How Rare Are Municipal Bankruptcies?

Local governments rarely opt to file for bankruptcy. View totals and bankruptcy laws for each state.
by | January 24, 2013

With all the talk surrounding municipal bankruptcy in recent years, some might view Chapter 9 as an increasingly common path for cash-strapped local governments.

Financial analyst Meredith Whitney first sounded the alarm during a 2010 interview on CBS’s 60 Minutes, predicting between 50 and 100 “sizable” defaults amounting to hundreds of billions of dollars. A few high-profile cases of cities seeking bankruptcy protection have since garnered national attention, with some media reports suggesting an impeding wave of Chapter 9 filings. A November story in Salon even declared American cities were “dropping like flies.”

In actuality, though, Chapter 9 filings have been few and far between. In all, only 13 localities sought bankruptcy protection over the past five years. A far greater number of sanitation authorities and other lesser-known special districts also filed, but the totals remain low given the number of municipalities across the country.

But just how rarely do localities opt for Chapter 9 bankruptcy protection?

To start, we’ll need to determine how many local governments are eligible to file. The Census Bureau classifies local governments as either “general purpose,” including cities and counties, or special-purpose, which comprise school districts, water authorities and other narrowly-defined municipalities. For the purposes of this analysis, we’ll look at general-purpose local governments since laws pertaining to special districts are less uniform.

Federal law permits all local governments to file for Chapter 9, but only if a municipality’s state government allows for it.

The degree to which laws limit Chapter 9 filings varies greatly from state-to-state. James Spiotto, a Chicago attorney who has studied municipal bankruptcy extensively, reviewed state laws, grouping them into different categories. He found 12 states specifically authorize Chapter 9, while 12 others permit bankruptcy filings given a further action taken by a state, official or other entity.

The following map illustrates states’ different approaches to municipal bankruptcy:

 
State specifically authorizes Chapter 9 filings
 
Chapter 9 filing is authorized upon conditions met and further action of state, officials or other entity
 
Municipalities have limited authorization (click for details)
 
No Chapter 9 authorization outlined, laws are unclear or filing otherwise prohibited

 

State policy classifications obtained from "Primer on Municipal Debt Adjustment," Chapman and Cutler LLP.

The 2012 Census of Governments counted 38,917 general-purpose governments throughout the country, 21,683 of which were located in states with laws permitting Chapter 9 filings.

As previously mentioned, few such governments have sought bankruptcy protection. Since 2008, only the following municipalities filed:

  • Gould, Arkansas (Dismissed)
  • Vallejo, California
  • Westfall Township, Pennsylvania
  • Village of Washington Park (Dismissed)
  • Town of Moffett, Oklahoma
  • Prichard, Alabama
  • Boise County (Dismissed)
  • Central Falls, Rhode Island
  • Harrisburg, Pennsylvania (Dismissed)
  • Jefferson County, Alabama
  • Stockton, California
  • Town of Mammoth Lakes California (Dismissed)
  • San Bernardino, California

This adds up to only one of every 1,668 eligible localities (0.06 percent) filing for bankruptcy protection over the past five years. If we exclude the filings later dismissed, only one of every 2,710 localities has successfully filed since 2008.

These are only estimates for general-purpose governments, given that some state laws may prohibit filings by a few select types of local governments. For a complete list of all recent Chapter 9 filings, including special districts, please refer to our municipal bankruptcies map.

To put these estimates into perspective, there were 389,278 commercial bankruptcy filings over the same time period, according to the American Bankruptcy Institute and Epiq Systems, Inc.

A Standard & Poors report published in October forecasted municipal bankruptcies will continue to remain rare. The company expects “pockets of outright credit distress,” but the report says the vast majority of municipalities are committed to meeting their financial obligations.

Cities exploring bankruptcy protection can be dissuaded by a litany of potentially negative consequences accompanying a Chapter 9 filing. For one, their credit ratings would likely take a hit. Municipal bankruptcy is a lengthy and costly process, with long-term implications impeding an area's future economic growth. The S&P report also describes how the short-term benefits of bankruptcy protection, such as temporary cash flow relief, typically dissipate within a few years.

"Filing a Chapter 9 petition — no matter the reason — sets in motion a process with damaging consequences to a municipality's fiscal and economic prospects," S&P notes.

If there’s one state that has experienced a noticeable uptick in municipal bankruptcies, it’s California.  The city of Stockton and town of Mammoth Lakes filed for Chapter 9 this past summer, then San Bernardino followed suit in August. The city of Vallejo also filed in 2008, but has since emerged from bankruptcy protection.

Each of the cities faced their own set of unique circumstances. But part of the reason for the filings could also stem from the relatively few barriers the state’s municipalities face when seeking bankruptcy protection.

State lawmakers declined to push through a bill last fall making it more difficult for California cities to seek bankruptcy protection. State law currently requires mediation prior to a Chapter 9 filing, but the mediator has limited power and cannot impose an agreement, leading some to view the state's process as a mere formality. The proposal, backed by unions, would have given mediators stronger authority and loosened deadlines in negotiations between localities and creditors.

Many argue local governments shouldn’t write off bankruptcy as an option in dire circumstances. At a Governing conference last year, Robert Flanders, the former receiver of Central Falls, R.I., said more localities would be pursuing Chapter 9 if the process did not have such a negative stigma attached. The city’s bankruptcy filing, he said, was key to gaining leverage in negotiating concessions with its unions.

"Bankruptcy is not the disease for these cities and towns; it's the cure," Flanders said.

And despite the relatively few Chapter 9 filings, some continue to forecast doom for more municipalities. David Dubrow, a partner of Arent Fox, LLP, told AdvisorOne.com last year he could see a wave of bankruptcies in the near future, particularly from medium-sized cities.

Most wouldn’t argue that quite a few local governments are struggling to balance budgets and pay off debts. But, if recent years are any indication, very few of them will end up pursuing bankruptcy protection as a last resort.

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