Monday, June 24, 2013

Detroit debt default and impact on solvent municipalities

From Bloomberg comes the story of how Detroit's recovery plan may impact the municipal bond market throughout Michigan:

    Emergency Manager Kevyn Orr’s plan to suspend payments on $2 billion of Detroit’s debt threatens a basic tenet of the $3.7 trillion municipal market: that states and cities will raise taxes as high as needed to avoid default.
Investors have viewed municipal bonds as "safe" for decades because municipal governments could always raise taxes to pay back the principal and interest.  Should local governments lose that power, local debt would be no more safe than corporate debt (probably less so - as corporations are constrained by the profit motive in their daily operations). 

Should investors lose confidence that cities can or will raise taxes no matter how much debt they acccumulate, the bond market will suffer far beyond Michigan.  Cities have incurred debt and expenses that today's economy cannot support.  Cities and other municipalities have been looking to other sources of revenue for years, as they turn their police and code officials into little more than bridge trolls. Muncipal employees (more and more) now demand money in exchange for safe passage (or permission to conduct business) instead of acting for purposes related to legitimate public safety concerns.  This trend will continue if municipalities have a harder time selling bonds.

Impairment of the bond market will also impact local officials' operation of school districts, sewer plants and public water - with resulting changes in school taxes, sewer rates and water rates.

It will take more than default by Detroit to affect local governments and local taxes in Pennsylvania.  But Detroit is not the only city that is facing or has faced these choices.  Even the federal government cannot print enough dollars to bail out every city in the country. 

Harrisburg is only a little further from the brink than Detroit.  Maybe Harrisburg can count on a massive bailout by the federal government.  Maybe it can't.  But it would be wise for local governments across Pennsylvania to consider scaling back operations and ambitious plans for sewer expansion and other adventures before they face a choice between (1) borrowing in a hostile bond market or (2) raising taxes and fees on already overextended residents. Whether a township is solvent or not, the ability to raise funds through the bond market may be seriously compromised by a municipal default by any city in Pennsylvania.

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