Reply #13: US cities forced to consider bankruptcy

[Demeter]

With cities, towns and counties across the country hard hit by the recession, local officials, investors and analysts are questioning whether bankruptcy could become more common... Since 1937, there have been a little more than 600 cases of Chapter 9, the part of the federal bankruptcy code applicable to municipalities, said James Spiotto, a partner at the Chapman and Cutler law firm.

Probably the most high-profile case came in 1994 with Orange County, California. Since the downturn hit, the city of Vallejo, California, went bankrupt in 2008. Last year, filings more than doubled from the previous year but still only came to 10. Among the larger cities, Harrisburg,PA and Detroit have raised the idea, without formal plans.

“Most municipal bankruptcies have been special districts with recourse to only one source of revenue and not large cities that are more diverse and have some sway to get investors to forbear,” said Matt Fabian, managing director of Municipal Market Advisors. The belief that municipalities rarely go bankrupt, or even default, is the bedrock of the $2,800bn (€2,100bn, £1,825bn) municipal bond market where they raise money at relatively low cost for public projects. If filings increase, market experts expect them to be mostly small, special cases.

They have long argued that the fear of higher borrowing rates associated with bankruptcy is severe enough to discourage most.

But with cities such as Harrisburg considering it, these long-standing beliefs are being challenged. “ ... The more bankruptcy is publicly discussed as an option for financial relief, the more its tarnish wears off, increasing the likelihood of its actual use”, Fitch Ratings warned in a report earlier this year.

The biggest impediment, however, could be that the process is much more prohibitive than for companies. Municipalities need permission from their state, and some states do not allow it. The municipality also must negotiate with creditors first, which could prevent a filing.

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