Helping or Hurting? The Efficacy of Municipal Bankruptcy
| Published date | 01 May 2021 |
| Author | Carolyn Abott,Akheil Singla |
| Date | 01 May 2021 |
| DOI | http://doi.org/10.1111/puar.13360 |
Research Article
428 Public Administration Review • May | June 202 1
Helping or Hurting? The Efficacy of Municipal Bankruptcy
Carolyn Abott Akheil Singla
St. John’s University Arizona State University
Akheil Singla received the Ph.D. degree
from John Glenn College of Public Affairs,
The Ohio State University. He is currently
an assistant professor at the School of
Public Affairs, Arizona State University.
His research focuses on public financial
management at the state and local level,
with an emphasis on government financial
health and capital markets. His work has
been published in
Public Budgeting &
Finance
,
Urban Affairs Review
, and
Public
Administration
.
Email: akheil.singla@asu.edu
Carolyn Abott received the PhD degree
in politics and social policy from Princeton
University, She is currently an assistant
professor in the Department of Government
and Politics, St. John’s University. Her
research interests include state and local
politics and the politics of public finance.
Her work has been published in
Journal of
Public Economics
and
American Journal of
Political Science
. She is currently writing
a book about the politics of state public
sector pensions.
Email: abottc@stjohns.edu
Public Administration Review,
Vol. 81, Iss. 3, pp. 428–445. © 2021 by
The American Society for Public Administration.
DOI: 10.1111/puar.13360.
Abstract: Local governments facing extreme fiscal stress have few options. One that has historically been rare is filing
for Chapter9 bankruptcy. The limited number of cases has prevented any systematic study of municipal bankruptcy.
But given the results of bankruptcy for individuals, there are reasons to believe that bankruptcy can provide a fresh
financial start for local governments. This study leverages six municipal bankruptcies in the years immediately following
The Great Recession to explore the effects of bankruptcy on local governments’ financial health. It employs a variety of
empirical approaches to generate a counterfactual for the bankrupt governments and assess the effects of bankruptcy:
synthetic control, propensity-score matching, staggered difference-in-differences, and an event study. The results show
that bankruptcy is associated with no declines and some meaningful improvements in financial health. These findings
suggest that Chapter9 bankruptcy may provide extremely stressed local governments with a potential path forward.
Evidence for Practice
• On its own, municipal bankruptcy does not appear to be harmful to the financial health of governments that
file for bankruptcy.
• There is some evidence that municipal bankruptcy can improve the financial health of governments that file
for bankruptcy relative to the counterfactual.
• The lack of harm and potential improvements are likely a function of the legal structures of Chapter9 that
allow local governments to retail control during court proceedings.
• Though municipal bankruptcy is a potential path for governments in extreme fiscal stress, it comes with
tradeoffs. The implications of breaking promises to public sector workers, bond holders, and other creditors
must be weighed against the potential benefits of improved financial health.
There are myriad sources of fiscal stress for local
governments. Structural issues can come via
general declines in the regional economy or from
population loss due to a large firm moving operations;
legacy costs associated with pensions or other post-
employment benefits like health care can account for
increasingly large shares of expenditures; risky financial
management choices via financial engineering can also
come with adverse consequences like increased costs;
and cyclical economic declines can reduce annual
revenue collections. This is by no means an exhaustive
list. However, local governments do not have the same
number of responses available to them when faced
with fiscal stress (Bozeman2010; Warner, Aldag, and
Kim2020). Given the hard budget constraint, which
requires most local governments to equalize revenues
with expenditures, governments focus on some
combination of three basic responses: raise revenues, cut
expenses, or use fiscal reserves to cover shortfalls. But is
there another option available to governments, one that
may soften the budget constraint?
Chapter9 of the federal bankruptcy code may be
one such pathway, as it allows governments that are
insolvent and have state approval to seek protection
and adjudication of their debts in a federal court
(Spiotto2012). Similarly—though not identical—
structured interventions for individuals and
corporations have received considerable attention
in scholarly literature. For instance, individuals
facing an overwhelming financial obligation can use
bankruptcy to remediate their situation. Individuals
liquidate their assets, and the federal court adjudicates
which creditors receive shares of those assets. In
return, individuals are supposed to receive a financial
fresh start, eventually returning to their standard of
living prior to being overwhelmed by their financial
obligations (Jackson1985). And though the fresh
start may not materialize, individuals going through
bankruptcy have improved outcomes (Dobbie,
Goldsmith-Pinkham, and Yang2017; Livshits,
MacGee, and Tertilt2007). Unfortunately, we have
little information about whether the intervention of
Helping or Hurting? The Efficacy of Municipal Bankruptcy 429
Chapter9 works in a similar fashion for governments. In light of
recent financial turmoil and decades of fend-for-yourself federalism
(Singla and Stone2018), it is worth asking: can bankruptcy provide
a fresh start for local governments facing overwhelming obligations?
This research endeavors to answer this question. Part of the
challenge of studying municipal bankruptcy, as it is commonly
known, is that it is a rare event. Among general-purpose
governments, only 31 of 39,000 have filed for protection since
2001 (Hogue2013; The PEW Charitable Trusts2018). As a result,
work evaluating bankruptcy tends to be limited to case studies
(Davidson2019; Howell-Moroney and Hall2011; MacKay2017;
Park2004). And while we have learned a tremendous amount from
these case studies, systematically isolating a generalizable trend or
effect is difficult in the absence of inferential statistics.
The dearth of evidence about Chapter9’s efficacy makes
prescriptions about bankruptcy similar to a Rorschach test. Senate
Majority Leader Mitch McConnell recently suggested Chapter9
had “saved some cities” and implied that bankruptcy was a
preferable alternative to federal aid to subnational governments
(Dennis and Selway2020). Credit rating agencies, however,
argue that municipal bankruptcy is unequivocally harmful and
should be avoided at all costs (Petek et al.2012). And because
studies of personal and corporate bankruptcy offer conflicting
evidence in different contexts, local public managers and elected
officials attempting to manage extreme fiscal stress may have
trouble discerning whether Chapter9 is a viable strategy by which
governments can create a financial fresh start or an accelerant likely
to worsen an already blazing fiscal fire.
In this study, we address a portion of the puzzle by evaluating
the effects of municipal bankruptcy on the financial health of
governments. Though known by many different names (e.g.,
solvency, financial condition, fiscal health, fiscal sustainability), the
construct of financial health assesses the balance of a government’s
resources against its obligations. Critically, operationalizing this
construct means accounting for variations in the timing of different
obligations. Financial health metrics can distinguish between a
reduction in a government’s ability to meet its immediate financial
obligations like payroll and its ability to meet long-term ones like
debt service payments. And as an outcome measure, financial health
has implications for a government’s ability to provide services to
residents (Gorina, Maher, and Joffe2018). Thus, by understanding
whether and how municipal bankruptcy affects financial health, we
gain critical insight into its efficacy as a policy tool.
To assess whether financial health improved after filing for federal
bankruptcy protection, we examine the six general-purpose
governments that filed for bankruptcy between 2010 and 2012.
The major empirical challenge of this examination is identifying
an appropriate comparison group. Leveraging a large dataset of
audited financial data for local governments, we first use a synthetic
control model to evaluate the effects of bankruptcy against a large
and comprehensive comparison group. We then supplement these
findings with a staggered difference-in-differences (DD) model
comparing the bankrupt governments to two sets of similarly
situated governments as determined via propensity-score matching.
We find no evidence that the governments that filed for bankruptcy
are worse off relative to the comparison group but have some
evidence of improvement relative to the comparison group. Though
these findings cannot clearly demonstrate that governments have
a financial fresh start, they do show that bankruptcy provides a
potential path forward for governments facing extreme fiscal stress.
Background: Eligibility for Municipal Bankruptcy
In order to use federal bankruptcy court to remediate its liabilities,
a local government must (1) have specific state authorization to
file for bankruptcy; (2) be insolvent; (3) be willing to file a plan of
adjustment defining how it will make changes to its obligations; and
(4) have made a good faith attempt to negotiate with its creditors
and failed (Spiotto2012). The first two criteria are of particular
import because they significantly reduce the potential pool of local
governments able to file. State approval is quite variable, as only
27 states have legislation specifically authorizing local governments
to file for Chapter9 bankruptcy. Some of these 27 authorize it
robustly, while others authorize it in very limited instances or only
if specific conditions are met.1 Of the remaining 23 states that do
not authorize Chapter9 bankruptcy, only two have specifically
prohibited municipal bankruptcy, while the other 21 have no policy
on the matter (The PEW Charitable Trusts2013; Yang2019).
Insolvency as a criterion is more difficult to define. The statute
identifies “not currently paying debts as they are due” as one form of
insolvency (11U.S.C. § 101(32)(C)); this is most commonly thought
of as default on a bond (i.e., missing a principal or interest payment).
A government experiencing cash flow problems such that it cannot
meet its obligations as they become due is insolvent. The second
definition of insolvency in the statute is forward looking, saying that
a government is insolvent if will not be able to “pay its debts as they
become due” (11U.S.C. § 101(32)(C)). Indeed, when Vallejo filed
for bankruptcy in 2008, it successfully argued that it was insolvent
because it could not meet its obligations due within the next year
despite not having defaulted on its bonds. Other aspects of this ruling
highlighted other challenges associated with defining insolvency.
For instance, what does it mean for a government, particularly one
with broad-base taxing authority and pots of money across several
funds, to be insolvent? Creditors in the Vallejo case argued that the
city was not insolvent because it had additional funds available to
cover the budgetary shortfall. The city argued that those funds were
restricted for other purposes (e.g., special revenue funds, capital
project funds, etc.) that could not be reallocated to cover operations.
The court sided with the city’s argument (In Re City of Vallejo2009;
Spiotto2012). This means that a government can be insolvent—even
if it appears not to be—if it can make a credible claim that its ability
to meet its obligations is impaired by self-imposed fund restrictions.
The court also rejected claims from creditors that Vallejo could
become solvent by cutting additional programs, saying that “further
funding reductions would threaten Vallejo’s ability to provide for the
basic health and safety of its citizens” (In Re City of Vallejo2009).
This implies that governments can be insolvent via their service
delivery, so cutting programs to meet financial obligations is not a
prerequisite for insolvency. Chapter9 cases in Stockton and Detroit
reinforce this interpretation of insolvency (Ives2015). All of this
is crucial because it demonstrates that while default is a sufficient
condition for insolvency, it is not a necessary one; governments have
multiple ways they can demonstrate insolvency to the court.2
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