Today there are many unknowns making the consumer and investors alike very nervous. However, a certainty is that the USA and its state and municipal governments must now come to grips with managing obligations that were tolerated in good times. In this As We See It, Joe Healy offers a realistic overview of some of the challenges. Despite problems here and abroad, there are companies and countries that will fare well providing opportunity for investors. Read on for some interesting observations.

The recent attempt by Central Falls, RI, to move into court receivership may seem like a local Rhode Island story but it could carry far reaching implications. Could this be a roadmap to survival for cities and towns throughout the country weighed down by years of poor fiscal decisions and disadvantageous contracts?

The RI legislature reacted quickly to pass legislation allowing the state more power to intervene before municipalities file for receivership. This new law addressed debt default concerns but has left pension issues somewhat unresolved. Still, it raises many questions.

First let’s take a look at the larger stage. How will governments, like the US, respond if we run out of magic bullets? By magic bullets, I mean those bailouts/stimulus/incentive programs acting as solutions to our financial problems that are currently working their “magic”. We are in uncharted waters when it comes to solving our huge predicament. Some pundits fear our “solutions” may only be temporary stop gap measures, not real answers. By the first of next year the $787 billion federal stimulus bill will be spent, and unless tax revenues make a dramatic rebound, the money trickling to cities and towns may be even less.

The outline of a plan is in place to rescue European debtor nations or, at least, keep countries like Greece paying their bills for the next year. What happens when there’s no more capacity for future bailouts or relief packages? The cry of “where’s my bailout?” may go unanswered if there are more bubbles to burst.

Many European banks are essentially under government control. If the current fiscal contagion grows worse for the PIIGS (Portugal, Ireland, Italy, Greece and Spain) who’s to say it ends there? In today’s “joined at the hip” world of globalization could these debt problems be a US problem, too, on top of our own “difficulties”? Unlike the US, many European nations have taken steps to reduce spending and control debt. Some have criticized these moves as a constraint on the economy yet such fiscal belt tightening is consistent with what we’re seeing from both individuals and corporations.

Yet, consider this scenario: if the situation becomes too dire could sovereign governments keep printing more and more money to meet their obligations, consequently, reducing the purchasing power of the dollar/euro/pound etc. and risking a spiral of inflation? The US debt to GDP is already 83%, a post WWII high, and rising. Not a pretty picture, but where do you go when you run out of options?

Central Falls, RI is a situation closer to home but serves as a microcosm of a bigger problem. This city is merely one example across our country rife with examples. According to a recent Providence Journal article, the Central Falls police and fire pension fund for retirees has only $4 million, but with accrued liabilities of $35 million. The city pays out $2.2 million a year in pension benefits from the fund. You do the math.

To some degree this problem is everywhere across our country. For the fiscal year ending next June, forty-six states face budget shortfalls that add up to $112 billion, according to the Center on Budget and Policy Priorities, a Washington research institute.

Pensions shouldn’t bear the sole brunt of criticism. There’s plenty of blame to go around when you include poor fiscal decision making, other national issues like tax policy, and the escalating costs of programs like Medicaid.

The U.S. Government Accountability Office, in March 2010, reported if states fail to act, their fiscal positions will steadily erode and hurt the U.S. economy through 2060. Fewer funds at the federal level eventually mean fewer funds trickling down to cities and towns.

Receivership is such an extreme response it has been described as “the nuclear option” for cities and towns. In receivership, the court appoints a receiver to run the company/ city/town with the responsibility to recoup and restructure debts. Previously, receivership was not a state takeover so it could be an “end run” past legislators reluctant to make difficult political decisions. My point being, the receivership discussion represents an alternate avenue that once seemed unthinkable, but is now becoming more “thinkable”. If receivership emerged as a replicable nationwide model it could be the ultimate reboot to solving fiscal woes. However, it would likely unleash bitter resentment and unrest from those who have won hard fought concessions through their good faith negotiations, and shatter retirees long-planned expectations of what retirement pensions would provide.

This story is destined to be long and drawn out. However, I believe that the threat of this “nuclear option” may get parties more willing to offer concessions in negotiations while making government leadership feel a bit more empowered.

Public sentiment could keep shifting if larger segments of socalled middle class voters (specifically those who aren’t beneficiaries of public pensions) feel threatened. Look at the polls and recent wave of incumbent election losses. Politics is a culture of survival and getting re-elected. As massive waves of the baby boomer generation enter their retirement years they may be retiring into a penny-pinching lifestyle to which they are not accustomed. Expect the “me” generation to question authority and ask why should I support “them” when I don’t have “mine”.

From an investment standpoint what could receivership mean for municipal bond owners? Will bonds of those on the cusp or entering receivership lose value in the face of likely ratings drops? Quite likely, initially. Will that be the impetus for large institutions that have restrictions upon minimum allowed credit ratings to dump such paper? Bond defaults? Possibly. However, in the long run could these bond issuers come out of a receivership style process leaner and more financially secure, thus morphing their bonds into a more sound investment? Questions upon questions.

In the longer term depressed bonds could offer good value if you are confident receivership type scenarios will work without bankrupting the bondholders. Also, keep an eye on new municipal issuance for a dramatic increase in bonds propping up underfunded pensions. Expect these “pass the buck till another day” issues to bolster the pools of available municipal issuance over the coming years and potentially weaken the soundness of municipal credits.

Clearly I’m raising more questions than I’m answering, but I want to outline what may be taken for granted as “the way it is,” can change, and there are other options. That said, when US retirees take to the streets striking in protest like their disaffected Greek counterparts, I hope our local union firefighters and police are there to quell the riots.