Earlier this year, the city of Stockton, California, defaulted on its debt and filed for bankruptcy. For analysts at ratings agency Moody’s, it marked a growing trend in local governments. Cities, which have historically been nearly flawless on their obligations, are opting to default on their debt because of financial troubles.
In a report issued Wednesday, Moody’s rated the debt of 30 cities, towns, villages, counties, and school districts as “speculative grade,” up from 25 last year. A speculative-grade rating for a local government means, at best, its debt is risky and, at worst, it could end in default. 24/7 Wall St. looked at 13 of the riskiest local governments that may be on the verge of bankruptcy.
In an interview with 24/7 Wall St., Moody’s Managing Director and Chief Credit Officer of U.S. Public Finances, Anne Van Praagh, explained that the number of cities, counties and towns that default on some or all of their debt is growing. She attributes this to “a significant amount of credit pressure, sluggish economic recovery, and cities not being able to grow out of their problems this time around.” She added that many cities see defaulting as the only way to avoid total economic disaster.
Perhaps the best example of this is Stockton. Even in bankruptcy, the city opted not to pay off its debt. The city was one of the most seriously affected by the housing crash. Stockton bonds are currently rated Caa3 by Moody’s, tied with Jefferson County, Alabama for the worst rating issued to a local government.
Different circumstances brought each government to this point. However, a few underlying causes are shared. In some cases, governments severely mismanaged their debt: they borrowed based on unrealistic projections of expenses. In other cases, the economic downturn hit particularly hard, weakening revenue. For some local governments, it was a combination of factors.
A weak economy with a fragile or shrinking tax base is one of the worst problems a local government trying to balance its budget can face. In Detroit, the population has fallen by roughly half in the past 50 years, including a 25% drop in the past decade alone. Unemployment is well into the double digits, and per capita income has been steadily declining. All these factors make it extremely difficult to continue raising revenue to service its debt.
Detroit’s 2011 general fund revenue was $1.23 billion while its outstanding debt was more than $2.5 billion. For some speculative-grade-rated governments, debt exceeds annual revenue by three, four, or even five times.
Poor management and the failure to accurately project revenues plague many of these governments. Le Center, Minnesota, has chronically overestimated revenues from real estate developments. Menasha, Wisconsin issued government issued bonds for a new steam power plant it had been building to attract manufacturers to the region. The project was cancelled, and the city’s general obligation debt was more than seven times its 2011 revenue.
Many of the local governments rated as speculative grade have been rated poorly for years. “Once you’re downgraded to speculative, it’s possible to reverse course,” said Van Praagh, “but it doesn’t happen that often.”
Moody’s also expects more local governments will be downgraded in the future. In its report, the ratings agency explained, “The credit pressures will continue to exert themselves on virtually the entire local government sector. For municipalities unable to adjust to the new environment, downgrades into speculative grade are unavoidable realities.”
Based on Moody’s report on U.S. speculative-grade local governments for 2011, 24/7 Wall St. reviewed the 13 towns, cities, villages, and counties with a credit rating of Ba2 or worse. Moody’s also provided reports on why these cities had been rated as speculative grade, as well as general fund debt and revenue for 2011. This level of credit rating implies a substantial risk of default.
These are the thirteen American cities going broke.