Should Financially Challenged Cities File for Bankruptcy?

May 4th, 2011
by Daniel Carlson
Meredith Whitney, CIBC Sr. Financial Instituti...

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In 2008 amid numerous bank failures, the small burg of Vallejo, California, declared bankruptcy. Few noticed.
Today although banks have recovered, little Vallejo is still in bankruptcy. And cities across the nation face dire economic straits. Unsurprisingly, a growing number of people are beginning to wonder, “Will other cities follow Vallejo off the economic cliff?”

Financial advisor Meredith Whitney thinks so. According to an article in The New York Times by Roger Lowenstein, Whitney, who heads Meredith Whitney Advisory Group LLC, believes that conditions are ripe in 2011 for “hundreds of billions” of defaults by cities and other municipalities. In response to her ominous predictions, investors have jettisoned approximately $25 billion shares of mutual funds invested in municipal bonds.

But the outlooks of some financial analysts aren’t as grim. BusinessWeek.com reports that New York-based Roubini Global Economics LLC expect that only “about $100 billion of U.S. municipal bonds will default” –and that’s within five years, not one. Likewise, Moody’s and other credit agencies don’t envision an epidemic of defaults. According to them, compared to economically troubled countries like Spain and Greece, cities carry much less debt relative to their economic size. And as for their bankruptcies causing panic throughout the economy? No.

Nevertheless, whether many or a few municipalities default on municipal bonds, the losers will be everyday citizens first and investors second. As services such as education take massive budget cuts, the first to feel the sting will be public employees like teachers.

So is bankruptcy really a good way out for cities facing economic crises? Probably not. Even in a state of default, cities have to function, and their responsibilities to their citizens don’t stop when bankruptcy starts. Perhaps the best solution would be for taxpayers to agree upon the services they’re willing and able to fund.

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