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Here Are 5 Signs That A Muni Is About To Go Bankrupt

By on August 13, 2012

Morgan Stanley is out with a note on municipal credit, focusing on the prospect for more bankruptcies like those that grabbed headlines in Stockton and San Bernadino. 

They expect moderately more bankruptcies, and that any that occur will continue to be idiosyncratic. However, they break down the common red flags for recent cases:

Common bankruptcy drivers:

  • Unusually high unemployment

Areas that have defaulted tended to have higher than average unemployment prior to the recession, and rose more sharply during the downturn. Unemployment levels above 16 percent are consistent with the level of stress that may cause a default.

  • Shocks to the tax base

Property taxes are a huge source of revenue for local governments. A sharp decline in housing prices can seriously harm the tax base. In Stockton, for example, house prices declined by 71 percent. 

  • A high/rapidly growing liability burden

Recent examples of default saw their debt burdens increase at a much higher rate than the broader market.

  • A weak or diminishing reserve cushion

Diminished reserves leave municipalities less able to respond to negative shocks. A big warning sign is a high fixed cost burden combined with a diminished cushion.

  • High or rising pension and benefit costs relative to budget
These sorts of long term contracts are much more difficult to restructure than other liabilities, and can quickly deplete reserves.
 
These factors are elevated compared to the past, but there are still relatively few cases that are extreme enough to merit worry.
 
By way of example, here’s a chart of unemployment rates for local governments:
 
Unemployment

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