Abracadabra! Bankrupt Cities are Suddenly Un-Bankrupt! (Or Not)

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Abracadabra! Bankrupt Cities are Suddenly Un-Bankrupt! (Or Not)Last month, the capital city of Pennsylvania filed for Chapter 9 bankruptcy protection. Harrisburg had taken out a $317 million loan to fund a municipal incinerator, but it didn't have the money to pay even interest on the loan, much less the principal.

So the Harrisburg City Council did what any debtor, backed into a corner and seeing no way out, would do. It filed for bankruptcy protection.

Court Calls "Backsies"

That was a big black eye for Harrisburg, for the state that surrounds it, and, crucially, for the mayor who allowed things to deteriorate so badly. So the mayor challenged the council's bankruptcy petition, and according to U.S. Bankruptcy Court Judge Mary France, Harrisburg was indeed legally required to get the mayor's sign-off before filing for Chapter 9.

The court threw the bankruptcy petition out, and voila! Harrisburg is magically not bankrupt anymore. Or is it?

Not So Fast, Tex

It's true that Harrisburg's not technically bankrupt. But unless Judge France slipped the mayor a 10-spot to tide the city over till it gets back on its feet, it still has the same problem it had before.

Bankrupt or not, Harrisburg is still insolvent. Keeping current on its debt would require selling off pretty much every revenue-generating asset the city possesses. And once Harrisburg sells them to pay this year's interest, it won't have any revenue streams left to pay next year's.

The only question now is whether the mayor makes a U-turn and leads the parade back into bankruptcy court or sells off assets to postpone the day of reckoning, setting the stage for Harrisburg Bankruptcy, Round 2, a few years from now. Or maybe the generous taxpayers of the rest of Pennsylvania will be asked chip in to save their capital -- by way of a state takeover of the capital city's finances.

In Even Deeper Debt Down South

Meanwhile, south of the Mason-Dixon Line, another high-profile municipal bankruptcy has struck, and it's a doozy.

Harrisburg's bankruptcy grabbed headlines because it's not every day you see a state capital pauperized. But in terms of size, its problems pale in comparison with the $3.2 billion hole that Jefferson County, Alabama, dug for itself while financing its new sewer system.

The biggest municipal bankruptcy in U.S. history was declared two weeks ago, when negotiations to reduce the county's debt to creditors including JPMorgan Chase (JPM) and Regions Financial (RF) broke down. Knowing they would get paid only what the county could afford if a bankruptcy case went to court, and also facing questions as to the validity of the debts (political corruption was alleged), lenders worked aggressively to cut Jefferson County's debt to manageable levels -- offering to write off as much as $1.2 billion. But it was all for naught. Negotiations collapsed two weeks ago, and Jefferson became the fourth municipality to declare bankruptcy this year -- following in the footsteps of Central Falls, R.I., Boise County, Idaho, and Harrisburg. (Like Harrisburg's, Boise's bankruptcy has since been rejected in court.)

The Story Behind the Bankruptcies

Unless you live in the cities and counties affected, you may wonder whether any of this matters to you. It does.

Eleven months ago, banking analyst Meredith Whitney went on 60 Minutes to predict that a wave of municipal bankruptcies would sweep the United States in 2011. Public finances were in such disarray that "50 to 100" municipal failures were likely, costing "hundreds of billions" of dollars. Happily, this hasn't happened. Whitney may have been right in 2007 when she was the lone voice crying "banking apocalypse" about Citigroup (C), but it looks as if she overstated the case on the municipal-debt crisis.

Or did she?

Just look at what happened in Jefferson County again, before the bankruptcy: The county owed $3.2 billion to its lenders, and the lenders offered to cut that debt to $2 billion, no questions asked. Why? You have to assume that the banks had their insurance set up to protect themselves in the event of a default, or that a peer such as MBIA (MBI) or Berkshire Hathaway (BRK.A) (BRK.B) had been contracted to step in and make good on its debt if the county couldn't.

So why offer to take a one-third haircut at all?

A Sneaking Suspicion

One has to wonder whether there's a reason the bankers didn't just trust their guarantors to pay off Jefferson County's debt.
Maybe they thought a bankruptcy so unlikely that they never took out insurance against it. Or maybe they worry that MBIA's balance sheet shows $12 billion more debt than cash, or that Assured Guaranty's (AGO) cash and debt are roughly equal, while the better-heeled Berkshire Hathaway has quietly exited the municipal-debt market, reducing its exposure to risks such as those we now see in Jefferson County.

It may not even matter whether the bankers have decided to forgo insurance against municipal bankruptcy risk, or whether they don't believe that insurance is worth the paper it's printed on. Either way, this pending local debt crisis doesn't look good for America's big banks -- or anyone who owns their stocks.

Motley Fool contributor Rich Smith owns no shares of any companies named above. The Motley Fool owns shares of JPMorgan Chase, Citigroup, and Berkshire Hathaway. Motley Fool newsletter services have recommended buying shares of Berkshire Hathaway.




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Mike

Fed res dollar printing has increased to keep up with US treasury's need for them as debt buyer of last resort. Euro is doing same for their debt but doesn't hold the luxury as world's res currency. Fed exports it's inflation to the world euro can't & WILL hypor inflate to ZERO. Europ will run to the dollar as others trade for gld/slvr. Even with small demand increase gld/slvr price rise outside the fed's ability to keep suprpressed & dollar will start its final fall, world WILL panic & gld/slvr will BE only reserve currency. World fiat monotary system is collapsing & we face deep depression. Got Gold? China & India does, why's that you figure?

December 26 2011 at 2:07 PM Report abuse -1 rate up rate down Reply
gramps180

Harrisburg was to big to fail. I smell bail out.

December 01 2011 at 11:04 AM Report abuse +1 rate up rate down Reply
Doug

Personally, I think the Governor of PA is courting disaster if he allows the state to step in and save Harrisburg and its creditors.

First, why on earth should we be forced by government to bailout fools that loaned money to other fools? The only thing the government should do is make sure that the fools that made the decisions are the ones that suffer the most.

Second, governments everywhere should stop borrowing money period. There is no reason except incompetence in leadership when these things happen apart from a natural disaster. We need a lot more accountability from our leaders and the whining and finger pointing must stop. If you cannot get the job done, resign and go away. These incompetent politicians are making a very nice living for themselves and their friends pretending to care about problems that they never, ever really want to solve. We keep letting politicians blame everyone and everything except themselves, and voters keep stupidly re-electing incompetence. It has to stop or the suffering will just get worse.

Third, anyone that thinks Harrisburg is the only city that will ever need to be bailed out by the state is a fool. Once you bail out Harrisburg, half the local politicians in the state will think even more that it is okay to borrow and spend to buy votes because the state will bail us out.

December 01 2011 at 9:15 AM Report abuse -1 rate up rate down Reply
1 reply to Doug's comment
evd10

I don't disagree with anything you have written, but it just might not be politically realistic.

December 01 2011 at 10:18 AM Report abuse rate up rate down Reply
Dereck

“It's all "B.S." not "Bull", "You can't Borrow without Leveraging­". In all this, there is a whole lot of "Termed" Government­-owned Property being Seized by the Lenders (The World Fortune), and many people will find themselves lost of Property (Residenti­al & Commercial­), Corporatio­ns and/or Businesses that they once claimed they owned in act of ignorance or perjury. I will also remind any readers of this comment that the World Fortune, to bolster and hasten the end of the "Human-shi­eld Barricade Standoff" with the United States Government and their criminal allies has Contracted China to purchase U.S. Bonds with Eurodollar­s, which is like getting "Two-for-O­ne".”

November 30 2011 at 10:27 PM Report abuse rate up rate down Reply
savemycountry911

The entire country is in trouble thanks to Obummer.

November 30 2011 at 8:46 PM Report abuse -3 rate up rate down Reply
evd10

I am a PA resident. There is no reason for Harrisburg to file for bankrupcy. Pittsburgh was in very bad financial shape a few years ago and the state came in and started to manage their finances. That was politically acceptable in a city run by Democrats because Democrat Rendell was governor. Now that our governor is a Republican he is probably is letting the incompetent Democratic Harrisburg politcians thrash around and embarass themselves for a while before he does anything. 300 million is a drop in the bucket in a state as large as PA.

November 30 2011 at 6:50 PM Report abuse rate up rate down Reply
Bill

Someone has been reading between the lines and i'm quite certain they are correct. Maybe it's time to run for the hills or to Canada or somewhere else. Prepare yourselves for what is coming folks.

November 30 2011 at 6:07 PM Report abuse +1 rate up rate down Reply
jdykbpl45

Are you better off with Obama?

November 30 2011 at 4:48 PM Report abuse -1 rate up rate down Reply
1 reply to jdykbpl45's comment
darkcloudcoward4

Only if we're all riding to Hawaii with the first family and when we get back we still have a job.

November 30 2011 at 8:29 PM Report abuse -2 rate up rate down Reply