Whether municipal bankruptcy law is a plausible alternative to either bailouts or decades of fiscal malaise for larges cities that are sagging under unsustainable debt, and whether it is time for congress to enact a bankruptcy law for states too. Chapter 9, viewed as a legal backwater, an option that might make sense for a local sewer or water district, but would never work for cities of any size. Of the 600 or so municipal bankruptcies since the 1930s only a handful involved substantial cities or counties.
Vallejo, CA, Jefferson County AL, Stockton and San Bernardino Ca all have filed for bankruptcy. The stigma of filing for filing chapter 9 are declining as more cities use it.
Congress and the states are less willing and less able to step in with bailouts. 2010 when a number of lawmakers flirted with the idea of proposing a federal bankruptcy law for states.
Officials in Ca and NY insisted that no state would ever actually file for bankruptcy and merely mentioning the worked would have a devastating effect on the bond markers. Liberal critics suspected that state bankruptcy was a ploy to whack public employees unions and insisted there was no need to alter collective bargaining agreements or pensions.
The ultimate decision to permit Detroit to file for bankruptcy rested with the governor, Rick Snyder. The filing also undercuts claims that enacting a state bankruptcy framework would cripple the state bond markets. There was very little change in municipal bond prices, even the day after Detroit’s filing.
Detroit’s only hope for a renaissance lies in $1.25 billion in infrastructure investment together with a restructuring of the city’s major obligations—including roughly $1.43 billion in “certificate of participation,” $1.01 billion of general obligation bond debt and $3.5 billion or more in unfunded pension liabilities.
The question of whether pension can be restructured has become the first major flashpoint in the case. Michigan state constitution says that pensions cannot be diminished or impaired, retirees and their representative have insisted that every nickel must be paid in full. Under ordinary bankruptcy law, pensions would be fully protected up to the amount of funding that has been set-aside for them, but any unfunded portion would be subject to adjustment. Federal bankruptcy law takes precedence over conflicting state law in accordance with the supremacy clause in Article VI of the US constitution, the bankruptcy treatment should prevail.
The biggest reason for the financial travails of the states that are currently in financial distress is woefully under-funded pensions. Under the laws of many states, there is almost no way to adjust the states obligations to retirees, no matter how extravagant or under funded the pensions are. Illinois pensions are radically under funded—by $97 billion under the states own estimates. The Illinois legislature has rejected proposals to try seriously to close the gap.
Source—weekly standard, david skeel