Broker Check

                                                                                                                                           September 15, 2010



Canary in the Coal Mine?



            Harrisburg, the capital of Pennsylvania, a city of 47,000, where 28% of the population lives below the poverty level, is deep in debt. It has two major problems, a debt of $288 million on an incinerator that burns trash, which needed $68 million in debt payments this year, (more than the annual budget of Harrisburg) and a general obligation bond payment due this year of 3.29 million. Their financial woes have been a train wreck in slow motion.


            The Harrisburg government debated whether to pay the bills, layoff police, delay paying the electric bill, or cut basic services. Ultimately, they decided to pay $637,500 towards the incinerator out of the total $71,290,000 liability, less than 1% of the obligation.


            Harrisburg general obligation bonds will be paid as these bonds were insured by Ambac Assurance, a unit of Ambac Financial Group. While the city is working with Ambac on a potential repayment plan, Ambac could go to court to force a property tax increase to cover the bond payment.


            At the last minute, the September payment was covered by the State of Pennsylvania advancing the city $3.3 million.


            This year’s incinerator payment was covered by reserves and by Dauphin County, which is the guarantor behind the city on almost half the debt. Dauphin County has authorized the bond trustee to sue Harrisburg to force it to pay a $35,000,000 payment due in December.


            After Jefferson County of Alabama’s default (City of Birmingham), this is the largest municipal default this year. This year some $886,000,000 of general obligation principal bonds have experienced “credit impairments”, such as dipping into reserve funds or tapping bond insurance.


            My view is that this may be the canary in the coal mine, the warning of a deadly situation. Because people are unemployed and afraid, they have reduced their purchases, which means less sales tax revenue is generated. Because fewer people are employed, there is less income tax revenue being collected from wages. Because fewer people are employed, more people are unable to pay their real estate taxes. All the foregoing are major sources of revenue to states and municipalities. The foregoing may be the underlying cause for Warren Buffet’s June warning of a “terrible problem” ahead for municipal bonds.


            State and municipalities across the country are one event away from similar straits, the result of piling up spending commitments regardless of the revenue base. Governor Rendel insists the state payment to Harrisburg is not a bailout but the pattern in these cases is that one rescue begets another. Next stop is Washington, where Financial Services Chairman, Barney Frank, has a proposal to provide a federal guarantee for local debt. Look for this to be a priority if Democrats hold the House and Senate this year as they seek to reward public unions for saving the day with their campaign cash. Putting all U.S. taxpayers on the hook for city debt would only provide local politicians with another excuse to avoid the cut backs, furloughs and reforms necessary to balance their ledgers. Whatever its short-term pain, bankruptcy is the only discipline which will break the addiction.


            The market’s consensus is that Harrisburg will not be the “first domino” that sets off a collapse. However, when the bond insurance companies run out of funds, will municipal bond holders keep their bonds or will muni bond prices weaken and can municipalities continue to raise money to fund their problems instead of tightening their belts by curtailing services, laying off civil servants and renegotiating contracts? Wall Street Journal 9/1/10 p. C1, 9/8/10 p. C1., 9/15/10  p. A18.


            Stay Tuned!


Do You Really Think They Won’t Tax Everything?


            Until now residents of Albany, New York did not have to pay a sales tax when getting their morning bagel. No more. New York, with a $9.2 billion deficit, needs every coin in your pocket. Now you will pay a tax if you eat a sliced bagel on the premises of Bruegger’s. Accounting 9/3/10.


           As always, if you have any questions about these or any other matters, do not hesitate to call me.

           Remember, We’re Here For You!!