Bankruptcy Is On the Table in Hartford

Over the past several months, the shadow of a potential bankruptcy has loomed large over Connecticut’s capital city. Hartford is struggling to close a $50 million budget hole -- nearly 10 percent of its spending -- and has stagnant revenues. As a result, it has been downgraded into junk status.

Hartford officials have already cut the budget to the bone, and with one of the highest property tax rates in the state, Mayor Luke Bronin says he won't raise them more. So now the question is, will the financially beleaguered state -- which already pays for half of the city's budget -- step in with more aid? Connecticut, which is facing a two-year, $3.5 billion deficit, has yet to pass a budget more than one month into the fiscal year.

Meanwhile, the city is likely trying to restructure its debt with bondholders. But if that is unsuccessful, it could seek permission from Gov. Dannel Malloy to file for Chapter 9 bankruptcy. Either way, things are coming to a head with a $3.8 million debt payment due in September and another $26.9 million payment deadline in October.

The Takeaway: History has shown that municipalities in this kind of tight spot often don’t fare well. Take Detroit: Much like the Motor City, Hartford has massive fixed costs, revenues that can’t keep up and a state that is unable to help.

Still, it’s unclear whether Hartford will follow in Detroit's footsteps and declare bankruptcy. A report this week from Moody’s Investors Service noted that Hartford’s debt restructuring “will be difficult because bondholders will balk until other measures are exhausted, including pursuing more labor concessions.”

Hartford could certainly default on its debt without filing for bankruptcy. But that would result in litigation and a potential restructuring that's not ideal because it would do little to address the city’s full financial picture.


Worried About Sales Taxes

As one storefront after another shutters in the face of online competition, state and local government revenue bonds could face instability. A new report from S&P Global Ratings warns that although sales tax revenue bonds have always incorporated the ebbs and flows in local retail sales, “a storm looms on the horizon.”

The trend toward online shopping, where a sales tax isn’t always collected, “could have negative consequences on sales tax revenue collections and, ultimately, on our ratings,” says the report, “if local officials do not adapt to what we view as a foundational shift in the retail center.”

The Takeaway: So what should local governments do to adapt? S&P says they could restructure bonds to meet lower retail sales tax revenue projections or refund debt with additional revenues. Localities can also lobby their state legislators to expand the sales tax to services, which would help insure against the risk of a declining sales tax base to online goods.

What the report doesn’t say is that much of this potential storminess could die down if states and localities are given the legal authority to collect sales taxes from online sales. While that doesn’t address our economic shift away from taxable goods to generally untaxable services, it could go a long way toward keeping the revenue stream stable.


A Lesson From Puerto Rico on Defaults

It’s been two years since Puerto Rico famously defaulted on its first debt payment. Since then, the commonwealth has racked them up, defaulting on a total of more than $59 billion in outstanding debt.

There’s a method to the madness, however. An analysis this week by Moody’s shows that the bonds with the weakest legal protections were the first to default. It seems the island territory's bonds have been caught up in the municipal market’s version of the TV show, "Survivor." In the end, only the strongest debt will survive, such as the commonwealth’s Children's Trust bonds. They are secured by payments from the 1998 tobacco settlement between state attorneys general and cigarette companies. Moody’s predicts those bonds will remain untouched.

The Takeaway:The commonwealth now has a form of bankruptcy protection to restructure its debt. But the escalation of Puerto Rico’s defaults gives us a window into what troubled cities and states could do without the option of Chapter 9 bankruptcy protection. States can’t file for bankruptcy and only about half of them allow their municipalities to do so. It also shows why muni bond investors are increasingly demanding secured debt, such as revenue bonds, and why more governments are taking pains to guarantee bondholders will get priority in the event of a restructuring.

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