Bankrupt Cities? What About Distressed Cities?

Bankruptcy grabs the headlines, but distressed cities are a more widespread problem – one that few states know how to address.
by | March 2014

This is part of an ongoing series called Finance 101 that goes back to the basics to help public officials.

Hanging on the door of his city hall office in Scranton, Pa., David Bulzoni has a framed print of a train. It’s there for two reasons: First, it’s a reminder of Scranton’s proud history as a railroad and cultural hub. Second, it’s a nod to the movie Unstoppable, the story of a runaway freight train and the two men who attempt to stop it. As the business administrator for a distressed city, Bulzoni sees ties between his job and the characters in the movie. “You’re just on an unstoppable train,” he says.

Scranton, a city of about 76,000, has been sliding into fiscal trouble ever since coal mining collapsed here in the 1950s. Like other cities that have lost their main industry, it has been suffering through an eroding tax base, aging population, and rising retiree and personnel costs. In recent years, political animosity among its leaders has exacerbated the city’s financial situation and led Scranton to default on a parking authority bond, earning it scorn from lenders and banks.

Officials have long been aware of the city’s fiscal failings. In 1992, the city council voted to enter into the state’s Act 47 program, which provides loan and grant money to financially distressed governments and helps them develop financial recovery plans. Few cities that have volunteered for the program have actually emerged from it. Twenty-one have entered and six have exited. Scranton is one city that has failed to flourish since it entered the program, and divided leadership has worsened its outlook.

Scranton’s woes and vulnerable fiscal footing are by no means unique. While municipal bankruptcies have gotten a lot of national headlines, it’s not the bankrupt cities that are the widespread problem. It’s the ones on the edge—the “distressed” cities. These are places that likely will never declare bankruptcy but are nonetheless struggling to become economically viable again.

Complicating the problem is the tense relationship between the stressed cities and their states. Cities don’t want to be treated like children. Duly elected city officials don’t like being told what to do by state overseers; they want a partnership, not a dictatorship.

Like their cities, states also want a partnership, but the difference often lies in what that should look like. From the state’s point of view, struggling cities are a poor reflection on the financial health of the state, and a danger to its economy. Yet the states don’t have the money for a bailout—never mind the political will to provide one, as many believe that wouldn’t put cities on sound footing in the future anyway. States want cities to settle down and take their advice, even if it’s tough medicine.

The question for both parties—the stressed city and the paternalistic state—is simple: How can we work toward a common goal of fiscal health? Finding a common solution, however, is more difficult.

Many states have put some legislative thought into how they will deal with troubled cities. All told, 19 states have intervention programs for distressed municipalities, but the potential level of involvement varies. The most assertive state is North Carolina. In a program that dates back to the Great Depression when more than 400 local governments and public authorities in the state defaulted on debt, the state’s Local Government Commission (LGC) was created to sign off on all local debt issuance. Today it still monitors local property tax intake and will not allow localities to issue debt if fund balances drop below a certain point. Officials in North Carolina claim LGC oversight is the key reason the state’s municipalities have strong credit ratings. Recently, Tennessee replicated North Carolina’s approach—albeit with a lighter hand. After the Great Recession, a number of local governments were drowning in debt thanks to investments in risky variable rate debt. That prompted Tennessee to mandate that local governments borrowing money draft debt management policies following very specific guidelines.

Similarly on the aggressive front, New York Comptroller Thomas DiNapoli and Gov. Andrew Cuomo launched a fiscal monitoring system a year ago designed to flag struggling municipalities. A new fiscal restructuring board will advise local governments seeking help and could offer a loan or grant of up to $5 million to those following their advice. Pennsylvania also has an early warning system for its cities. It was developed in the mid-2000s, two decades after the Act 47 program.

Many observers wish more states would consider monitoring their local governments’ finances. “It’s a really proactive way to reveal budget distress,” says Steve Fehr, co-author of a Pew Charitable Trusts report on state intervention programs. States with more conventional intervention protocols, he suggests, “don’t react until it’s too late.”

Part of the dilemma for cities, of course, isn’t monitoring, but the way local finances have been reconstituted in recent history. Over the last century, city revenue streams have gone from being based almost entirely in property taxes to being more weighted in charges and fees, notes Michael Pagano, dean of the College of Urban Planning and Public Affairs at the University of Illinois at Chicago. That has played heavily in the state-city tension as cities try to rebalance their fiscal footing. “States continue to restrict the authority of municipals to create a lasting revenue structure,” Pagano says. That said, he adds that the idea that more taxing power would be a fix is still largely theoretical. “We can point our fingers at the state because they do have enormous amounts of discretionary control over what cities do.” And it is unclear whether expanded taxing authority would actually solve cities’ fiscal problems, he says. “Whether it would actually be better is the question.”

Many of these issues over state intervention are on view in Scranton. Act 47 and Scranton’s financial turmoil have played out in city council meetings, on balance sheets and on Wall Street—even though on the surface, Scranton doesn’t look like a city that can’t pay its bills. White tablecloth restaurants dot downtown and smiling residents shout conversations at one another across the street. “This isn’t a run-down, hopeless, we’re-never-going-to-get-better community,” says Mike Washo, a former county commissioner and now the appointed receiver for the city’s troubled parking authority.

Over the past 20 years, this center of northeastern Pennsylvania has developed into a tourist destination, spawned a medical school and seen demand for downtown living soar. Former Mayor Chris Doherty was able to round up tens of millions of dollars in economic development efforts: Downtown’s silent, century-old relics have been restored and turned into restaurants, apartments and retail. The city even gained a bit of fame as the setting for the Dunder Mifflin Paper Company, the fictional paper sales company featured in the television series “The Office.”

“Scranton is not on fire,” says Chamber of Commerce President Robert Durkin, despite the “very challenging, complicated financial problems of the city government.”

Exacerbating Scranton’s problems has been political infighting, triggered by the prospect of state intervention. Even Scranton’s decision to seek Act 47 status was divisive—the city council unanimously approved the decision despite the vehement opposition of then-Mayor Jim Connors. Connors, who viewed the act as abdication to an unelected entity, immediately butted heads with the nonprofit assigned by the Pennsylvania Department of Community and Economic Development (DCED) to coordinate Scranton’s recovery. It’s that sort of knee-jerk resistance by local officials that really frustrates a state, says Clyde “Champ” Holman, DCED’s deputy secretary of community affairs and development. “It really comes down to personalities,” he says. “Some have the attitude as if we’re taking over. And that’s the wrong attitude.”

But in Scranton, even a subsequent—and more cooperative—administration under Doherty resulted in little progress. Doherty and the state hinged Scranton’s recovery plan on its ability to change costly union contract provisions using Act 47 as legal justification for doing so. Fire and police unions fought the recovery plan and the state Supreme Court agreed, ruling in 2011 that the city must pony up what is now a roughly $30 million award in back pay. It ultimately weakened Act 47’s protection by granting the award despite Scranton’s distressed status and without consideration of the city’s ability to afford the payment.

The adverse court ruling aggravated already negative fiscal pressures. Political wrangling after the Supreme Court decision resulted in the city council forcing the city parking authority into default on its bonds. The move cut off the city from credit markets for months. Cash flow problems forced Doherty to temporarily cut workers’ salaries to minimum wage.

Even today the fiscal picture continues to look shaky. The 2014 budget includes a 57 percent property tax hike and a 69 percent garbage fee hike to help close what was a $20 million projected deficit. The city still struggles with credit: After one bank backed out of a financing deal, Scranton scrambled to find a lender that would let it borrow enough money for paydays until tax receipts come in. It was a tough sell. “Once you default on a bond issue, you have hell to pay for years,” Bulzoni says.

From the state’s perspective, Scranton’s political divisiveness is the main reason it has struggled to shed the distressed cities label. “Doherty was really willing to work with us,” says Holman. “The council president [Janet Evans] never, ever stepped foot in our department and resisted us every step of the way.” Evans, who retired from the council after 2013, has long maintained that the DCED has not done enough to assist Scranton’s recovery. In a tense council meeting in 2012, she blamed the state for the Supreme Court outcome, saying that “the state and DCED had turned their backs on Scranton taxpayers” and that the department had ignored her request to appoint a different recovery coordinator for the city.

At its core, Scranton is like many other distressed cities. As the employment center for the region, it bears the brunt of the daily influx of workers without the benefits of a matching tax base. From Pagano’s perspective, this means that a distressed city’s problems should really be viewed as a regional issue. Where states can help is in facilitating that conversation. “It’s a great opportunity to start rethinking all of these relationships between cities and states and what controls states ought to have,” says Pagano. “We don’t seem to be having that conversation.”

In New York, Syracuse Mayor Stephanie Miner couldn’t agree more. The 20th-century framework for cities that relies on property taxes doesn’t work when the main industry skips town, she says. Even though Syracuse qualifies for consulting and a loan from the state restructuring board, it isn’t taking the help. The city has already hired consultants, pored over its books and made the suggested changes. A small state loan, Miner says, won’t put a dent in the city’s multimillion dollar problem.

Instead, Miner suggests the state can get in the game by facilitating talks between mayors and their neighboring county executives. It could loosen business regulations in some circumstances or give up control of restrictive labor practices. “You can’t tax your way out of the dynamic,” Miner says. “And in order to change that dynamic, you have to have the state change it.”

About 30 miles north of Syracuse, Fulton Mayor Ron Woodward is eager to open his books to the state. Fulton is one of the first cities to take New York up on its offer to work with the financial restructuring board, which is interviewing city leaders to develop an action plan for Fulton. Woodward speculates it may include consolidation of services and debt reform. The city of about 12,000 has been crippled by the loss of food manufacturers and rising pension costs, but Woodward says New York’s expensive business policies have been the nail in the coffin for not just Fulton but much of upstate New York. Fulton lost two manufacturers to Wisconsin, where energy costs and workers’ compensation insurance are far cheaper. “I don’t think anybody at the state level is intentionally at fault,” he says. “The state deals with much bigger issues and I don’t think they really understand what’s happening [with the local economic structure].”

Woodward’s point is that cities feel as if they’re not being heard. Sometimes it is because there is too much political commotion at the local level. But this isn’t true for every case. And in spite of that, cities still see themselves as the doers when compared with their states—cities deliver services. If city issues are not approached early on and with this sensitivity, state intervention can aggravate the local attitude. “Most people now think that cities are the only level of government that works,” Miner boasts. “The irony in all this is people’s perception that cities solve all the problems—and we’re the ones in crisis.”

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