What are the alternatives to bankruptcy?

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

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.

31 comments

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  1. stolson
    stolson 23 July, 2013, 16:42

    Can property owners who keep getting special assessments to pay the bloated union pensions start recouping money by asking the city to sell off all assets and reimburse them? It seems many are forced to pay for all this unfunded liabilities via their property.

    Reply this comment
  2. SeeSaw
    SeeSaw 23 July, 2013, 18:44

    Identify the special assessments you are referring to, please. If you have a special assessment on your property that is in addition to your Prop. 13 taxes, a majority of the eligible voters in your, respective, assessment District voted it in. I would like to know what additional property taxes you are being forced to pay to cover pensions.

    Reply this comment
  3. SeeSaw
    SeeSaw 23 July, 2013, 21:02

    As usual, the conservative site will conveniently side-step acknowledgment of the “Myers, Milius-Brown Act of 1968, signed by Republican Governor Ronald Reagan, to maintain the usual excuse to throw stones at the “Dills Act”, signed by Governor Jerry Brown in 1977.

    Reply this comment
  4. stolson
    stolson 23 July, 2013, 22:21

    For Detroiters…I know they were assessed this.

    Reply this comment
  5. Ted Steele, The Decider
    Ted Steele, The Decider 24 July, 2013, 14:04

    almost 30,000 US municipalities and after all these years only a very small handful of BK’s…..why you ask?

    Because it’s way worse coming out and after on so many levels!

    Now– back to your cubicles doomers!

    wiiiiiiiiiiiiiiiiiiiiiiish!

    Reply this comment
  6. Ted Steele, The Decider
    Ted Steele, The Decider 24 July, 2013, 14:06

    Well said Seesaw— and the teabaggers hate to acknowledge the Constitutional underpinnings of Dill and Myers-Milius!

    Reply this comment
  7. The Ted Steele Conceptual Abstraction Unit
    The Ted Steele Conceptual Abstraction Unit 24 July, 2013, 09:36

    Some of you Doomers ™ might want to read/or re read the Federalist essays and maybe…oh…let’s say a little thing called the…

    wait for it..

    10th A.

    Reply this comment
  8. BobA
    BobA 25 July, 2013, 08:58

    Alternatives to bankruptcy? That’s a no brainer!! Taxes, taxes, taxes and more taxes, Once that avenue is exhausted then it’s on to fees, fines and penalties.

    Once everyone and everything is tapped out, the state government should then consolidate and package the debt of all the failed municipalities and sell it as high yield junk bonds, collateralized debt obligations (CDOs)and credit default swaps to the suckers overseas.

    Reply this comment
  9. Ted Steele, The Decider
    Ted Steele, The Decider 26 July, 2013, 07:08

    old Bo-bo—ever the cynic.

    Reply this comment
  10. BobA
    BobA 26 July, 2013, 11:17

    Ted:

    It’s time for your annual smack down but Lucky for you I’m in a jocular mood today. I’ll get back to you when I’m ticked off and in the mood to smack you around a bit. Until then, chill out and wait for it.

    P.S.: This doesn’t mean I don’t like you. You’re a good guy who means well but has gone astray. I’m here to shock your senses and set you back on the right path.

    Reply this comment
  11. The Ted Steele Conceptual Abstraction Unit
    The Ted Steele Conceptual Abstraction Unit 26 July, 2013, 15:12

    Bo-bo—

    “My” annual smack down? LOL…I think you’re having delusions of adequacy again Bob-bo. Don’t you mean your weekly smack down? I have seen you more down than up out here little buddy! But thanks for playing!

    Reply this comment
  12. Rex the Wonderdog!
    Rex the Wonderdog! 26 July, 2013, 23:58

    Some of you Doomers ™ might want to read/or re read the Federalist essays and maybe…oh…let’s say a little thing called the… wait for it.. 10th A. –

    ====================================
    You idiot ted, the 10 Amend. does not diminish the Supremacy Clause, you progressive surrender monkey 😉

    Reply this comment
  13. Rex the Wonderdog!
    Rex the Wonderdog! 26 July, 2013, 23:59

    Ted: It’s time for your annual smack down but Lucky for you I’m in a jocular mood today. I’ll get back to you when I’m ticked off and in the mood to smack you around a bit. Until then, chill out and wait for it. P.S.: This doesn’t mean I don’t like you. You’re a good guy who means well but has gone astray. I’m here to shock your senses and set you back on the right path.
    ==
    Please smack and shock seesaw too 😉

    Reply this comment
  14. Ted Steele, The Decider
    Ted Steele, The Decider 27 July, 2013, 09:28

    LOL Poor Poodle!

    Well little buddy– you might reread the progeny of New York v. Miln and Gibbons v. Ogdon etc etc and about 25 other cases that in fact often dance around the tension between the 10th A and the Supremacy Clause…..or have someone read and explain them to you….it isn’t quite as simple as you are. I mean, as it seems.

    First– Google Stare Decises and then PROGENY— THEN the cases— follow the controlling authority, read the dissents, and HURRY back out here asap with another conclusory mess of a post !

    HURRY !!!!!!!!!!

    Reply this comment
  15. The Ted Paradox
    The Ted Paradox 27 July, 2013, 11:51

    Tori,

    You have come a long way from the Tony PIO days! This is a nice article.

    Reply this comment
  16. Rex the Wonderdog!
    Rex the Wonderdog! 27 July, 2013, 14:46

    OMG, Teddy telling others to “Google”…Hahahahhahahaha…….so funny!

    You are a joke Teddy Steals! Always have been, always will be. Here is an idea, try to actually get a legal education, and stop trying to figure the law out using “Google”..I love it!

    Supremacy Clause, muni pensions= Bye Bye 😉 Ask Detroit’s GED cops and firehwiners how THEY’RE doing 😉

    Reply this comment
  17. Ted
    Ted 28 July, 2013, 14:58

    Hey little buddy you better Google those cases before I
    School ya yet again!

    Reply this comment
  18. The Complex Ted Matrix
    The Complex Ted Matrix 28 July, 2013, 18:22

    Mmmmmm dreaming again Poodle? 0 for 15 ™

    Reply this comment
  19. The Ted Steele Conceptual Abstraction Unit
    The Ted Steele Conceptual Abstraction Unit 29 July, 2013, 08:16

    “get a legal education”?

    Little buddy, I’m just a GED!

    Right?

    No comments on the landmark cases I cited? Is your Google down?

    LOL Always on your mind…. Ted Steele

    Reply this comment
  20. stolson
    stolson 13 August, 2013, 16:54

    Just read where Baltimore in heap of trouble now. More so than Chicago and St Louis and Cleveland. Will see how this bankruptcy thingy plays out. Will China come in to our rescue?

    Reply this comment
    • Tough Love
      Tough Love 5 April, 2014, 23:42

      Rescue ?

      No way. What WILL happen is that the Public Sector pensions and retire healthcare will be “toast” before long.

      Reply this comment
  21. Ulysses Uhaul
    Ulysses Uhaul 24 August, 2013, 18:01

    The RAGWUS will solve all….where in the heck is Donkey and Rizzo?

    Reply this comment
  22. The Ted Steele Conceptual Abstraction Unit
    The Ted Steele Conceptual Abstraction Unit 5 September, 2013, 11:14

    What is ragwis???

    Reply this comment
  23. Rex the Wonderdog!
    Rex the Wonderdog! 3 October, 2013, 20:25

    What is ragwis???
    ==
    It s 12 years at Lompoc for Fatty Rizzo!

    Reply this comment
  24. Ulysses Uhaul
    Ulysses Uhaul 2 December, 2013, 21:12

    RAGWUS……..think Hondo or Donkey blessed us with Rizzo-type conspiracies perpetrated by greasy politicians and GED overpaid cops.

    The Poodle is somehow in it too.

    Reply this comment
  25. Ted Steele DD
    Ted Steele DD 18 December, 2013, 17:47

    But what does ragius stand for?

    Reply this comment
  26. Queeg
    Queeg 19 December, 2013, 17:34

    Look up the archives of Hondo, Donkey and Poodle….

    Reply this comment
  27. Rex the Wonder Dog!
    Rex the Wonder Dog! 3 May, 2014, 04:09

    Teddy, what is trough feeder???

    Reply this comment
  28. Reader
    Reader 5 June, 2014, 00:05

    Why are officials not conducting contests for solutions/ideas just like having contests for singing, dancing, literary contests, etc.?

    Reply this comment
  29. fletch92131
    fletch92131 26 September, 2014, 17:40

    Basically, I think that California needs to contract-out everything that it legally can. Under federal rules, unless a decision has to be made, most jobs can be outsourced/privatized, although I don’t know what California’s rules are. Assuming there as “liberal” as federal rules are, I say follow the ideas in my blog here on Saving California, http://bit.ly/10rkHTM

    Reply this comment

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