Magazine article Foreign Policy

Building on Sand: Out of Cash and out of Options, America's Cities Need a New Plan-And They Might Need Washington to Design It

Magazine article Foreign Policy

Building on Sand: Out of Cash and out of Options, America's Cities Need a New Plan-And They Might Need Washington to Design It

Article excerpt

When a debt crisis hits, it can cause ripples in all kinds of unexpected places. Even, it seems, on American beaches. [paragraph] In decades past, the lifeguards who stood watch over the shores of Atlantic City, New Jersey's iconic resort town, epitomized good-time summer living. And they did so during the heyday of good-time retirement perks: The former guards have been enjoying government pensions since 1928. [paragraph] Alas, those prime Atlantic City times are long gone. Now drowning in as much as $550 million in debt, the town can no longer afford to pay the annual $1 million owed to these aged lifeguards. But a proposed state Senate bill might allow the city to cut the retirement benefit, leaving the once-bronzed lifesavers high and dry. [paragraph] Viewed on its own, this particular pension plan is but a blip on the radar that registers America's debt quagmire, yet it points to a more troubling, widespread trend. These days, numerous city and state governments face overwhelming debts, which they are unlikely to ever pay off. And they are responding in capricious and unpredictable ways that could make the problem even worse.

Of course, it goes without saying that the United States is a big borrower. While the federal debt is estimated at around $19 trillion, which is slightly bigger than the nation's entire gross domestic product, city and state governments have issued about $3.7 trillion in bonds, more than triple their borrowing in 2000, in the so-called municipal bond market. On top of that, state governments have made unfunded pension promises that could total more than $3 trillion--a financial burden that looks completely unsustainable.

Those raw numbers are worrying. But what is truly frightening is that many city and state governments aren't organizing this liability in a consolidated way. Instead, they are shuffling the debts around, rather than finding credible solutions.

To understand the scale of the situation, take a look at Puerto Rico. In recent years, this island has issued a dizzying array of public and quasi-public bonds, which now total about $70 billion (around 100 percent of its gross national product). In addition, the commonwealth is estimated to have an additional $45 billion in pension liabilities.

Since growth has collapsed, Puerto Rico seems unlikely to pay this bill, which suggests it urgently needs to devise a restructuring plan. But it can't. That's because the amount of official debt is divided into at least 14 categories of bonds, which have been sold by the local electricity company and the central government, among other entities. Only some bonds are "secured," meaning that investors can seize assets if a default occurs; this also means each bond is unique in the event of default.

If Puerto Rico were a company, consolidation would be a fairly easy process: Debtors or creditors would file for Chapter 11 bankruptcy protection and a judge would help determine who got paid. If Puerto Rico were a sovereign nation, the International Monetary Fund might play this role. While officials at the U.S. Treasury are keen to find a solution, there is strong opposition in Congress to anything that would be perceived as a bailout.

This leaves the U.S. territory stuck in limbo. In May, the beleaguered island defaulted on one small(ish) $422 million bond. As of press time, Puerto Rico seemed headed toward defaulting in July on a $2 billion bond. …

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