Association for Public Policy Analysis & Management

US Bankruptcy Codes Chapter 9 specifies the procedure for local governments to file for bankruptcy and restructure their debt. A distinguishing feature of Chapter 9 is that localities can only file for bankruptcy if allowed by state laws. While some states give blanket-authorization, other states only conditionally permit local bankruptcy filings or do not give authorization. The latter approaches represent more state control over fiscally distressed localities; and many of these states legislate intervention programs to take actions and prevent local governments from filing for bankruptcy. Bankruptcy authorization and state intervention may cause moral hazard problems among local governments in incurring more deficit and short-term debt as these institutions allow localities to shift burden of fiscal distress. Relying on variations in state bankruptcy authorizations and intervention programs across states and over time, this paper investigates the impact of such policies on the deficit and short-term debt condition of local governments. Fixed effects models provide mean estimates and fixed effects quantile regressions offer estimates for specific quantiles of financial condition outcomes. This paper finds that state authorization for municipal bankruptcy is associated with higher level of local short-term borrowing, and localities with high debt burden are more likely to increase borrowing upon states passing bankruptcy authorization. State intervention programs are not associated with change in local deficit on average, but midsized general purpose governments and governments that are not already running a high deficit incur more deficit upon the initiation of the state intervention program.