What Happens When a City Goes Bankrupt?

by Kolin Karchon  On August 1st, the city of Central Falls in Rhode Island filed for Chapter 9 bankruptcy protection citing that  “the city’s financial condition has deteriorated to the point where it is insolvent.” The city’s pension plan is expected to run out of assets by October, but city negotiations regarding benefit cuts with current workers...

by Kolin Karchon 

On August 1st, the city of Central Falls in Rhode Island filed for Chapter 9 bankruptcy protection citing that  “the city’s financial condition has deteriorated to the point where it is insolvent.” The city’s pension plan is expected to run out of assets by October, but city negotiations regarding benefit cuts with current workers and retirees were not successful. With nowhere to go, the city is asking the state Supreme Court to allow the rejection of city union contracts.

Although this is upsetting to watch, it should be seen as a reminder to cities or states that they could be the next Central Falls. In the case of Central Falls, a large portion of the cities expenses go towards labor costs. The city employee salaries are set to rise because of contractual agreements that are currently in place, but with a slowing economy and higher operation costs, the city is literally running out of money. In fact, for a city of just 19,000, it has accumulated $21 million of outstanding debt.

However, there are some alternatives that have been attempted in various cities across the country that have essentially gone bankrupt. Benton Harbor, Michigan was recently appointed an Emergency Financial Manager (EFM), who is allowed to dissolve public employee contracts. The idea may sound radical, but the idea has been in place in Michigan for decades. The EFM legislation was put in place over 20 years ago under Governor James Blanchard, a Democrat. The greatest advantage to the EFM system is that the manager can do what is necessary to ensure the well-being of a local government, including setting aside union contracts. Benton Harbor’s EFM, Joseph Harris, described the situationas follows:

“I’m looking at what’s good for Benton Harbor, nothing more, nothing less,” Mr. Harris said. “And until you can break the contracts, your hands are tied.”

The use of an EFM is extremely rare and has only have happened to a handful of entities in Michigan. One potential outcome that an EFM approach can do is cause surrounding cities to fall in line so that they may not be appointed an EFM and as a result, they get their budgets in order.

As for Illinois, the fiscal condition of some cities may be more dire than some think. If the state and various cities fail to address mounting debt and continue to increase contractual employee benefits, their financial situations could quickly deteriorate.

To read the full article on Central Fall, Rhode Island, click here.