Bond failures may bankrupt cities

The sign in front of a City Hall.

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KAI RYSSDAL: You know how every now and then we bring you a completely obscure term from the world of high finance and try to explain it? We're not doing that anymore. At least, not for a little while. We figure you've had about all you can take of structured investment vehicles and auction rate securities. Suffice it to say the municipal bond market took another turn for the worse this week. The latest to blow up are things called variable-rate demand notes. Look that one up for yourself if you really want to know. Or drop us a line, we'll tell you. What it means in practice is that cities and states are seeing their borrowing costs more than quadruple while revenues are going downhill.

From New York, Marketplace's Jill Barshay reports now on the double whammy of the real estate crash and the credit crunch.


JILL BARSHAY: The gods seem to be conspiring against municipalities these days. A couple weeks ago their borrowing costs soared when something called auction-rate bonds fell apart. Now the same thing has happened with this other finance source.

CYNTHIA KROLL: Well, it's like the next shoe dropping. Who knows how many shoes we have out there to drop?

That's Cynthia Kroll. She's a regional economist at the Fisher Center at UC Berkeley.

The City of Vallejo, Ca. may declare bankruptcy this evening. She says that could affect residents in a number of ways.

CYNTHIA KROLL: They'll close libraries. I think they're talking about rotating among fire stations so that they don't have to pay so much overtime. The city will have less in the way of public safety services as recreation services are often the first thing to go... maintenance. And you drive around the Bay area and you can just see that already has gone in a lot of communities.

Local governments across the country are expected to feel this downturn a lot more than the last one. That's because cities rely on property taxes as their main source of revenue.

Robin Prunty is a senior director in the public finance department at Standard and Poor's.

ROBIN PRUNTY: We expect that local governments will face greater challenges this time around because of the real estate market being much weaker. You know, when you look back at 2001 recession, real estate was really one of the big strengths in the economy.

Prunty doesn't expect many cities to go bankrupt.

PRUNTY: I think it's important to keep in mind that governments generally plan for rainy days. They keep reserves.

Prunty says if this downturn lasts just a year or two, most cities should weather the crisis. There may be fewer clerks at city hall. Or fewer swim classes at the recreation center.

In New York, I'm Jill Barshay for Marketplace.

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