Why So Many Municipal Bankruptcies in California?

Only a week after the City of Stockton, California, declared bankruptcy, the small ski resort town of Mammoth Lakes, California, filed for bankruptcy.

The city’s largest creditor, Mammoth Lakes Land Acquisition, won a court judgment for $43.0 million, which meant the city needed to come up with the money immediately. The city of Mammoth Lakes could not pay due to its expanding budget deficit and so bankruptcy was the only alternative left.

Mammoth Lakes Land Acquisition offered the City of Mammoth Lakes a 30-year repayment option at $2.7 million per year, but the budget deficit at Mammoth Lakes is so impossible to close that the city felt it had no option but to finally leave it to the courts to decide how to fix the budget deficit.

More cities in California are becoming desperate, as their budget deficits threaten to lead them down the same path as Stockton and Mammoth Lakes.

Obviously, the biggest revenue generator for Californian municipalities consists of taxes from homeowners. Since the housing market disintegrated in 2008, these tax revenues have been cut dramatically, worsening the budget deficits.

Now California’s Fontana, Ontario, and San Bernardino County have jointly decided on a new approach to the housing market in hopes of closing out their budget deficits. This new approach simply highlights the desperation on the part of municipalities to increase tax revenue and so close out their budget deficits.

The municipalities want to take the mortgages within the housing market that are currently at less than the value of the home from the banks, have the courts decide what the value of the home currently is, force the banks to take the principal loss on the home, and resell a new mortgage to the current homeowner at the reduced price. (Source: The Wall Street Journal, July 5, 2012.)

This means, for example, taking a $300,000 mortgage, forcing the banks to take a $100,000 loss on it and allowing the homeowners to remain in the home with a new $200,000 mortgage, which would reflect current prices in the housing market.

The banks, of course, are not happy about this idea. Others proclaim that it will prevent further lending by the banks in the housing market and will depress housing prices further.

The housing market needs relief and reducing principal is certainly an excellent way of helping revitalize the housing market. However, arguments won’t matter in this case, because to be eligible, homeowners within the housing market must be current on their mortgage payments and they must hold mortgages that are not federally guaranteed.

Only 10% of all mortgages in the U.S. are not federally guaranteed within the housing market.

As this represents such a small portion of the housing market, debate is irrelevant. What’s worse is that those behind on their mortgage payments are the ones who need the principal relief within the housing market.

Regardless, this highlights the desperation among municipalities to increase their revenue bases to cover their budget deficits and also dispels the myth that the housing market is recovering.

Reducing principal in the housing market is one of the only ways to revitalize it, but this plan has such limited scope that it will have very little effect, especially as there is no obligation to accept such programs.

Where the Market Stands; Where it’s Headed:

Slowly, very slowly, the stock market moves lower. The bulls are calling for higher stock prices, because stocks are trading “cheaply” based on price-earnings multiples.

The bears like me are calling for lower stock prices because of a brewing global recession that will sharply reduce the earnings of American corporations.

The only thing left is for the Fed to announce a third round of quantitative easing (QE3). But at this point, I don’t know if the stock market’s reaction to such a move would be overly positive.

What He Said:

“Interest rates at a 40-year low: The Fed has made borrowing as easy as possible, resulting in a huge appetite for loans and mortgages. We are nearing a debt crisis.” Michael Lombardi in Profit Confidential, April 8, 2004. Michael first started warning about the negative repercussions of then Fed Chairman Greenspan’s low-interest-rate policy when the Fed first dropped interest rates to one percent in 2004.