This article originally appeared in Business Insider
August 25, 2011
By David Johnson, ACM Partners
Harrisburg, PA might possibly manage to make a $3.3 million payment, due September 15, on general obligation bonds. If it does, however, bondholders should take no comfort in the fact, only marvel at the continued byzantine maneuverings that are quickly becoming a hallmark of the slowly evolving but inescapable cycle of municipal distress.
In order for Harrisburg to make its $3.3 million bond payment, the overly indebted town of 50,000 must first receive an advance payment from the Harrisburg Parking Authority. That payment from the Harrisburg Parking Authority is contingent upon a loan of between $6 and 8 million being approved by lender Metro Bank. Also, the Harrisburg City Council must vote to extend the lease of the parking authority by an additional 10 years. To be clear, this is what needs to happen to make a bond payment. As Robert Philbin, spokesman for Harrisburg mayor Linda Thompson conceded: “If we do not receive those funds for any reason, we will not be able to make that bond payment on the 15th.”
The types of byzantine, multi-party financial maneuverings that Harrisburg is now engaged in are very familiar to restructuring professionals. This is nothing less than a municipal version of the Danza de la Muerte of distressed debtors. Clearly, the municipal version of this dance is quite extended, as concern about Harrisburg’s ability and willingness to continue servicing its debt is not new.
Stepping back, all those active in the municipal bond market should take a moment to ponder just what this dance implies for the municipal bond market more broadly. Many continue to reference a historically low municipal default rate and argue that what’s past is prologue. To those I would encourage taking a few hours away from Shakespeare and instead considering modern cinema, which provides a more apt quote: “We may be through with the past, but the past ain’t through with us.”
The pension and healthcare obligations that many local governments have taken on are onerous and only growing more so. Underfunded pensions and (often) completely unfunded healthcare benefits threaten to strangle local governments. In a 2006 essay, Malcolm Gladwell laid out the situation facing companies and national governments as their dependency ratios grew. We are now in the midst of a similar problem for local governments, with the added complexity that local governments have considerably less ability to increase revenue compared to the other two groups.
Nationwide, heavily indebted local governments with onerous pension and healthcare obligations are facing a revenue crunch at the absolute worst moment. Sale leaseback transactions may help, property and sales taxes may be adjusted and local governments can certainly learn to operate more efficiently. But none of those changes, individually or in combination, will prevent a moment of reckoning when local government officials will be faced with the painful choice of providing essential services (the actual role of local government, whatever investors might think) or paying bondholders and retirees in full. At that point bondholders will learn just how actionable their claims to senior priority are. Given the tenor of the Jefferson County negotiations, my expectation is the bondholders are in for series of painful financial haircuts.