In May of 2008 a small city of Vallejo, which is just north of San Francisco, filed for bankruptcy. According to an article by Roger Lowenstein in the NY Times, the cities bankruptcy could offer “a sneak preview of what could be the latest version of economic disaster.” At the time, the nation paid little attention to what happen because the nation was “too busy watching banks fail.” Now almost three years later, the banks have recovered but Vallejo still remains in bankruptcy.
With cities all across America in “dire financial distress,” people are worried that many cities will follow in the footsteps of Vallejo. Meredith Whitney, who predicated the banking meltdown, has issued an “Armageddon-like prediction of mass municipal defaults.” People have listened to the warnings and in the months after Whitney issued her prediction, “investors unloaded about $25 billion in shares of mutual funds that invest in municipal bonds.” However, for her predication to come close to coming true, it would take defaults of “40 cities with as much debt as Detroit to reach even $100 billion.” According to an article from Buisnessweek.com, Roubini Global Economics LLC in New York is predicting “about $100 billion of U.S. municipal bonds will default during the next five years;” far less than the “hundreds of billions” that Meredith Whitney predicted for 2011 alone. Predictions like Whitney’s have even lead legislators to suggest that state governments should be allowed to file for bankruptcy the same way cities are allowed to.
Defaults on municipal bonds would not only hurt investors but “ordinary Americans” as well. According to the article in the NY Times, Whitney is correct about there being a crisis in local government, but it is yet to be seen if the outcome will be bond defaults or major cuts to tax payer services such as education. So far it seems as if public employees such as teachers are going to “suffer well in advance of investors.”
In the past the vast majority of municipal bonds that failed were issued for “quasi public projects rather than cities” themselves. Credit agencies such Moody’s have downgraded municipal bonds and expects defaults to rise in 2011 but “do not predict a default epidemic.” They contend that cities and states “carry much less debt relative to the size of their economies” when compare to troubled countries such as Greece or Spain and are less likely to default. They acknowledge that cities and states do have a problem with debt but not one that will trigger a “chain-reaction panic” like what occurred with the banks.
While bankruptcy may sound attractive at first blush, it may not be the best option for cities and state troubled with financial hardship. “The fantasy of using bankruptcy to suspend government runs up against a hard truth: even in bankruptcy, cities and states don’t disappear nor do their obligations.” Thus, “Until voters can agree on what government services they want and will pay for, it is possible that bondholders will bank the profits while taxpayers, employees and citizens share the losses.”
Page Perry has over 125 years collective experience representing institutional and individual investors in securities-related litigation and arbitration all over the country. While past results are not indicative of future success, Page Perry’s attorneys have recovered over $1,000,000 for clients on more than 45 occasions.