[This article was originally published by the Independent Institute]
When Detroit went bankrupt in 2013, it was a basis for pundits to make negative projections on urban America. After all, a city with decades of Democratic rule and left-wing policy had declared itself insolvent. It was just a matter of time, the thinking went, before politically-similar cities followed.
Six years later, the specter of mass municipal insolvency still holds sway for some. Famed investor Warren Buffett has warned about purchasing municipal bonds or opening companies in states with excessive debt. Strong Towns, an urban affairs non-profit, makes similar claims. But these warnings do not reflect any broader condition about U.S. cities. Rather, the threat of fiscal insolvency is a problem in specific cities, for specific reasons, and have very specific solutions.
First, let’s look at the general outlook of U.S. cities: are they fiscally insolvent? Existing data and market signals suggest no. Muni bonds – which represent city-issued debt that investors buy on the open market – have long been considered among the safest investments. City governments generally have bond ratings listed as high quality or better, because they have a history of paying debts. Municipal default is extremely rare, and bankruptcy is almost non-existent. During the Recession, 1 in 1,668 general-purpose local governments filed for bankruptcy.; and there have only been 600 bankruptcies in U.S. history, out of 90,000 municipalities.
The bankruptcy cases that have happened were high-profile, such as Detroit, Stockton, and San Bernardino. Other prominent cities on bankruptcy watch include Compton, Fresno, Oakland, and Providence. How did they get there? That is where different interpretations come in.
Strong Towns – the non-profit that’s become increasingly influential to government officials and planners – attributes it in part to sprawling growth patterns. It claims that cities overextend their infrastructure, running up liabilities that cause bankruptcy or other forms of distress.
That theory is not, however, reflected in the numbers. Built infrastructure costs tend to be a minor expense in city budgets (in Detroit, the largest expense is by far police protection, as it is in many cities). Nor is there a correlation between a city’s growth pattern and its fiscal condition; according to a 2017 Fiscal Times report ranking 116 cities, the two now in the worst fiscal condition are actually among America’s densest – New York and Chicago.
Buffet’s explanation for municipal distress is closer to the truth: public employee retirement costs. “If I were relocating into some state that had a huge unfunded pension plan, I am walking into liabilities,” he told CNBC. “Because I mean, who knows whether they’re gonna get it from the corporate income tax or my employees.”
Government retirement costs have indeed been the biggest cause for rising taxes and debt in the bankruptcy cases thus far. When Detroit filed, nearly half of its $18.5 billion debt was due to unfunded pension liabilities. The bankruptcy cases in Stockton and San Bernardino hinged on the same issue – whether to impose haircuts on retired employees or creditors.
In New York City and Chicago, even the vast revenues generated from so much commerce and density do not compensate for their patronage-ridden governments. Chicago, according to the Center for Tax and Budget Accountability, owes “$28 billion to the systems that pay retirement benefits to school teachers, police officers, firefighters, and other city workers — and its required contributions to those systems are scheduled to increase by over a billion dollars over the next four years, taking up more than twenty percent of the entire city budget.” In New York City, nearly 75% of the $197.8 billion debt is due to retirement liabilities. A recent CALmatters report found that retirement liabilities could bring insolvency to hundreds of California cities.
The answer to this issue, then, is pension reform. There have been several attempts by cities nationwide to shore up their systems, by reducing the benefits or converting defined-benefit plans to 401(k)-style plans. They’ve had varying degrees of success, depending on the legal climate in different states for reform.
But for U.S. cities that don’t struggle with pension problems, the situation is less dire. Municipal governments are generally not profitable; but nor are they so racked by long-term obligations as to be insolvent. Rather, they are thriving economic engines that produce jobs, growth and prosperity – while generally covering their costs.