Harrisburg's Crisis Tests Pennsylvania

Pennsylvania Governor Tom Corbett last week warned Harrisburg, his state's capital, of the serious consequences that would ensue if the City Council failed to approve a plan to pull the city out of insolvency. "If there is no approved plan at this point," Corbett wrote in a letter to Mayor Linda Thompson, "then the city is likely to become mired in litigation and financial chaos." Undeterred by the dire warnings, the council voted down Thompson's financial emergency plan on Wednesday.  Now come the litigation and financial chaos-and a new test of how a state should respond when a local government can't pay its bills.

Harrisburg, a city of 50,000 people, is $310 million in debt from a botched retrofitting of a waste-to-energy incinerator. As Bloomberg reports , that debt is five times the size of the city's general fund. The city and the state have been trying for months to find a way to restructure the debt. The state officially declared Harrisburg financially distressed in December and this spring offered a plan to mend its finances, which included slashing the city's payroll and employee benefits. But the City Council rejected that plan in July, then rejected the mayor's new version of it on a 4-3 vote Wednesday.

Without a rescue plan, Harrisburg risks missing a bond payment due September 15. Before Wednesday's vote, Corbett said the state would likely take over the city's finances if the mayor's plan were defeated. Yesterday, the (Harrisburg) Patriot News reported that state lawmakers were drafting legislation to do just that. What isn't going to happen, at least not now, is a municipal bankruptcy. Corbett signed a bill in July that forbids cities of Harrisburg's size from filing for bankruptcy before July 2012. Senator Jeffrey Piccola, that bill's sponsor, said at the time that he feared a Harrisburg bankruptcy filing would hurt the credit of other local governments, but some critics warned that ruling out bankruptcy would reduce the city's leverage with creditors.

In taking Piccola's approach, Pennsylvania is trying a different strategy than some other states confronted recently with insolvent local governments. Vallejo, California, decided on its own to file for bankruptcy in 2008, without the state doing anything to stop it. Jefferson County, Alabama-that state's most populous county-has been on the brink of bankruptcy for years as it tries to get a better deal from creditors. A state-appointed receiver took Central Falls, Rhode Island, into bankruptcy last month. On the other hand, state aversion to municipal bankruptcy isn't unusual: About half of the states forbid it entirely.

So far, mass municipal bankruptcies on the scale that financial analyst Meredith Whitney warned about in December haven't materialized. Still, troubled local governments are increasingly leaving states with difficult choices, including decisions as to when municipal bankruptcy makes sense.

Tags: Economy