Municipal bankruptcy fears overblown, official says

Tuesday, September 21, 2010

The near default on bond payments by Harrisburg, Pa., has stoked fears of a wave of municipal bankruptcies. But the chairman of the Illinois Finance Authority says the speculation is overblown.

"Municipal bond defaults aren't the end of the world," said Bill Brandt, who heads the Illinois agency that oversees billions of dollars in loans and investments for businesses, local governments and nonprofit organizations. "Anybody looking for hundreds of cities falling into bankruptcy, that's just not in the cards."

Brandt spoke to me Monday before he was scheduled to appear on a panel about municipal insolvency presented by the merican College of Bankruptcy, Jenner & Block and Mesirow Financial.

As chairman of the finance agency, Brandt's job is to be optimistic about the state's economic prospects. But he's also a consultant who specializes in financial restructuring in his day job and has years of experience evaluating balance sheets and zeroing in on problem areas.

He's not foolish enough to dismiss the fiscal challenges facing Chicago, other Illinois communities and cities across the country. Faced with falling tax revenues, rising pensions and health-care costs and powerful public-employee unions, cities are struggling to balance their budgets and maintain services.

Some will not be able to pay their bills. A municipal default can ripple across a state, boosting borrowing costs or making credit unavailable for other cities and school districts.

Brandt predicts that several cities across the country will embark on restructuring their debts over the next decade. The restructuring just won't happen in bankruptcy court, he said.

Sorry, bankruptcy attorneys.

"I think the bankruptcy guys are hearing a siren song because they're always looking for the next wave," Brandt said. "I would temper my enthusiasm if I were them."

Chapter 9 of the U.S. bankruptcy code provides for the reorganization for the municipalities under a broad definition, which includes counties, taxing districts, municipal utilities and school districts. But Chapter 9 cases are rare.

In the more than 70 years since Congress established a federal mechanism for resolving municipal debts, there have been about 600 municipal bankruptcy petitions filed, according to the administrative office of the U.S. courts.

In the year ended June 30, there were more than 1.6 million bankruptcy cases filed in U.S. Courts. Only 12 were Chapter 9, including one in Illinois by the village of Washington Park in the southwestern part of the state.

A big reason Chapter 9s are so rare is that states don't like them. A hastily filed bankruptcy petition could roil bond markets. About half the states prohibit government bodies from filing for bankruptcy without permission from a state legislature or other higher authority.

Several states, including Illinois, also have receivership laws that provide safety nets for cash-strapped cities. Illinois has only one "financially distressed" city: East St. Louis. But it has languished under such status since 1990, when the state established the East St. Louis Financial Advisory Authority to assist the city with its financial management.

Illinois at the time lent East St. Louis $34 million to help it restructure its debt. The arrival of a riverboat casino helped the city boost revenues. But now East St. Louis faces budget cuts again, including police layoffs, because casino revenues have decreased.

With states also financially strapped, lifelines to cities may dwindle and bankruptcy could become a more attractive option.

But as the experience of one California city shows, bankruptcy may not offer much relief. Two years after filing for bankruptcy, Vallejo still isn't free of its crushing pension obligations.

"A lot of animosity has built up in the Vallejo bankruptcy," Brandt said. "The question becomes is there anything being accomplished through a bankruptcy that could have not been accomplished by a gubernatorial commission or some other state agency?"