Thursday, June 23, 2011

The Tale of One City. This is no Dickenson Tale

The Harrisburg, state capital of Pennsylvania, is  a town  that I have driven  through many times on my trek back to Columbus over the last 33 years. According to a recent analysis from the PA state Department of Community and Economic Development, DCED, Harrisburg is likely to end the year with a nearly $3.5 million deficit in its $58 million budget, and things are only expected to get worse. By 2015, the deficit is likely to be $10.4 million, which will eat up about 16 percent of the city’s general fund budget. It can’t be much surprise that the city finds itself essentially  a ward of the state under the auspices of Act 47, a receivership program that is basically the final firewall between the capital city in the nation’s sixth-largest state and bankruptcy court.
“The City of Harrisburg is facing a direct, immediate and grave financial crisis,” the DCED wrote in a massive 422-page analysis of the government’s perilous condition. “The financial crisis is so severe that the City teeters uncomfortably on the verge of bankruptcy that could be triggered at any moment by parties outside its control.” The study further warns of possible “catastrophic results” in which bankruptcy might come from “the stroke of a judge’s pen.”
How did this happen?
Harrisburg, a city of 49,000 people, finds that its financial problems are multi-pronged, but started with what, at the time, seemed like a good idea; build an incinerator plant to deal with the solid waste not only for Harrisburg but perhaps other cities that were closing landfills and needed alternatives for waste disposal. This disastrous 2003 incinerator project that was supposed to be a revenue driver has ended up costing the people of Harrisburg millions of dollars in cost overruns and malfunctions.  The city still owes $220 million on the bond issue to build the plant. The debt service on that project alone is $18 million per year, which amounts to nearly one-third of the entire 2011 city budget. How is it possible that a city that has a budget of $54 million per year can afford $18 million in interest payments and on top of that they still have to pay back the $220 million they borrowed to build the plant, They can't.
In short, irresponsible public spending combined with crippling fixed costs and an inability to grow have probably sent the City of Harrisburg into bankruptcy. My guess is that the state does not have the funds to bail out the city and take over not only the $220 million for the plant, plus the other debt of the city. Meredith Whitney has publicly stated that she feels we will see many municipal defaults at the city and local government level before things turn around. Harrisburg is one example of why I continue to shy away from municipal bonds and will do so no matter how compelling the value seems to be in the municipal bond market.
We are facing problems across the country where local and state government do not have the income to cover the liabilities already on the books. Some investors will lose some of their money. Keep in mind that even if you own insured muni bonds the insurance is only as good as the financial resources of the bonds insurers. If losses exceed assets the municipal bonds insurers will not be able to pay all the claims you will lose money even if you bought insurance protection.
Dan Perkins

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