Chapter Nonsense (Part 2)

If anyone was looking for an example of how municipal bankruptcy works—or doesn’t–they need look no further than Vallejo, California.

Back in May 2008 the city of 120,000 failed to win pay cuts from the city workers’ unions. They subsequently filed for protection from creditors under Chapter 9 of the U.S. bankruptcy code. Since then they have spent $9.5 million in legal fees to receive $6 million in concessions from the administrative and police unions. In the interim, control of city operations was given to the court. And the process is likely to drag on another six months.

Grants for cultural and arts programs have been eliminated, road maintenance is at 10% of recommended levels, and they have 150 fewer fire and police officers than before the trouble began. Part of the problem is the city can’t borrow money any more. No bank will extend credit, for fear of being caught up in the bankruptcy process. So vendors require prepayment for services.

Other cities have observed the process and have said, no thanks. San Diego, California relied on negotiated pay cuts and higher benefit contributions from the unions to resolve its fiscal crisis in 2009. Harrisburg, Pennsylvania received a Section 47 advance from the State after it couldn’t make its bond payments. These municipalities decided to negotiate outside of the bankruptcy process.

Winston Churchill said that jaw, jaw, jaw is always better than war, war, war. When it comes to bankruptcy, negotiating via the courts is an expensive proposition.

Douglas R. Tengdin, CFA
Chief Investment Officer
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