July 15, 2012

Municipal bankruptcies on the rise

Colin Read, Everybody's Business

---- — We are beginning to see on the horizon an approaching wave that may wash over us all.

Three municipal governments in California recently sought bankruptcy protection. San Bernardino is following Stockton and Mammoth Lake in its effort to settle with creditors and restructure contracts and liabilities in a way that proves more sustainable.

An incorporated municipality is much like a private-sector corporation seeking bankruptcy protection. A court will help broker an arrangement in which creditors take their share of liquidated assets if there cannot be found a way to reorganize. Courts prefer, though, to help broker a reorganization that allows a viable entity to go on in a more sustainable manner. This typically means breaking contracts, settling debt for pennies on the dollar and reaffirming that corporations must not spend and commit beyond their means going forward.

Municipalities are different from private-sector bankruptcies in a couple of important aspects, though. First, they have the ability to increase revenues, to a point, simply by increasing the tax rate. However, once the tax rate becomes excessive, they discover residents flee to lower-cost communities rather quickly. Residential flight depresses property values, which forces the tax rate up even more, and creates a viscous cycle that rarely ends well.

Municipalities are also different in that their predominant factor of production is us. Government is labor intensive, and the labor often lives in the municipality. In some sense, government is like a worker co-op. The voters are shareholders, but many are also employees. When beleaguered mayors go to a town meeting to announce that their city cannot pay its bills and must contemplate layoffs or wage reductions, those voters who are also employees like to remind the room that the mayor works for them and cannot lay them off.

The difference between a municipality and a worker cooperative is that only a minority of the voters work for the municipality. However, these voters have a much bigger stake in the decisions of government because they are taxpayers, like all of us, but their economic future is also tied to government spending. They may have one vote, but they wear two hats.

It is difficult at times to tell which hat they wear. We don’t need a bankruptcy, though, to witness this conflict. If a municipal employee laments cutbacks in local government, are they taxpayers or employees at that moment? If a parent or teacher laments education cutbacks, are they a taxpayer or one that benefits more directly from education spending? This tension makes for much more passioned discussions when government proposes cutbacks than when a corporation seeks reorganization.

This tension is divisive for a community. Those who work for government believe they have secured promises from government officials that are being retracted. They are justifiably upset. And yet, if the promises are kept, those taxpayers who will have to bear tax increases are upset instead.

Private corporate bankruptcies are less impassioned because the stakes are lower. In both private and municipal bankruptcies, jobs may be lost. However, private companies are getting out of the business of making long-term promises they may not be able to keep. They once promised pensions, in the form of defined-benefits packages, but only about 7 percent of the private sector does so any more. In an unusual quirk among nations, the U.S. requires many employers to provide for health insurance, as other nations typically assume that burden at the national level. Health benefits are not a long-term promise made by many employers, however. They recognize most private-sector employees are on their own for health care if employment ends.

This move away from long-term promises in the private sector could be viewed as a reasonable response to a problematic situation. The alternative is to simply have private firms make all kinds of promises they know they can’t keep to garner a loyal workforce, and then declare bankruptcy and renege when the economy prevents them from living up to all their promises. False promises are worse than no promises at all.

The growing wave of municipal bankruptcies is a product of false promises. Municipalities are now realizing that they cannot simply raise taxes any more to live up to unrealistic promises in an uncertain world. Nor can they print money, or borrow beyond their means without running the risk of much higher interest rates as their bonds are rated downward. Vallejo, San Bernardino, Mammoth Lake and Stockton, Cal.; Prichard and Jefferson County, Ala.; and Central Falls, R.I., are the latest victims of long-term promises politicians could ill afford to make. Unfortunately, they won’t likely be the last.

Colin Read chairs the Department of Economics and Finance at SUNY Plattsburgh. Continue the discussion at