Research Papers / Why Cities and Counties Fail: Municipal Bankruptcy [2]

Most people have heard of a Chapter 7, 11 or 13 Bankruptcy. Some people have even experienced them while others have had someone they know go through one. In general, people see it as something unpleasant and recognize it as something they never wish to experience. Now there is a different type of bankruptcy that more people are learning about: Chapter 9 Bankruptcy. Recently Detroit became the largest city or municipality to file for Chapter 9 Bankruptcy. Chapter 9 or municipal bankruptcy is not new; however, this most recent incident has raised the level of interest on this traditionally esoteric topic. Concern has come from all sides of the political, ideological and ethnic spectrum. And while it doesn't have the exact same effect as a personal bankruptcy (Chapter 7, 11 or 13), its collective effects on the community are similar: loss of confidence, stigma, a need to rebuild, an inability to acquire credit, and in general an overall difficult experience result. To safeguard a community from this tragic situation it is important to understand the causes and what can be done to prevent them. Research shows that municipalities have failed due to mishandled pensions, lack of government intervention and the unwillingness of local leaders to make tough political decisions.

The recent failures of various municipalities have induced alarm amongst civic leaders and municipal investors. Fear is one of the worst byproducts of Chapter 9 Bankruptcy. When a City or County fails, investors and citizens worry they can't trust them with their money. They question whether their investments or tax dollars are safe. It takes time to rebuild bridges that have been lost due to recklessness, corruption and greed. It is extremely rare for a city or county to file for bankruptcy; even more unlikely is a second filing by the same city or county. In fact it has only occurred five times; however, "three of the five re-filings occurred in 2009" (De Angelis 323). This coupled with the recent filing of Detroit have led to a greater desire to understand the signs and warnings of a possible Chapter 9.

This angst spans the political spectrum as Democratic and Republican leaders have demonstrated concern. Mayor Rahm Emanuel, a prominent democratic leader has recently acknowledged that "the pension crisis is no longer around the corner" ("After Detroit, Who's Next?"). This statement is powerful coming from a leader that has traditionally been sympathetic to pension increases and union demands. He understands the danger that unfunded liabilities can place on his municipality. Chicago's failure is not a legacy he would wish to carry. Republican State Representative Phil Lovas recently sponsored and passed legislation to reform Arizona's pension program for elected officials (Lovas). He was concerned about the negative fiscal effect they were having on the state as well as the municipalities. And while the legislation only dealt with elected officials pension, it serves as a model for future pension programs that are wreaking havoc on the finances of local and state governments.

Mishandled public employee pensions have been a key contributing factor to municipal bankruptcies. Unsustainable pension programs have not only forced municipalities into Chapter 9 Bankruptcy, but they have caused a more expensive and prolonged process. The city of Vallejo failed due to "labor contracts that were out of line with the city's budget realities" (De Angelis 327). In other words they were making promises that they couldn't keep. This can be difficult to forbear when government leaders face severe pressure from union leaders. If citizens do not get engaged to counter this pressure, the politician will be more inclined to give the unions what they want. They may think that since no one is complaining that it doesn't matter or that the storm clouds are far enough in the distance that it won't affect them. They remain content to leave it to the next to be elected. Furthermore, if they say something now, the unions may spend largesse to boot them from office. The reality is that the citizen who isn't paying attention is not going to come to their aid. The result is a politician who kicks the can down the road. Unfortunately after a few years they end up like the city of Vallejo where "pension liabilities and financial obligations for labor contracts are by far [their] largest debt" (De Angelis 327). This is the type of policy that leads to the most painful type of Chapter 9 Bankruptcy.

Other cities, like Orange County, that experience Chapter 9 due to one-time expenditures or a lawsuit settlement can get back on their feet quicker. "Unlike Orange County, Vallejo's bankruptcy process has not been quick, and unlike Orange County, where the distress was precipitated by a one-time event," the city of Vallejo has been dealing with their pension problem for years; and it now consumes "more than three-quarters of Vallejo's General Fund spending" (De Angelis 328). Orange County and Vallejo teach a powerful lesson. Pensions have to be handled responsibly or a long painful, drawn out Chapter 9 bankruptcy is most likely on the horizon.

Detroit, which has just started the bankruptcy process, had burgeoning unfunded pension liabilities that have been building up over decades. In fact, Detroit has racked up over 3.5 billion in unfunded pension liabilities since the mid 1950's (Plumer). This is basically Vallejo on a grander scale. They continued to make deals that couldn't be kept in the long run but they continued to delay doing anything about it for 60 years. It has finally caught up with them, and more than just poor union negotiations have been revealed as part of the problem. Corruption has now been exposed as investigations into the improperly funded pensions proceed. For example, Ronald Zajac "was indicted in March along with former police and fire trustee Paul Stewart on charges of bribery and conspiracy involving more than $200 million in investments before the two pension funds" (Helms and Dixon). That is a ridiculous amount of taxpayer money wasted because people were too afraid, ignorant or apathetic to take care of the problem. Another important lesson of mishandled pensions is the risk of corruption rearing its ugly head. Now the stigma of a bankruptcy is coupled with that of corruption; a double dose of poison that will require longer healing time. Cities and counties must be vigilant with their pensions to avoid Chapter 9.

The failure of State and Federal governments to intervene with local governments can be another cause for Chapter 9 Bankruptcy. Unlike Vallejo whose principle cause for Chapter 9 was pension problems, Jefferson County Alabama entered into a sewer contract that they couldn't pay off. When "the State of Alabama refused to get involved with Jefferson Counties' financial woes" a Chapter 9 Bankruptcy was filed. (De Angelis 329). This could have been avoided had the state intervened during the "several years" that Jefferson County contemplated the filing (De Angelis 329). As seen here there is no requirement for a state to get involved. They may decide that assistance would be more damaging than allowing the failure or some states may worry that they encourage bad behavior if bailouts come to easily. The good news in this case is that compared to Vallejo which held systemic problems, Jefferson County was dealing with a one-time issue. After their sewer problems were resolved, they bounced back relatively quickly. Not having to file would have been ideal but clearly the state did not feel it in their best interest to bailout the city.

Bailouts are much more likely to come from the state level than from the federal government. "States... are the best first responders to municipal fiscal" and they are also the most concerned on the negative impacts of the municipalities failure on the state (Gillette 310). When a state gets involved, they will typically place requirements for their bailout or as seen in Detroit they may put an emergency manager over all of the operations to help facilitate the process. In a way it becomes martial law for political leaders and public employees. They all have to answer to the state's appointed manager. This as well as the strings attached, such as structured pay backs, are why "many states prefer that the federal government bailout their distressed municipalities; however, "the federal government has rarely employed bailouts with respect to local governments" (Gillette 309). This is probably wise as the federal government is more detached and would have a much more difficult time enforcing any requirements they might place on the municipality. This autonomy is welcomed by the municipality but since federal assistance is so difficult to obtain, a state bailout is the typical scenario.

It may come as a surprise that another reason municipalities fail is because political leaders allow it to happen. They don't want to make tough political decisions. For them doing nothing is the best choice for their political careers. Harrisburg Pennsylvania has several instances where political expediency took priority to making difficult choices that would benefit its citizens. To the argument that the city could instead have cut services, the mayor responded, "To disrupt [services] because we can't make a bond payment would just be unconscionable. And as a leader I couldn't do it" (Gillette 284). What he may have really meant to say was "If I cut services, the people who usually don't pay attention to city council meetings (which is most people), will start coming out of the woodwork and when the next election comes I will be voted out of office." It is safer for him to pass something off as though they had no other choice, therefore making themselves innocent bystanders, rather than catalysts to the process. Harrisburg officials didn't throw in the towel completely. In fact, they explored a bailout from the state. But as mentioned before, states usually require specific action, and these actions may not always help someone's political career. "When the mayor and the state persisted in pursuing a bailout plan that required the sale or lease of city assets, the city council voted to file for bankruptcy" (Gillette 284). Rather than take the conditions of the state sanctioned bailout, the council opted to file for bankruptcy. Was this the better choice for the city? Considering that it should be done as a last resort and only if no other option is available then one would have to assume not. Both of these examples show a more subtle strategy by politicians to choose Chapter 9 Bankruptcy, because it will benefit themselves and not the constituents that they serve; political reasons would be a good response to why these bankruptcies commenced.

It was for political reasons the auto industry was bailed out by the Obama administration; however, the City of Detroit does not appear to be graced by the same political favor or merit the same hospitality. "Michael Barone, a Detroit native, veteran Washington political analyst and author of the respected Almanac of American Politics, points out that there are important economic and political differences that separate the Detroit auto and city bankruptcies" (Payne). In other words it's going to cost too much and the prospect of bailing them out would not go well with the American people. Politics is a game of pleasing the masses, so when "public opinion polls [oppose] bailouts and many [worry] about the precedent set for other corporate bankruptcies" it becomes politically untenable to assist Detroit from the federal level (Payne). Many have spoken out against this. Some have claimed abandonment, wondering how this can be the case when their city just voted by a supermajority for the sitting President; the same man who bailed out the UAW (United Auto Workers). The failure of Detroit has demonstrated that as a political body it does not have the breadth, depth or influence that the UAW has (Payne). The winds of politics are always changing so it is still possible for the administration to reconsider. But that doesn't seem likely. Unfortunately for Detroit, they are politically radioactive as they have been rife with corruption. A bailout for them and any other scandal ridden municipality appears to be a political death trap.

The recent events of volatility amongst municipalities have caught the attention of the mainstream media. The failure of Detroit has not been ignored. If the economy continues to strengthen, the topic of Chapter 9 Bankruptcy may return to obscurity. But as long as record failures as far as scope, size and frequency continue, it is likely to become a more common topic than one would hope for. So much of society and civilization rely on vibrant communities. A vanguard for a strong community can include recognizing the signs that could mortally wound its financial stability. If pensions are not kept in check, if systemic issues would preclude state assistance and if political leaders aren't willing to make tough decisions then Chapter 9 Bankruptcies will continue to augment. It's time for civic leaders to get educated on all of these signs. If they see any of these issues, if only in their infancy, they should take immediate action to halt or if possible reverse the danger of Chapter 9 bankruptcy. Political courage is required, and expected from those whom they were elected to maintain the fiscal stability of their community.

Works Cited
"After Detroit, Who's Next?" wallstreetjounal. com Wall Street Journal Jul 22 2013. Web. 15 Aug. 2013 .
De Angelis, Michael, and Xiaowei Tian. "United States: Chapter 9 Municipal Bankruptcy - Utilization, Avoidance, and Impact." Until Debt Do Us Part : Subnational Debt, Insolvency, and Markets. Ed. Otaviano Canuto and Lili Liu. N.p.: World Bank Publications, 2013. 311-52. Print.

Gillette, Clayton P. "Fiscal Federalism, Political Will, and Strategic Use of Municipal Bankruptcy." University of Chicago Law Review 79.1 (2012): 281-330. Print.
Helms, Matt, and Jennifer Dixon. "Orr Confronts Detroit Pension Funds Plagued by Poor Investments, Kickbacks and Corruption." Freep. com. Detroit Free Press, 20 June 2013. Web. 2 Sept. 2013.

Helms, Matt, Nancy Kaffer, and Stephen Henderson. "Detroit Files for Bankruptcy, Setting off Battles with Creditors, Pensions, Unions." Freep. com. Detroit Free Press, 19 July 2013. Web. 05 Sept. 2013.

Lovas, Phil. Phone Interview. 7 Sept. 2013.
Payne, Henry. "Why Obama Let Detroit (city) Go Bankrupt." The Detroit News. The Detroit News, 30 July 2013. Web. 13 Aug. 2013.
Plumer, Brad. "Detroit just filed for bankruptcy. Here's how we got here." Washingtonpost. com. The Washington Post, 18 July 2013. Web. 5 Sept. 2013.