What Central Falls and the Debt Deal Mean For Cities

As Congress eyes domestic cuts, the bankrupt Rhode Island municipality shows what happens when a city can't afford to function.
by | August 5, 2011
 

(Governing's Ryan Holeywell discussed municipal bankruptcy and domestic cuts on NPR's 'On Point' this week. Click here to listen.)

Two extraordinary events happened within hours of one another on Monday: Congress approved an agreement that would prevent the country from defaulting on its debt – and in the process set the stage for a decade of deep spending cuts. The same day, Central Falls, R.I., a city of about 20,000, filed for bankruptcy when it was unable to recover from its crippling pension obligations. It marks the fifth municipal bankruptcy of the year and the 11th since the start of 2010.

The two events are more related than they seem.

To get it out of the way, let’s be clear: Central Falls is not a harbinger of things to come for cities and countries across the country. And the bankruptcy is not disrupting the municipal bond market either. That’s because everybody was aware of the path Central Falls was taking, says Peter Hayes, head of the municipal bonds group at asset management firm BlackRock. “It’s been anticipated for so long,” Hayes says. “They were already considered junk status.”

Others point out that Central Falls – an older, smaller town with unusually troublesome finances – is an outlier that’s not representative of cities in general. In other words, “it ain’t that big a deal,” says Richard Larkin, a vice president at Herbert J. Simms & Co., an underwriter of tax-exempt bonds.

Unfortunately, the Central Falls bankruptcy will likely give further credence to the municipal doomsayers of the world, led by analyst Meredith Whitney, who famously predicted on 60 Minutes last December that 2011 would feature 50 to 100 sizable municipal bond defaults. Of course, those predictions turned out to be wildly off. There have been just 24 municipal defaults through June totaling $746 million, Bond Buyer reports, and none were state and local general obligation bonds. In fact, the country’s on pace to have fewer municipal defaults this year than it has in each of the last two years.

And municipal bankruptcies are even rarer. Historically, there’s only about eight a year, and even during these times of austerity, bankruptcies aren’t outpacing that clip. But Central Falls may overshadow those numbers, as observers fail to differentiate between the short-term financial pinches affecting nearly all localities with the long-term deficits of unfortunate places like Central Falls. “I think maybe people who aren’t informed may look at this and say, ‘Holy cow, Meredith Whitney’s right,’" Larkin says.

Unfortunately, the attention paid to municipal bankruptcy obfuscates the real story: the major cuts coming to states and localities at a time when they can afford it least.

The debt ceiling deal cut between Democrats, who were merely trying to avert default, and Republicans, who used the threat of default as a bargaining chip, could result in about $2 trillion in spending cuts over 10 years. About half that total could come from domestic, discretionary spending – the category that includes everything besides entitlement programs and defense.

So why does it matter? About a third of that spending goes directly to states and localities, typically through grants. Sure, state and local leaders are glad the country didn’t default on its debt, since that process likely would have caused a cascade of credit downgrades to state and local issuers. But nobody in state and local government actually expected default to happen. So as pundits in Washington pontificated about what would happen, hypothetically, if the debt limit wasn’t increased (Would we stop paying soldiers? Would we stop mailing Social Security checks?), state and local leaders were more concerned with the damage that would be done once a compromise was reached. And now they know: they’ll bear the brunt of many of the cuts.

“A lot of the deficit cuts will directly affect state and local funding,” Hayes says. In fact, those cuts may be so deep that the credit ratings agencies might put some jurisdictions on a “negative watch,” or warning that their credit ratings could be downgraded. Local leaders are scrambling as they try to figure out what, exactly, the cuts will entail. So far, they have little idea. After all, Congress agreed to cut domestic spending to its lowest level in 50 years without first deciding what it would actually cut. But state and local leaders are expecting the federal contributions toward education, community programs, housing, infrastructure, first responders – basically everything that state and local governments do – will take a hit.

Even before the debt agreement was signed, states and localities were on notice. The House Appropriations Committee recently approved a plan to eliminate $1.1 billion for state and local policing programs. House Republicans have signaled they’d like to eliminate the $3.9 billion Community Development Block Grants program, which provides aid directly to localities for programs like low-income housing and community centers. President Obama’s own budget cuts the program by $300 million, which would seem to represent a best-case scenario for localities. The president’s budget cuts or eliminates dozens of other programs geared toward state and local governments, including a 50 percent cut to a program that helps poor people afford heating and air conditioning. The House's highway and transit bill reduces funding by about 28 percent over its predecessor, and that's before even adjusting for inflation. And all these plans were made before the debt ceiling compromise. The list goes on.

Ted Ellis, mayor of Bluffton, Ind., and an officer with the National League of Cities, says federal lawmakers can expect to hear from local leaders when their recess ends as they make their case for these programs and others.  “When Congress comes back, we’ll be there, and we’ll be there with our armor on,” Ellis says. But those pleas may fall on deaf ears. The problem states and localities often face is that Congress lacks an incentive not to make their life difficult but cutting their funds.

With debt and deficit reduction the issues du jour, targeting programs that aid localities gives federal lawmakers a way to tout their fiscal responsibility credentials without dealing with the implications. Those issues, of course, fall on governors, mayors and county leaders to sort out. “A smart cut is when you eliminate duplication,” says Mesa, Ariz., Mayor Scott Smith, a leader of the U.S. Conference of Mayors. “A dumb cut is when you cut just to cut.” Smith says when he tries to explain the difference to members of Congress, he’s often greeted with blank stares.

So what does Central Falls have to do with the debt ceiling? State and local governments continue to struggle. Though state revenue is just now starting to improve, it’s still below pre-recession levels. Cities are in worse shape, since property tax revenue is continuing its downward decline. The Center for Budget and Policy Priorities found that 38 states have made “deep, identifiable cuts in K-12 education, higher education, health care, or other key areas in their budgets” for the fiscal year that began in July.

Meanwhile, cities are cancelling infrastructure projects, laying off personnel and cutting back on basic services. In Central Falls, they’re doing the same things, but to the extreme. Streetlights have been turned off. The city’s state-appointed conservator closed the library. And the community center. And the pool. The bankruptcy plan calls on a 40 percent reduction to the police and fire budgets. Some of their emergency operations may even be outsourced to private companies. Essentially, all the things that make a city a city are on the chopping block.

Cities are basically service agencies, and low-income and middle class residents rely on those services. As the Brookings Institute recently wrote about the debt ceiling compromise, “(t)he burden of closing the gap will be placed on poor and middle-class households.” After all, it’s not the wealthy who borrow books from the library and take their kids to the community pool.

In Washington, budget cuts affecting localities are discussed in abstract terms. But Central Falls gives us the unique opportunity to see what exactly happens when a community lacks the resources to serve its residents. It’s not a pretty picture, but it’s one worth looking at closely.

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