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How Scary Are Municipal Finances?

Not as scary as you think, but scary enough to be picky.

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You don't have to look hard to find a reason to worry about municipal finances these days. Reports of a looming day of reckoning in the municipal-bond market from a wide array of commentators are ubiquitous. Former Los Angeles mayor Richard Riordan took to the Wall Street Journal's editorial pages to predict that the country's second-largest city would declare bankruptcy before 2014. Testifying before the Financial Crisis Inquiry Commission in June, Warren Buffett sounded alarms about the "terrible" financial distress facing many state and local governments in coming years. Buffett's muni insurer, Berkshire Hathaway Assurance Corp., has scaled back its activity substantially, guaranteeing only $40 million worth of muni bonds in 2009 compared with nearly $600 million the year before.

Given the severity of the Great Recession compared with prior downturns and the tenuous nature of the recovery, there's little comfort in the argument that muni defaults will remain rare just because they always have. But even though state and local governments continue to struggle through the worst economic climate in decades, many of the specific concerns getting attention in the media appear overblown. Some of the worst news stories involve isolated municipalities that made reckless moves well before the downturn, and many muni researchers can and did anticipate their troubles in advance.

Highlighting the Obvious
Dire straits in Harrisburg, Pa., have made headlines lately, but the foundation for its current predicament was laid back in the early 1990s, when the city agreed to guarantee the debt of an incinerator plant that had been plagued with problems since the 1970s, when it was built. The plant was already burdened with close to $100 million in debt when the Federal government shut it down in 2003 for polluting. At that point, Harrisburg borrowed another $125 million to rebuild it, hoping that it would make enough money collecting trash to eventually pay down the debt. Those revenue projections were far too rosy, however, and now the plant is saddled with almost $300 million in debt that it can't afford to pay off, leaving Harrisburg on the hook. Unfortunately, the $68 million due on the plant's debt this year alone exceeds the city's annual budget by $3 million.

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Miriam Sjoblom does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.