A new fulcrum point for city survival.

AuthorParikh, Samir D.
PositionAbstract through III. A New Fulcrum Point A. Overarching Goals, p. 221-258

ABSTRACT

Municipalities have historically enjoyed immense stability. This era of tranquility is over, and fiscal deterioration is accelerating. Policymakers and scholars have struggled to formulate debt restructuring options; almost all have embraced federal bankruptcy law. But this resource-draining process is not the fulcrum point for any meaningful solution to municipal demise. Indeed, for the vast majority of distressed municipalities, the lever of municipal recovery will not turn on the solutions that have been offered to date. This Article radically shifts the municipal recovery debate by arguing that state law is the centralized point at which officials can exert the necessary amount of pressure to gain concessions from key creditor constituencies. To that end, I propose a comprehensive fiscal monitoring system that identifies and then directs distressed municipalities into a dynamic negotiation model designed to restructure inveterate debt obligations. Animating this proposal is a more nuanced understanding of the Contracts Clause that allows a municipality to explore unilateral contract modification in an effort to facilitate consensual agreements with creditor constituencies.

TABLE OF CONTENTS INTRODUCTION I. CHALLENGES FACING MUNICIPALITIES A. Overview B. Perverse Incentives and Cost Shifting C. The Elusive Nature of Resource Adjustment II. MORE AGGRESSIVE FORMS OF REHABILITATION: STATE AND FEDERAL ATTEMPTS TO ADDRESS MUNICIPAL INSOLVENCY A. Current State Law Restructuring Approaches B. The Misplaced Fulcrum: Why Chapter 9 Is Not the Answer III. A NEW FULCRUM POINT A. Overarching Goals 1. Sustainable Viability 2. Proactive, Delineated Debt Adjustment Mechanism 3. Meaningful Unilateral Contract Modification Options 4. Maintain Access to Credit Markets 5. Safeguard the Chapter 9 Option if Negotiations Fail B. Managing the Restructuring Mechanism: State Primacy and Reversing Devolution During Financial Distress C. Addressing the Contracts Clause 1. A New Perspective on the Contracts Clause 2. The Federal Judiciary's Approach to the Contracts Clause 3. Distilling Contracts Clause Jurisprudence to Understand a Distressed Municipality's Bargaining Position IV. THE NUANCES OF AN OPTIMAL STATE DEBT ADJUSTMENT MECHANISM A. Stage One: Soft Monitoring's Scarecrow B. Stage Two: Financial Triggers C. Stage Three: Reversing Devolution During Municipal Distress 1. The Poles in the Local Governance Spectrum 2. Restructuring Control Boards and the Center Point D. Stage Four: A Clear Negotiation Structure and Contract Modification 1. Negotiating with Bondholders 2. Negotiating with Employee Unions a. Compensation and Benefits b. Current Employee Concessions c. Retiree Concessions E. Stage Five: Recovery Plan V. CONSEQUENCES OF IMPLEMENTATION: RAMIFICATIONS TO BORROWING COSTS CONCLUSION INTRODUCTION

On October 16, 1975, Hugh Carey, then governor of New York, was attending an event at the Waldorf Astoria when one of his aides approached and informed him that he was needed at his midtown office. (1) No further explanation was necessary. Carey promptly left the event as if he had been summoned to a loved one's deathbed. (2) And, in some ways, he had. New York City was facing its financial death.

When Carey entered his office, he discovered that the city did not have sufficient funds to meet its payroll and other obligations that would come due the next day. (3) City and state officials were working frantically to secure additional funds. (4) Abraham Beame, then mayor of New York City, had called the White House and asked to plead his case to President Gerald Ford. (5) Beame was told that Ford was sleeping, but, rest assured, his staff was monitoring New York City's situation. (6)

The White House was well aware of New York City's impending demise. City leaders planted the seeds of the city's death spiral in the 1960s when they removed barriers to the growth of its payrolls and social programs and financed the city's largesse with excessive borrowing. (7) From 1961 to 1975, municipal employees unionized and labor costs increased 313%. (8) During the same period, spending on social welfare programs increased over 828%. (9) City residents enjoyed free tuition at the City University of New York and subsidized fares on the mass-transit system. (10) City officials lacked the fortitude and political capital to curtail spending; bloated social programs had been overfed for years and could not be weaned. (11) For the decade prior to the city's financial crisis, local officials had allowed expenses to increase by an average of 12% every year while tax revenues increased only 4-5%. (12) Consequently, New York City had to borrow billions of dollars through the municipal credit markets to cover this budgetary shortfall. (13) By 1975, the city had an operating deficit of more than $3 billion, (14) but made no attempt to curtail spending. Instead, city officials obfuscated the impending crisis with an array of accounting gimmicks that covertly saddled the city with debt that it had little chance to service. (15)

Fearing the worst, Mayor Beame had his staff draft a press release that read, "I have been advised by the comptroller that the City of New York has insufficient cash on hand to meet debt obligations due today. This constitutes the default that we have struggled to avoid." (16) However, the press release was never distributed. (17) In the face of this unprecedented cataclysm, state officials were able to obtain funds from an unlikely source. Albert Shanker, the president of the New York City teachers' union, reluctantly agreed to transfer $453 million from the Teachers' Retirement System into the city's coffers in exchange for city bonds. (18) This act delayed the city's default, but it did not save the patient. The prospect of the city failing was still very real.

In the months that followed, officials implemented a plan that ultimately allowed the city to avoid a federal bankruptcy filing and heal its financial wounds. The state created the Municipal Assistance Corporation of the City of New York (MAC) to issue new municipal debt. (19) State legislators agreed to provide a 28% increase in intergovernmental aid. (20) Bondholders deferred debt and interest payments on bonds, and various banks provided additional financing. (21) Congress passed the New York City Loan Guarantee Act of 1978 that offered $2.3 billion of short-term loans to New York City. (22) Perhaps most importantly, municipal employees accepted short-term pay cuts and layoffs and allowed pension funds to be invested in new MAC debt. (23)

In the years since New York City's brush with financial collapse, American municipalities (24) have enjoyed relative stability. Since 1954, only sixty-three municipalities with taxing authority sought protection under Chapter 9. (25) But this era of tranquility has ended. Municipalities have begun to experience the same financial inferno that started to consume our national economy in 2008. Tax revenue is declining. (26) Healthcare costs are escalating and eclipsing revenue growth. (27) Unfunded liabilities for state and municipal retirees' healthcare benefits amount to more than $1 trillion. (28) Pension systems are underfunded by as much as $4.4 trillion. (29) These burdens fall on the state as well as all municipalities located within its borders. Not surprisingly, twenty-eight municipalities have declared bankruptcy or become subject to a receivership since late 2008, and five of the six largest municipal bankruptcies in American history are in this group. (30) Amidst this bloodshed, experts have predicted an even larger tidal wave of financial distress for municipalities in the upcoming years. (31) The scope of this problem is far broader than many would suspect. Systemic municipal failure is a multi-tiered problem with ripple effects, because fiscally crippled municipalities impose significant economic costs on state and national economies. (32)

Academics and policymakers have struggled to propose viable solutions to the staggering financial problems facing municipalities. Up to this point, the literature has focused on federal bankruptcy law and the options available under Chapter 9. (33) In particular, scholars have argued that Chapter 9 bankruptcy judges need more power and municipal debtors need more weapons in their arsenal to address crippling union obligations and bond debt. (34) Politicians and scholars have made a variety of suggestions, and some have gone so far as to suggest amending the Constitution to allow states to seek federal bankruptcy protection. (35)

Federal bankruptcy law, however, is not the fulcrum point for any meaningful solution to municipal financial distress. The lever of municipal recovery will not turn by implementing the solutions already proposed. Indeed, the literature fails to appreciate that Chapter 9 is a resource-draining process that perpetuates cost shifting, fails to produce needed structural changes, yields poorly formed results, and raises borrowing costs that further burden future generations. This Article radically shifts the municipal recovery debate by eschewing federal bankruptcy law and proposing that state law can be the centralized point at which officials exert the necessary amount of pressure to gain concessions from unions and bondholders. I seek to reframe our solution inquiry through the prism of a state debt adjustment mechanism. My proposal is premised on a comprehensive fiscal monitoring system coupled with a clear debt negotiation structure for distressed municipalities. Animating my proposal is a more nuanced understanding of the Contracts Clause that allows a municipality to explore unilateral contract modification of key obligations in an effort to facilitate consensual agreements with creditor constituencies.

Ultimately, my proposal seeks to (1) identify pressured municipalities at a time when measured adjustments can be sufficient to create...

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