Urban decay, urban bankruptcy, and fiscal reality

Remember Meredith Whitney?  She’s the analyst who, in late 2010, predicted massive municipal defaults on their bonds, which in so many words implies municipal bankruptcies.  We mentioned her twice here.  Here’s the interview with ’60 Minutes’ where she made her predictions.

At the time, she became a prophet without honor in her own country.  As Michael Lewis recalls:

Inside the financial world a new literature was born, devoted to persuading readers that Meredith Whitney didn’t know what she was talking about. She was vulnerable to the charge: up until the moment she appeared on 60 Minutes she had, so far as anyone knew, no experience at all of U.S. municipal finance. Many of the articles attacking her accused her of making a very specific forecast—as many as a hundred defaults within a year!—that failed to materialize. (Sample Bloomberg News headline: MEREDITH WHITNEY LOSES CREDIBILITY AS MUNI DEFAULTS FALL 60%.) The whirlwind thrown up by the brief market panic sucked in everyone who was anywhere near municipal finance. The nonpartisan, dispassionate, sober-minded Center on Budget and Policy Priorities, in Washington, D.C., even released a statement saying that there was a “mistaken impression that drastic and immediate measures are needed to avoid an imminent fiscal meltdown.” This was treated in news accounts as a response to Meredith Whitney, as she was the only one in sight who could be accused of having made such a prediction.

Well, guess what?  The bankruptcy filings of three California cities in the past few weeks – first Stockton, then Mammoth Lakes, and now San Bernardino – has ladled egg onto the faces of Ms. Whitney’s critics.  As the San Francisco Examiner points out, “Basically the roster of California cities has become a game of dead pool to see which one will drop next”.  Michael Lewis again:

What Meredith Whitney was trying to say was more interesting than what she was accused of saying. She didn’t actually care all that much about the municipal-bond market, or how many cities were likely to go bankrupt. The municipal-bond market was a dreary backwater. As she put it, “Who cares about the stinking muni-bond market?” The only reason she had stumbled into that market was that she had come to view the U.S. national economy as a collection of regional economies. To understand the regional economies, she had to understand how state and local governments were likely to behave, and to understand this she needed to understand their finances. Thus she had spent two unlikely years researching state and local finance. “I didn’t have a plan to do this,” she said. “Not one of my clients asked for it. I only looked at this because I needed to understand it myself. How it started was with a question: How can G.D.P. [gross domestic product] estimates be so high when the states that outperformed the U.S. economy during the boom were now underperforming the U.S. economy—and they were 22 percent of that economy?” It was a good question.

From 2002 to 2008, the states had piled up debts right alongside their citizens’: their level of indebtedness, as a group, had almost doubled, and state spending had grown by two-thirds. In that time they had also systematically underfunded their pension plans and other future liabilities by a total of nearly $1.5 trillion. In response, perhaps, the pension money that they had set aside was invested in ever riskier assets. In 1980 only 23 percent of state pension money had been invested in the stock market; by 2008 the number had risen to 60 percent. To top it off, these pension funds were pretty much all assuming they could earn 8 percent on the money they had to invest, at a time when the Federal Reserve was promising to keep interest rates at zero. Toss in underfunded health-care plans, a reduction in federal dollars available to the states, and the depression in tax revenues caused by a soft economy, and you were looking at multi-trillion-dollar holes that could be dealt with in only one of two ways: massive cutbacks in public services or a default—or both. Whitney thought default unlikely, at least at the state level, because the state could bleed the cities of money to pay off its bonds. The cities were where the pain would be felt most intensely. “The scary thing about state treasurers,” she said, “is that they don’t know the financial situation in their own municipalities.”

“How do you know that?”

“Because I asked them!”

All states may have been created equal, but they were equal no longer. The states that had enjoyed the biggest boom were now facing the biggest busts. “How does the United States emerge from the credit crisis?” Whitney asked herself. “I was convinced—because the credit crisis had been so different from region to region—that it would emerge with new regional strengths and weaknesses. Companies are more likely to flourish in the stronger states; the individuals will go to where the jobs are. Ultimately, the people will follow the companies.” The country, she thought, might organize itself increasingly into zones of financial security and zones of financial crisis. And the more clearly people understood which zones were which, the more friction there would be between the two. (“Indiana is going to be like, ‘N.F.W. I’m bailing out New Jersey.’ ”) As more and more people grasped which places had serious financial problems and which did not, the problems would only increase. “Those who have money and can move do so,” Whitney wrote in her report to her Wall Street clients, “those without money and who cannot move do not, and ultimately rely more on state and local assistance. It becomes effectively a ‘tragedy of the commons.’ ”

The point of Meredith Whitney’s investigation, in her mind, was not to predict defaults in the municipal-bond market. It was to compare the states with one another so that they might be ranked. She wanted to get a sense of who in America was likely to play the role of the Greeks, and who the Germans. Of who was strong, and who weak. In the process she had, in effect, unearthed America’s scariest financial places.

“So what’s the scariest state?” I asked her.

She had to think for only about two seconds.

“California.”

There’s much more at the link.  I highly recommend reading Mr. Lewis’ article in full, not only to understand the mess in which California finds itself, but to understand what’s happening in other union-heavy states – New York, Massachusetts, Illinois, etc.  New Jersey and Wisconsin have elected governors that are tackling the problem head-on.  They’re meeting resistance, but their tough talk is getting results.  I’m willing to bet other states will soon elect governors with similar attitudes.

As for the spendthrift municipal governments?  Michael Lewis spoke to Mayor Chuck Reed of San Jose.

“How on earth did this happen?” I ask him.

“The only way I can explain it,” he says, “is that [the unions] got the money because it was there.” But he has another way to explain it, and in a moment he offers it up.

“I think we’ve suffered from a series of mass delusions,” he says.

I didn’t completely understand what he meant, and said so.

“We’re all going to be rich,” he says. “We’re all going to live forever. All the forces in the state are lined up to preserve the status quo. To preserve the delusion. And here [San Jose] is where the reality hits.”

Warren Buffett believes that more municipal bankruptcies are on the way.

Billionaire-investor Warren Buffet said on Friday bankruptcies by three California cities in three weeks are making traditionally objectionable Chapter 9 municipal bankruptcy filings more palatable to local governments in financial crisis.

“The stigma has probably been reduced when you get very sizeable cities like Stockton or San Bernardino to do it,” Buffett said in a Bloomberg Television interview. “The very fact they do it makes it more likely.

. . .

“Once people find that the city works the next day, it makes it easier for the city council next time they have a problem with pensions — or whatever it is — just to say, ‘Well, we’ll declare bankruptcy,'” Buffett said.

There’s more at the link.

That figures.  Spent your way into a corner?  Take the easy way out.  Declare bankruptcy so you can default on all your commitments and all your promises.  The fact that millions of your bondholders will lose the income on which they rely to fund their pensions is neither here nor there.

Folks, this is where the rubber of the economic crisis hits the road of reality.  When your trash is no longer picked up as often, because the city can’t buy gas for its garbage trucks;  when your streets are no longer as well lit, because bulbs are too expensive to replace;  when crime soars, because police numbers have to be cut;  when fires burn a building to the ground, because fire stations have been closed, or are operated on staggered hours . . . all these are symptoms not only of financial ruin, but of the decay of the physical fabric of our society.  When that goes, the moral and spiritual fabric of that society often follows.  Remember the old Latin tag, ‘Mens sana in corpore sano’?  It means ‘A sound mind in a healthy body’.  It implies that one can’t have a sound mind in an unhealthy body;  alternatively, an unsound mind will lead to an unhealthy body.  Basically, it says that balance is a good thing.  Disrupt the balance, and bad things follow.  Our cities are living proof of that.

The only answer I know that works in the real world – one that I’ve seen working in poverty-stricken areas all around the world – is for like-minded people to band together.  Get together with your friends, and bring in like-minded people whom they can recommend.  Form a small group whose members can help each other to sustain themselves.  Some can grow and/or cook food;  some can clean;  some can guard and protect;  some can earn money at their jobs to help others keep going;  some can repair clothes, or cars, or washing machines;  some can cut lawns, tidy up, and haul away trash.

By working together, we can all help ourselves.  If we stand aloof, we may soon not be standing at all.

Think I’m joking?  Tell that to the people of Stockton, California – ‘the most miserable city in America’, according to Forbes.  Tell it to the residents of San Bernardino.  Tell it to all those cities whose leaders are desperately looking for a way out of their troubles . . . and not finding one.

Urban decay.  It’s almost certainly coming to a city near you – and when it does, its effects may well spill over into your neighborhood.  Start preparing yourselves now.

Peter