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Philadelphia zapped by bond-market turmoil

October 13, 2008

Ben Waxman, Philadelphia Daily News


*Ben Waxman reports for It's Our Money, a joint project of the Daily News and WHYY, funded by the William Penn Foundation. Contact him at or 215-854-5307.


AMONG the most serious of the domino effects of the worldwide financial meltdown is what's happening in the municipal bond market. This market - the banks, hedge funds and other financial institutions that buy up cities' debt - has been frozen since mid-September.


One factor: In recent years, the same financial wizards responsible for the subprime meltdown came up with complex ways to package municipal debt that made borrowing easier but way riskier. That led to a false confidence in the municipal market similar to the one that drove the inflated increase in home values.


Our graph, from the Bond Buyer, the nation's leading newspaper of municipal finance, shows the sharp drop-off in money being lent to cities and states over the last three weeks.


To make matters worse, three of the firms that insure bonds, guaranteeing payment of municipal debt for investors, were downgraded by credit agencies last week. The city insures about $1.2 billion worth of debt through Financial Security Assurance, which is owned by a European company called Dexia that's facing its own financial crisis.


All this means that cities and states are having a hard time getting credit. California recently announced it might need a $9 billion loan from the feds if more funds aren't available soon. This is really scary when you consider how much credit cities and states rely on for daily operations.


For example: The sporadic way that tax revenue comes in means most cities have to use TRANS bonds (tax revenue anticipation bonds) to even out their cash flow. It's become difficult to generate any interest in these normally rock-solid investments.


For cities like ours, this credit squeeze puts a higher price on daily operations. Philadelphia borrows about $350 million a year against future tax revenue for routine expenses like payroll and buying supplies. Markets turmoil has made borrowing more expensive by $7 million since January.


According to city finance director Rob Dubow, the current turmoil is "unprecedented" and "the worst crisis in bond market history." Plans to borrow money for capital projects like the new Youth Study Center may be put on hold if the market doesn't improve soon. The city could also see increased costs for routine transactions like payroll.


Last week, Mayor Nutter had a press conference to report that the budget shortfall he was already anticipating could double, from $450 million to $850 million over five years. Although he didn't specifically mention the bond market - he focused on a shortfall in revenues, especially from the real-estate transfer tax and wage taxes - the bond market is going to have a huge impact on how we deal with our shortfall.


Nutter released just a few details about how the city will close that gap. A larger strategy will be released at the end of October. (See editorial.)


With the market shifting every day, it's hard to predict how long this will last. DuBow says the city won't really have to worry until December or January, and a lot could happen before then.


What can we do to deal with the bond-market crisis? It's Our Money asked several local experts how the city can best weather the storm.


According to Brett Mandel of Philadelphia Forward, the first step is to rethink how bond deals are done. "You usually have someone who is lead counsel on a bond issuance and a couple of other lawyers who are getting paid as well," said Mandel. "It's time to examine if we need all of these lawyers."


Mandel's comments were echoed by Steve Wray of the Economy League. "Maybe we can use the current difficulties to develop creative solutions," Wray said. "The crisis creates an incentive for greater cooperation and coordination among local governments."


Does that include rewriting the tax code to reduce the need for short-term borrowing? According to Wray, "This isn't the time to announce a new tax plan. This is a time to be thinking hard about how our tax base is changing and how that will impact us . . . That means looking at all the different taxes and figuring out what should be changed. We've got to survive and then be poised to thrive."


Another issue that emerged from these conversations is the need for a rainy day fund.


The city doesn't set money aside during boom times to deal with leaner conditions. There is some dispute over whether the City Charter allows such a fund, but it's worth tackling.