Default Without Capital Account: The Economics of Municipal Bankruptcy

Abstract

This paper analyzes the concept of municipal bankruptcy in a comparative framework with commercial bankruptcy. Cities are corporate bodies that continue to exist despite the ever changing identities of the residents. The common designation of cities as municipal corporations suggests an affinity between them and commercial corporations that would offer a bridge between commercial and municipal bankruptcy. Despite this apparent affinity, however, there are significant institutional differences between the two forms of corporation that prevents construction of such a bridge. Commercial bankruptcy allows both creditors and debtors to resolve problems that emerge in consequence of a debt default, and to do so in a generally beneficial manner given the fact of insolvency. By contrast, municipal bankruptcy is a process that benefits some city creditors at the expense of others.

Keywords: municipal bankruptcy, debt and democracy, ownership of municipal corporations, commercial corporations vs. municipal corporations, Ricardian equivalence and capital accounts

JEL Classification: D23, G33, H74, H77, P48