Closed out of the municipal-debt market, Harrisburg, Pa. is struggling to pay for upgrades to aging pipes that contributed to sinkholes.
HARRISBURG, Pa.�With midnight approaching on New Year's Eve, Sherri Lewis and her two children knelt to pray for a better year ahead.
A few minutes later, she heard a rumbling that sounded like fireworks. The ground outside her apartment had opened up, showing a municipal disaster that shows how far this city's finances have sunk.
A sinkhole, measuring about 50 feet long and eight feet deep, had swallowed Ms. Lewis's street, damaging water and gas pipes and forcing more than a dozen residents to evacuate one of the city's poorest neighborhoods. "I thought the world was ending,'' says Ms. Lewis, 42 years old.
Harrisburg officials have identified at least 40 other sinkholes around the 50,000-person city. The combination of particularly sandy soil and leaky pipes under Harrisburg's streets make it susceptible to sinkholes, city officials say. But Harrisburg has a bigger problem: The Pennsylvania capital can't afford to replace many of the aging pipes, some of which date back to the 19th century.
Sinkholes Expose Harrisburg's Fiscal WoesView Slideshow
Jeff Lautenberger for The Wall Street JournalA pedestrian walked down North Fourth Street in Harrisburg, Pa., on Jan. 18, where a sinkhole measuring 50 feet long opened up on New Year's Eve.
- More photos and interactive graphics
Harrisburg is in default on its debt and has been effectively shut out of the municipal-debt market, which cities and states use to finance everything from building schools to paving roads.
Harrisburg's misery is familiar to many U.S. cities trying to climb out of debt used to finance convention centers, hotels and employee pensions. Some governments are cut off now from funding for necessities such as repairing infrastructure.
On Wednesday, Illinois officials postponed plans to sell $500 million of bonds to pay for school and transportation projects, fearing prospective bond investors would demand high interest rates because of the state's pension problems.
Harrisburg's latest problems started when city officials agreed to guarantee a large portion of the $350 million in debt used to retrofit a state-of-the-art trash incinerator. The project generated millions in fees for Wall Street bankers and lawyers, while leaving taxpayers with a mortgage they can't afford. Amid this borrowing spree, city and state officials say, Harrisburg neglected to invest enough in its aging water pipes.
Today, Harrisburg is struggling to upgrade other critical infrastructure, including a sewage treatment facility that sometimes dumps untreated wastewater into the Susquehanna river.
"We can't do anything right now because no one will lend to us,'' said William Cluck, chairman of the Harrisburg Authority, the city agency overseeing the water-treatment facility.
Harrisburg has weathered frequent financial turmoil since the incinerator debt deals, but the city has hit a particularly rough patch at the start of 2013.
Officials had predicted they would be unable to pay city employees as of Thursday, unless they could find a short-term loan to bridge the gap until tax revenue is collected in March.
Throughout the fall, representatives for the city went door-to-door looking for a lender. But RBS Citizens Financial Group, M&T Bank Corp. and PNC Financial Services Group all turned them down, said people familiar with the discussions. Some of the bankers were worried Harrisburg might seek bankruptcy protection, one of the people said. PNC and Citizens declined to comment on the talks. M&T had no immediate comment.
A state court has appointed a receiver to oversee Harrisburg's finances. The receiver, William Lynch, says he would like to avoid bankruptcy.
The receiver's financial team prepared "Plan D," which essentially involved the city borrowing the money from itself. Harrisburg obtained a $4 million line of credit from fee revenue collected by the sewer and trash departments, the very funding source that is supposed to be used to upgrade underground pipes.
The city had no choice, said Steven Goldfield, a senior counselor at Public Resources Advisory Group and a financial adviser to the receiver. "When you have to patch up deficits year after year like this, and defer capital expenditures, that's when bad stuff happens, like sinkholes," Mr. Goldfield said.
City officials believe the sinkhole outside Ms. Lewis's apartment may have been caused partly by excessive weight on unstable ground.
Earlier that day, the back tires of a city garbage truck broke through the street and got stuck in the pavement. Officials believe leaking underground water pipes eroded sand under the pavement and contributed to the street giving way. The truck was pulled out, but the weight of the towing equipment may have been a factor, the mayor's spokesman says.
At around 3 a.m., city workers called a contractor, who wanted assurances that the city could pay for the repairs. The city is about three months behind on its bills.
Since the New Year, Mr. Goldfield and other advisers to the receiver have been negotiating almost daily with the city's debtholders and public-employee unions, seeking concessions.
Not every creditor will budge. Rosemawr Management LLC is charging the parking authority as much as 10.75% interest on about $10.5 million in bonds. The receiver's team has asked the New York investment firm to forgive a $3 million penalty the authority has to pay if it pays back the bonds early. Rosemawr has refused, according to people familiar with the matter.
Work crews are replacing pipes under North Fourth Street, but many of the city's other sinkholes have temporary patches. It would cost almost half of the city's $50 million budget to permanently fix them, a city engineer estimates. The city is seeking state grants to pay for some of the work.
Ms. Lewis returned home after nine days in a Red Cross shelter and a hotel. While she was away, her apartment was looted. Thieves stole her son's computer and her late mother's jewelry. "I know the city is broke,'' she says. "But that's not our fault."
Write to Michael Corkery at michael.corkery@wsj.com
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