Thursday, February 28, 2008

1 down, 10.000 to go

Ilargi: This sort of news article will become very familiar soon. What's good to note is that towns, unlike companies, don't close the gates and cease to exist when they declare bankruptcy. Probably creditors will be the biggest victims here, along with those working for the town. It will be allowed to continue as some sort of 'minimal facility', providing only urgent and 'necessary' services. Road maintenance won't be among them.

California City Moves Closer to Bankruptcy Filing
Vallejo, a city of 135,000 outside of San Francisco, moved closer to bankruptcy after negotiations with its labor unions collapsed. Bondholders will likely be asked to sacrifice some of their investment if the city seeks bankruptcy protection, an attorney for the municipality said last night. Vallejo faces ballooning labor costs and declining housing-related sales-tax revenue, leaving budget officials projecting that money will run out within weeks.

The city council is scheduled to consider a resolution tomorrow to file for Chapter 9 bankruptcy protection, after negotiations with labor unions to win salary concessions broke down Monday. If approved, Vallejo would become the biggest city and second-largest local government in the state after Orange County to file for bankruptcy.

Municipalities throughout California are grappling with billions of dollars in labor and pension cost increases incurred during the late 1990s. The crisis comes as the worst housing slump in the U.S. in 26 years saps tax revenue. The state's own $16 billion deficit led Governor Arnold Schwarzenegger last month to declare a fiscal emergency.

Bondholders are "creditors who would have to come to the table and it may be possible to adjust how much you are paying them and on what time period, which would, in effect, free up money that could be used as part of the plan to resolve the city's problems on a longer-term basis." John Knox, a public finance attorney with the law firm Orrick, Herrington & Sutcliffe, told the city council last night.

'Last Resort'

Vallejo faces a $6 million shortfall and won't have money left to pay salaries as of March 31, according to the city manager's office. The deficit is expected to grow to $13 million during the coming fiscal year, beginning July 1, according to budget documents.

Police and firefighting salaries, pension and overtime consumes $63.1 million, or about 74 percent of the city's $85 million general fund budget. The city has slashed $13 million in spending since December 2006, firing 47 workers.

"Bankruptcy is a last resort," said councilwoman Joanne Schivley. "But guess what folks, that's where we are now at."

Standard & Poor's on Feb. 21 changed its outlook to negative from stable on $59 million of city bonds. That debt, backed by water-system revenue, motor vehicle license fees and special district property assessments, is rated A and A-, the sixth- and seventh-highest investment grades.

Big Impact

Clark Stamper, who oversees $600 million of municipal bonds at Stamper Capital & Investments, including Vallejo debt, said a bankruptcy filing could encourage other California communities to consider the step should the city persuade a judge to reopen labor agreements. "What happens in Vallejo is going to be the model for what happens across the state," Stamper said yesterday. "It will have a big impact."

Chapter 9 of the federal bankruptcy code deals specifically with municipal governments such as cities, counties and school districts, allowing them to reorganize their debts and come up with a way to pay them off. If the city seeks bankruptcy protection, basic government services such as police and firefighting, would continue. The filing would freeze all creditor claims while city officials devise a plan to solve the financial troubles. That plan would need approval by the court, which could dissolve the labor contracts that aren't set to expire until 2010.

Compounded Woes

Vallejo was home to the West Coast's first naval shipyard, which was shuttered in 1996. The area has been one of the hardest hit in Northern California by the housing market slump.

Home prices in Solano County dropped 19 percent in January from the year before, according to DataQuick Information Systems, a firm that tracks real-estate in the state. Compounding the city's woes is lost tax revenue when above- normal rains damped attendance at a local Six Flags Inc. marine world amusement park, one of the 10 largest employers in the county.

Orange County in Southern California filed the biggest municipal bankruptcy in U.S. history in December 1994 after former Treasurer Robert Citron's wrong-way bet on interest-rate derivatives sold by Merrill Lynch & Co. lost $1.6 billion. The county of 3 million people is the third-most populous in California after Los Angeles and San Diego.

Bankruptcy Stigma

Desert Hot Springs, a town of 20,000 people north of Palm Springs, filed for bankruptcy in 2001, when it couldn't afford a legal judgment of almost $6 million. Both Orange County and Desert Hot Springs sold municipal bonds to pay creditors and emerge from bankruptcy.

Three years ago, the threat of bankruptcy loomed in San Diego as three mayoral candidates said a filing was one option for dealing with the city's soaring pension indebtedness to police and other employees. Jerry Sanders, who won the election, never pursued that step. Half Moon Bay, a small town south of San Francisco, has also considered bankruptcy because of a legal judgment handed down in November in a dispute with a real estate developer.

"Bankruptcy is a bad idea," Vallejo resident Andy Russo told the council during a standing-room-only informational hearing last night in city hall. "The stigma of bankruptcy will stick to us for a long, long time."


Anonymous said...

California City Moves Closer to Bankruptcy Filing

No insurance!?

Stoneleigh said...

This sort of thing is why I disagree with Warren Buffet that munibond insurance is a good business to be in right now. It may have been a good business, and so have a good existing track record, but the housing bust, and consequent loss of tax revenue, will hit municipalities very hard. Labour unions are not likely to want to play ball, however unaffordable their benefits become.

In inflationary times, people take wage cuts in real terms all the time, as their salaries fail to keep up the increasing cost of living. Since 2000, for instance, purchasing power in the US has been cut dramatically (by about 50%) through increases in the money supply. People don't complain though, because they don't see the real erosion of their financial position.

In deflationary times, things are very different - salaries and benefits would have to be cut just to stay the same in real terms, and will need to be cut by a larger amount for employers to be able to manage in tighter times. This means a big rollback in salaries and benefits at a time when people are highly indebted and often have little scope for absorbing financial shocks. Essentially, this means war in the labour market. Get ready for strikes, lockouts, layoffs and disruption of all manner of public services.

Anonymous said...

Stoneleigh, Illargi,

How do I convince family that we are actually moving to deflation now? When I mention that credit and financial assets are vanishing faster than the money supply is increasing, the response is that helicopter Ben will provide the iquidity/credit/cash as needed. The housing market will correct downwards since it is overpriced, but the fed will inject as needed to stabilize the economy.
How do I respond?

Anonymous said...

Thank you for posting this. I have a friend who owns a house in Vallejo, CA. They were just assessed another $2000 in property taxes. (on top of what they already just paid) The police sent out a mass mailing asking for $100 donations so they can afford to buy a new cruiser. It's pathetic. According to the Vallejo friend, down the street, $750,000 (last year)townhome just sold for $300,000. There are almost no buyers even at those prices.

Ilargi said...


US residential real estate is down some $2 trillion, derivatives are down a multiple of that. World markets are estimated to have lost over $10 trillion. US Banks have lost and written down $200 billion, which takes at the very least an additional $2 trillion of credit space away. Total Wall Street losses are estimated to top $1 trillion in the next few years. That is $10 trillion less credit.

The losses will inevitably pick up speed as we move forward. Much remains hidden, since it's not priced by any market. If the Fed would try to compensate for all that, they'd have to come with wheelbarrels, not helicopters. They won't do that. They'll try and minimize the losses for the banks, and let you pick up the tab. The gamblers run the casino.

Anonymous said...

You stated that the fed would not
inject the wheelbarrows of cash/credit needed. Why is this not in their best interest?

Stoneleigh said...


The fed doesn't print currency, it midwifes credit creation by lowering the cost of money in order to make borrowing and lending an attractive proposition. Unfortunately, that 'solution' (which is akin to trying to cure a hangover by having a few more drinks) requires willing borrowers and lenders. As we have seen from the various credit markets drying up, willing lenders are in increasingly short supply, and many borrowers are simply tapped out in any case (eg already paying their mortgage with their credit card). Under these circumstances, cutting interest rates is like 'pushing on a piece of string'.

The US banking system is essentially insolvent already (no non-borrowed reserves left). The Fed could monetize debt by accepting garbage as collateral, but they won't do that because the bond market would send the cost of government borrowing through the roof in no time at all, which would mean extremely high interest rates and a crashing economy. Debt junkies can't afford to make their 'fix' harder to come by.

Only after international debt financing is a thing of the past is inflationary currency printing likely, and that will be after we've lived through credit deflation.

Anonymous said...

interesting :)

sjn said...

You've convinced yourself on your thesis, but I think you're quite wrong that the treasury doesn't produce, and the fed inject newly "printed" money. When the fed accepts as collateral worthless notes with no expectation of repayment, when short term "credit" is offered at below the rate of inflation, free money is distributed to the public for "stimulus", the economy contracts while the major financial institutions are too big to fail; there is an increase in supply of money over the rate of growth in the economy. The policy is to maintain liquidity and financial stability even and especially while the economy contracts.

Of course a shrinking economy means real economic loss of wealth, and monetary policy can't change that. What it does do is determine where the losers are. Illiquid paper assets such as mortgage derivatives and overrated bonds with no hope of payments that are not marked to market intrinsicaly have no value, when the fed monetizes them, it is a transfer of wealth from all holders of real assets and creditors.