Is Your City Going Bankrupt?

Could your well managed city be going bankrupt?

You see the federal government has the right to invent currency out of thin air. They can just print it. In modern day terms, that means changing a number in an account to say that you now have more money. The US Federal Reserve does this in the US. The Bank of England is responsible for this act of magic, and the Bank of Canada has the official right to perform this sleight of hand without going to jail.

But let’s talk about what a city is. A city is not constitutionally enshrined. It only exists, usually as a corporation, enacted by the state or provincial legislature in which it resides. The bylaws of the corporation are determined at the state or provincial level and they define the decision making power of the city council around how local regulations can be enacted and they define the rules around the collecting and spending of money.

You see, many cities were only allowed to borrow money for very specific purposes. I’m aware of a lot of cities that can only borrow money for capital projects. They’re barred by law, from borrowing money to fund operating expenses.

That seems like a prudent bit of fiscal management. A city that borrows money to fund day to day operations is heading for bankruptcy at some point.

Since the start of the pandemic, many cities have experienced shortfalls in revenue. A review of several cities showed that they were carrying little more than 40 days of cash burn in the form of liquidity. Under the current circumstances, that may not be enough.

Many cities collect about ¼ of their revenue in the form of service fees and user charges. Since the start of the pandemic, these revenues have fallen to nearly zero.

In addition, cities have seen a significant drop in tax revenue collected. Tax revenues account for about 50%-70% of a city’s total revenue.

Many cities have responded with significant workforce reductions. They’ve cut non-essential services like libraries, swimming pools, recreation facilities and so on.

They’ve maintained essential services like police, fire and various emergency services. They’ve deferred maintenance where possible.

But at a certain point, there are no more discretionary services to cut. First responders are key to protecting life and safety in our society.

So what happens when a city declares bankruptcy? First of all, unlike a corporate bankruptcy, there will be no liquidation. In the US, a city bankruptcy is governed by Chapter 9. A judge will be appointed to oversee the spending of monies and the rebalancing of the budget.

There will be no free pass that allows the city to abdicate responsibilities for providing municipal services. The City still has the obligation to get its fiscal house in order. It still have to balance the budget. It still has to settle with the claimants. The city still has to pay its legal bills, and the city still has to deal with its unfunded liabilities.

When there's a label put across a city or a county that says, you're in bankruptcy, it equates in the minds of the public to dysfunction. You couldn't manage your own business, so you end up in bankruptcy.

The lasting legacy of a bankruptcy is that the city is not a place to invest. It discourages people from moving there. It discourages the creation of jobs. It’s assumed that the place is economically depressed. Jobs start to leave permanently.

Then real estate prices start to fall. They fall because jobs are leaving

The inevitable cutting of essential services means reduced safety for residents who live there. You might see an increase in crime, in vandalism. You might see an increase in desperation within the population.

Even some of the best managed cities could stumble into bankruptcy. In these uncertain times, a review of a city’s financial state should be part of the required due diligence for a new project.