Defaults by Cities Looming as U.S. Mayors Say Deficits Hinder Debt Payment

The mayors of Los Angeles and Chicago said the financial strains still weighing on local governments in the wake of the recession may cause cities to default on their bonds.

Los Angeles Mayor Antonio Villaraigosa, a Democrat, said municipalities are being squeezed as states move to balance their own budgets, a step that can involve taking more funds that would otherwise be sent to towns and cities.

“There’s no question you’ll see some cities in default,” Villaraigosa told reporters today at a press conference in Washington, where the U.S. Conference of Mayors is meeting. “The difference between us and the federal government is they can print money. The states balance their budget oftentimes on the backs of cities, counties and school districts. We actually have to balance a budget.”

Speculation about local governments defaulting has weighed on the $2.9 trillion municipal market, where returns tumbled during the last quarter of 2010 by the most since 1994. Last week, yields, which move inversely to prices, hit the highest since the depths of the financial crisis in December 2008, according to the Bond Buyer 20 Index, a gauge of 20-year bonds backed by general tax revenue.

Investors, concerned about rising interest rates and speculation that defaults will escalate, have pulled money from mutual funds that buy municipal bonds for nine straight weeks, according to data from Lipper FMI, a Denver-based research firm.

Whitney Forecast

Meredith Whitney, the banking analyst, has predicted as many as 100 “significant” municipal defaults reaching “hundreds of billions” of dollars this year. That forecast has been met with skepticism by bond analysts and investors including Lyle Fitterer of Wells Capital Management in Menomonee, Wisconsin, the top manager of U.S. municipal-bond funds in the past decade.

Villaraigosa said in an interview that he didn’t think the number of defaults are going to be as large as some have speculated, saying they may be confined largely to small cities. He said it was a “nonstarter” for his city.

“I don’t expect that you are going to see a lot of big cities, frankly,” he said. “Mayors are willing, and have demonstrated in the past, that they will make the tough decisions necessary to get us back on a sound financial footing.”

Defaults Not Common

Defaults by cities and counties are rare. In a study last year, Moody’s Investors Service said that of the 54 municipal issues it rated from 1970 to 2009 that defaulted, only three were backed solely by a municipality’s pledge to repay.

Harrisburg, the capital of Pennsylvania, last year was declared “financially distressed” under the state’s program for cash-strapped cities after missing bond payments it guaranteed on a troubled incinerator project. Jefferson County, Alabama, the state’s most populous, was pushed close to bankruptcy because of sewer-financing deals that turned costly during the financial crisis.

Since the recession began, most municipal-bond defaults have been on securities backed by specific revenue, such as assessments on new housing developments. Last year, defaults in the municipal-bond market dropped to $2.7 billion from $7.3 billion in 2009, according to the Distressed Debt Securities Newsletter.

New York Cuts

In the most-populous U.S. city, New York Mayor Michael Bloomberg pledged today to avoid raising taxes as he vowed to cut the cost of government to close a deficit that may be about 7 percent of a projected $67.5 billion budget.

“A new defining challenge confronts us: forcing government to live within its means, by forcing government into the 21st century,” Bloomberg said in remarks prepared for his State of the City address. “The economic future of New York City is hanging in the balance.”

The mayor is founder and majority owner of Bloomberg News parent Bloomberg LP.

Chicago Mayor Richard Daley, a Democrat, said some cities are struggling to meet expenses, including costs for their employees’ pensions.

“These are serious financial problems for many cities, especially the smaller cities that can’t deal with the day-to- day cost of government,” Daley said today at the press conference in Washington. Asked whether he expected to see a lot of cities default, he said: “I wouldn’t doubt it.”

Villaraigosa emphasized that Los Angeles, the second largest city in the U.S., isn’t veering toward a default.

“We’re going to do everything we have to do to balance our budgets,” he said, referring to himself and other mayors.

“There is no scenario where we would ever be in the ‘B’ situation,” he said, referring to municipal bankruptcy. “We don’t even use that word.”

To contact the reporter on this story: William Selway in San Francisco at wselway@bloomberg.net

To contact the editor responsible for this story: Mark Schoifet at mschoifet@bloomberg.net

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