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Bankrupt Cities Face Ethical Issues

Thursday, Jul. 12, 2012

There is a stigma about declaring personal bankruptcy, but it does not compare with the reputation that comes to a city that goes bankrupt. Ask the mayor of San Bernardino, the latest California city to file for Chapter 9 bankruptcy protection. As of this week, the city of 211,000 found it had just $150,000 in the bank. According to the Los Angeles Times, “The city barely scraped together enough money to cover its June payroll.”

Uncertain economic times are impacting local government to a degree that we have not seen in the past. Vallejo, a Bay Area city, declared bankruptcy in May 2008; Stockton did the same last month. Cities large and small are vulnerable. Earlier this month Mammoth Lakes, a resort town of 7,392 filed bankruptcy papers, in part because they could not pay a $43 million court judgment.

While costs of providing city services and employee benefits have skyrocketed, the slow economy and decline in real estate values have contributed to the $45 million shortfall in San Bernardino.

An “exit route” would not be possible without recent state legislation that changed bankruptcy law. The move was prompted by the 1994 bankruptcy of Orange County, the largest county in the United States to go bankrupt.

The results of declaring bankruptcy  include drastic reductions in police and fire protection, layoffs, and severe cuts in basic services such as parks, libraries, and road repairs. While it is easy to blame the financial problems on the pension programs (many are unfunded or underfunded), there is no benefit at this point to place the blame on any one factor. In some cases, the loss of redevelopment funds and the inability to pay off bonds are determining factors. And because any tax increases must be passed by the voters (one provision of Proposition 13), cites are unable to keep revenues in line with expenditures.

Is this the tip of the bankruptcy iceberg? Michael Coleman, a fiscal advisor for the League of California Cities admits there may be more cities facing this option in the future, but predicts some will able to weather the storm. As for the others, Coleman says. “Some cities may not go into bankruptcy, but they may dissolve. They may cease to exist.”

Discussion questions:

  • Should cities have the right to declare bankruptcy?
  • The law dictates how creditors are to be treated. What ethical obligation do cities have to their employees in times of fiscal collapse?

Tags: bankrupt cities, California budget

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