Saturday, December 14, 2013

Municipal Bankruptcy: The Endgame?

Muni credit can be interesting, and its getting interestinger by the day. At present we have a good number of muni credits which are grappling with unwieldy unfunded pension liabilities, either in or out of bankruptcy. There are many forces at play. The political cards are generally stacked in favor of pensioners and against bondholders, insofar as politics matters. (It used to matter in Detroit, but no longer.) More crucially, in some states, public pensions are constitutionally protected, whereas bondholders are left out in the cold.

A federal judge recently ruled that Detroit’s pensions are subject to the Federal Bankruptcy Code, even though protected by the Michigan Constitution. The pro argument is that Federal law always trumps state law; the con argument is that Chapter Nine defers to the states in the governance of bankrupt munis. Don’t think about this issue! It will be decided by SCOTUS soon enough.

Regardless of the outcome of the who-trumps-who question, we are already learning that the sacrosanct General Obligation claim is effectively unsecured in bankruptcy, and subject to cramdown. Those speculators who bought junk GOs in the belief that GOs always get paid are going to be disappointed, and no one will cry for them. (It will mean, however, that deadbeat munis won’t be able to sell any more GOs, at least to the mentally unimpaired.)

But, as a thought experiment, let’s assume that SCOTUS decides in favor of the pensioners, for whatever reason. And let’s also assume that the bondholders also get something in the final settlement, such that the bulk of the city’s liabilities are not extinguished. Or, alternatively, that some cities are not permitted to go bankrupt, like Harrisburg. Either way you get a situation in which a dying city with an incurable structural deficit is saddled with most of its legacy obligations, with no way out. What then?

One might suggest that such cities could be rescued by their states, as NYC was rescued by NYS in the late seventies. And that could happen in states where the city and the state are both controlled by the same political party, like Illinois (if Illinois had any money to spare, which it doesn’t). But where the city and state are controlled by different parties, like Detroit and Harrisburg, there will be no state bailout. What then?

I can only imagine that those cities will have to go the way of Carthage (North Africa, not Illinois). They will have to disappear. We have already seen this process in a number of cities with evanescent tax bases. But never in a big city like Detroit or Chicago, or a big territory like Puerto Rico. It seems to me that instead of having monorails and and electric sidewalks, the City of the Future may be an empty wasteland.

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