Could bankruptcy be the answer?
Published: August 8, 2012
The consequences are far-reaching.
Last year, Alabama's Jefferson County filed the largest municipal bankruptcy in U.S. history when it declared it was unable to deal with debt totaling more than $4.2 billion. The primary reason for its financial downfall, as reported by the Bloomberg news service, was a massive sewer project "dogged by political corruption" and a "derivative-laden" refinancing scheme.
Until recently, municipal bankruptcies, which fall under Chapter 9 of the federal bankruptcy code, have been relatively rare. Even when the law first came into effect, to help cities struggling to survive during the Great Depression, it wasn't widely used.
New York City declared bankruptcy in the 1970s. In 1994, Orange County — one of California's most populous and prosperous counties — filed for bankruptcy. As the New York Times reported, officials in that county accused Merrill Lynch and other Wall Street firms of encouraging the county treasurer to "borrow hundreds of millions of dollars on behalf of the county and to invest in exotic, highly volatile securities." The resulting losses totaled more than $1.7 billion by the time OC went belly-up.
In the Pennsylvania capital of Harrisburg, city officials have been battling with the Legislature and governor in an attempt to file bankruptcy so that they can get out from under the crushing debt of a municipal incinerator deal gone bad.
Tova Perlmutter, executive director of Detroit's nonprofit Sugar Law Center — which has gone to court in an attempt to have PA 4 ruled unconstitutional and is helping represent a coalition trying to pass a referendum on the controversial law in November — tells Metro Times that the position taken by some Harrisburg officials is instructive.
An editorial in the Harrisburg Patriot-News summarizes what Perlmutter says is a salient point:
"As the city tries to find a way out of more than $317 million in debt for a city of less than 50,000 residents, the basic game plan has been clear for a while: Sell and lease city assets, renegotiate union contracts and get concessions from creditors. ... [But] it is virtually impossible for Harrisburg to get out from under its debt without the threat of bankruptcy. That does not mean the city will ultimately have to go into Chapter 9, but it will almost certainly need to use the threat of bankruptcy as a negotiating carrot."
By taking bankruptcy completely off the table, Perlmutter says, the city loses the leverage it would have when attempting to negotiate with bondholders and creditors.
But Gov. Snyder isn't the only one determined to keep that arrow out of Detroit's quiver. The Bing administration is also opposed to even considering bankruptcy as a viable option.
"There is no upside for the City of Detroit to declare bankruptcy," Deputy Mayor Kirk Lewis says in reply to an e-mailed question. "It would hobble the region and the state. We believe we can fiscally stabilize the city by re-prioritizing our spending and creating revenue enhancements. Today we're able to provide city services to our citizens, in part, based on our ability to borrow. If we stop paying our lenders, we lose that ability and that just isn't an option."
Meanwhile, other municipalities outside of Michigan do perceive some advantage to bankruptcy.
The Reuters news service reports that there have been nine Chapter 9 municipal bankruptcy filings in the United States so far this year. In California alone, three cities have filed for bankruptcy in recent weeks. Two of them — Stockton and San Bernardino — have a combined population of more than 500,000 residents. The third, Mammoth Lakes, is a small resort town in the Sierra Nevada Mountains.
Another California town — Vallejo, which is near San Francisco — successfully emerged from three years of bankruptcy protection last summer.
There's good reason for all this action. As noted in the Washington Post:
"Declaring bankruptcy used to be a last resort for cities, not only because it would cripple their ability to borrow for years to come but because of the blow to their reputation. But that attitude has started to change as more cities have found themselves facing fiscal catastrophe; bankruptcy offers an opportunity to start over with a clean slate."
An online legal journal, AmLaw, summed up the results of the deal Vallejo agreed to:
"That plan calls for reduced interest payments to bondholders, scaled-back health benefits for city workers, and retooled collective bargaining agreements with municipal labor unions that will cut pay for Vallejo employees ..."
The bottom line, according to one of the lawyers who represented the city, which racked up a reported $11 million in legal fees, was this: "Everyone's taking a hit, that's the maxim of bankruptcy."
It is a maxim that should be applied to Detroit and the rest of Michigan, say critics of Snyder's stance and PA4.
Under current law, there's no straight path to Chapter 9. A city or school district in financial distress has to be under the authority of an emergency manager, who is the only one who can recommend bankruptcy. If that happens, it is up to the governor to make a final determination.
Which means that, at least the way things stand now, it's not going to happen.
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