In this Policy Initiative Spotlight, Renewing America contributor Steven J. Markovich examines the growing problem of municipal bankruptcy, and the heavy-handed approach taken by some states in response. He highlights the alternative approach taken by one state, North Carolina, which has eliminated bankruptcies and lowered borrowing costs for cities despite the economic challenges facing the state.
Last October the capital of Pennsylvania, Harrisburg, filed for Chapter 9 bankruptcy. Harrisburg’s finances were hit hard by a money losing project to refit a large trash incinerator. Proponents had hoped the project would be profitable, but instead it generated $288 million in debt, laden on top of additional debt of more than $200 million added over the past three decades for community development of the city of 49,500. In November, that filing was overturned. Pennsylvania’s governor has taken control of the city’s finances, though the city is still fighting for the right to declare bankruptcy.
This approach—giving the state power to step in when a municipality is financial crisis—is a common policy response across the nation. But it may not be the best one. North Carolina, in contrast, has for decades used its Local Government Commission (LGC) proactively to keep the debts of North Carolina cities in check and has helped avoid the default problems plaguing many states.
Harrisburg is just one of a growing number of cities that cannot pay their debts. Across the nation municipalities are defaulting on their obligations at rates well above historical norms. According to the credit rating agency Moody’s, there were an average of 2.7 municipal defaults per year from 1970 to 2009, in 2010 and 2011, the average was 5.5 defaults.
Many states have procedures in place once a municipality faces troubles. Under Pennsylvania’s Financially Distressed Municipalities Act, for example, once a city meets the criteria of financial distress, the state appoints a coordinator to prepare a recovery plan within 90 days. The city can either accept that plan, or reject it in favor of its own if the state approves. The state can also grant emergency loans, grants, or merge distressed communities. In May, Altoona became the twenty-seventh distressed municipality in Pennsylvania since the law was enacted in 1987.
In North Carolina, the approach has been different. Before assuming new debts, municipalities must earn the approval of the state’s LGC by convincing it that the funds to be borrowed are adequate and reasonable to complete the desired project, and that the city can afford to repay the debt. Once approval is given, the state agency, not the municipality, sells the debt or bonds on behalf of the local government. After debt is issued, the LGC oversees annual independent auditing of local governments, monitors their finances, and offers administrative assistance.
The LGC was created during the depths of the Great Depression in 1931, when defaults raged across North Carolina. In 1933, more than 200 cities and counties were in default, and a similar number of special districts. But since 1942, North Carolina has had no bond defaults.
Today, North Carolina suffers from one of the four highest unemployment rates in the nation, but unlike the other three states with that distinction, all of North Carolina’s local governments continue to pay their debts. This track record has earned North Carolina a top credit rating from all three of the major ratings agencies, one of only eight states to receive that rating. North Carolina has also been lauded by credit analysts. Andrew Teras from Standard and Poors said: “North Carolina’s oversight model is one of the strongest of any state.”
North Carolina’s approach also lowers borrowing costs for its municipalities. According to Standard and Poor’s Municipal Bond Indices, North Carolinia’s municipalities face the eighth lowest yield among all of the states. In contrast, Pennsylvania and California cities come in at twenty-seventh and thirtieth respectively. The yield spread between California—one of the other four states with the nation’s worst unemployment rate—and North Carolina is 0.73 percent, which represents an annual difference of $187 million on the $25.7 billion market value of North Carolina municipal bonds.