Cities on the Brink

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

Pfeiffer agrees that bankruptcy should be a last-ditch effort. “You have to look at this as a continuum, with bankruptcy at the far end,” he says. “Along the way you have things like renegotiating your labor agreements and debts with bondholders, tightening up operations through layoffs and furloughs, and eliminating or reducing services. Many financially distressed municipalities have done this and avoided bankruptcy, working out their respective problems.” (See “Beating Back Bankruptcy,” below.)

They key word is “respective.” Both Pagano and Pfeiffer say every municipality’s problems are unique, requiring different remedies for different ailments. Nevertheless, they do cite a few similarities, chiefly their grand promises made to city workers. “Unlike the private sector, states, cities and towns continued to provide defined-benefit pension plans instead of more cost-effective defined-contribution strategies,” says Pfeiffer. “The recession highlighted the extent of these obligations, which were steep.”

Pagano takes a blunter tone. “In my state of Illinois, if you’re the head of a labor union for just one measly day, you’re entitled to a state pension for the rest of your life — even if you’ve never contributed a single cent to it,” he says. “In Stockton, city retirees get free health care for life, in an era when people are living a lot longer. These are the deals that were being made 30 years ago. There was no bright light on them and no one questioned them. It’s too bad that the taxpayers and city pensioners have to suffer for the stupid things done by people three decades ago.”

Preventing such suffering in the future requires the gumption to take action now, says Bob Deis, who retired Nov. 1. “A lot of cities are sitting on time bombs,” he maintains. “Their retiree medical insurance liabilities and pensions are adding up, as baby boomers retire by the droves and want their share.”

Is bankruptcy the best solution for troubled cities? It’s too soon in Detroit, Stockton, Vallejo and Jefferson County to conclude that the patient is healed. But when all other options are exhausted, the answer would seem to be yes.

Still, cities must carefully weigh the risks of bankruptcy. It can tarnish a municipality’s reputation, steering businesses in other directions. It also affects the ability to attract bond investors, potentially scaring them away for good. “I wish we could go back and ask Moody’s, Standard & Poor’s and the other rating agencies why they gave AAA credit to these places years ago, when they were making these risky promises and deals,” Pagano muses.

It’s too late to do that, of course. But it’s not too late to do something. “If municipal finance leaders don’t take charge of these problems now, they’re aiding and abetting the equivalent of a Ponzi scheme,” Deis charges. “Finance is either a part of the solution or part of the problem.”

 Russ Banham is a contributing editor of CFO.

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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