Debt Limits' End

Debt Limits’ End Nadav Shoked * ABSTRACT: Debt is a major tool funding American local governments. Local governments are, however, severely constrained in their ability to rely on this vital tool. For over a century now, state constitutions and statutes have strictly curbed local governments’ power to issue debt. The effectiveness of these legal restrictions has often been questioned, but the rationale for their existence has not been doubted. This Article presents the first systematic appraisal of the justifications offered for the limits state laws place on local indebtedness. It finds all the varied normative accounts lawmakers and commentators provide glaringly lacking. Even the most prevalent explanation—portraying debt limits as alleviating the inter-generational conflict between current residents who borrow money and spend it, and future residents who must repay the loans—is inconsistent with the economics of public finances and the laws of local government. After exposing the flaws of this and all other normative ends heretofore assigned to debt limits, the Article uncovers the sole end that may be attributed to them. Debt limits, it establishes, institute a degree of inter-municipal equity in access to credit, ensuring that one municipality does not deplete credit markets to the detriment of other municipalities located within the same state. But although debt limits do thereby serve an end, that lone normative benefit they generate is found to be of meager proportions. The limits therefore often represent unwarranted, costly—and deleterious—legal interferences in local finances. This Article’s novel analysis should hence lead, if not to debt limits’ abolition, then at least to their redesign so that their form corresponds to their inescapably limited end identified here. I. INTRODUCTION ........................................................................... 1240 * Associate Professor of Law, Northwestern University Pritzker School of Law. For invaluable comments on drafts of this Article, and for fruitful conversations about the ideas they incorporated, I am grateful to Michelle Wilde Anderson, Kenneth Ayotte, David Dana, Matthew Fisher, Gerald Frug, Amnon Lehavi, Max Schanzenbach, and Richard Schragger. I also benefitted from the input of participants at the faculty workshop at Northwestern University School of Law, at the Law and Economics Workshop at the Hebrew University Law School, and at the Big Ten Junior Scholars Conference. Finally, I am thankful to Jack Licata and Jonathan Saltz who provided exceptional assistance in research. 1240 IOWA LAW REVIEW [Vol. 102:1239 II. DEBT LIMITS LAW ....................................................................... 1246 A. L OCAL D EBT ......................................................................... 1246 B. L OCAL D EBT ’ S L EGAL L IMITS ................................................. 1251 C. L OCAL D EBT ’ S L EGAL L IMITS ’ H ISTORY ................................. 1256 III. DEBT LIMITS LAW’S NORMATIVE ENDS ....................................... 1258 A. D EBT L IMITS AS M EASURES TO P ROTECT M UNICIPALITIES AND L ENDERS ’ J OINT I NTERESTS .................................................... 1259 1. The Argument ........................................................... 1259 2. The Argument’s Flaw ................................................ 1261 B. D EBT L IMITS AS M EASURES TO P ROTECT R ESIDENTS ............... 1263 1. The Argument ........................................................... 1263 2. The Argument’s Flaw ................................................ 1265 C. D EBT L IMITS AS M EASURES TO P ROTECT F UTURE R ESIDENTS ............................................................................ 1267 1. The Argument ........................................................... 1267 2. The Argument’s Flaw ................................................ 1269 D. D EBT L IMITS AS M EASURES TO P ROTECT THE F EDERAL G OVERNMENT ....................................................................... 1273 1. The Argument ........................................................... 1273 2. The Argument’s Flaw ................................................ 1274 E. D EBT L IMITS AS M EASURES TO P ROTECT THE S TATE G OVERNMENT ........................................................................ 1275 1. The Argument ........................................................... 1275 2. The Argument’s Flaw ................................................ 1278 F. D EBT L IMITS AS M EASURES TO P ROTECT O THER M UNICIPALITIES .................................................................... 1285 1. The Argument ........................................................... 1285 2. The Argument’s Limits ............................................. 1289 IV. DEBT LIMITS LAW REFORMED ..................................................... 1291 A. R EDRAFTING D EBT L IMITS ..................................................... 1292 B. R EINTERPRETING D EBT L IMITS .............................................. 1294 V. CONCLUSION .............................................................................. 1297 I. INTRODUCTION In a capitalist economy, few financial activities are more routine—yet vital—than the lending and borrowing of money. 1 Accordingly, the law might regulate the form of loans issued and the practices of those involved in the 1. E.g. , CHRISTINE DESAN, MAKING MONEY: COIN, CURRENCY, AND THE COMING OF CAPITALISM 2–6 (2014) (relating capitalism’s advent to a decision to facilitate lending). 2017] DEBT LIMITS’ END 1241 lending market, 2 but it does not directly limit market participants’ freedom to procure debt. 3 If Jane desires to assume a debt, she need only find a willing lender. The same is true if Jane Corp. entertains such a desire: as a corporation, Jane Corp. might be subject to reporting obligations, 4 but the law will not challenge Jane Corp.’s ability to proceed. 5 The market, not the law, determines who shall qualify for a loan. 6 This basic truism of American law is abrogated, however, in one exceptional case. The law may assume an indifferent posture towards Jane or Jane Corp.’s credit desires, but when the City of Jane fancies a loan, the law aggressively intercedes. In all states but one, arduous constraints will be placed along the City of Jane’s path toward credit. 7 The City might be flat-out prohibited from borrowing funds beyond a certain amount; it might be required to attain resident approval for the move— perhaps by a supermajority—in a referendum; it might even be subjected to both these restrictions concurrently. 8 The law thus treats local governments strikingly differently from individuals or corporations, by placing on their debt—and only on their debt—limits. These limits’ unique nature is further accentuated by yet another key contrast contained within the current law. The law not only treats city debt obligations differently from individual or corporate debt obligations; it also separates city debt obligations from other city obligations. Hence, if, for example, the City of Jane desires a new football stadium, it will be, as noted, constrained in its ability to issue debt to fund construction. 9 At the same time, it will not be constrained in its ability to fund construction through a budget allocation; 10 to grant tax subsidies to the privately-owned football team constructing the stadium; 11 to lease to the team, for a fraction of its value, the 2. For example, secured loans are regulated. U.C.C. § 9-109 (AM. LAW INST. & UNIF. LAW COMM’N 2015). States’ usury laws limit interest rates. E.g. , CAL. CONST. art. XV, § 1. 3. Inevitably, however, the regulation of loans and lending practices leads to the pricing out of certain borrowers from the market, and thus indirectly limits the freedom to procure debt. 4. The Securities and Exchange Commission monitors publicly-traded corporations. See 15 U.S.C. § 78d (2012). 5. Douglas G. Baird & Robert K. Rasmussen, Private Debt and the Missing Lever of Corporate Governance , 154 U. PA. L. REV. 1209, 1216–17 (2006). Commercial banks are an exception: they are subject to capital requirements enforcing assets to liabilities ratios. 12 C.F.R. § 324.1 (2016). Banks’ unique treatment is revisited infra note 136 and accompanying text. 6. The law may do the opposite: e.g., it prohibits lenders from denying mortgages because of applicants’ race. 42 U.S.C. § 3605 (2012). 7. See infra notes 76–88 and accompanying text. 8. See infra notes 76–88 and accompanying text. 9. See infra Part II.B. 10. Government funds can only be spent for a “public purpose” and thus seemingly cannot aid private endeavors. However, courts rendered the requirement inconsequential by deferring to legislatures’ determination respecting aid’s public purpose. Richard Briffault, Foreword, The Disfavored Constitution: State Fiscal Limits and State Constitutional Law, 34 RUTGERS L.J. 907, 914 (2003). 11. For example, as part of the stadium plan Inglewood approved for the NFL’s St. Louis Rams—as they were relocating to Los Angeles—public support was provided through $100 1242 IOWA LAW REVIEW [Vol. 102:1239 land for the stadium; 12 or to acquire the land through eminent domain and transfer it to the team. 13 Thus, both elements of local debt limits’ legal functioning—the singling out of the “local” and the targeting of “debt”—stand out. The limits apply to local governments and not to other market participants engaged in identical activities; and they apply to some local government activities but not to similar, indeed often economically identical, local government activities. How—if at all—can these anomalies be accounted for? What normative ends may actually be served by the law’s unique limits on local debt? Are the limits, in their current legal form, well designed to serve those normative ends? These are the questions this Article tackles. The time is ripe, perhaps as never before, for a...