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July 9, 2012

Two California cities have swept municipal bond news headlines recently: Stockton and Mammoth Lakes.  Both cities made the choice to file for Chapter 9 Bankruptcy, which has made some conservative investors a bit worried, and has created a bit of excitement for some speculative investors.  Many are left wondering if these two are anomalies, or if they are a sign of things to come.   While the bankruptcy filings are unfortunate, and arguably unnecessary, they are generally a result of poor decision making by local governments.

Stockton helped create a perfect storm.  In lieu of giving their employees even higher salaries, the City piled up an estimated $800 million in unfunded pension and healthcare liabilities to current and former employees over the last couple of decades.  A notable portion of the unfunded liabilities included granting unlimited lifetime healthcare to employees and their spouses, provided the given employee served the City in excess of one month – an unheard of and rather expensive benefit, even among local governments.  In addition, the City issued approximately $300 million in general fund secured debt in an attempt to fulfill the vision of a select group of politicians and residents’ ideal riverfront community.  Mix in some faulty accounting practices with the collapse of the residential real estate market in the region, and suddenly tax dollars were insufficient to cover every obligation of the City.  The City held talks with all 18 of its creditors, pursuant to AB 506, in an attempt to avoid filing for Chapter 9 Bankruptcy.  However, as could be explained through game theory, no parties cared to give much of a concession, and thus will likely lose out as attorneys rack up legal fees.

Mammoth Lakes is a completely different story.  The resort town, made famous by the Mammoth Mountain Ski Resort, has experienced a substantial amount of successful development over the last couple of decades.  However, one developer became a bit problematic.  Mammoth Lakes Land Acquisition (MLLA) had the dream of creating a large scale development near the Mammoth Yosemite Airport.  Due to multiple issues, including the Federal Aviation Administration stating they would not have allowed the development to continue as proposed, MLLA opted to sue the City over the stalled development, and was awarded a $43 million judgment, including interest and legal fees.  Prior to filing for Chapter 9, the Town entered into the negotiation process with creditors under AB 506, however, the 800 pound gorilla in the room, MLLA, refrained from participating in the talks.  Attorneys for MLLA feel the City should assume more debt or raise taxes to settle the judgment, neither of which are popular ideas among its residents.

Both the Stockton and the Mammoth Lakes filings were largely the result of exceptional situations.  Even within these cities, enterprise and land secured debt, both of which are secured by restricted lines of revenue, are minimally impacted by the filings.  Labor costs tend to be the greatest expense of local governments.  While many local government employees’ salaries may not be increasing, health care and pension costs are increasing at faster rates than any form of tax revenue supporting such expenses.  In recent local elections, the Cities of San Jose and San Diego recognized this threat, and voters approved measures to rein in the unsustainable benefits.  Debt service tends to be a modest obligation of local governments.  Government employees are enamored with their benefits, but sometimes they need to be reined in when fiscal challenges arise in order to be sustainable for the long term.

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