Failing Cities and the Red Queen Phenomenon

Boston College Law Review, Apr 2017

Cities and counties are failing. Unfunded liabilities for retirees’ healthcare benefits aggregate to more than $1 trillion. Pension systems are underfunded by as much as $4.4 trillion. Many local government capital structures ensure rising costs and declining revenues, the precursors to service-delivery insolvency. These governments are experiencing the Red Queen phenomenon. They have tried a dizzying number of remedies, but their dire situation persists unchanged. State legislatures have failed to respond. More specifically, many states have refused to implement meaningful debt restructuring mechanisms for local governments. They argue that giving cities and counties the power to potentially impair bond obligations will lead to a doomsday scenario: credit markets will respond by dramatically raising interest rates on new municipal and state bond issuances. This argument—which we term the “paralysis justification”—has been employed widely to support state inaction. The paralysis justification, however, is anecdotal and untested. This Article attempts to fill a significant gap in the literature by reporting the results of an unprecedented empirical study. Our study aggregated data for every fixed-rate general obligation, municipal bond issued in the United States from January 1, 2004 to December 31, 2014. It included over eight hundred thousand issuances in total. By employing multivariate regression analysis, we conclude that the paralysis justification is a false narrative. Municipalities located in states that offer meaningful debt restructuring options enjoy the lowest borrowing costs, all other things equal. This Article removes one of the largest obstacles to financial relief for many cities and counties. We hope to encourage recalcitrant state legislatures to enact the structural changes their local governments need desperately.

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Failing Cities and the Red Queen Phenomenon

Recommended Citation Samir D. Parikh & Zhaochen He, Failing Cities and the Red Queen Phenomenon Failing Cities and the Red Queen Phenomenon Part of the Health Law 0 1 2 Policy Commons 0 1 2 Labor 0 1 2 Employment Law Commons 0 1 2 Retirement Security Law Commons 0 1 2 Securities Law Commons 0 1 2 the State 0 1 2 Local Government Law Commons 0 1 2 0 Samir D. Parikh Lewis & Clark Law School 1 Thi s Article is brought to you for free and open access by the Law Journals at Digital Commons @ Boston College Law School. It has been accepted for inclusion in Boston College Law Review by an authorized editor of Digital Commons @ Boston College Law School. For more information , please contact 2 Zhaochen He Christopher Newport University - SAMIR D. PARIKH* ZHAOCHEN HE** Abstract: Cities and counties are failing. Unfunded liabilities for retirees’health care benefits aggregate to more than $1 trillion. Pension systems are underfunded by as much as $4.4 trillion. Many local government capital structures ensure ri sing costs and declining revenues, the precursors to service -delivery insolvency. These governments are experiencing the Red Queen phenomenon. They have tried a dizzying number of remedies , but their dire situation persists unchanged. State legislatures have failed to respond. More specifically, many states have r efused to implement meaningful debt restructuring mechanisms for local gover nments. They argue that giving cities and counties the power to potentially impair bond obligations will lead to a doomsday scenario: credit markets will respond by dramatically raisi ng interest rates on new municipal and state bond issuances. This argument—which we term the “paralysis justification”—has been employed widely to support state inaction. The paralysis justification , however, is anecdotal and untested. ThisArticle attempt s to fill a significant gap in the literature by r eporting the results of an unprecedented empirical study. Our study aggregated data for every fixed-rate general obligation, municipal bond issued in the United States from January 1, 2004 to December 31, 2014. It included over eight hundred thousand issuances in total. By employing multivariate regression analysis, we conclude that the paralysis justification is a false narrative. Municipalities l ocated in states that offer meaningful debt restructuring opt ions enjoy the lowest borrowing costs, all other things equal. This Article removes one of the largest obstacles to financial relief for many cities and counties. We hope to encourage recalcitrant state legislatures to enact the structural changes their local governments need desperately. © 2017, Samir D. Parikh & Zhaochen He. All rights reserved. * Associate Professor of Law, Lewis & Clark Law School. ** Assistant Professor of Economics at Christopher Newport University. We thank Douglas Baird, Jay Westbrook, JJ Prescott, Kellen Zale, Rafael Pardo Charles Tabb, Charles Silver, David Skeel, Colin Marks, Brian Blum, Katherine Porter, and Jim Grant for their input and guidance. We thank Oren Haker for helping formulate our research design. We would like to acknowledge Brian Adams and the University of Portland for granting us access to the Bloomberg Terminal. We thank Peter Farrell, Josh Goldberg, and Aaron Johnson for their research assistance. Finally, we would like to acknowledge our families for their unwavering support. 2017] INTRODUCTION The atomic bomb had its genesis in the city of Chicago. In 1942, the e xperiment producing the first controlled, self -sustaining nuclear chain reaction occurred at Stagg Field. 1 The primitive reactor was too weak to power even a single light bulb but proved that the power of the atom could be unleashed and controlled.2 This nascent event was emblematic of the type of innovation for which the city was known during the early twentieth century. Chicago was “the pace–maker of the world.”3 The city’s trajectory since these halcyon days, however, has been disappointing. In May of 2015, Moody’s Investor’s Service dropped Chicago’s bond ra ting to junk status, the only major city in the United States to enjoy this ignominy.4 The downgrade was a result of the city’s almost $9 billion in bond debt coupled with the fact that its four primary pension plans had a combined underfunding of nearly $27 billion. 5 The aggregate, unfunded public -worker pension liability per Chicago resident is almost $20,000.6 As a point of comparison, the same liability per Detroit resident shortly before that city filed for bankruptcy was less than $5000.7 Without some sort of radical intervention, the city has no chance of servicing this debt. Chicago is home to a financial atomic bomb, and it is not alone. So how does one dismantle an atomic bomb? Well, as the proverb nistructs: do not build it in the first place. Unfortunately, path dependence is ushering municipalities8 towards financial Armageddon.9 States could provide municipalities the means to address their pr (...truncated)


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Samir D. Parikh, Zhaochen He. Failing Cities and the Red Queen Phenomenon, Boston College Law Review, 2017, Volume 58, Issue 2,