Sunday, July 21, 2013
More Cities Should Go Bankrupt
Filing for bankruptcy is
an incredibly useful corporate turnaround tool. We should make it
easier for local governments to do it.
Yesterday, Detroit’s Chapter 9 bankruptcy filing was greeted with
sadness by those with personal or emotional attachments to the city. But
while you wouldn’t want to call it a cause for celebration, there’s no
need for mourning either. The genuinely sad thing about Detroit is not
the bankruptcy but the circumstances that induced it—decades of economic
and population decline amid deteriorating public services and civic
conditions. The bankruptcy itself, however, is not the decline. It’s a
sensible step forward that at least gives the same city some chance for
the future. And it raises the question of why more local governments with fiscal problems don’t file for bankruptcy.
After all, in the corporate world, while no CEO is excited to take
his firm through bankruptcy, it’s widely recognized as a valid strategic
move. If the appropriate legal framework were in place, it’s also a
move that could be advantageous for cities like Providence, R.I. and
Baltimore as well as smaller Michigan municipalities rocked by the same
large economic trends as Detroit.
American Airlines filed for bankruptcy in December 2011, and through bankruptcy has managed to once again emerge as a profitable company. In its reinvigorated form, it’s merging with US Airways and like many airlines before it, it will be much stronger post-bankruptcy than pre-. More recently, bankruptcy helped bring Twinkies back from the brink of extinction.
Personal bankruptcies, by the same token, are a sign of bad
economic circumstances, but the relative ease of obtaining them in the
United States is a source of national economic strength. Americans can
take economic risks—starting businesses or moving to new cities—secure
in the knowledge that if things don’t work out they’ll be able to shed
debts and start over again. Without access to bankruptcy, both firms and
individuals would be endlessly crippled by the mistakes of the past.
But while American law allows firms and households to discharge debts
in bankruptcy relatively easily, the municipal bankruptcy process is
much more difficult. Even cities in quite a bit of financial distress
rarely file for bankruptcy, and when they do, their petitions are often
rejected, as happened to Harrisburg, P.A. in November 2011 after a disastrous incinerator project
landed the city in tough financial straits. The fact that Detroit is
only taking this step now, even though it’s been a byword for urban
decline and distress for years, is a sign of how rare the bankruptcy
course is. We ought to change that. Local governments are very different
from private businesses, but they’re similar in the sense that past
mismanagement can make future progress impossible without the
opportunity to shed debts.
In the case of Detroit, while the causes of long-term decline are
complicated, the sources of fiscal distress are pretty simple. The
city’s lost 28 percent of its population since 2000, and it’s lost well
over half its population since its peak of 1.8 million residents in the
1950 census. The larger Detroit of the past took on obligations to bond
holders and pensioners that today’s smaller Detroit can’t possibly pay
without further devastating city services. Heavily taxing the remaining
residents and businesses to pay off old debts simply ensures that the
city’s tax base will keep shrinking.
Of course, if you think of “Detroit” as a person, this is just
Detroit getting its comeuppance for past sins. But a city is more like a
company in the sense that the managers who created the problems are
usually gone by the time the reckoning comes. And even the best managers
can’t turn a city around unless they can direct a much larger share of
the city’s revenue to current services rather than paying off old debts.
Making it hard for cities to shed old debts in bankruptcy does have
one benefit—if municipal bankruptcy were easier, lenders would be more
reluctant to lend cities money. But the relative ease with which cities
can borrow money is at least as much a bug as a feature. Politicians
operate with relatively short time horizons—they often face term limits
or have ambitions for higher office—that encourage them to incur
long-term obligations that don’t really make sense. Municipally subsidized stadiums and convention centers
are particularly tempting to local politicians who like the ribbon
cutting and don’t care if the economic impact studies commissioned by
local boosters meet any kind of reasonable standard. And for a mayor
looking to make nice with the municipal workforce without shelling out
for unpopular tax increases, there’s nothing easier than a promise of
future pension benefits that his successor will have to figure out how to pay for.
If it were easier for cities to go bankrupt, lenders would scrutinize
these projects more closely, recognizing that bum debts are likely to
be repudiated. Union leaders who regarded pension promises as
low-credibility would focus their bargaining on more transparent salary
demands. Cities would, overall, be better governed.
The fear of municipal bankruptcy is driven in part by the perception
that one city going bankrupt imposes costs on other municipalities in
the same state. That’s a completely reasonable concern, but as Clayton
Gillette has argued it could be fixed by making the process more robust
and allowing bankruptcy judges to impose tax increases
and asset sales as part of the settlement. The idea is to ensure that
bankruptcies are driven by real inability to pay rather than a mere lack
of political will. What’s more, the pile of terrible press Detroit is
getting today underscores the fact that prudent politicians are going to
be reluctant to be “the guy who drove City X into bankruptcy” even when
it makes the most sense.
But it’s silly to let the mistakes of the past prevent a city from
having a future, and naive to think that cheap debt is an unmitigated
blessing in the municipal context. Corporate America would be much worse
off without relatively easy access to reorganization through
bankruptcy, and America’s cities and towns should have much the same.
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