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The year 2007 marked the height of the housing bubble. Residential real estate prices were through the roof, especially in Arizona, Nevada, and California where speculators had swamped the market. This overvalued sector resulted in exceptionally high revenues for the Sun Belt cities that based most of their budgets on steadily growing property taxes.
Several cities, understanding the ups and downs of business cycles, maintained their level of spending or increased it by a modest amount. But other municipalities acted as if the good times would never end. Glendale, Ariz. borrowed to build a gargantuan pro football stadium and hockey arena nearly 20 miles from the city center. Stockton, Calif. borrowed $300 million to build their own arena, shopping centers, theaters, and a palatial waterfront complex.
A management consulting firm warned San Bernardino not to make similar mistakes, noting that the market would eventually slow. The southern Californian city opted against fancy sports arenas, but chose instead to vastly increase promised pensions to city workers.
In 2010, the spending hangover began. The San Bernardino’s City Manager warned that revenue had plummeted while employee expenses had soared. That fiscal year alone was facing a $40 million deficit. The City Council didn’t much care and continued pressing for increases in pay and pensions for police and fire. Anyone who argued against the expenditures were vilified as opposing first responders.
It was no surprise that San Bernardino declared bankruptcy two years later. But even that wasn’t enough to shake some fiscal sense into the city of 205,000. Reuters reported Tuesday that city leaders have defaulted on nearly $10 million in required payments for bond debt, refusing even to negotiate with bondholders.
The missed payments illustrate the trend among cities in bankruptcy to favor payments to pension funds over bondholder obligations, which has increased the hostility between creditors and municipalities.
San Bernardino declared last year that it intends under its bankruptcy exit plan to fully pay Calpers, its biggest creditor and America’s largest public pension fund with assets of $300 billion.
The city continues to pay its monthly dues to Calpers in full, but has paid nothing to its bondholders for nearly three years, according to the interest payment schedule on roughly $50 million of pension obligation bonds issued by San Bernardino in 2005.
The non-payment of the bond debt and the city’s lack of interest in talks with its pension bondholders just weeks before it must produce a bankruptcy exit plan should serve as a wake-up call to Wall Street issuers of debt to struggling cities, according to Michael Sweet, a bankruptcy attorney with Fox Rothschild in San Francisco.
Today in San Bernardino, public safety spending swallows up 73% of the general fund. But in similar bankruptcies such as Detroit and Stockton, municipal lenders had to accept huge cuts while pensioners faced little if any loss. Needless to say, the municipal bond market is nervously watching this play out and wondering how much its practices must be changed.
These failed cities show that limited government isn’t just a matter of politics or ideology — it is a matter of morality. Politicians promise the world to favored constituencies only to cut services to residents. Wealthier people can always move out of town, but the poor are stuck with rising crime and dilapidated neighborhoods. The middle-class and small business owners are too upside-down in their real estate to flee the increased danger and decaying infrastructure.
Whether a city, state or nation is in a boom time or a bust, the only government that citizens can afford is a small one.