Bankrupt, USA: Why our cities aren't too big to fail

by Kit R. Roane, September 15, 2010: 5:48 AM ET

FORTUNE -- Harrisburg, Pennsylvania, has dodged a debt bullet. The only problem is that the gun is still loaded.

The Keystone State's cash-strapped capital was scheduled to default on a $3.3 million bond payment on Wednesday. It avoided that debilitating fate when Pennsylvania's governor, Ed Rendell, pledged to resolve the problem with $4.4 million from the state's own challenged coffers.

This gives Harrisburg a chance to fight again another day. But its problems are far from over, and that's bad news for investors in the $2.8 trillion muni-bond market.

States from California to Illinois have been in deep crisis since the recession began, hammered by drastic cuts in tax revenue and inflexible spending demands for things like health care, debt service and pension plans. Forty-eight states grappled with fiscal shortfalls in their 2010 fiscal budgets. Totaling $200 billion, or 30% of state budgets, this fiscal shortfall is the largest gap on record, according to the DC-based Center on Budget and Policy Priorities, which sees at least 46 states facing shortfalls this fiscal year.

Some cities are in even worse shape than Harrisburg. Central Falls, Rhode Island, recently went into receivership when it couldn't pay its bills. San Diego is said to be considering bankruptcy to get out from under its pension obligations. Miami's city council, hoping to avoid Harrisburg's fate, recently used emergency powers to slash city salaries and pensions and is now instituting hefty traffic fines and garbage fees. This year, ratings agencies have cut the debt in several cities -- including Littlefield, Tex., Detroit, Mich. and Bell, Calif. -- to junk.

Harrisburg's default on bond payments for its ill-fated $288 million incinerator project would have given it the dubious distinction of birthing the second-largest default on general-obligation municipal bonds this year. The largest default was on $227 in municipal warrants issued by Jefferson County, Alabama. Given that general obligation bonds are backed by the full faith -- and taxing power -- of the issuing government, and aren't supposed to default, even the hint of strain with such a bond is worrisome.

Buffett's prediction: Stiffing creditors 

The growing perceived risk has sent a few municipal bond buyers in search of safer pastures. Warren Buffett's Berkshire Hathaway (BRK-A), which doubled its municipal bond holdings as investors fled the sector between June 2008 and March 2009, was more recently selling its municipal bond investments and moving to shorter maturities. The reversal followed Buffett's February 2009 investor's letter, where he noted that city councils were much more likely to skin bond insurers and bond investors than their own constituents.

He said the trend will begin when "a few communities stiff their creditors and get away with it." His municipal bond insurer, Berkshire Hathaway Assurance Corporation, also quickly pulled back from the market that year, insuring less than 8% of the $600 million in municipal bonds it guaranteed in 2008.

The problem, he told the US Financial Crisis Inquiry Commission this June, is that nobody really knows what state and major city municipal bonds are worth. Calling the municipal debt market "troubled," he opined: "If the federal government will step into help them, they're triple-A. If the federal government won't step in to help them, who knows what they are?"

Many participants in the municipal bond market, which is made up of more than 50,000 different issuers and more than 1.5 million issues, see concerns like those voiced by Buffett as overblown. After all, most states are likely "too big to fail" in the federal government's eyes. And, no matter how you slice it, defaults have remained exceedingly rare over the last thirty years.

According to Moody's, the ten-year default rate for investment-grade municipal bonds in recent decades has hovered around six-tenths of a percent. Dominic Frederico, the CEO of Assured Guaranty (AGO), a bond insurer, told attendees at an investment conference last week he calculates there have been only 60 municipal bond defaults through August 2 and that most of these defaults were not investment grade. The numbers, he said, show no evidence of a crisis at hand.

Defaults on the rise

That's just the sort of data that has kept a multitude of yield-hungry and tax-averse investors flocking to the sector. In August, investors plowed more than $1.2 billion a week into municipal bond funds. They invested a record $69 billion in new money there in 2009, up from just $7.8 billion in 2008 according to the Investment Company Institute. High-yield --or "junk" -- bonds have been exceedingly popular too.

But defaults on municipal debt have been rising, according to the Distressed Debt Securities newsletter, which says defaults rose from $349 million in 2007 to $7.77 billion in 2008. They have breached $4 billion so far this year, according to Bloomberg, despite heavy stimulus injections and other dollops of federal aid. Also, while AAA-rated bonds rarely go down the drain, the more speculative grades don't always stand up so well, with bonds rated B to C having ten-year cumulative default rates of 11% to 13% even in good times.

Municipal bond defaults could continue to rise even if the economy gains a footing. According to the US Government Accountability Office, despite the federal help, state and local governments continue to operate in the red. Without massive austerity, the GAO predicts their fiscal positions will continue to worsen for the next fifty years.

The problem is that the vast majority of municipal bond investors these days tend to be of the mom and pop variety and they are not generally being compensated much for risk. As Bond Buyer notes, heavy investor demand last month pushed "10-year tax-exempt yields below 2.20% and 30-year munis lower than 3.70% for the first time in history."

Despite the Pollyannaish view expressed by such a yield, critics fear that you don't need another Panic of 1873 -- when ten states, including Alabama, Arkansas, Tennessee, Michigan and Minnesota, defaulted on their municipal debts -- to seize up the system.

Drop dead

Perhaps not even something like the famed default of New York City during the Gerald Ford administration in 1975 would be needed to instigate a panic. Rapidly rising interest rates would be enough to wipe the smile off many retail investors in muni-bond funds. A few smaller but well-known municipalities threatening default could send them fleeing for crowded exits.

And crowded they would be. Despite the liquidity of municipal bond mutual funds and ETFs, their underlying bond holdings trade far less often. The "new normal" hasn't helped matters, noted bond giant Pimco this January, explaining that many of the major broker dealers in the municipal space -- Bear Sterns and Lehman Brothers for instance -- are no longer with us, while many of the major liquidity providers there, such as single strategy municipal hedge funds, "collapsed or were shut down."

Nor is a wave of defaults off the table just because they have not occurred in recent decades. Before the housing downturn, real-estate bulls saw housing prices laddering to the sky and often noted that real-estate prices had never declined nationwide -- until they finally did.

As Richard Bookstaber, the senior policy advisor at the Securities and Exchange Commission wrote in a blog post this April, the municipal market is massive, leveraged and opaque, blessed by questionable analyst ratings and backed by revenues already mortgaged off to someone else.

In other words, it bears all the hallmarks of a crisis in waiting.

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Shaolin warrior monks take a leap of faith

Bryce Hallett

Leaps of faith ... Belgian choreographer Sidi Larbi Cherkaoui and one of the 17 Shaolin monks demonstrate their acrobatic skills in Sutra. Photo: Hugo Glendinning

A troupe of high-flying Buddhist monks cured a renowned choreographer's creative fatigue, turning modern dance on its head in the process, writes BRYCE HALLETT. 
 
In the political arena, cultural exchange suggests a formal diplomatic arrangement aimed at broadening horizons or engendering a level of mutual understanding and trust. In the arts world, it is more about loosening stereotypes, creative leaps of faith and breaking down barriers to achieve original and adventurous forms.
An unlikely cross-cultural partnership, and one of the big touring success stories of recent years, is the acclaimed contemporary movement piece Sutra, which was commissioned by the British dance house Sadler's Wells in 2007. It opens in Sydney this week for the Spring Dance season at the Opera House.

Directed, choreographed and performed by the Moroccan-Belgian dancer Sidi Larbi Cherkaoui, the East-meets-West collaboration fuses contemporary European dance, the martial arts feats of 17 Buddhist monks from the Shaolin Temple in China, an ingenious set of wooden boxes by the British sculptor Antony Gormley and an original score by the Polish composer Szymon Brzoska.

Leaps of faith ... Shaolin monks demonstrate their acrobatic skills in Sutra. Photo: Hugo Glendinning

Cherkaoui, 34, came to notice when he won a Belgian dance contest in 1995 by creating an energetic jumble of hip-hop, classical ballet and African moves. The judges were reportedly spellbound. His strength, agility and vulnerability caught the eye of the visionary Alain Platel, whose Compagnie C de la B has trained and influenced many of the world's leading dancers.

Cherkaoui says creating Sutra was a rewarding but daunting experience, not least because it meant earning the trust and involvement of the young warrior monks, who are aged between 20 and 22. "They follow a strict Buddhist doctrine and the challenge was to gain their acceptance, then inspire them to expand their perspective about the role of martial arts," says Cherkaoui, who began his career as a hip-hop dancer. "Kung fu and tai chi are integral to their faith and it was important to observe their culture from within."

The innovative and prolific choreographer, who performed Zero Degrees with his friend and kindred spirit Akram Khan at the 2007 Sydney Festival, spent months in the remote mountainside monastery near the city of Dengfeng in Henan Province. He observed a religious life that puts the individual in a system of ritual and discipline, and joined the increasingly receptive monks for meals, exercise and meditation.

Shaolin monks demonstrate their acrobatic skills in Sutra. Photo: Hugo Glendinning

"I didn't go in [to the temple] with a plan but with an open mind and heart. I remember saying to a friend who encouraged me, 'But what could I be doing?' I couldn't see the outcome but when I was there I saw the potential. The monks were intrigued by me and I was intrigued by them. I realised I could apply my knowledge to their rituals and adapt their precise movements – the powerful kicks and daring backflips – into something transformative, dramatic, mysterious and exciting."

Ever curious and open to ideas (Cherkaoui is a big fan of Bruce Lee's high-flying virtuosity), the loquacious choreographer says his pilgrimage was both personal and practical, and motivated by a desire to regenerate his ideas and overcome creative fatigue.

"At the time I was looking for a new way of expressing myself," he says. "The Shaolins were wonderfully open and relaxed around me. During our initial encounters, we spoke a lot about how their kung fu training and mastery connects with the outside world and how they relate spiritually to animals and the environment."
Despite the lack of heating and other comforts, Cherkaoui says he felt at home and was tempted to stay for as long as he could. It helped, of course, that he doesn't drink, smoke or eat meat.

He says Sutra's gradual blossoming into a multi-faceted movement piece was unforced, well-organised, rigorous and mutually engaging. "It was fascinating to see how much common ground we had and, amazingly, their way of expressing some things turned out to be similar to my own Belgian humour. There was lots of laughter."

Meanwhile, Gormley, who also collaborated on Zero Degrees, was busy designing the 21 open-sided spruce boxes that would eventually adorn the stage and be used to create an array of striking images, including lotus flowers, skyscrapers, mazes and burial grounds.

The Turner Prize-winning sculptor's work is as much about the body as it is about the incongruous landscapes in which he locates his figures. He relished furthering his artistic partnership with the supple and strong Cherkaoui. He also spent time at the Shaolin Temple. Working on Sutra allowed him to nourish his spirituality while returning to the vocabulary of dance.

"To me, dance is one of the most direct art forms there is and one of the most poetic and vulnerable," Gormley says. "The monks have a wonderful freedom of spirit and they're as interested in hip-hop and contemporary culture as they are in the Buddhist sutras."

Gormley, who had spent two years in India living in monasteries and practising meditation in his youth, quickly responded to the physicality of the monks and the austerity of their environment. His coffin-like boxes were partly inspired by his earlier travels to China, where he was astonished by the compartmentalised domestic arrangements for young girls at a factory he visited. The image of five or six beds stacked on top of the other came to mind when he saw the dormitory arrangements in the monastery. It got him thinking, then creating a set design he imagined would be static. Cherkaoui, who grew up enchanted by the expressive and liberating movements of Kate Bush and Madonna, had other ideas.

No sooner had the boxes arrived than the super-fit Shaolins attentively responded to the choreographer's playful instructions as they manipulated the set pieces to form a variety of patterns and forms in which they could hide, spring out, make walls or topple them like dominoes.

"It reminded me of when I was a child playing with Lego," he says "The monks don't speak English and communicate through gesture; they are soulful and talented. Some are naturally artistic while others don't know how to separate performance and life. Their whole Shaolin philosophy is based on discovery and self-discovery and a healthy sense of how to handle suffering."

Cherkaoui says his time in the monastery recalled the hothouse environments of Les Ballets C de la B and the Royal Danish Ballet. For someone who has spent much of his career exploring notions of identity and the role of the collective, he found much in common with the monks. "The monks all commit to the Buddhist way, to the same thing, and their shared ritual assumes profound meaning when set against all the communities that are divided and where people are either oppressed or trying to break free."

Having grown up Muslim in Belgium, Cherkaoui is acutely aware of what it is like to be an outsider and he says becoming a choreographer was his response to this. "It's given me the freedom to explore my own language and [to] blur the lines of gender. My education was always as an individual and having to find your own thing . . . I'm still looking for purpose and it has a lot to do with my family. My parents were very divided people. They loved each other but [they] were struggling with each other in a culture of two extremes. It's that continual ping-pong: do you stay true to yourself or do you abandon yourself to the other; there is no real happiness either way."

Sutra is at the Sydney Opera House from Thursday to Sunday, September 19.

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Renovation Under Way: China Property Developers Making Longer-Term Investments

By RUSSELL FLANNERY

 

Many of the entrepreneurs that today rank as China’s richest real estate developers made their early money from selling apartments to the country’s growing middle class. Focusing on apartments and residential property made sense: residential projects generated cash quickly for then-young businesses that didn’t have much financial staying power when the government first opened up the industry more than a decade ago.
Yet as successful companies have built up their resources and even gone public, they are increasingly looking to make longer-term investments in commercial property such as office buildings and malls that can generate long-term income from rents. “A lot of big local developers have emerged in the last five years or so, and they want to build a stand-alone portfolio of office buildings and malls,” Steven McCord, associate director of research at Jones Lang LaSalle said in a meeting of the Shanghai Foreign Correspondents Club on Thursday.

The speed of that push varies across different markets in China, but the longer-term trend is clear, McCord said. Companies that once focused on residential property that have become more active in commercial investments include China Vanke, Shimao Property Holdings, CR Land and Greentown China, he says.

The change is part of an evolution of the real estate industry in China since the country launched its economic reforms three decades ago. When government opened the way for the private capital in the 1990s, young local developers didn’t have the money to make long-term investments. So in Shanghai, for instance, many of the office buildings put up in that era were built by relatively well-off overseas Chinese, especially from Hong Kong. Among them: iconic Plaza 66 along Nanjing West Road, which was developed by Hong Kong’s Chan family. Younger domestic private sector developers focused on housing projects that would generate cash flow quickly.

Over time, however, they added mixed-use residential-commercial sites that at a minimum included retail space for shops to serve the nearby residents and were able to produce long-term income from rents, rather than just one-off revenue from selling the space. Now, some are even in the process of building office towers, McCord says.

Growing single-investor ownership of buildings would be good for the stability of property markets in the country. Sole owners of whole buildings usually have the financial wherewithal to make it through market downturns, McCord says.

Shanghai’s Lujiazui office district, for instance, a decade ago had a vacancy rate of more than 40%, but it didn’t turn into a full-blown financial crisis because the owners could ride out the storm and carry the property on their books.

Growing interest in commercial property may also be good news for real estate consulting companies like Jones Lang LaSalle that help manage property. It would also benefit companies such as E-House of Shanghai, which recently set up a property management subsidiary.

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