MuniLand

Washington state DOT spox says shutdown “is not going to be years, but it could be weeks.” Bridge obsolete, but not structurally deficient.

— danvock (@danvock) May 24, 2013

This week a semi truck plowed into the I-5 bridge crossing the Skagit River in the State of Washington, causing part of the bridge to collapse. The incident echoes the failure of the Minneapolis bridge in 2007. These are serious but rare occurrences in the U.S. Even so, the nation’s infrastructure needs more attention.

Here is the estimate of necessary infrastructure spending for the next seven years by the American Society of Civil Engineers:

Note the last line that shows an annual funding gap of $200 billion a year. Where can this money be found? Let’s have a look at defense spending:

Since September 11, 2001, national spending on defense has doubled to more than $800 billion per year. Historians will argue over whether the United States’ involvement in Iraq and Afghanistan left the nation safer, but the fact is that we have underspent on public infrastructure, while overspending on military operations. The following chart contrasts the two types of spending. The blue line is military spending and the red line is infrastructure spending. It’s clear where the nation’s priorities have been:

The state-appointed emergency manager for Detroit, Kevyn Orr, has been given a year of legal authority to address Detroit’s insolvency problem. It is a herculean task to right decades of complex problems. Muniland observers believe that the city will end up filing for Chapter 9 bankruptcy.

The rationale for this relates to certain limitations of the emergency manager’s authority. Outside of Chapter 9, the emergency manager cannot legally cut debt or pension liabilities, and the likelihood that bond market creditors and the city’s 48 unions will voluntarily make concessions seems slim.

Orr has authority to cut public employee wages. He possibly could obtain pension concessions as part of wage negotiations. Detroit Mayor Dave Bing already reduced public employee wages by 10 percent last July, when he used his new authority under the state’s Consent Agreement to cut the pay of city workers in 40 unions and make other changes to labor agreements.

Two California cities, Pacific Grove and Canyon Lake, are trying to end their participation in CalPERS – the statewide public pension plan. The communities are unable to bear the cost increases in their retirement systems, which they are unable to control today. Now we hear news of another community and a non-profit group on the other side of the country that are trying to untangle themselves from established pension plans.

Ted Nesi, reporting for WPRI, details Coventry, Rhode Island officials who are trying to walk away from a non-teacher school worker pension plan:

Elected officials in Coventry have taken an apparently unprecedented step by washing their hands of responsibility for one of their employee pension plans, saying taxpayers have no obligation to come up with enough money to stop it from running out of cash within 12 years.

The newly confirmed chairman of the Securities and Exchange Commission, Mary Jo White, testified to the House Financial Services Committee on May 16 and requested an increase in funding for her agency. SEC funding does not come from federal government revenues, but from fees assessed on securities transactions. White’s request to increase the agency’s funding does nothing to increase the federal deficit or take funding from other programs. She is merely asking to spend the money the agency collects.

This is the SEC’s Budget Authority (what Congress says the SEC can spend, in the center column) and the Actual Obligations (what was spent, in the right column) for the last several years, in thousands:

There have been increases since the financial crisis in 2008, but the Budget Authority from Congress was frozen between fiscal year 2012 and 2013. Chairman White explains why this will not do:

Since going through a three-year bankruptcy process, a lot of wonderful initiatives have taken place in Vallejo, California – a city of 118,000 people in the northern end of the San Francisco Bay. After the city’s police force was cut down over 300 community watch groups formed to protect neighborhoods. The city recently launched Nextdoor, a private social network platform for neighborhood communication. In the most substantial move, the city has established a first in the nation “Participatory Budgeting” process. It was described by a participant as:

Funded by $3.2 million dollars allotted by a citywide sales tax passed by Vallejoans while still in bankruptcy, the city of Vallejo embarked on Participatory Budgeting (PB), the first US city to ever try PB citywide. PB Vallejo garners ideas from its stakeholders and citizenry with the goal of funding proposals that benefit the public, are a one-time expenditure, and are implemented by the city of Vallejo or other approved public agencies and nonprofits.

Did the city residents take it up?

Over 600 people assembled together at meetings across the city and online at www.pbvallejo.org to come up with over 800 ideas and suggestions on the well-being of Vallejo. 100+ volunteer budget delegates have worked together and with city staff to flesh out those ideas into viable proposals. These proposals will go onto a ballot in May where the citizens of Vallejo, ages 16 and above, will vote on which plans will go forward to the city council to fund and implement this fiscal year. The budget delegates are now preparing for three planned expos in April where they will present the proposals that will be on the ballot so the voters of Vallejo can interact, ask questions and walk away with what they need to make an informed vote.

Last December I wrote about a project sponsored by California Treasurer Bill Lockyer that is now up and running:

In the past year, three California cities have filed for bankruptcy. This casts a pall on the bonds of other California cities, because investors wonder if they also contain buried fiscal issues. In an effort to create more transparency, a new open source ratings project was recently launched:

Responding to market concerns about municipal credit quality, the California State Treasurer’s Office has commissioned a San Jose State University economist and a government-bond research group, Public Sector Credit Solutions, to develop a default probability model for city bonds.

Puerto Rico now faces a $495 million revenue shortfall for the year. Revenues have come in less than projected, and having pared government jobs under the former governor Luis Fortuño, Puerto Rico is now resorting to one-off financial maneuvers to fill the budget hole. Moody’s describes the moves in a May 15 report:

In our issuer comment of March 18, 2013, Puerto Rico Faces Large Mid-Year Budget Gap, we noted that full year revenues for fiscal 2013 were likely to be $910 million or 10.4 percent below initial estimates of $8.750 billion and 9.3 percent below fiscal 2012 revenues. Revised estimates showed the shortfall to be slightly larger at $965 million as of January 31, 2013. In response, the commonwealth has implemented a number of corrective measures, including modest expense reductions.

Puerto Rico’s revenues are likely to decline 9 percent from 2012, and it has no time to raise taxes to capture more. The commonwealth has resorted to refinancing debt and moving debt between entities. It brings to mind how shell games are played.

A big trip line for states and cities is the host of promises they have made to provide health benefits to retirees (Other Post Employment Benefits (OPEB)). Almost universally, cities and states are shouldering these OPEB costs as they come due. Pay as you go, if you will. From a recent Bloomberg presentation:

These so-called OPEB promises made by the 15 biggest cities alone total $115 billion, with an average burden of $2,300 for every man, woman and child, according to data compiled by Bloomberg. How will local governments manage to make good on their pledges without becoming insolvent? Will we see governments reduce benefits and raise their cost for current workers, as has been the case in several cities and states?

Cities and states cannot unilaterally end these benefits, outside of Chapter 9 bankruptcy, because they are contractual promises. As Stockton, California was entering the bankruptcy process, it eliminated lifetime unlimited health care benefits for former employees and their dependents. Stockton had awarded these OPEBs to former employees who had worked for the city for as little as a month, and the expense helped push the city into bankruptcy. Retirees and former employees took Stockton to court and a judge ruled that, given the city’s fiscal distress, it could cease these benefits.

This week, New York Governor Andrew Cuomo unveiled his proposal to create a Financial Restructuring Board to help distressed local governments manage their finances. One of the key features is an alternative binding arbitration process for unions and municipalities to resolve contract issues more rapidly. New York has an unusual employee provision that leaves all previous contract terms in place if municipalities and unions fail to reach an agreement. This provision could prevent old contracts from festering with rich wage increases and swelling employee and pension costs. Governor Cuomo said in a press release:

Growing retirement costs, declining populations, decreasing property values, and the recent fiscal crisis have all contributed to the difficult financial issues facing localities today…The Financial Restructuring Board will bring together state and local officials to help localities make tough decisions and solve this crisis now instead of kicking the can down the road.

Governor Cuomo pointed his finger at four New York cities that have balanced their budgets for years with substantial state aid. It includes a chart that details state subsidies to these cities via the Aid and Incentives for Municipalities (AIM) program:

On Tuesday the SEC is holding a roundtable on credit ratings to address the ongoing question of ratings shopping. Rating shopping is when a bond issuer shops its deal to various credit rating agencies to see who will assign the highest rating. The rating agencies that will assign the best ratings are given the business and the rating fee. Here is how the SEC describes its event:

As previously announced, the roundtable will consist of three panels. The first panel will discuss the potential creation of a credit rating assignment system for asset-backed securities. The second panel will discuss the effectiveness of the SEC’s current system to encourage unsolicited ratings of asset-backed securities. The third panel will discuss other alternatives to the current issuer-pay business model in which the issuer selects and pays the firm it wants to provide credit ratings for its securities.

The possibility of a credit rating assignment system comes from legislation that Minnesota’s senator Al Franken inserted in Dodd-Frank. Franken’s law requires that the SEC study the feasibility of a bureau or panel that would assign a rating agency to rate an offering. Currently issuers choose which firms will rate their offering although for structured finance or asset-backed deals issuers must share the particulars of the new deal with all raters recognized by the SEC in that category. This is equivalent disclosure and something that I have advocated with the SEC since 2007 and Congress since 2008. It has slightly increased competition in rating structured finance securities as seen in the chart above although the size of the market has declined since 2007.