Let cities go bust

Hilary Rosenberg

February 04, 1993|By Hilary Rosenberg

IN THE preliminary fiscal 1994 New York City budget he introduced last week, Mayor David Dinkins included some unrealistic measures to close a $2.1 billion gap.

In the end, the mayor will surely have to deal with the deficit by raising taxes and cutting already deficient services.

That formula can only discourage new investment and perpetuate a downward spiral.

While they are meeting annual budgets, New York and other troubled cities such as Los Angeles, Chicago, Baltimore, Detroit, Bridgeport, Conn., and East St. Louis, Ill., are not generating the tax revenue to meet their primary obligations of safe streets, good schools, decent housing and adequate services.

For all the money city halls have borrowed, the inner cities continue to deteriorate. And it is doubtful that President Clinton, restrained by the federal deficit, will be able to give the cities the jump start they need.

Traditional government solutions aren't working. When do politicians lose their turn? In business a company that cannot meet its liabilities is forced to work out a new financial structure, often in bankruptcy.

This is not the end of the world. Indeed, as the economy climbs out of recession, there are many positive examples of what bankruptcy can do for troubled corporations.

In the past few years, large companies such as Federated Stores, Revco, Republic Health and Sunbeam-Oster filed for bankruptcy under Chapter 11 of the bankruptcy code, which protected them from creditors while they revamped operations and negotiated with banks, bondholders and shareholders. Many companies have survived, saving thousands of jobs.

What allowed these companies to turn around in a relatively short time was the discipline of the Chapter 11 process, for all its flaws.

It treats financial distress as the crisis that it is, forcing companies and creditors to work together. Management must file reorganization plans that creditors and a bankruptcy judge must approve. Often this organized process attracts "vulture" investors who contribute needed capital, reaping huge returns when the companies rebound.

Perhaps distressed cities such as New York would be better served if they were allowed, or required, to file for bankruptcy or undertake some court-supervised reorganization.

The credit-rating agencies would determine when this would happen. They are already beginning to rate municipal debt based on quality-of-life factors such as crime and schools.

Yes, with bankruptcy, cities would default on bonds. Unable to issue new bonds, cities would have to take quick action on new ways to raise revenue.

A "workout" would force long-needed regionalization and economies of scale, such as the sharing of waste disposal, education and police with neighboring communities.

Cities would also privatize services and sell assets such as airports for sources of revenue. (Defaulted debt could be traded for stakes in privatized operations.)

These financing methods would be a major part of a bankrupt city's strategic plans to pay off bondholders and revive itself. The plan should be a product of negotiations among city, state and federal politicians, community leaders, unions and businesses.

It should specify how the city will build a new foundation for its depressed neighborhoods by fighting crime, bolstering schools, rehabilitating housing and attracting investors with enterprise zones, tax incentives and subsidized loans.

And like the corporations, bankrupt cities should detail prospective returns on investment -- for social programs as well as for business ventures.

Only with a structured reorganization under way will investors come in numbers to take stakes. They could purchase discounted bonds, buy into privatizations including asset sales or invest in small businesses.

Such a reorganization took place in Ecorse, Mich., in the late 1980s. In 1986 a judge appointed a receiver who by privatizing services and selling municipal assets restored Ecorse to fiscal health in five years.

Bankruptcy is a drastic measure that will forever change the financial structure of urban America and it won't work smoothly every time, as it doesn't in business.

But given the economic crises in our cities, perhaps only something as frightening as bankruptcy will prove an effective agent of change.

Hilary Rosenberg, a senior editor at Institutional Investor magazine, is author of "The Vulture Investors."

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