To File or Not to File: The Causes of Municipal Bankruptcy in the United States

Article excerpt

ABSTRACT. About 500 municipalities have declared bankruptcy since Congress passed the Municipal Bankruptcy Act in 1937. Based on the experiences of these municipalities and the municipal bankruptcy literature, this paper develops a theory of why municipalities go bankrupt and discusses various ways to prevent other municipalities from going bankrupt. The paper identifies three-dimensional factors that may make municipalities go bankrupt: long-term and short-term, political and economic, and internal and external perspectives. The paper ends with an observation that government failure in the form of municipal bankruptcy can be reduced by strengthening the audit powers of the states and by utilizing more municipal bond and liability insurance policies.

INTRODUCTION

In the 1990s, several large local governments in the United States had declared bankruptcy or had considered declaring bankruptcy. Orange County, California declared bankruptcy in 1994 after losing more than 1.7 billion dollars in its investment pool. Bridgeport, Connecticut filed for Chapter 9 in 1992 after incurring budget deficits for several years. Washington, D.C. has been under the virtual receivership of Congress since 1996 when it was unable to meet its expenditure obligations as a result of a $600 million annual budget deficit. Miami, Florida, has been faced with a similar fate when the state appointed a financial control board to take away its purses in order to put financial matters back on a sound footing. Although only a small percentage of local governments go through the destructive experiences that these governments went through and most bankrupt local governments are small entities, it is alarming to see that the nation's largest local governments are not immune from financial disasters.

Despite the increasing frequency of bankruptcy among large local governments in the last decade, local government scholars, particularly those who study local politics and urban finance, have paid only scant attention to the issue of municipal bankruptcy. There have been a few case studies, but not many comprehensive studies of municipal bankruptcy have been published in the United States. Furthermore, most of the existing studies were done by law scholars who are interested in the legal issues of Chapter 9 bankruptcy rather than by political scientists or public administration scholars who are interested in the politics and systematic causes of bankruptcy (For studies by legal scholars, see Hempel, 1973; Spiotto, 1993; McConnell & Picker, 1993; Spitz, 1993; Kupetz, 1995; Picker, 1995. For case studies, see Cohen, 9 199 89; Jorion, 1995; Brown, 1995; Baldassar, 1998). As a result, little is known about the systematic causes of municipal bankruptcy. Perhaps this lack of attention reflects the good economic times of the recent years when most local governments have been financially well off. However, the bright facade that we see may foreshadow the dark danger that may lurk in the background. It is usually better to prevent a financial disaster from occurring when financial resources are plentiful than to try to fix the barn after the animals are already stolen.

In providing a comprehensive explanation of the causes of municipal bankruptcy, this paper briefly examines the history of municipal bankruptcy law, explains the current debt relief clauses in Chapter 9 of the Bankruptcy Law, develops a multi-dimensional causal model of municipal bankruptcy, examines several prominent municipal bankruptcy cases, and closes with a discussion on ways to prevent future bankruptcies. Throughout the paper, and particularly in the causal model section, two themes are emphasized. One theme is that cases of municipal bankruptcy need to be explained from several perspectives including long-term and short-term, political and economic, and internal and external perspectives. Another theme is that municipal bankruptcy should be explained separately from municipal fiscal crisis because not all municipalities that experience fiscal stress go bankrupt. …