Explaining Southern California's economy

Cities in financial trouble: debt defaults are still rare

Stockton, CA Leads Nation In Rate Of Foreclosures

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A deserted section of downtown Stockton. The bankrupt California city has shown a willingness to default on its debt, according to Moody's.

With four California cities in the past two months either declaring bankruptcy (Stockton, Mammoth Lakes, and for all practical purposes San Bernardino) or making noises about declaring bankruptcy (Compton), it's easy to conclude that we're on the leading edge of a wave of Chapter 9s that will sweep across the state.

But the fact is that municipal bankruptcies are exceptionally rare. This is one of the attractions of the $3.7-trillion municipal bond market, which hasn't been signaling a wave of cities going bust, nor steeply discounting the debts of cities that are broke (cities in bankruptcy don't have to default on their debts — they can keep right on paying as they move through Chapter 9). 

However, Moody's, one of the big U.S. rating agencies. put out a report yesterday titled "Recent Local Government Defaults and Bankruptcies May Indicate A Shift in Willingness to Pay Debt." In it, the Moody's analysts write that they "expect the vast majority of rated municipalities" — and for Moody's that's 8,500 cities — to "muddle through and pay their debts."

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Compton is latest California charter city to face bankruptcy

Gritty Compton Works To Escape Cycle Of Violence

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Compton is the latest Southland city to declare bankruptcy.

Compton could become the fourth city in California to head for bankruptcy, according to Reuters. The Los Angeles County municipality, just south of L.A., would join Stockton, Mammoth Lakes, and San Bernardino in confronting Chapter 9 protection. 

Compton's situation is extremely worrisome compared to much larger San Bernardino and Stockton, but it's not exactly surprising. Compton's current budget deficit, at $43 million, is substantially bigger than Stockton's $26 million but about the same as San Bernardino's $45 million. But Compton's population is only 93,000. San Bernardino's is over 200,000 and Stockton's is over 300,000.

And if you follow Reuters' reporting, $37 million of Compton's budget shortfall has materialized just since July 10, as financial officials and the city council have worked through severe revenue losses. 

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San Bernardino's finances were already dire in 2010

Researchers Predict Major Earthquake To Hit California In Next 30 Year

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San Bernardino City Hall. In 2010, the City Council was warned that bankruptcy was on the horizon.

A former San Bernardino City Council member, Tobin Brinker, commented on my post from yesterday about the bond markets being taken by surprise by the Inland Empire municipality's vote this week to become the third California city to declare bankruptcy. The one-time representative of the city's third ward wrote about a council meeting that took place in 2010: 

[C]ity Treasurer David Kennedy spoke and explained the city had lost $40 million dollars in its investment pool in the previous three years. If major changes aren't made he will not be able to certify that the city can meet its payroll for the next six months. He was the first person to mention BANKRUPTCY. The City Finance Director Barbara Pachon spoke and shared a slide titled "Symptoms of Bankruptcy." She informed council members that we unfortunately meet all of the symptoms....

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San Bernardino bankruptcy caught the bond market by surprise

Berdoo Bankrupt

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San Bernardino city council voted to prepare a bankruptcy late Tuesday. The bind market was completely shocked.

You'd think a $3.7-trillion municipal bond market would watch over the cities that issue debt like a hawk. But of course, that can be tough when you're talking about something that big. And although ratings agencies like Moody's and S&P monitor the finances and prospects of default for thousands of cities, they don't always have a clue what's going on inside city hall.

Shocking as it may sound, right up until it voted to move toward a Chapter 9 declaration earlier this week, San Bernardino's bonds were rated "investment grade" — meaning that institutional investors and big mutual funds could buy them. Some of the city's bonds have been downgraded to "junk" status now, reports Reuters. But from the perspective of the bond market, San Bernardino didn't look like a city facing a fiscal crisis with effectively no money in the bank, the inability to meet its payroll, and a possible scandal brewing over whether the city has accurately represented its finances to the outside world.

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San Bernardino bankruptcy: Much worse than Stockton

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San Bernardino City Hall. The city's fiscal crisis could make its possible bankruptcy far worse than Stockton's.

The San Bernardino City Council voted last night to prepare to file bankruptcy. If the Inland Empire city does enter Chapter 9, it would be the third California municipality to do so this year, following Stockton and Mammoth Lakes.

But according to the bankruptcy lawyer who helped draft AB 506, the new California law that compels cities considering bankruptcy to first submit to a "neutral evaluation" process, and an economist who studies the Inland Empire, San Bernardino could look a lot worse than either of the cities that have already filed for Chapter 9.

"The San Bernardino situation is extremely challenging," said Karol Denniston of Schiff Hardin in San Francisco. "They don't seem to have considered the 506 process." 

A call to an aide to Mayor Patrick Morris to determine whether San Bernardino had considered going through mediation was not returned. [UPDATE: The mayor's Chief of Staff, Jim Morris, got back to me late Wednesday to explain that the city had considered the mediation requirement and is working with bankruptcy attorneys to ensure that the city is complying with state law. He also said that a fiscal emergency hasn't yet been declared but that it could soon be, in reponse to what he described as San Bernardino's cashflow crisis.]

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