Emptying the Notebook: Bankruptcy

At the end of my explainer piece on pension rights in municipal bankruptcy, San Diego City Councilwoman Donna Frye said she believed the city was close to running out of money.

This lends itself to an interesting question. Can a city, which collects taxes from residents, visitors and businesses, ever really run out of money? It’s not quite a Zen Buddhist kōan, but an existential issue all the same.

In municipal bankruptcy, the term is “insolvency.” A city becomes insolvent if it can’t pay its bills now or in the future. But in theory, a city could keep cutting services or pushing out its debts forever.

A forum on municipal bankruptcy hosted by the San Diego County Taxpayers Association last fall addressed this issue. Here’s how voiceofsandiego.org CEO Scott Lewis summarized it:

True or False? By its very nature, a city can’t be insolvent because it will exist into perpetuity and can either cut services or push its debts out to the infinite future because it will be around in 100, 200 or 300 years. It’s therefore never going to be at a point where it can’t make good on the most immediate of obligations.
This was one of the most interesting themes of the conversation.
(Bankruptcy attorney) Margaret Mann answered it best. Yes, a municipality can push its debt off years, even centuries into the future. But a dollar now is worth far more than a dollar in 350 years. Creditors and employees need money now.
And if a city is in bad enough shape, cutting and cutting until it’s back in balance will leave you with an untenable situation:
“If you really take the hypothetical out the whole way, you are going to end up with a city with no services,” Mann said.
In other words, the municipal bankruptcy option is codified in law precisely to protect a basic level of services residents might expect their city to deliver. If city management has left it so imbalanced that it will have to eat into core public health, safety and infrastructure services to make good on its debts, the bankruptcy option is there as a last resort to right the ship.
“The premise is there needs to be at least a modicum of services that a municipality provides its citizens. How much it is, you can debate those kind of issues. But I don’t think you can debate some of the fundamental needs,” Mann said.

It’s worth noting that unions challenged the insolvency of the city of Vallejo, which is currently in bankruptcy, on the grounds that the city had money in restricted funds. A federal judge said Vallejo was insolvent because that money legally couldn’t be used to pay debts in the city’s day-to-day operating budget.

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Speaking of Vallejo, an interesting editorial ran this weekend in the San Francisco Chronicle. The costs of Vallejo’s bankruptcy, the newspaper argued, go beyond money. Vallejo has fewer police officers than it did five years ago and the highest violent crime rate of any comparable city in the state. It may have to lay off more to address its cash flow problems.

— LIAM DILLON