5 American cities going broke

More and more American cities are struggling with debt and facing bankruptcy. Here is a look at those with the deepest problems.

By 247 Wall St. Oct 29, 2012 10:41AM

Abandoned factory © Giorgio Fochesato, Vetta, Getty ImagesBy Michael B. Sauter, Alexander E.M. Hess and Samuel Weigley

 

In June, the city of Stockton, Calif., defaulted on its debt and filed for bankruptcy. For analysts at ratings agency Moody’s, it marked a growing trend in local governments. Cities, which have historically been nearly flawless on their obligations, are opting to default on their debt because of financial troubles.

 

In a report issued last week, Moody’s rated the debt of 30 cities, towns, villages, counties, and school districts as "speculative grade," up from 25 last year. A speculative-grade rating for a local government means, at best, its debt is risky and, at worst, it could end in default. 24/7 took a look at 13 of these local governments that may be on the verge of bankruptcy; read on for the details and a list of the worst-off five.


In an interview with 24/7 Wall St., Moody’s managing director and chief credit officer of U.S. Public Finances, Anne Van Praagh, explained that the number of cities, counties and towns that default on some or all of their debt is growing. She attributes this to "a significant amount of credit pressure, sluggish economic recovery, and cities not being able to grow out of their problems this time around." She added that many cities see defaulting as the only way to avoid total economic disaster.

 

Perhaps the best example of this is Stockton. Even in bankruptcy, the city opted not to pay off its debt. The city was one of the most seriously affected by the housing crash. Stockton bonds are currently rated Caa3 by Moody’s, tied with Jefferson County, Ala. for the worst rating issued to a local government.

Different circumstances brought each government to this point, though a few underlying causes are similar.


A weak economy with a fragile or shrinking tax base is one of the worst problems a local government trying to balance its budget can face. In Detroit, the population has fallen by roughly half in the past 50 years, including a 25% drop in the past decade alone. Unemployment is well into the double digits, and per capita income has been steadily declining. All these factors make it extremely difficult to continue raising revenue to service its debt.

Detroit’s 2011 general fund revenue was $1.23 billion, while its outstanding debt was more than $2.5 billion. For some speculative-grade-rated governments, debt exceeds annual revenue by three, four, or even five times.

 

Poor management and the failure to accurately project revenues plague many of these governments. Le Center, Minn., has chronically overestimated revenues from real estate developments. Menasha, Wis. issued government issued bonds for a new steam power plant it had been building to attract manufacturers to the region. The project was cancelled, and the city’s general obligation debt was more than seven times its 2011 revenue.

 

Many of the local governments with bonds rated as speculative grade have been rated poorly for years. "Once you’re downgraded to speculative, it’s possible to reverse course," said Van Praagh, "but it doesn’t happen that often."

 

Moody’s also expects more local governments will be downgraded in the future. In its report, the ratings agency explained, "The credit pressures will continue to exert themselves on virtually the entire local government sector. For municipalities unable to adjust to the new environment, downgrades into speculative grade are unavoidable realities."

 

Based on Moody’s report on U.S. speculative-grade local governments for 2011, 24/7 Wall St. reviewed the 13 towns, cities, villages, and counties with a credit rating of Ba2 or worse. Moody’s also provided reports on why these cities had been rated as speculative grade, as well as general fund debt and revenue for 2011. This level of credit rating implies a substantial risk of default.

 

1. Stockton, Calif.
 Credit Rating: Caa3
 2011 general fund revenue: $180.3 million
 2011 general fund debt: $248.5 million
 Median income: $47,946

Stockton, with a population of nearly 292,000 people in 2010, became the most populous city to file for bankruptcy in June after the city was unable to close a $26 million deficit. According to Moody’s, the Caa3 rating given to Stockton’s debt assumes that bondholder losses will be greater than 20%. A weak economy has hit Stockton particularly hard. The unemployment rate was 15.4% in April, cutting the revenues coming into city coffers. Stockton’s current year budget, which began in July, called for suspending $10.2 million in debt payments and $11.2 million in employee compensation and retirement benefits.


2. Jefferson County, Ala.
 Credit Rating: Caa3
 2011 general fund revenue: $311.1 million
 2011 general fund debt: $1,141.3 million
 Median income: $45,244

In November 2011, Jefferson County, Alabama, filed for the largest municipal bankruptcy in U.S. history in terms of amount owed after county leaders and investors couldn’t reach agreements to refinance $3.1 billion in sewer bonds. The bonds have been in default since 2008. The county has continued to pay school and special tax bonds while in bankruptcy, although its sewer bonds remained in default. Moody’s placed a negative outlook for the bonds because "losses to bondholders once bankruptcy proceedings conclude could exceed the levels implied by the current ratings."

 

3. Pontiac, Mich.
 Credit Rating: Caa1
 2011 general fund revenue: $36.2 million
 2011 general fund debt: $86.7 million
 Median income: $30,753

Pontiac is the only city on this list to have a speculative rating predating the recession -- since March 2006. Pontiac’s financial troubles, mostly the result of its reliance on the declining automotive industry, have been evident for years. As of June 2012, the city’s unemployment rate was a whopping 22.2%, or about 2.5 times the national rate. The city’s tax revenue continued to dwindle as its population diminished -- the population of 59,515 as of the 2010 U.S. Census was 10.3% lower than in 2000. During 2012 alone, the city outsourced its police force to Oakland County and its fire department to Waterford township. Despite these moves, Moody’s projects that the city will close out fiscal 2012 with a deficit of $8.4 million due to retiree healthcare obligations and debt service expenditures. And if Pontiac doesn’t make reforms in regards to health care and debt service expenses, the deficit could rise to $14 million by the end of fiscal 2013.

 

4. Detroit, Mich.
 Credit Rating: B3
 2011 general fund revenue: $1,229.2 million
 2011 general fund debt: $2,508.3 million
 Median income: $28,357

Since last October, Detroit’s credit rating has fallen significantly -- from Ba3 to B3. According to Moody’s,  the city "suffers from high unemployment, high poverty, low income, concentrated exposure to a dominant industry, and a depressed housing market." In April, Michigan reached an agreement with Detroit that prevented the appointment of an emergency manager, who would manage the city’s finances and would have authority to remove the mayor and city council. Although Michigan raised $129 million in funds for Detroit in August, the city has only received $50 million -- the rest is dependent on its ability to make financial reforms. On Oct.15, Moody’s noted that Detroit remains under review for a further downgrade, highlighting uncertainty surrounding possible amendments to the city’s fiscal 2013 budget.

 

5. Central Falls, R.I.
 Credit Rating: B2
 2011 general fund revenue: $17.9 million
 2011 general fund debt: $21.0 million
 Median income: $34,389

Central Falls, a city of around 20,000 people located outside of Providence, filed for Chapter 9 bankruptcy in Aug. 2011. At the time, the city faced $80 million in unfunded pensions liabilities and retiree health benefits, or about than four-and-a-half times its annual general fund revenues of $17.9 million. During its time in bankruptcy, the Rhode Island legislature funded $2.6 million to help prevent severe cuts during bankruptcy. A judge approved of the city’s plan to emerge from bankruptcy in September 2012. As part of its plan to emerge from bankruptcy, the city will increase property taxes by 4% annually for the next five years. It will also cut pensions of workers who retired at a young age by up to 55% and will have a reduced workforce indefinitely.

 

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