It’s a tale of naiveté, doublethink, and lack of vision. The New York Times has done a study of US cities and their debts. Many US cities have gone guarantor for failed public projects, and those debts are now sending them to the wall in a big way. The city of Harrisburg, Pennsylvania tried to file for bankruptcy, but was “blocked by the state”. It’s a good indicator of the depth of the problem and the lack of understanding which has promoted a cycle for government debts at all levels. It’s also a good indicator of the cynicism of many loans to public authorities- “Let the taxpayers carry the can” is the net effect.
The New York Times
“These are debts that do not show up clearly, no matter how closely you look at the balance sheets,” said Carmen M. Reinhart, an economist at the Peterson Institute for International Economics who has written extensively about government debt. They “come out of the woodwork in bad times.”
In a number of communities, especially in New Jersey, Michigan and Washington State, local officials have recently scrambled to work out fiscal emergencies caused by guarantees and similar promises. Hoboken dodged a bullet last year, for instance, when a buyer was found for a bankrupt hospital whose debt the city had guaranteed. Buena Vista, Va., narrowly missed a creditor foreclosure of its city hall and police building, after a park authority failed to repay the bonds for a golf course.
You see the pattern of abuse. That a city’s finances could be at risk as a result of a golf course says volumes. These are the sorts of projects which might get a line or two in a local paper. They’re also private sector projects, using developers and local contractors, the whole Chamber of Commerce thing. Everybody signs off on everything, and the damage shows up a decade or so later. The local finance company organizes the finance and gets a guarantee from the city to make the projects look ironclad.
There’s a reason for this very uncharacteristic propriety and probity on the parts of lenders. Loans are assets for finance companies. The more they lend, the bigger the dollar asset value of their portfolio gets. If they lend $10,000,000, the net asset is that $10,000,000 + interest + equity in the project, + guarantees. Lenders are sitting pretty, in theory. They can borrow more themselves, because they actually have assets worth more than the original outlay. That original $10,000,000 has become an asset worth for the sake of argument $14,000,000. Put together a portfolio of loans where you can come up with a figure of 140% of your original capital, and you can borrow that much more, lend more, and make more money. $1 billion may be able to borrow $1.4 billion, based on the value of assets.
(This is just a general principle. It is quite a bit more complex than that. The actual value of debt does include ratings, provisions for bad debt and a range of other practices. It's just that people in finance apparently don’t take these things seriously until they’re on the wrong end of the equation.)
The trouble with this particular fairy tale is that when things go bad, they’re left with bad debts, and that’s what’s happening in the US cities. The fact is that a debt has to be paid to be a real asset, and defaults and write-offs seriously undermine the portfolio of assets, which in a worst case scenario can trigger multiple issues across the financial prairies, hitting those who lend to the lenders.
Behind the scenes around the world, banks are now charging each other a lot more to lend to each other. This is a combination of risk management and genuine distrust. Nobody knows to what extent the banks are exposed to high risk loans like the recent Greek loan debacle. The US cities are in almost equally absurd situations, for example the city of Harrisburg issued bonds to fund an incinerator project in 1998. That debt has now gone well and truly out of control:
Every few years after that, the authority running the project issued more bonds, and the city guaranteed those as well.
The audit showed that the authority had been selling new bonds for the cash to pay its older bonds — saving unwitting residents from having to honor their guarantees for a time, but blowing up their debt from the incinerator to an impossible $310 million. That’s more than three times what residents owe on the city’s own bonds
$310 million, in effect, for an incinerator which has been burning more public money than any amount of trash it could possibly burn. Guess where this money goes. Straight back into the debt circus, for more shaky loans.
One US city (Scranton, PA) reneged on its debt guarantee and refused to pay. The city was worried it wouldn’t be able to make payroll. Lenders threatened everything from court-ordered tax increases to refusal to supply fuel for the city’s police and other services. The city became a “pariah” and is hard pressed to find finance.
That’s a serious generic overhanging problem for the US cities. Most public authorities are very much leveraged in terms of real cashflow. Revenue simply doesn’t cover the massive real costs of operation. They’re basically hostage to these very sharp practices.
This type of lending isn’t illegal, but you’d have to question its sanity.
Check this out for a piece of logic:
1. Lenders do have the right to be sceptical of city revenues and manage their risks. That makes sense, insofar as everyone knows local government revenue is often pretty iffy.
2. So, knowing that very well, the lenders then add the impost of guarantees to their loans, blowing out the onus on revenue into a much bigger problem?
3. This process continues until debt is well in excess of any possible value of the original loan?
4. The accumulated debt is allowed to become a monster, like the $310 million Harrisburg incinerator, and a potentially lethal liability to lenders and borrowers alike?
5. City payrolls and essential services are threatened on the basis of a completely unrealistic situation?
6. This is an “everybody loses” scenario. Holders of bad debts are in no better condition than their borrowers. Lenders could be crippled.
7. Add to this the fact that the incredible costs loaded on to US public authorities are systemic from rural counties to Washington DC, and you have an economy which is living on book entries, not hard cash.
There’s a grimly ironic payoff to this. All these public projects are based on economic factors. Many cities got saddled with debt in the name of economic stimulus, trying to create “growth”. The culture of finance has effectively castrated that sort of economic management. Real growth, and therefore economic recovery, is now being stymied by debt.
“Economic growth”, that obscene phrase, now means “how much can we charge everybody for this”, and it applies across the board. Devaluation of incomes and revenue is entirely cost-based. What used to cost $1 million now costs $10 million. The $10 million is called “growth”. It’s not. It’s ultra-hyperinflation, disguised, badly, as “growth”. That myth’s been systematically killing public revenues, education, health, and everything else and driving costs up for decades. Now it’s coming home to roost, and dragging down the entire economy.
(People have got so used to the idea that costs always rise, that they’ve forgotten that the big prosperous years were the days when costs were driven down by competition. Endlessly rising costs have been poisoning standards of living for years, now the disease has eaten through into every aspect of financial life.)
Someone famously said that America owes itself money, as a sort of soothing excuse for the fantastic levels of public debt, particularly Federal debt. Most Americans wouldn’t need to be told that having deadbeats in the family isn’t exactly unusual. The fact is many of those debts are no longer payable, if they ever were. Lenders don’t have “assets”. They have fantasies.
The US cities are a great illustration of the reasons for eliminating public debt. It’s a liability to everybody and the economy as a whole. America is way behind the times in terms of public debt management. All levels of government are seriously afflicted with this curse.
To get rid of US public debt, a more or less complete reversal of the trends of the last 30 years are required:
1. Costs to public authorities must be competitive, and competition must create lower prices.
2. No more “favors” to insiders, all debts must be cleared by a fully accountable process.
3. Real dollar costs for governments at all levels, but particularly the cities, must go down. There’s no way city revenues will ever match these huge costs.
4. City authorities must have a real-world debt control system. They got around basic common sense debt limits with guarantees, very unwisely, as it turned out. The loopholes must go.
5. Public authorities should be legally freed of any obligation to provide guarantees by statute. These guarantees obviously don’t work.
6. Lenders must take some risks, or not lend. They can’t have what is effectively double cover on loans. Protecting lenders “on principle” has become a surefire way of protecting very bad business.
7. Bad debts owed by US cities should be quarantined to prevent further damage to both lenders and the cities.
There’s two ways of doing this- Either keep tripping over predictable mistakes, or clean up the damn mess.
It really is a circus. The lions are eating everything, and there are no real nets for the cities on the high wires. The joke is that PT Barnum didn’t go broke.