Junk Cities: Resolving Insolvency Crises in Overlapping Municipalities

Abstract

What would happen if the City of Chicago, the Chicago Public Schools, and Cook County all became insolvent at the same time? How should policy-makers and courts respond? This Article argues that the pension and budget crises that have left so many local governments deeply in debt have generated another looming problem: the prospect of simultaneous debt crises in overlapping local governments—municipalities, school districts, counties, and other special purpose entities that govern and tax the same territory. These crises will be worse than prior local insolvency crises, as conflicts among overlapping governments will increase the pain suffered by taxpayers, service recipients, and creditors alike. There has been virtually no public discussion of this problem, and as result, much is still unknown about who would bear the costs of simultaneous insolvency crises and how courts and legislatures would respond.

This Article explains how collective action problems among overlapping local governments will make addressing simultaneous insolvency crises difficult, as jurisdictions will hold out against needed restructuring of their obligations in the hopes that another jurisdiction will go first, thereby relieving the strain on the shared tax base, or alternatively, raise revenues in ways that are individually rational but collectively costly. Existing tools for addressing local governmental insolvency, particularly Chapter 9 bankruptcy, cannot currently address coordination problems among overlapping local governments. Accordingly, the Article proposes several changes to Chapter 9 doctrine and to state laws that would counteract the collective action problems that afflict overlapping local governments during insolvency crises and spread the pain of restructuring.

Keywords: Chapter 9, municipal bankruptcy, fiscal crises, insolvency

JEL Classification: H72, H74, H77