Scranton: When Your City Needs to Go Bankrupt

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By Josh Barro

A lot of cities are in financial trouble these days, but the case of Scranton, Pennsylvania, stands out for its unusual degree of bickering as it descends into the fiscal abyss. Mayor Chris Doherty has cut nearly every city employee’s pay -- including his own -- to minimum wage ($7.25 an hour).

The mayor is acting in defiance of a court order mandating that he pay the employees in full. The International Association of firefighters ran a full page ad in the Scranton Times this past weekend, depicting the mayor in a dunce cap for his actions.

Mayor Doherty has a pretty good counterargument: The city literally doesn’t have the money to pay its employees. Two weeks ago, the city’s bank balance dwindled to just $5,000. Now, it’s about $130,000, enough to cover one day’s municipal expenses and not enough to meet payroll. Thanks to a bridge loan from the state, Scranton may soon be able to pay employees in full, but not forever -- the bridge loan only provides enough money to get the city into August.

Doherty wants a 78 percent property-tax increase over three years, but the city council won’t give it to him. According to the Guardian, relations between the mayor and the council have deteriorated so much that the former  won’t even attend the latter's meetings.

Even if the mayor had gotten the tax increase he wanted, that still wouldn’t have been enough to fix the city’s finances. The city of 75,000 faces a $21 million budget gap next year. That’s about half the amount that the city currently collects in taxes or one and a half times its property tax collections. And it’s not clear how much more the city can collect -- already, 13 percent of billed property taxes go uncollected. The sheer enormity of this gap relative to the city’s tax base is the reason the city needs to be looking at bankruptcy, rather than desperately searching for a way to meet all of its obligations.

At first glance, Scranton’s troubles appear to have materialized almost overnight. In reality, the city’s solvency problems are years old, but one event this spring turned them into a liquidity problem, putting an end to the tactics Scranton has been using to keep itself temporarily afloat. The turning point came in late May when the city council refused to cover a bond payment due from the Scranton Parking Authority. The authority owns two underutilized downtown parking garages and has $54 million of bonds outstanding, which it cannot service with parking revenue. The authority indicated it would not make the June bond payment and directed the city, which had guaranteed the bonds, to do so.

Scranton’s guarantee of the parking bonds is a full faith and credit guarantee, meaning the bonds are supposed to be treated just like the city’s general obligation bonds. Failing to perform on the guarantee was therefore a default, causing Scranton to lose access to both the bond- and bank-lending markets. In June, the city made a quick about-face and agreed to make the bond payment, but it was too late: debt markets were already spooked, and other defaults (such as a failure to properly inspect the garages) were found on the parking bond.

Losing credit market access is always a problem for governments, but two special circumstances make it a particular disaster for Scranton. The first is that the city has a large and ongoing structural deficit -- it was preparing to float $26 million in bonds, partly to cover the gap in the current year’s budget. The second is that the city is almost out of cash, meaning that if it can't borrow, it can't pay its bills. A city with a balanced budget and some cash on hand can operate without access to credit; Scranton can’t.

For years, Scranton has been addressing its budget gaps with a combination of borrowing, asset sales and one-time funding sources. In May, Senator Bob Casey (a Scranton native) helped secure a $5 million grant from FEMA to help the city re-hire firefighters it had laid off. That is helping for now, but the grant only runs for two years. Scranton also sold its future parking meter revenue and applied the proceeds ($6 million) to the current budget -- producing one-time money but depriving the city of future revenue.

The city is running out of assets to sell. Mayor Doherty is having to revise his proposed recovery plan because one of his proposed revenue items, selling the city’s storm sewers, hit a snag: The city doesn’t actually own the sewers.

Eventually, Scranton will have to get its books into balance. For now, local officials are focusing on a short-term solution that will allow the city to pay its bills: finding a way to get that $26 million bond issuance done. But that will require demonstrating to lenders that the city is creditworthy, which is unlikely as long as the mayor and council are unable to agree on a financial recovery plan.

One odd aspect of this fight is that, while officials in San Bernardino were verging on eagerness for the bankruptcy they authorized this month, Scranton’s officials are resistant. It’s not clear what they’re waiting for. The best sign that Scranton needs to go bankrupt is that the actions that would have to be taken to service its bonds, guarantees, union contracts and pension obligations, such as more than doubling property taxes, are unthinkable.

Scranton’s finances only work with big infusions of money from asset sales, borrowing or outside benefactors -- which is to say, they don’t work. This is exactly the situation for which Chapter 9 bankruptcy exists. Instead of borrowing more money or raising its property taxes through the roof, Scranton should just admit it can’t service its debts, and seek to restructure them.

(Josh Barro is lead writer for the Ticker. Follow him on Twitter.)

Read more breaking commentary from Josh Barro and other Bloomberg View columnists and editors at the Ticker.

-0- Jul/19/2012 16:34 GMT