How Does a City Go Bankrupt?

Posted on 25. May, 2008 by in Credit & Debt, Economy

If you haven’t heard, the California city of Vallejo filed for bankruptcy protection this week after they were unable to come up with over $17 million to balance the budget. The story prompted me to ask, “How does a city go bankrupt?”

The short answer is: just like the rest of us.

Sometimes there are extenuating circumstances like a rash of lawsuits or a natural disaster that drains the city coffers dry; however, most cities go bankrupt because of poor management and even worse budgeting.

Which should, actually, give you hope. After all, if a city staff of 15 accountants can’t balance the budget, it can’t be that easy can it? Granted, balancing a city budget is a little harder than your family of four, but it is based on the same principles. Unfortunately, however, cities get caught up in union negotiations and local politics which prevents them from making the same decisions you and I might make. For example, politicians aren’t too popular when they need to raise taxes to increase revenues. As a result, many politicians hesitate to raise taxes while at the same time keeping city service levels the same. And, just like a personal budget, you can’t survive very long when your income doesn’t cover your expenses.

Federal Bankruptcy Help:
To help cities in dire straits the US Government enacted the first municipal bankruptcy legislation 1934 during the Great Depression. Although similar to other bankruptcy chapters in some respects, chapter 9 is significantly different in that there is no provision in the law for liquidation of the assets of the municipality and distribution of the proceeds to creditors. Could you imagine the city being forced to liquidate city roads, sewers, and parks? The town Burger King could end up owning the park by your house!

Instead, chapter 9 is generally limited to approving the city’s bankruptcy petition, confirming a plan of debt adjustment, and ensuring implementation of the plan. But most of the time, cities use the courts to simplify debt repayment and to eliminate the need for multiple forums to decide issues.

In the more than 60 years since Congress established Chapter 9 bankruptcy legislation, there have been fewer than 500 municipal bankruptcy petitions filed. Although chapter 9 cases are rare, a filing by a large municipality can— like the 1994 filing by Orange County, California—involve many millions of dollars in municipal debt.

In the case of Vallejo, its the largest city in California to declare bankruptcy, and the only one to do so because of long-term economic problems. City officials have said that the city has been hit hard by the weak housing market and rising public employee salaries and benefits. In fact, 80% of the city’s budget is set aside to pay for police and firefighter protection.

What Happens After Bankruptcy?
Almost nothing as far as you and I are concerned. Water keeps flowing, garbage is collected, and the roads and parks are maintained. Generally, the city’s larger development projects get put on hold, and long-term projects are scrapped for the time being. The government can be dissolved and taxes can be raised to cover the shortage. But generally bankruptcy gives the city power to impose terms and conditions for salaries and benefits unilaterally. The city obtains the upper hand to force terms with respect to its collective bargaining agreements including police and firefighter unions. So why it’s probably safe to assume that day-to-day life will remain the same, you can also count on your city taking a huge step backwards in terms of financial prosperity. That city library that was planned for next year – you won’t see that for at least 7 years. Relationships with city workers will have to be mended, and the city government will have to regain the trust of the citizens, or find people who are more capable of running the city,

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