bankruptcy

What if your city files for bankruptcy?

But the bad economy has forced many cities to cut services to the bone, says Luis Salazar, a bankruptcy lawyer in Coral Gables, Fla., who served as a city councilman in Leonia, N.J., when that town faced a budget crisis in the late 1980s and early 1990s.

"A lot of these cities have already made severe cuts, so it's not clear how much worse services can get," Salazar says. "You still need cops, and you still need to put out fires."

But there is a silver lining in bankruptcy, according to Salazar. The city gets breathing room from creditors.

"Breathing room may not save services that are on the chopping block, but it makes it possible for the city to reset and eventually get back to a point where it can offer services at a lower cost," Salazar says.

What happens to taxes?

While increased revenue would be a boon to any city facing bankruptcy, it's unclear whether taxes would go up immediately. For one thing, "You're asking people to pay more at a time when they are getting fewer services," Salazar says.

Even if a city can muster the political will to raise taxes, doing so may not help revenues, says Dennis Hoffman, an economics professor at Arizona State University in Tempe, Ariz.

"Increased taxes may come later on, but there's often a stigma associated with municipal bankruptcies, and that can mean an erosion of the tax base if people leave," Hoffman says.

Adams says the buck stops with the bankrupt municipality. County and state taxpayers aren't on the hook for a bankrupt municipality's debts. But in dire cases, it's possible for a city to dissolve.

"When that happens, the burden of providing services falls to the county, and in some areas, the state may have to pick up the slack," Adams says. "So, it's possible that those costs may be passed on indirectly to taxpayers elsewhere."

Borrowing money again

One big long-term consideration that can impact both services and taxes is how the municipal bond market treats a city that has filed for bankruptcy.

"Municipal bond issuers have a long memory," Hoffman says. "So it's possible that a bankrupt city will pay more to borrow or won't be able to borrow at all."

Salazar says that paying more to borrow or not being able to borrow at all can be a huge long-term blow to a city.

"Cities need to borrow to pay for infrastructure projects," he says. "But they also need to borrow to finance their day-to-day budgets because bonds are how many cities manage cash flow. Remember, tax revenues don't always come in when it's time to pay police and fire."

Increased borrowing costs may just be a fact of life for some cities in the years to come. But what really worries Hoffman is how the municipal bond market responds to cities that didn't file.

"Municipal bonds used to be considered a fairly conservative, safe place to park money," Hoffman says. "While that's still largely true, it's also possible that bond issuers will demand higher interest rates because a wave of big municipal bankruptcies may increase the perceived risk of lending to cities."

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