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American Cities Going Bankrupt: Making Sense of the Growing Trend

American Cities Going Bankrupt: Making Sense of the Growing Trend

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October 10, 2012
Archive, Business, OODA Original
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Yesterday and Today

Financial fallout in many US cities following the recession has left a growing number of US cities in economic crisis of their own. With no ability to pay runaway pension promises and even basic salaries, more and more cities are declaring bankruptcy. Bankruptcy, however, is a last resort option that leaves a deep and uninviting scar on its cities for many years to come. Fortunately, the economic condition of the US as a whole is far better than the dire economic conditions of many of her cities.

On June 28, 2012, the city of Stockton in California became the largest city in US history to declare bankruptcy. The suburb of San Francisco with a population of nearly 300,000 sank quickly after its massive housing bubble burst. Even now, however, larger cities all over the country are struggling to settle their impossible debts without resorting to bankruptcy. Economists have listed multiple cities in Rhode Island, Pennsylvania, New York, and California to be in “severe danger” of bankruptcy. Many other US cities have found themselves in difficult economic straights short of bankruptcy. These cities include New York, San Diego, San Francisco, Los Angeles, Detroit, Cincinnati, Honolulu, DC, and Newark.

Since 1981, 42 municipalities have filed for bankruptcy yet over a quarter of these have been in the past 4 year.  In 2009 and 2011, the number of municipalities declaring bankruptcy more than doubled the yearly norm. Thus far, the numbers in 2012 match the numbers of these difficult years. In addition to the growing numbers, the sizes of the cities declaring bankruptcy are also growing.

City bankruptcies have not occurred at this frequency and size in America since the Great Depression. Fortunately, the number and circumstances surrounding these bankruptcies in recent years are not as dire as those in the 1930s. Depression era problems are vastly different from today’s financial upsets surrounding the recession. The methods for handling the problems have also changed since the 30s. While these bankruptcies are not harbingers of a massive economic crash, the current situation presents a new economic reality for governments at local, state and even the national level.

Why?

Today, the major cause of bankruptcy and financial disarray of many cities are runaway pension programs that consume up to three quarters of the annual budget of many struggling local governments. This is especially true of East coast cities with economic struggles. Other cities have undergone their own unique issues. Some, like Stockton, have seen house and property prices plummet as their markets collapse. Some, like Jefferson County in Alabama, have found themselves billions of dollars in debt from public works projects gone awry. All of these cities have scrambled to find an alternative to bankruptcy. Most attempt various solutions but most of these either fall short or fail outright.

The future of the pension problem facing cities is uncertain. The question of whether or not pension promises are contract rights or property rights has yet to be tested in a high court. If pensions were defined as property rights, cities would be under Constitutional obligation to pay all promised pensions in full. If ruled contract rights, cities could rewrite or renegotiate pensions. A ruling one way or the other would completely reshape the debates surrounding city bankruptcy. As it stands, unions and other interested groups battle relentlessly for pensions as property rights. Unions continue to be a powerful force in city bankruptcy deals.

These cities and others have been forced to lay off hundreds of workers and pay public employees at minimum wage. Scranton, PA is currently paying all public employees, including the mayor, the minimum wage of $7.25 per hour. Lawsuits from organized labor are piling up against Scranton and other cities, adding substantially to the already impossible level of debt and expenditures. Attempts to raise taxes have been met with a furor equal to the anger caused by the pay cuts. Try as cities might to raise themselves out of these messes, their hands are often forced towards Chapter 9 of the US Bankruptcy code.

Chapter 9 Bankruptcy

The current state of bankruptcy laws for municipalities grew out of correctives to problems from the Depression era policies. The 1934 Bankruptcy Act permitted, for the first time, cities and municipalities to file bankruptcy. Today, cities and municipalities cite the US Bankruptcy Code Chapter 9, a chapter for cities and towns. An important note to this legislation is that bankruptcy under Chapter 9 does not erase debt or permit cities to default on the debt. It merely gives the city or town time to reorganize and broker a deal with its creditors. In Pennsylvania, the state legislature passed a law that prompted a federal judge to block the bankruptcy filings of Harrisburg, the state capital. Currently, only half of US states allow municipal bankruptcies.

The time and requirements of Chapter 9 bankruptcy ensures that bankruptcy truly is the last resort. Most cities install commissions to ensure that all other possibilities are exhausted before resorting to bankruptcy. In California, such commissions are now required by law. According to one bankruptcy lawyer, “The threat of [city] bankruptcy is quite a lever. . .It may make other cities’ negotiations more successful, more fruitful.”

For cities undergoing or struggling with the threat of bankruptcy, the first items to go are infrastructural development and pensions. These actions are generally coupled with tax increases where passed by the legislatures. While necessary for long-term success, both movements depress the local economy, the economic and social effects of which will last for years. After a city declares bankruptcy, it is also next to impossible to secure any pieces of the massive US municipal bond market, the most important financing sector for local governments in the US. In short, municipal bankruptcy, although an economic necessity, decreases the quality of life for everybody in the district.

According to Richard Ciccarone, the managing director of an LLC that manages over 8 billion dollars in municipal bonds, “Chapter 9 is not a victory for anyone; it comes with hardships for the entire community, as well as bondholders. It’s no positive for economic development.” These hardships last for many years.

The Future: Storm Clouds and Blue Skies over Cities, States, and the Union

In the midst of the current financial difficulties looming high at the international, national, and local level, it is easy to predict increased difficulty or even a economic apocalypse of some one sort or another. The 1994 bankruptcy of Orange County, CA, however, can provide some helpful balance. A collapsed high-risk investment fund lost the city 1.5 billion dollars and rendered it unable to pay its bills. The city was forced into a lawsuit that ended in jail time for some and then Title 9 bankruptcy for the city. The crisis forced the city to reorganize and re-prioritize spending. In other words, the crisis forced them into fiscal responsibility. In less than a decade, Orange County was once again the prosperous Californian city it had been prior to bankruptcy.

For cities facing bankruptcy, the arduous process might be what it takes to pop the balloon of unsustainable budgets and set themselves up for recovery and future success. If, however, cities with runaway pension programs are not permitted to renegotiate future pensions, then those cities will cease to function. Fortunately, that knowledge ought to keep the courts away from making such a destructive ruling. For states with failed public works projects, fiscal re-prioritization will also help to set municipal governments up for future successes.

Similarities in the Eurozone

The bankruptcy crisis in some US cities are similar to the current Eurozone financial mess but on a much smaller scale and with many nuanced differences. Because of its size, the US as a whole is not in danger from the financial collapses of a handful of its cities. Similarly, the Eurozone will live on thanks to the comparative size of Germany and France who will not permit their economic union to collapse. They will coax or boss Greece, Spain, and the others into fiscal sustainability before the union collapses (or else they will cut off the dead growth of a collapsed state). Cities in the US have it much easier than the PIIGS and others in Europe. The cities are still embedded in the massive US economy. That massive economy will help to raise up the bankrupt cities once the cities reorder their budgets and plug themselves back into the strong grid of the American economy.

Conclusion

In conclusion, the Title 9 bankruptcy is like a broken bone. It is exceedingly painful when it occurs. It is even more painful when the bone must be reset. It is often the case, however, that the bone grows back stronger as a result of the brake. Cities going through Title 9 bankruptcy are in severe pain. This pain is only highlighted during the filings and then the bankruptcy negotiations. Cities that are successful in cutting runaway programs and curtailing unsustainable spending will emerge from the bankruptcy with the possibility of a quality future. The future of each city, however, is still uncertain as the steps requisite for future success have yet to be taken. Time will tell how cities are able to maneuver the tricky waters of budgets and the unhappy task of cutting spending, especially social spending.

Michael Brooks

Michael Brooks is an OODA analyst with a strong background in international relations, regional studies, and world religions.

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