Cities on the Brink

Municipal finance chiefs are fighting to keep their troubled cities solvent. Sometimes it’s a losing battle.

Jefferson County’s problems were unique. Unlike Detroit, Vallejo and Stockton, it does not have any union contracts (Alabama has a “right to work” law prohibiting agreements between labor unions and employers). Also, the county’s statutory pension program for public workers is fully funded. Rather, a massive, unanticipated tax revenue shortfall combined with more than $3 billion in sewer-related debts brought it to its knees.

The tax-revenue deficit occurred swiftly, when the Alabama Supreme Court in March 2011 struck down the county’s occupational tax as unconstitutional. “The tax [0.45 percent on wages of all workers in the county] provided about 40 percent of the general fund’s revenue,” says Patrick Darby, a partner at the Birmingham-based law firm Bradley Arant Boult Cummings, one of two firms representing the county in the bankruptcy proceedings. “Although a replacement tax was enacted, that, too, was struck down as unconstitutional.”

13Oct_Cities_JeffersonThe sewer debacle is more nuanced. “We were under an EPA mandate to do an extraordinary volume of work on the sewer system, and we borrowed heavily to fund it,” Darby says. “The county was sold some faulty derivative financial products, a process that was tainted by fraud and corruption. Ultimately, some elected officials and contractors were sent to jail and we defaulted on the sewer debt.”

Jefferson County wasn’t the only municipality playing with fire. “Orange County and other local governments also used and abused exotic financing tools like derivatives,” says Marc Pfeiffer, assistant director of the Local Government Research Center at Rutgers University’s Bloustein School for Planning and Public Policy. “Such tools are not appropriate for government agencies, and we’ve fortunately seen a real reduction in these practices.”

These warnings came too late for Jefferson County, however. “Without getting any assistance from the Alabama legislature to replace the tax, and without making any progress to renegotiate the sewer debt,” Darby says, “the county determined there were no options left other than Chapter 9.”

When Bankruptcy Makes Sense
One can argue that there are always options to avoid bankruptcy. But when there is no money left in the till to service outstanding debts or pay for ongoing operations, a city can’t print money like the federal government — something has to give. Chapter 9 does just that. It gives municipalities needed freedom from creditors and union contracts until a repayment plan between the parties is created to resolve outstanding debts and contractual issues.

While Pagano argues that Chapter 9 should always be a last resort, he believes that Detroit, Stockton, Vallejo and other municipalities had no recourse — not that he lets them off the hook for their financial messes. “Detroit operated in denial for decades, failing to diversify its economic base even though it was apparent that the Big Three automakers that put it on the map were pulling back,” he says.

3 thoughts on “Cities on the Brink

  1. I was the city manager in 2008 that recommended BK for Vallejo. We had no choice; the city ran out of money to pay for union contracts. The city labor unions were stupid and they could not comprehend the math involved in operating a city.

    Basically, the math goes something like this: The fire union charged their members $175.00 month x 12 months/year x 100 fire fighters x 2 ( election cycle every 2 years) = $410,000. Police union charged $125 per month x 12 months/year x 145 cops x 2 years (election cycle once every two years) = $435,000. Together these two unions bought their elected Council members every 2 years since they financed the local elections by the tune of $$845,000 for every election. No one could compete with the fund raising. They controlled the City Council, their own contracts and the rest of the city too. Hence, their contracts were not sustainable and bankruptcy was the result. The Fire and Police union cooked their own “petard” as the saying goes.

  2. A couple of comments related to the County of San Bernardino: the County did not borrow $37M to help solve its budget problem, it actually prepaid $37M in debt using one-time funds to generate ongoing savings to help bring the budget in line. Second, the County is moving away from cafeteria style benefit plans, which are pensionable in our system and thus cost substantially more.

    These types of actions, combined with cooperation from employee bargaining groups and an elected Board willing to make difficult financial decisions in a timely manner have allowed the County to continue to adopt structurally balanced budgets throughout the economic downturn.

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