HarrisburgWhose Priorities Dominate? Some states allow their local governments to declare bankruptcy under Chapter 9 of the federal bankruptcy law. This law allows a city or county to negotiate with vendors and creditors and agree to pay a certain percentage of the bills owed. Chapter 9 does not give automatic priority to bondholders; if loans are considered unsecured, their payments may be cut along with other obligations. In recent years, controversy has developed about whether states should allow their local governments to declare bankruptcy, or whether the troubled local governments should instead give up their autonomy to a state-appointed financial crisis administrator who makes decisions on which bills will be paid in full. One reason for the state control option is to protect bondholders and, by implication, the ability of the state and its other governmental units to borrow at inexpensive rates. A default on bond repayment in one city increases the perception of risk and hence borrowing costs for other jurisdictions in the state. When Harrisburg, Pennsylvania, experienced severe financial problems, city officials wanted to declare bankruptcy so all the citys major creditors, including the bondholders, would take some losses, but the state denied the city permission to declare bankruptcy and instead appointed a receiver. The deal ultimately worked out to get the city out of fiscal trouble required the bondholders to be paid in full. The citys employees were asked to forego a raise and pay part of their health insurance. The agreement worked out without benefit of bankruptcy proceedings was expected to protect the state and other cities in the state from an increase in the cost of borrowing.

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