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That’s a question that J.P. Morgan took on in its recent analyst report The ARC and the Covenants 3.0, in which it considered the total debt burdens of the governments of U.S. cities, counties, and states.
Here’s an excerpt from the report’s Executive Summary, in which the private bank explains its interest in the results of the analysis and what liabilities are included in each level of government’s total debt, which goes into the calculation of their “IPOD” ratio, which is their estimate of the true burden of debt local governments throughout the United States:
As managers of $70 billion in US municipal bonds across our asset management business (Q2 2017), we’re very focused on credit risk of US municipalities. Last year, we completed our tri-annual credit review of US states. While a few states have very large debts relative to their revenues, many are in decent shape. This summer, we completed a review of the largest US cities and counties. In general, US cities and counties have substantially more debt relative to their revenues than US states. While most have several years to undertake remediation measures, some very difficult choices will be required in order for them to meet all of their future obligations. And when these choices become untenable and rare municipal bankruptcies do occur, bondholders have usually received lower recoveries than pensioners.
The concept of “debt” needs to be expanded when thinking about municipal credit risk, since general obligation bonds are only part of the picture. As “debt”, we include unfunded obligations related to pensions and retiree healthcare along with bonds, leases and other obligations supported by each municipality’s general account. As shown above, bonds and leases (“net direct debt”) only represent around one third of the total debt of US cities and counties.
The chart below shows our “IPOD” ratio for US states, cities and counties. This measure represents the percentage of a municipality’s revenues that would be needed to pay interest on direct debt, and fully amortize unfunded pension and retiree healthcare obligations over 30 years, assuming a conservative return of 6% on plan assets. While there’s no hard and fast rule, municipalities with IPOD ratios over 30% may eventually face very difficult choices regarding taxation, non-pension spending, infrastructure investment, contributions to unfunded plans and bond repayment.
Here is the chart showing J.P. Morgan’s IPOD ratios for U.S. cities, counties and states, with the results ranked from worst (left) to best (right). Do you see your city, county or state listed among the worst?
For the local governments with the worst debt burdens, residents can expect that their governments will be compelled to try to improve their fiscal plights, most often by increasing their taxes and cutting the services they provide. They might likewise take steps toward directly reducing their liabilities before they might be forced to file for bankruptcy, say by correcting their public employee pension and health care benefits to reflect what they can afford to sustain with their revenue. But their success in doing that depends on how much political power local government bureaucrats wield and the extent to which they choose to oppose needed reforms.
And then, there’s the third option: forcing the issue and filing for bankruptcy. But wouldn’t it be better for the politicians and bureaucrats to face the music on their own long before a federal judge has to be brought in to fix the problems they created for themselves?