Professor Juliet Moringiello, a widely recognized expert on municipal bankruptcy, is a frequent commentator on the topic in the national and international news media. She developed and teaches a Cities in Crisis seminar and has published several law review articles on the role of the state in the Chapter 9 process.
By Juliet Moringiello, Professor of Law
The eyes of Pennsylvania are often on Harrisburg, the seat of government for the Commonwealth, but five years ago the world turned its attention to this capital city—and not for a good reason.
Cited by CNN Money as one of “America’s 7 Junkiest Cities,” and featured in Britain’s Economist for its “hellish financial state,” the city of Harrisburg was suffocating under $400 million in debt, much of it incurred to retrofit a trash-to-energy incinerator that had fallen out of compliance with federal environmental regulations.
The incinerator transactions had the hallmarks of a juicy story: an untested contractor who filed for bankruptcy without having provided a performance bond to the city; financial and legal maneuvers designed to evade statutory limits on municipal debt; and a complicated debt structure that included multiple interest rate swaps. Late in the evening of October 11, 2011, the city took a step that a minuscule number of cities had ever taken: It filed for bankruptcy under Chapter 9 of the Bankruptcy Code.
Although the incinerator financing grabbed most of the headlines, Harrisburg’s financial distress was precipitated by many of the typical pressures on urban areas. Municipalities provide necessary services to their residents and fund these services by collecting property and other taxes. Harrisburg is a small city with about 50,000 residents, 32 percent of whom live below the poverty line. As the state capital, almost 50 percent of the land in Harrisburg is tax exempt, much of it occupied by government buildings. Like many core cities, Harrisburg is surrounded by relatively prosperous suburbs, yet the city and its suburbs do not share municipal services and their costs. Pennsylvania, with more than 2,500 municipalities, is notable for the extent of its municipal fragmentation.
Harrisburg is now on the mend. After the bankruptcy court dismissed the city’s petition for lack of state authorization, Harrisburg began the painful process of negotiating with its creditors under state supervision. Those efforts produced the “Harrisburg Strong Plan,” which restructured the city’s debts and stabilized its budget by selling the incinerator and monetizing the city’s parking system.
Harrisburg’s downfall and ongoing recovery provide several lessons to policymakers working to address municipal financial distress around the country. In Pennsylvania alone, 20 cities are designated as “distressed” by the state pursuant to the Municipalities Financial Recovery Act, known as “Act 47.” Chester and Scranton have been in the Act 47 program for more than two decades. Outside the state’s borders, Atlantic City, New Jersey, is reeling from the collapse of its tourism base, Chicago struggles with its pension obligations, and Puerto Rico and its public entities owe more than $70 billion to creditors.
Lesson No. 1: Authorizing Chapter 9 can speed the recovery process.
Before the 1930s, there was no federal municipal bankruptcy law. Because municipalities are creations of their states, any federal debt adjustment process raises the specter of unconstitutional interference in state affairs. Under the Tenth Amendment to the United States Constitution, all powers “not delegated to the United States by the Constitution nor prohibited by it to the States are reserved to the States respectively, or to the people.”
This limits the extent to which the federal government can interfere in state affairs. To alleviate constitutional concerns, the Bankruptcy Code prohibits a municipality from filing for bankruptcy unless its state authorizes it to do so. Anticipating that the city of Harrisburg might file for bankruptcy and fearing the effect of such a filing on the credit ratings of other cities in the Commonwealth, the Pennsylvania General Assembly prohibited certain cities from filing for bankruptcy in June 2011. Six weeks after Harrisburg filed for bankruptcy, the court rejected the City Council’s challenge to this prohibition and dismissed the city’s petition.
A state can choose whether to authorize its municipalities to file for bankruptcy and only about half of the states grant this permission. Cities that cannot file for bankruptcy lack an important tool to force creditors to the negotiating table. The Contracts Clause of the Constitution prohibits a state from impairing contracts, and Chapter 9 preempts state laws that purport to bind non-consenting creditors to a collective debt adjustment proceeding. Seventeen months after prohibiting Pennsylvania cities from filing for Chapter 9, the legislature restored authorization. By all accounts, this was key to the acceptance of the Harrisburg Strong Plan.
It is often hard to obtain Harrisburg’s downfall and ongoing recovery provide several lessons to policymakers working to address municipal financial distress around the country. Consensus without the threat of compulsion, and Chapter 9 bankruptcy provides a city with the ability to force creditors to take less than what they are owed. If the state had not restored Harrisburg’s ability to file for bankruptcy, the creditors might still be holding out for more money.
Lesson No. 2: It is necessary to strike the right balance between strong state
supervision and democracy.
When a city is in financial distress, someone must make difficult choices about how to resolve that distress. Sometimes a state finds it necessary to step in to make those choices. In Pennsylvania, the state does so through Act 47. Passed in the 1980s to address the hardships faced by cities and towns after the collapse of Pennsylvania’s steel industry, Act 47 allows the state to exercise varying levels of oversight over municipal finances. Harrisburg entered the Act 47 program in December 2010 and the Department of Community and Economic Development appointed a coordinator to develop a plan to assist the city in managing its financial distress. The law provided that once the city adopted the plan, the coordinator would be responsible for implementing it. It was not so simple in Harrisburg. The majority of the City Council was at war with the mayor, making it impossible for the city’s leaders to agree on anything. As a result, the city never accepted the plan. Because the architects of Act 47 had never anticipated that a city would refuse to adopt a plan, the law contained no mechanism to deal with such a refusal.
Nine days after Harrisburg filed for bankruptcy, Gov. Tom Corbett signed a bill amending Act 47 to provide for the appointment of a receiver to manage a distressed city’s finances. A week after the dismissal of Harrisburg’s bankruptcy petition, bond lawyer David Unkovic was appointed as the first receiver for any Pennsylvania city.
He and his successor, Gen. William Lynch, remain the only municipal receivers ever appointed in Pennsylvania. Receiverships are often denounced as state takeovers of cities. The reality is more nuanced than that. A Pennsylvania constitutional provision prohibits the legislature from appointing any special commission to “perform any municipal function whatsoever.” This “Ripper Clause” likely prohibits a state-appointed receiver from usurping the authority of a municipality’s elected officials. As a result, neither Harrisburg receiver had the power to force the mayor or City Council to do anything, necessitating a collaborative approach to address the city’s financial problems.
In other states, such as Michigan, a state appointed receiver like the emergency manager appointed for Detroit displaces the city’s elected officials. As states decide how to assist their distressed cities, the powers and even the name assigned to the person appointed to help the city get on firm financial footing matter. New Jersey Gov. Chris Christie ignited a firestorm when he appointed an “emergency manager” for Atlantic City. New Jersey has long been known for its robust oversight of its municipalities, and no municipality in New Jersey has ever filed for bankruptcy. By giving his appointee the title emergency manager (a title absent from New Jersey’s oversight statute), Gov. Christie sent a signal to the bond markets that Atlantic City might follow in Detroit’s footsteps and file for Chapter 9, an impression reinforced by the emergency manager’s appointment of Kevyn Orr, the emergency manager for Detroit, as an adviser.
Harrisburg and its creditors were able to agree to the Strong Plan because both receivers worked hard to gain the trust of the city’s elected officials and residents. This was no small feat, having been appointed by a white Republican governor to
manage the finances of a predominantly minority Democratic city. The fact that the receivers did not displace elected officials may have been a blessing.
Lesson No. 3: There is no true recovery without addressing the underlying causes of distress Debt adjustment alone cannot revive a city.
Shrinking cities nationwide are being crushed by pension obligations incurred at a time when their populations and workforces were much larger. Many of Pennsylvania’s municipalities provide their own police protection and other public services. Municipal elected officials around the country tend to serve on a volunteer or part-time basis and are often unsophisticated in financial matters yet they sometimes enter into the kind of complex financial transactions more typical of large corporations.
These structural problems are more difficult to address. Most municipal pensions are not large, and retirees depend on them to sustain a minimum standard of living. Although the most recent amendments to Act 47 allow the state to dissolve a non-viable municipality, the law cannot compel municipalities to merge or share responsibility for services. As a result, distressed core cities will remain so unless they can somehow attract development. The state legislature is considering several proposals to restrict the kinds of debt that can be incurred by a municipality and only time will tell whether they become law. Harrisburg’s story illustrates that multiple factors drive a municipality into financial distress and that a multifaceted approach to preventing and alleviating such distress is imperative. Harrisburg’s problems revealed flaws in the Act 47 program, which the legislature moved to correct.
As Puerto Rico, Atlantic City, and 20 distressed Pennsylvania municipalities deal with their financial problems, all eyes are on Harrisburg again—this time to learn how Pennsylvania worked with the city of Harrisburg to pull it from the brink of bankruptcy and how state lawmakers continue to work to address shortcomings in its laws governing pensions, local government debt, and municipal financial distress generally.
