This is the first article in a two-part series
Recent developments in Detroit have renewed interest in municipal bankruptcy proceedings and the reasons that brought that city to its present financial situation.
In a court hearing Wednesday, an attorney for the city – which filed for Chapter 9 status in July --- contended that without the protection of bankruptcy to enable it to restructure its $18 billion in debt, nearly two-thirds of every dollar of taxpayer money would go to cover debt and other expenses. But the bankruptcy status would also enable the city to cut pensions for thousands of people, prompting protests by crowds gathered outside the courthouse.
Chapter 9 of the Bankruptcy Code concerns the reorganization of municipalities, including counties, school districts, authorities, etc. This code is unique when compared to bankruptcy law for private corporations. Corporations can declare bankruptcy -- usually Chapter 11 of the code -- but municipalities cannot be liquidated and judges cannot force municipalities to take specific actions, principally because the U.S. Constitution sets limits on the judiciary’s power over municipalities.
Although Detroit is the country’s largest Chapter 9 bankruptcy case, there have been other recent examples of local governments filing for Chapter 9. In California, principally as a result of the long recession and foreclosures caused by the subprime mortgage crisis, a number of high-profile municipalities, including Stockton, Vallejo and San Bernardino, have gone through or are going through the process. Although different in charter, another recent classic case is Jefferson County, Alabama, which defaulted on sewer construction bonds -- and previously in 1994, the Orange County, CA, situation where the county sustained investment losses triggered by interest rate speculation that plunged the affluent county into bankruptcy. (1)
The principal role of judges in municipal bankruptcy is to decide if a municipality is eligible, approve its plan to adjust its debts, and verify that the plan was properly implemented. The judge, for example, cannot interfere with the operation of the debtor. Municipalities have less leverage in restructuring their organization than corporations. Municipalities, for example cannot typically sell assets, but they can negotiate how debt is restructured, including how its bonded debt, pension obligation, and other contractual commitments can be adjusted. (2)
It is not the intent of this paper to analyze bankruptcy actions but rather to suggest that more careful oversight by state governments could have negated these drastic actions. Many states, including very large ones, such as California and Texas, have no laws or processes that provide adequate oversight and intervention to limit fiscal distress that could lead municipalities into declaring bankruptcy. (3)
Most students of municipal finance would acknowledge that New Jersey has some of the country’s most distressed municipalities, including Camden, Trenton and Newark. Yet none of these municipalities or any of the other 1,500 jurisdictions (including municipalities, school districts, counties and authorities) in the state approaches the need to declare bankruptcy. Why is that?
One answer is that New Jersey has one of the most significant set of laws, budgetary tools and overall state oversight programs, including aid funds from the state, to monitor local government finance –and, when necessary, actually ‘take over’ a municipality experiencing severe financial stress.
This paper will review the overall structure and nature of the state government in New Jersey and its local governments; analyze the laws and processes that provide the state with extensive oversight authority; and finally discuss some specific measures and recent actions that have further limited fiscal stress at the local level of government.