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.

Singing the passion song

Singing the passion song

Kathleen Kennedy Townsend, the former lieutenant governor of Maryland, writes passionately in The Atlantic about the need to create jobs in the United States, especially those linked to infrastructure. I welcome her opinion as we need more passionate voices drawing attention to the need to stop outsourcing American jobs. We will never recover if we make economic decisions solely on the the basis of manufacturing costs. Ms. Townsend says:

As a country we have to decide what our values are. Do we really want to be a nation that funds our spending spree through the Chinese, who then make our goods and do our work while we go into debt and remain unemployed? Work is more important than saving tax dollars. Jobs are critical. Work, not an unemployment check, is what makes people feel they are worth something.

I hope the combined forces of politicians, the unions, and the Chamber [of Commerce] will eventually overcome the resistance to the infrastructure bank. We need to create jobs, and we need to rebuild our roads, railways, sewage, and water systems. Most of all, we need to revive our sense of energy and excitement — the deep fulfillment that comes of making things we can touch and feel, things that really improve our lives.

Decades-long infatuation with financing our spending

Decades-long infatuation with financing our spending

Sheila Bair, who served as Chairman of the Federal Deposit Insurance Corporation for five years through the financial crisis, has completed her term. In a weekend op-ed in the Washington Post, she urges America to rid itself of its addiction to financing consumption and “growth” with debt. This is the core requirement for America to become financially stable again and to return to “real” growth. From Bair’s Washington Post oped:

Now that I’m stepping down, I want to sound the alarm again. The common thread running through all the causes of our economic tumult is a pervasive and persistent insistence on favoring the short term over the long term, impulse over patience. We overvalue the quick return on investment and unduly discount the long-term consequences of that decision-making.

Our decades-long infatuation with financing our spending through ever-growing debt, in the private and public sector alike, is the ultimate manifestation of short-term thinking. And that thinking, particularly in business and in government, is actually getting worse, not better, as we look for solutions to put our economy on a sounder footing.

Insurers have “manageable” muniland risk

Insurers have “manageable” muniland risk

Meredith Whitney has made many assertions about muniland, but the only one that I had not heard from others before she stepped onto the national stage was her contention that insurance companies would be forced to sell their municipal bonds into a declining price spiral. She alleged this would collapse muniland, so it’s very interesting to see Moody’s assess the risk for insurance industry. From Property Casualty 360:

Property and casualty insurers remain the most exposed sector among financial institutions to volatility within the municipal-bond market, holding about $355 billion in municipal bonds, but the overall level of risk should be manageable, Moody’s says.

In a Special Comment, Moody’s says municipal bonds represent 60 percent of the industry’s equity capital base, as measured by policyholders’ surplus. This figure is down from the prior year, when the industry held about $370 billion in municipal bonds, representing about 70 percent of policyholders’ surplus.

Real people are connected to every actuarial assumption

Pension reform sounds abstract and distant from everyday life. It is almost entirely confined to state- and local-government workers. Companies stopped giving pensions to their workers decades ago as they switched employees to 401(k)s and other voluntary-type retirement schemes. This removed enormous future liabilities from the balance sheets of companies and shifted the risk of adequate retirement means to individuals.

Public pensions plans are now  squarely in the sights of state legislatures. They are terribly underfunded and have grown unsustainable. Changes, though, must be made within the law. For example, states cannot categorically take away pensions because they are “contracted obligations.” But states can and are chipping around the edges and making changes to things like “cost of living adjustments” (COLA) and the required retirement age.

These legislative modifications are being challenged in courts. This is not surprising since people don’t generally give up their benefits or rights on a voluntary basis. In many cases these pensions are the only thing that retirees will have to fund their retirement. Workers are not winning their court cases, though. The WSJ reports that:

Has Chris Christie “fixed” the problem?

Has Chris Christie “fixed” the problem?

Joan Gralla of Reuters reports that Governor Chris Christie will be signing the pension and health-benefit reform law today. This is an important step for the health of New Jersey’s pension plans, and Governor Christie should be lauded for his accomplishment.

The state’s 2010 Debt Report (page 15) said that they have $87.5 billion in unfunded liabilities as of June 30, 2009 and that the rate of increase has gone up substantially in recent years:

    $30.7 billion for the seven major state pension funds $56.7 billion in unfunded post retirement health benefits

Unfortunately Governor Christie has skipped payments of $5.5 billion over the last two years and compounded these unfunded liabilities. One of these skipped payments was used to claim a “balanced budget.” Your household budget is not really “balanced” if you skip your car loan payment for a year.

Greening the city

Greening the city

Many cities took a big step forward for clean air when they adopted buses fueled by natural gas. But there are other important projects that will make getting around easier, quieter and less polluting. New York City is getting ready to take a big step. From American City:

New York City has the potential to take those [bike sharing] concepts and scale them up to a size unseen on this side of the Atlantic. Mayor Michael Bloomberg, a man the transportation community has a complicated relationship with, has been dangling a transformative bike sharing program in front of alternative transportation advocates since 2009 when New York’s city planners issued an “exhaustive proposal” that included a 10,000 strong fleet of safety-equipped, GPS-ready bikes.

Economically, the deal is a victory for innovative financing because it fully absorbs the burden of maintenance, damage, and —as this is a city— theft, vandalism, and “artistic destruction.” New Yorkers would buy their memberships on weekly, monthly, or yearly bases and get an unlimited number of free rides that take less than 30 minutes; ride a little longer, pay a little more. New York has decided that an initial burst of capital will serve their purposes the best not least because of their uniqueness among American cities in terms of density and population.

Save the $100,000 that Meredith Whitney charges for research

Just the numbers please

You can save the $100,000 that Meredith Whitney charges for her research. Reuters has the data on municipal bond issuers with the weakest profiles by bond-market standards. Puerto Rico leads the pack as the least credit-worthy issuer. Issuer Weekly Yearly Outstanding Unfunded S&P Moody's Spread* Average Tax-supported Debt Pension Rating Rating Puerto Rico 225 203.7 $40 bln $24 bln BBB A3 Illinois 174 175.5 $24 bln $62 bln A+ A1 California 95 106.3 $87 bln $50 bln A- A1 Michigan 80 81.2 $7 bln $12 bln AA- Aa2 Nevada 70 68.0 $2 bln $2 bln AA Aa2 New Jersey 65 54.7 $32 bln $37 bln AA- Aa3 D.C. 60 57.3 $6.4 bln $0 A+ Aa2 N.Y. City 47 55.7 $61 bln $76-122 bln AA Aa2 Rhode Isl. 47 45.9 $2 bln $4 bln AA Aa2 Ohio 38 31.9 $11 bln $2.9 bln AA+ Aa1 *In basis points for the week ended June 17, 2011, Sources: Municipal MarketData, Moody's Investors Service, Standard & Poor's Ratings Services, local government budget reports, official statements

The roots of delusion

Small snippet from an excellent piece in the New York Times on the roots of the unfunded pension mess (emphasis mine):

Is the taxpayer backstop the root of pension problems?

Public workers have been protesting against the reduction of their benefits in several states. It got a more than a little testy in Wisconsin this winter, which has led to several recall elections for legislators there.

It is the right of public workers to push back when they believe they have been treated unfairly. But it is also the responsibility of public workers, and especially their union leaders, to help create a realistic, sustainable benefit scheme for themselves. Too often union leaders insisted on more and more benefits and lower contributions while ignoring the damage done to the viability of their pension plans.

Maybe they didn’t worry because they knew that taxpayers would have to make up shortfalls in underfunded pension plans. Maybe the guaranteed taxpayer backup is the root of our fiscal problems. It has placed all the responsibility for fiscal prudence on elected officials who often are easily swayed by well-organized constituent demands.

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