pulling the plug o n state debt
Amendment, but the structure of the Constitution as a whole
orderly and legal way” to assist “the people of these great urban
is designed to give the states a great deal of independence. This
centers that are now simply being crushed out of existence by
concern is easily addressed. So long as a state can’t be thrown
taxes and by debts.” The New Deal Congress obliged by enact-
into bankruptcy against its will, and bankruptcy doesn’t usurp
ing the first municipal bankruptcy law shortly thereafter.
state lawmaking powers, bankruptcy-for-states can easily be
As with much New Deal legislation, the early history of mu-
squared with the Constitution. But the solution also creates a
nicipal bankruptcy law was rocky. The Supreme Court struck
second concern. If the bankruptcy framework treads gingerly
down the original law in 1936, concluding that it would infringe
on state prerogatives, as it must to be constitutional, it may be
on state authority, even if the state vigorously welcomed the law.
exceedingly difficult for a bankruptcy court to impose the ag-
(One reason for rejecting municipal bankruptcy, according to
gressive measures a state needs to get its fiscal house in order.
Justice James Clark McReynolds, whose opinion was and is
Neither of these considerations – state sovereignty or the lim-
widely criticized but who was perhaps prescient, was that state
ited force of a bankruptcy framework that gives wide berth to
bankruptcy might be next.) But two years later, after the famous
governmental decision-makers – is hypothetical. We now have
“switch in time” from its earlier pattern of striking down New
more than 70 years of experience with a special chapter of the
Deal legislation, the High Court gave its blessing to a 1937 ver-
“Although bankruptcy would be an imperfect solution to outof-control state deficits, it’s the best option we have, at least if we want to have any chance of avoiding massive federal bailouts of state governments,” writes David A. Skeel. bankruptcy code – now called Chapter 9 – which permits cities
sion of the law. Congress’ revisions to the municipal bankruptcy
and other municipal entities to file for bankruptcy. For decades,
legislation were slight, but the Court was ready to uphold it.
this chapter did not get a great deal of use. But since the success-
Because the law was “carefully drawn so as not to impinge upon
ful 1994 filing for bankruptcy by Orange County, California,
the sovereignty of the State,” the Court concluded, and made
after the county’s bets on derivatives contracts went bad, mu-
sure that the state “retains control of its fiscal affairs,” it now
nicipal bankruptcy has become increasingly common. Vallejo,
passed constitutional muster.
California emerged from bankruptcy last year after primarily
Municipal bankruptcy differs in a few key respects from
restructuring its collective bargaining agreements with its public
the law applying to nongovernmental entities. Unlike with
employees; Jefferson County in Alabama (home of Birming-
corporations, a city’s creditors are not permitted to throw the
ham) recently filed, and Harrisburg, Pennsylvania has tried to
city into bankruptcy. A law that allowed for involuntary bank-
file. The experience of these municipal bankruptcies shows how
ruptcy could not be reconciled with anyone’s interpretation of
bankruptcy-for-states might work, what its limitations are, and
state sovereign immunity. A city must therefore avail itself of
why we need it now.
bankruptcy voluntarily; no one else, no matter how irate, can
Municipal bankruptcy dates back to the last epic financial
trigger a bankruptcy filing. And when municipalities do file for
crisis, the Great Depression of the 1930s. According to testi-
bankruptcy, the court is strictly forbidden from meddling with
mony in a 1934 congressional hearing, 2,019 cities and other
the reins of government. The current law explicitly affirms state
governmental entities had defaulted on their debt at that time.
authority over a municipality that is in bankruptcy and prohib-
Back then, the leading advocates of a bankruptcy option for lo-
its the bankruptcy court from interfering with any of the munici-
cal government were progressives, especially those whose cities
pality’s political or governmental powers. A court cannot force
were overwhelmed by debt.
a bankrupt city to raise taxes or cut expenses, for instance. Such
In 1933, Detroit Mayor and future Supreme Court Justice
protections have long since quieted concerns that municipal
Frank Murphy assured Congress that bankruptcy would be “an
bankruptcy intrudes on the rights of the states, and they would
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