Bankrupt cities and towns send warning message - is anyone listening?

You will start hearing about this more and more in the coming months and years and how these situations are handled could indicate the speed of our potential recovery.   As of this writing multiple cities large and small have filed for bankruptcy under crushing debt.  Vallejo in California is a perfect example of a high profile city followed by Prichard, Alabama and even Houston,Texas.  Baltimore,Detroit,Philadelphia and Chicago are looking at crippling financial woes threatening to push these major cities into bankruptcy.  There are many more cities and towns of various sizes including states like Oregon and California, whose only remaining option will be bankruptcy and yet there is one common theme running through all of these stories.  Unsustainable pensions and unions unwilling to negotiate!

Bankruptcy allows the cities to modify their union contracts or simply default on the pensions all together. 

I have looked at every opportunity available to obtain money to help fund the retirement plan for the City of Prichard. After careful review of all of our options, bankruptcy protection seems to be the only solution left at this time. Over the past 50 years, the pension plan was amended by the Legislature more than fifteen times, and always the economic burden on the City was increased

This is the dirty secret and whether some brave souls wish to admit this fact is no longer relevant.  Consider the cycle that plagues so many municipalities in America.  During boom time local governments hire and expand government, raise wages, make outlandish promises and sign contracts for exotic pensions that us poor suckers in the private sectors can only dream of having.  For instance there are still people that believe government workers are underpaid, but this is just a mythical relic that is no longer true.  In fact public sector employees enjoy higher salaries and significantly better benefits on average.  During a recession or contraction local governments slash services, but all the entitlements promised are still around and kicking.  Once the boom recovers once again, more and more state and local employees are hired and the pension liabilities grow. 

Who is paying for all the pensions?  YOU are of course.  Meanwhile private sector jobs have seen wages stagnate for the past EIGHT years yet public sector employees threaten strike if their wage raises are unsatisfactory.  As the cycles of booms and busts continues the government grows and grows and the pension system balloons out of control. 

We are now reaching a breaking point where the revenues collected from private sector taxpayers continues to fall off a cliff, but public sector pensions and wages continue to rise.  They are absolutely going in the opposite direction and cannot be sustained. 

There is one caveat here though and this is of course the municipal bond market, the market by which local governments take on debt.  If cities declare bankruptcy they will no longer be liable to pay out interest on the municipal bonds and this will result in chaos because the federal government MUST ensure that payments will be made no matter what.  Contract violations are a serious business and cannot be tolerated, although an exception can be made in the matter of union pensions if they threaten the livelihood of the city.  Still, there are two possible alternatives to this outcome.

1)  Cities declare bankruptcy and violate ALL contracts including municipal bond obligations.
2)  Cities do not declare bankruptcy, but default on pension obligations or file for bankruptcy but continue paying out bond interest.

The first scenario will lead to chaos, lawsuits, protests and a breakdown of the system by which cities and towns fund themselves.  The second scenario will be and is the only viable way to get out of the massive hole we dug ourselves into.