

This link from a recent release by the Brookings Institution, Robert Puentes comments on the New Jersey and Virgina transportation funds.  New Jersey’ transportation trust fund will be spending all of its revenues on debt service by 2011; Virginia’s new governor too, suffers lack of funds for infrastructure improvements.  Concerning gas tax as a mechanism for raising funds, New Jersey and Virginia are among the lowest in the nation.  Granted, New Jersey heavily tolls its turnpike drivers.  The website, GasBuddy shows a map by county of prices around the country — updated every 15 minutes.  New Jersey is clearly on the low end, Virginia a bit higher but not nearly as high as New York or California….