Largest U.S. City So Far to Declare Bankruptcy

Largest U.S. CityBuried under a huge budget deficit with pension obligations it had no way of honoring, Stockton, California could not reach a deal with its creditors and so will be forced to declare bankruptcy within days.

The mayor of Stockton, Ann Johnston, felt she had no choice. Before reaching this point, the city cut all of its public services and employees by an average of 40%! Unfortunately, despite these cuts, the creditors and the city couldn’t come to an agreement on the budget deficit shortfall.

Now a bankruptcy court must decide whose pension/health care/other benefits get cut in order for the city to meet its budget deficit. These proceedings will drag on for years and will cost the city millions of dollars. A much smaller city, Vallejo, California, took three years to emerge from bankruptcy.

Now it will be up to a bankruptcy judge to decide if retiree medical benefits will be cut, and to what extent, to meet the budget deficit. Will pensioners survive cuts as the city tries to meet the budget deficit?

The financial crisis of 2008 that caused housing prices to collapse left Stockton’s tax revenue base decimated, leading to mounting budget deficits. The unemployment rate is currently 15.4% for the city and, according to RealtyTrac, one in 195 homes is in foreclosure, which ranks it fifth-highest among all cities in the U.S.

With this backdrop, it is no wonder that Stockton has an enormous budget deficit and is traveling down the bankruptcy road. Before the financial crisis, municipal bankruptcies were almost unheard of during the last four decades.

In 2010, there were six municipal bankruptcies; in 2011 there were 13; and thus far in 2012, Stockton makes the seventh. I’m sad to say there will certainly be more where that came from. (Source: Associated Press, June 27, 2012).

Next in line could be the city of North Las Vegas, which declared a state of emergency because it cannot meet its budget deficit. In all circumstances, the state of emergency is reserved for natural disasters, but with the unemployment rate and foreclosure rate very similar to Stockton’s at over 15%, the huge budget deficit forced the city to stop paying bills.

Only under a state of emergency is the city able to stop paying bills, outside of declaring bankruptcy. Since the financial crisis, the fall in housing prices and the amount of foreclosures has killed the revenue base for North Las Vegas.

City unions are now fighting the state of emergency declaration in court, claiming it is unjustified and so payments to them must be made. In the meantime, massive cuts to city services are being implemented and large layoffs will be announced in order to meet the budget deficit. (Also see: “Job Cuts at State and Municipal Level Pick up Steam.”)

The repercussions of the financial crisis of 2008 are still playing out, dear reader. It has been four years, and still the financial crisis continues to cause damage. Poor consumer spending, stubbornly high unemployment, the debt crisis in Europe, a slowing economy in China…all pushing us down the path to Recession Part II for America.

Michael’s Personal Notes:

Yesterday, we saw the news headline that U.S. durable goods orders for May beat economists’ expectations. Not so fast.

The U.S. durable goods report is an important gauge of economic recovery, because it focuses on big-ticket items that are purchased by businesses and consumers that are meant to last at least three years; a sign of business and confidence in consumer spending.

Durable goods orders increased 1.1% in May on expectations of 0.5% (source: Commerce Department). This is a nice upside surprise and seemingly a sign of economic recovery. However, when the volatile transportation orders are removed from the figure, it is a miss: 0.4% on expectations of 0.7%. Economic recovery, really?

The most important part of the durable goods orders number that best reflects how the economic recovery is holding up and the future outlook for consumer spending is the core durable goods number, which leaves out transportation and defense orders. Core durable goods orders were up 1.6%—after a disastrous April—when economists were hoping for a stronger rebound of 1.9% just because April’s number was so weak.

Worse still is that, year-to-date, the increase in durable goods orders is the weakest since the same period in 2009. This is not an indication of an economic recovery. This is more evidence to the contrary, pointing to an economic slowdown. This slow growth in orders can only mean that consumer spending will continue to be weak as well.

A few months ago, I presented a chart highlighting the record amount of durable goods inventory being created in this country. Well, in 28 of the last 29 months, inventories have continued their relentless climb upward. This month marked another record $365.8 billion on the shelves.

This means fewer goods are sold and shipped while more goods gather dust on the shelves. This is not a sign of an economic recovery and stronger consumer spending—just the opposite. (See: “U.S. Retail Sales Numbers Now at Worst Point in Two Years.”)

So when the headline number comes in at 1.1%, what they don’t tell you, dear reader, is that the biggest gain in inventory since January made the number look larger than it really is. So while the stock market may appear to celebrate an economic recovery with strong consumer spending, the truth is that with inventory build-up removed from the equation, the picture doesn’t look rosy at all.

Where the Market Stands; Where it’s Headed:

We are in a bear market rally in stocks that began in March of 2009. The rally is tired and “long in the tooth,” as they say. World economic growth is slowing quickly, which will put pressure on the profits of public companies, thus resulting in lower stock prices.

In a nutshell, the bear market rally we’ve been experiencing since the spring of 2009 is almost over. The market is only presently being held higher on the hope that the Federal Reserve will come to the rescue again with another form of quantitative easing (i.e. money printing).

What He Said:

“Prepare for the worst economic period ahead that we have seen in years, my dear reader, as that is what I see coming. I’ve written over the past three years how, in the late 1920s, real estate prices fell first before the stock market and how I felt the same would happen this time. Home prices in the U.S. peaked in 2005 and started falling in 2006. The stock market is following suit here in 2008. Is a depression coming? No. How about a severe deflationary recession? Yes!” Michael Lombardi in Profit Confidential, January 21, 2008. Michael started talking about and predicting the economic catastrophe we began experiencing in 2008 long before anyone else.