Municipalities and Excessive Debt: Local Insolvency Regimes as an Alternative to Bailouts?

In many countries around the world, local governments have considerable fiscal autonomy. They are able not only to raise revenues or spend money on their own but also to incur debt. However, the right to borrow inevitably implies the risk of insolvency and bankruptcy, which can have tremendous negative repercussions on service delivery by municipalities, endanger their proper functioning and create severe externalities for other jurisdictions within a federation. In principle, higher tiers of government have two options to deal with local debt crises: they can either implement bailouts or provide a mechanism to restructure municipal debt within a well-structured procedure. Therefore, this chapter discusses the role of local insolvency regimes as an alternative to municipal bailouts. First, the advantages and disadvantages of local insolvency regimes will be discussed from a theoretical perspective. Subsequently, empirical evidence from existing local insolvency regimes in Europe and the USA will be presented and examined. On this basis, core features and requirements, which a well-designed local-level insolvency framework should exhibit, will thereby be derived from this examination.