Municipal bankruptcy

Source: Shayne Kavanagh, Government Finance Officer’s Association, Long Term Financial Planning Blog, September 22, 2010

Municipal bankruptcy is a topic of great interest to many local governments. This blog post presents the results of some of GFOA’s research into the topic.

GFOA recommends that municipalities make every effort to avoid bankruptcy. This is because, first, bankruptcy will exact a serious cost on the community’s reputation and the government’s creditworthiness. The harm to the community’s reputation could sap its economic vitality and will increase the government’s cost of borrowing. Besides these costs, the cash outlays required to go through the court proceedings are significant. Legal and consulting fees and staff time preparing for hearings and responding to requests for information could easily reach into the millions of dollars (and more for larger governments). Finally, bankruptcy is not a cure-all. As a practical matter, a judge is unlikely to completely void any of the municipality’s obligations (so debts and bondholders will still need to be paid). Also, as a matter of law, a judge cannot override provisions of state law that may be contributing to the municipalities financial distress, such as public employee pension benefits that are guaranteed by state law. Further, the municipal government is not dissolved by bankruptcy and although bankruptcy may provide some additional latitude to local government officials, in the end, it is the municipality’s management and elected officials who still must make the hard choices required to reach financial health.

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