Detroit meltdown unlikely to prompt bankruptcy wave

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(MoneyWatch) "Don't cry for us, America," tweeted noted film director and Michigan native Michael Moore about Detroit's plunge this week into bankruptcy. "You're next."

Although that sentiment is understandable given the shock of seeing a major American city go bust, the notion that the largest municipal bankruptcy in U.S. history could lead to a string of bankruptcies by other cities and towns is probably wrong.

For one, Detroit's descent into fiscal chaos has been a process that has played out for several decades. The collapse was triggered by a range of factors: a declining tax base resulting from the "white flight" and ensuing suburban sprawl that started thinning Detroit's population beginning in the 1950s; a sharp decline in manufacturing and shrinking auto sector; social unrest in the 1960s and '70s; heavy retiree health and pension costs; and mismanagement by city officials, just to name a few.

By contrast, the 23 municipalities that have declared bankruptcy since 2010 went under chiefly for one reason: The 2008 housing crash. Stockton, Calif., which until Detroit's collapse was the most populous U.S. city to file for Chapter 9 protection, went bankrupt earlier this year after borrowing heavily in the mid-2000s to fund the construction of a new city hall, marina and other infrastructure. But soaring unemployment and falling real estate prices after the financial crash wreaked havoc on the city's finances.

The 2011 meltdown in Jefferson County, Ala., the second-largest municipal bankruptcy after Detroit in terms of debt, also stems mostly from the recent crash. In that case, local officials spent heavily on a sewer system, funding the project with risky bond swaps peddled by Wall Street banks that left the county awash in debt.

Meanwhile, with the U.S. economy slowly coming back to life, most state and local governments today are in better shape than they were during the worst of the housing crisis.

"Thanks to the boost to tax receipts generated by the economic recovery, most cities are now on a much firmer footing," wrote Paul Dales, senior U.S. economist with Capital Economics, in a research note.

Tax collections in 47 (early-reporting) states rose 9.3 percent in the first three months of 2013, compared with the year-ago period, according to the Rockefeller Institute, a public policy research group in New York. Revenue from personal income, corporate and sales taxes are up.

Most cities and towns aren't exactly flush with cash, in other words, but unlike Detroit they are also not sinking in quicksand. 

"Are all municipalities in trouble with their general-obligation bonds? Absolutely not," said Natalie Cohen, head of municipal research at Wells Fargo Securities. "Detroit has been in trouble for many years. They were below investment-grade in the 1980s and again in '92. That's not news. This is clearly huge, but not a mystery to people in the markets."

Another reason why the vast majority of municipalities are unlikely to follow Detroit's lead: Legally, they can't. Most states bar localities from seeking federal bankruptcy protection, said Michael Pagano, dean of the College of Urban Planning and Public Affairs at the University of Illinois at Chicago.

"If states don't want cities to pursue a Chapter 9 filing, they can prevent them from doing so," he said, noting that only 12 states allow municipalities to declare bankruptcy.

Perhaps the biggest reason to think that towns and cities aren't queuing up to go belly up -- bankruptcy is financially disastrous, leaving local economies scarred for years.

Municipal bond investors stop investing, borrowing rates climb, small businesses close shop, and entrepreneurs ship off to healthier parts of the country. Investors and business may wait on the sidelines for years, as bankruptcies wend their way through court. 

Such uncertainty amounts to a "stalemate" for a city's public and private sector, Pagano said. Meanwhile, there is a high political price to be paid for the kind of economic turmoil that follows a city's bankruptcy. For local leaders, bankruptcy is usually a last resort.

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