The Death of the Financial Crisis Has Been Greatly Exaggerated

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Despite rumors to the contrary, the financial crisis is far from over. After starting in America's bloated mortgage market and morphing into a sovereign debt crisis in Europe, it may now be headed back to U.S. shores with a vengeance, as the country's cities begin staring down the barrel of debt-fueled insolvency themselves.

Stockton, Calif., is the biggest American city ever to file Chapter 9, but it likely won't be the last. The crash of 2008 may have only been the beginning of America's economic pain.

Agricultural heaven, municipal-debt hell
Stockton is a city of 291,000-plus located 50 miles east of San Francisco, in the nutrient-rich San Joaquin river delta. With its thousands of miles of canals, Stockton and the delta form an agricultural heaven for California and the U.S., supplying 25% of the country's food.

But with $700 million of debt currently on the city's books, Stockton is also a municipal-debt hell, a direct result of the real estate crash and soaring employee pension costs.

When the housing market was booming, real-estate taxes made the city flush with revenue, which it used to bankroll expensive revitalization projects. But once the real estate market collapsed, the previous river of taxes turned into a trickle, while demands on the city's money by pensions and health-care expenses remained heavy.

With no place else to go to make up the difference in its resulting budget deficit, the city turned to the bond market, which doesn't suffer fools gladly.

Hell hath no fury like the bond market scorned
The bond market is what's currently strangling Europe half to death. With sovereign debt in so many European countries reaching previously unheard-of levels, the bond market has started making that debt unsustainably expensive.

When Ireland could no longer afford to pay on its debt, it was bailed out by the European Union and effectively shut out of the bond markets. It's the same story for Greece, and might be the same story soon for Spain and Italy. Saddled with plenty of sovereign debt of its own, the U.S. has avoided the wrath of the bond market so far because it's still, somewhat remarkably, seen as a safe haven.

As a result, when there's economic trouble anywhere in the world, investors rush into U.S. Treasury bonds, keeping our interest rates artificially low. U.S. debt is about as cheap as it can get right now, but this may not always be the case.

The labors of Hercules and Lincoln
Stockton isn't the only city currently on the Chapter 9 chopping block. The Wall Street Journal reports that Hercules, Calif., and Lincoln, Calif., are in the process of debt restructuring. Harrisburg, Pa., may also soon seek bankruptcy protection, the second time it's sought shelter from its creditors in two years.

Perhaps most disturbingly, Moody's Investor Service has issued a warning that Detroit has a high risk of potential default or bankruptcy. Detroit has a population of more than 700,000 and was once a thriving American city on par with any of the country's other great industrial towns, such as Chicago, Pittsburgh, and Cleveland.

Going from bankruptcy in Stockton to bankruptcy in Detroit is less a step than an Olympic-level leap.

California here we come, right back where we started from
In the run-up to the financial crash, people, banks, cities, and countries alike all gorged on the cheap money flooding the U.S. and world economy. It was difficult not to. Figuring out you're in a financial bubble when you're in one isn't easy. Even the famed Alan Greenspan didn't know for sure.

And California experienced a bigger housing bubble than most, but at the time it looked like house prices were going to continue rising indefinitely. Of course, no asset keeps rising in price forever, a lesson we've learned many times before but somehow always manage to forget. The citizens of Stockton are in the middle of a bracing refresher course on the subject right now, one the rest of us may soon be taking as well.

Motley Fool contributor John Grgurich does not own shares of the companies mentioned. Motley Fool newsletter services have recommended buying shares of Moody's. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

Read/Post Comments (3) | Recommend This Article (7)

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  • Report this Comment On July 02, 2012, at 12:40 PM, XMFGortok wrote:

    What caused the Cheap money? The Federal Reserve setting the rate of interest on money at near zero.

  • Report this Comment On July 02, 2012, at 12:48 PM, outoffocus wrote:

    Great title. Not sure if you'll get alot of agreement. Seems like most people believe happy times are here again.

  • Report this Comment On July 02, 2012, at 1:05 PM, XMFGrgurich wrote:

    Cheap money also came from 90's emerging market money that had no place to go, so the big banks invented CDOs as a new "safe" way to invest. The money also went into sovereign bond purchases. Sounds a bit like Greece, eh?

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