Why city and town bankruptcies still aren’t likely

When Central Falls filed for receivership in May, the cash-strapped city’s move shocked bond markets and led to the rapid passage of a new state law to manage the process.

At the time of Central Falls’ original filing, Rhode Island state law did not allow cities and towns to file for bankruptcy under Chapter 9 of the U.S. code; the new law includes a provision that now allows it in extreme circumstances. (States are not allowed to file for bankruptcy under federal law, contrary to what Kerry King thinks.)

But Chapter 9 is still an unwieldy process, and cities and towns are unlikely to use it even as they find themselves squeezed by debt and pension payments, according to The Wall Street Journal’s David Wessel:

Recent close calls in Harrisburg, Pa., and Central Falls, R.I., spark predictions that the next phase of the financial crisis will be a tsunami of municipal bankruptcies and defaults. Muni-bond experts at rating agencies and bankruptcy lawyers assure us that isn’t likely. …

After Vallejo, Calif., won a federal judge’s OK to use Chapter 9 in 2008 to extricate itself from union contracts, there were widespread predictions that other cities would follow.

“Two and a half years later that hasn’t been the case,” says Robert Kurtter, who oversees state and local government ratings at Moody’s Investors Service. “What municipalities have discovered is that it is very expensive, the outcomes are uncertain because the rules are uncertain and it’s not clear what the municipality gains.” …

The future, though, may not resemble the past. The magnitude of the problem is daunting. State and local governments have borrowed $2.4 trillion as of mid-2010, according to Federal Reserve data. That’s up 35% from five years ago.

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