Friday, February 29, 2008

Why Vallejo matters

I hinted last week that the potential bankruptcy of Vallejo, California is worth keeping an eye on. Since NPR did a story on the Vellajo situation it has entered the public discourse more widely. But why does it matter? I have discussed the potential issues in a Federal bankruptcy filing publicly in the past. Also here.

Municipalities can declare bankruptcy in federal court under their own section of bankruptcy code. Local governments, and things that are quasi-governments (AHERF was actually a Chapter 9 filing which is worth keeping in mind) have declared bankruptcy under chapter 9 of federal bankruptcy code. Some refer to Act 47 here in Pennsylvania as quasi-bankruptcy, and in a very limited sense that may be true, but it is nonetheless a big step below what would happen if a federal court accepts a bankruptcy filing.

Does this matter for Pittsburgh? Without a doubt. There are too many preliminaries to get into in depth, but some say Chapter 9 bankruptcy is irrelevant because the Commonwealth of Pennsylvania would not allow the city to declare federal bankruptcy. Even if that were true, the logic implies that if the state wanted to let the city go bankrupt it could do so. But hold that thought because it is irrelevant. A fundamental question is whether the state would have any choice but to accept bankruptcy if for example a bond payment were to go unmet. Consider also the case of New York City. Many talk about its bankruptcy in the 1970’s yet the truth is NYC did not actually file bankruptcy because it couldn't. At the time, chapter 9 bankruptcy was quite strict in its criteria for filing. One requirement was that a government had to negotiate with every single one of its creditors before a bankruptcy filing would be accepted. For a government the size of NYC, with untold number of potential creditors, that criteria was unmeetable. Nonetheless, bond payments did go unpaid and those who are clear with their descriptions will talk about the “technical bankruptcy” that the city went through.

But is bankruptcy for Pittsburgh inconceivable? If you have listened carefully to the statements of the folks on the original ICA board you will have heard that they seriously considered federal bankruptcy as an option. That in itself is significant. If you listened closely you would find some inconsistencies in the explanations given for why the idea was not followed up. One answer is they were told by counsel that bankruptcy was not a legal option. I would say that if there is indeed a formal legal opinion on this matter in the ICA files it should be made public.


Here is the big problem, and why Vallejo really matters. Lawyers in general must act within the framework of precedents that define the law and how they expect judges to rule in the future. For Chapter 9 bankruptcy there are few precedents of note and fewer still that apply to the situation that the City of Pittsburgh is in. The biggest Chapter 9 bankruptcy is probably Orange County in California which did in fact have its bankruptcy filing accepted. I have said before that Orange county was in better shape fiscally when it entered bankruptcy than the City of Pittsburgh would be when it exited a bankruptcy. Orange county had solid finances but had invested in some risky derivatives that put them in a short term cash crunch more than anything else.

One precedent of note is Bridgeport, CT which attempted to declare bankruptcy in the early 1990’s but was told that it could not because it had the fiscal capacity to raise taxes or borrow enough to get through its situation. That precedent was clearly on the mind of Pittsburgh city officials in the early 1990s’s when money was literally running out and the sale of the water authority was the only thing that got the city through several years of severe operational budget deficits. City officials at the time would have preferred a bankruptcy I am sure, but am equally sure they were told by lawyers that they couldn’t. Since federal bankruptcy is very much dependent on the cash-status of a filer, vice how much one has in assets which are untouchable for the most part for a public entity, it was in many ways the perfect time to consider bankruptcy. I would say that the Bridgeport precedent is important, but the current debt in the city far outstrips the situation in Bridgeport at the time and some would argue that if Bridgeport had waited a year or two, the federal court would have had little choice, but to accept its filing and proceed. but that is a story unto itself for the lawyers to debate.


But where are we now. Why Vallejo matters is that it could potentially address some big unanswered questions about what bankruptcy could mean for a large municipality facing multiple debt costs and an unsupportable budget. Right now there is a pretty big question out here over how the various forms of the City’s debt would be handled if bankruptcy were to happen. To keep it simple there are two big chucks of debt out there, a big general obligation bond debt, and a big unfunded pension liability. I have talked to many a lawyer , and even some bankruptcy lawyers and there just isn’t a clear answer out there to the question of how those two debts would be treated in bankruptcy. Is one more senior than the other? Would one be liquidated before the other? That is the fundamental question that will determine what bankruptcy would mean for a large municipality such as Pittsburgh.

Consider that the pension debt is ‘senior’ to the bond debt. It’s not really a debt on any accounting of course, it’s a future liability documented by actuarial reports which is one of the problems. If the bond debt is at greater risk then the biggest potential impact of a bankruptcy filing would be on the bond holders. Most city debt is insured by bond insurers (refer to the whole bond insurer mess which is its own story these days) so they are the ones who are at risk. I suspect it is really the reinsurers on the monoline bond insurers who are at the real risk. If bond debt would be liquidated whole or in part before pension liability is addressed, the city could go through bankruptcy, clear out a large part of its unsupportable debt service and proceed. I would imagine many city residents and employees would like that idea, but the bond insureres would sue to say this can't happen. How that case comes out would determine the endgame.

Then consider the other option. If the bond debt is more senior and the greater risk in bankruptcy is that pension liability could be vacated… then what do you have. A lot of happy bond holders (or as I said bond insurers) but a lot of unhappy city employees who will see their anticipated pension benefits vanish whole or in part. If for no other reason than the sheer politics of that, let alone the story of leaving so many city pensioners in the poor house, that isn’t going to happen voluntarily. and even if that did play out, then they would sue to say the bond debt should go before they are thron under the bus as it were. Same situation just with different plaintiffs.

But which is the case? The unknown is the first problem. If Vallejo answers that in anyway then the political powers that be could change their perspective on whether a bankruptcy filing is either desired or permitted. As they say, watch out below.

8 Comments:

Blogger fester said...

Chris --- thanks for a lot to think about. I'm doing a quickie stress testing of locally controlled tax revenue for a couple of SW PA entities right now if we see a significant slow down or recession this year or next year. Pittsburgh is at significant risk as a good chunk of its locally controlled revenue does not come from property taxes (which are fairly sticky in the current political climate) but comes from sales/use taxes on non-staple or at least relatively easily substitutable goods and services. Revenues in these cases are pro-cyclical. For instance the parking tax is a proportional tax and if Downtown employment decreases, high price paid parking demand decreases. The amusement tax is a tax on truly discretionary spending which is the first consumer spending that is reduced when times are tight etc.

Friday, February 29, 2008 10:45:00 AM  
Anonymous Anonymous said...

Is there anyway to default on just the part of the pension that goes to the elected officials and senior staff? I'd hate to see, just for an example, the men who pick-up my garbage lose out. Every week, they get rid of my garbage with no mess, so I think I should keep my end of the bargain and pay taxes to give them the retirement they were promised. And no garbage man (or police office or fireman, etc.) has ever tried to sell me a "vision for the future of Pittsburgh" or any nonsense like that.

On the other hand, idea of paying taxes to ensure that Tom Murphy or Pat Ford has a better retirement than I'll ever get doesn't sit well.

MH

Friday, February 29, 2008 11:21:00 AM  
Blogger Richmond K. Turner said...

Great post. I'm wondering why you see the bond vs. pension debt question as an either/or proposition. I get what you are saying about some forms of debt being more senior to others, and the senior debts get paid off first. But you also suggest that there isn't any current case law to delineate which of these two debts is senior to the other.

In these circumstances, I'm guessing that a bankruptcy court would treat the two debt burdens as being on roughly the same level, and take a bite out of both of them. Precedents set elsewhere will help guide this decision, but I doubt that either debt stream will get away scott-free. At least I would hope not.

All that being said, I would regard defaulting on our bonds as more problematic than cutting back on pension payments. A bond default can work, but it can work only once . After that, there won't be any new buyers for our debt for a number of years.

Friday, February 29, 2008 11:42:00 AM  
Blogger C. Briem said...

I've discussed this canard about default locking us out of the debt market for some time into the future. It's an unknown of course but it also reflects too much history. Debt market has matured (some could argue in bad ways) in recent years/decades and by definition there are lots more options for higher risk debt than in the past. Given that the city would fundamentally come out of a bankruptcy in better fiscal health than it did going in its hard to believe it will be locked out of the debt market. In the past you almost had to wonder whether the bond market itself (or bond insurance market) would feel a need to 'punish' a defaulter, but that just is pure speculation.

could the debt be treated equally. Could be sure, but that is just the unknown. The fundamental problem there is that they are just apples and oranges in practical terms. Pension liability is a fairly presumptive future liability that is changing every estimation. Bond debt is uber-quantified. I am not quite sure you could theoretically treat both the same. Either way, some side will be mad and force the issue to be settled.

Friday, February 29, 2008 11:58:00 AM  
Blogger C. Briem said...

and the problem with the implicit contract with the folks who pick up the garbage... is that most of the folks who made that bargain to pay some future pension have moved away or passed on. Thus that contract will have to be paid by those people who have moved in, or future residents who will need to be enticed to live in the city.

Friday, February 29, 2008 1:47:00 PM  
Blogger C. Briem said...

and looking at today's market close.. it's worth wondering the status of the city's pension funds given the dismal state of the market this year.

Friday, February 29, 2008 4:11:00 PM  
Anonymous Anonymous said...

Good bankruptcy lawyers; you filed the bankruptcy recently, and it sounds like the summons was from an old debt, you should be able to have the debt which prompted the summons to be discharged in the bankruptcy. If you already listed that debt in your bankruptcy, you just need to get the opposing party, and the court notice of the bankruptcy. If not, you'll typically need to add the debt to the bankruptcy so it can be discharged. Either way, don't ignore it, let the court know what's happening. In most places there is a "notice of bankruptcy" or "notice of stay" form you can file with the state court where the summons was issued. Good luck.

Thursday, March 18, 2010 5:34:00 PM  
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