While we had the most amazing March and April here in Minnesota when it was warm and sunny seemingly every day, May so far has been a little cold and dreary. No complaints, mind you, but I am now facing the day we all knew would eventually come: a Target Field rainout. I live two hours north of the stadium so getting to the game is logistically a commitment. Especially with two girls here at home that can't be left without supervision until my wife gets done with work. Should I line up a sitter, drive down, get rained out and then drive back for a wasted evening or do I stay home and risk that my assumption of a rainout will be incorrect? I would not be having this problem if we still had the Metrodome, but that is a burden I will gladly bear.

The News Digest this week is going to be very short. Sorry about that. It is the original feature of this blog - the reason I started it - and I love putting it together. My schedule today is not allowing me much time for writing or analysis so I am just going to pass along one article, but it is a big one.

We have written here a couple of times about the idea of municipalities filing bankruptcy. I have privately sent my thoughts and analysis to some people that I know that are in the business of setting up municipal bond issuances. In both cases the responses I have gotten have been a polite rendition of either, "you are crazy" or "you don't know what you are talking about".

I readily willing to admit that I have more questions than answers here, but it seems to me like the finances of many cities are balanced precariously on some societal assumptions that are simply not true. The author of this article seems to concur, drawing parallels to the mortgage crisis we are enduring:

Just as with mortgages, the very fact that investors place unlimited faith in a market could eventually destroy that market. If investors believe that they take no risk, they will lend states and cities far too much—so much that these borrowers won’t be able to repay their obligations while maintaining a reasonable level of public services. The investors, then, could help bankrupt state and local governments—and take massive losses in the process. To avoid that scenario, investors must take a long, hard look at what they’re doing. Where state and local finances are untenable, they should stop throwing good money after bad. 

But cities won't (or in some cases, can't) really default, can they? They are the essence of "low risk" investing, right? Most people - even professionals - assume so.

The analysts also think that lending to state and local governments isn’t risky because they—unlike private firms—have a captive source of endless funds. If a company misjudges its product line or its prices, its customers and investors can flee, depriving it of money; such a company will have a hard time persuading anyone to give it one dollar more. State and local governments, by contrast, can always tax their residents and businesses to pay the bills, even as they gut services.

That is conventional wisdom, but many cities have the ability to access bankruptcy and those that don't can simply choose to not pay their debtors. Once the Growth Ponzi Scheme runs its course and cities have to choose between (populism alert) stiffing the people that "suckered them" into believing hyper-growth was their salvation and paying for police protection and parks, the politics of the decision may mean default.

Investors continue to assume that financial calculations would trump political calculations in such a case—that is, that no state or city would default, even if the public supported it, because it would cut off the borrower’s access to credit markets. But that would be true only if the state or city in question considered immediate access to bond markets more important than cutting the amount it already owed. Furthermore, a state or city that did cut down its obligations might, strangely enough, have an easier time getting financing afterward, since new bondholders would know that its finances were finally sustainable.

The uncomfortable truth is that as municipal debt grows, the risk mounts that someday it will be politically, economically, and financially worthwhile for borrowers to escape it.

Once you understand that fact, and the reality of how bad the situation is in many of our cities where they have either a) invested heavily in new growth that won't happen and/or b) failed to get the returns needed from their existing investments to maintain the systems they created to support it, things change dramatically.

Even during the boom, money fell short. By 2008, state and local debt rose to $2.2 trillion outstanding—49 percent higher, after inflation, than in 2000. Add the health and pension benefits for government workers, and you’re up to a staggering $3.2 trillion. Once the recession’s severity became apparent, state and local officials should have realized that hard fiscal times were coming and begun cutting back on the unsustainable costs. Instead, they have kept on spending, and borrowed to do it: states alone have already borrowed another $15 billion for operating costs over the past two years.

I highly recommend reading the entire article. It is well written, insightful and eye-opening.

 

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