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December 6, 2011

Tip of the Iceberg: State and Municipal PIIGS in America

By Eric Schaefer (via Doug Short)

On Thursday, November 10th, Jefferson County Alabama filed for bankruptcy. At $3.1 Billion, the county commissioners’ decision to seek Chapter Nine protection makes this technically the largest municipal bankruptcy in U.S. history. Credit markets were unfazed by the news.

The problems caused by a sewer project gone wrong coupled with an interest rate swap entered into for all the wrong reasons was widely known in municipal finance circles. So the commissioners’ decision not to accept concessions from creditors was not entirely unexpected.

Tip of the Iceberg?

State and Local Government Indebtedness
to Nominal GDP Fiscal Year 2009
Click to View

The Jefferson County announcements follows on the heels of two other high profile municipal bankruptcies in 2011 — Harrisburg the state capital of Pennsylvania in September and Central Falls of Rhode Island. Despite the recent filings there has not been the tidal wave of bankruptcies some analysts and pundits predicted. While we have been skeptical of some of the wilder assertions, we do believe investors should remain judicious when considering investments in municipal bonds. Most states and local governments appear to have sufficient flexibility to meet their obligations in the short-term; the problem is the longer term.
This is the reason why there has not been a stampede of PIIGS (Portugal-Italy-Ireland-Greece-Spain) in the municipal finance markets. True, state and local governments have been hard hit by the Great Recession.

But collectively they are not as over extended as perhaps, say, the Federal Government in Washington.  Net debt (debt less cash set aside for the purpose of debt service) averaged 13.4 percent of nominal gross domestic product (GDP is a widely used measure of economic aggregate economic activity) in 2009. Adding in unfunded pension liabilities brings the ratio to 18.2 percent nationwide. Although unfunded pension obligations darken the longer term fiscal picture they do not pose a problem currently.  Yet, that is.

Even though the deficit between pension assets and liabilities need not be closed tomorrow, unless there is a dramatic improvement in plan returns, the gap is unlikely to be closed without large contributions over the next several years. An aging workforce aggravates this deficit as the present value of plan liabilities grows.

Then there is the challenge posed by retiree healthcare costs. (For these we have found no comprehensive measure of the expected, future expense.) A key problem is retiree healthcare obligations are largely unfunded — most municipalities set aside no assets to defray these costs. So as an aging workforce retires, medical expenses are likely to consume a larger and larger portion of general revenue. Finally there is the Federal fiscal mess. Municipalities rely on Washington for 22.2 percent of their revenue. At $536.8 Billion in 2009, municipal revenue sharing poses a convenient target for deficit cutters.
So just because there has been no surge in municipal bankruptcies is no cause for complacency. We are only seeing the tip of the iceberg. What lurks below the surface poses the real danger.


Chart illustrates the net indebtedness to nominal gross domestic product (GDP) of the fifty states and the District of Columbia based on data for the period spanning 2008 to 2009. Deep blue indicates a lower relative level of indebtedness; deep red indicates a higher level.
Indebtedness is defined as the sum of outstanding state and local government debt and unfunded pension liabilities, less reserves set aside for debt service. This total is divided by average nominal GDP for the calendar years 2008 and 2009.
Pension asset and liability data was obtained from Boston College’s Public Pension Plan Database (PPD) for Fiscal Year 2009 (2008 for CT plans). The PPD does not include plan data for every municipality; it estimates the PPD covers approximately 85 percent of public pension plan assets and members.
(Source: US Census Bureau; Bureau of Economic Analysis; Public Pension Plan Database of Boston College; AIFS estimates.)
Courtesy Eric Schaefer of American Independent Financial Services, LLC via dshort.com (EconMatters author archive here)

The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters.

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