Public Debt: Redux via Municipalities

I was inspired by a segment on NPR’s Morning Edition today as it related to yesterday’s post about public debt. It hit me that national debt may draw the most attention, but there might be a bigger issue in another version of the topic:  public debt by local government.

Over the last year or two, there have been a growing number of stories about towns and cities seeking bankruptcy protection, filing for bankruptcy, and even defaulting on their debts. The NPR segment on Fannie and Freddie references the recent case of Stockton, California who has just filed for bankruptcy. For the last two years or so, Maywood, California has also been in the news for their financial decisions about how to take on their increasing debt burdens. Then there’s the case of my home town, Harrisburg, PA, and its continuing mess of debt, state takeover, and now a federal suit. Harrisburg has made national headlines over the last several years for its frivolous spending under former mayor Steven Reed, as well as the potential of it being factored under Pennsylvania’s Act 47 which is designed to “help” financially distressed cities in the state.

Getting back to the question I posed above, we need to ask ourselves what the differences are between national governments and municipalities (or even states) when it comes to debt. The first one that comes to mind is that external debts, like Bagus talked about in his article I referenced yesterday, are non-existent for states and municipalities. This is simply because those governments deal in the currency of the nation they fall under. Obviously, the federal government controls all external debts to other nations, so this removes the risky external debts that Bagus draws attention to.

The second difference I see is trade deficits. For the same reason as external debts above, trade deficits are non-existent for states and municipalities because they use the same currency and all foreign transactions are handled by the federal government.

Let’s stop here and address a point before I move onto the final difference I see. Remember that Bagus claims that the levels of external debts and trade deficits are the biggest windows into the health of a currency, and, in turn, an economy. Since both of these factors are non-existent for states and municipalities, there is no gauge to measure their financial health outside of crunching numbers and deducing whether or not the organization if financially sustainable or not. This may appear to cloud the waters a bit, but hopefully my third and final point will clear things up.

The final difference I see between national and local governments is the absence of access to a printing press for the latter. As Bagus says, the only two ways for a government to rid itself of the unhealthiness of accumulated debt and deficits is to either default on the loans or inflate away the problems via the printing of more money, which in turn lowers the value of the currency to a more appropriate level of worth. Local governments, being under the supremacy of the US Dollar, has no way of inflating themselves out of their spending mishaps short of hoping and praying that the Federal Reserve somehow miraculously inflates to the levels needed to mitigate their problems.

This lack of monetary creation forces municipalities into a single option if they find the hole they’re in too deep:  default. Filing for bankruptcy and having their assets liquidated to pay off their debts is the only way to get the government back on track. The hands of those organizations are tied, and possibly for good reasons. I’m not sure I’d like to imagine a world where every local and state government had their own Federal Reserve-approved printing press with freedom to print as much money as they saw fit.

I see this conundrum being a double-edged sword, for three reasons. First of all, the lack of inflationary measures by local governments forces them to get real with their financial crises and address the real problem:  unsustainable spending. Secondly, I believe the number of defaults and bankruptcies by cities and municipalities adds yet another window into the health of a currency. And, lastly, if the “triple entente” of external national debts, the trade deficits, and the defaulting of municipalities are all boldly apparent, what’s also apparent is the severe lack wisdom when it comes to leadership decisions and finances at all levels of government.

What adds to all this trouble, especially in Pennsylvania, is when the state steps in and denies the city or municipality their rights to default or file Chapter 9 bankruptcy, as legislated by the US government. Taking away the only viable option for severely distressed cities is asking the entire state and sometimes the nation to bear the burden of the costs for recovering the city. In this regard, we’re not that much removed from what’s happening in the Eurozone, are we?

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