"The City Is On The Verge Of Collapse" - East Cleveland Is Begging To File For Bankruptcy

With Detroit emerging from bankruptcy yesterday, its experience under Chapter 9 was apparently so successful (occasional subsequent massive power outage notwithstanding), that suddenly every other insolvent city in the US is also i) admitting it is in dire straits and ii) hoping to recreate the Detroit experience.

Enter East Cleveland.

As Bloomberg Brief reports, the council president in East Cleveland said if she had her way, the city would follow Detroit's path and become Ohio's first municipality to file for bankruptcy to help solve its fiscal woes.

State Auditor Dave Yost said the suburb of 17,500, where oil baron John D. Rockefeller once had a summer estate, is insolvent. Things in the small town, representative of most small cities in middle America, are so bad "the community lacks a working ladder truck in its fire department, had its mobile phones shut off and faces $1.7 million in unpaid bills."

East Cleveland, a city of three square miles, has struggled with its finances for decades, said Finance Director Jack Johnson. About 43 percent of residents live in poverty, almost triple the state level, while median household income, at about $20,600, is less than half the Ohio average, U.S. Census data show

It encountered "the perfect storm'' after the recession, with the 2011 closing of a Cleveland Clinic hospital that generated about $1.5 million a year in income taxes and the loss of about half its annual $3 million in state aid since 2010, he said. "There have always been challenges here, but those two things just sort of made it devastating,'' he said.

City officials say the options include asking voters to raise taxes, deeper spending cuts, merging with Cleveland or filing for bankruptcy protection.

Of course, none of those options would rest well with the voters who elect the city officials in well-paying jobs, so the alternative is to simply go straight for the shortcut that cuts liabilities by more than half while, most importantly, preserving city official jobs. After all, why engage in painful reform when someone else (preferably someone who doesn't vote you into office) can bite the bullet.

Council President Barbara Thomas favors the latter, following the Motor City's record $18 billion bankruptcy in July 2013. Detroit was able to reduce its liabilities by $7 billion and exited Chapter 9 as of today.

"We might come out a little bit better, just like Detroit,'' Thomas said. "Isn't it better to clear away your debt in a proven process than to keep trying to rob Peter to pay Paul?''

Ohio has rebounded from the recession that ended in 2009, recovering all but a quarter of the 375,000 jobs it lost.

The state might have, but the small suburb city has not: "Yost sent a Nov. 21 letter to the commission overseeing its finances saying East Cleveland is insolvent, and that its recovery plan "is inadequate to return it to fiscal health in this current environment.''

"It is fair to say the City is on the verge of collapse,'' Yost wrote.

An East Cleveland bankruptcy would probably cause less of a stir among bondholders than those in Detroit and Central Falls, Rhode Island, said Howard Cure, head of muni research at Evercore Wealth Management LLC, which oversees $5.5 billion.

"Detroit is different because it's the biggest city in Michigan, and Central Falls is different because Rhode Island is such a small state,'' Cure said. "Here, you have a small city in a big state, and I don't think it would garner the same concerns.''

Well, that settles it: time for bonds to eat some more losses. Until, of course, the bondholders who are massively levered themselves, scream bloody murder and threaten a repeat of 2008, slamming any attempts of downside risk, and demanding another blank check bailout or else the entire financial system gets it.

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