In the past several weeks three California cities filed for bankruptcy as they struggled to deal with decreased revenues and rising public pension costs. What was once a rare occurrence may become more widespread as experts say we can expect to see more municipalities in California and across the nation turn to bankruptcy.
This week San Bernardino became the third city to file for bankruptcy protection in California this year. The city, located within the metropolitan area known as the Inland Empire, had a $45.8-million budget shortfall and wasn’t going to make payroll this summer. Also earlier this summer Stockton, California, with a population of more than 290,000, became the largest city to enter Chapter 9 bankruptcy. It had a $26-million gap in its general fund. The small resort town of Mammoth Lakes, California also went bankrupt earlier this month after struggling to pay a $43 million debt.
Chapter 9 bankruptcy is a special form of insolvency reserved for municipalities. The first municipal bankruptcy legislation was enacted during the 1930s and Great Depression. Since the law was established, fewer than 500 cities have filed for bankruptcy. One of the biggest filings came in 1994 when Orange County went bankrupt. Last year Jefferson County Alabama, the most populous in that state, was among 13 US cities and counties that filed for bankruptcy in 2011.
This most recent outbreak of bankruptcies may be a signal that more will come as cities run out of options. Many cities in California continue to deal with high unemployment (about 15% of San Bernardino residents are unemployed). California also has high levels of foreclosures. The struggling economy there has hurt property valuations and decreased city revenues. That is on top of higher employee costs tied to public pensions.
But the problem is not just in California. Last week Scranton, Pennsylvania cut all city workers’ pay to minimum wage. Police officers, street maintenance workers, and even the mayor are being paid $7.25 an hour now after the city was hurt by mounting debt and languishing revenue streams.
The municipal bond market seems to be absorbing the impact that these few bankruptcies and financial troubles have caused. Although the cases involve millions of dollars, they are still small in the grand scheme of the national municipal bond market. There are 36,000 cities and towns across the United States and municipal bonds have traditionally been low risk for default. It would take many more cities to declare bankruptcy for it to truly impact the bond market at this point.
As for these struggling cities, many are finding it difficult to pay employees or run city services. Under bankruptcy they will be able to renegotiate work contracts and hold off on making some payments. Bankruptcy is typically viewed as a last option and these cities can expect the cost to borrow money in the future to be higher. But cities have few options and focusing on paying bills today is a higher priority than borrowing money in the future.