When Cities Are at the Financial Brink: The Case for "Intervention Bankruptcy"

Many local governments today are on the verge of insolvency. Prominent examples include Atlantic City, New Jersey; the Chicago Board of Education; and Hartford, Connecticut.

For various structural reasons, including entrenched poverty and near-historical debt levels, many more cities are likely to suffer fiscal distress in the coming years. The risk of insolvency for large cities is now higher than at any point since the federal government first passed a municipal bankruptcy law in the 1930s.

But the recent experience of some bankrupt cities, as well as much legal scholarship, casts doubt on the effectiveness of municipal bankruptcy. To strengthen government’s ability to address municipal insolvency, this report argues that federal bankruptcy and state intervention, which are often posed as alternative approaches, should be combined. We call this approach “intervention bankruptcy.”

Crucially, state governments, whose consent is legally required for any locality to file for bankruptcy, should intervene at the outset and appoint a receiver before allowing a city or other local government entity to petition for bankruptcy in federal court. No municipal bankruptcy should be authorized if local officials will direct it. 

• Cities’ debt levels are near all-time highs, and the risk of municipal insolvency is greater than at any time since the Great Depression.
• Recent experience with municipal bankruptcies indicates that when local officials manage the process, they often fail to propose the changes necessary to stabilize their city’s future finances. 
• Suggested legal changes to grant federal judges more power in municipal bankruptcies are, at best, uncertain to be enacted and are, in any event, ill-suited to this nation’s federalist structure.
• Many fiscally distressed cities need operational reforms, in addition to less debt and a balanced budget. Stateappointed experts are best positioned to implement such restructuring programs.

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Daniel DiSalvo is a senior fellow at the Manhattan Institute and associate professor of political science at the City College Of New York (CUNY). Stephen Eide is a senior fellow at the Manhattan Institute.