Oct. 14, 2011 at 7:32 AM ET
Even if it’s legal (and it’s not certain that it is), Harrisburg, Pa.’s, decision to file for bankruptcy protection is certain to be a long, arduous and costly process, experts say.
That’s why so few municipalities have chosen what could be a scorched-earth option for their credit rating since the law was enacted in 1937, after the Great Depression.
“The experience that many cities have had in Chapter 9 is not a pleasant one,” said Paul Maco, a partner at the law firm Vinson & Elkins and a former director the office of municipal securities at the U.S. Securities and Exchange Commission. “It tends to be much more drawn out and expensive than they may have at first thought. Essentially, there’s a lot to reveal itself here.”
Indeed, experts say that filing for bankruptcy protection under Chapter 9 should be a last resort for a cash-strapped municipality because doing so is very expensive, and can be fatal to the general reputation of a community and its credit rating. The lower a city’s credit rating goes, the higher its borrowing costs will rise.
The fallout from the city council’s decision has taken on the proportions of a Greek tragedy, with city and state legislators bickering over the legality of the move, which in effect roadblocked a state-takeover of the city.
The cash-strapped state capital of 46,000 people is mired in debt of more than $300 million, including $83 million in past due payments, much of it stemming from the construction of an incinerator.
“The size of the outstanding bond debt is overwhelming,” wrote attorney Mark Schwartz, who is representing the City of Harrisburg in the bankruptcy filing. “Negotiations are impracticable with one group of creditors where negotiations with another key group have hit an impasse.”
Harrisburg comptroller Dan Miller told CNBC that “it’s irresponsible not to file for bankruptcy. It’s the only plausible option we have for a long term recovery in our city.”
But Harrisburg Mayor Linda Thompson said in a statement on the city’s blog that “this action clearly violates city law” and was indicative of “careless disregard for procedure and process.” She urged support for her own recovery plan that would boost earned income taxes to 2 percent from 1 percent.
And a spokesman for Pennsylvania governor Tom Corbett told The New York Times that the filing was a violation of Pennsylvania’s Municipal Financial Recovery Act, which was amended last year to prevent cities from filing for Chapter 9.
Experts say Harrisburg’s fate depends on whether the judge assigned to the case determines that the filing is legal. Either way, the city proceeds with its daily affairs: garbage still gets hauled away; the water keeps running; police still walk the beat; and firefighters still come to the rescue.
Experts said Chapter 9 is like a private business filing for Chapter 11 bankruptcy protection in that it buys the city some time to negotiate with its creditors. But it’s unlike Chapter 11 in that the judge cannot turn the reins of city government over to those creditors or to the court, for obvious reasons.
Nor is it like a Chapter 7 liquidation proceeding.
“You can’t liquidate a city,” said Maco “There’s no estate per se. The bankruptcy judge does not step in and in effect run the city.”
Congress established federal laws for the resolution of municipal debts more than 60 years ago, but such filings are rare; since 1980, there have been just 243 municipal Chapter 9 filings according to the American Bankruptcy Institute.
What Chapter 9 does offer Harrisburg is the chance to work things out under the umbrella of a more regulated process.
“What’s really happening here is an adjustment of the debts,” said Alan Gover, senior partner at the law firm White & Case in its financial restructuring and insolvency practice. “Chapter 9 offers no path to a fundamental resolution of financial problems. It offers essentially a basis for further negotiation, mediation, and compromise… and it costs a lot of money.”
Despite the travails, cash-strapped cities are opting for Chapter 9, seeing in it a chance to do what corporations do when they get into financial straits. In August, the small New England hamlet of Central Falls, R.I., groaning under the weight of its pension and retiree obligations, filed for Chapter 9.
In an October 2010 study by the National League of Cities, nearly nine in 10 finance officers of nearly 350 cities polled said their cities were less able to meet fiscal needs in 2010 than in 2009. The report also said that concern about cities’ fiscal health was at the highest level in the NLIC survey’s 25-year history.
Gover doesn’t think that Harrisburg’s Chapter 9 filing is indicative of more municipal bankruptcies across the country, simply because they’re such a difficult process.
“I don’t think this is a harbinger of a wave,” he said.