Strapped for Cash, Local Governments Sputter

One of the hardest hit local governments is the city of Detroit, where, according to research done by The Pew Charitable Trusts, the situation is "as dire as anywhere."

Detroit Mayor Dave Bing has said he will lay off more than 1,000 people, one-10th of his workforce, by late September unless the unions agree to have their members take 26 unpaid furlough days this year. Bing has described the city's fiscal situation as "a train to hell."

Defaults are rare. The rate of municipal defaults is around 1 percent historically. But they do happen.

The City of Menasha, Wis., in September defaulted on a $25 million bond offering tied to a utility project. And while city officials try to work out a solution, Moody's Investors Services said recently that "recovery prospects for note holders remains unclear."

Hazy in Alabama

In Jefferson County, Ala., there is a $3.2 billion debt tied to sewer system bonds under the county's jurisdiction.

Officials there concede the debt can't be paid. So now what? It's still not clear. The choices are not easy, the debate, contentious.

"Bankruptcy is clearly the way to go here, but there is a political stigma," said Robert Bentley, a state representative from nearby Tuscaloosa County who is running for governor.

Bentley, a Republican, is suggesting that the Jefferson County cordon off the sewer agency from the county, and have it file Chapter 9.

But his opponent, incumbent Republican Gov. Bob Riley, opposes bankruptcy.

Riley has been grappling -- unsuccessfully -- with this problem for the better part of the past two years. Last year, Jefferson County officials went so far as to seek the governor's permission to declare itself in a financial state of emergency and even floated the need for a contingency plan for state troopers to operate jails if unpaid deputies walked off the job.

Jefferson County eventually put 1,000 of 3,600 state employees on leave to fill a budget gap, while Riley appealed to Treasury Secretary Timothy Geithner for a bailout, which didn't happen. Jefferson Country continues to explore options to avoid bankruptcy and refinance.

Richard Ciccarone, managing director and head of research at McDonnell Investment Management, which specializes in municipal bonds, said more than 50 percent of the 400 or so municipalities in his database face some sort of budget deficit.

He likens the current situation to the late 1970s, when relentless local government cash pinches led to new taxes, which in turn spawned a tax revolt, such as the one in California -- any new taxes needed to go to referendum and required a two-thirds majority -- which in turn helped lead to the epic shortfalls seen in the Golden State today.

"At some point the leaders and citizens need to make some tough choices about what kinds of government services are realistic, and this will play out all over the country," Ciccarone said. "It'll be painful, but necessary."

There are some examples of municipal governments that have pulled back from the brink and in relatively short order.

In 2003, Buffalo, N.Y., facing a looming budget shortfall and a major labor contract negotiation with its police department, was placed by then Gov. George Pataki under the strict monitorship of a financial control board.

Literally forced to confront its fiscal problems, Buffalo officials resorted to a painful mix of layoffs and spending freezes while ceasing to borrow any more money before paying down debt.

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