Fears of crushing debt spread to cities, provinces

Recanati, Italy, faces a financial crisis and is being forced to sell off park land, scale back aid to the elderly and scrap costly repairs on leaking churches and ancient cobblestone streets.
Recanati, Italy, faces a financial crisis and is being forced to sell off park land, scale back aid to the elderly and scrap costly repairs on leaking churches and ancient cobblestone streets. (Anthony Faiola - The Washington Post)
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By Anthony Faiola
Tuesday, April 27, 2010

RECANATI, ITALY -- This 12th-century gem, birthplace of the poet Giacomo Leopardi, rests on a lyrical hilltop in the Apennine Mountains. But these days, Recanati is also sitting on something else: a pile of financial trouble.

Concern over near-bankrupt countries forced Greece on Thursday to request a huge international bailout. The plight here, however, underscores fears of a new front in the battle against global debt -- at the state and local level.

Recanati is one of hundreds of municipalities around the world facing a deepening financial crunch from bad investments, plummeting tax revenue, high debt levels and rampant overspending. In the United States, at least six states have budget gaps bigger than Greece's, with Hawaii shifting to a four-day school week to cope. In Spain, a substantial drop in tax revenue from a bust in construction is battering budgets in the cities of Madrid and Valencia, as well as in the provinces of Catalonia and Andalusia, raising the threat that ratings agencies will downgrade their debt.

The picture is particularly bleak in Italy, where many cities and towns invested heavily in complex bets on interest rates. Now deep in the red, Recanati is being forced to sell off parkland, unload a public kindergarten, scale back aid to the elderly and scrap costly repairs on leaking churches and ancient cobblestone streets.

"We are in a financial emergency because of our debts; it has become the sword of Damocles hanging over our heads," said Francesco Fiordomo, Recanati's mayor.

Experts are not yet predicting cascading bankruptcies, but they warn that increasing problems in heavily indebted municipalities and provinces are creating financial time bombs that could lead to defaults. Those concerns are already raising cities' borrowing costs on both sides of the Atlantic and contributing to budget woes, forcing many struggling jurisdictions to raise taxes and cut services.

Analysts are also warning that national coffers could be further strained if heavily indebted countries are forced to spend precious resources to rescue local jurisdictions. Portugal, under fire for allowing its cash-strapped regional governments to assume more debt, was hit by a debt downgrade by Fitch Ratings last month.

"We are only now beginning to understand the full scope of the global debt problem. This isn't just about national governments; you're talking about local governments and municipalities," said Eswar Prasad, an international economics expert at the Brookings Institution. "Many of them were engaged in risky investments in the past, and now we are seeing those problems come to a head."

* * *

Across Italy, budget problems have been severely compounded by growing liabilities on complex bets placed on interest rates during the credit boom of the past decade. Similar bad bets are well documented in the United States. Los Angeles, for instance, is losing $19 million a year off interest rate contracts; a wager by Jefferson County, Ala., has left it struggling to avoid bankruptcy.

But problems with these exotic financial instruments are only now emerging in Europe, putting a fresh spotlight on the excesses of borrowers and the ethics of bankers who sold them.

Greece has come under scrutiny for using such deals to hide the extent of its debt. In Italy alone, an estimated 519 cities and towns are facing more than $1.3 billion in losses from derivatives deals, according to a report from the Bank of Italy.


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