Thursday, October 13, 2011

To bankrupt or not to bankrupt

The news is that Harrisburg has filed for bankruptcy.  While technically true that they have filed for bankruptcy, this may be shot down before it all begins.  The funniest part of this at the moment is that all the judges for this are in Tampa for a conference.  So hold your breath.

Remember, bankruptcy has not been far below the horizon here in the past.  The closest the city of Pittsburgh should have come to bankruptcy was in the early 1990's just as Tom Murphy became mayor.  Yet the history is that the City of Bridgeport, CT had just before that time tried to file bankruptcy but was denied by a federal court to even enter bankruptcy.  Municipal (Chapter 9) bankruptcy is not like bankruptcy for you and me in lots of ways.  US constitutional issues prevent a judge from exerting many of the powers over a state entity the same way might happen in recievership for an individual or company. 

In Bridgeport's case the court ruled that the city was not really broke enough to file for bankruptcy, i.e that it had the fiscal capacity to tax or borrow its way to meet its obligations. Unlike other bankruptcies which really look at assets and liabilities, Chapter 9 is more about cash and the fiscal capacity to raise cash.  Most public assets are not going to be considered for sale or liquidation no matter, so there is no risk of the mayor's chair being carted off to a flea market. 

The thing is that while I believe the City of Pittsburgh was in a far worse shape than Bridgeport was at the time, that precedent was clearly the biggest thing on the mind of city lawyers who likely advised a bankruptcy filing would not go forward.  I personally bet they were wrong on that and that Pittsburgh was not in as good shape as Bridgeport was and well over the line of insolvency in a public sense.  There is even a school of thought that says if Bridgeport just waited another year before filing its fiscal condition would have been so bad that the court would have had no choice but to let the filing go forward.

Still I bet Bridgeport's aborted bankruptcy is the only thing that kept the Murphy administration from filing for bankruptcy right as they took office when they were told the city was about to go cash zero. Prevented from bankruptcy all sorts of even worse things happened.  The result was that over the subsequent decade city in succession 'sold' or liquidated the water department into the water authority (long story there), the city's debt ballooned,  tax liens sold off to a third party without much concern for city of Pittsburgh development and no significant increase (Pension bonds were a wash I would say.. at best) in pension funding would leave us where we are today.   So today we have more debt, more pension liability, no direct control of the water system (think of all the problems that has caused) and had much of a decade of neighborhood economic development arrested because it was held hostage by a wall street company that couldn't spell in Latin

Then there is this logic people say the Commonwealth of Pennsylvania must 'approve' any bankruptcy filing.  Also technically true in the legal sense.  In the real world sense it is not so important.  The lawyers might argue, but consider a few things.  In Pennsylvania the state approval for letting a federal bankruptcy filing go forward is mostly embedded in the Act 47 law and process.  There has been municipal bankruptcy in Pennsylvania, even one  recently in the case of Westfall Township.  Did Westfall get permmission to file for banktruptcy?   I would argue it didn't in that an Act 47 process only began after they filed and had a bankruptcy proceeding move forward. The state went along, but it was kind of after the fact.  And in one of the stranger acts of jurisprudence.. some folks may remember the monster AHERF bankruptcy that still lives on in shaping the region's state's health care system.  AHERF, even though it was not a municipality, was a Chapter 9 bankruptcy.  Does not quite make sense to me, but I think it was just too big and too complex to really fit into a Chater 11.  *

In the bigger sense it does not matter if the state really approves a major bankruptcy or not.  If bills go unpaid, or say bond payments don't go out.  Bad things happen and at some point someone would be forced to do something.  The state would have little choice to 'approve' a bankruptcy, or a judge would find some way to rule that a filing could go forward. 

Also unmentioned in the article is the story of Vallejo, California and its bankruptcy that is just about to come out of.  That also is a case where I have argued the fundamental finances there are far better than they were (or are) here.   Go figure and again think about all the victory signs last month when the state accepted the while pension accounting scheme. Is Vallejo a model for what may happen in Harrisburg?   Probably not just yet.

So what happens now?  My guess is that when the judges get back from Tampa and have a hearing on any of this they are likely to push back and say no... no filing for you.   Sort of like the soup guy on Seinfeld.  Federal judges are not going to want to get into what is, on top of everything else, a political circus in the city of Harrisburg.   They will tell them they are not there to settle the city's political problems, whether or not that is the verbiage of any actual ruling who knows.  So a bankruptcy may happen... but I bet it is not right now.   

Still,  I am surprised the Commonwealth let this all get this far already.  There are consequences across the state for such financial miasma in any one municipality, let alone in the state capital.

__________________
* Being such a legal post it is required that I have more footnotes than content. While I have been told AHERF had Chapter 9 proceedings, some legal beagles are disputing that.  So I will defer to the folks at the bar. 

24 Comments:

Blogger john b said...

That is a lot of brain candy there Chris, really enjoyed the read.

Reading the bloomberg piece I was reminded of the Bob Roberts movie filmed here back in 1992. To think what this city could be if we still had (local) control of our water system and much of the abandoned properties.

Thursday, October 13, 2011 9:13:00 AM  
Anonymous MH said...

Didn't the abandoned property thing work out, kind of? I thought Pittsburgh bought the tax liens back for less than they were sold for. Of course, that only happened because the property values tanked so much.

Thursday, October 13, 2011 9:24:00 AM  
Anonymous BrianTH said...

Sorry, Chris, but when it comes to the City of Pittsburgh, the lawyers are right and you are wrong. There is a special "second class city" provision in state law that specifies Pittsburgh can only enter Chapter 9 with the governor's permission. That's a stark reality you need to acknowledge, and that is why you can't just cite Westfall, or for that matter Harrisburg if they manage to get through under the wire.

Now you raise the issue of what would happen if the City officials decided to just stop paying the City's bills. You claim "The state would have little choice to 'approve' a bankruptcy." Actually, no, the state could also choose to take over management of the City and start paying its bills again.

All this is important because people are using the myth of the unilateral Pittsburgh bankruptcy to argue against actually reforming all of the state laws that have put the City into this position. Maybe that isn't your intent, but you are de facto helping those people every time you make this erroneous argument about the City's real world options.

Thursday, October 13, 2011 10:57:00 AM  
Anonymous MH said...

Actually, no, the state could also choose to take over management of the City and start paying its bills again.

I have my doubts that the state will do this for Harrisburg and, politically, Pittsburgh is worse. What can they do? They can either 1) raise a whole bunch of new taxes or 2) they can cut a whole bunch of services or 3) they can not pay a whole bunch of bondholders. Given who lives in Pittsburgh and has money, doing #1 requires will require more taxing of old people who vote and suburbanites who hate Pittsburgh’s government for various sound and unsound reasons. (I have no idea who has money in Harrisburg.) Doing #2 would likely be a popular choice for a Republican governor except that in the case of Pittsburgh (and Harrisburg) the services nobody can pay for were rendered years ago. And, in general, nobody elected wants to take blame for cutting services. Doing #3 is what you say they will take over the city to avoid letting the city do.

Regardless of what the law says, this is the kind of situation where I would expect increasingly extravagant threats but resistance to actual action. Like the pension funding law, so great is the need to avoid responsibility that any stupid rationalization might be accepted if it fills a political need.

Thursday, October 13, 2011 11:24:00 AM  
Anonymous BrianTH said...

MH,

The easiest thing for the state to do would be just to tweak the IGA law a bit. To pay creditors, there would be at least a couple options.

One would be that creditors could get first-dibs on any state-based revenues owed to the City (under the current IGA law, these get stuck in an escrow account if the City fails to carry out an approved financial plan, but in fact revenues pledged to creditors are already exempt from escrow).

If for some reason redirecting state-based revenues to unpaid creditors proved insufficient, the state could also expand the IGA's mandamus powers (it already has some) allowing them to order further payment of creditors from the City's accounts.

In practical terms, doing things like this might well force the City to then raise taxes and/or cut services. But as I just outlined it, it wouldn't be the state or the IGA taking those steps--those steps would still fall on the City's other officials.

In fact, the existing situation under state law has already forced the City to cut services. So there is obviously no necessary political reason a scheme with those contours could not work.

Thursday, October 13, 2011 12:02:00 PM  
Anonymous MH said...

Anyway, I have very little knowledge of Pittsburgh's situation that I didn't learn here or the Comet, but I do try to follow the broader news. It is very clear that making it harder to enter bankruptcy does not always result in more money paid to creditors.

Thursday, October 13, 2011 12:04:00 PM  
Anonymous MH said...

My last comment was written before reading Brian's last comment.

Thursday, October 13, 2011 12:05:00 PM  
Anonymous MH said...

In practical terms, doing things like this might well force the City to then raise taxes and/or cut services.

That's what happened in Harrisburg, as near as I can figure. The city council refused to do either and put the ball back in the state's court. I have no idea what will happen but I suspect that game theory (e.g. prisoner’s dilemma or chicken) will give you a better guess at the outcome than the plain text of state law.

Thursday, October 13, 2011 12:11:00 PM  
Anonymous BrianTH said...

By the way, if there really is some fundamental limit to what the state can do to the City, I'd suggest it is something like this. Eventually, a high enough ratio of taxes to services in the City would cause such a flight of residents and economic activity from the City that its net revenues after paying for services would start declining in a way that no further tax increases or service cuts could fix. And at some point, it might well be the case that the City's creditors could not be paid no matter what the state did. In that circumstance, I would agree that either a bankruptcy or a bailout would be "forced" on the state.

But of course Pittsburgh is nowhere close to that point yet. And of course it would be terrible for the City and the entire region if it had to get to that point before the state acted. But the politics of the situation may well be leading to such a result, and again it doesn't help if people erroneously argue the City can unilaterally decide to file for Chapter 9 before such a point.

Thursday, October 13, 2011 12:12:00 PM  
Anonymous BrianTH said...

MH,

I agree the Harrisburg case will give us a better read on the politics. In fact, I also agree that no one should assume the current law for Pittsburgh will remain the same, but that isn't the same thing as saying the City can unilaterally force those laws to change in a HELPFUL way.

And unfortunately, right now it seems like the politics are dictating that faced with the possibility of a Harrisburg Chapter 9 proceeding, state law will be changed in an UNhelpful way. Applying that lesson to Pittsburgh suggests a rather dark result, at least if it tries to force the state's hand in the current political climate.

Thursday, October 13, 2011 12:16:00 PM  
Anonymous BrianTH said...

Oh, and I should add that at least the simple versions of game theory assume rational, self-interested actors. I don't think you can assume those results apply in a straightforward way to entities being managed by elected public officials (for that purpose you need something like public choice theory instead).

Thursday, October 13, 2011 12:19:00 PM  
Anonymous MH said...

...the possibility of a Harrisburg Chapter 9 proceeding, state law will be changed in an UNhelpful way.

If you mean that the law will change to make it harder to declare bankruptcy, I suspect that is very possible in the short term. As with consumer debt, my expectation is that such restrictions are just enough to punt the issue down the road to make the bankruptcies big enough to really hurt the creditors.

Thursday, October 13, 2011 12:22:00 PM  
Blogger C. Briem said...

Not to interrupt.. but on MH's comment:

Didn't the abandoned property thing work out, kind of? I thought Pittsburgh bought the tax liens back for less than they were sold for. Of course, that only happened because the property values tanked so much.

I am not sure the low property values of stuff with liens actually went down further. They overpaid, or in otherwords bought a turd. They did a decade later sell the portfolio back for cents on the dollar compared to what they paid. We basically ripped them off, not that I feel bad about it.. They should have known better up front. They mostly sold back because of the bad PR the Bloomberg article rained down on them. The city owes that reporter a BIG key to the city or something.

Thursday, October 13, 2011 2:06:00 PM  
Anonymous BrianTH said...

MH,

The problem is that the creditors of today are not necessarily the same people as the creditors of tomorrow. Accordingly, the creditors of today may be more than happy to take their full pound of flesh, even if it so weakens the body in question that it means there is eventually less flesh to go around for the creditors of tomorrow.

Thursday, October 13, 2011 3:33:00 PM  
Anonymous MH said...

The creditors of tomorrow are somebody else's problem (unless I become one of them). I'm sure the creditors will take as much as they can get, but the incentives for elected officials in Harrisburg run counter to that. And, by writing a state law that effectively says you need state permission to seek bankruptcy, the state has managed to more explicitly link the credit of every PA government body with the credit of the least solvent. Which is why I think this is better considered a giant game of chicken (or "hot potato" if somebody has described that type of game at a theoretic concept) than as a legal issue.

Thursday, October 13, 2011 7:35:00 PM  
Anonymous BrianTH said...

But if you live in or otherwise have a stake in Pittsburgh, your interests in these present-day disputes may well be more aligned with future creditors than present creditors. In other words, unjustifiably delaying bankruptcy is often bad for future creditors precisely because it is bad for the debtor too.

Anyway, I don't understand the nature of this "link". Keep in mind that in general, it is Chapter 9 law that a locality must have state authorization for a Chapter 9 filing. PA has a law which provides conditional authorization, but some states don't--what sort of "link" of credit does that create in those states? It just means a certain remedy for excessive financial liabilities isn't automatically available to localities in those jurisdictions.

And as I previously noted, the special PA law for second-class cities (of which there is exactly one) already explicitly says Pittsburgh needs the governor's permission to enter Chapter 9. It does not, however, provide any sort of state guarantee of payment of Pittsburgh's creditors. How does that "link" any other entity's credit to Pittsburgh's credit?

These aren't just legal technicalities. A locality can't force a state to play chicken, hot potato, or anything else if the state doesn't want to play. So if a state wants to let overwhelming financial liabilities systematically destroy a locality, it can in fact do that. And the fact that will be bad for future creditors is cold comfort for other people with a stake in that locality.

Friday, October 14, 2011 1:08:00 PM  
Anonymous MH said...

How does that "link" any other entity's credit to Pittsburgh's credit?

If Pittsburgh (or Harrisburg, depending on who you ask) goes bankrupt, the borrowing costs for other PA entities will be increased. This point is implicit in the post and in nearly every news story linked to in the post. Even without the state law’s requirement, this link is there in the minds of lenders, but because it takes an act of state government to go bankrupt, the state created a kind of unofficial guarantee that resulted in lower borrowing costs for Pittsburgh and other PA entities. This will make the link even stronger should the first domino fall.


So if a state wants to let overwhelming financial liabilities systematically destroy a locality, it can in fact do that.

It most certainly can and I don’t think I’ve disputed that. In fact, this is clearly the first option of at least one party in the legislature is you count bonds and both parties if you count bonds and pensions. What I don't think the state can do is let overwhelming financial liabilities destroy a locality without resulting in negative political consequences for those people elected to run the state government. Which is why I think that most people in state government will try to finesse the issue for as long as they can. As near as I can tell, the state supervision of Pittsburgh fits this pattern. The state isn’t demanding an actual fix because it knows that an actual fix will be painful enough to, for example, make 20,000 Allegheny County voters decide that a 7% tax on poured drinks isn’t a big demerit when it comes to voting.

Friday, October 14, 2011 1:37:00 PM  
Anonymous BrianTH said...

I still must be missing something.

Of course I get that there may be some pre-existing linkage in the mind of municipal creditors (although I also wonder about how far we should go with that--creditors have the ability to distinguish the default risk of different businesses, so why not different municipalities?). I also get that putting a barrier in the way of municipal Chapter 9 filings may reduce their borrowing costs.

I further get that if the state did grant permission for a Chapter 9 filing to Locality X, creditors might think it was more likely the state would in the future grant permission to Locality Y for a Chapter 9 filing. But at the limit that is no worse for Y's creditors than Y never needing the state's permission in the first place. So if anything, this need to get the state's permission reduces, not enhances, any natural link between different local creditors.

Finally, I just don't see this alleged "guarantee": the state is in no way suggesting it will ever take responsibility for paying the locality's debts just because the locality needs the state's permission to file under Chapter 9. Again, I think you could say such a regime favors creditors who are scheduled to get paid earlier over creditors who are scheduled to get paid later, but it doesn't add any new sources from which creditors can collect.

"What I don't think the state can do is let overwhelming financial liabilities destroy a locality without resulting in negative political consequences for those people elected to run the state government."

I'm not so sure statewide elected officials who essentially count on zero votes from the locality in question would share your reasoning.

Moreover, again I think you need to add the dimension of time to your analysis. Things a particular state elected official does now could lead to that result, but only by the time some other elected official was in charge. And if important "friends" of that state elected official benefit in the short run, and will be more than willing to put that elected official on the corporate dole once he or she becomes an ex-official, then I think you have all the circumstances you need for a disaster for that locality to actually occur.

"As near as I can tell, the state supervision of Pittsburgh fits this pattern. The state isn’t demanding an actual fix"

Again, I'd suggest that better fits the pattern of current state officials being more than happy to let future state officials take whatever political hit comes from Pittsburgh being devastated by the current state official's actions.

Friday, October 14, 2011 8:29:00 PM  
Anonymous MH said...

Finally, I just don't see this alleged "guarantee": the state is in no way suggesting it will ever take responsibility for paying the locality's debts just because the locality needs the state's permission to file under Chapter 9.

The state is suggesting it can make the locality pay and I contend that it can only do that to a point and that said point is well below where bond buyers figured it would be in 2006 or what ever.

Things a particular state elected official does now could lead to that result, but only by the time some other elected official was in charge.


I suppose if they could find a way to take over a localities finances, spend the bulk of them on debt service, and still have the locality vaguely function for a year, they will try that. But, I'd guess that all the small-pain cuts have been made.


I think you have all the circumstances you need for a disaster for that locality to actually occur.

I expect disaster to occur for many local government. It's already happened for some. I'm merely arguing that you can't read the state law and guess how the disaster will happen.

Friday, October 14, 2011 9:01:00 PM  
Anonymous BrianTH said...

"The state is suggesting it can make the locality pay and I contend that it can only do that to a point."

Correct, so as I noted, this is really about favoring early creditors (those with payments due before the point of true insolvency) over later creditors.

"I suppose if they could find a way to take over a localities finances, spend the bulk of them on debt service, and still have the locality vaguely function for a year, they will try that."

You just described what is actually happening with the City of Pittsburgh right now, and the process has lasted for a lot longer than a year, and will likely be able to continue for many more years.

"I'm merely arguing that you can't read the state law and guess how the disaster will happen."

But you have argued a lot more than that. You seem to think political considerations are going to be helpful, but I think that once you realize all this is already happening in slow motion, it turns out political considerations are going to continue to be unhelpful, unless we can start changing the political situation.

And in that context, the legal status quo does matter, because it is always safer for politicians to do nothing and claim whatever results is someone else's fault.

Saturday, October 15, 2011 8:52:00 AM  
Anonymous MH said...

What happened in Pittsburgh is the state accepted a transparent dodge to avoid having to take responsibility after the city council members, led by those from the districts that pay taxes, refused to permanently restrict their last politically viable revenue stream. When push came to shove, everybody got cold feet.

Saturday, October 15, 2011 10:22:00 AM  
Anonymous BrianTH said...

Actually, they did "permanently restrict" that revenue stream--they just got a worse deal for it.

So basically a host of current elected officials decided to make the future financial situation worse in order to avoid having to do anything unpopular now, which is precisely what I have pointed out can keep happening indefinitely.

And again current state law matters because it makes this sort of short-sighted foolishness the path of least resistance for most of the relevant political actors.

Saturday, October 15, 2011 11:31:00 AM  
Anonymous MH said...

Like we haven't had the revenue stream debate before.

Saturday, October 15, 2011 2:07:00 PM  
Anonymous MH said...

Apparently, ten or eleven parties sent lawyers to the first Harrisburg bankruptcy hearing. I'm sure that points to a quick settlement.

Monday, October 17, 2011 2:12:00 PM  

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