Central Falls, Rhode Island Files For Chapter 9 Bankruptcy

(Edith Honan) - Central Falls, Rhode Island, one of a handful of U.S. cities and counties facing fiscal collapse in the wake of the economic recession, filed for a rare Chapter 9 bankruptcy on Monday.

The bankruptcy filing -- a risky and potentially expensive move that could freeze the city out of the municipal bond market -- marks a symbolic blow as state and local governments struggle to pull themselves out of the recession.

The smallest city in the smallest state made the filing as it grappled with an $80 million unfunded pension and retiree health benefit liability that is nearly quadruple its annual budget of $17 million.

"The current situation is dire and it necessitates decisive steps to put the city back on a path to solid financial footing and future prosperity," Rhode Island Governor Lincoln Chafee said in a statement.

Still, dire predictions of mass municipal defaults made late last year by Wall Street analyst Meredith Whitney have not come to pass. A string of failures could rattle the $2.9 trillion U.S. municipal debt market.

The Central Falls filing was not the start of a "huge nation-wide trend", said Adam Stern, a vice president at Boston-based Breckinridge Capital Advisors, a municipal bond investment firm.

"A bankruptcy filing is sort of an endgame over years and years of economic distress, so it's not something your typical U.S. town or city is likely to experience anytime soon," he said.

There have been only 624 municipal bankruptcies -- called Chapter 9 filings -- since 1937, with five occurring last year, according to James Spiotto, a municipal bankruptcy expert at the law firm Chapman and Cutler.

Alabama's Jefferson County is currently working to ward off the largest municipal bankruptcy in U.S. history stemming from its $13.2 billion sewer bond crisis. The Pennsylvania state capital of Harrisburg, which has about $3 million incinerator debt, is also considering bankruptcy.

Those cases lead some to take a pessimistic view on the future of municipal bankruptcies in the United States.

"Chapter 9 has been a fairly unusual event but we and many others think that's not necessarily going to be the case going forward," Sean Scott, a municipal bankruptcy expert at law firm Mayer Brown,

"THE BIG ASK"

The finances of Central Falls, a city of just 19,000 located six miles from the state capital of Providence, had been under state control since July 2010.

Central Falls has $21 million of outstanding debt, according to Moody's Investors Service, which in June cut the city's credit rating by one notch to Caa1.

State officials worked to avoid a municipal bankruptcy filing, saying they feared it could upset Rhode Island's other fragile localities.

Earlier this year, the state passed a law that guarantees bondholders will be paid before a distressed city like Central Falls deals with its other obligations. It was not immediately clear whether the law would hold up in bankruptcy court.

"Everything was done to avoid this day," said Central Falls' state-appointed receiver, retired judge Robert Flanders, Jr. "Services have been cut to the bone."

"Taxes have been raised to the maximum level allowable. We negotiated with ... the police and fire unions, without success, attempting to reach voluntary concessions, and we tried in vain to persuade our retirees to accept voluntary reductions in their benefits," Flanders said.

Last week, the city's retirees were asked to vote on a measure that would slash their pension payments by half, in what Flanders had dubbed "the Big Ask." He said the concessions were "necessary to affect a viable and feasible turnaround plan for the city."

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