As cities in California lineup to file for bankruptcy, it’s not allowed in about half the states in the US. In fact, only 24/50 states in the US allow local municipalities to file for bankruptcy as a way out of debt. Even though this is a factor, the Fitch Ratings will continue to factor in the probability of municipalities filing bankruptcy under Chapter 9. The rating agency believes it should include this for all tax supported local debt that is under their ratings.
In recent news, many bond companies have been fighting back using the courts targeting benefits in municipal bankruptcy. It seems that cities filing bankruptcy are not giving the bondholders a fair shake in mediation prior to filing bankruptcy to get paid back. Recently, Vallejo, California came under fire for only paying $6 million against $410 million in debt, while guaranteeing pensions of their employees. The bond companies in their complaint have stated that the pensions are nothing more than a debt and should be treated the same way that the debt from bonds is treated.
For many years it was rare to see a bankruptcy filing and $3.7 trillion municipal bond market. Last year, in 2011, there were 13 cities with Chapter 9 bankruptcy petitions and there are nine so far this year, with California leading the way with three cities filing for bankruptcy.
With the real estate market continuing to decline many municipalities are left with the question, The local governments rely heavily on the solid tax base from homeowners and as the prices of houses dropped, so do the property taxes. It seems that California is leading the way in the number of people losing their homes to foreclosure and filing bankruptcy. If this trend continues on, most cities will end up with the same fate of California cities like, Vallejo, Mammoth Lakes, San Bernardino and Stockton.