Remember the poster child that many pundits liked to point to as a harbinger of municipal finance Armageddon?
It looks like they’ll have to find another punching bag: The city of Vallejo, California is exiting bankruptcy.
When the city of 120,000 just north of San Francisco filed for bankruptcy in May 2008, its leaders attributed the problems to lower tax collections and onerous labor contracts.
Last week, a federal judge in Sacramento approved a debt-restructuring plan that enables the city to exit Chapter 9 bankruptcy. The five-year plan reorganizes its debts and addresses $195 million in unfunded pension obligations, according to the Bond Buyer. The plan reduces payments for retiree health care, cuts pension benefits for new employees, increases pension contributions from current workers and creates an emergency fund.
Deals had been previously reached with bondholder Union Bank and National Public Finance Guarantee Corp.
Most important, municipal debt backed by specific revenues was unaffected by the agreement.
Protection for bondholders
Along with Vallejo, the small city of Central Falls, Rhode Island was another favorite exemplar of the pundits, who seemed to revel in the travails of municipalities and in fostering anxiety among investors. Like Vallejo, however, the facts behind the headlines tell a different story.
As noted in The New York Times, Central Falls entered bankruptcy court this week, undone primarily by its inability to pay for retirement benefits promised to police and firefighters. In bankruptcy, the city will attempt to reduce pensions and require retirees to pay a portion of their health care premiums.
Bondholders, however, will apparently still get paid. Under a state law passed last month — and one that may be emulated by other states and cities — general obligation bonds must still be paid, even in bankruptcy.
The real lessons behind Vallejo
The saga of Vallejo and Central Falls provides important lessons for individual investors — but for reasons other than what the fear mongers peddle.
First, municipal bankruptcy is highly unusual and is a move of last resort. Politicians are usually thrown out of office, the process is costly and extremely time consuming and, above all, it damages the city’s credit standing and increases borrowing costs going forward, a fact recognized by Rhode Island in its measure to protect bondholders. Cities and counties have numerous options to address financial problems, from raising taxes and fees to negotiating with creditors. In most cases, the threat of bankruptcy is enough to encourage compromise.
What’s more, the small number of issues facing imminent crisis are virtually all below investment grade and are almost exclusively the province of institutional investors; in Vallejo’s case, the only bondholder who suffered was Union Bank. The majority of individual muni investors shun excessive risk and look for quality.
As Vallejo’s story recedes, and measures to protect municipalities’ standing among investors come to light, the problem for fear mongers predicting calamity in the muni bond market goes beyond finding another city to bash. It’s the narrative itself, as the credibility behind these bold, but unfounded, predictions continues to erode.