One of the most treacherous and disturbing trends in credit analysis is the increasing likelihood that municipalities may consider chapter 9 also known as municipal bankruptcy, according to many All-American Analysts.
During 1991, the municipal bond industry was hit with Bridgeport Connecticut's attempts to file for municipal bankruptcy and the possible default of Philadelphia upon some of its debt obligations.
H. Russell Fraser, 1991 All-American Municipal Analyst Conference Chairman and chairman of Fitch Investors Service Inc., notes the lack of stigma attached to bankruptcy in the corporate sector may be tainting the thinking of municipal officials.
"We're seeing an erosion in the moral fiber of America," Fraser claims, evidenced by the decline in spending for education, infrastructure and increased spending on prisons.
He adds that Americans are facing a serious decline in their quality of life.
Nancy Utterback, All-American High-Yield Analyst, found that she is spending a greater amount of time in the courts trying to follow the decisions impacting airlines that support the creditworthiness of municipal securities.
She invite one of the nation's top legal experts on municipal bankruptcy, James Spiotto, partner at the firm of Chapman & Cutler, to speak with her at the conference.
Spiotto has represented issuers, indenture trustees or bondholders in litigation, bankruptcy or workouts of over 400 troubled bond issues in over 35 different states.
A Look at the Record
In 1934 a municipal bankruptcy code was passed, butit was declared in unconstitutional in 1937 because it was deemed to interfere with the sovereign rights of states and municipalities.
A revised bankruptcy code was created in 1937 on a temporary basis, but in 1946 the term clause was repealed, and Chapter IX was a permanent part of the bankruptcy code.
Essentially, the bankruptcy code for municipalities is designed to provide a "forum whereby a municipality could voluntarily seek an adjustment of indebtedness," according to Spiotto.
Additionally, municipalities cannot be forced into involuntary bankruptcy and the courts are limited to disapproving or carrying out a proposed composition.
Since 1937 to 1991, there have been 452 municipal bankruptcy filings. From 1937 to 1972 there were 362 bankruptcies.
Spiotto notes that between 1972 and 1979 there were nine bankruptcies, which was typical of the post-depression era's average of about one bankruptcy per year.
After New York City's and Cleveland's problems, the bankruptcy code was amended in 1976 and 1978 to eliminate deficiencies in the code.
From 1979 to 1991 there were 81 municipal bankruptcies, which was a dramatic uptick in the average annual filings from about one a year to about ten a year.
Spiotto believes the reasons for the increased number of municipal bankruptcies are both multiple and complex.
What Types of Credits Go Bankrupt?
The types of credits that go into bankruptcy are special districts, such as sewer districts, not towns and cities, Spiotto explains.
Municipal utilities represent 45 out of a total of 81 bankruptcies, while eight were cities or counties, four were educational endeavors, 14 special revenue districts, and four transportation districts.
By state, Nebraska (36 bankruptcies) and Colorado (12 bankruptcies).
Some states have specifically prohibited municipalities from filing for bankruptcy, i.e. Georgia.
Eighteen states have specific statutes that authorize their municipalities to file.
Tell-tale Tremors
Spiotto says, "There are many tremors that lead up to a major earthquake and we're only beginning to feel the tremors in municipal bankruptcies.
"The 'death spiral' for municipalities begin with the taxpayer revolts that force the municipalities to have less revenues available to fund the services, such as education, streets and sanitation, and police," he says.
Next, the quality of life suffers and people move out of the cities. Cities increase taxes to make up for the lost revenues, which causes more people to move, and the death spiral is in full swing.
Another factor that is accelerating the death spiral is the lack of spending on infrastructure. "The delays in capital improvements has gone on too long," he said. Ultimately, the lack of spending on maintaining and improving existing infrastructure hurts the ability of cities to retain existing businesses or attract new businesses.
Yet another factor in the detah spiral of urban areas is the decline in education. Spiotto recalls President John F. Kennedy's remark that the progress of the nation can be no greater than the quality of our education. He believes that businesses go where the workforce is educated - "we're going to loose out if we don't educate the next generation of workers."
The burden of education is primarily local, but in some cases local and state, he notes.
Additionally, with the cuts in federal grants that served as 'seed money' for many municipalities, "the entire burden [to stop the death spiral] is on the municipalities."
"You can go to any major city and find areas that have become T.S. Elliot's Wasteland. We haven't had a housing program since the 1980's so it shouldn't surprise anyone that we have homeless people," he adds.
Today's Problems to Surface in Late 1992
If you trace municipal defaults in the 1980's, the defaults occur about 18 months after a financial downturn. "The current economic recession will hit the municipalities in the next year or two," Spiotto predicts.
Given a rate of ten bankruptcies during the free-spending 1980's, the prospects for the 1990's are not rosey.
But, while there are some real challenges for the 1990s, there are opportunities where the state can step in to help cities, such as Pennsylvania's recent help for Philadelphia.
Regional approaches to solving problems, such as regional transportation authorities, are another example of finding creative solutions.
Indeed, under bankruptcy protection, the questions during the 1990's are likely to be what services a troubled municipalities should fund and what new tax sources can be identified.
Spiotto has specific suggestions about how and when municipalities should approach the difficult decision of filing for bankruptcy.
He will be discussing them at the All-American Municipal Analysts Conference.
