After Municipal Bankruptcy

Overview

The recent high-profile bankruptcy filings by Detroit and a handful of other local governments around the country have renewed state and local policymaker interest in strategies to prevent future financial crises as well as in the choices states face about whether to intervene to help distressed cities and counties.

Starting with Vallejo, California, in 2008, a string of municipal Chapter 9 bankruptcies shook Prichard, Alabama; Central Falls, Rhode Island; Jefferson County, Alabama; Detroit; and Stockton and San Bernardino, California. Detroit was the largest municipal bankruptcy in U.S. history, and Jefferson was the largest county bankruptcy.¹ In the wake of this wave, policymakers have an opportunity, similar to the one that followed New York City’s near default in 1975, to update and expand laws and policies clarifying states’ role in monitoring and intervening in financial crises of local governments.

© Wade Bryant/ Getty Images

The Detroit skyline at sunset.

Understanding what happened in Detroit and other recent Chapter 9 filings is critical to preventing future bankruptcies and the years of pain that can accompany them: service reductions, employee layoffs, cuts to public pensions, bond investment losses, property tax increases, millions of dollars in legal fees, infrastructure decay, and loss of population. As federal Judge Steven Rhodes said when he approved Detroit’s bankruptcy plan in 2014, the necessary adjustments “will cause real hardship. In some cases, it is severe.”²

The difficulties are one reason some analysts predict that there will not be a rash of filings in the coming years, even though many troubled cities are still struggling to balance revenue and spending following the last recession. A few cities—North Las Vegas, Nevada; Desert Hot Springs, California; and Atlantic City, New Jersey—are on the precipice, but no city has filed for bankruptcy since Detroit did so in July 2013. Detroit ended its bankruptcy in December 2014, leaving San Bernardino as the only city with an unresolved Chapter 9 filing.³

Until now, lawyers and financial analysts have conducted most post-bankruptcy analyses, focusing on the effect on investors who buy and insure municipal bonds. But state and municipal leaders need to weigh broader impacts on residents and workers. This report offers important lessons from Detroit and other municipalities to help policymakers avoid future financial meltdowns and manage fiscal crises when they do occur. Among the lessons learned:

• Early state intervention in local governments’ financial emergencies can help avert a crisis or possible insolvency.
• When local governments have no options other than filing for Chapter 9 protection, a broad outreach plan that includes all stakeholders throughout the process can help resolve conflicts.
• Once a local government exits Chapter 9, a long-term recovery plan that outlines immediate financial fixes and long-term strategies, such as investing in economic growth, is critical to addressing underlying fiscal problems and preventing future crises.
• By taking active steps to budget over the long term—matching expenses and revenue over several years—local officials can promote fiscal health and increase their city’s capacity to weather the ups and downs of the business cycle.
• Regular monitoring of local government finances can help state officials detect early signs of distress.
• State policymakers can prevent Chapter 9 filings by developing alternatives, such as naming a monitor or temporary manager to restore a city’s finances.

Download the full report.

Endnotes

1. Chapter 9 refers to the section of the U.S. Bankruptcy Code dealing with municipal bankruptcies. The source for the record Detroit and Jefferson County bankruptcies was Matthew Dolan, “Record Bankruptcy for Detroit,” The Wall Street Journal, July 19, 2013, http://www.wsj.com/articles/SB10001424127887323993804578614144173709204.
2. Bankruptcy Judge Steven W. Rhodes, “Oral Opinion in Re: City of Detroit,” U.S. Bankruptcy Court for the Eastern District of Michigan, Southern Division, Nov. 7, 2014, http://www.mied.uscourts.gov/PDFFIles/DBOralOpinion.pdf.
3. Michigan Governor Rick Snyder, termination letter to emergency manager Kevyn Orr, Detroit bankruptcy, Dec. 9, 2014, http://www.michigan.gov/documents/snyder/Final_Termination_Letter_120914_476126_7.pdf.