California Cities in Fiscal Trouble ‘Conga Line’

California Cities in Fiscal Trouble ‘Conga Line’ (CNBC, Oct 3, 2012):

Vallejo started it.

Then came Stockton. Mammoth Lakes. San Bernardino. Which California city will go bankrupt next?

Shuttered businesses in downtown Stockton, California.”There’s a lot of them lined up in the conga line,” said Marilyn Cohen, CEO of Envision Capital Management.

Up next could be the city of Atwater, where civic leaders will vote Wednesday night on declaring a fiscal emergency. They may even lay off a quarter of the town’s 90-person workforce.

Atwater, not far from bankrupt Stockton, is reportedly facing $95 million in outstanding debt and a current deficit topping $3 million. Add those together and that’s $3,500 of debt for each of Atwater’s 28,000 residents, a place where the estimated median household income is around $40,000.

A fiscal emergency is considered a first step toward bankruptcy. Many California cities have taken this route, and most of them have been in the northern part of the state.

This is also the same part of the state which boasts California’s economic engine, Silicon Valley. How can so many local governments be hurting when tech is surging?

“Things like social media just don’t create a lot of jobs,” said Joel Kotkin, Distinguished Presidential Fellow at Chapman University. “It doesn’t help Oakland, it doesn’t help the East Bay, it certainly doesn’t help places like Stockton. … Really what’s going on in Silicon Valley might as well be happening on another planet.”

Marilyn Cohen said that while most of the fiscal emergencies and bankruptcies are happening in Northern California, Southern California has plenty of candidates. “The city of Compton is in such disarray the auditor wouldn’t even write an opinion, because there’s been such fraud and abuse.”

She is advising clients to sell many munis, like those in an account she just took over. “When the account hit we sold his Compton bonds, we knew it was in peril. We sold some Fairfield bonds,” she told CNBC. “We’re selling everything that we think is even moderately tainted or in trouble.”

Her fear is that bondholders are no longer bulletproof. While Atwater’s mayor said the city plans to make an upcoming debt payment, Stockton and San Bernardino have stopped paying creditors. Stockton City Manager Bob Deis recently disparaged creditors as the lone holdout willing to cut a deal.

“My big worry is that they’re going to really stick it to the bond holders like we saw in Stockton, like we are seeing in San Bernardino,” Cohen said. “It used to be that was the Holy Grail. A city could file bankruptcy but the bond holders would come out whole, like they did in Orange County.”She said municipal bondholders need to be proactive about bonds in troubled cities, even if it means selling at a loss. “Get out of Dodge immediately.”

Cohen added that ratings on many bonds haven’t been updated to reflect current financial troubles, and, in fact, some bonds are so lightly traded they might not even be priced appropriately. “Be very, very careful. That’s my words of wisdom.”

Recently, the state of California sold more bonds than originally planned to meet buyer demand, even at relatively low interest rates of 2.45 percent.

In California, general obligations bonds are second behind education in getting paid, but given the state’s continuing multi-billion dollar deficit, the enthusiasm with which the bonds were purchased surprised some.

“It tells me that demand is outstripping supply, and that people want to buy no matter what before the elections, before their state and federal taxes go up,” Cohen said.

She said the safety of the state’s GO bonds, on a scale of one to ten, are “eight and a half or nine.”

She prefers buying bonds for things like local airports, or the Los Angeles Department of Water and Power, “Things you can understand in which pension obligations are not the main 800 pound gorilla.”

So what’s the outlook?

“There’s nothing wrong with California that can’t be fixed,” Chapman University’s Joel Kotkin said.

He said income and sales tax hike proposals on the November ballot may help the state’s credit ratings in the short term, as more cash comes into Sacramento. Long term, though, he believes they hurt the state. “We will just be delaying the inevitable, and at the same time, chasing particularly young, upwardly mobiles out of the state.”

He said Silicon Valley cannot save the state from another recession, only hard choices in Sacramento can.

“We share a Mediterranean climate with Greece and Spain,” he said. “We’re not quite where they are in terms of their economies, but we’re working on it. We’re really trying to take what is probably the most blessed economy on the planet and turn it increasingly into a second world country.”

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