Harrisburg Bond Shortfall Is A Warning On Taxes, Spending and Bonds

Last Updated Sep 13, 2010 12:03 PM EDT

The capital city of Pennsylvania, Harrisburg, came close to missing a $3 million interest payment on some municipal bonds last week, saved by an advance on future funds from the state government. It's an unusual event, because these are general obligation bonds have been viewed in the past as pretty safe.

There are a lot of messages in this news. (This one catches my eye because I grew up in Pennsylvania, but in the white-bread suburbs closer to Philadelphia.) One, it illustrates the fragile financial condition of our governments -- that the crisis that started two years ago is still throwing off aftershocks. From the Financial Times, back in July:

"The risk in the second half of the year is that investor attention switches from Europe to the US," said Robert Parker, senior adviser at Credit Suisse Securities, who singled out parts of California, as well as towns and cities in Illinois, Michigan and New York state as among the most vulnerable.

"You will see investor concern about the viability of those cities and therefore you will see, inevitably, further spread widening in the municipal bond market."

We've heard about the troubles at the local government level, but the press has emphasized the crazy parts -- managers of small towns being paid high six-figure salaries, or abuses of pension benefits by state workers. The news from Harrisburg is altogether different, about governments having to scramble to provide basic services.

On the flip side of every spending cut is a service cut. From PennLive.com, the online arm of the Harrisburg Patriot-News, Central Pennsylvania's Leading News Source:

There is no law requiring districts to provide bus service, according to the state Department of Education. However, if a district chooses to provide it, it must be made available to all students in the district.


While the association doesn't keep statistics on arrangements that districts make regarding transportation, Salter has heard of districts outsourcing busing, shortening routes and requiring those living within a mile of their schools to find their own transportation.


Transportation can be a real challenge for rural districts, Salter said, because covering their vast expanses can be costly and time-consuming.


East Pennsboro [one town making cuts] is again considering changes to its busing policies, including stepping back from the practice of transporting all students, board President Dennis Helm said.

"Some of us think it's ridiculous [to bus every student], and other people take pride in it," Helm said. "We're gathering information to see if this is something we want to continue or not."

Two, it reminds us of the direct connection between Wall Street and Main Street. I'm sure the mortgage mess that has undermined home prices has a role in what's happening in Harrisburg.

Three, it reveals that our financial system has not been reformed in any meaningful way and is still very weak. The Harrisburg bonds in question are supposed to be guaranteed by Ambac, one of several insurance companies that specialize in backing up municipal bonds, but Ambac is circling the drain, too.

Do you own any municipal bonds? US investors bought a net $35 billion of munis in the first seven months of 2010, up from $23 billion in the same period a year earlier. General obligation municipals, known as GOs, traditionally have been viewed as safe investments, on the grounds that a city or state has unlimited power to raise taxes. In such a severe recession, however, Harrisburg apparently couldn't scrape together the $3 million. (There has already been a default on a $282 million bond the city participated in.)

From today's Financial Times:

On Sunday, Ed Rendell, the governor of Pennsylvania, announced a $4.3m cash transfer and said missing the bond payment was "not an option". "Harrisburg's financial future is still very cloudy, and difficult decisions still need to be made to return this city to financial stability," he said in a statement. "Allowing a missed bond payment, however, would not be a good decision."
Interesting that a paper from London is writing so much about the Keystone State's ninth-largest city, population 50,000 (although the greater Harrisburg-Carlisle-Lebanon metro area weighs in at about 600,000). If a trend of quasi-bailout and forbearance starts rolling around the country, it could drive up yields and melt bond fund net asset values. So far, though, municipal yields have not shot up, and are below levels of six months ago.

Four, these types of service cuts are not just in rural Pennsylvania. There was a similar move in New York City this year, when for a day or two there was talk of taking away students' free bus and subway passes, but those cuts were avoided somehow.

The students aren't the only ones to feel the pinch. People rely on jobs such as school bus driving to earn extra income. A cousin of mine who was a farmer used to drive a school bus. And not having school buses will pinch the parents who have to make other arrangements.

To tie this all together -- the recession is still with us, and the effects are complex and spreading. The Harrisburg GO bond incident is one of many we will see in coming years, as taxpayers, businesses and governments at all levels figure out their new levels of income, and adjust their budgets accordingly.

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