More city bankruptcies on California horizon?

San Bernardino declaration raises questions over which city is next

LOS ANGELES (MarketWatch) — Is a high foreclosure rate a possible indicator of municipal bankruptcy? And is there an epidemic looming?

Experts say high foreclosures do seem to be at least a symptom of a possible local financial meltdown after San Bernardino became the third California city in just a few weeks to declare itself bankrupt. But it’s rare that a city tumbles into bankruptcy, and it’s unlikely that high foreclosures alone will cause it.

Foreclosure capitals
Cities with the highest foreclosure rates

RANK	CITY	RATIO OF TOTAL HOMES PER FORECLOSURE
1	Palm Bay, Fla.	170
2	Visalia, Calif.	174
3	San Bernardino, Calif.	179
4	Vallejo, Calif.	180
5	Stockton, Calif.	195
6	Modesto, Calif.	199
7	Bakersfield, Calif.	205
8	Atlanta, Ga.	224
9	Phoenix, Ariz.	245
10	Chicago, Ill.	252

Source: RealtyTrac

San Bernardino, roughly an hour east of downtown Los Angeles, follows Stockton from the state’s agricultural center — the largest municipal bankruptcy to date — and the Sierra Nevada mountain community of Mammoth Lakes. While the Mammoth Lakes insolvency is due largely to a hefty court judgment against that city, Stockton has a regular presence at or near the top of the most-foreclosed cities list, along with San Bernardino.

Also near the top of that list is Vallejo, in the San Francisco Bay Area. Vallejo declared bankruptcy in 2008 and has been embroiled in a protracted battle with creditors ever since.

“They were hit disproportionately by the housing slowdown,” said Stephen Levy, director of the Center for Continuing Studyof the California Economy. “They were just hammered.”

The connection is easy to make. A high foreclosure rate often is an indicator of lower property values in a region, as it usually is a drag on prices. The lower the property values, the less revenue a city gets in taxes, one of its key sources of income.

Levy says it’s not just lower property values that are hitting city coffers; municipalities throughout the state are having to contend with ever-increasing pension costs for public-safety personnel. But all cities are having to deal with that, and so a region’s property values are the biggest variable that can affect a budget, he says.

Leslie Appleton-Young, chief economist of the California Association of Realtors, says property values in San Bernardino County experienced a 65.6% drop from their peak of $350,290 in August 2006 to their trough of $120,410 in May 2009.

Prices have come up a bit in the region that includes San Bernardino and neighboring Riverside since then, but values are still less than half of what they were at the peak, she said.

“It’s definitely off the bottom, but it’s still well off the prices we saw a couple of years ago,” Appleton-Young said.

Along with the Vallejo, San Bernardino and Stockton regions, other California mainstays on the highest foreclosures list include the inland cities of Modesto, Bakersfield, Merced, Fresno and the state capital of Sacramento.

Also high on that list are a number of cities in states bordering California — including Las Vegas, Reno and Phoenix — as well as a number of towns in another warm-weather state: Florida. The Palm Bay region is at the top of RealtyTrac’s most-foreclosed city list for May, and not far from the top 10 are three other Florida cities: Cape Coral, Tampa and Miami.

Does that mean these cities are vulnerable to bankruptcy? Not so fast, says Jeffrey Esser, executive director of the Government Finance Officers Association in Chicago.

“Bankruptcies are very rare,” Esser said. “Three does not make a trend. But keep an eye on California and see if there are others.”

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He points out that this most-recent recession has been the strongest since the Great Depression, and thus the hardest hit ever for California cities under the 1978 landmark measure that slashed property taxes in the state, Proposition 13.

“Proposition 13 put severe constraints on revenue,” he said. “Yet the cost of running government continued to go up.”

His sentiments were echoed by Dick Larkin, senior vice president and director of credit analysis for Herbert J. Sims & Co. Larkin said in a note to clients Wednesday that he doesn’t see a wave of insolvency across the country.

“I am worried, however, that this phenomenon may grow in California, which still feels the effects of 1978’s Proposition 13 that dramatically lowered property taxes,” he wrote. “Were that to happen, bond issuers in the state (including the state itself, which plans a $10 billion note issue in a few weeks) may be painted with a ‘scarlet letter’ of ‘B’ for bankruptcy.”

Also troubling to Larkin is the swiftness with which San Bernardino voted for insolvency. When New York and Philadelphia teetered on the brink of bankruptcy in the 1970s and 1980s, respectively, city leaders resisted and instead developed five-year plans to balance their books.

“The city, like most around the country, had been facing flat or declining tax revenue and growing expenditures. However, there had been no public inkling of the magnitude of San Bernardino’s budget problems in 2012; the city’s normal budget process was disrupted with the departures of the city’s manager and assistant manager in April,” he said. 

Russ Britt is the Los Angeles bureau chief for MarketWatch.