Building on Sand
Out of cash and out of options, America's cities need a new plan—and they might need Washington to design it.
By Gillian Tett
When a debt crisis hits, it can cause ripples in all kinds of unexpected places. Even, it seems, on American beaches.
In decades past, the lifeguards who stood watch over the shores of Atlantic City, New Jersey’s iconic resort town, epitomized good-time summer living. And they did so during the heyday of good-time retirement perks: The former guards have been enjoying government pensions since 1928.
Alas, those prime Atlantic City times are long gone. Now drowning in as much as $550 million in debt, the town can no longer afford to pay the annual $1 million owed to these aged lifeguards. But a proposed state Senate bill might allow the city to cut the retirement benefit, leaving the once-bronzed lifesavers high and dry.
Viewed on its own, this particular pension plan is but a blip on the radar that registers America’s debt quagmire, yet it points to a more troubling, widespread trend. These days, numerous city and state governments face overwhelming debts, which they are unlikely to ever pay off. And they are responding in capricious and unpredictable ways that could make the problem even worse.
Of course, it goes without saying that the United States is a big borrower. While the federal debt is estimated at around $19 trillion, which is slightly bigger than the nation’s entire gross domestic product, city and state governments have issued about $3.7 trillion in bonds, more than triple their borrowing in 2000, in the so-called municipal bond market. On top of that, state governments have made unfunded pension promises that could total more than $3 trillion—a financial burden that looks completely unsustainable.
Those raw numbers are worrying. But what is truly frightening is that many city and state governments aren’t organizing this liability in a consolidated way. Instead, they are shuffling the debts around, rather than finding credible solutions.
To understand the scale of the situation, take a look at Puerto Rico. In recent years, this island has issued a dizzying array of public and quasi-public bonds, which now total about $70 billion (around 100 percent of its gross national product). In addition, the commonwealth is estimated to have an additional $45 billion in pension liabilities.
Since growth has collapsed, Puerto Rico seems unlikely to pay this bill, which suggests it urgently needs to devise a restructuring plan. But it can’t. That’s because the amount of official debt is divided into at least 14 categories of bonds, which have been sold by the local electricity company and the central government, among other entities. Only some bonds are “secured,” meaning that investors can seize assets if a default occurs; this also means each bond is unique in the event of default.
If Puerto Rico were a company, consolidation would be a fairly easy process: Debtors or creditors would file for Chapter 11 bankruptcy protection and a judge would help determine who got paid. If Puerto Rico were a sovereign nation, the International Monetary Fund might play this role. While officials at the U.S. Treasury are keen to find a solution, there is strong opposition in Congress to anything that would be perceived as a bailout.
This leaves the U.S. territory stuck in limbo. In May, the beleaguered island defaulted on one small(ish) $422 million bond. As of press time, Puerto Rico seemed headed toward defaulting in July on a $2 billion bond. But there is no resolution in sight, since different creditors and pension funds are fighting bitterly to protect their claims.
Sadly, this is not a unique tale. Chicago’s debt, for example, is astronomical. In addition to accumulating $9.8 billion in outstanding bonds between 2000 and 2012, the city is estimated to face at least $20 billion in future pension claims. Paying this off is likely to be so difficult that the rating agencies downgraded Chicago’s debt to a notch above “junk” last year, and the city’s bonds are trading at a steep discount. Chicago recently sold new bonds that trade at 84 percent of their face value, implying that investors expect future losses.
Like Puerto Rico, Chicago can find no simple solution to its debt crisis. The city’s pension liabilities, for instance, are divvied among four main programs. Mayor Rahm Emanuel has tried to persuade various groups to cut the pension commitments, arguing that this approach—along with tax hikes—would help make the system sustainable again. Nevertheless, coordination in Chicago is almost impossible, as the state’s legal system makes it difficult to unite pensioners, creditors, and unions.
To be sure, easy solutions don’t exist. But Chicago, Puerto Rico, and even Atlantic City could take a page from Rhode Island’s playbook. Until the start of this decade, when Gina Raimondo became state treasurer, Rhode Island was facing an unsustainable pension bill. Raimondo, a former private equity executive, embarked on a campaign to inform citizens about the extent of the state’s debt, as well as of her plan to fix it. The public outrage helped force the unions to the table. And while this was controversial (some unions sued), it was eventually accepted.
One American city has also been able to restructure its debt successfully. When Detroit, weighed down by $18 billion, declared bankruptcy in 2013, its debts were eventually consolidated. Since then, city authorities have pledged to make finances more transparent. This enabled Kevyn Orr, the emergency manager who oversaw the bankruptcy, to win voter and union support for a restructuring plan.
Most cities cannot copy Detroit. Illinois law, for example, protects pension rights at almost all costs.
Thus, without the shock of a bankruptcy court—or the frenetic work of one pioneering local official—change is unlikely in Chicago.
Left with no options, the time has come for Washington to act. This isn’t to say that financial support should be pushed to cash-strapped cities; clearly, an ever-rising federal debt makes that an impossible scenario. But Washington should introduce legislation that forces the nation’s cities and state governments to audit their debts and make them accessible. In addition, Washington should create a process that would enable municipal debtors and creditors to find a collective solution, rather than a piecemeal approach.
Such accountability won’t be painless for anyone. If nothing is done, however, the alternative—a cloud of uncertainty hanging over many American cities and states—could be debilitating. At a time when the nation badly needs to create a climate for growth, Washington cannot afford that possibility.
Gillian Tett is U.S. managing editor of the Financial Times and author of The Silo Effect: The Peril of Expertise and the Promise of Breaking Down Barriers.
A version of this article originally appeared in the July/August issue of FP magazine.