Get Out of Muni Bonds: Fed Analysts say Falling Property Values May Amplify Municipal Budget Crises

The impact from the Great Recession is not completely over, especially at the municipal government level.

The dramatic fall in home prices is shrinking the property tax base, contributing to a sharp decline in municipal tax revenues, says a study by Federal Reserve Bank of Cleveland researchers Thomas Fitzpatrick IV and Mary Zenker.

Using Cuyahoga County, Ohio, as an example, Fitzpatrick and Zenker say that differences between market and county estimates of property values from 2008 through 2010 imply that when property values are reassessed in 2012, they will be between 11 percent and 18 percent lower than the 2010 county estimates. This suggests that after reappraisal, the county tax base will be at least $1.1 billion lower than it was in 2010.

The impact has been felt most strongly in Cuyahoga County's central city (Cleveland) and its inner-ring suburbs, which may see property values fall 38 to 45 percent and 26 to 30 percent, respectively.

Moody's Downgrades Los Angeles From Aa2 To Aa3

It's getting ugly outhere.

Moody's Investors Service has downgraded to Aa3, from Aa2, the rating on the City of Los Angeles' general obligation bonds.

Moody's stated:

The downgrade primarily reflects the continued erosion of the city's historically better-than-average willingness and ability to quickly rebalance its budget mid-year. This is a particularly important rating factor for Los Angeles since its balance sheet has typically been relatively weak for the rating level. The downgrade also partly reflects the likelihood that the city's general fund reserves at the end of the current fiscal year could be materially weaker than we had previously expected, now that an expected transfer from the Department of Water & Power may be reduced. The loss of these DWP funds would, at a minimum, make the city's planned rebuilding of its budgetary reserves over the next few years more difficult, if only because it would likely be starting from a weaker position. Given the likely difficulty in rebuilding reserves according to the city's three-year plan--particularly in the current economic environment--our rating outlook for the city's general obligation and general fund ratings remains negative. The downgrade primarily reflects the continued erosion of the city's historically better-than-average willingness and ability to quickly rebalance its budget mid-year. This is a particularly important rating factor for Los Angeles since its balance sheet has typically been relatively weak for the rating level. The downgrade also partly reflects the likelihood that the city's general fund reserves at the end of the current fiscal year could be materially weaker than we had previously expected, now that an expected transfer from the Department of Water & Power may be reduced. The loss of these DWP funds would, at a minimum, make the city's planned rebuilding of its budgetary reserves over the next few years more difficult, if only because it would likely be starting from a weaker position. Given the likely difficulty in rebuilding reserves according to the city's three-year plan--particularly in the current economic environment--our rating outlook for the city's general obligation and general fund ratings remains negative.

10 Municipal Bankruptcies In 2009?

It's a race. On the one hand you have the Fed pumping money into the bank system at near Zimbabwe rates to re-inflate the system, on the other had, Ben Bernanke's 2008 Summer of Monetary Stinginess is having its latest impact on municipalities.

Will Bernanke's money gusher reach the municipal sector in time? If not, it is going to be another mess.

The accountant who predicted the nation’s largest municipal bankruptcy says as many as 10 insolvencies will roil the $2.7 trillion U.S. market for state, county and city debt next year, according to Bloomberg.

John Moorlach said in 1994 that Orange County, California’s leveraged investing strategy could wreck its finances. The county went bankrupt about six months later after losing $1.6 billion.

As many as four cities in California and six others nationwide may seek court protection from creditors next year under Chapter 9 of the bankruptcy code, the section devoted to municipal governments, Moorlach said in an interview.

Moorlach said many California cities are watching Vallejo, a city of 117,000 on San Francisco Bay that filed under Chapter 9 in May. The city hopes to rewrite its labor contracts with police and firefighters.

“If Vallejo is successful in unwinding pension agreements, you could see Chapter 9 become a whole new industry,” Moorlach said.

Of course, the Fed and Treasury will in some fashion come to the rescue of any big cities that get into trouble, but it still is extremely dangerous to hold this paper. For smaller municipalities where a rescue may not occur at all, holding municipal paper is like playing Russian roulette.