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GOVERNMENT: City Bankruptcies May Signal Trouble for California

Sacramento Bee, Nov. 23, 2008

By Robert Lewis

Are they signs of difficulties yet to come for municipal governments? Or, is the revelation that two small cities in Northern California are considering bankruptcy protection merely news of isolated financial trouble that's unlikely to spread around the region?

Government leaders and experts on municipal finance are quick to say Rio Vista and Isleton face unique difficulties that might not affect others. But with local, state and national economies fully roiled, the same experts acknowledge that other municipalities on the brink could tumble into insolvency.
Rio Vista and Isleton face budget shortfalls and massive debt. Their leaders are looking at the same bankruptcy option that Vallejo chose in May.

If other cities follow suit, it may mean trouble across the state.
"The more that start talking about it, the more that start filing, investors will stop investing in municipal securities," unless governments are willing to pay more in interest, said Matthew Fong, former state treasurer who oversaw California's finances in the wake of Orange County filing for bankruptcy protection in late 1994.

After that county filed for Chapter 9 bankruptcy following a major loss on investments, lenders became wary, Fong said.

"Any other county or city that went to the market was punished by what I call the 'Orange County premium,' " he said. "What appears to be a local problem is really a regional and state issue."
More cities and counties are likely to consider bankruptcy protection as the housing slump continues and credit remains tight, said Michael Coleman, fiscal policy adviser to the League of California Cities. Sales tax revenue has been declining for several years, but property tax revenue lags. The impact of the real estate downturn will become more evident in the next several years.

Most cities will weather the troubled times, Coleman said. But small cities with few revenue streams and inflexible employee contracts – particularly newer cities that have funded recent budgets largely with taxes on new development – could be in trouble.

"There's something to be said for economies of scale," Coleman said.
After Vallejo's bankruptcy filing, state finance experts did look at historical causes and effects of municipal failures, said Paul Rosenstiel, California's deputy treasurer.

Of 60 municipal entities nationwide that sought bankruptcy protection between 2000 and 2007, only 13 were general governments – cities and counties. The median population size was 700; the largest was Desert Hot Springs, population 16,000, in Southern California.

Most of the bankruptcy filings were the result of a sudden event – like a lawsuit – that a small town was unable to handle.

The Village of Hillsdale, Mo., for example, filed after having to pay $88,000 to a police officer who slipped on a patch of ice, Rosenstiel said.

"Vallejo is fairly unique in recent history," he added, referring to the Solano County city of 120,000, which had trouble paying even day-to-day expenses.

It is difficult to predict how the municipal finance market will respond and what impact bankruptcy filings could have on other California cities' ability to borrow.

"We have very little experience with that because municipal bankruptcies are so rare," Rosenstiel said.
History shows they're rare even in times of economic turmoil, said Mark Baldassare, president of the Public Policy Institute of California.

But in these uncertain times, and amid a tightening credit market, municipal insolvencies could reverberate.

"One thing credit markets don't like is surprise," Baldassare said. "Municipal bankruptcy just adds to the uncertainty."

Officials, lawyers and financial experts all seemed to agree that bankruptcy is – or should be – a last resort.

Rosenstiel also cautioned against overgeneralizations.

Vallejo's leaders say that city's budget woes stem from public safety salaries and benefits. Rio Vista has had decades of costly sewer problems. And Isleton – a Delta town of about 850 people – has allowed debt to accumulate.

"I'm not saying there won't be more bankruptcies. There might be. But right now there's one," Rosenstiel said.

Last Updated: Dec 07, 08

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