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Municipal Bankruptcy – A Story in Search of a Trend?

March 13, 2010

NLC is receiving a lot of media inquiries about the prospect of cities filing for Chapter 9 bankruptcy.  It’s not surprising that the chattering classes are agog about cities going under.  It’s a grabber of a headline: “City X Files Ch. 9!”  The problem with this story is that the numbers just aren’t there to back it up.  It’s a story in search of a trend.

Here’s the facts.  According to the USCourts.Gov website  “The first municipal bankruptcy legislation was enacted in 1934 during the Great Depression…Congress enacted a revised Municipal Bankruptcy Act in 1937, which was upheld by the Supreme Court (1938). The law has been amended several times since 1937…The purpose of chapter 9 is to provide a financially-distressed municipality protection from its creditors while it develops and negotiates a plan for adjusting its debts.”

Since that time, there have been approximately 600 municipal bankruptcy petitions filed.  That is 600 filings among all municipal corporations, which includes municipal governments (approximately 19,000 according to the U.S. Census), towns (16,000), counties (4,000), taxing districts (too many to count), municipal utilities, and school districts.  In short, the incidence of municipal bankruptcies is beyond rare.  

Amid the declining fiscal conditions facing many municipalities it’s likely that a few more will file for Ch. 9 in the next couple of years, or may at least raise bankruptcy as an option.  But, these Ch. 9 cases will continue to be exceptions.  Fiscal stress will be a factor, for sure.  But, in most instances, peculiarities of the specific jurisdictions will be what pushed them over the edge into bankruptcy.  The Orange County, California bankruptcy of 1994 was driven by a risky investment pool, political fragmentation, and voter animosity about taxes (for more, see When Government Fails by Mark Baldassare).  More recently, the Vallejo, California bankruptcy filing was driven by efforts to curb a longer-term structural imbalance problem that is the result of a declining economic base and public safety contracts that are significantly out of alignment with the city’s budget realities.   

The most recent inquiries we’ve received have all been in response to the city of Harrisburg, Pennsylvania raising the prospect of filing for Ch. 9.  But, here again, the story isn’t the underlying fiscal condition of the city.  The fiscal challenge they face is that they built an incinerator plant with overly optimistic scenarios for having the plant online and revenues that the plant would generate. 

The danger of the recent attention to municipal bankruptcy is that it might engender a lack of confidence in the solvency of municipal finances and debt, triggering changes in credit market behavior that add to the fiscal challenges cities are already facing, in which case the story becomes the trend?

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