The American federal debt problem is well known. There are famous debt clocks which are tracking the increase in American federal debt. However, that calculation does not take into account the true scale of America’s debt problem. This is because the American federal debt is out of control. This is a known fact.

However, many investors do not know about the fact that the American municipal debt is also out of control.

Very few publications have been tracking and reporting the municipal debt situation in America. Forbes in one of them. Forbes has repeatedly mentioned that more than 75% of the top cities in America are essentially broke.

It has also reported that the financial condition of the top three cities is extremely serious and that they could face bankruptcy very soon.

In this article, we will have a closer look at America’s municipal debt problem.

The Current Municipal Debt Situation

The municipal debt situation in America is frightening, to say the least. Top American cities face a combined debt shortfall of over $530 billion. The top cities are the biggest contributors to this number.

For instance, according to the Forbes report, New York alone is facing a debt shortfall of close to $190 billion. It has assets worth $60 billion whereas its liabilities are estimated to be around $250 billion. This number means that every resident of New York City has a municipal debt of about $64000.

This makes the situation scary since the median income in New York is close to $60,000. Hence, more than 50% of New Yorkers owe more than their annual income in municipal taxes, and most of them are not even aware of this situation.

The situation is equally bad in Chicago as well. The municipality of Chicago owes over $45 billion to its bondholders. However, it only has assets of $10 billion to make good on its promise. Hence, there is a debt shortfall of about $35 billion.

The absolute numbers are smaller when compared to New York, but the percentages are quite similar. Also, the per capita debt amounts to $36000 for Chicago residents. This is also a sizeable number since the income earned by Chicago residents is lower than what is earned by New Yorkers.

There are many other cities like Los Angeles which have a smaller but sizeable problem. Every Los Angeles resident owes about $6000 in municipal tax debt. The problem is that none of the American cities have a municipal debt surplus. All of them have a shortfall. Some shortfalls are manageable whereas others are simply staggering.

How Did The Situation Get So Bad?

Investors are now starting to pay attention to the American debt situation which has worsened dramatically over the past few years. However, the question arises as to why the American municipal debt problem has gone largely undetected until now. Some of the important reasons have been listed below:

• Firstly, the credit rating agencies have failed to report on the worsening debt situation. This is because of the fact that they are mostly paid by the municipalities themselves. The credit rating framework needs to be improved so that investors are made aware of the risks that they face
• The municipalities have been using accounting tricks which allows them to understate their liabilities. For instance, the financial position of Chicago is understated by $3 billion. Most of these accounting shenanigans are done while reporting future pension liabilities. It is estimated that only about 75% of the total pension liability has been reported by the municipalities.
• The pension schemes being used by these cities are increasingly complex. They allow politicians to make false claims that the budgets were balanced. As a result, many of these politicians get re-elected which further exacerbates the problem.
• Cutting pensions and raising taxes are the two ways in which the problem can be solved. However, given the left-leaning nature of the present generation, such measures would immediately make any politicians unpopular. Hence, in order to stay in office, the politicians are allowing the freebies to continue which is creating a massive debt crisis in America.

Why Do Investors Keep Lending To Cities And States?

Not all investors are unaware of the financial mess that many cities are in. However, they still continue to lend to them. The reasons for the same are as follows:

• Just like federal debt, the state debt and municipal debt is also backed by an unlimited ability to tax the citizens and pay back the debt. Also, in principle, state and municipal governments cannot really default on their debts. Hence, the investors are relatively sure of receiving back their principal as well as interest. This is the reason that they continue to give money to state governments.
• Secondly, investors also know that the federal government would not let the states go bust. If the banks were too big to fail, then the states definitely are! Investors, therefore, look upon the creditworthiness of the American federal government and the Federal Reserve before they lend to states and municipalities.

The bottom line is that unless the federal government takes some action from preventing more debt from accumulating, this situation will continue worsening.