States hold sway over their cities in bankruptcy matters

July 23, 2012

Bloomberg View’s Josh Barro wrote an interesting piece Thursday urging Scranton, Pennsylvania to declare Chapter 9 bankruptcy. Scranton has achieved national attention after the mayor reduced all city workers’ pay to minimum wage last week because the city could no longer afford paying their full salaries, a powerful image of how little cash Scranton has left.

The problem with Barro’s proposal is that Scranton cannot file for Chapter 9 without the consent of Pennsylvania’s state government. Chapter 9 bankruptcy is a part of the federal bankruptcy code, and it gives individual states the authority to decide whether their cities can go bankrupt:

States play a key role as gatekeepers or guardians in that, by virtue of [bankruptcy code] amendments codified in 1994, they have to specifically authorize their municipalities to file for Chapter 9. Silence on the matter is taken as a prohibition on filing.

If you watched the fiscal crisis unfold in Pennsylvania’s state capital of Harrisburg over the last two years, you saw how many obstacles the state imposed on its cities to prevent them from filing for bankruptcy. Pennsylvania’s Act 47 prescribes how the state can manage its fiscally distressed cities. My Reuters colleague Hilary Russ wrote an excellent story on the weaknesses of Act 47, including the fact that it requires no hard deadlines on cities to devise and implement a recovery plan. Scranton has been in the state’s distressed city program for 20 years.

Act 47 does allow for the appointment of an outside receiver with significant powers to negotiate with creditors and seek court approval to force a city to raise taxes. This is what’s happening in Harrisburg right now and could be considered equivalent to a state-level bankruptcy process.

Bankruptcy can be a very useful process for cities seeking to reduce debts. But cities also need to consider cutting the number of employees they have, stopping automatic pay increases, lowering pension costs and raising taxes and fees to generate more revenue. Chapter 9 bankruptcy does have a stigma that will significantly raise borrowing costs once a city regains access to the markets.


PA Independent:  Scranton could join national trend of bankrupt cities, despite officials’ opposition

City of Scranton: Independent Auditors Report for December 31, 2010

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