The financial failure of Stockton, California, is a sad tale of inflated expectations and poor decision making, but it’s not a harbinger of things to come in the US municipal bond market. Stockton is a unique case, as my colleague Guy Davidson explains below.
An Extreme Boom and Bust
Stockton’s City Council approved a financial plan on Tuesday, June 26, designed to steer the city through bankruptcy; the city is expected to formally file for Chapter 9 protection as early as today. With a population of 297,000, Stockton will be the largest US city to seek Chapter 9 protection. The city recently completed a series of mediation meetings with its major creditors—primarily employees and debt guarantors—but failed to obtain enough concessions to balance its budget.
Historically an agricultural port community in the Central Valley, Stockton experienced a tremendous housing boom as people working in the San Francisco Bay area sought less expensive housing inland. The median home price in Stockton soared to $407,000 by 2005. Since then, it has fallen to $118,000, as many homeowners tired of both the two-hour commute to San Francisco and Stockton’s high crime rates. Stockton’s housing price drop was the third-largest in the US. Its foreclosure rate is the highest. And few cities have as many loans “underwater.”
During the boom years, Stockton officials assumed strong growth would continue and increased spending and borrowing sharply. General-fund and related debt grew sixfold over six years, including commitments for housing projects, an arena and parking garages. The city also granted particularly generous pension and retiree health-care benefits to employees and in 2007 sold pension-obligation bonds.
With the crash in housing prices, city revenues plunged in 2009, and the city did not cut expenses quickly enough to balance its budget. In addition, its ability to raise revenues was severely constrained by California law’s Proposition 13 and other voter-approved changes to the California constitution.
Stockton announced in February that it would cease debt-service payments on three series of lease revenue bonds. The budget plan approved this week also suspended payments for the city’s 2007 taxable pension-obligation bonds. Stockton has not suspended payments on 10 other securities, which include redevelopment-agency bonds, water-revenue bonds and sewer-revenue bonds, and are supported by dedicated revenue streams, not the general fund.
There are 90,000 units of government in the US; last year there were only nine municipal bankruptcies. So far this year we are aware of only three, including Stockton’s. We do not expect Stockton’s bankruptcy to be the first in a wave of defaults in California or across the country. Stockton’s economic crash was extreme and the city’s decisions were financially aggressive.
There is no question that many local governments remain challenged. But while many California cities have seen housing prices plunge, Stockton’s case is not typical. San Jose, San Francisco, Los Angeles and San Diego are under fiscal pressure, but they are all in much better financial shape than Stockton, as shown by more stable fund balances, healthier revenues and more diverse local economies.
Across the US, local and state government finances have improved modestly on average over the last two years. Preliminary data from the Rockefeller Institute’s compilation of states’ tax collections show that major tax sources increased in the first quarter of 2012, the ninth consecutive quarter of tax-revenue growth since the recession.
Local governments face more difficulties because their budgets rely largely on property-tax revenues, but only a tiny percentage of them have experienced revenue declines equivalent to Stockton’s. More importantly, housing prices appear to be stabilizing—the S&P/Case-Shiller Home Price Indices showed that average home prices increased 1.3% in April. And many local governments have come a long way since 2008 by reining in costs and cutting employment costs, usually the largest operating-budget expense. Since the peak in August 2008, local governments have cut a total of 528,000 jobs, or 3.6% of their workforce, according to the Bureau of Labor Statistics.
The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AllianceBernstein portfolio- management teams.
Douglas J. Peebles is Head of Fixed Income and Guy Davidson is Director of Municipal Bonds, both at AllianceBernstein.