America's troubled cities are like Tolstoy's unhappy families: each has problems all its own. New York's 1979 near-bankruptcy, like Orange County's 1997 financial collapse or Pennsylvania's seizure of Harrisburg's books in 2012, like Detroit's Chapter 9 bankruptcy filing last week, all made end-is-near headlines. But maybe they tell less about our present and future than about local conditions, including political incompetence...
Writing in the Bond Buyer, Mark Schwartz, the colorful Main Line lawyer who led Harrisburg City Council's initial Quixotic attempt to stiff bondholders instead of selling city assets, points out that the Chapter 9 filing Detroit's state proconsul filed last week isn't like corporate bankruptcy -- it doesn't give debtors control. Rather it creates 'an uncharted free-for-all" in which state officials try to cobble together a more realistic, or at least sustainable, financial plan.
City government, Schwartz notes, is supposed to provide basic services to (often poor) people. But too often cities end up as vehicles to sell bonds for stadiums and other "economic development" boondoggles, scarfed up by investors' "insatiable appetite for tax-free investments tha twill forever ensure Wall Street's ability to market any piece of garbage," Schwartz added. Bond insurers, squawking loudest about forcing cities to pay investors, merely "bet wrong"; they deserve to share the pain of not getting paid every dollar they are owed, he argues. If General Motors and Chrysler paid noteholders "cents on the dollar" so they could stay in business (and also keep paying retiree pensions), why should muni investors expect much beter treatment?
"American industry has long and routinely used bankruptcy as a practice to shed and reshape obligations. This is, unfortunately, something that municipal bondholders will increasingly have to stomach," Schwartz concludes. "Instead of turning their wrath on issuers, they migh tmore profitably obtain redress from the bankers, lawyers and rating agencies who launched the bad paper to begin with."
The muni bond market hasn't collapsed; borrowing costs haven't surged higher, as Janney Capital Markets analyst Tom Kozlik joined his fellow muni-watchers in assuring concerned bond buyers last week. "The proposition that more cities will follow the city into the bankruptcy has little support," adds Matt Fabian in his Municipal Market Advisors newsletter. Of course muni salesmen have an incentive to whistle past the grave.
But "Michigan's antipathy for bondholders is startling," Fabian added. After years of Democratic mayors begging for bailouts, the Republican state government is now pushing for muni-bond haircuts that would trim bond investors' returns to near zero. Investors in future Michigan bonds should demand higher interest rates, knowing that Michigan and its cities "will use what leverage they can to defraud and default on unwary lenders," Fabian argues. He's urging clients to avoid any public bonds from Michigan.
"Bankruptcy is the ultimate failure of a municipal government," Fabian adds. But in Detroit's case, it's also the refusal of a conservative state government to allow taxpayers to continue subsidizing business as usual. Fabian doesn't engage the implications of that less-is-more ideology, the overthrow of the Democratic-led urban debt regime. Instead, he warns, Detroit's default will cause "acute increases in market access costs" for all Michigan issuers. Given how quickly bankrupt entities can typically start floating new issues, I expect even skittish muni-buyers will be more discriminating of deadbeat cities vs. paying issuers, than Fabian says.
Still: Stiffing the city's retired police officers and their average $19,000 yearly pensions won't fix Detroit, Fabian points out: "The city's fundamental problem is revenues, not liabilities." Michigan needs to fix Detroit by restructuring what the city is and does. So "the state's disinclination to help is a major disappointment."
What could the state do, really? Fabian lists examples of "constructive strategies" from the past generation of city turnarounds: "a New York City-style debt refinancing venicle; a Pittsburgh-style" regional tax; "a Miami-style regional" police and other "service integration; a Washington, D.C.-style tax and government restructuring;" or even a "Chicago-style" sell-off of city assets to pay down debt. "Michigan, apparently, will have none of this and is likely only making things worse for Detroit" by making the city's bonds look "worthless." It would have been much easier, he concludes, to restructure the city's long-term debt and make the payments manageable so Detroit can quickly borrow again when it makes sense to do so.
The good news: as mainstream investors dump Detroit bonds at a loss, vulture investors and hedge funds are buying them at a deep discount. As with corporate bankruptcies, these opportunists have an incentive to negotiate lower bond payments. As long as they still turn a profit.
A closer example to Philadelphia may be, not Detroit, but Chicago, which like Philadelphia feels pressure to sell city assets and to pump billions into its underfunded pension system. Chicago Mayor Rahm Emanuel has not been so effective as Philadelphia's Michael Nutter in convincing Wall Street that he's serious about tax and spending reform. Last week Moody's Investors Service, which says it's been taking pension debt more seriously, cut Chicago's bond rating three notches, to A3 from Aa3; which will likely boost future urban borrowing costs for towns facing similar liabilities, whatever happens over in Detroit.