A Michigan law that allows the state to intervene when a local government faces financial distress is one of the nation's most aggressive, according to a study released Tuesday, days after Detroit became the largest city to ever file for bankruptcy.
Only 19 states have laws letting the state government intervene to help cities in financial distress. The Pew Charitable Trusts report found that Michigan, North Carolina, Pennsylvania and Rhode Island are states with the most extensive programs.
Municipal bankruptcies are rare. Pew found that of the 55,000 local governments in the U.S. that sell bonds, 276 have filed for bankruptcy since 1980 — most special tax districts, not cities.
Kil Huh, Pew's director of state and local fiscal health, said it's tough to gauge whether one state's approach is better than another's and whether Michigan's decision to intervene to take a city through bankruptcy like what's happening in Detroit will make a difference or not.
He said city residents in California, which doesn't get involved in distressed cities, and Rhode Island, which does, have "experienced a lot of pain" after bankruptcies led to reduced services, higher taxes and in some cases retirees getting less in pension benefits.
According to the study, however, Vallejo, Calif., took three years to emerge from Chapter 9 while Central Falls, R.I., avoided a prolonged bankruptcy largely because state lawmakers approved a law guaranteeing bondholders would be paid in full.
"States are weighing what role, if any, they should play," Huh said, noting that local governments were the last to emerge from the Great Recession because of the lag time between the decline in home values and drop in property tax revenues, along with cuts in state aid to municipalities.
Republican Gov. Rick Snyder in December put a new Michigan emergency manager law on the books a month after voters repealed a version that gave sweeping powers to a single person to overhaul financially distressed communities.
The new law, passed by the GOP-controlled Legislature, gives local governments and ailing school districts the opportunity to choose their own remedy. If a review team finds that a financial emergency exists, those communities can request an emergency manager, ask for a mediator, file for bankruptcy or introduce a reform plan with the state. In addition to Detroit, five other Michigan cities and three school districts are being run by emergency managers.
Huh said Michigan, one of the first states to enact an intervention law in 1990, wants to "figure out a way to help localities so they don't become the next Detroit."
Detroit emergency manager Kevyn Orr, appointed weeks before the new law took effect, used his authority under the law to file for bankruptcy last week with Snyder's blessing.
Orr was unable to persuade a host of creditors, unions and pension boards to take pennies on the dollar to help with the city's massive financial restructuring to address debts that could amount to $20 billion. If the bankruptcy filing is approved, city assets could be liquidated to satisfy demands for payment.
More than 21,000 city retirees who receive pension and health care coverage are among 100,000 creditors left wondering their fate, and some say Snyder and the state should help Detroit with a financial bailout.
It appears Michigan has adopted some practices that Pew researchers recommended in their report — a monitoring system to classify cities' level of distress, for instance. The study suggests that cities and states institute multi-year financial planning and focus on legacy costs such as retirement benefits and that states try to engage all stakeholders to gain a local community's trust.
Pew said there is a long history of states attempting to help cities avoid financial disasters. New Hampshire created a commission to oversee Manchester's troubled finances in 1921 and North Carolina followed suit a decade later after a wave of municipal faults in the Great Depression.
Cities can't file for bankruptcy without a state's permission, according to the study. Twenty-seven states authorize some form of bankruptcy. Two states, Georgia and Iowa, passed laws prohibiting cities from seeking Chapter 9 protection, Pew said.
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