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As Great Recession 'jet-lags' through economy, chapter 9 bankruptcy becomes a more familiar term

Pension-plan dysfunction grabs headlines, but municipal bankruptcies' causes-and-effects are much wider and deeper


Last time I logged off, I left you with breaking news that the supposed debt-ceiling crisis had likely been averted.

Looking back, I wish I had posted something similar to what Dave Ramsey's site had nailed on his "no debt" tree trunk: Basically, there was never any way that the U.S. would default.

Of course, the apparent, threatening gridlock did result in a credit downgrade from S&P, the same folks who played an integral role in Wall Street's takedown of the economy. Predictably, that has caused a furor all its own--including of week of whipsaw action in the equities market--and now the SEC has decided to investigate S&P. (A whispered aside: what I'm saying is this: it is c-r-a-z-y that the rating "agencies" have not been investigated stem-to-stern, before now.)

Nervous municipalities across the country following Rhode Island, Alabama cases

As interesting as that may be, there's more immediately instructive principles involved in two "municipal," Chapter 9 bankruptcy cases: one that's been filed for a Rhode Island town of about 19,000 residents, and one that has been delayed (for now) in Jefferson County, Alabama--which if filed would be the largest municipal bankruptcy in U.S. history.

(Note: Although commonly understood to refer to a town or city, municipal in stricter language refers to a governmental subdivision of a state, or a state itself.

Central Falls' pensioneers in bullseye for cuts

Of course, Chapter 9 filings have received coverage before, but for now let's look at what The New York Times calls "the small, beleaguered city" of Central Falls, R.I., which filed for bankruptcy on Aug. 1, seeking "to cut the pension checks it has been sending its retired police officers, firefighters and other workers by as much as half. All the city promises now is that its retirees, many of whom do not get Social Security, will not have their benefits cut to less than $10,000 a year."

State lege protects bond holders

However, the Rhode Island legislature recently passed a law protecting bond holders:
But investors who bought the city’s bonds could do much better: Rhode Island recently passed a law intended to make sure that they would be paid in full, even in bankruptcy.

Retirees are wondering how the city can cut what they believed was a guaranteed benefit. “We put our time in, we put our money in,” said Walter Trembley, 74, a retired Central Falls police officer. “And the city, through their callousness and everything else, just blew it. They were supposed to put money in and they didn’t.”

Cities and local governments make lots of promises: to their citizens, workers, vendors and investors. But when the money starts to run out, as it has in Central Falls, some promises prove more binding than others. Bond lawyers have known for decades that it is possible, at least in theory, to put bondholders ahead of pensioners, but no one wanted to try it and risk a backlash on Election Day. Now the poor, taxed-out city of Central Falls is mounting a test case, which other struggling governments may follow if it succeeds.

A wakeup call?

Worse, says an Aug. 8 piece at Business Insider, Central Falls' action may be the first of many: "The filing was a wakeup call for Rhode Island, which is suffering from widespread pension crises. Combined, the state's municipal pension plans are only 41% funded, and face an unfunded liability of $2 billion. Rhode Island's unfunded obligation (at the state level) is $6.8 billion, and some experts argue it could actually be as high as $9 billion.

Pension reform cited as systemic problem

“ 'Unless there’s pension reform, Central Falls may not be the last municipality in Rhode Island that faces bankruptcy,' Gary Sasse, who is helping Providence with its financial reforms, told Bloomberg.  'No question Central Falls was unique and was an economic basket case but there are other communities in the state with locally administered pension plans that are in serious trouble.'

"In West Warwick, for example, a 'sizable' unfunded pension liability led Moody's Investment Services to downgrade the town's credit rating Friday to Baa1, just two levels above junk bond status."

Across the nation, municipal pension plans increasingly are drawing howls of protest--being called outrageously generous--and calls for immediate reform. But that's not the only route to fiscal  disaster for so-called general purpose entities (cities or counties, for instance).

Jefferson County's crisis: new sewer system

In Jefferson County, Alabama, the problem traces to a $3 billion+ bond deal that financed a new sewer system. The county has been stewing over the deal for about three years and though on the brink has not yet filed for bankruptcy protection; last week county officials spurned a deal offered by bond-holding creditors, yet also declined to file a bankruptcy petition. From an Aug. 12 account at Bloomberg: "Jefferson County, Alabama, officials extended until mid-September talks with creditors holding $3.14 billion of sewer bonds after rejecting a proposed settlement to avert what would be the biggest U.S. municipal bankruptcy."

Commissioners give creditors cold shoulder, but decline to file petition

From the same article:
Yesterday’s public meeting followed a 24-hour see-saw that had commissioners believing they could reach a deal the night of Aug. 11 and then ready to file for bankruptcy the next morning, according to interviews with members of the panel.

The decision to extend the talks until Sept. 16 came after the five-member commission outlined concerns with an offer by bondholders to settle the crisis. The county of 660,000, home to Birmingham, the state’s largest city, has struggled after a sewer-bond refinancing collapsed during the 2008 credit squeeze.

Next time: In Part 2, we'll look more deeply into this situation and chapter 9 bankruptcy in general.

Consumer bankruptcy for yourself

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