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State Receivership or Bankruptcy: What Leads to the Best Outcomes for Cash Strapped Cities in America? | Public Sector Inc

State Receivership or Bankruptcy: What Leads to the Best Outcomes for Cash Strapped Cities in America?

In 2011, multiple municipalities made national headlines as the severity of their fiscal hardships were revealed. Governments in Vallejo and Stockton, California, Harrisburg, Pennsylvania, and Montgomery County, Alabama, were forced to the financial brink under the overwhelming burden of decreased tax revenues, high unemployment rates, and massive public-employee pension liabilities. This will examine the arguments for and against two policy options for cities and local governments in fiscal distress: state receivership and bankruptcy. Detroit’s demise has been the most recent installment in this ongoing national discussion, as epitomized by the State of Michigan’s efforts to install an emergency manager rather than allow the city to have a federal judge oversee a municipal bankruptcy filing.

Steven Greenhut

Steven Greenhut

Steven Greenhut is the California columnist for U-T San Diego. Greenhut formerly was vice president of journalism at the Franklin Center for Government and Public Integrity, where he managed a team of 35 investigative reporters and editors who covere...Read More »

Michael Stampfler

Michael Stampfler

Michael Stampfler served as the Emergency Manager for the city of Pontiac, Michigan from July 2010 to September 2011. Pontiac, a community of 65,000, with a budget approaching $100 million ($60 million General Fund) was placed under the oversight of ...Read More »

Day 1 – Opening Remarks

Steven:

Residents of economically troubled cities need municipal bankruptcy as an option to help free them from the unsustainable benefit packages that public-sector unions have secured from weak-kneed council members. But they should be leery of receivership plans that allow out-of-town commissars to come in and order changes with few checks and balances.

“When the state stepped in to take over financially struggling Central Falls in 2010, Rhode Island’s smallest city lost something fundamental: its democratic government,” reported Governingmagazine in January.

It’s refreshing that a receiver could come in and cut pensions for current employees given that such pensions – often approved after union arm-twisting and based on false fiscal promises – are the driving force for municipal insolvencies. But as Governing added, “[T]he receiver’s office has appointed people to non-financial boards; approved business licenses, including, elected city officials say, a ‘massage parlor’ they opposed; instituted new police promotional exams; approved a new ordinance banning overnight street parking; and even issued a congratulatory citation for a new Lions Club.” The receiver also raised taxes.

By contrast, municipal bankruptcies provide an orderly process by which officials deal with insolvency, one that forces changes and can result in the same cutbacks, but with more accountability. Vallejo, California emerged from bankruptcy by slashing services rather than touching current employees’ pensions, thus showing that bankruptcy is no panacea. But in California I fear that any appointed receiver would reach for the tax-hike lever early and often. Receivership and bankruptcy laws vary with each state, so the benefits and disadvantages vary also.

By the way, the Central Falls receiver could not achieve pension rollbacks from retirees, so he took the city into bankruptcy any way.

It would be better if neither option was necessary, but many municipalities cannot control their spending. Bankruptcy is the most reasonable “if all else fails” option given the political circumstances.

Michael:

The serious financial conditions of cities facing either receivership or bankruptcy have generally developed over many years. Neglect, dubious legal practices and poor administration have all likely had a part in putting the community in such a desperate situation. What is critical is to find a solution to the complex and numerous problems leading up to this situation. 

I would agree that receivership should offer the opportunity to comprehensively refine community practices in governance – along with financial practices – so that many of the same problems which contributed to the financial distress do not merely resurface and create the same situation a few years later. Receivership laws, if “beefed-up” can address the problems and provide a remedy that allows creditors and bond holders to remain confident in government, and may be better than bankruptcy at actually improving governing practices.

Improvement as to refinements in areas of governmental service provision – in addition to financial performance – seems more likely to work for success of the community in the long run. Opportunities to apply structure and discipline to governmental operations should be long-term and be viewed as being as important as balancing the books.  Receivership should be designed to “succeed” in the more holistic sense because of the emphasis that can be placed upon the contributing factors by those experienced in governing. 

As to whether those numerous factors which contributed to financial distress will be more adequately addressed under receivership law than under bankruptcy, I think it most prudent to work under comprehensive receivership statutes first before resorting to bankruptcy.

Day 2 – Rebuttals

Steven:

 couldn’t agree more with Michael Stampfler’s opening statement that “the serious financial conditions of cities facing either receivership or bankruptcy have generally developed over many years.” Indeed, cities have embraced excessive pay and pension deals and figured that the booming economy would pay for any ridiculous thing they authorized. Then the economy soured.

Bankruptcy and receivership are crucial options that must be pursued before compensation packages crowd out public services by consuming municipal budgets. But the question is which process offers the best means to accomplish this purpose. Stampfler wrote that receivership is the better process, but hasn’t explained why. So I’ll reiterate the points I made yesterday: bankruptcy provides the most orderly process for doing this and avoids the main pitfall in state-ordered receivership – the appointment of a czar who can take the city in questionable directions. Democracy is messy, but dictatorship offers greater pitfalls.

I admit that it’s refreshing to watch an out-of-town receiver come in and slash pensions, force overpaid firefighters into the real world, cut the budget and fix quickly what took officials years to screw up. This is better than not doing anything. But these commissars have too much power to meddle into affairs outside the budget realm. Receivers can bypass city councils on most functions and can even impose new taxes on the public.

Yesterday, I quoted Governing magazine’s article about the complaints of Central Falls, Rhode Island, residents. Governing also profiled Lou Schimmel, who is the emergency fiscal officer who basically runs Pontiac, Michigan. He “has almost unilateral authority to run the government in this city of 60,000 that state leaders have deemed to be in the midst of a fiscal emergency.” I mostly like the tough measures he has imposed. But municipal bankruptcy can achieve the same thing without the problems.

Michael:

More municipalities are expected to soon be teetering on the financial precipice because of the lagging national economy and added subsequent pressures mounting at the local government level. What should be achieved is a refinement to the current insufficient receivership legislation.  Legislation typically stops short: it doesn’t reform the institutions of governance in financially distressed communities, and doesn’t sufficiently address restructuring the community economy during the receivership so that the community will exit receivership with a better chance of succeeding.

But bankruptcy is not a cure-all either. In Michigan, for example, the City of Ecorse entered into receivership in 2007 after going through the bankruptcy process between 1986 and 1999. Even though an August 3, 1999 article entitled “Privatization Brought Ecorse, Michigan Back From Bankruptcy” by Michael D. LaFaive, Managing Editor of Michigan Privatization Report, a quarterly publication of the Mackinac Center for Public Policy, extolled the virtues of the steps then taken by the bankruptcy receiver – the same individual currently handling the City of Pontiac receivership and recently featured inGoverning Magazine as the State’s “expert” in these matters.  It was prophesized that Ecorse would have “a bright future.” Not so: receivership was less than 10 years away after bankruptcy!

The bankruptcy formula was not sufficient then, and it is, sadly, not sufficient now in the same way that the receivership formula is not sufficient. The rest of the formula – after balancing the books – should be developing civic capital to be able to lead the community post-receivership and redeveloping the community’s economic structure, encourage sustainability and economic viability post-receivership. This must be a priority in receivership legislation.

First, improved receivership legislation is needed to provide a chance for and encourage community success. Bankruptcy which can fail long term as well would not be a necessary consideration if a more comprehensive approach were taken in receivership.

Day 3 – Question from Jack, a reader in Michigan

Mr. Greenhut seems to feel that the bankruptcy process is better than the receivership process mainly because it avoids stripping certain democratic rights from local governments. Mr. Stampfler seems to feel that the receivership process is better than the bankruptcy process because bankrupt cities often go back into receivership anyway, so better to fix receivership laws than opt for bankruptcy. As a Michigan resident who has seen so many of our cities go in and out of state control, I don’t really care about these issues as much as I care about efficiency and effectiveness. Does one of these options cost less to execute, take less time to complete, and lead to structural changes in the way that a city is organized to help avoid the same problems being repeated?

Steven:

hank you for your question, Jack. A receivership can more quickly make superficial changes, but a receiver cannot create the deep, substantial changes that can be directed through the bankruptcy courts. So if you want real reform, the bankruptcy route is the best, even if it can take a bit longer than putting a receiver in place. A receiver can make flashy changes in day-to-day issues, and, as the Governing magazine articles make clear, receivers often focus on the wrong things. They erode the democratic process, but that’s only one of the problematic features of this approach. A receivership can be a “stealth way to implement tax increases,” as former Orange County, California, Treasurer Chris Street explained to me. Furthermore, receivers are good at chopping lower-level positions, but rarely slash the management positions and overhead that are bigger problems. In bankruptcy court, the books are open and it’s harder for officials to hide the real numbers in front of a judge. Bankruptcy does not always fix the problem, as Vallejo’s experience proves, but it is more likely to result in substantial, lasting change than receivership.

Michael:

Neither bankruptcy nor receivership – as currently practiced – offer solid solutions to improve local government efficiency and effectiveness. Both “balance the books” quickly by draconian reductions in employment and services. These cuts alone do not guarantee effectiveness and efficiency in local governance and are oftentimes only temporary financial fixes. The disruption in public service and the negative effect on public confidence in government as a whole must be calculated in the costs of not getting it right the first time. Applying the same failed methodologies is repeated with the hope that another dose of the same tough medicine will finally fix the problem and lead the community out of a cycle of financial duress.

There are many examples in Michigan, like the City of Flint; which entered receivership in 2002, received “the cure,” and exited receivership only to again enter receivership in 2012. Another Michigan example is the City of Ecorse which is now in receivership after a bankruptcy which only ended in 1999.  Cities like Pontiac or Benton Harbor are close to exiting receivership but with little hope, in my opinion, of avoiding a rapid spiral to re-enter receivership sooner rather than later.

Receivership should be undertaken with the goals of improving local government efficiency and effectiveness while addressing the immediate financial problem of balancing the books in a financially distressed community. But the emphasis in state legislation is just on balancing the books. The civic capital attributes and skills to help effectively and efficiently operate the government post-receivership are not developed during receivership as they should be developed. Rebuilding the economic infrastructure of the distressed community is not a priority during receivership. When the hapless city exits receivership, it has no significant better chance to achieve economic/financial success in the future.

Day 4 – Closing Remarks

Steven:

Finally, Michael Stampfler got to the heart of his argument, as he wrote: “Neither bankruptcy nor receivership … offer solid solutions to improve local government efficiency and effectiveness. Both ‘balance the books’ quickly by draconian reductions in employment and services.” He complains that neither approach can assure that cities don’t get into the same fix again.

I thought we were debating the relative merits of bankruptcy or receivership when cities spend years digging themselves into a hole. My point – both are necessary options, but bankruptcy is a better route because it provides a court-managed, orderly process. Receivers make splashy cuts and even impose tax increases – and there’s nothing residents can do about it.

Stampfler’s new argument is bizarre. Municipal bankruptcy or receivership cannot assure that future city leaders make wise decisions any more than personal bankruptcy will assure that the person who declared it will start making wiser decisions once he has access to credit again. But not entering into either process is to assure that cities will continue to squander their money. The public is suffering now as pensions, health care and pay packages crowd out services.

Orange County, California, Supervisor John Moorlach, who predicted the largest municipal bankruptcy in the nation in his county in 1994, has a license plate that says, “SKYFELL.” But the sky didn’t fall. The county reorganized, didn’t raise taxes, didn’t slash services and became a model for municipal governance. Years later, a different board ran up unfunded pension liabilities, but such is life. There is no magical formula to bypass the human condition. Legislation that allows bankruptcy and receivership needs to focus on getting out of debt; it’s up to local governments to rebuild from there.

Profligate cities need a day of reckoning which can provided by bankruptcy or receivership. The former is the more efficient method that best protects the rights and wallets of taxpayers.

Michael:

Both municipal bankruptcy and receivership are expensive “remedies” to failed public policy. In bankruptcy, for example, it is possible for holders of bonds for the municipality in question to receive less than the full return. In receivership, taxes may be raised.  Both cases point to an expense to be borne by various individuals. It is clear that the situation represents an expense to be borne by someone – it is not without cost.

The larger question is how to best structure a remedy which will be less costly in the long run.  When the process fails and has to be attempted again in a few years – as I’ve mentioned in regard to the Cities of Flint and Ecorse, Michigan for example – this is much more expensive than it has to be, and again, someone must pay for the “re-do”.

The argument has to be made that receivership legislation is not currently sufficient to build governance capacity, or civic capital, and does not sufficiently emphasize steps to rebuild or restructure the economy of the distressed community by committing to capital infrastructure redevelopment. So, it is likely that communities which have suffered many years will continue – even after receivership or bankruptcy – to continue to suffer and many times re-cycle through a costly process which needs legislative strengthening. The many improvements and reforms necessary to make a city economically viable should be undertaken during the course of receivership: it should not be viewed as strictly a balancing of the books exercise.

If the goal is to truly improve viability and sustainability, avoid costly recycling through the process, and overall improve government efficiency and effectiveness: receivership legislation should be improved to emphasize capacity building (civic capital) and economic infrastructure rebuilding/restructuring.

Steven Greenhut

Steven Greenhut is the California columnist for U-T San Diego. Greenhut formerly was vice president of journalism at the Franklin Center for Government and Public Integrity, where he managed a team of 35 investigative reporters and editors who covered state capitols across the country. He founded CalWatchdog in 2009, which provided Sacramento-based investigative news coverage and he writes regularly for publications including Reason, Human Events, Bloomberg and City Journal. He is author of the 2009 book, "Plunder! How Public Employee Unions Are Raiding Treasuries, Controlling Our Lives And Bankrupting the Nation" and the 2005 book, "Abuse of Power: How the Government Misuses Eminent Domain."

Michael Stampfler

Michael Stampfler served as the Emergency Manager for the city of Pontiac, Michigan from July 2010 to September 2011. Pontiac, a community of 65,000, with a budget approaching $100 million ($60 million General Fund) was placed under the oversight of an Emergency Manager by the State of Michigan in 2008. Previously, he served as City Manager of Portage, Michigan, Casselberry, Florida, and Talladega, Alabama. Mr. Stampfler has over 30 years of experience in public administration, with a special focus on bringing financial stability to city and county governments. He has been citied extensively in publications discussing emergency manager crises including the Associated Press, Detroit Free Press, and Crain's Detroit Business.

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