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The small city of Central Falls, R.I., appears to be headed for a rare municipal bankruptcy filing, and state officials are rushing to keep its woes from overwhelming the struggling state.<\/p>\n
The impoverished city, operating under a receiver for a year, has promised $80 million worth of retirement benefits to 214 police officers and firefighters, far more than it can afford. Those workers\u2019 pension fund will probably run out of money in October, giving Central Falls the distinction of becoming the second municipality in the United States to exhaust its pension fund, after Prichard, Ala.<\/p>\n
\u201cTime is running out,\u201d warns Robert G. Flanders, the state-appointed receiver, who recently closed the public library and a community center to save money. He has no power to cancel the city\u2019s contracts with workers, so instead he has begun approaching retired police officers and firefighters with what he describes as \u201cthe Big Ask\u201d: will they voluntarily accept smaller benefits in the name of saving Central Falls?<\/p>\n
Central Falls, R.I., promised more in pensions than it could afford and the fund is expected to run out in October. Central Falls is just over one square mile, i.e. tiny and poor.<\/p>\n Members of a community center in Central Falls, R.I., closed because of city budget problems, saying good-bye.<\/span><\/em><\/p>\n Some of the retirees are in their 90s, and Central Falls, like many American cities, has not placed its police and firefighters in Social Security. Many have no other benefits to fall back on.<\/p>\n State lawmakers are trying to contain the damage, mindful that it would be a bad time for any state to seek help in Washington. Last month they rescinded an offer of state aid to Central Falls, just after Moody\u2019s downgraded the city\u2019s credit to \u201cpossibility of default.\u201d<\/p>\n But the state still has risks related to the woes of its municipalities, risks that have gone largely unnoticed because it is not as big as, say, Illinois and California. Several other Rhode Island cities are sinking under big debt burdens. Even Providence, the capital, risks running out of cash in September, according to its auditor, and if it scrapes by until October, it must then come up with $60 million for its own municipal pension plan.<\/p>\n Some analysts fear that a Central Falls bankruptcy, and a whiff of other problems out there, could scare nervous investors away from bonds issued by Rhode Island\u2019s other municipalities, perhaps setting off a chain reaction that could push the state itself to the brink. There is a precedent: the last American state to default on its bonds, Arkansas in 1933, got in over its head by trying to help struggling municipalities.<\/p>\n More recently, when local governments have veered toward bankruptcy \u2014 Orange County, Calif., in 1994; Cleveland in 1978 \u2014 neighboring municipalities have found it harder to sell their own debt. During the New York City fiscal crisis of 1975, New Jersey suddenly found its bonds harder to sell.<\/p>\n \u201cThat type of contagion is what you\u2019re trying to avoid,\u201d said James E. Spiotto, a bankruptcy specialist at the law firm Chapman & Cutler, who is not involved in Rhode Island\u2019s problems.<\/p>\n Rhode Island has an investment-grade credit rating, but it is in no position to bail out a string of teetering cities, or take over their shaky local pension funds the way the federal government does when some companies go bankrupt. The state treasurer, Gina M. Raimondo, says Rhode Island must first stabilize its own pension fund, which continues to require more and more cash each year, despite four overhauls since 2005 that were supposed to get the cost under control. The Securities and Exchange Commission is investigating. If the state turns out to have understated its commitments, it could deliver a new jolt to bond markets still nervous after two traumatic years.<\/p>\n Lawmakers in Rhode Island are trying to reassure investors. On July 1 they passed a law giving certain bonds, known as general obligations, legal priority over all other payments that municipalities must make, including retirement benefits. The measure, awaiting Gov. Lincoln Chafee\u2019s signature, also requires Rhode Island\u2019s cities, towns and districts to dedicate their general revenue to paying bondholders first, and to raise property taxes as much as necessary to make all payments to bondholders on time.<\/p>\n It gives less secure types of bonds priority, too, and makes local officials personally liable for any losses they cause by failing to comply with the new requirements.<\/p>\n When the city of Vallejo, Calif., declared bankruptcy in 2008, no one thought it would ripple out over the whole state. Partly that\u2019s because California has shock absorbers: laws on the books that assure bondholders they will be paid and a big, diverse state economy that could bail out a distressed city if need be.<\/p>\n Rhode Island is different. There are only 39 cities and towns in the state, so one troubled city cannot easily fade into the background. And there is not just one troubled city. Recent tests found one in four in some degree of distress.<\/p>\n A startling number have stumbled by trying to operate their own tiny pension funds for selected groups of workers, rather than participating in a state-run pension system for municipalities. There are 36 of these local pension funds, and 23 have been designated at risk, with Central Falls the most endangered. A legislative report found that eliminating all their shortfalls would cost more than the total statewide property tax levy.<\/p>\n In Central Falls, the receiver looked into whether the state-run pension system for municipalities could take over the local plan, but found that a radical restructuring would have to come first.<\/p>\n The city, just north of Providence, is small and poor, but over the years it has promised police officers and firefighters retirement benefits like those offered in big, rich states like California and New York. These uniformed workers can retire after just 20 years of service, receive free health care in retirement, and qualify for full disability pensions when only partly disabled.<\/p>\n Just over one square mile, Central Falls has a tightly packed population, filled mostly with immigrant families, that struggles on a median household income of less than $33,520 a year, according to the Census Bureau\u2019s 2005-9 American Community Survey. The typical single-family house, after a recent revaluation, is worth about $130,000. It is hard to see how anyone thought such an impoverished tax base could come up with an additional $80 million for retirement benefits. If the city were contributing the recommended amount to the plan each year, it would take 57 percent of local property tax revenue.<\/p>\n Daniel L. Beardsley Jr., executive director of the Rhode Island League of Cities and Towns, said it was not the city\u2019s idea. Other states limit what can be decided in collective bargaining, but Rhode Island\u2019s law says that for police and firefighters, \u201cwages, hours and any and all terms or conditions of employment\u201d are subject to negotiation.<\/p>\n \u201cThat means even the length of a mustache,\u201d said Mr. Beardsley, who over many years has represented Central Falls and other municipalities in contract negotiations. Talks broke down more often than not, he said, and then the same state law called for binding arbitration, which for many years was a clubby process that emphasized comparable benefits all across the state more than any city\u2019s ability to pay.<\/p>\n \u201cIt was a domino effect,\u201d he said, leaving Rhode Island with the nation\u2019s highest per capita spending for fire services and sixth-highest for policing. (The binding arbitration law does not apply to public workers other than police officers and firefighters in the state, although some want it extended to teachers.)<\/p>\n Central Falls is already spending about a fourth of its budget on employee benefits, and that will rise sharply when the pension fund is exhausted. Mike Andrews, president of the local firefighters\u2019 union, said about one in four of his men now qualified for retirement, but were afraid to retire, concerned that their pensions would be chopped in bankruptcy.<\/p>\n \u201cWe\u2019re always willing to come to the table and try to work something out,\u201d he said. \u201cWe want to get this corrected as much as anyone, because if it doesn\u2019t get corrected, we suffer.\u201d<\/p>\n What can go wrong with the high-yielders? Like NLY.<\/strong><\/span><\/p>\n First, to go “wrong:” <\/span> <\/strong><\/span>higher interest rates.\u00a0 Annaly borrows short and lends long. They also use lots of leverage, so when their margins get squeezed, they’ll get really squeezed.<\/p>\n But I believe interest rates will stay low for a long long time, given the abysmal nature of the economy and the Administration’s efforts to boost it with monetary policy, i.e. low interest rates.<\/p>\n NLY seems to agree with me since they just announced\u00a0 a 100 million share sale, to raise over $2 billion. You don’t sell mega-tons of shares if you think your business is going to hell and a handbasket.<\/p>\n If\u00a0 you believe as I do that\u00a0 interest rates will be low for some substantial time, then you must believe\u00a0 that NLY will continue to perform well.\u00a0 When you can borrow at almost zero and lend for four or five percent, the leverage returns are gigantic.\u00a0 Thus, the high yield.<\/p>\n Of course, since it works the same way in reverse, the yields will drop quickly when rates do rise.\u00a0 Probably can wait until the first significant cut in the distribution.\u00a0 However, when that happens, the price of the shares will have already dropped (probably by more than 10%).\u00a0 The drop will in all likelihood wipe out a year’s worth of returns.<\/p>\n If it drops sufficiently to wipe out a year’s worth of dividends, NLY would have to drop to $15.30 or so. This has happened and is the risk with NLY (and others of its mortgage REIT ilk). Here’s NLY over the past ten years. Don’t forget: You’re not looking at this stock for capital appreciation. You’re looking at it to hold, while you savor its nice 14.4% dividend yield — at last night’s close of $18.05 — which is higher than the $17.70 the company is selling 100 million new shares at. That must tell you something.<\/p>\n![\"\"](\"https:\/\/www.technologyinvestor.com\/wp-content\/uploads\/2011\/07\/CentralFalls.jpg\" "\\"CentralFalls\\"")
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