When States Take Over Financially Troubled Local Governments

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Welcome back to Route Fifty’s Public Finance Update! I’m Liz Farmer and this week is the third and final installment of my series on Chester, Pennsylvania’s bankruptcy. You can find the first two parts here. This week, I’m taking a look at state oversight of distressed municipalities. 

A number of states have programs in which they actively monitor municipal finances and roughly 20 have emergency manager laws allowing for direct intervention. People have long debated how effective these oversight programs are at generating a real recovery and what the right level of intervention even is. Duly elected city officials don’t like being told what to do by state overseers. States on the other hand, typically want troubled cities to just buckle down and take their advice—even if it’s tough medicine.

So while the whole point of these programs is to avoid or mitigate extreme distress, they can also create or exacerbate tension between cities and states along the way. 

Two Decades, Little Progress

By all accounts, Chester’s approach to being placed in Pennsylvania’s municipal distress program in 1995 was to just ignore the state’s advice. Fred Reddig, a retired state official who has coordinated recovery plans for a number of distressed municipalities, worked on Chester’s case from 1995 to the early 2000s. He recalls that during that time, it was difficult to compel local officials to follow any of the state’s recommendations and that relations were tense. 

“It’s like rowing a boat—when everybody is rowing in the same direction, you make progress,” he said. “But when the two sides are rowing in two different directions you go nowhere. And that was the case in Chester.”

And by the time that changed, the fiscal problems had deepened.

Pennsylvania’s oversight program is called Act 47 and was enacted in 1987, a time when many of the state’s localities were struggling amid steep declines in the steel and coal industries. Act 47 provides loan and grant money to financially distressed governments and helps them develop financial recovery plans, with the goal of keeping them out of bankruptcy. But nearly two decades later, 21 cities had entered and just six had exited the program. In response, the legislature in 2014 passed an amendment requiring all Act 47 municipalities to exit oversight within five years from the date of their most recently enacted recovery plan.

Shortly thereafter, the leadership in Chester changed, with longtime state Rep. Thaddeus Kirkland elected mayor in 2015. He inherited a city that had stopped making its annual pension payments, was operating under a structural budget deficit and unable to pay its bills. Under his administration, the city began a working relationship with the state recovery coordinator for the first time in 20 years and tensions began to ease somewhat. 

The city made some progress on economic development goals and saw a dramatic reduction in crime through an initiative in partnership with the state. By 2018, Chester had “successfully implemented a significant number of recommendations, resulting in moderate improvement in its fiscal condition,” an updated recovery plan from that year stated. “However, these positive steps have not been sufficient to restore fiscal balance.” 

Two years later, the pandemic exacerbated Chester’s already precarious financial situation so the state took a more aggressive step and installed a receiver to actively manage the recovery. City officials saw it as a direct affront to their leadership. Cooperation not only ceased once again, the relationship became more strained than ever. In fact, a recent state court ruling described a “lack of transparency, lack of cooperation, and blatant disrespect of [the] Receiver and his team.”

After a year and a half of little cooperation from the city and almost no progress on developing a financial sustainability plan, receiver Michael Doweary filed for bankruptcy on behalf of the city. 

“Is there a love affair with myself and the receiver? No there's not,” Kirkland said during a recent interview. Still, he added that he intended to “work through” the city’s chief operating officer, Leonard Lightner, who was recruited by Doweary, “to make sure we work together to move our city forward.”

Early Warning Systems

Of course, receivers or emergency managers aren’t usually welcomed with open arms. Many view it as an 11th-hour state takeover focused on budget and finances when there are usually more deep-seated problems.

“An emergency manager is like a man coming into your house,” Donald Watkins, a Pontiac, Michigan city councilman told the New York Times in 2013. “He takes your checkbook, he takes your credit cards, he lives in your house… He tells you it’s still your house, but he doesn’t clean up, sells off everything, and then he packs his bag and leaves.”

Rob DiAdamo, a lecturer at Boston University's law school who teaches a class on state and local governance, noted many communities that end up under some form of state oversight had structural economic problems long before the state intervened.

"It may be more effective for the state to be looking at how to bring opportunities back to these communities than wait for the crisis and have people argue about the best way to address it," he said. "It's like waiting for the patient to have a heart attack and discussing treatment options when the crisis could have potentially been avoided by first encouraging healthier eating habits and exercise."

Following the Great Recession, a few states got more actively involved in monitoring and providing support for their distressed municipalities. 

New York established a fiscal stress monitoring program designed to be an early warning system for local government financial problems. A fiscal restructuring board also advises local governments seeking help and makes loans or grants of up to $5 million available to those following their advice. More recently, California, which has long monitored and intervened in school district finances, launched a “local government high-risk dashboard,” a system that is designed to provide a snapshot of how 471 cities around the state are doing financially.

Credit rating agencies tend to view these programs as a positive for the municipalities they monitor. Moreover, noted Fitch Ratings analyst Pascal St. Gerard, it can be politically easier for a state to impose the changes that need to be made in some places where local officials don’t have the will. 

But in order for any of these programs to have a lasting effect, state and local officials have to find a way to work together.

“Inherent in the law is an expectation that the municipality is going to cooperate and that elected officials are going to be transparent,” said Doweary. “It’s my experience working in two other Act 47 communities [Reading and New Castle] that Chester is really an outlier when it comes to that cooperation.”