Keeping an eye on the financial mess in Stockton

The city might well have filed for bankruptcy by now were it not for a new state law that requires municipalities to first try working out their differences with creditors - most notably public employees. That process was set in motion earlier this week when lawmakers voted to skip $2 million in bond payments to creditors. As a result, the city is technically in default. The mediation goes on for 60 days, and if there's any progress, they'll go at it for another 30. Union members have the most to lose if Stockton is forced to file for Chapter 9 protection (think retirement benefits), which is why organized labor strongly supported the new mediation law. Actually, most everyone agrees that bankruptcy isn't a great option for cities, considering the mess that came out of the Vallejo filing. From AP:

Stockton, a city of more than 290,000 people, located 50 miles south of the state capital, was hit hard by the recession and foreclosures, forcing it to make deep cuts to police and other services. It has a combined $15 million deficit, a little more than 9 percent of the city's $165 million annual general fund. The deficit could double in the next fiscal year. When the city demanded concessions from the police union last year, the union took out billboards, including one that read, "Welcome to the 2nd most dangerous city in California: Stop laying off cops!"

What's interesting is that the municipal bond market is not in a panic - despite what happened in Vallejo. Quite the contrary. From Bloomberg:

In fact, demand for new muni bonds remains strong. The State of California is in its second day of a successful $2 billion debt sale. Treasurer Bill Lockyer says retail demand for the state's bonds has been "pretty hefty." There's enough demand that, as our colleagues at Bloomberg News are reporting, California has been able to lower the yield on some of the bonds it's offering. Demand has been strong because there aren't many appealing fixed-income alternatives. Despite having the lowest yields since Lyndon Johnson was president, muni bonds were seen as "cheap" compared with Treasuries, Morgan Stanley Smith Barney said in a research note from Feb. 10. And since those muni bonds are tax-exempt, their actual benefits are higher. Strong investor demand has helped push up muni bond prices. According to the Merrill Lynch Municipal Master Index, prices are up more than 11 percent over the past year, and since those muni bonds are tax-exempt, their actual benefits are higher.