Could Your City Go Bankrupt?
I never knew that cities in America could file for bankruptcy until recently a Northern California city named Vallejo made the news for being on the edge of bankruptcy. So how does this happen, and what happens to a bankrupt city or municipality?
Apparently municipalities go bankrupt for the same reasons why individuals and corporations go bankrupt. Basically, when a city or county does not have enough money to cover it debts and payroll obligations, it could file for Chapter 9 bankruptcy. This type of bankruptcy was created during the Great Depression and allows the locality in trouble to negotiate a plan with its creditors. It also protects against the liquidation of assets. Here are some real situations where cities and counties faced bankruptcy:
Losing at lawsuits - The scenic coastal city near me named Half Moon Bay was nearly forced into declaring bankruptcy last year when a judge handed down a $37 million judgement against the city for delaying a developer's chance to build on a piece of land he acquired in Half Moon Bay. After 14 years the land became wetlands and the developer sued and won. Half Moon Bay's general funds are only about $10 million per year and it could not afford the judgement.
Mismanagement - The largest bankruptcy of a municipality happened in 1994 when the entire Orange County declared that they could no longer pay their debts. This was due to the county treasurer betting the county's money on highly risky investments. Unfortunately, he bet the wrong way and the county lost billions of dollars. If you want to read more about this incident, this paper titled When Government Fails: The Orange County Bankruptcy is a very detailed summary of what happened.
Distressed economy - When the greater economy goes south, cities and localities collect less taxes, but still have to meet their financial obligations. Vallejo's current plight is partially due to the rapidly falling real estate prices in Solano County. Out of the nine counties that make up the San Francisco Bay Area, Solano is hardest hit by the housing crisis.
So what happens to a city or county after bankruptcy? Well, it seems that generally life goes on, but the government could be dissolved, and services may be vastly reduced. Property taxes and other public service charges could also be increased. Any new developments such as public swimming pools and schools would generally not happen. All of these things could happen even when a financially troubled locality does not file bankruptcy. For example, New York City faced bankruptcy in the 1970s during the economic stagflation and was bailed out by a large federal loan. Even though the city did not go bankrupt, city services were cut drastically and crime rates rose. Public transit fees rose even though the maintenance on the subways were largely neglected. It is safe to say that life goes on, but the quality of life in a financially distressed place would be vastly reduced.
Another side effect of the bankruptcy of one city is that nearby cities' credit ratings may also be affected. Locales surrounding a bankrupt city or town may find that they may have a harder time borrowing money from creditors. Less access to money means that the services in these cities may also be reduced. Basically, bankruptcy could destroy the reputation and quality of life of a large area, and that is a reason why many municipalities do whatever they can to stay out of it.
Will we see more cities and counties filing for Chapter 9 in the near future? I hope not, but with falling property values and rising inflation, it may be tough for the places we live to foot their bills.