Failing Cities and the Red Queen Phenomenon

Abstract

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.