CHICAGO — Chapter 9 guru James Spiotto says states increasingly realize the importance of early intervention in their distressed cities to avoid the crisis of a municipal bankruptcy in which everyone loses.
In a post-Detroit world, the role of states in overseeing and helping their stressed local governments, with statutory liens, quasi-judicial authorities or even basic oversight, is more important than ever, he said.
"I think we're in a time when we can take a look and know what history has taught us about Chapter 9, and realize it's a last resort that can be avoided," Spiotto said. "New York City; Cleveland, Pittsburgh and Philadelphia: we really want the coordination between the state and local government. We've never kept track of the tough situations where it's worked," he said. "It's the bankruptcies that we've kept track of, and those are the aberration."
History shows that distressed governments in states with even basic oversight, such as requiring approval from a state-level official, as well as the authority to file for Chapter 9, see the most effective financial relief, Spiotto, a managing director at Chapman Strategic Advisors LLC, says in a
Since 1980, municipalities in states that lacked intervention or 'second looks' — in which the governor or another state official needs to approve a local bankruptcy — are more than six times more likely to file Chapter 9 than governments located in states where a second look is required, according to Spiotto.
"If you're going to have Chapter 9, having a second look is far better than just the blanket authorization," he said. "Overall it's always good, whether you authorize Chapter 9 or not, to have some ability of the state to provide assistance and oversight so there can be early detection of financial problems."
The paper, titled "Chapter 9 and Alternatives — Part One: Lessons Learned: An Update on the Municipal Bankruptcy Experience" is the first in a three-part series that focuses on the importance of state intervention in distressed local credits.
The next papers will focus on the Illinois Municipal Protection Authority, a proposal from the Civic Federation that would establish a quasi-judicial authority to help Illinois governments deal with pension-related and other fiscal burdens; and on the ability of statutory liens that help lower borrowing costs for local governments.
"There is a real desire in various state legislatures to say, 'How do we lower the cost of borrowing, how do we help provide municipalities technical assistance, what do we do when things are bad?'" said Spiotto.
Historically, constitutional and statutory local debt limitations and the ability for locals to issue refunding bonds have been among the most important and basic of state-level tools aimed at controlling and helping local governments, according to Spiotto.
Those approaches are increasingly being enhanced by some states, according to Spiotto.
"Although these mechanisms vary by type and degree of supervision and assistance, the widespread development of these mechanisms indicates the growing trend of more active oversight and supervision of municipalities by states in order to build better credibility with citizens and creditors, including the municipal bond market," Spiotto writes in the paper.
The ability to file Chapter 9 can be useful as an "or else," Spiotto said. But talk of bankruptcy can hurt bondholders, as some market participants have noted in the case of Chicago Public Schools.
"You don't want to create a cloud over any municipality," he said. "This is a last resort and we don't want to get there, so let's all work together to avoid that, because the one thing we know is that in bankruptcy everybody gets less and you're not going to be a winner."
