Poisoning the Well

As expected last night the Stockton, California city council voted six to one to declare bankruptcy. Stockton’s will be the largest municipal bankruptcy in U. S. history:

(Reuters) – Stockton, California will become the largest U.S. city to seek protection from its creditors after its leaders approved a budget on Tuesday night based on the city filing for bankruptcy.

A Chapter 9 bankruptcy by the city of nearly 300,000 in California’s Central Valley, about 85 miles east of San Francisco, could come as early as Wednesday.

Stockton’s city council voted six to one in favor of the 2012-2013 budget after a contentious five-hour meeting where angry retired city workers pressed council members to reject the $155 million spending plan. It proposes eliminating retirees’ medical benefits to help fill a $26 million budget deficit.

The most significant factors in Stockton’s financial woes are debt service, pensions, and retiree healthcare benefits. Of those the last is the one rising fastest.

Stockton isn’t expected to be the last U. S. city to declare bankruptcy in the near future:

Peter Navarro, a professor of economics at the University of California – Irvine, says there is, “a long queue out there of cities like Stockton that are going to be doing the same thing.”

Navarro points to cities such as Vallejo, Calif. and Central Falls, Rhode Island, which also went bankrupt, largely because of unfunded pensions. Jefferson County, Ala. filed for Chapter 9 protection, sinking in $3 billion dollars worth of debt.

“This is not a story about Stockton,” Navarro stressed. “It’s a story about the failure of our national economy. And the reason is simply because we don’t make (manufacture) things (goods in the U.S.) anymore.”

Among large cities in financial distress frequently named for potential bankruptcy are Los Angeles, San Diego, Detroit, New York, and my own home, Chicago. Let’s take a look at Chicago’s finances and see if we can figure out where the problems are. As you might expect Chicago’s budget is byzantine. It could hardly be more so if it were deliberately intended to be misleading which it probably is.

Here are some of the highlights:

Item	Amount ($ millions)	Percent
Total budget	$ 6,693	100%
Police	1,258	18.8%
Fire	550	8.2%
Fleet and facility management	299	4.7%
Streets and sanitation	240	3.6%
O’Hare and Midway	377	5.6%
Water management	255	3.8%
Pensions	476	7.1%
Employee benefits	485	7.2%
Debt service	1,437	21.5%

It should be noted that this does not include the Chicago Public Schools, a completely separate fiscal nightmare.

There are a number of different ways to divide this baby. I hope it is as apparent to you as it is to me that a very high proportion of Chicago’s budget (28.6% = debt service + pensions) comes from the city’s failure to deal with its fiscal issues prudently in the past. Unfortunately, there is very little the city can do about that now.

After that the biggest chunk is present employee wages and benefits, well over half the budget. That’s something the city can do something about.

I haven’t discussed the revenue side. Prospects for additional revenue for the city are bleak. Chicago already has the highest retail sales tax in the country. There are limits to how high and fast Chicago can raise property taxes. The city sold its parking meters. The city does not have the power to impose an income tax.

What about aid from the federal government? That brings me around to the title of this post. I strongly suspect that prospective bond investors are very wary of getting the federal government involved. Their experience with the bailouts of GM and Chrysler may encourage them to believe that in any bankruptcy in which the federal government comes in as a white knight they are very likely to be left with bupkis while the public employees’ unions come out unscathed. We might expect the unforeseen secondary effect of the GM and Chrysler bailouts to be higher financing costs for state and local governments and that does, indeed, seem to be the case.

I only see three potential avenues for the city:

1. Really tough negotiating.
2. Bankruptcy.
3. A Wayback Machine.