Detroit’s collapse may cost Philly $500,000 a year

When one city falls, others shudder.

The city of Philadelphia will end up paying hundreds of thousands of dollars more in interest costs for the next 20 years because Detroit filed for bankruptcy last week, the week before Philadelphia planned a major bond offering.

The market jitters were aggravated by the fact that two days before the Detroit filing, Moody’s sharply downgraded the city of Chicago’s credit because its municipal pension fund is taking on water. Sound familiar?

It all made investors a little more wary of municipal bonds, once thought to be the safest investment you can make.

“We will be paying more to borrow,” Philadelphia City Treasurer Nancy Winkler told me in a phone interview Tuesday.

She estimates the Chicago and Detroit events will add a about a quarter percent to the interest rate the city will pay for its $197 million bond offering, adding around $500,000 a year to the annual debt service the city will pay for those bonds.

In addition, the city decided to postpone a planned refinancing of another $167 million in previously issued bonds to take advantage of lower interest rates. That deal, which would have saved the city about $20 million in overall interest costs, is off the table for now.

The good news, Winkler noted, is that Philadelphia’s credit rating has improved enough in recent years to more than offset the interest cost of the recent market shudders. She says the city’s net interest cost on this week’s bond issue will be close to a half percent less than when the city last did a general obligation bond issue two years ago—saving close to $900,000 a year in interest costs.

Which is good, but it would have been better without the tremors from the Midwest.

Why it matters

I found my way to Winkler’s door this week because I wanted to explore some troubling issues raised by Detroit’s bankruptcy filing.

Detroit went to court saying there’s just no way it can pay its creditors in full, raising the touchy question of who will get paid what.

Among the big creditors are city pensioners who count on monthly checks and investors who hold Detroit bonds.

On the face of it, the most humane thing seems to be to preserve those pensioners’ life support and let the investors go away hungry.

But it’s not so simple. For one thing, a lot of the investors are other pension funds who count on returns from bonds they’ve purchased to support their people.

Beyond that, in the real world, cities everywhere rely on the bond market to borrow money needed to finance capital projects and manage cash flow. The interest rates they pay depend on how confident investors are that they’ll get the bond payments they’re promised.

For decades, municipal general obligation bonds, in which a city pledges its “full faith, credit and taxing power” to pay bondholders, were considered a safe harbor.

“It’s your basic bonds that the proverbial Aunt Mary would buy, and for years, they were regarded as sacrosanct,” said Paul Burton of the Bond Buyer, a specialty publication that covers the municipal bond market.

Because city bonds were considered so safe, investors would accept lower interest rates on them, saving taxpayers money on annual bond payments.

But what happens if a city as big as Detroit can get a federal bankruptcy judge to say it’s OK to renege on its pledge to bondholders? It hasn’t happened yet and it may not—there will be lengthy court battles on this. But a bankruptcy filing that raises that prospect two days after a credit downgrade for Chicago is enough to rock the municipal bond world.

“Our market’s in sort of a delicate state,” said Katherine Clupper, a managing director for the firm Public Financial Management. “So news like Detroit’s bankruptcy as well as the downgrade of Chicago, that all goes to make investors nervous.”

So suddenly, Aunt Mary’s bonds don’t seem quite so safe, just as Philadelphia is about to issue a couple hundred million dollars’ worth of bonds. And we pay more.

The point is that stiffing investors affects a lot of people besides the investors. It’s a reflection of how tough these policy decisions become in a world where the financial system is so connected to everything in the economy.

Philly next time?

One of the things you see now in the media is speculation about which city is the Next Detroit.

The Wall Street Journal’s Sunday editorial “After Detroit, who’s next?” mentions Philadelphia and Chicago in the same sentence along with the entirely inaccurate statement that Philadelphia is “spending 20 percent of its budget on pensions to make up for shortchanging the system.”

It’s true past leaders have shortchanged Philadelphia’s pension system, but Winkler said there’s plenty of proof in the pudding of improved credit ratings that Philadelphia has managed its way through the recession in relatively decent shape.

She noted that when Moody’s Investors Service issued a list earlier this year of about 20 particularly troubled public pension funds, Philadelphia wasn’t on it.

I asked Bond Buyer‘s Paul Burton who, trust me, can bend your ear for awhile about financially distressed cities in the Northeast, what he thinks of the chances for a financial meltdown in Philadelphia’s future.

“Philadelphia is in an improving situation,” Burton said. “They’ve got some good people running it. Nancy Winkler, the city treasurer, is well regarded in her field … the city of Philadelphia is not Detroit, no.”

He did say the school district is a financial “red flag,” which is probably an understatement.

It’s comforting to know that, at least from the viewpoint of creditworthiness, Philadelphia is in relatively good shape. Nobody thinks we’re about to default on a bond payment.

But it’s troubling that we’ve kept our books balanced with a series of tax increases that can’t be good for the economy, and we still aren’t close to funding the school system, much less giving our kids the education they deserve.

But that’s a topic for another day—and the next mayor’s race.