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City Symbolizes Budget Crisis Facing Many Across US

Tuesday, 29 Jun 2010 | 3:01 PM ET

State capital Harrisburg, population 50,000, is only the ninth-biggest city in Pennsylvania. Yet it has become a center of debate over the nation’s brewing municipal fiscal crisis.

Harrisburg, PA
Jeremy Woodhouse | The Image Bank | Getty Images
Harrisburg, PA

Thanks largely to a troubled incinerator project that has failed to generate the expected returns, Harrisburg will owe its creditors a total of $300 million in the coming years, as bonds it floated to help finance the incinerator come due. More immediately, the city has $68 million in obligations for this year—a sum that exceeds its annual budget. And Harrisburg has no clear mechanism for repaying its debts.

The Pennsylvania capital’s financial woes are emblematic of what cities and states are facing around the U.S., where 46 of the 50 states are expected to face budget shortfalls in the coming fiscal year, according to the Center for Economic and Policy Research. For most states, that period begins Thursday. (New York, whose fiscal year begins April 1, is one of the exceptions.)

And Wall Street bond traders are watching what happens in Harrisburg very closely, noting that the city is one of the more troubled bond issuers in a municipal market that figures $2.8 trillion in size, according to Municipal Market Advisors.

The historic rate of default on municipal bonds, which are floated to raise financing for public projects and other public services, is less than 1 percent, according to data kept by Standard & Poor’s. But market watchers think that even with painful cuts to schools, libraries, government jobs and other services, as well as the tax increases that many municipalities are levying, that rate may accelerate as cities and states struggle to close the gap.

Harrisburg on the Brink
Harrisburg, Pennsylvania has become the pollster-child for muni bond default fears, with CNBC's Kate Kelly.

“The severity and length and the depth of this particular recession has stressed state and local budgets,” says Peter Hayes, head of the municipal bonds division at Blackrock , which manages $106 billion in muni bonds. “They’re struggling to find ways to balance these budgets,” he adds, “so the headlines are getting loud.”

Indeed, a top story in the local Harrisburg newspaper late Monday night stated that “Negotiators are working late, but there’s no budget deal yet,” as state lawmakers at the grand capital building in downtown Harrisburg struggled to work out a budget in time for the new fiscal year. By midday on Tuesday, new reports suggested that lawmakers had a tentative agreement in the works.

But the city of Harrisburg remains at an impasse. On one side of the debate over its fiscal conundrum is city controller Dan Miller, a certified public accountant who recently penned a cash-flow analysis predicting that the city would be $7 million in the red by the end of 2010.

Miller argues that the city’s effectively insolvent, and should file for Chapter 9 bankruptcy in order to reorganize its debts. “We can’t handle that $300 million in debt, he told CNBC in an interview Monday. “We’re insolvent, we can’t pay it, so we need to have a clean and defined solution and a break to start all over.”

Harrisburg mayor Linda Thompson, who replaced longtime city mayor Stephen Reed last fall, after winning the support of Pennsylvania Governor Ed Rendell and launching an aggressive get-out-the-vote campaign, disagrees. Thompson says she has plans for improving the city’s fiscal health that include working with consultants to trim costs and sell assets.

“We do have some very valuable assets that we own and operate,” Thompson told CNBC, saying that Harrisburg is home to a large parking system and other real estate holdings.

She added that talks were underway with Harrisburg’s bond insurer, Assured Guaranty, to reach a forbearance agreement. “It’s just a matter of language and we’re close,” she said. Assured Guaranty says it “is working closely with all parties to effect a satisfactory solution to the debt problems” of the city and the incinerator.

Jesse Bergman contributed to this story.

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