Largest City Bankruptcy Ever: Stockton Will Not Be Alone

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Largest City Bankruptcy Ever: Stockton Will Not Be Alone
Too much borrowing and spending will doom other municipalities

By Bob Stokes
Wed, 27 Jun 2012 16:30:00 ET

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Stockton, Calif., is set to become the largest U.S. city ever to seek Chapter 9 bankruptcy protection.

(Last year, Jefferson County, Ala., became the largest county to seek bankruptcy protection.)

An agricultural center of 290,000 people in Central California, the fiscally insolvent Stockton has already "eliminated one-fourth of the city's police officers, one-third of the fire staff, and 40 percent of all other employees," says a June 27 CBS News report. "They also cut wages and medical benefits."

Stockton, CA: Fiscal insolvency due to excessive debt, high employee costs and even bookkeeping errors.

Stockton is one of the nation's hardest hit by the housing bubble. The city stopped paying its bondholders months ago.

Think Stockton is an outlier? Well, consider this CBS News headline (June 27):

Economists say Stockton, Calif. won't be last U.S. city to go bankrupt

The article adds that:

A professor of economics at the University of California - Irvine, says there is, "a long queue out there of cities like Stockton that are going to be doing the same thing."

[The professor] points to cities such as Vallejo, Calif. and Central Falls, Rhode Island, which also went bankrupt, largely because of unfunded pensions. Jefferson County, Ala. filed for Chapter 9 protection, sinking in $3 billion dollars worth of debt.

The March 2012 Elliott Wave Theorist addressed why politicians have done almost nothing to keep cities from going broke:

The answer is that the state’s legislators are so beholden to public sector unions that they are oblivious to the financial meltdown all around them and aren’t about to do anything before more cities’ finances hit the wall....

This is exactly the scenario we are steadfastly predicting: bankruptcy. And bankruptcy—reneging on debt—is deflation. Investors think they have money when they hold a bond, but bond values are going to melt away. That’s deflation. Public retirees think they will keep getting money, and many of them have no doubt planned for future living expenses based on pension promises. But the expected money won’t materialize. The flood of municipal bankruptcies coming this decade is going to be something to witness. The wait has seemed interminable, but when the crisis hits, everyone will talk about how “sudden” it is.

Indeed, local governments' money problems have been anything but sudden.

As the New York Times best-seller Conquer the Crash marks its 10th birthday (learn how to read 8 free chapters here), consider what it said in 2002:

Governments that have borrowed to the hilt were running deficits even in the booming 1990s, so the risk of default in a depression is huge. If the issuers of your tax-exempt bonds default, you will have the ultimate tax haven: being broke. (p. 255, second edition)

Owning municipal bonds can be hazardous to your financial health.

Despite the rise in muni-bond defaults, investors remain amazingly complacent. [The chart above] shows the ratio of 10-year AAA muni yields relative to 10-year U.S. Treasury note yields. The ratio rises when muni investors demand higher yields relative to Treasuries due to a perceived increase in risk. The spike on the left side of the chart occurred in the fourth quarter of 2008 in conjunction with the first phase of credit deflation. The ratio’s low occurred in December 2009, at 79 basis points. A creeping rise through 2010 and 2011 led to an interim high of 145 basis points on October 3, 2011, in conjunction with the stock market’s decline into a low on October 4. As stocks rallied and optimism once again increased, the ratio pulled back to a March 19 low at 104 basis points.

Interestingly, the Dow’s rise to a new recovery high...was accompanied by a rising muni-to-treasury ratio...Muni investors have so far shrugged off the increased risk of defaults.

Financial Forecast, May 4, 2012

Complacency is a financially dangerous mind-set right now.

The financial dominoes are all lined up, and it appears the invisible finger has just nudged the first domino.

Prepare your portfolio now for what EWI sees just ahead by reading the Financial Forecast Service via a 30-day risk-free trial>>

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Tags: Club EWI, commercial real estate, conquer the crash, debt, deficit, deflation, economic depression, economic indicators, Elliott wave, home sales, housing prices, municipal bonds, pension funds

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