Harrisburg, the capital of Pennsylvania, filed for bankruptcy last month. The tiny city of Central Falls, R.I., filed in the summer. Hamtramck, Mich., tried to declare bankruptcy last year but was stopped by the state. From coast to coast, cities have had to cut services, lay off workers and raise taxes as the downturn has lingered.
Municipal bankruptcies remain extremely rare, and each of these cases can be viewed as unique, a one-off: Jefferson County was undone by a major sewer project marred by corruption, Harrisburg by borrowing more than it could repay for a disastrous incinerator project, Central Falls by pension problems, and Hamtramck by the woes of the auto industry. Viewed another way, though, they show how the downturn has left the nation’s most distressed cities with few options for papering over huge problems, and left some desperate elected officials placing their hopes in bankruptcy judges.
Their desire for simple solutions may be in vain, though: for constitutional reasons, the part of the federal bankruptcy code that municipalities use, Chapter 9, sharply limits the power of bankruptcy judges to intervene in local governance.
“Chapter 9 really puts the judge more in the position of being a referee than somebody who can really run the county,” said Paul S. Maco, a partner with the firm of Vinson Elkins who led the Office of Municipal Securities at the Securities and Exchange Commission during the bankruptcy of Orange County, Calif. — the nation’s largest municipal bankruptcy until this week. “Chapter 9 doesn’t take away the difficult political decision-making needed to address a financial credit problem.”
Jefferson County has been plagued by distrust for years. The state, under Gov. Robert Bentley, had tried to broker a deal to avert bankruptcy. It fell apart, county officials said, over a failure to reach agreements with creditors. County officials decided that the county’s credit was so bad that filing for bankruptcy risked little.
By any measure, Jefferson County, home to nearly 700,000 people and to the city of Birmingham, is an extreme case. The seeds of its fiscal collapse were planted more than a decade ago when the county was ordered to rebuild its dilapidated sewer system, which had been sending raw sewage into rivers. The county, which had long sought to avoid paying the true cost of its sewer system, signed off on a series of complex financial deals that officials barely understood. The deals had hidden risks, and they went bad.
Several officials were convicted of taking bond-related bribes, including a former county commission president and Birmingham mayor. Two bankers are fighting federal accusations that they made secret payments. And in 2009, J. P. Morgan Securities forfeited $752 million to settle a fraud complaint by the S.E.C.
The complicated bond-and-derivative structures did not work out for the county: they failed during the financial turmoil of 2008, leaving the county with a $3.2 billion debt, to be repaid faster than planned.
The debt crisis was then compounded by a budget crisis when one of the county’s biggest sources of revenue, an occupational tax, was struck down in court and Alabama’s Legislature balked at letting the county replace it with a new tax. That forced Jefferson County to slash its budget by nearly a third: it laid off more than 500 workers, closed several court houses, and stopped maintaining its roads.
Now officials say they will have to come up with an additional $40 million in cuts by Jan. 1. Given that the sheriff’s department is no longer responding to car accidents on county roads, county officials said, there seems little left to trim.
“All of the areas that are not constitutionally mandated are next to be cut,” said James A. Stephens, a county commissioner, mentioning senior citizen services, building inspectors and economic development expenditures. In other words, he said, Jefferson County, home to the largest city in the state, will have the bare-bones services of a sparsely populated rural county.
Many in the county are pinning their hopes on the bankruptcy: by the time the county filed this week, faith that the various players could arrive at a fair deal had sunk as low as ever.
Campbell Robertson reported from Birmingham, and Mary Williams Walsh and Michael Cooper from New York.
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