Municipal Default and Bankruptcy

The Provisions of Municipal (Chapter 9) Bankruptcy
The Municipal Bankruptcy Act of 1934, or Chapter 9 of the U.S. bankruptcy code, outlines the legal provisions for municipal bankruptcy. Very broadly, and like other bankruptcy chapters, it is intended to provide relief for municipalities from their bondholders and, more recently, pension and retirement benefits holder while they restructure their finances.

Chapter 9 is very different from more common bankruptcy measures, such as Chapter 7 or 11 (corporate) and Chapters 7 and 13 (personal), for a few reasons. These differences stem from the tenants of federalism, as well as Constitutional state sovereignty: states have jurisdiction over matters within their borders. As a result, the bankruptcy court plays a very limited role in bankruptcy proceedings: they approve the petition, confirm the negotiated plan for repayment, and help ensure the plan is put into effect.

State Bankruptcy
A state cannot, by law, file for bankruptcy. The primary justification for is simple: states are sovereign, and therefore have domain over their own internal affairs. As such, some U.S. courts have argued that allowing federal bankruptcy courts jurisdiction over state bankruptcy would violate the states' Constitutional protection of state sovereignty.

Whether or not to grant states bankruptcy protection is a point of contention. Opponents argue that allowing states to go bankrupt will have dire consequences for the municipal bond market, not to mention the consequences for the state that goes bankrupt itself - lower credit ratings, higher interest rates for borrowing, and fewer entities willing to contract with said state. Proponents, though, argue that states such as New Jersey and Illinois have too many obligations - from bonded debt to pension liabilities and retirement health insurance benefits - for which they will not be able to pay, and must have some recourse for debt relief if, and when, they default.

This issue is gaining urgency in American public policy, thanks in part to revelation of the extent to which American public pensions are underfunded, and the amount that municipal governments will eventually have to pay for other post-employment benefits like retiree health insurance.

Local Government Bankruptcy
Where states cannot file for bankruptcy because of their sovereign status, local governments like cities were granted to ability to file for bankruptcy in federal courts in 1934. Not all municipalities are granted the right to file for bankruptcy, however, by their state; since states have domain over their internal matters, they make the ultimate decision regarding who may file for bankruptcy. Below is a map which outlines the broad policies of each state. More detailed information can be found here.

Very rarely do municipalities fail to pay back their outstanding obligations. From 1970 to 2014, less than 1% of rated municipal bonds - bonds for which creditworthiness was determined by one of the three major ratings agencies: Moody's, Standard&Poor's, and Fitch - went into default. Even further, during the fiscal strain of the Great Recession only .004% of state and local governments defaulted on their general obligation bonds.

Despite how rare municipality default is, however, there have been many recent and high-profile cases of municipal default and bankruptcy. Since 2010 alone, 9 local governments have filed for bankruptcy with varying degrees of success. From Governing magazine, the nine local governments are as follows :

"-- City of Hillview, Ky.

-- City of Detroit, Mich.

-- City of San Bernardino, Calif.

-- Town of Mammoth Lakes, Calf. (Dismissed)

-- City of Stockton, Calif.

-- Jefferson County, Ala.

-- City of Harrisburg, Pa. (Dismissed)

-- City of Central Falls, R.I. -- Boise County, Idaho (Dismissed)"

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