Get Ready for the Largest Municipal Bankruptcy in U.S. History

In his book The Sun Also Rises, Ernest Hemingway penned a classic exchange regarding bankruptcy.  "How did you go bankrupt?," asked one character.  "Two ways.  Gradually, then suddenly." was the reply.

Well, the same can certainly be said of Detroit, Michigan.  Detroit is getting ever closer to declaring bankruptcy (see here).  If Detroit does declare bankruptcy, it would be the largest municipal bankruptcy in the history of the United States.

What does this have to do with Minooka CCSD 201?  Well, most of us know that the State of Illinois has financial trouble of its own, including the worst underfunded pensions in the nation and pension contributions that are increasingly eating into current services.  Well, if you follow the link above and read the article, you will notice that the Detroit emergency financial manager, Mr. Orr, is contemplating a plan where, among other things, retirees will receive less than 10% of their promised benefits under the current pension plan.  I am quite sure that this is going to cause a great deal of financial hardship for those retirees.  One lesson that we can learn from Detroit's example is that when a municipality (or perhaps a state, in the case of Illinois) gets into serious financial trouble (and by all accounts Illinois is already there), the "promises" that were made pursuant to a pension plan become negotiable.

Now a state is different in at least one important respect: under current law, states cannot file for bankruptcy protection.  They can, however, renegotiate "promises," and you can be sure that they will.  States after all go bankrupt (or become insolvent) just like any other entity . . . "[g]radually, then suddenly."

Our Children's Future

A recent article in the New York Times about the plight of Detroit (click here) got me to thinking.  I sure hope that our children take better care of their children's future than we have taken of our children's future.  You might ask, "what does the plight of Detroit have to do with my children's future?"  Well, the quote from John Boyle at the end of the article sums it up nicely:  “Detroit is a microcosm of what’s going on in America, except America can still print money and borrow."  Detroit is indeed a microcosm of what is going on in America.  From coast to coast and from local government on up, we have made promises that were unsustainable.  We should have known that they were unsustainable when they were made.  After all, a little basic mathematics, including an understanding of exponential functions, is all that is necessary to know that continuous growth in public sector wages, pensions and taxes cannot be sustained.  That was then, and this is now.  Now it is time to pay the piper.

We have created a society which our children cannot afford.  And, what is worse, we continue to make the same mistakes at every level of government.  

Is This The Future Of Illinois?

This blog is about Minooka CCSD 201, but sometimes I post about happenings in other places in order to illustrate a point.  (Also, because the school district is affected by happenings on the state and federal level).  This is one of those times.  It seems that Harrisburg, Pennsylvania is sinking, not only financially but literally (see here).  You see, they spent money unwisely and took on too much debt.  As a result, the city is on the verge of bankruptcy and is having difficulty getting a loan.  Over the years, they neglected the maintenance of basic infrastructure like sewer and water pipes.  Now, sink holes are opening up all around the city due to the sandy soil and the leaking pipes.  The city not only neglected this maintenance but now is having trouble even making its payroll.  The State of Illinois, meanwhile, had its credit rating recently down graded (again) by one of the major rating agencies (see here), leaving Illinois with the worst credit rating of any state in the nation.  As a result, Illinois recently shelved plans to issue $500 million in bonds for school and transportation projects (see here).  Now, Illinois may eventually issue these bonds, but the state (and, therefore, ultimately the taxpayers) will end up paying more in interest on the bonds due to the state's poor credit rating.  This is a classic debt-spiral, which I have written about previously (see here and here).  Harrisburg is merely farther along down the spiral than Illinois.

So, what causes a debt-spiral and how does a state, city, school district (or nation, for that matter) avoid one (or, if it is already in one, how does it get out)?  If you boil it down to its root cause, a debt-spiral is caused when an entity (state, city, school district, etc.) refuses to live within its means.  Public sector entities are supported by taxes on the private sector (even money printing by a central bank like the Federal Reserve is ultimately a tax).  However, there is only a certain level of taxation that the taxpayers (the private sector) are willing or able to support.  It is sometimes difficult to determine what that level of taxation is for any given public sector entity since it depends on a multitude of factors.  As is all too typical, once a public sector entity starts to bump up against that level of taxation and has trouble raising current revenue it enters the debt markets and floats bonds in increasing amounts to obtain current funds in exchange for future taxation.  (Long term debt financing for necessary and prudent capital projects is one thing, but debt financing for current consumption is a clue that you have entered debt-spiral territory.)  The interest payments on these bonds, of course, just make the current problems worse and the public entity finds itself going to the debt markets with increasing frequency just to pay for current services.  (This is very much like a family that lives beyond its means and starts to use mortgage debt or a home equity loan to pay for day to day expenses.)

So, how does a public sector entity avoid a debt-spiral?  The same way that an individual or a family avoids a debt-spiral: it lives within its means.  For a public sector entity, that means that it must keep its expenses below (to be safe, well below) that level of taxation that the relevant taxpayers are willing or able to support.  This is the crux of the matter since most people spending public money do not spend such money as if they were spending their own money.  They tend to spend it much more freely.  Once a public sector entity finds itself in a debt-spiral, how does it get out?  There are really only two ways out: some form of debt restructuring (such as bankruptcy) or a bailout from a public sector entity higher up the food chain (also known as "kicking the problem upstairs").  In order to avoid going back into the debt-spiral again, the public sector entity must live within its means.

Calvin Coolidge (one of the most underrated Presidents of the United States) once stated the following:  "I favor the policy of economy, not because I wish to save money, but because I wish to save people.  The men and women of this country who toil are the ones who bear the cost of the Government.  Every dollar that we carelessly waste means that their life will be so much the more meager.  Every dollar that we prudently save means that their life will be so much the more abundant."