Tuesday, 17 July 2012

Will California go Bankrupt?

David McNew/Getty Images

Once again, California, the home of Hollywood and entertainment has filed for Bankruptcy for the third time in a month. Is this a rare occurrence or do we expect to see more of this coming our way?
Let’s investigate!

Stockton, CA

Population: 291,707
Median household income: $45,730

Prior to the housing collapse of 2008 this city was Booming.  The city had spent over $190Million on a new Harbour, City Hall, Stadium and Parking Garages. In early 2007 average home sales totaled 7,000 on a quarterly basis with a median price of $340,000 per unit. Unemployment was low with the majority of employment in the construction industry and public works.  

What happened after 2008?

Quarterly average home sales dropped by 1,500 and the same house that was selling at $340,000 is now  selling at $110,000 (68% drop in value…ouch!).  In addition, with less houses being built, the construction industry took a big hit.  Unemployment is now at its highest, 20.1% which is 10% above the California State average.  Furthermore, as Stockton panicked to pay its debt, it almost cut public wages by 43%, police force and fire by 25% and 30%.  Anyone paying close attention to this city could see this coming a mile away!  The city had no other options.  It has a looming pension obligation and health benefits totaling $400Million.   
20% of the city unemployed combined with a 68% drop in housing value, filing for bankruptcy was the only option left.  

Mammoth Lakes, CA

Population: 7,392
Median Household Income: $51,929

Mammoth Lakes, California is a small resort town up in the Sierra Nevada Mountains.  Its largest creditor, "Mammoth Lakes Land Acquisition" has been involved in an ongoing court case battle since 2006.  Unfortunately, the city lost the case (breach of contract) and was forced to make full payment of $43 million by June 30, 2012.  This city has an annual operating budget of only $2.8Million which makes it feasibly impossible to pay off "Mammoth Lakes Land Acquisition" unless each citizen was willing to cough up an additional $6,000 in taxes. 


San Bernardino, CA

Population: 209,924
Median household income: 35,978

This city was also hit hard by the 2008 housing turmoil. It displayed a high degree of foreclosures and a rapid decline in the housing market.  Since 2007, home prices have declined from $300,000 to $100,000.   In addition, unemployment rose to 16.% with the majority of labour employed in construction. 
The city calculates that public safety spending now accounts for 73% of the general fund budget.  Also, the city imposed a 10% pay cut to public workers but the firefighter union successfully revoked it.  In addition to failed negotiation attempts with union, its pension cost are soaring and have  doubled since 2006.  Pensions are set to reach $25Million.   
With little cash on hand (approximately $120Million for this fiscal year) San Bernardino was not able to meet its contractual agreements and filed.   


Stockton and San Bernardino both displayed the following symptom

      Excessive public spending
Rapid foreclosure rates with the largest share of employees in the construction industry
Unemployment above 15% (well above the national average of 8.2%)
        Strong Unions with high pension cost

It’s clear to see these two states have a high degree of sensitivity to the housing sector.  Most economists like to call this “elasticity” With the average price of a house costing approximately $300,000, the municipal government was able to generate a substantial amount of revenue off property taxes.  Furthermore, the majority of labour was in the construction industry causing a surge in unemployment which ultimately had spillovers into other areas. 

To answer the question "do we expect to see more of this coming our way?"
Municipalities that exhibit the above symptoms are at risk of bankruptcy.  Areas which were hardest hit by the housing market and have yet to recover (home prices are still falling in most cities) are areas to look out for.  One piece of advice, stay away from municipal bonds if they display these symptoms. 

Herman Venegas

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