Strapped for Cash, Local Governments Sputter

As fallout from the housing market collapse and financial crisis continues to spread across the country, America's city and county governments struggle to make ends meet.

Increasingly, some local governments simply cannot.

A quick and ugly snapshot:

The city of Vallejo, Calif., outside San Francisco, filed for Chapter 9 bankruptcy in 2008, even before the worst of the economic crisis began. A reorganization plan is still winding its way through a federal court with no end in sight.

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Jefferson County, Ala., weighed down by $3.2 billion in sewer debt, has been struggling to avoid bankruptcy. Soon, some in the state fear, it may have no choice.

In Harrisburg, Pa., city officials worked with an outside consultant to create an emergency financial plan to stave off a crisis and figure out a way to meet $300 million in debt tied to a botched incinerator project. Harrisburg Mayor Linda Thompson has insisted bankruptcy is the last option, but has also said that all options were on the table, a spokeswoman for the city said.

Borrowing more money, which is how Harrisburg and other municipalities fell into the red in the first place, is often no longer an option. State-level funding is drying up. Property taxes, among the largest sources of revenue for local governments, are heading down along with property values as lagging assessment cycles catch up with realities in the market.

'Tipping Point'

While there hasn't been an actual spike in municipal bankruptcies in recent months relative to historical norms, the outlook is bleak.

"We're now at a tipping point," said Jim Spiotto, an attorney with Chicago-based Chapman and Cutler, which specializes in distressed municipal finance.

His firm has tracked 206 municipal bankruptcies since 1980, including cities, counties and various other debt issuing entities such as school districts, hospital and sewer authorities. The peak year for filings was in 1987 when there were 18; last year, there were nine, including the City of Prichard, Ala., and the Village of Washington Park, Ill.

Terrible Trifecta

"What happens from here depends on how local governments choose to respond," Spiotto said. "They have to work through these problems, and there is every reason to believe that they can."

The triple whammy of falling tax revenues and high unemployment as well as massively unfunded state and local pension liabilities (by one count as high as $1 trillion) is crushing local governments in ways not felt since the Carter administration.

There is reason, though, for some optimism amidst the gloom. Major municipalities, such as New York City in the mid-1970s and Philadelphia in the early 1990s, have pulled back from the brink of insolvency using a mix of new taxes, layoffs and other spending cuts.

Working through tough economic times -- belt tightening -- is leading to tough choices as well as some controversial measures and proposals. Imposing annual fees for access to 911 emergency services has stirred debate in Tracy, Calif. In Utah, meanwhile, a legislative proposal to save money by eliminating some students' senior year of high school drew fire and was eventually taken off the table for another year. Recently passed measures to increase income taxes in Oregon continue to divide that state.

Civil Servants on Firing Line

Still, something has to give. Often, it is civil servants and their unions.

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.

Today, Buffalo comptroller Andrew SanFilippo said, the city, remarkably, has a nearly $100 million surplus that it is putting away for a rainy day.

"We got tough on spending, stopped borrowing and basically lived within our means," SanFilippo said. "Services had to be cut. The police department agreed to curb overtime. We closed some fire houses. But we figured it out."

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