Bankruptcy Series: What are the alternatives to bankruptcy?

November 12, 2012 - By admin

Editor’s Note: This is the Ninth in a CalWatchDog.com Special Series of in-depth articles on municipal bankruptcy.

Nov. 12, 2012

By Tori Richards

It was 1975 and New York City was running out of cash. Its excessive spending and lack of financial oversight created a $14 billion debt, with more than half of it short-term. A request for a bailout from the federal government, headed by President Gerald Ford, didn’t happen and was memorialized with the famous New York Daily News headline, “Ford to City: Drop Dead.”

So rather than watch the Big Apple fail, the state of New York took action and helped make the city the strong metropolis it is today. That landmark process has become a primer for other entities to follow in keeping out of bankruptcy.

“It’s a well-regarded credit now,” municipal bond manager Tom Dalpiaz said of the city. “New York’s budgetary process is very strong. They keep track of it, have projections and know when they are going to run into trouble.” Dalpiaz oversees portfolios worth $280 million as senior vice president of Advisors Asset Management in Colorado.

But before arriving at a disaster point, municipalities can employ a variety of strategies to stay solvent, experts say.

“You can only do what is sustainable and affordable and if you make promises you can’t keep, then the best thing you can do is correct that mistake as soon as possible,” said Chicago bankruptcy attorney James Spiotto, considered one of the foremost experts on the topic. “You have to watch your budget.”

Before a municipality can file for Chapter 9, it has to be truly insolvent and not just looking for a way to get out of existing contracts and pensions. Cities like Vallejo, Calif.and Central Falls, R.I. had minuscule budgets compared to their looming pension payments and the contracts with city workers were excessive. Bankruptcy was the only option.

The Municipal Assistance Corporation

New York legislators knew that a bankruptcy filing for their world-class city would be disastrous for the state’s credit rating, Wall Street and the economy. So they created the Municipal Assistance Corporation  in 1975.

With members appointed by the governor, this state agency converted the city’s sales and stock transfer taxes into state taxes which were used as security for additional bond sales. It also advanced funds to keep the city running, according to a report from the California Research Bureau.

“The MAC demanded that the city institute a wage freeze, lay off employees, increase subway fares and begin charging tuition at city universities,” the report said. “Despite a summer of labor unrest, these measures stuck and MAC was able to refinance some city debt, but the market was still resistant.”

Next, the state created the Emergency Financial Control Board, which took control of the city’s finances.

“The state law creating the EFCB required the city to balance its budget within three years, change its accounting, and submit a three-year financial plan,” the report said. “The Board had the power to review and reject the city’s financial plan, operating and capital budgets, contracts negotiated with the public employees’ unions, and all municipal borrowing.”

Six years later, the city had a balanced budget and was able to sell long-term bonds. By 1985, MAC was no longer needed and New York was again a thriving city. It had overcome an operating deficit of $2.2 billion, the report said.

“MAC hasn’t issued bonds in 20 years,” Dalpiaz said. “It did the job and now the sick patient is up and healthy and on its own. That’s how the state is supposed to work with a troubled municipality.”

What New York accomplished has been emulated by other states across the nation, but not where it has been needed the most. Jefferson County, Ala. and Orange County, Calif. were both in dire straits financially, with the latter filing for bankruptcy in 1994 to close a $1.7 billion deficit. Jefferson County, Alabama’s largest and home to Birmingham, filed for bankruptcy on Nov. 8, 2011.

Neither California 16 years ago, nor Alabama today, has helped floundering counties avoid bankruptcy. California, which is also home to the bankrupt cities of Vallejo, Stockton, San Bernardino and Mammoth Lakes, passed a law last year that stops short of doling out funds. Assembly Bill 506, by Assemblyman Bob Wieckowski, D-Fremont, requires municipalities to work with a neutral evaluator under the California Debt Advisory Commission and obtain permission before filing for Chapter 9.

“This bill would NOT ban municipal bankruptcies or make them impossible,” according to a statement on the California Labor Federation’s Website. “Instead, it would simply create an oversight structure to ensure that bankruptcies are only entered into when necessary.”

What the Website doesn’t say is that a federal judge has the authority to deny a bankruptcy petition that lacks merit. For example, Bridgeport, Conn. filed in 1991, but the case was dismissed by a judge who ruled that the county was not insolvent.

Interestingly, California is in dire straits itself and some have floated the idea of amending federal bankruptcy law to allow states to reorganize their finances.

In a January 27, 2011 column, Newt Gingrich and Jeb Bush called for Congress to “allow states in default or in danger of default to reorganize their finances free from the union contractual obligations.” Gingrich is the former speaker of the U.S. House of Representatives and a was Republican candidate for president. Bush is a former governor of Florida. 

Organized Labor

Municipalities that aren’t lucky enough to have a MAC-style agency helping out have to look toward other options in preventing bankruptcy. One of the most obvious is controlling labor costs.

Worker contracts and their pensions proved to be the undoing of both Vallejo and Central Falls and have placed an untold number of other municipalities in danger, including San Diego and Los Angeles.

“To the extent that employee compensation costs are a problem, states have it within their power to change collective bargaining rules,” said E.J. McMahon, a senior fellow with the Manhattan Institute, a New York-based free-market think tank. “If you are threatened with fiscal distress because of collective bargaining rules, you can change the rules.”

In California, those rules were enacted in 1977 with what’s called the Dills Act. The bill was signed into law by none other than Jerry Brown, during his first stint as governor. The rules and can be undone by the Legislature at any time, McMahon said. He added, “California has a statutory presumption that the pensions are contractual. No one has been willing to test [in court] that it’s a benefit not yet earned by future employees.”

Another recommend overhaul in California and perhaps elsewhere is civil-service rules.

“Most of the states need to move to a new place away from old civil-service rules and there is not a move to do that,” McMahon said. “A federal judge can’t just say, ‘Let’s get rid of these civil service rules’.”

Unyielding unions, which drove Vallejo into bankruptcy, got more than they bargained for when a judge ruled that the labor contracts could be broken. That precedent-setting move is bad news for unions in future cash-strapped municipalities.

“There are painful choices that need to be made when a budget needs to be cut,” Dalpiaz said. “No one wants their ox to be gored; everyone thinks the problem is somewhere else. The fighting gets intense and. before you know. it people throw up their hands and say, ‘We have to file for bankruptcy’.”

Lessons from the Past

New York’s problems may have dated back to the 1960s, but 50 years later they seem remarkably contemporary. According to the California Research Bureau, the following “gimmicks” existed:

* Overly optimistic forecasts of revenues;

* Heavy use of revenue anticipation notes, including notes for revenues that did not materialize;

* Underfunding of pensions;

* Use of funds raised for capital expenditures for operating costs;

* Appropriation of illusory fund balances, meaning that special fund revenues were overestimated and used to balance the budget;

* Writing checks late.

Of course, any expert would advise entities to conduct affairs in the opposite manner. Bankruptcy attorney Robert McConnell, who represented Vallejo, said too few lawmakers have a working knowledge of finances.

“They get elected because they are popular, not because they are accountants or financial experts,” he said. “They leave it to their professional staff to explain it to them. When you go to a city council, board of supervisors or water district meeting, they have their accounting experts out there to explain it to them. Any legislator has to do his or her own independent research.”

Understanding finances will help lawmakers pinpoint the exact reason for fiscal trouble, which is the first thing a municipality needs to do, according to the report, “Municipal Bankruptcy: Avoiding and Using Chapter 9 in Times of Fiscal Stress.” It was written by attorneys John Knox and Marc Levinson, who also represented Vallejo in its bankruptcy.

Some financial stressors are a one-time problem — such as Jefferson County and a huge sewer repair bill. Others are systemic and flaws in the municipality’s operation.  The former may be able to be rectified by spreading payments out over a long period of time; the latter requires structural change which lawmakers may not want to tackle.

Regardless, it’s essential that officials closely monitor the operating fund so they will know when the money runs out.

Knox and Levinson wrote, “A municipal official who requires or even permits employees to come to work if the official knows that the municipality will not be able to pay them may be violating state labor laws or committing common law fraud. In some states, this may even constitute a criminal offense.”

Novel Approaches

Obviously, raising taxes could stave off some filings, although the public doesn’t appear to have an appetite for that, especially in the high-tax states such as California, where municipal bankruptcy threats are more common. But there are other things legislators can do. According to a 2008 report from the American Bankruptcy Institute, state legislators can pass a law requiring cities to set aside a certain amount of money every year as a “rainy day fund,” with a mandate that it cannot be spent until a time of need. Research showed that states with such laws weathered recessions better than others that didn’t.

Also, local tax systems can be reformed to required suburbs to share in part of a city’s expenses. This could be accomplished by the creation of special districts to levy taxes. Where citizens refuse to back tax increases, a host of fees could be tacked on to services such as trash, sewage, parking and utilities.

But above all, just have common sense, McConnell said.

“Don’t give away the bank. Our previous city council made some pretty generous agreements with our labor unions. That can only be sustained with a healthy economy.

“Bankruptcy is like a boat overloaded with people in the water when a storm comes,” McConnell continued. “It’s that one wave that sinks them and they are all done. We have to be more careful than we ever were before.”

Richards is an award-winning investigative reporter.

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Comments(27)
  1. Frank says:

    This article states that “raising taxes could stave off some filings, although the public doesn’t appear to have an appetite for that, especially in the high-tax states such as California.” I guess the author hasn’t read the news that California passed Prop 30 last week? Bloomberg reports that “California debt is rallying the most in three months as Governor Jerry Brown’s tax-vote victory leads investors to bet the state will get its first credit-rating upgrade since 2006.” Just shows you again that Meredith Whitney didn’t know what she was talking about…

  2. Queeg says:

    Buzzard says we are ok now….let it go….sick of the useless and pitiful rants by bunker doomers…get on with your shattered life…..and pay your fees and taxes.

  3. Hondo says:

    Go ahead, raise taxes. They tried that in the last couple years in both Kalifonia and Illinois. The result; more deficits. You can look that up.
    Then what do you do when you raised taxes and still can’t balance the budget?
    The fine article by Tori Richards could be condensed into a few words. You can’t spend more than you take in. There, in 8 words, none of them longer than 5 letters, I described the problem and the solution.
    But the republicans can’t win a race against Santa Claus, someone who promises everything and says someone else will pay for it, not you. But if you taxed 100% of all the income on the people who make more than 250k, you wouldn’t get half way to balancing the Obama budget. You can look that up.
    Hondo……

  4. Dyspeptic says:

    Grab a bottle of ouzo and a few gyro’s – We’re all Greeks now.

  5. Queeg says:

    Dys….gloom….doommmmm….whahhhhhh….Buzzard doing great job….be led for a change….bunker boys need grown up tough love!

  6. Donkey says:

    “The Golden State”, a golden state no more. My former party’s operatives have impounded for themselves massive amounts of The American Workers’ money from our economy. Now, we in CA have hundreds of dead shopping malls, even those malls in rich areas are about 40% dead, none full that I have seen. How many dead jobs is that? . . all the while my former college-mates plunder the public in their bureaucracy jobs.

    The democrats in general have impounded our money for themselves by means of their interconnected cabal of insider thieves. They have taxed our creators, our entrepreneurs, our employers at the highest tax rates on earth. Here in CA they have regulated & taxed thousands and thousands of American Workers’ jobs right out of existence in their zest to excise their unhappy childhood memories of their mommies and daddies . . . . by hurting & destroying those who symbolize their parents.

    Those job creators whose enterprises this plundering cabal hasn’t killed outright have left to Ireland, China, Peru, et al, . . . if they can. Of course, the dead jobs stay here in CA.

    The democrats have formed an unholy alliance with crooked, crony capitalist corporations like GE/corrupt and thieving government unions (who rob their members of billions to give that cash ONLY to democrat candidates)/insider sister organizations such as ACORN, NOW, CA Teachers Association, et al/ . . . all led by academia’s smooth-talking PC speech-controllers who organize the overall plunder of our public treasuries.

    The only course of action left to the freedom seeking citizens is to refuse to feed the RAGWUS thieves by moving business and home from this state. :)

  7. Ted Steele, The Decider says:

    Poor Dysphoric—–His retrolentalphibroplasic youth has left him stranded in a doomy dream sequence……zzzzzzzzzzzzzzzz……oh no!….zzzzzzzzzzzzzzz……the sky is falling……..zzzzzzzzzzzzzzzz

  8. Rex the Wonder Dog! says:

    Teddy, what is a “seious dem”???? :)

    zzzzzzzzzzzzzzzz……oh no!….zzzzzzzzzzzzzzz……the sky just fell on teddy!!!!!!!!!!

  9. Queeg says:

    Repubs are out of touch perennial losers….Poodle get relavent….your a cynical sort.

  10. Ted Steele, The Decider says:

    Some trolls never learn!

    Rex the Poodle— 0 for 14 ™ !

  11. Hondo says:

    I was wondering the same thing, Rex. Just what is a ‘serious dem’? A democrat who actually feels guilt as compared to the sociopaths who make up the rest of his party?
    Teddy has admitted that he doesn’t trust the leaders of his own party to run the state.
    I actually agree with him. I don’t trust the republicans to run the state either.
    My motto? The lord is my shepherd, not the republican party.
    Hondo…….

  12. Hondo says:

    And I have to say that ‘Donkey’ is an incredibly gifted writer. As opposed to most of the liberals here who do nothing but call people names. I do try not to get sucked into the little tit for tat name calling. I do wish the Queeg would respond to our thoughts with thoughts of his own, not his name calling. He, and most of the liberals here, seem to be well read and when they do write out a response, it is a worthy argument.
    In the mean time I’ll work to become as worthy a scribe as Donkey.
    Hondo……

  13. Ulysses Uhaul says:

    Hondo…..Queeg is a little off….eye twitches when he gets upset at dumb posts on CWD….he works in the yard with doomers moving out of state…that’s a tough job listening to a bunch of whining cheap skates….some of these pikers even try skipping out with boxes, packing supplies, tape and marking pens…..Queeg is Queeg…you would be koo koo too putting up with doomer problems.

  14. Ted Steele, The Decider says:

    Hondo– you’re almost right– I trust em– but need to verify—- we have no excuse now—–But– what a great election!

    Carry on!

  15. BobA says:

    The only viable alternative to bankruptcy is to raise taxes and keep raising them until the state can get a federal bailout. There’s also the option of confiscating the excess income of people making over $60K a year.

    It’s unfair for people to make more than what they need to pay their bills and put food on their table. It’s only fair that they relinquish their excess income so that others can have their fair share of the income pie. The government has a right and an obligation to take their excess income and redistribute it in the interests of equality and fairness.

    I am writing my state senator and representative to suggest that they introduce an “Income Equality & Fairness” bill in Sacramento.

  16. Rex the Wonder Dog! says:

    Hondo says:
    I do wish the Queeg would respond to our thoughts with thoughts of his own, not his name calling.

    Juts read the comments he posts under his other handle, Teddy Steals ;)

  17. Rex the Wonder Dog! says:

    Hondo says:
    I was wondering the same thing, Rex. Just what is a ‘serious dem’? A democrat who actually feels guilt as compared to the sociopaths who make up the rest of his party?

    Only Teddy knows what a “serious dem” is…Teddy, 411 on what a serious dem is please ;)

  18. BobA says:

    Rex, Hondo:

    The person you’re referring to can’t respond with a cogent of their own because it might cause them to suffer a brain aneurism if they tax their brain that hard.

    I’ve been reading this forum for some 6 months now and that person has never written more than one or two sentences and once they get beyond the first sentence their “comment” devolves into utter nonsense. I ascribe more intelligence to a primate than that person.

  19. Ulysses Uhaul says:

    BofA

    eloquent…..magnifico….you describe well.

    however, your checkbook is in quick draw mode….Super majority ain’t your friend…

    – Ulysses

  20. Tough Love says:

    File for bankruptcy and cut he pensions by 50% (75% for safety).

  21. BobA says:

    Ulysses Uhaul:

    I haven’t written a checks in years. Who still writes a check, you? My condolences. The rest of your comment makes no sense.

  22. SeeSaw says:

    Donkey, I know a sure way for you to stop those self-pitying rants about the degredation of CA. Turn on the news and watch the latest videos of the wholesale slaughter of men, women, and children, in the Syrian Civil War. Make sure you take a good look at that dead toddler slung of top of an end table, like it was just a chew-toy. If those scenes don’t cause you to regurgitate and renew your loyalty to your country and state, I don’t know what will!

  23. SeeSaw says:

    Bob, I pay all my bills with personal checks. I do not use an ATM machine. I go to the bank, and will continue to do so, until they lock the doors and refuse me entry!

  24. BobA says:

    SeeSaw:

    If that works for you then so be it. I find auto-pay to be more convenient.
    I have 3 different banking accounts that are all interlinked and I move money around as needed. By the way, my Royal Bank of Canada account pays the best rates on savings and money market accounts.

  25. ted says:

    BobA— You’re super dreamy…mmmmmmmmmmmmmmmmmmmmmm

  26. eatingdogfood says:

    Democrats + Unions = Bankruptcy!

  27. Donkey says:

    SeeSaw, take a good look at who is killing those people in Syria! Yea, it’s their own government! No different than our government that is stealing us blind and will soon be murdering us in the streets to keep their crooked pension scheme.

    As far as the “Syrian toddler” goes, we had a teenage girl murdered in Sunview park, by two government agents of the HBPD. Ashley MacDonald was a victim of government murder, so was Kenny Trentidue, and Kelly Thomas.

    I was a member of the USN, I don’t need to renew anything for you to show my loyality to our Constitution!! :)

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