The painful truth is that as debt increases, so do the risks it will be politically, economically and financially worthwhile for borrowers to walk away from paying back their loans to bondholders. Surprised local taxpayers from Stockton, Calif., to Scranton, Pa., are finding themselves obligated for parking garages, hockey arenas and other enterprises that can no longer pay their debts.
Officials have signed them up unknowingly to backstop the bonds of independent authorities, the special bodies of government that run projects like toll roads and power plants.The practice, meant to save governments money, has been gaining popularity without attracting much notice, and is creating problems for a small but growing number of cities.
Here is a real time list of the largest municipal bond defaults.
Thomson Reuters suggests that local taxpayers are backing so-called enterprise debt at five times the rate they did 10 years ago. The resulting municipal bonds are sometimes called “double barreled,” because they are backed by both the future revenue of a project and some sort of taxpayer backstop. The exact wording and mechanics can vary.
With many cities now preoccupied with other crushing costs — pension obligations, retiree health care, accumulated unpaid bills — a sudden call to honor a long-forgotten bond guarantee can be a bolt from the blue, precipitating a crisis. The obligations mostly lurk in the dark. State laws requiring voter pre-approval of bonds don’t generally apply to guarantees. Local governments typically don’t include them in their own financial statements or set aside reserves to honor them.
“These are debts that do not show up clearly, no matter how closely you look at the balance sheets,” said Carmen M. Reinhart, an economist at the Peterson Institute for International Economics who has written extensively about government debt. They “come out of the woodwork in bad times.”
In a number of communities, especially in New Jersey, Michigan and Washington State, local officials have recently scrambled to work out fiscal emergencies caused by guarantees and similar promises. Hoboken dodged a bullet last year, for instance, when a buyer was found for a bankrupt hospital whose debt the city had guaranteed. Buena Vista, Va., narrowly missed a creditor foreclosure of its city hall and police building, after a park authority failed to repay the bonds for a golf course.
In other places, bond guarantees have been time bombs, causing problems too severe to be solved in a workout. Stockton may be headed for Chapter 9 bankruptcy this week after pledging taxpayer money to backstop authorities’ debts for a hockey arena and other showcase buildings. Scranton, a faded former coal center, touched off a full-blown debt crisis this month, losing access to the capital markets when its City Council refused to honor a taxpayer guarantee for a parking authority’s bonds.
Residents of Pennsylvania’s capital, Harrisburg, recently learned from a forensic audit that their city’s fiscal woes could be traced to a guarantee issued in 1998, for the bonds of a trash incinerator project. Every few years after that, the authority running the project issued more bonds, and the city guaranteed those as well.
The audit showed that the authority had been selling new bonds for the cash to pay its older bonds — saving unwitting residents from having to honor their guarantees for a time, but blowing up their debt from the incinerator to an impossible $310 million. That’s more than three times what residents owe on the city’s own bonds.
Harrisburg tried unsuccessfully to declare bankruptcy last year but was blocked by the state. It is widely expected to try again.
The “full faith and taxing power” of communities, a solemn pledge, was being used to guarantee revenue bonds for nonessentials like solar-power projects, apartment buildings and a soccer stadium — things bailout-weary taxpayers might walk away from if the guarantees were called.
Moody’s cut several communities’ own credit ratings to junk, briefly making New Jersey the nation’s leader in junk-rated municipalities. (Now Michigan has that distinction.) The gritty town of Harrison, just across the Passaic River from Newark, had its rating cut a rare eight notches in a single year, when it couldn’t honor a promise to pay debts connected with construction of the Red Bull soccer stadium.
Harrison had to borrow from Hudson County to get through the crisis, but that in turn raised doubts about whether the county’s taxpayers would honor their guarantee of yet another project’s debts — $85 million for a faltering waste-disposal system.