Three American cities on the brink of broke

Harrisburg, Penn.

    Pennsylvania's capital owes $68 million in bond interest payments this year -- $3 million or so more than its entire annual budget. The Harrisburg Authority, the governing body that issued the bonds to construct a state-of-the-art trash incinerator, has already been unable to make several payments, and now the county government, which footed the bill last year for a $775,000 swap fee, is suing for the funds.

    The authority is also indebted to the owner of the trash-burning facility, Coventa Energy, to the tune of $20 million. In April the authority also missed a $637,500 payment to Coventa, and is now in the process of negotiating a forbearance.

    The mayor has said the city won't declare bankruptcy, but the governor has vowed not to bail Harrisburg out, leaving everyone wondering what options are left. In the meantime, the city is sifting through its assets, some of which include arcane Western artifacts purchased by the previous mayor with public funds, to see whether there's anything they can put on eBay before the next payment comes due.

Detroit

    To make up for a 2010 budget shortfall of $280 million, Detroit issued $250 million of 20-year municipal notes in March. The issuance followed on the heels of a warning from city officials that if its financial state didn't improve, it could be forced to declare bankruptcy. Nonetheless, demand for the bonds was high, thanks in large part to a guarantee that the state would make the payments if the city became insolvent. Michigan has already proved that it has few qualms about stepping in. In early 2009 the state took over the Detroit Public School System, which was facing a budget deficit of more than $300 million. Now a governor-appointed "emergency financial manager" oversees every penny spent.

Bankruptcy and contagion risk

    There's no standard operating procedure for a city or county default. In some cases the state steps in with a loan, and in others the city or county will declare bankruptcy, though that is rare. "There isn't the legal obligation," says Carl Dincesen, an independent tax-exempt-bond risk consultant.

    Bankruptcy may not even be the best option, or the most efficient. The city of Vallejo, Calif. has been in Chapter 9 bankruptcy for two years. "Chapter 9 should be a final step, not a first option," Cleveland says. It opens a city up to seizure of public and perhaps even of private property, judicial oversight of city spending, state assumption of the debt, and a lien tax revenues.

    Because of the rarity of such bankruptcy filings, experts seem to agree that a Greek-like contagion threat, in which exposure to bondholders is so great that a large-scale default or bankruptcy would cause a massive financial seizure, isn't likely in the U.S.

    Still, a major default or bankruptcy would be a shock, just as Orange County's bankruptcy shook investor confidence in 1994. "Because economic growth prospects are bleak, [a bankruptcy would] drain resources away from service divisions and infrastructure finance," says Fabian. "It's going to be a drag on economic growth."