Tags: federal reserve | detroit | municipal | bankruptcy

Detroit Failure May Signal More Widespread Problems, Dudley Says

Tuesday, 14 April 2015 10:23 AM

The municipal bankruptcies in Detroit and Stockton, California, may foretell more widespread problems in the United States than is implied by current bond ratings, a top Federal Reserve official said on Tuesday.

"While these particular bankruptcy filings have captured a considerable amount of attention, and rightly so, they may foreshadow more widespread problems than what might be implied by current bond ratings," New York Fed President William Dudley said at a closed-door workshop on Chapter 9, the part of the U.S. bankruptcy code covering local government insolvencies.

"We need to focus our attention today on addressing the underlying issues before any problems grow to the point where bankruptcy becomes the only viable option," he added, according to a text of his speech.

Dudley, whose Fed district includes the debt-stricken U.S. territory of Puerto Rico, did not mention by name any municipalities or states that risked going the way of Detroit and Stockton. But he highlighted the difficulties some jurisdictions face when they issue debt to finance operating deficits, and when they under-fund public pensions.

In Chicago, for example, unfunded pension liabilities for the city, the board of education and other local governments that draw taxes from it exceed $35 billion, according to the Civic Federation, an independent fiscal watchdog.

The city, which received a warning last week from ratings agency Standard & Poor's, has $8.3 billion in general obligation bond debt and frequently uses debt to close budget shortfalls.

Puerto Rico, meanwhile, is struggling with more than $70 billion in total debt and must overcome opposition from local lawmakers as well as demands from investors for extra security as it attempts to sell more debt.

Dudley said borrowing to pay off a current year operating deficit is inconsistent with running a balanced budget, leaves the municipality with no new asset, and is "equivalent to asking future taxpayers to help finance today's public services."

Unfunded pension liabilities are estimated to be as high as several trillion dollars, Dudley said.

"At a certain point, the debt service burden clashes with maintaining a sufficient ongoing provision of services to forestall people from voting with their feet," he said.

"This may occur well before the point that debt service capacity appears to be fully exhausted," Dudley added. "In other words, the prioritization of cash flows to debt service may not be sustainable beyond a certain point."

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Bankruptcies in Detroit and Stockton, California, may signal broader strains in the finances of states and localities than bond ratings indicate, Federal Reserve Bank of New York President William C. Dudley said.
federal reserve, detroit, municipal, bankruptcy
Tuesday, 14 April 2015 10:23 AM
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