Lessons Learned from Financially Distressed Governments and
How States Have Addressed and
Solved the Problem

Debt management has been a major challenge for government entities since the fourth century BC, James E. Spiotto, Managing Director, Chapman Strategic Advisors, LLC, reassured Forum participants. He presented an analysis of how different sovereign entities have managed debt in the past, including mistakes and shortcut attempts taken to balance the budget that did not work and should be avoided in the future.  He then reviewed successful debt management strategies, including economic discipline by state and local governments, investment in infrastructure to support economic growth, and diversification of tax sources to prevent over-concentration of sources of funding.

Economic downturns have been the periodic cause of budget challenges. Since 1776, local governments have faced 6 panics, 38 recessions and 4 depressions, the last depression and recession being the Great Depression of the 1930s and the Great Recession of 2008.

Some past efforts to balance budgets in the aftermath of economic downturns have included:

repudiation of debt

devaluing the currency

voiding or claiming it’s not “my debt”

invalidating debt that was deemed not beneficial

declaring Chapter 9 bankruptcy

The recent bankruptcies of Detroit, Michigan; Jefferson County, Alabama; Stockton, California; San Bernardino, California; and Vallejo, California have called into question the long-term sustainability of our cities and governments, raising questions about the ability of US cities to maintain infrastructure and essential services at an acceptable level while at the same time pay ever-increasing costs of public workers and their unfunded pensions, and Other Post-Employment Benefits (OPEB) liabilities that should have been addressed earlier.

 Lessons Learned From the Detroit Bankruptcy

Municipal Defaults

Mr. Spiotto reported that, historically, states and local governments have met their obligations, and municipal bond defaults remain extremely low. The ultimate recovery rate remains higher for state and local government entities than corporate defaults with at least 60% recovery for the 1970-2013 period for municipal-rated bonds versus 48% recovery for corporate senior unsecured-rated bonds.

Capital markets work effectively when credibility and predictability of outcome are clear and unquestioned.

In the past, causes of municipal bond defaults have been linked to inability to pay rather than an unwillingness to pay or political risks associated with paying or not paying. However, unfunded pension obligations and deferred infrastructure costs are a more recent phenomenon. Today, new causes of default are less linked to inability to pay and are more a question of willingness to pay, Mr. Spiotto said.  They include:

1. Deferred costs of capital improvements and infrastructure costs.

2. Decline of urban areas – Loss of population and business development.

3. California’s Proposition 13 mentality – The popularity of tax caps and limitations and the problem with them in economic downturns.

4. Off balance-sheet liabilities – Unforeseen judgments and derivatives problems.

5. Unaffordable and unsustainable personnel costs due to lack of growth in population and business development.

We are closer to a tipping point and departure from the historical assurances that governments will meet their obligations than we have ever been. Will states adhere to the principle of honoring the payment of public debts going forward?

Economic Discipline, World-Class Infrastructure, Growth-oriented Policies

The application of economic discipline, maintenance of a world-class infrastructure, and government policies to stimulate and encourage economic development have led to effective strategies to prevent municipal defaults and bankruptcies and will help states weather the storms of economic downturns, Mr. Spiotto said. These strategies encompass:

•  diversification of tax sources

•  use of legislation for limits on debts and taxes

•  permitting and encouraging refunding of expensive debt

•  providing oversight and assistance at times of financial distress

•  developing new and improved mechanisms to detect and address financial challenges.

 State Authorization of Municipal Bankruptcies

In concluding his remarks, Mr. Spiotto said that business development and economic stimulus, creating new jobs and taxpayers and increased revenue will help balance the budget. While efficiency and reductions or elimination of wasteful expenditures are helpful, it is business development and economic stimulus that will create new jobs and boost tax revenues. Mr. Spiotto pointed out that for every dollar invested in infrastructure, there is a $3 return in economic benefit over 20 years.

Now is the time to invest in state and local government improvements that will help balance future budgets, he said. The window of opportunity is now opening for the significant reshoring of good, new jobs due to lower energy costs, better worker productivity, improved and competitive costs of business, and the current desire of foreign investors to invest in US businesses, because they lack any other safe currency and economy in which to invest.

Discussion

Sen. John Cullerton (IL): What do you recommend to fix Puerto Rico’s economic crisis?

Mr. Spiotto: Puerto Rico should seek oversight from the federal government so that there is an authority that can devise a Recovery Plan. They could make rules to help stimulate the economy, allow negotiations or mediation with creditors, and modify and restructure debt. Adding economic development to a troubled situation always improves the outcome.

Sen. Troy Fraser (TX): Detroit was a willing lender and debtor in the US. The rules are not clear for Puerto Rico, and rules can change. Creditors worry that contractual obligations will change. However, a pledge of revenues is a property right that cannot be renegotiated.

Sen. Eduardo Bhatia (PR): We recognize that there are good-faith and bad-faith players in this situation. We need a negotiator to manage the process. The US Senate approved a Fiscal Control Board for Puerto Rico, but its acope of authority is unacceptable. It takes away the power of Puerto Rican legislatorss to make a budget.

Mr. Spiotto: The best option for Puerto Rico and its creditors is to agree on a plan based on real numbers, on what can actually be paid.  The proposal to adjust debt payment must come from the debtors, based on the reality of what they can do. An authority can provide credibility and guide the negotiations, but it should not impose a plan from on high.

Speaker Biography

James E. Spiotto, JD

James E. Spiotto, JD,  is a Managing Director of Chapman Strategic Advisors LLC, the consulting subsidiary of Chapman and Cutler LLP.  In this role, he is engaged in strategic and advocacy initiatives on topics of high interest to municipal market participants and the presentation of educational forums on issues impacting the financial services industry.  He is also the co-owner and co-publisher of MuniNetGuide.com, an online resource specializing in municipal-related research and information concerning state and local government, including public finance, infrastructure, job market data and economic statistics and analysis.  He is also a member of the Board of Directors of Retirement Security Initiative, a national, bipartisan, non-for-profit advocacy organization focused on protecting and ensuring the fairness and solvency of public sector retirement plans.

Other Winter 2016 Forum Highlights articles:

James E. Spiotto

Managing Director

Chapman Strategic Advisors, LLC

Economic downturns have been the periodic cause of budget challenges. Since 1776, local governments have faced 6 panics, 38 recessions and 4 depressions, the last depression and recession being the Great Depression of the 1930s and the Great Recession of 2008.

Capital markets work effectively when credibility and predictability of outcome are clear and unquestioned.

We are closer to a tipping point and departure from the historical assurances that governments will meet their obligations than we have ever been. Will states adhere to the principle of honoring the payment of public debts going forward?

For every dollar invested in infrastructure, there is a $3 return in economic benefit over 20 years.

Sen. John Cullerton

Sen. Troy Fraser

Sen. Eduardo Bhatia

James E. Spiotto

Senate Presidents’ Forum

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