Municipal haircuts

By Dave Anderson:

Vallejo, California is in Chapter 9 municipal bankruptcy. Pittsburgh and other major cities in the Rust Belt wish their fiscal situations were as good as Vallejo. Vallejo is acting as a test-case for many city and county governments that are teetering on the fiscal edge.  Decision makers want to see what types of actions will be allowed and not allowed in a bankruptcy proceeding. 

Chris Briem passes along a warning from Fitch that Vallejo bond-holders will likely take a haircut in the Chapter 9 bankruptcy.  This is important because it means the haircuts that all stakeholders will take will be distributed and the cuts on futture income streams will not be entirely concentrated on union pensions or workforce salaries.  Local unions that can vote as near-monolithic blocs have disproportionate influence in low-turnout municpal elections and primaries.  If that is the case, the political decision to seek municipal bankruptcy becomes an easier decision as it will be less likely to be seen as a union busting move.   

If more communities file for municipal bankruptcy (hi Detroit, esp. after the municipal pension fund gets kicked in the gut by the Rivers Casino in Pittsburgh filing for bankruptcy, or Jefferson Co. Alabama or any other mid-size or greater Rust Belt city), the traditional restraints against defaulting disappearas I noted last year:

 Once a few munis have started defaulting, they're all going to be "downgraded or shut out of the capital markets for future bond sales", whether they default or not. So at that point, they might as well just default. Municipal bond insurance, it turns out, might well be yet another one of those trades which makes lots of money until it blows up...

 we know that sales tax revenue is declining rapidly, property tax revenue is declining at a slower pace as communities are taking their time re-assessing values downward and other government pass-throughs and budgetary supports are under significant pressure.  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. 

The recent and relevant precedent of Vallejo bond-holders taking a haircut makes the political decision to default easier.  And at that point, once one or two more marginal and large municipal governments default or enter Chapter 9, all of them should.