The warning signs of insolvency

Hindsight is always 20-20. But looking back on Chester's unfortunate run up to its bankruptcy, all the red flags were there.

The MLS stadium in Chester, Penn., still sits amid warehouses and empty lots. (Credit: Liz Farmer)

Happy Finance Friday! Last week, the judge in Chester, Pennsylvania’s, Chapter 9 bankruptcy gave the green light for the case to move forward over the objections of elected officials and one creditor. This ruling was the expected outcome and means the city can start the process of restructuring its debt. The ruling by U.S. Bankruptcy Judge Ashely M. Chan is notable for its detailed account of the city’s very clear spiral to insolvency.

For one, the city committed just about all of the “7 Deadly Sins of Public Finance” (a favorite article from my Governing magazine days). What’s more, traditional fixes didn’t seem to work and despite all these warning signs, Chester was still able to borrow money. There’s not any one person to blame here and hindsight is always 20-20. Still, as I’ll lay out below, the way things were going it kind of makes you wonder who—if anyone—was worried the city’s luck would eventually run out.

Public finance’s 7 deadly sins

In 2014, I wrote a feature on the most common “no-nos” of fiscal policy as part of Governing magazine’s Finance 101 project. I interviewed credit analysts, think tank experts, academics and practitioners and eventually came up with the list of seven sins, which you can read in full here.

Pretty much everybody does at least some of this stuff some of the time and especially in a down economy. But as analyst Tom Kozlik noted at the time, “If I’m looking at a situation where the same things are happening pre- and post-recession, then it’s a significant problem.” Here are some of the ones related to Chester.

Balancing the Budget with One-Time Fixes

Among other short-term fixes, Chester borrowed money for operating costs multiple times over the past two decades. It did so several times between 1996 and 2006 to meet payroll and deliver basic services to its citizens, Chan’s opinion noted. Twice in 2017, it borrowed money to stay afloat—including $12 million to pay off other obligations.

“For years, the City’s obligations have exceeded revenue from taxes and other sources available to it,” Receiver Michael Doweary’s initial bankruptcy petition said, “and the City has borrowed and deferred paying certain obligations, and relied on one-time federal rescue money to survive fiscally.”

Shortchanging Pension Obligations

When lawmakers demonstrate a chronic unwillingness to contribute what is necessary to keep the plans fully funded, it’s a sure way to rack up debt and endanger fiscal solvency. For Chester, that meant not making its full pension payment for six years, further damaging plans that were already not healthy. Chester’s insolvency, Judge Chan noted, is largely due to “its past and current inability to fund its substantial pension obligations.”

In fact, Chester's Police Pension Plan now has so little cash it “is effectively in ‘pay-as-you-go’ status, meaning the City must continually put money into it to cover monthly benefit payments throughout the year,” Doweary’s latest financial report says.

Ignoring Financial Checks and Balances

Weak financial controls can lead to serious dollar losses. Governments can lose track of how much money they actually owe a special fund or lax internal monitoring can result in poor financial choices not getting flagged until it’s far too late. As I wrote about last month, Chester’s system of government makes the whole “checks and balances” thing optional when it comes to budgeting. But there are other dangers. 

For example, when Councilman and Finance Director William Morgan realized that he’d lost $400,000 in taxpayer money to a phishing scam, he reported it to the local police department but didn’t tell anyone else in the city administration about it for another three months. “There's a lack of separation [of duties]…a lack of internal controls,” Doweary said during testimony in Commonwealth Court last fall. “It’s severely impacted our ability—the city's ability—to recover.”

Another red flag: No economic development magic

In the lawmakers’ playbook of revitalization, subsidizing entertainment venues to spur further economic development is a classic approach. And as skeptical as I am about all the economic feasibility studies that almost always predict one subsidized development will lead to millions of dollars in other investments, the basic concept isn’t off-base. City after city can point to a professional baseball stadium, for example, as the catalyst that prompted other developers to invest.  

But developers don’t act on charity. They build around these entertainment venues because their economic modeling says they’ll make money. But in Chester, that didn’t happen.