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Cities, States Face Tough Choices on Debt Amid Cash-Flow Concerns

February 8, 2011 at 6:57 PM EST
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Wall Street investors and some in Congress recently have raised concerns about the risk of cash-strapped municipalities defaulting on bonds they issued. Judy Woodruff talks to the National League of Cities' Chris Hoene and Richard Larkin of Herbert J. Sims and Company, an investment banking firm, about the risks of default.
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JUDY WOODRUFF: Finally tonight: troubles ahead for some of the nation’s cities.

Wall Street investors and some in Congress are starting to ask if some cash-strapped municipalities might default on the bonds they issue. The fears are stoked in part by comments made by a financial analyst.

Meredith Whitney told CBS’ “60 Minutes” in December: “There’s not a doubt in my mind that you will see a spate of municipal bond defaults. You could see 50 to 100 sizable defaults. This will amount to hundreds of billions of dollars.”

Last month, municipal bond sales fell to their lowest level in more than a decade. And all of this is the subject of a congressional hearing tomorrow.

Well, we try to make some sense of the risks and what governments might do to avoid defaulting on their obligations with Christopher Hoene of the National League of Cities, and Richard Larkin. He’s a senior vice president of credit analysis at Herbert J. Sims and Company, an investment banking firm.

Thank you both for being with us.

Chris Hoene, to you first.

We’re talking about a $3 trillion market. So, remind us, what are municipal bonds, and why have they been so popular?

CHRISTOPHER HOENE, National League of Cities: Municipal bonds are the primary instrument by which cities, states, counties, school districts, special districts of all kinds fund their infrastructure. They issue these…

JUDY WOODRUFF: More than cities?

CHRISTOPHER HOENE: More than cities. Yes, it’s 90,000 units of government across the United States. And this is the way that they fund long-term infrastructure projects. They issue bonds.

And those bonds are paid out over 20-year periods or 30-year periods, typically backed by either the general tax authority of the jurisdiction or by an individual revenue source itself that’s produced by the infrastructure project.

JUDY WOODRUFF: Three trillion dollars. Why so popular?

CHRISTOPHER HOENE: Well, they’re — they’re — it’s because of the security. They’re backed by either the full faith and credit of a general purpose jurisdiction, like a state or a city or a county, so their taxing authority, or they’re backed by an individual revenue source that, say, is produced by the infrastructure itself, say a hospital or a stadium or the like.

JUDY WOODRUFF: And there’s a tax benefit here?

CHRISTOPHER HOENE: Absolutely, yes.

JUDY WOODRUFF: They — you…

CHRISTOPHER HOENE: They’re tax-exempt. And so, in the sense of other investments, they’re made cheaper because of the tax status.

JUDY WOODRUFF: Richard Larkin, they have traditionally, I was reading, had very low rates of default. So, what’s the concern now?

RICHARD LARKIN, municipal bond analyst, Herbert J. Sims & Co.: Well, Meredith Whitney, in her “60 Minutes” interview, had predicted hundreds of billions of dollars of — of municipal bond defaults.

And I can’t tell you that that couldn’t be further from the truth, at least as I see it. I have covered states and cities and their payments of debt since 1975. And for hundreds of billions of dollars of defaults to occur, this would have to be worse than the Great Depression.

JUDY WOODRUFF: And I would point out that we did ask Ms. Whitney to appear on this show. She was unable to be with us.

Is that the generally held view, Richard Larkin, though, that — I guess I’m asking, is her view a minority view in the field?

RICHARD LARKIN: Yes and no.

I would say, within the field, other municipal analysts that I talk with regularly tend to agree with what I have to say. And I’m not saying there won’t be defaults. This is clearly the worst recession since the Great Depression. There will be defaults and there will be bankruptcies.

But no municipal analysts I know worth his salt even thinks it will come close to — to $20 billion of defaults.

JUDY WOODRUFF: Chris Hoene, let’s talk about cities and states. I mean, how many of them are potentially in this — in this kind of trouble, where they could default or have to take strong measures to avoid default?

CHRISTOPHER HOENE: Well, the defaults and the bankruptcy story isn’t really the situation that they’re facing.

The truth is they are facing significant financial stress because of what’s happened with the recession and the fact that their revenues are down. But the actions that they’re taking mostly are in terms of cuts in city services, cuts in state services, cuts in personnel. There have been 435,000 jobs lost in the state and local sector since 19 — I mean, since 2008.

And so it’s about the choices they’re making on the other front. They’re balancing their budgets. They’re paying their debts. The issue isn’t default and bankruptcy. It’s about these other choices that they’re having to make.

JUDY WOODRUFF: But — but we just heard Mr. Larkin say that there will be some defaults.

CHRISTOPHER HOENE: Well, there will probably be a few more defaults than normal. And, in fact, we actually saw a decrease in the total number of defaults in 2010 from the years prior to that.

You may see a few more defaults because of the stress, but that won’t be a significant part of the market. The historical default rate in this sector is less than one-third of 1 percent. So, even if it went up a little bit, we’re talking about a statistical rarity here.

JUDY WOODRUFF: Richard Larkin, what exactly is at stake here? And how spooked — is there a sense of how spooked investors are at all this?

RICHARD LARKIN: Let me first say I agree with Chris completely.

When I talk about $20 billion of defaults, that to me is the upper level. And it’s going to be mostly smaller units of government that were probably in distress before this even began or corporate bonds that have tax-exemption. I just couldn’t agree with him more on this.

JUDY WOODRUFF: And — and — but — and picking up on this point about, you know, to what extent, though, are investors concerned? To what extent do they look at what these cities and states are doing, and — and relaxing or being confident that their investment…

RICHARD LARKIN: Individual — individual investors, I think, are very worried because they can’t get away from the bad news headlines that seems to be a steady drumbeat day after day, with this constant phrase of hundreds of billions of dollars of defaults.

I have spoken to a lot of our individual investors to try to put their mind at ease. And again as I said before, there will be defaults. I think Chris even agrees with that.

But the amount of defaults will be a little higher than normal for a recession, but certainly not the gloom and doom that is being spread by some analysts.

JUDY WOODRUFF: Chris Hoene, speaking for the National League of Cities, which is what you’re representing here, tell us a little bit more about what these cities and states are doing. You said they’re cutting.

CHRISTOPHER HOENE: Right.

JUDY WOODRUFF: What are they cutting, and how deep are they cutting?

CHRISTOPHER HOENE: Well, in 2010, 79 percent of the cities around the country cut personnel. They laid people off. They went through furloughs. They made other cuts in pay.

Sixty-nine percent of them actually cut or delayed their infrastructure projects. So, essentially, what they have done is, recognizing significant difficulties on the revenue side, they’re making very significant cuts on the services side or on the expenditure side.

JUDY WOODRUFF: So, there’s a lot of pain. And it’s being felt in these cities and — and local governments, state and local governments around the country.

CHRISTOPHER HOENE: Yes, absolutely. And I think that’s the real story here. It’s not the distractions about a part of the market that is actually still solid. It’s about a set of stories that are about the effects on quality of life when cities have to cut public safety services, or they have to close libraries, or they have to cut jobs in the middle of a pretty significant economic downturn.

JUDY WOODRUFF: From — from Wall Street’s perspective, Richard Larkin, when you’re looking at a congressional hearing like the one tomorrow, looking at that, what do you — I mean, what — what is the worry, what’s the expectation of what could come out of that?

RICHARD LARKIN: I’m not sure what this committee is trying to drive at, trying to look at the witnesses that are on the list to appear.

Several of them have very strong concerns about the ability of cities to be able to finance their operations and — and keep their debt payments current. I know there’s at least one person on there that tends to agree with my views that cities and states will do what is necessary to balance their books, make their debt payments on time.

It won’t be pretty. There will be spending cuts. There may be tax hikes. There may be some temporary measures to get over this recession. But bottom line is cities and states will pay their debt. And I’m hoping that will come out of the hearings tomorrow.

JUDY WOODRUFF: And, Chris Hoene, your expectation about tomorrow’s hearing?

CHRISTOPHER HOENE: Well, I think the hearing mostly won’t result in much.

It’ll – it’ll actually have a lot of people probably saying exactly the type of things you have heard said here tonight, which is cities are going to pay their debts. States are going to pay their debts. There’s some difficult choices ahead about how they balance their budgets, but that’s not going to be about compromising this major source of infrastructure funding that they have available to them, a source of funding that is mostly sacrosanct and that they will protect above most other services.

JUDY WOODRUFF: All right, gentlemen, we’re going to leave it there.

Chris Hoene, Richard Larkin, thank you both.

CHRISTOPHER HOENE: Thank you.