SAN DIEGO — Though municipal bankruptcies may never become widespread, industry insiders warned during The Bond Buyer’s California Public Finance Conference more will come because of the pressure on local governments.
“I really don’t expect … this great wave of Chapter 9 bankruptcies across the country,” said John Knox, a partner at Orrick, Herrington & Sutcliffe LLP and bankruptcy attorney for Vallejo, Calif. “I think probably there will be a couple more because of the great stress that local governments are under.”
As an example, Knox noted the “balkanization” of local governments in California who have had their general funds squeezed by falling revenues and reduced funding from the state.
He said the municipalities have had to do more leveraging to pay for core services such as police and fire departments.
“I see us kicking the can down the road,” said William Brandt of Development Specialists Inc. He said some local governments have just been forestalling coming to grips with their dire fiscal situations.
Brandt noted that bankruptcies generally come in two types — those driven by one time events, and those related to budget problems.
He said the budget woes are usually linked to political issues, such as negotiations with unions over pensions and medical benefits, rather than an insurmountable fiscal event.
The experts agreed that government entities should do everything to try to avoid Chapter 9.
“Don’t go into bankruptcy; it is frightfully expensive,” said Robert Stout, the former finance director for Vallejo and now a consultant to the city.
He said the city has so far spent $12 million on its bankruptcy. Vallejo is close to finally exiting bankruptcy after it received a federal judge’s approval for its exit plan. It is now finalizing contract details with its largest bondholder, Union Bank.
Stout noted the city now has one-third fewer employees and has slashed pension liabilities and medical benefits.
Vallejo, with a population of 120,000, filed for bankruptcy in May 2008 after three years of deficits caused by dwindling tax collections and what it called unsustainable labor contracts.
James Pass, a portfolio manager at Guggenheim Partners, said municipal investors must now pay close attention to politics.
“The credit crisis has changed the whole industry and we are seeing a new way of looking at bankruptcy from the political as well as the buy-side point of view,” Pass said. “It is true to say there is never a bad bond, there is just a bad price.”
Pass said he still looks at stressed credits where there is value, but it requires a lot of close attention to the political situation.
He noted that municipalities need to be careful of what they say regarding bankruptcies because it could hurt them down the line when they seek more financing.
“Our firm is very intrigued by what is going on in Harrisburg and Jefferson County,” Pass said, referring to financial problems in Pennsylvania’s capital city and the county in Alabama that is home to Birmingham. “It is a vicious news cycle.”
