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You are undoubtedly seeing in the news that high earners are leaving New York, Los Angeles, and other metro areas. This does not begin to address the magnitude of the problem. There are dozens of cities that are trending towards fiscal collapse. Indeed, taxpayers are leaving.
Businesses also are closing, or leaving. Municipal budgets are already deeply underwater. Liabilities are under-reported to the extent that auditors are raising flags. And then there is the fraud, which will lead to deep cuts in disbursements from the federal and state governments.
What we are observing is the very earliest signals of a broad-based collapse in the finances of major municipalities that would likely only be averted via federal bailouts. We estimate that within two years, dozens of metro areas will undergo significant layoffs of public employees, deep reductions in services, and restructurings of public retiree pensions. To envision what we expect for many of these metro areas, contemplate Detroit, and its erosion to eventual bankruptcy in 2013. From the peak, Detroit lost two-thirds of its population and 85% of its taxpayer base.
What do the municipal bond ratings agencies have to say about all of this? In essence, the story is that muni bonds provide investors with a safe, tax-free return. It’s been over a decade since any town of significance blew up. So, if history is any guide, muni bonds are a good place to park your capital. Muni bond proponents couldn’t be more wrong.
Tax and Other Revenues Collapsing
Some cities are losing 6% of taxpayers annually. Services are being cut. Crime is increasing. Synthetic economic activity (welfare, SNAP, EBT, related social services) accounts for as much as 30% of all economic activity in some metro areas, according to JSI Analytics data. That economic activity is at great risk of being defunded.
Businesses are closing or leaving at record rates, while new business formation is at historic lows. Commercial real estate values are collapsing, with residential values now falling as well. Property tax revenues are a top-three source of revenue for most cities and counties. The declining tax base leads to cuts in public services followed by rising crime, which accelerates the outbound migration of taxpayers. The trend becomes a self-reinforcing, downward trajectory.
The remaining population is primarily lower- and middle-income households, many of which rely on government subsidies to make ends meet. Average FICO scores drop materially. The residual population is higher risk to all businesses. Consumer and business fraud rise, along with other crimes.
‘Whack a Mole’ Is No Risk Management Strategy
Just as has happened with private credit, ratings agencies will start raising flags once a few municipalities blow up. At that point, you can only react. You’ve seen this movie before.
Our firm has created an analytical framework for gathering data, and researching the problem:
- We start with 50 states, we have their financial trendline data, and we’ve rated them.
- We have financial trendline data on 210 municipalities, all graded on their ability to fund obligations going forward, not their historical performance.
- Our model analyzes the current fiscal situation for each metro area. We then layer on estimates of the revenue base, using taxpayer migration data, business births/deaths and migrations, economic activity estimates, and planned capital investments by businesses. That is compared against current and future liabilities.
- Based on our analysis of the results, we make the determination as to how long a given municipality can avoid a material default. Such a default would lead to a significant reduction in public services, a cut to public employee pensions, or an outright default on payments.
- We have scored the cities by risk, and we compare those scores to risk assessments provided by credit ratings agencies. The differences are stark.1
Dozens of major metro areas in the U.S. are deteriorating economically and fiscally, at an alarming pace. We estimate material defaults and significant operational risks within these metro areas over the next two years.
The Fact Pattern of a Municipality on a Default Trajectory
We use Portland, Oregon as an example — though many more municipalities are in similar predicaments — to illustrate what this pattern looks like:
- Prior to COVID, Portland’s finances were manageable on a near-term basis. This is because long-term liabilities (primarily retiree pensions and benefits) would irrefutably become a problem.
- During COVID, spending rose over 40%, primarily across various social assistance programs, requiring new municipal subagencies, mainly in the areas of healthcare and social services, with significant increases in hiring. Federal support offset the increase in spending, so the annual budgets were balanced.
- Concurrently, significant numbers of businesses closed or departed the city during COVID. This is also true of high earners. Tax revenues declined as a consequence. Federal support offset much of this as well.
- In 2024, federal aid to the state of Oregon and to the city of Portland was reduced. This led to an immediate budget shortfall, as the administrative overhead was not reduced meaningfully as COVID wound down.
- In 2025, federal aid was reduced again, further impacting the budgets of the state and the city Portland.
- The loss of businesses and taxpayers across the income strata accelerated in 2025. This again had an effect on tax revenues. Property tax revenues will undoubtedly be materially affected in 2026 due to a decline in property values.
- Portland plans to issue new debt this year, much of which is planned to cover substantial operating deficits. In years prior, tax revenues covered operating expenses, with the exception during the COVID years when federal revenues covered shortfalls.
- Liabilities relating to city employees are not being fully recognized. This has been noted by Portland’s controller and auditors.
It is also worth contemplating what challenges exist in running a business in Portland. Also, take credit risk into consideration if you extend credit to businesses in Portland.
When it comes to doing business in Portland, or with businesses operating in Portland, keep these statistics in mind:
- Credit risk is three to five times higher than the risk of loss in 2019, based on our in-house analysis;
- Crime: Risk to employees and property is significantly elevated;
- Rising insurance costs in excess of national averages;
- Elevated consumer and business fraud; and
- Banks modify collateral and lending terms to mitigate operational risk.
Taxpayers Voting With Their Feet
This is one of the key inputs for our municipal risk model.
Metro Area Financial Ratings and Risk Assessment
The database of 210 U.S. metro areas includes revenue, expenses, and liabilities that have been tracked in detail since 2015. The metro areas are grouped as follows:
- F rating: estimate of material default on pensions, public services and/or bonds within two years.
- B, C, D rating: estimate of material default on pensions, public services and/or bonds within five years.
- A rating: sustainable finances for the foreseeable future.
Credit risk, fraud, and other deleterious outcomes rise due to the municipal fiscal decline. The remaining population reflects the lower two thirds of the prior population. The risks of this remaining population are consistent with persons with FICO scores of 740 and below.
The Detroit Trajectory
The fiscal mismanagement observed in Detroit from the 1980s through decades thereafter was truly a slow-moving train wreck. Without billions of dollars in soft bailouts, doled out over decades, Detroit would have collapsed in the 1980s, or 1990s at the very latest.
Similar federal support for cities was provided during COVID. Profligate city administrators chose to keep budgets high after COVID, while federal support dried up. If taxpayers and businesses are also departing, this puts the city in question on the Detroit Trajectory.
Conversely, a well-managed municipality such as Salt Lake City saw its budget rise over 30% from 2019 to 2023, before falling back to its long-term trend line by 2024.
In 2013, Detroit was the largest metro area in the U.S. to have declared bankruptcy. Investors in Detroit’s municipal bonds lost approximately 40% of their principal value. 13 years later, the city of Detroit has not recovered economically: Real estate values, commercial investments, tax revenues and other measures are well below their pre-bankruptcy highs. It is worth noting that most states’ legislatures prohibit their municipalities from seeking bankruptcy protection. Nothing, however, prevents an insolvent municipality from facing reality.
A ‘Blue City’ Problem?
Fiscal issues are in no way a “blue city” problem. As an example, it’s commonly known that the state of Florida is very well fiscally managed. Orlando and Tampa follow suit, and are two of the better run municipalities in the entire U.S. Miami, however, scores a solid F rating, as we have seen their liability/asset ratio deteriorate from 1.34 in 2023 to 1.9 in 2025. Nor are Texas’ largest municipalities immune from fiscal mismanagement.
Investment & Portfolio Management Implications
Based on the data, we make the following recommendations to investors in municipal debt:
- Municipal Bonds: Treat fiscally stressed metros as elevated credit risk. Prioritize essential service revenue bonds over general obligation bonds. Demand higher spreads and incorporate governance risk into credit analysis.
- Real Estate: Reduce exposure to office, retail, and multifamily in outflow metros. Tilt toward Sunbelt markets with strong inbound migration and business formation.
- Private Credit & Consumer Lending: Expect higher default rates and weaker collateral values in shrinking metros. Reassess exposure to local banks and insurers concentrated in these regions.
- Scenario Planning: Incorporate Detroit-style stress scenarios into risk models — pension cuts, tax-base erosion, business flight, and long-term stagnation.
- Strategic Allocation: Migration trends are slow-moving but powerful; they justify structural tilts in long-term portfolios.
Summary
Is it possible the credit ratings agencies are missing the risks associated with municipal debt? We believe that the same backward-looking fixation that caused the major ratings agencies to be eight months late on private credit is why they’re not seeing what is unfolding with municipal debt. They’re not looking deeply beyond what is reported by city controllers, even when the annual financial reports are delayed by many months, and the auditors are raising flags.
Do opportunities exist within this environment of risk? Absolutely. Many municipalities operate in a fiscally responsible manner, though their debt offerings are normed to the same bucket of risk as the problematic cities.
Ironically, some of these well-managed cities are smaller and consequently somewhat illiquid in terms of the marketability of their debt. At the same time, it is worth noting that this is where many upper-income households and businesses have been migrating in recent years. The voting mechanism of taxpayers’ feet is providing an insightful function.
Endnote
1 For example, Portland is rated as AAA by S&P, AA+ by Fitch and Aaa by Moodys. Our methodology rates it as an F based on the fact that the city will be required to make cuts to critical services of at least 10% within two years. Portland also has unfunded liabilities amounting to $28,444 per taxpayer as of 2024.
Read more by Paul Hill here:
Paul Hill is a business economist, entrepreneur, inventor/holder of multiple patents, and developer of economic forecasting and risk management tools. He is a former lecturer and advisor for the UCLA Anderson School, as well as an advisory board member for the Computer Science Department at Santa Monica College. As the founder and president of JSI Analytics in 2008, and co-founder of EducateToCareer.org, he and his team provided actuarial services to lenders and servicers of over $200 billion in student loans. JSI Analytics currently provides a suite of tools for economic trends analysis and credit risk management, which are utilized by fixed income investors, commercial banking, and trade credit industries.