MuniLand

Bondholders have cut the line

Something doesn’t seem right in Central Falls, the Rhode Island city that declared municipal bankruptcy yesterday. Now that the state receiver has filed Chapter 9, all the town’s dirty laundry has been hung out in public, and, like any bankruptcy, it’s not pretty. Overspending and declining tax revenues doomed this poor town, along with liberal doses of alleged corruption.

Here is what doesn’t seem right in Central Falls. The city is dead broke and those they owe money to are lined up at City Hall to collect. But for some odd reason, the city’s bondholders have pushed ahead of all the others in line to claim full repayment of their debts; those later in line must settle for 50 cents on the dollar. Retired police officers and firemen will have their pensions cut by 50%.

It wasn’t Central Falls’s decision to give preferential treatment to bondholders. Last year legislators in the state capitol passed a law making the claims of bondholders superior to all other claims in bankruptcy. The Rhode Island General Assembly’s action flies in the the face of common bond market practice, which is that bondholders get in line with everyone else and a judge overseeing bankruptcy proceedings gives a fair resolution to all the creditors.

The law passed by the Rhode Island General Assembly upends the order of priority for payments in bankruptcy. Municipal bankruptcy is filed in federal court, and cities cast themselves at the mercy of the federal bankruptcy law. Because our federal constitution reserves all rights to the states that the federal government does not claim, it makes this area of the law a funny hash of competing jurisdictions. And it possibly encourages the Rhode Island legislators to try and change the rules.

The federal bankruptcy code does create some special protection for holders of “special revenue” bonds. The law firm Jones, Day characterizes the exemption:

The smallest city in the smallest state

Central Falls, Rhode Island — the smallest city in the smallest state — filed for bankruptcy today after years of decline. It is the fifth U.S. municipality this year to seek protection from the courts under the bankruptcy law. The Governor of Rhode Island stood with city officials as the bankruptcy process commenced. Reuters quoted him as saying in a statement:

“The current situation is dire and it necessitates decisive steps to put the city back on a path to solid financial footing and future prosperity,” Rhode Island Governor Lincoln Chafee said in a statement.

Central Falls’s population peaked in 1930 and has declined ever since; it currently has only 19,000 inhabitants. The town is extremely poor with median household income of $22,628 and per-capita income of $10,825, according to the 2000 Census. Central Falls, like many hidden American towns, is at the end of municipal row.

Supporting less prosperous brethren

There are many financial linkages between various levels of government in muniland but everyone eventually has to stand on their own. It’s like the cousin you grew up with but don’t see much now other than holidays. When your cousin loses their job and their mortgage is being foreclosed you want to help but in a limited way. You want the cousin to get a job and cut a deal on their mortgage or do a short sale. You don’t want them moving into your home or having access to your bank account. It’s the same between the federal, state and local governments. They are cousins. But not that close.

My fellow Reuters blogger, Felix Salmon, said yesterday that states are considered too-big-to-fail by the financial markets:

There’s certainly a general understanding, in the markets, that California is too big to fail: if push came to shove, the federal government would bail it out rather than let it default.

The middle sadness

The middle sadness

Paul Mason, the economics editor of the BBC’s Newsnight program, recently retraced John Steinbeck’s footsteps during America’s Great Depression.  What he found was a broad swath of sadness as he observed many citizens who have lost jobs and homes. It’s the invisible America. From the BBC:

I drop down into Albuquerque, into Joy Junction, which in the red dusk looks like a scene from Steinbeck. There are 300 homeless people staying here, all families.

Jeremy Reynalds, an expat Brit who runs the place, tells me frankly that the mainstay of the place are people with drug, alcohol and domestic violence issues. But as the years of crisis have dragged on, there is a new phenomenon – the homeless middle-class.

Geeks for democracy

Geeks for democracy

“How do you enable people to have a louder voice within their communities?” asks Conor White-Sullivan. He answered his own question by developing Localocracy, a platform that hosts community-focused discussion boards seeking participants who are registered to vote and who use their real names. Localocracy gives citizens an opportunity to generate discussions to influence each other, their government and journalists.

Conor is one of 16 winners of “Champions of Change,” a contest the White House hosted in June that showcased the potential of Web apps that utilize data sets made available by federal, state and local agencies. Developers who were chosen to attend created applications that enable users to find and organize pick-up games at public facilities, guide citizens through zoning ordinances and direct parents to child-friendly locations, as well as numerous other services. See more of this wonderful project at GovTech.com.

Jefferson County part 6

According to the Birmingham News the court-appointed receiver over the Jefferson County sewer system, John S. Young, announced late Wednesday that the bondholders had a counter-proposal for the county commission. This was a few short hours before the commission’s 1:00pm meeting today to decide to declare bankruptcy.

The state becomes the guarantor

Jefferson County, Alabama is getting a lot of attention as it negotiates with the holders of $3 billion of sewer bonds. The county would like to pay $2 billion to settle the $3 billion of bonds outstanding and limit the rate increases county residents would have to pay. This arrangement would pay bondholders (led by JP Morgan) 66 cents on the dollar — not a great recovery but not outrageous either. Bondholders want the state to guarantee this new arrangement and stand ready to pay in the event of another default.

There is an alternative option for settling the matter: a Chapter 9 municipal bankruptcy. The county is now prepared to go that route if necessary and have hired an expert attorney to lead them through the process if they so choose.

The county accumulated this sewer debt over a number of years to fund the development of an EPA-mandated sewer system. Its construction was laced with delays, cost overruns and corruption. It’s the poster child for disastrous public works and bad dealing by Wall Street. The credit rating for this debt started out as AAA in 1997 when it was issued. The bond insurer FGIC stood behind the debt and helped raise the credit to the highest level, AAA, from Baa1. In the chart above you can see the rating move in February 1997 as the insurer came in and pledged to repay bondholders if default occurred.

What would a debt-limit crisis cost the states?

Thanks to Jordan Eizenga at the Center for American Progress, you can see some scenarios of the impact of the halt in payments to states if the debt ceiling is not raised. Jordan says:

The key thing to remember is that these are cuts that would occur even if we protected Social Security, Medicare, Medicaid, defense, and UI. Failing to raise the debt limit causes unavoidable pain to states.

Roll your mouse over to see the effect on each state. More analysis here.

It’s on in Alabama

The crisis in Jefferson County, Alabama is quickly coming to a head. The County Commissioners’ willingness to file for Chapter 9 municipal bankruptcy is putting a lot of pressure on bondholders, led by JP Morgan, to agree to a settlement. It appears that the entire Alabama political structure is aligned to do the best for their citizens. Right now the epicenter of the struggle between the people and Wall Street is Birmingham, Alabama.

Markets hold the whip, but are they rational?

There has been a lot of discussion over the past few days about whether the United States deserves a triple-A rating. The weak and meandering attempts of the Congressional leadership and President Obama to reach a consensus on raising the debt ceiling has prompted this storm of confusion. The political theater is painful.

Most of the talk about ratings revolves around whether the level should be lowered one or more notches. But in The Telegraph today Ambrose Evans-Pritchard goes further and says it’s not really that important whether the United States retains a triple-A because the credit rating agencies don’t have the credibility to strip the rating to the world’s largest sovereign debt issuer (emphasis mine):

Yes, the US may be stripped of its AAA by Standard & Poor’s. A nice one-day story, but otherwise irrelevant. Global bond vigilantes are quite able to make their own judgement on the substantive default risk of the US. The rating agencies are out of their league on this one.

Oh Illinois!

 

Oh Illinois!

Illinois has massive problems: the state has more liabilities than assets, and the credit-default swap market says they are the number one state at risk for default (see chart above). The Bond Buyer ran an excellent story on how the liabilities of Illinois are rapidly increasing:

In a sign of Illinois’ ongoing fiscal challenges, its net assets deteriorated by $8.4 billion in fiscal 2010, pushing its deficit in that category of financial reporting up to a negative $37.9 billion, according to a new report from state auditor general William Holland.

The figure takes into account the state’s accounts payable that were $9.1 billion in fiscal 2010 and $55.1 billion of debt obligations, including outstanding bonds and pension obligations. The figures provide a wider view of a state’s overall long-term fiscal health than the snapshot provided by annual budget numbers.

Most expensive sewage system in history

If you say “Jefferson County” to a professional in muniland, you will likely get a shudder of mild revulsion. This Alabama county is the biggest example of Wall Street aggression towards a public entity since Orange County, California declared bankruptcy in 1994 after buying too many interest-rate derivatives. Dodd-Frank, the financial-reform law that’s been in effect for a year, changed the rules for municipal bonds and derivatives.  But did it change them enough to avert a repeat scenario?

First, a little background: Jefferson County was ordered by the federal EPA to build a sewer system at an estimated cost of $1.2 billion. The construction went over budget and was rife with massive corruption that has ensnared 17 people. The funding of the sewer project was equally corrupt. JP Morgan was under investigation for bribery in 2009 and eventually reached a settlement with the SEC. The Washington Post reported this at the time:

J.P. Morgan Chase agreed to a $722 million settlement with federal regulators over accusations that the bank and two former executives made illegal payments to win municipal bond business from Jefferson County, Ala.

  • # Editors & Key Contributors