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Pew: States Can Take Steps to Help Cities Avoid Bankruptcy Filings

States can adopt several practices to help municipalities in financial distress avoid having to file for bankruptcy protection, The Pew Charitable Trusts said in a report released Tuesday.

The nonprofit organization said, for example, that states and cities can be proactive in detecting and tackling local government financial challenges by overseeing local finances and offering technical advice for long-term financial planning.

The 60-page report, The State Role in Local Government Financial Distress, examines the range of state involvement in local government finances and identifies characteristics of local financial distress.

The report found that despite the recent wave of bankruptcies, including last week when Detroit became the largest city in U.S. history to file under Chapter 9, fewer than 10 municipalities file for bankruptcy each year.

Pew said that a filing usually has a single identifiable cause: a bad investment decision, a failed infrastructure project, an expensive legal decision or escalating pension costs.  Detroit, which has more than $18 billion in debt, has major pension problems.

Ultimately, state and local officials want to avert bankruptcies for several reasons including the fact that the stigma of receivership and a state takeover can remain for years, as well as increased borrowing costs for capital projects such as roads, parks, and public buildings, the report said.

The report also found that only 19 states have enacted laws allowing the state government to intervene in a city, town or county financial crisis. Local governments often accept state intervention begrudgingly. The report says several Michigan cities pushed back against what they considered to be state interference. There was resentment among local officials in Detroit when, in March 2013, Michigan Gov. Rick Synder appointed emergency manager Kevyn Orr to take over day-to-day operations of Detroit.

Intervention practices vary among the states that actually have them and some are more aggressive than others when they step in to help. Michigan, North Carolina, Pennsylvania and Rhode Island are among the states with the most extensive assistance programs, the report found.

Alabama and California are among those without programs. Connecticut, Massachusetts and New York decide the level of involvement on a case-by-case basis, depending on the severity of a city’s financial emergency.

Some states have not set up intervention programs because their cities have not experienced the same level of stress as those in other states.

The report profiled seven states — Alabama, California, New Jersey, North Carolina, Michigan, Pennsylvania and Rhode Island — that have cities that filed for bankruptcy, are in serious financial distress or have claimed success from state intervention.

Alabama’s Jefferson County is the largest county bankruptcy in U.S. history and California, where several local governments have filed for bankruptcy, were chosen by Pew as examples of states that historically do not assist local governments.

New Jersey cut back on financial aid to troubled cities including its capital Trenton, during the Great Recession. The state is trying to figure out its role going forward.

North Carolina has the oldest intervention program in the country, emphasizing state-level monitoring to detect early signs of trouble.

Michigan and Pennsylvania are deeply involved in their local government’s finances but are similarly affected by changing economic conditions that are out of their control and make it harder for cities to rebound.

Rhode Island strengthened an existing weak program after the budget emergency in Central Falls, including by adding a first-of-its-kind provision protecting investors in the city’s bonds.

Kil Huh, director of Pew’s state and local fiscal health project, said there are some common features among distressed cities. “They tended to be cities that lived beyond their means, promised benefits that they didn’t have a good chance of affording over the long run. Quite frankly there were some factors outside of their control, like the long run economic as well as demographic trends that harmed these cities over the long haul,” Huh said in a conference call with reporters Tuesday.

Huh said these trends are not unique to these seven states but other states as well that may be considering potential intervention programs to short-circuit fiscal distress.

Another proposal Pew suggested was for states and cities to adopt multi-year budgets to better manage finances.

“This strategy provides governments with a structure to match expenses and revenue over several years,” the report said. “Those plans should include a focus on so-called legacy costs such as retirement benefits.”

States should design intervention programs to involve all stakeholders in the solution and return control to local officials quickly, Pew said.

When states are more transparent and engage the entire community — unions, elected officials, city employees, investors, muni bond lawyers and other stakeholders — they gain trust, Pew said. In the case of Central Falls,  its credit-rating increased due to its reassurance to investors, the nonprofit said.

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