Do muniland’s flare-ups signal a bigger fire?

Now that three California towns have declared bankruptcy in the past few weeks, the mainstream media is abuzz with headlines of imminent doom for state and local governments. Adding fuel to the fire were Warren Buffett’s comments on Bloomberg TV about how cities may find it easier to declare bankruptcy after seeing others do it:

“The stigma has probably been reduced when you get very sizeable cities like Stockton or San Bernardino to do it,” Buffett, 81, said in an interview today on “In the Loop with Betty Liu” on Bloomberg Television. “The very fact they do it makes it more likely.”

He said the nation isn’t on the brink of hundreds of billions of dollars in defaults, as banking analyst Meredith Whitney predicted in 2010. “I don’t think we’re at the precipice,” Buffett said. “People will use the threat of bankruptcy to try and negotiate, particularly pension contracts, with their employees.”

Unlike Buffett, I’m not sure that public unions will yield to local politicians who wave the threat of municipal bankruptcy at them. As soon as there is a case when labor and pension contracts are actually crammed down in a bankruptcy proceeding, then public unions might start to worry. The closest muniland came to this kind of restructuring occurred in the bankruptcy proceeding in Central Falls, Rhode Island. There, labor and pension contracts were modified, but its situation is unique because of Rhode Island’s law prohibiting any haircuts for bondholders. Unions had to take all the losses in the bankruptcy proceeding because no one else would.

Furthermore, Buffett might be talking his book here. Bloomberg reports that Berkshire Hathaway held municipal bonds valued at about $3 billion as of March 31 – about 9 percent of its fixed-maturity portfolio – and as much as $16 billion in derivatives tied to such debt. That his company’s position in muniland CDS is much bigger than his position in municipal cash bonds indicates that he is very pessimistic about muniland’s prospects and is willing to bet on that outlook.

Privatize San Bernardino’s EMS services

The City Council of San Bernardino, California, has declared its intent to file for bankruptcy and has issued a fascinating document that outlines the steps it would take to regain fiscal solvency. It’s a very creative and orderly attempt to reshape the finances of the government.

Proposals include a tax on phone service, estimated to raise $6.7 million dollars a year; a comprehensive asset plan to set market-rate rents for some city-owned properties and below-market-rate leases for others to create incentives for development; an increase in fees for false alarms that police respond to; and the outsourcing of tree trimming, street sweeping, graffiti abatement, streetlight maintenance and trash collection.

Although these ideas could raise new revenues, they do not really address the most burdensome parts of San Bernardino’s budget.

Bankruptcy and fudged accounting in San Bernardino

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.

Did the police and fire departments sink Stockton?

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.

Why Stockton is broke

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 needs to do a Half Moon Bay

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.

Stockton hits the wall

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…

Why America won’t pay for more stimulus

This morning’s jobs report revealed that 79,000 net new jobs were created in the country in May, nearly 50 percent below the consensus forecast of 150,000. Almost immediately following the release, there were loud and insistent calls for another round of monetary and fiscal stimulus. “Job growth stumbles again, raising pressure on Fed,” the Reuters headline ran. My fellow Reuters blogger Felix Salmon called for immediate federal stimulus funded by more debt issuance. Felix’s rationale, like many others’, is that with U.S. borrowing costs so low, stimulating current economic activity is a higher priority than worrying about paying down the debt in the future. Or to put it differently, a little more debt is preferable to enduring the economic pain of the economy rightsizing itself.

However, economic weakness is concentrated in just a few regions, and the solutions that many are pushing for – additional fiscal stimulus from Congress or further monetary easing from the Fed – are too diffuse to make much of a difference or require a national constituency that is unlikely to materialize. Unemployment fell in 37 states in April, but in California, Rhode Island and Nevada, there are still massive employment problems. The National Conference of State Legislatures reports (emphasis mine):

Unemployment rates were down in 37 states, the District of Columbia, and Puerto Rico in April 2012. Only five states saw unemployment rise and eight states had no change for the month, according to figures released by the Bureau of Labor Statistics on May 18, 2012.

Dark clouds in the Golden State

In a YouTube address released last Friday, California Governor Jerry Brown shocked his constituents with an announcement that the state’s projected revenue shortfall had increased to $16 billion. This followed very weak April state income tax collections, which deepened the budget hole from the $9 billion that Brown had originally forecast in January. The new deficit is a result of a reduced revenue outlook for California, higher school funding costs, and decisions by the federal government and courts to block certain budget cuts. New cuts that Brown floated yesterday will reduce General Fund spending as a share of California’s economy to its lowest level since 1972‑73.

The $92 billion budget that Brown had proposed in January for the fiscal year 2012-2013 (which starts on July 1) looked like this:

With the new revenue shortfall, almost every area of the state budget has been targeted for cuts; education, which accounts for 53 percent of General Fund spending, is the only category that was spared. In his revised proposal, Brown substantially increased K‑14 spending (i.e., includes two years of community college or vocational training) and protected the University of California and California State University from further, deeper cuts. School spending is mandated by Proposition 98, which requires that California pass through a substantial portion of state revenues to local governments to fund education.

Overall, Brown proposed that half of the budget hole should be plugged with spending cuts, 35 percent with tax hikes and 15 percent with financial gimmicks. Brown’s preferred budget cuts (pages 5-7) total $8.3 billion and include a $1.2 billion reduction to California’s medicaid program (Medi-Cal), an $880 million reduction to welfare (Temporary Assistance to Needy Families payments) and a 7 percent reduction in hours to in-home supportive-care-services providers.

The impact of defense cuts

Reductions to our outsize military budget are scheduled to take effect in 2013. Congressional Republicans have vowed to reverse these mandated reductions, but so far organized resistance in Congress has not appeared. President Obama has vowed to veto any legislation that would overturn the cuts.

I previously described the size of the annual reductions:

President Obama proposed spending approximately $924 billion on defense, veterans care and international affairs for 2012. This represents about 24.7 percent of the $3.729 trillion federal budget. The automatic cuts to these areas required by the Budget Control Act of 2011 will equal about $75 billion per year over eight years. This would be on top of already enacted Defense Department reductions of $45 billion per year over 10 years. The combined $120 billion of annual spending cuts will equal about 12.9 percent of the joint budget for defense and intelligence. It’s a big cut, but it would barely dent the capabilities of the biggest military force on earth.

Annual reductions of 13 percent are substantial, but the nation will still spend significantly more than any other on earth. And it’s important to remember we will be spending 25 percent of our federal budget on the military even though, it is hoped, we will not be fighting a war. It’s not clear that the U.S. would have the “fiscal space” to ramp up spending to fight another big war and care for Social Security, Medicare and Medicaid beneficiaries.

  • # Editors & Key Contributors