Municipal Bankrupcty Filings set to Soar- Updated

In 2011 we are set to see the number of municipalities filing for bankruptcy spike.  I first started posting about this in 2009 when the City of Vallejo, California filed for bankruptcy due largely to pension costs that got out of control.  A judge eventually granted Vallejo relief from its existing employment contracts with its public unions.

Now comes Prichard, Alabama who becomes the first city to default completely on its pension obligations to retired workers.  The city has sought bankruptcy protection twice and each time a judge has put obligations on the city that were unable to be met.  This time Prichard just decided to stop paying.

Lest you think these problems are half a country away, please read up on Harrisburg, PA which has decided to stop paying a loan it received for building a large garbage incinerator.  In addition to the incinerator debt, Harrisburg is coping with a $9 million deficit in the current budget. The city is considering layoffs, closing and leasing or selling a firehouse, and the selling of two fire trucks, among other measures. It has assigned volunteers to man police stations in order to have all officers on the streets. Ed Rendell stepped in to give $4.4 million to Harrisburg so they could finally make that bond payment.  Unfortunately, that is just going to delay the inevitable.  In Pennsylvania there are some very strict laws on municipalities filing for bankruptcies. For more on that read up on Act 47.  As you read that article please note that once a city enters Act 47, it pretty much never leaves.

So what does this all mean to you?  It means rising interest rates for municipalities and government entities in general.  In Pennsylvania we are slightly better off than in states where there is no implicit guarantee of the State stepping in when bond payments are missed (as was the case in Harrisburg).  However it is important to note that lenders take into account many factors when calculating interest rates to be charged to borrowers.  One of the most important factors after inflationary expectations is risk premium. See this link under "Market Interest Rates" to see all of the factors involved.

For Mt. Lebanon we have a pretty stable rating.  However, if municipal bankruptcies increase significantly across the country it will begin to impact interest rates for even the best rated government agencies.

***Update
For another perspective on the difficulty of filing Chapter 9 bankruptcy, please see this detailed article by Bond Girl.  She says that, while many municipalities will have difficulty paying the bills, it is much more difficult for them to actually enter the bankruptcy process.  This is somewhat of a contradiction to what the Meredith Whitney's of the world have been saying on TV and in the press lately.

Thanks for reading.

James