The capital city of Harrisburg, Pennsylvania, with a population of about 47,000 filed for municipal bankruptcy relief under Chapter 9 on Wednesday, October 12. This is the second city to file Chapter 9 this year – Central Falls, Rhode Island, entered bankruptcy just last August.
Harrisburg Controller Dan Miller believes this was the best thing the city could do, “I think it’s the only real option that we had.” The city had been plagued by many problems – severe flooding last September forced more than 10,000 residents out of their homes, high unemployment (7.7%), high poverty rate (29%), and the costly incinerator project.
Last Tuesday, the city council voted 4 to 3 to hire counsel and file for Chapter 9 bankruptcy protection. Mark Schwartz, the council’s attorney, prepared the petition. He noted that Chapter 9 bankruptcy will give the city much needed “bargaining power” to work out deals with city workers, retired workers, creditors, and the commonwealth.
But Is This Bankruptcy Filing Legal?
Governor Tom Corbett, legislators, Harrisburg Mayor Linda Thompson, and Assured Guaranty all claim the city council’s action is illegal. Harrisburg is a so-called third class, Act 47 distressed city under state law, and is prohibited from filing for Chapter 9 relief. Harrisburg need only agree to a rescue plan, just as Philadelphia did, without the need for bankruptcy. The legislature amended the fiscal code earlier this year to restrict the capital city’s ability to file for bankruptcy, yet it filed nonetheless. The mayor says the city council lacked authority to hire its own bankruptcy attorney without mayoral approval; that the city solicitor has to approve the hiring of outside counsel, as well any resolutions and ordinances from the council, none of which happened in this case. The lower house recently passed a bill allowing the commonwealth to take over the capital city’s finances and, essentially, force a rescue plan. The senate is scheduled to vote on the bill next week. Everyone, it seems, is against the city’s bankruptcy.
Why File for Bankruptcy When Offered an Act 47 Rescue Plan?
Bankruptcy provides protection in a way that no state rescue plan can. The city council determined that any Act 47 rescue plan would require renegotiating labor contracts and selling the city’s most valuable assets, namely its parking garages and its updated incinerator. In other words, only the creditors would benefit under the rescue plans, at the city’s expense. Furthermore, the city council believes that the proposed Act 47 rescue plans would overburden the city’s residents by selling revenue-generating assets and raising taxes, while asking too little of Dauphin County, municipal bondholders, and the municipal bond insurer Assured Guaranty. After rejecting two proposed rescue plans, Councilman Brad Koplinski described the council’s resolution as a search for “a global solution with shared pain for all of the stakeholders.”  That may mean reducing the principal owed to Harrisburg municipal bondholders.
Failed Incinerator Project.
The engine driving the uncontrolled debt for Harrisburg is the city’s failed incinerator. The 1972 Harrisburg Incinerator Project was designed to burn trash and create steam heat for the city. The incinerator never made money and required major costly revamping. The city’s entire budget is actually under $60 million. But the incinerator project underwent a major overhaul between 2005 and 2008, becoming something of a financial abyss, and put the city another $310 million in debt. Think about that for a moment. 47,000 residents carrying $370,000,000 in principal debt at the city level – that is $7,872 per person, more or less.
Impact on Municipal Bond Investors.
The Harrisburg municipal bonds, or munis, are mostly insured, so individual bondholders should be well-protected in the city’s Chapter 9 bankruptcy. When the city cannot make the scheduled payments, the bond insurer pays the principal and interest for the city as scheduled. More specifically, the incinerator bonds were covered by Assured Guaranty out of Hamilton, Bermuda. (In late September, however, Standard & Poor’s Ratings Services downgraded Assured Guaranty Ltd.’s to “CreditWatch Negative.”)
Update 5 – Harrisburg Bankruptcy Sets Up Fight with State
Capital Files for Bankruptcy