Intervention bankruptcy – essentially combining federal bankruptcy and state involvement – could strengthen government's ability to manage municipal insolvency, according to the Manhattan Institute for Policy Research.
"Intervention bankruptcy is an attractive alternative to reforming Chapter 9," senior fellows Daniel DiSalvo and Stephen Eide wrote in "When Cities are at the Financial Brink," a report the free-market leaning think tank issued Thursday. "Intervention bankruptcy requires no change in federal law."
By contrast, they said, prospects of Congress changing the federal Bankruptcy Code are uncertain, and further empowering federal judges in municipal affairs "is sure to raise federalism concerns."
Governments on the verge of insolvency today include Atlantic City, N.J.; Hartford, Conn.; and the Chicago Board of Education.
"The recent experience of some bankrupt cities, as well as much legal scholarship casts doubt on the effectiveness of municipal bankruptcy," DiSalvo and Eide wrote. "Cities' debt-levels are near all-time highs. And the risk of municipal insolvency is greater than at any time since the Great Depression."
Bankruptcies the past five years have included Detroit; Central Falls, R.I.; and Stockton, Vallejo and San Bernardino, Calif. The latter received tentative approval last month to exit Chapter 9. The City Council in Harrisburg, Pa., filed for bankruptcy in 2011 but a federal judge nullified it.
Pension debt is increasingly a problem.
"State and local governments tend to address problems when, and usually only when, they reach a critical point. Tackling the public pension problem is no exception," Municipal Market Analytics said in a commentary Tuesday. "The growing funding gap and associated crowding-out effect that pensions are having on many state and local governments budgets are indisputable."
In addition, general obligation and pension debt obligations have impaired the ability of many cities do provide basic services such as law enforcement.
In his book, "Municipalities in Distress? How States and Investors Deal with Local Government Financial Emergencies," Chicago-based bankruptcy expert James Spiotto argued that cutting government services below a certain level, even if necessary to fund pensions and other obligations, violates state-constitution provisions about maintaining adequate service levels.
State-appointed receivers, DiSalvo and Eide wrote, can help reduce pension debt through bankruptcy. Robert Flanders and Kevyn Orr did just that in Central Falls and Detroit, respectively, they said. By contrast, they added, neither Vallejo nor Stockton – both of whose bankruptcies city managers directed -- reduced pensions in bankruptcy.
They cited a 2014 report by Moody's Investors Service that said rising pension obligations would challenge post-bankruptcy recoveries in Vallejo and Stockton. By contrast, Moody's called the Central Falls bankruptcy plan a credit positive, and upgraded Detroit's general obligation bonds in 2015.
Still, Detroit faces an unexpected gap in pension obligations that could surge to roughly $200 million by fiscal 2024, according to city actuaries at Gabriel, Roeder, Smith & Co. Holdings.
"A more promising approach would be for state-appointed receivers to manage municipal bankruptcy plans – subject, of course, to federal court approval," DiSalvo and Eide wrote.
This is preferable, they added, to leaving local officials in charge or further empowering a federal judge. State oversight – such as Pennsylvania's Act 47 workout program for distressed communities – or outside advisory services do little to reduce contractual debt obligations, they said.