The squeeze on municipal finances is forcing New Jersey cities and towns to lay off workers and look at sharing services with their neighbors.

But if the fiscal crunch worsens, as some predict it will, bankruptcy might seriously be explored in city halls around the state.

Under laws passed in the wake of the Great Depression, the state of New Jersey must give its permission before a municipality can file bankruptcy — and that's not likely to happen, experts said. Instead, the state provides financial assistance, known as transitional aid, to financially distressed municipalities — and that money comes with strings attached, to limit nonessential spending, freeze promotions and noncontractual salary increases and prohibit public spending on civic amusements, like parades. Municipal finance is tightly monitored by the Department of Community Affairs Division of Local Government Services, whose director, Thomas Neff, has said publicly he has no intention of letting municipalities file bankruptcy. In dire cases, the state steps in and runs a distressed municipality until fiscal health is restored.

Yet municipal bankruptcy can't be ruled out entirely, according to Sills, Cummis & Gross attorneys who formed a municipal restructuring practice a year ago to advise towns and cities struggling with fiscal constraints that include the 2 percent cap on property taxes, minimal increases in state aid and a bumper crop of successful property tax appeals wrought by the real estate slump.

"We've been talking to several distressed cities in New Jersey," said Ted Zangari, a member of Sills Cummis, who declined to name the towns. "As the easy ways to cut costs are eliminated, you're going to start seeing real pain. Bankruptcy is something that doesn't have to occur if towns proactively pursue a restructuring — in tandem with the state — because the state has tight control over what a town can and cannot do."

Andrew H. Sherman, a member of Sills Cummis, said some municipalities may find their debt levels are unsustainable and should conduct "an analysis of where the obligations are, and when and how they can be cut. Bankruptcy is a tool that has to be explored.'"

And George R. Hirsch, another member of Sills Cummis, said distressed towns need to identify their cash drains, then look to raise revenue via asset sales — selling and leasing back buildings and other municipal assets, privatizing facilities, and outsourcing services.

The firm has recent experience with municipal debt restructuring. Last year, Sills Cummis represented the Hoboken Municipal Hospital Authority, which had warned it could default on $51.6 million in bonds unless it found a buyer for the hospital. The crisis ended with a deal to sell the hospital to the owners of Bayonne Medical Center.

While some municipalities could benefit from legal insolvency advice, Zangari said the stigma of bankruptcy is an obstacle. "There is hesitation on the part of some mayors with whom we've spoken, who say 'the minute anybody hears that we would even contemplate a bankruptcy, it's apocalyptic.'"

The attorneys said in bankruptcy, a distressed municipality might have more control over its operations than it would in a state takeover, while the possibility of bankruptcy could give the municipality more leverage in negotiating with unions.

But Marc Pfeiffer, who recently retired as deputy director of the Division of Local Government Services, said allowing towns to declare bankruptcy is a slippery slope if officials "think they can get out of problems by going bankrupt and deferring payments to bondholders and breaking union contracts. Bankruptcy is a significant moral hazard that municipalities should be doing everything possible to avoid."

James Ryan, spokesman for the New Jersey State Police Benevolent Association, said there already have been police layoffs across New Jersey, without bankruptcy entering the conversation. "We are not aware of any town that has asked the state to go broke," he said. "Doing so would not only have a questionable impact on contracts, but would hurt bond holders, the ability of towns to borrow money and lower property values."

Harry Pozycki is chairman of the nonprofit Citizens Campaign, which encourages citizens to serve on local boards and run for municipal office. He said municipalities "should attack the huge amount of waste in local government, before running to bankruptcy court."

An audit issued earlier this year by state Comptroller Matthew Boxer estimated municipalities and counties could save $100 million a year on health insurance expenses by switching to a state health plan. Pozycki said local governments don't necessarily have to switch to that plan, but should adopt the campaign's "best price insurance" reform model, "which requires that the insurance broker be hired to work exclusively in the interest of the government entity, with no compensation from insurance companies."
Ray Caprio, a professor at the Bloustein School of Planning and Public Policy of Rutgers University, who is forecasting a municipal fiscal crisis in New Jersey in three to four years, said, "We have to rethink how we fund government, and whether or not certain services should even be provided by local government." He said ideas being explored include allowing towns to impose their own sales taxes, extending the sales tax to more services, outsourcing parks and recreation to nonprofits, and having residents contract for their garbage collection.

William G. Dressel Jr., executive director of the state League of Municipalities, said the fiscal stress is being addressed in part by the Legislature's reform of the public pension and health benefit system, which will eventually require public employees to contribute as much as a third of their health premiums. "This is a real significant breakthrough — I'm amazed we are talking about these things and trying to address them."

Dressel said the fiscal crisis was as bad or worse when he joined the league in 1974 — just prior to enactment of the state income tax in 1976.

Regardless of which party is in power in Trenton, Dressel said, the state has always dealt with local fiscal crises with stringent state oversight and financial aid. "Unless there is a dramatic change in philosophy and thinking, I would be very surprised if (municipal) bankruptcy ever happens in New Jersey."


E-mail to: beth@njbiz.com