Add Jamie Dimon, CEO of JP Morgan Chase, to the growing list of influential business minds who are warning that an increasing number of cities may go bankrupt in 2011. Dimon’s comments come in the wake of those made by famed investor Warren Buffet, and Analyst Meridth Whitney who contend that municipal failures will represent the next big financial crisis.
It should come as no secret that cities have had to scale back spending over the past couple of years, resulting in furloughed workers and reduced wages, among other cuts. Revenue has fallen sharply, while debt has increased. The resulting concern over a new financial crisis stems in part from investors who see municipal bonds as an investment opportunity, largely ignoring the dire straits many cities currently face. Municipal agencies depend on the bond markets and the sale of bonds in order to raise money to help finance infrastructure and new construction projects. The low interest-accruing bonds are to be repaid by the municipalities over a specified time period. Subsequently, as cities face mounting financial stress, the reality of defaulting on these bonds appears even more likely. The cumulative effect of such a scenario across many cities and states is reason enough why Dimon’s comments should not be taken lightly.
In a June 2010 Bloomberg article, Buffet said the government may feel inclined to bail out sinking states, it would be hard in the end for the federal government to turn away a state having extreme financial difficulty when they’ve gone to General Motors and other entities and saved them.
California is struggling along ranking dead last in credit rating among the fifty states. This low ranking, in tandem with higher interest rates and nervous investors, is making it hard for weaker states (like California) to borrow and stay afloat.
Municipal bankruptcy was put on a pedestal with the 2008 chapter 9 filing by the City of Vallejo, California. After failing to establish pay cuts with it’s city workers union, Vallejo resorted to court. Many who have followed the Vallejo case will point out that they had no choice but to file. However, the two-year long Vallejo case, which is nearing an end, (a bankruptcy exit plan is due Jan 18) has shown other cities throughout the nation that going to court is not only costly and time-consuming, but there are no guarantees of an amicable outcome.
The Vallejo example surely alerted many city administrators as to what to avoid, but whether enough drastic change has taken place in surrounding areas is debatable. Recently, former Mayor of Los Angeles Richard Riordan said that the city he once represented would be bankrupt by 2014. The thought of pairing a true mega-city with the words “bankrupt” is now a jaw-dropping, but very much real, concern. Frankly, the economy is catching up with many cities, and they had better get going fast.