A wave of bankruptcies?

The bankruptcy of San Bernardino, population over 200,000, should not surprise anyone. In fact, as we look at it more closely, we can see that a city that has fully embraced the post-WW II development model, riding its boom to the inevitable bust.

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When I was on vacation last week, the city of San Bernardino, CA, entered into bankruptcy. This is the third California city to declare bankruptcy in recent weeks, following Mammoth Lakes and Stockton. A number of people emailed me and wanted my opinion on whether or not this was the beginning of a "wave" of bankruptcies. 

My answer: I really don't know.

Those of you that have been with us a while understand that I don't trust people who make very specific predictions. Such people generally think too much of themselves, assume they know more than they do, or both. If we know a bridge is poorly designed, we can predict with some confidence that the bridge is going to fail. Only a fool would be confident predicting which car in a line of cars will cause the collapse.

These individuals cities, their bankruptcy filings and other financial hardships are the cars driving over the poorly designed bridge. Ultimately, the bridge is the problem. As long as we stick with the post-WW II model of growth for our cities, insolvency is inevitable. 

In fact, we're essentially experiencing default of one type or another in almost every city in this country. In every city that I've ever interacted with, basic maintenance of critical infrastructure is being deferred because the city lacks the immediate cash necessary to complete the task. As maintenance is deferred, the costs expand, a cascade of compounding, future liabilities. Look at your own community and understand that not all defaults will be accompanied by formal bankruptcy filings. Most seem likely to be just a general across-the-board decline.

San Bernardino is interesting, however, because it really is the first major city that seems to be imploding under its own weight. There is a saying in the investment world (most often attributed to Warren Buffet) that only when the tide goes out do you discover who's been swimming naked. In other words, when new growth feeds the system with cash, even the most poorly managed cities can look well run. Slow that growth, take away their redevelopment assistance and all of a sudden the ones that have been really gaming it are quickly exposed.

While there are some reports that San Bernardino may have be gaming it with some illegal activity, that doesn't seem to be the cause for their literally running out of cash. San Bernardino has a budget for 2011/2012 of $258 million. That is an enormous sum of money. Reports on the bankruptcy suggest that labor costs and pensions are the problem, but it is hard to believe that the $1.2 million increase in pension funds would create the immediate conditions for bankruptcy. In other words, pension obligations may break them over time, but it is not the reason they have no money in the bank today to pay their bills.

San Bernardino's portion of its employee pension costs has risen to $2.2 million in the current fiscal year from $1 million in fiscal 2006-2007, according to a report on the city's website.

And while it is true that police and fire constitute large expenditures, combined they only amount to a third of the budget. My experience says that 1/3 public safety, 1/3 infrastructure and 1/3 general government is within fairly normal ranges. If the city's firefighting union does only contain 122 members as reported in this article, the city is spending $253,000 per fire fighter, which seems extraordinarily high. Undoubtedly a lot of that goes to equipment and training, but salaries make an easier target for those upset about expenditures.

Steve Tracy, a fire engineer and spokesman for the city firefighters' union, said the city's labor groups had already given $10 million in concessions. He cited the mayor and former city manager's pet projects, including a call center and new movie theater downtown, as reasons for the $46-million deficit.

"Before you start putting blame on the labor groups, get your own fiscal house in order," he said.

While San Bernardino experienced the rapid growth of the second and the bubble period of the third life cycle of the Suburban Experiment, that growth never really translated into community wealth. The typical resident of San Bernardino is not only 17 years younger than the average Californian, they live in a house valued at less than half the California average and that household in total brings home less than 60% the state's typical.

Despite this, they have a rather low density at 3,569 residents per square mile. By comparison, Detroit -- which is dealing with contraction as its population comes to grips with the fact that its tax base is far out of balance with the liabilities of its horizontal expansion -- has a density of 5,144 residents per square mile. If you bristle at the Detroit comparison, consider that, when adjusted for localized cost of living, the typical San Bernardino resident makes only 7% more, not enough to live as large as they are pretending to be able to (that is, if you consider strips malls, bland subdivisions and big box retail to be living large).

The average house in San Bernardino costs 2.7 times more than the average Detroit house as well, although the spread on rents is only 18%. All this tells me is that housing prices have a lot further to fall in San Bernardino. House prices will need to fall -- or rents increase -- another 50% for a 30-year mortgage to cash flow as a rental property. Without significant wage inflation, which itself would cause numerous financial hardships, it is not clear how rents could rise substantially.

From all outside appearances, it seems that the business of San Bernardino -- the apparent reason for it existing -- was to build San Bernardino. A full 13% of the work force is still in construction, with much of the other employment coming in secondary, service industries (education, health care, etc...). The city was #11 on the list of Top 101 cities with the largest percentage of males in the construction and extraction occupations (#16 for females). City budgets still show huge revenue projections for permit fees, plan review fees and development impact fees.

I can' find anything substantively produced in San Bernardino. They have two Targets, two Home Depots, a Walmart, Sam's Club, Costco, four Walgreens and eight McDonalds. It is not clear where their money comes from (likely it came from mortgages and equity loans), but it is clear that an enormous percentage of it that leaks out of the community each day. 

As Jim Kunstler has said of his Long Emergency insights, "we're in the zone". If we go a year before we have another bankruptcy or have dozens in the next couple of months, it would not surprise me either way. Ultimately, though, since nearly every U.S. city has embraced the same development model, all local governments are going to have to deal with these issues on some level.

The time to start adopting a Strong Towns strategy is now.

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