In the last 20 years there’s been a lot of talk about the amount of debt the federal government has taken on. Those conversations have intensified in the last couple of years. Similar conversations are now being had about the financial situations of states, but could you imagine your own home town having the same problem?
Well it’s rare, but not out of the question. Towns, like other governments, and businesses, and people, borrow money to meet cash flow needs in the short term or for specific projects. You might borrow money to buy a car, a town might borrow money to build a new school. There’s always risk when you borrow money. Most of the time everyone pays back what they borrow, but sometimes they don’t. Just as you can lose your income, so can governments. If a local government doesn’t want to raise taxes (during say an election year) then bankruptcy maybe be a logical choice.
In the US this is called chapter 9 bankruptcy (chapter 13 is common for individuals, 11 and 7 for businesses). This bankruptcy is popular for municipalities because it allows them to renegotiate things like pensions and contracts, in addition to dealing with creditors. When anyone borrows money, they must agree to covenants. Covenants are triggered when the borrower defaults or breaks any other rules. They aren’t called covenants when you borrow for a car, but the equivalent may be them taking your car if you don’t pay. A bond covenant for a municipality may allow the lender to force governments to raise taxes to make the payment, which is why they seek protection in bankruptcy court.
With so many governments strapped for cash, the chapter 9 bankruptcy is coming up more and more in conversations. Nowhere is this more true than in Harrisburg, PA. They’re starting to have the chapter 9 talk. But you don’t live in Harrisburg now do you (well a couple of my readers do), so why should you care? Remember the credit crisis? Some are saying with growing pension issues and reduced tax income, many municipalities may face similar issues in the coming years. If more towns default to get out of debt, you can be sure the interest rate on municipal debt will shoot up. Muni debt is used to finance many projects such as schools, roads, and public works projects. More interest rate means less capital available for these projects. This translates to more taxes or fewer projects.
Which will it be? Who knows. The talks of double-dip recession mean nothing compared to this. A muni debt crisis fueled by a pension crisis could produce the kind of depression we saw in the 30s. The likelihood is limited, but don’t think this doesn’t pertain to your town simply because you don’t live in Harrisburg
 By The Weakonomist |
The Weakonomist is the founder of Weakonomics. Clicking the picture of the puppy will tell you more about him. If you like what you're reading consider subscribing to the blog, following him on Twitter, and checking out the related posts below. Please consider a donation if you really enjoy Weakonomics. Also keep in mind that nothing I say can be construed as financial advice. |
