Onto the 9th Chapter of Hell

By Dave Anderson:

Or the municipal bankruptcy code. 

Chapter 9 is the federal bankruptcy code for municipalities.  Pittsburgh has flirted with it a few times but the state of Pennsylvania has not given the city permission to seek federal protection.  Several area communities have flirted with it but their finances have been re-organized by the state.  Vallejo, California is currently the largest community in Chapter 9 protection while Jefferson County, Alabama is casting an eye at bankruptcy after they got hosed on a swaps deal related to a major sewage infrastructure campaign. 

Harrisburg is seriously considering entering Chapter 9.  The city is on the hook for a loan guarantee that they extended to a municipal authority.  That loan was used to build a commercial trash incinerator.  The loan defaulted, and it is larger than the annual municipal budget. 

Chapter 9 could get a workout as the local governments are overextended.  Meredith Whitney believes that there could be a trillion dollar hole in local government balance sheets:

I THINK THE CRISIS WITH THE STATES WILL RESULT IN AN ATTEMPT AT LEAST
FOR THE THIRD NEAR TRILLION DOLLAR BAILOUT. THAT HAS CONSEQUENCES ON THE
DOLLAR, ON JUST ABOUT EVERYTHING. IT CERTAINLY HAS CONSEQUENCES ON THE
U.S. RECOVERY. SO IT'S A MACRO CALL, AND YOU CAN ALSO PLAY MICRO IN
TERMS OF WHAT'S GOING TO HAPPEN? WE DON'T THINK THERE'S A RISK WITH THE
STATE DEBT SERVICE. WE VERY MUCH THINK THERE'S A RISK WITH THE MUNICIPAL
LOCAL DEBT SERVICE.

If this is the case, then it makes sense for distressed municipalities to get to Chapter 9 first so that they get ahead of the wave of reputational risk pricing increases and clean up their balance sheets faster:

Local governments will be making a decision of taking a hit on their
credit by defaulting or crippling their community with an escalating
cycle of tax rate increases to produce flat or declining revenues and
horrendous services.  Sooner or later, pulling out of the credit market
for five years will be very attractive...

There are options to extend and pretend which seems to be the consensus Serious response as debts could be renegotiated at generational low interest rates for long terms.  However local governments that are in trouble will most likely try to whack their pension funds as they are the biggest pool of money floating out there, and it is easy to demonize small segments of the population in an age of zero-sum politics.