MuniLand

San Bernardino, California made headlines this week for two distressing reasons. First, its city council voted to move toward declaring Chapter 9 municipal bankruptcy. Next, the city’s attorney made the shocking revelation that San Bernardino’s books have been cooked for 13 of the past 16 years, meaning that the surpluses the city had reported were, in fact, deficits.

San Bernardino is the third California city to move toward bankruptcy in the last few weeks, but the issue of bad accounting elevates this bankruptcy to a whole new level. The California Legislature enacted a new law last fall, AB 506, that requires 90 days of mediation between the city and creditors prior to a new municipal bankruptcy filing. But it is hard to see how that will be possible in San Bernardino’s case, since there are no legitimate financial filings to negotiate from. Moreover, the city doesn’t have the ability to pay its bills for 90 days during mediation. We’ve entered the twilight zone of muni workouts here.

Putting aside the issue of the city’s inability to follow proper accounting standards, San Bernardino may have a political leader in its mayor who is willing to take on the public unions and get necessary concessions from police officers, firefighters and other city employees. In the video above, Mayor Pat Morris discusses how the city will need to renegotiate salary and pension deals with city workers. Generally, salaries account for 70 to 80 percent of a local government’s cost structures and matter much more than debt service. Cities in California have the right to break wage and pension contracts with workers in bankruptcy. The problem is that we haven’t seen any political leaders willing to stand up to the unions.

The lawyers for public unions seem to be working hard to spin these bankruptcy stories as municipal development run amok. But the story in San Bernardino, like Stockton, is a case of enormous salaries paid to police officers and firefighters. In addition to the high wages paid to these workers, San Bernardino swelled the ranks of its public safety workforce relative to the population between 2004 and 2008. This trend is in reversal now, and finding a balance between public safety and fiscal sustainability will be tough. San Bernardino has a lot of work ahead of it.

Further:

City of San Bernardino: Budgetary Analysis and Recommendations for Budget Stabilization

How does a bankrupt city pay its public safety workers twice the median household income of the area’s residents? More important, why haven’t the city manager and council stopped this wage bonanza?

In Stockton, California, public safety workers earn on average 126 percent of the maximum salary and at least 200 percent of the minimum wage for their respective wage categories. The California State Controller’s Office has all the data, and it’s not pretty.

Stockton’s median household income was $50,011 in 2010. In contrast, the average total wage paid to a city police worker was $93,111. For employees of the fire department, it was $110,303. Admittedly, these are dangerous professions, but surely they are not so dangerous as to require pay of double the median household income of the entire community.

Stockton Vice-Mayor Kathy Miller talks about the exorbitant salaries paid to city workers and why the city is filing bankruptcy.

The media has described the problems of Stockton, California as being caused by the housing crisis and economic recession. A non-profit, California Common Sense, points to another reason for the city’s bankruptcy: its extraordinarily generous employee compensation agreements (emphasis mine):

[Stockton] employee salaries are scheduled to automatically increase 2.5-7%, depending on General Fund revenue growth. Consequently, employee salaries increase 2.5% even if the General Fund shrinks compared to the previous year.

Mammoth Lakes, a popular northern California ski town, has filed for Chapter 9 bankruptcy after mediation talks failed with its largest creditor, a developer who was awarded a $30 million settlement against the town in April 2008. The settlement has since ballooned to $43 million, including lawyer fees. Lawyers for the creditor, Mammoth Lakes Land Acquisition, say that the town is solvent and is just using the bankruptcy court to hide from the judgment they owe the company. Reuters’ Jim Christie reports:

Lawyer Dan Brockett said the town invited Mammoth Lakes Land Acquisition to enter into mediation only to follow the law until it could move forward with a bankruptcy filing.

“The mediation in our view was something they would do to check a box,” Brockett told Reuters, adding that his client will contest the town’s eligibility for bankruptcy.

LA trader: “if stockton was a surprise, i dont know where you’ve been for the last 3 months.” Still, a LOT of stockton bonds put out to bid

— Taylor Riggs (@TaylorRiggs_BB) June 27, 2012

The City Council of Stockton, California voted this week to adopt a “pendency budget” in preparation for filing for Chapter 9 bankruptcy, which will place the city under the protection of the bankruptcy court and stay all legal actions against it. This maneuver gives the city some breathing room to come to an agreement with its creditors, especially bondholders and retirees, over how to reduce what the city owes them. This comes after months of Stockton being under a state-imposed “mediation period” in which these kinds of negotiations were voluntary.

Reuters’ Jim Christie reports on the background of the story:

Stockton’s city council voted six to one in favor of the 2012-2013 budget after a contentious five-hour meeting where angry retired city workers pressed council members to reject the $155 million spending plan. It proposes eliminating retirees’ medical benefits to help fill a $26 million budget deficit…

In his New York Times column yesterday, Joe Nocera laid the blame for the fiscal catastrophe in Woonsocket, Rhode Island on Jon Brien, a state legislator who blocked a bill that would have plugged a massive hole in the town’s budget by raising property taxes on its residents by 13.8 percent. Nocera argued that Brien took these actions to shrink the local government because he’s a conservative ideologue, further highlighted by the fact that Brien is also on the national board of ALEC, an advocacy group that pushes for smaller government.

Maybe it’s true that Brien was primarily motivated by ideology, but if Nocera had taken even a cursory glance at the financial statement for Woonsocket, he would see Brien’s position has some merit. Spending on retiree benefits and municipal debt are drowning Woonsocket. The city is in a death spiral.

Let’s start with what Nocera got right: Municipal pensions, the traditional whipping boys for conservative critics of out-of-control government spending, are not Woonsocket’s big problem. The town’s pensions are actually 60 percent-to-90 percent funded, pretty good by Rhode Island standards (page 77). Maintenance of the pension funds required a contribution of only 2.2 percent of the 2011 budget.

Last June I wrote about a bizarre, unrated municipal bond deal that was issued to finance some new parking garages at Yankee Stadium. Because very few people were using the parking facilities, it looked like the $237 million of tax-exempt bonds would soon default. Now the law firm of the former mayor of New York, Rudy Giuliani, has been hired to strike a deal between Bronx Parking Development Co, the parking garages’ operating entity consisting of a husband-and-wife team based in upstate New York, and the bondholders. From the Daily News:

Former Mayor Rudy Giuliani’s law firm has been hired by a group of private bondholders to restructure $237 million in tax-exempt financing for the nearly bankrupt owner of the Yankee Stadium parking system.

The surprise choice of Giuliani’s firm, Bracewell & Giuliani, is part of an agreement reached last week between Bronx Parking Development Co, owner of the 9,000-space garage and lot system, and its creditors.

Chart source: Bonddesk

State politicians in Alabama, Pennsylvania and Rhode Island have lambasted municipalities within their borders that have either declared, or attempted to declare, bankruptcy. The politicians gripe that when a municipality in their state goes into Chapter 9 bankruptcy, it affects the cost of borrowing for the state and other issuers located there. But this rests on the false assumption that markets do not discriminate between different borrowers. Municipal bond issuers, like public companies, are looked at individually because every entity has its own story. After all, when American Airlines went bankrupt, it was not as if all airlines suffered.

Alabama Governor Robert Bentley explicitly used the increased cost of borrowing for other Alabama towns as a bludgeon against Jefferson County officials who declared bankruptcy last November. The Birmingham News wrote:

He [Governor Robert Bentley] said the county’s situation already has affected borrowing throughout the state and he expects the bankruptcy to increase the cost of borrowing even more. “The credit rating of Jefferson County is terrible already so it can’t get much worse, but certainly filing bankruptcy does not help,” he said. “I know they were frustrated but at some point, you have to step up and have to be a leader and have to be a statesman and you have to do what’s right. Bankruptcy is not right.”

Bond markets generally focus on who has rights to specific cash flows and control over assets. That was what Alabama federal bankruptcy court Judge Thomas Bennett was addressing when he issued an opinion Friday afternoon covering the insolvent Jefferson County sewer system.

To recap the situation in Jefferson County, re-read what I wrote in November:

Last year, amid the county’s fiscal and political meltdown, the Russell County Circuit Court appointed a water system professional, John Young, to take over the management and operation of the sewer system. This action came at the request of the bond indenture trustee, the Bank of New York, which wanted the bond payments protected. Now the county is fighting with the receiver and creditors for control of the sewer system in bankruptcy court.

The crux of Judge Bennett’s ruling related to whether the sewer receiver, John Young, could keep control of Jefferson County’s most important asset, the sewer system, while the county was trying to consolidate its assets in the bankruptcy process. Bank of New York and other bondholders argued that the federal bankruptcy proceeding could not trump judicial actions taken at the local level. In other words BoNY, representing bondholders, wanted to keep the control of the sewer system and its cash flows. Although revenue bondholders have a lien, or right, to the cash flows of the sewer system, they also wanted control of the asset.

The New York Times really needs to improve the quality of its reporting on the municipal bond market. Mary Williams Walsh makes such a terrible hash of the situation in Jefferson County, Alabama, that she is bound to set off another muniland hysteria in the mold of Meredith Whitney.

In the opening paragraphs, Walsh contends that general obligation bonds (GO) issued by state and local governments and with the pledge of their “full faith and credit” may not be as creditworthy as always assumed. About half of the $3.7 trillion municipal bond market is general obligation bonds. She dramatically states that investors who own GO bonds might be in for a “surprise:”

People who own what is considered the safest type of municipal bond may be in for a surprise.