Penn State Of Chaos

The first blow in the coming municipal bond debt crisis is here, and it's being played out this week in Harrisburg, capital of Pennsylvania.

This year, Harrisburg leaders acknowledged they could not make roughly $68 million in debt payments - owed by the authority that runs the plant and backed by the city - that were due.

Since then, officials have scrambled to negotiate a solution that could stave off a declaration of bankruptcy. But those efforts have bogged down amid infighting - between the new mayor and the city controller, and the mayor and members of City Council.

Last week, the city announced it would skip a $3.3 million payment on a general-obligation bond this month.

That amount is small potatoes compared with the separate debt for the ill-starred incinerator project. But it looms large in another way: General-obligation bonds are the seemingly durable, reliable bonds that municipalities strive to ensure are paid on time. Failure to do so put Harrisburg's fiscal woes on public display and reignited bankruptcy talk.

The announcement had municipal-bond-market analysts shaking their heads, warning that the city was endangering its ability to borrow in the future, and predicting a long and tricky road to recovery.

"It is not a good sign when the state of Pennsylvania's capital city is on the edge of bankruptcy," said Matt Fabian, a managing director at Municipal Market Advisors, a research firm in Westport, Conn. "The bond markets will take notice of that - and they won't lend money."

The incinerator problem is bad enough, but now the city is planning to skip out on its biannual bond payments, and that's going to cause serious problems down the road.  The city is insured by an underwriter called AMBAC, but that's going to put a huge dent in Harrisburg's credit rating, and they're not going to be able to borrow much of anything.

The real problem is that there's potentially hundreds, if not thousands of Harrisburgs out there in America, waiting to throw in the towel on muni bonds as revenues dry up and tax increases are out of the question.  That could rock the entire $3 trillion muni bond market to its core.

A lot of long-term investing is done in muni bonds, and if those start going under, the domino effect could be catastrophic.

Just another piece of good news, I guess.  Big cuts in social programs don't fare well at election time, neither do tax increases.  That leaves bond payment default.  Harrisburg will not be the only city to go down that road over the next few years.