John Moorlach, the accountant who predicted the 1994 Orange County bankruptcy sees Up to 10 Municipal Bankruptcies in Coming Year

The accountant who predicted the nation’s largest municipal bankruptcy says as many as 10 insolvencies will roil the $2.7 trillion U.S. market for state, county and city debt next year as public finances worsen amid calls for federal aid to state and local governments.

John Moorlach said in 1994 that Orange County, California’s leveraged investing strategy could wreck its finances. The county went bankrupt about six months later after losing $1.6 billion.

As many as four cities in the Golden State and six others nationwide may seek court protection from creditors next year under Chapter 9 of the bankruptcy code, the section devoted to municipal governments, Moorlach said in an interview.

Two California cities, Rio Vista, with a population of 8,000, and Isleton, a 10th as large, have said budget gaps and debt loads may force them into insolvency. Likewise, Jefferson County, Alabama, which is trying to restructure $3.2 billion in sewer debt, has considered what would be the largest U.S. municipal bankruptcy.

There may be 36 bankruptcies over the next two years, said Richard Ciccarone, chief research officer of McDonnell Investment Management LLC of Oak Brook, Illinois.

Ciccarone predicts a dozen defaults in 2009 “and at least double that number in 2010.” He didn’t identify cities or counties and said his forecast is based on studying how municipalities respond to economic crises.

Those cities in California and Jefferson County Alabama should just succumb to the inevitable and declare bankruptcy now. Dragging things out just wastes more taxpayer money. For more on the fiscal crisis in California, please see California Implodes In Multiple Ways.

Municipal Bankruptcy Laws

Interestingly, Municipal Bankruptcy Law has its origin in the great depression. Here are a few facts from the link.

Federal municipal bankruptcy laws were first introduced in 1934 during the depths of the Great Depression as municipalities across the country struggled to provide necessary services while facing a dramatic drop in tax revenues. The enactment of federal bankruptcy laws allowing municipalities to impair debt was necessary because of the inadequacy of traditional state remedies.

Prior to the establishment of federal bankruptcy laws, the principal state remedy for creditors was an action for mandamus to compel increased taxes. [1] However, imposing new taxes was often counterproductive because of the inability or unwillingness of the citizenry to pay, the rush of individual creditors filing separate mandamus suits, and the “hold-out” problem among creditors. [2] Rather than enter a voluntary comprehensive agreement with the city and creditors, minority creditors often derailed efforts to reach voluntary agreements by “holding-out” to use the mandamus remedy to get a tax levy for full payment. [3]

At the same time, state law could not force an unwilling creditor to compromise his claim without violating the constitutional prohibition against state impairment of contracts. [4] Thus, without a federal bankruptcy law which permitted municipalities to scale down their indebtedness and bind all creditors, both creditors and debtors were “at an impasse to neither’s advantage”

Federal Bankruptcy Law Requires that the State Specifically Authorize a Municipality to File for Chapter 9.

Federal law permits municipalities to seek protection from their creditors by filing for bankruptcy under chapter 9, but only if the state specifically authorizes its municipalities to file. The state may attach various requirements subject to granting authorization such as approval by a state body prior to filing, state appointment of a trustee, and state control over the municipal debt readjustment plan. Once the state has granted authorization to file, courts have construed such consent as state policy favoring the pre-emption of federal bankruptcy law over state policies which undercut the efficacy of chapter 9.

The Vallejo Warning Shot

Earlier this year Vallejo, California filed bankruptcy. The problem with Vallejo was simple: It promised more in salary and pension benefits to city union workers than it could possibly afford to pay.

Governing.Com discusses the implications of the Vallejo bankruptcy in Vallejo’s Fiscal Freefall.

Vallejo, a city of 120,000 about 35 miles northeast of San Francisco, flat-out went broke this year through a combination of generous public-safety salaries, declining property values and fiscal mismanagement. The city is estimating a $17 million deficit for the current fiscal year.

“Vallejo was sort of the canary in the coal mine — the sickest patient goes first,” says Dean Gloster, an attorney representing Vallejo’s unions. “Even better-run cities are going to be facing similar issues as health care costs rise and the baby boomer generation reaches retirement age.”

Reasonable people can — and do — disagree about how Vallejo found itself in bankruptcy. But the largest share of the blame in Vallejo has centered on public-safety salaries and benefits, which make up about 75 percent of the city’s general fund budget. Base pay for firefighters is more than $80,000 per year and employees can retire at age 50 with a pension equal to 90 percent of their salary, the result of a retroactive pension increase several years ago.

With the downturn in the housing market hammering revenues, Vallejo is asking the bankruptcy judge to void the collective-bargaining agreements that led to those salary and benefit arrangements. And the possibility of hard-fought union contracts going up in smoke has struck fear in the heart of labor groups.

Not all troubled jurisdictions can declare bankruptcy. Municipal bankruptcies are illegal in one state, Georgia; untested in several, such as Iowa and Maryland; and unlikely in others, such as New York and Pennsylvania, that have their own procedures on the books for rescuing distressed localities.

I am thankful the union did not negotiate a settlement. The next step is to hope a judge voids those collective-bargaining agreements.

Threat of bankruptcy is the only way to bring government wages in line with wages and benefits in the private sector. Retiring at age 50 with 90% of salary is simply obscene. It is also not affordable.

How does Chapter 9 work?

Please consider Vallejo Bankruptcy Filing Garners Attention in Municipal Finance Circles. The article features an interview by MuniNet with Jim Spiotto, a partner with the Chicago-based law firm of Chapman and Cutler LLP which specializes in the law of finance: banking, corporate finance, securities and public finance.

MuniNet: How does Chapter 9 work?

Spiotto: Chapter 9 of the United States Bankruptcy Code, the Adjustments of Debt of a Municipality, is philosophically designed to give municipal entities a fresh start. In order to file for bankruptcy, a municipality has to establish to the satisfaction of the Bankruptcy Court that, among other things, the municipality has become insolvent.

While insolvency is a balance sheet test for corporate bankruptcy purposes, for Chapter 9 purposes, insolvency is a question of whether the Debtor is able to pay its obligations. Municipal bankruptcy effects debt adjustment, not debt elimination.

A Chapter 9 Plan of Debt Adjustment must be based upon an analysis of the municipality’s cash flow, including taxes and other revenues, and a determination of the validity and amount of claims.

MuniNet: Can all state and local government entities file for Chapter 9?

Spiotto: Only local governments – those entities created as instrumentalities by the state – can file for Chapter 9; states cannot file. Moreover, one of the requirements of the Bankruptcy Code is that the municipality be specifically authorized by state law to file a Chapter 9 petition.

Different states have different rules about who can file. Georgia, for example, prohibits municipalities from filing for bankruptcy. Nineteen states have specific authorization procedures in place for municipal bankruptcy.

MuniNet: Is filing for Chapter 9 the only solution for a municipal facing a serious financial crisis?

Spiotto: Unlike individuals and corporations, where utilizing bankruptcy is more acceptable as a restructuring tool, filing for bankruptcy is really a last resort for a municipality. The stigma of bankruptcy has the potential to seriously impact a municipality’s ability to borrow funds that might be needed to build roads, bridges, sewers, a new city hall or to execute other public improvement projects.

MuniNet: What implications will the outcome of the Vallejo bankruptcy filing have for other local government entities?

Spiotto: Vallejo will be an interesting case to watch … If it succeeds in navigating these waters, reducing its obligations to its public workers, writing new employment contracts and adopting a pay-as-you-go method to fund its pension and other post-employment benefits (OPEB) systems, others may well follow its lead.

Consider this staggering comparison: State and local public employees comprise approximately 12 percent of the U.S. workforce and have an estimated $800 billion or more of unfunded pension liabilities (not counting other post-employment benefits). By comparison, employees in the private or corporate sector make up about 78 percent of the U.S. workforce with an estimated $450 billion of unfunded liabilities.

California Municipal Bond Yields Rise

California Bond Yields Rise to Four-Year High on Budget Impasse

California’s fiscal crisis pushed yields on tax-backed debt to a four-year high as the state struggles with a $42 billion budget deficit. Bonds due in 10 years yield about 53 basis points, or 0.53 percentage point, more than general obligation bonds rated A+, the most since early 2004, according Bloomberg municipal bond yield indexes. California has approval to sell $53 billion of bonds for public works projects.

The nation’s most-populous state will run out of money to pay bills as soon as February unless lawmakers end an impasse over how to close the funding gap. California has the second- lowest credit ratings in the country because of perennial fiscal shortfalls and legislative gridlock.

“The spreads have widened and investors are getting much more compensation for California bonds,” said Paul Brennan, who oversees about $12 billion in municipal-bond funds for Nuveen Asset Management in Chicago.

Double Dipping In Florida

The St. Petersburg Times is reporting Double dipping rises despite outrage.

This year some of Florida’s public officials are giving a whole new meaning to the phrase “home for the holidays.”

It’s a new crop of double dippers, taking advantage of a loophole in state law that allows them to “retire” by taking 30 days off and return to work in their old jobs with a salary and a pension. Many also collect a lump-sum “retirement” payment that can reach hundreds of thousands of dollars.

At least 25 of those spending December at home were re-elected in November — sheriffs, property appraisers, court clerks and tax collectors, six circuit judges and one state attorney.

None announced their “retirement” plans before voters cast their ballots, and most have not made any public announcement of the resignation letters they have written to Gov. Charlie Crist.

Baker County Sheriff Joey Dobson is getting $311,173 in a lump sum payment and will collect an annual salary of $128,000 and a monthly pension of $5,699. He said he searched for alternatives to taking December off and returning in January, but he said state retirement officials told him it was his only option.

“I have worked for 35 years, but I’m not a wealthy man,” Dobson said. “I sure didn’t want to do it, I hate to be out of the office.”

Miami Dade Community College president Eduardo Padron collected $893,286 in a lump-sum retirement benefit in 2006 and began collecting $14,631 a month in retirement pay in addition to his annual salary of $441,538.

Other double-dipping college presidents include Edwin R. Massey at Indian River State College in Fort Pierce and James R. Richburg at Northwest Florida State College.

Massey collected more than $585,000 in a lump sum last June and now collects a monthly pension of $9,823 plus his annual salary of $286,470.

Richburg, who has been in the news for his controversial dealings with House Speaker Ray Sansom, got a lump sum of $553,228 in 2007 and started collecting a monthly pension of $8,803 in addition to his $228,000 annual salary.

I do not even live in Florida and I am outraged by this. How can any community college president be worth $441,538, a pension benefit of $14,631 a month, on top of a lump sum benefit of $893,286? No wonder education costs are so outrageous.

Given that Florida is ground zero for the housing bust and Florida has no restrictions on filing Chapter 9, I confidently predict several cities or counties in Florida declare bankruptcy.

Ohio and Michigan are also basket cases and add a sprinkling of a few more including Jefferson County Alabama, and it’s easy to come up with a total of 20 municipal bankruptcies for 2009. That is double what John Moorlach predicts.

Once the ball gets rolling and the stigma wears off, 20 can easily be wrong to the low side. These bankruptcies, should they happen, will be a good thing. Wages and benefits in the public sector need to come down, and this will be one way to see that it happens.

Mike “Mish” Shedlock
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