Monday, July 18, 2011

Central Falls Leads the Field

Frederick J. Sheehan is the author of Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession (McGraw-Hill, 2009) and "The Coming Collapse of the Municipal Bond Market" (, 2009)

Despite the band aids, the trend towards insolvency continues. Central Falls has reached a dead end. Applications are manifold.

Central Falls, Rhode Island, faces a plight that should be studied for its application elsewhere. It is nearly out of money. This is common news today, whether in Greece or California. The various parties are assumed to possess a means to carry on. This is assumed because it is generally so. The banks had the Fed; General Electric had the Fed and the FDIC; Greece has the ECB; California is prepared to launch a bridge loan.

Quoting the New York Times (July 11, 2011): "The impoverished city, operating under a receiver for a year, has promised $80 million worth of retirement benefits to 214 police officers and firefighters, far more than it can afford. Those workers' pension fund will probably run out of money in October...."

The retirees face a bleak future: "Central Falls, like many American cities, has not placed its police and firefighters in Social Security. Many have no other benefits to fall back on."

The inability to meet payments, as is true across the western world, was evident decades ago. The parties refused to think through the consequences of their actions: "The city, just north of Providence, is small and poor, but over the years it has promised police officers and firefighters retirement benefits like those offered in big, rich states like California and New York. These uniformed workers can retire after just 20 years of service, receive free health care in retirement, and qualify for full disability pensions when only partly disabled."

The previous paragraph reflects poorly on the grand wizards of Central Falls. The Times noted: "Central Falls...filled mostly with immigrant families, struggles on a median household income of less than $33,520 a year.... The typical single-family house... is worth about $130,000."

Although this was a news story, the Times reporters, Mary Williams Walsh and Abby Goodnough, could not restrain their fury: "It is hard to see how anyone thought such an impoverished tax base could come up with an additional $80 million for retirement benefits. If the city were contributing the recommended amount to the plan each year, it would take 57 percent of local property tax revenue."

That is hindsight. We are used to expedients: delayed pension contributions; 8% projected investment returns; economic recoveries around the corner; market recoveries around the corner; real-estate appreciation (higher tax receipts); higher tax rates; bank loans; bond issues; state bailouts; federal bailouts.

These avenues are closed. The state of Rhode Island "has an investment-grade credit rating, but it is in no position to bail out a string of teetering cities, or take over their shaky local pension funds the way the federal government does when some companies go bankrupt." The Pension Benefit Guaranty Corporation is the backstop to private pension plans. None exists for public plans. (Could there be a Christmas Eve Special - see emergency decrees on December 24, 2009, when no one was looking - that sweeps all public pension benefits into Uncle Sugar's side pocket? No doubt. Minds in Washington are much slower than in Central Falls.)

The state of Rhode Island may follow its mendicant municipality's plight: "Rhode Island must ...stabilize its own pension fund, which continues to require more and more cash each year, despite four overhauls since 2005 that were supposed to get the cost under control. The Securities and Exchange Commission is investigating. If the state turns out to have understated its commitments, it could deliver a new jolt to bond markets still nervous after two traumatic years."

Rhode Island is reluctant to seek federal aid for itself (a possible source of funds for Central Falls): "State lawmakers are trying to contain the damage, mindful that it would be a bad time for any state to seek help in Washington." As a practical matter, one in four of the cities and towns in Rhode Island are in "some degree of distress." A well-funded state would not know where to start.

A bright side to Central Falls' requiem is that it must make decisions today that most others will avoid as long as possible.

An example of the latter is Cambridge Hospital in Cambridge, Massachusetts. The Boston Globe (July 11, 2011) reported: "A state Superior Court judge has ruled that the owner of Cambridge Hospital can't move forward with its plan to cut retiree health benefits for 289 nurses, a decision being hailed as a victory by the Massachusetts Nurses Association."

The judge is delirious. He would fit right in with the empty suits at the European Central Bank. Living in a world of make-believe, he (and they) interpret laws and freeze reality as if it were 1953. (Under Massachusetts law, courts are to interpret pension benefits within "reasonable expectations" of the beneficiary.)

Cutting to the chase, the owner of the hospital is down to its last buck. "An accounting change... would increase the hospital system's costs by about $30 million over the next three years. The proposed cut [40% of the current benefit] prompted the union to reject a 'last and final' contract offer last summer."

As with Central Falls, the avenues to acquire cash are shut (extrapolating from the article). The judge decided to ignore the facts and make matters worse for the nurses. Matters will be worse because, as the old adage goes, if you're going bankrupt, it's better to be first.

The citizens of Central Falls are not going to rust. They need to think. The city may be able to sell or lease assets. It could ignore federal laws and regulations imposed on cities unless Washington funds its impositions on Central Falls. Of this, there is no chance. The feds would probably be more fearful of this tactic gaining publicity than of prosecuting city officials. Such an ultimatum would probably cut Central Falls spending by 50%. The city could issue scrip to employees and suppliers. Scrip is "emergency money" that was used across the United States in the 1930s. (See: Standard Catalogue of Depression Scrip of the United States, by Ralph A. Mitchell and Neil Shafer.) Merchants chose whether or not to accept it. It was often accepted during the 1930s, at least for a time, when a solution beckoned.

In general, the better solutions will accrue to those who sell first. Early sellers will get better prices. At some point there will be a flood of selling. It is impossible to know when that will be. As a guess, sometime after the next 30% stock market dive. This, as a guess, will happen after the U.S. government, stock-market support operation fails. All government support operations fail.

The sellers will include leveraged companies, banks (all are leveraged, by definition, in a fractional reserve system), pension plans, the so-called "rich" (many need to sell surplus houses and golf-club memberships to pay tuitions), endowments, hospitals, colleges, the sports industry, and municipalities. The latter will have to sell or lease highways, parking garages, bridges, sewer systems, water systems, utilities, and many other services traditionally provided by states, counties and towns: from garbage to schools.

There is a visceral resistance by municipalities to such thinking: The private sector is not to be trusted. Central Falls may be fortunate in selling to the enemy before prices plunge. A great buyer's market is in the making.