For the past 18 months, Jefferson County, Ala. — home to 660,000 residents and the city of Birmingham — has teetered on the edge of bankruptcy. Since April 2008, the county has failed to make payments to creditors holding bonds that paid for its sewer system.
With $3 billion in bonds for a system that serves only 150,000 customers, the county simply built more sewers than it could afford. “It's a terrible situation,” said Bettye Fine Collins, president of the Jefferson County Commission. “I don't think there's another situation in this country that would compare.”
The roots of Jefferson County's financial problems may be unusual, but they're not unique. The county's sewer debt has been around for years, but the problem only spun out of control after Jefferson refinanced its bonds using securities for which the market collapsed, along with much of the rest of the financial system, last year.
Local governments haven't been hit quite as hard as states by the economic downturn, but they aren't exactly flush. Sales taxes are down, while property taxes — the main source of revenue for localities — are being adjusted slowly downward to reflect plummeting housing values. (Most properties are not reassessed on an annual basis.) “Sales taxes, property taxes, building permit fees — they're all down,” says Jim Phillips, a spokesman for the National Association of Counties. “It's an ‘all of the above’ type of suffering.”
A survey released Sept. 1 by the National League of Cities found that 88 percent of local finance officers find that's it harder to cover the costs of running their governments than it was a year ago, with a similar number predicting still worse fortunes in 2010. That's the most pessimistic assessment since the survey began in 1986.
Detroit Mayor Dave Bing recently laid off 200 city employees, but that wasn't enough to plug a cash shortfall approaching $80 million. The Motor City is watching property and income taxes go down at the same time Michigan is cutting aid to localities — a cost-saving move being pursued by many states. “I don't see the city getting out of this financial mess short of a bankruptcy,” said Joe Harris, a former chief financial officer for Detroit.
The collapse of the municipal bond insurance market, sparked by last year's financial meltdown, has affected local governments all over the country. Such insurance enabled state and local governments to borrow money more cheaply because they had the backing of private guaranty companies. Dallas, for example, used to pay about 4 percent for construction bonds that had the backing of private insurers. However, since that kind of insurance is now almost impossible to find, the city would have to now pay 6.5 percent. That difference in cost has put, among other things, a $700 million hotel project on hold.
Rep. Barney Frank, D-Mass., who chairs the House Financial Services Committee, intends to push legislation this fall that would allow the U.S. Treasury to insure municipal bonds, making it cheaper for states and localities to issue debt.
“I know that a lot of people are looking for ways for the federal government to help out state and local governments that aren't based on spending,” says Tracy Gordon, a public-finance expert at the University of Maryland. “Some people think perhaps there will be another stimulus involving more payments to states and localities, but others say that's not politically viable.”
Municipal bonds have been nearly as safe an investment as Treasury bonds. According to Moody's, a bond-rating agency, the 10-year default rates for all investment-grade municipals is 0.1 percent, compared with 2.1 percent for investment-grade corporate bonds.
But although municipal bankruptcies are extremely rare, defaults on municipal bonds are becoming more common. There were only 29 municipal defaults in 2007, totaling $300 million worth of bonds. In 2008, those numbers leapt to record highs: 150 defaults, totaling $7.8 billion, according to Richard Lehmann, publisher of Forbes/Lehman Income Securities Investor.
And cities and counties that go bankrupt don't act the same as bankrupt companies. They can't be forced to liquidate the way bankrupt chains such as Circuit City or Linens 'n Things have been. This gives local governments nearing default a tremendous amount of leverage in demanding that creditors make allowances. Jefferson County's creditors have offered $1.3 billion in concessions, but county commissioners haven't felt sufficiently pressured to take the deal.
The fear of taking on responsibility for debt issued by city, county and state governments may make Frank's proposal a hard sell. “If you were in debt, would you be more or less likely to increase your liabilities if you knew someone else would pay them off?” asks Richard W. Rahn, a senior fellow at the Cato Institute, a libertarian think tank. “Many children can quickly figure out the answer to this question, but it seems to be a real stumper for members of the House Financial Services Committee.”
The political wind Frank's bill faces may be one reason why the National League of Cities is pushing a separate proposal to create a mutual insurance company that would be owned by states and localities seeking muni bond insurance. But that plan calls for federal assistance, too — at least initially. The league figures it needs $5 billion from the U.S. Treasury to jump-start the effort but that the money could be paid back from profits.