“I did not want to become known as the judge on Detroit’s first bankruptcy case.”

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April 23, 2015
Visit the project blog: The Municipal Sustainability Project

A Reprise: the Electronic Rhythm of Municipal Bankruptcy. The current leader of the Indubitable Equivalents and retired U.S. Bankruptcy Judge Steven Rhodes who oversaw the largest municipal bankruptcy in U.S. history yesterday reflected on his experiences over the 17-month trial and provided insights and perspectives with regard to much of his decision-making process, describing this municipal bankruptcy, from his experiences, as one that sprang from his belief in the “mission of the City of Detroit. It’s who we are…We always love to give people a second chance, a fresh start, to forgive them. That is, after all, what bankruptcy is about.” Speaking at an event to honor his many years of civic service, Judge Rhodes emphasized his desire to have allowed the media to broadcast directly from his courtroom during the Motor City’s bankruptcy proceedings: “I believe in a public case like this, the judge in charge should have the discretion to open it up to the media,” adding he wished the media had pushed the issue of camera access to the courtroom: “I wish that someone in the media had made a formal issue out of this by filing a First Amendment motion…It’s likely that I would have granted that motion but it never happened.” In detailing the process of Detroit’s long and painstakingly expensive journey leading up to bankruptcy, Judge Rhodes was explicit that the city’s lack of municipal services “was causing its residents real injury and real hardship.” Moreover, he noted, many Detroiters felt angry and disenfranchised by an emergency manager appointed by Michigan Gov. Rick Snyder that they felt was racially motivated. Nevertheless, he said he believed that, in the end, “the bankruptcy resulted in a plan most of Detroit’s retirees, employees and its financial creditors supported.” The city’s 120-page plan of adjustment dissolved more than $7 billion of the city’s $18 billion of debt, enhanced the city’s moribund credit rating from junk status to investment grade, and, critically, included “a 10-year, $1.7 billion investment to set (the city) on a path to restore municipal services and to revitalize itself.” Judge Rhodes reported Detroit is now ready to address blight, explore information technology development, fix street lights, and improve fire and EMS training, buses and parks. In his presentation yesterday, Judge Rhodes repeated one of his “lessons learned” from the session at the New York Federal Reserve when he told the audience that the “smartest thing” he did during the bankruptcy was to appoint U.S. District Chief Judge Gerald Rosen as mediator in the case, noting: “He put together a team of great mediators and that team deserves much of the credit.”

In a massive trial that stretched over nearly a year and a half and involved nearly 100,000 creditors, Judge Rhodes noted that, unsurprisingly, some parties were left disappointed by the bankruptcy results, even as most creditors, employees, and retirees supported the plan: “The city’s plan paid 10 percent” to general unsecured creditors, including people with injury claims against the city, he said, and citizens opposed to water shutoffs were also disappointed, he noted, referencing a ruling he had made in the case that “there is no constitutional right to affordable water,” comparing it to the lack of right to affordable housing, food or heat, albeit adding: “I had very mixed feelings about that outcome…Obviously, people need water to live.” Nevertheless, he made clear his focus from day one of the historic trial was to keep the municipal bankruptcy proceedings open and transparent, so residents could stay informed and involved in the process: “One of the hardest parts of the case for me was the fact that it was as much a political case as it was a legal case.” He noted that he had invited people into the courtroom to speak on their concerns, and 93 unrepresented parties took him up on the offer during the eligibility phase, of whom nearly half appeared in his courtroom to address Judge Rhodes: “Although it was a bit burdensome, it sent a powerful message about the openness of my process.”

Judge Rhodes yesterday said that he devoted much of his focus to ensuring any proposed plan of debt adjustment be feasible, able to be implemented by the city, and enduring: “I did not want to become known as the judge on Detroit’s first bankruptcy case.” That is, he was intently focused on seeking to ascertain that any plan he approved would be one which would put Detroit on a fiscally sustainable path—so that it would never have to revert to municipal bankruptcy. Thus, he noted the key importance with regard to his goal of preserving the artwork housed at the Detroit Institute of Arts: “To sell the art would be to forfeit Detroit’s future.” Subsequently, he also noted the important role the Detroit Financial Review Commission will play in overseeing the implementation of the plan over the next decade. But he closed with a critical warning that, in the end, it will be the people of Detroit and “their memory of that anger (toward emergency management) is what will prevent this from happening again.” In looking to the city’s fiscal future, Judge Rhodes also warned the Detroit Public Schools need attention. He said Detroiters should vote for candidates who will “continue this commitment” to the city’s revival.

Getting Schooled on Detroit’s School Finances. Judge Rhodes’ apprehensions about the Motor City’s school system and its perilous fiscal status happened to emerge nearly simultaneously with comments and recommendations in a new report (The full report is available here) titled “State Assumption of School Debts,” in which the very fine Citizens Research Council of Michigan, an independent public policy research group, urges the Michigan Legislature to craft a clear policy for addressing distressed school districts prior to taking on the Detroit Public Schools (DPS), where the issue is whether the state should assume much of the city’s school district’s municipal bond debt, as well as some of its pension liabilities. The report comes as Gov. Rick Snyder is expected to unveil, as early as today or tomorrow, a proposal to reform the fiscally-challenged district. The plan is expected to divide DPS into two districts, an ‘old’ one which exists only to service outstanding state-aid backed operations debt, and a ‘new’ one which would assume overall educational responsibilities as well as the remaining bond debt. DPS’ debt, which totals $2.1 billion, has become a major target for Gov. Snyder and a high-profile coalition of Detroit leaders who are pressing for the state to take over at least $300 million of the state-aid operations debt. The cross-cutting fiscal dilemma arises as the Coalition for the Future of Detroit Schoolchildren has recommended that Michigan assume $124 million annually of Detroit Public Schools’ (DPS) financial obligations: the obligations include debt service payments for long-term notes issued to finance current operations as well as required payments to the school employee retirement system for employee “legacy costs.” If the state takes on these debts, DPS would see an almost $2,500 per-pupil increase in the amount of money available for classroom instruction; however, the report warns, this would come at the expense of $124 million fewer state dollars available to share across all other public schools in the state, noting: “While DPS is currently the most recent financially and academically struggling district requesting direct state assistance with its debts, 55 other school districts across the state began the current fiscal year in a deficit situation…A request from any one of these districts, some of which are under the control of state-appointed emergency managers, may not be too far off.” The issue of state assumption of school district debts is not exactly new in Michigan: the state has assumed the debts of four financially struggling school districts since 2012 – Muskegon Heights (2012), Highland Park (2012), Inkster (2013), and Buena Vista (2013); however, it did so without a specific policy in place. Instead, emergency managers in Muskegon Heights and Highland Park were able to gain access to additional state assistance to pay off school debts by “charterizing” the entire districts. The Michigan Legislature passed a state law to allow the dissolution of the Inkster and Buena Vista school districts and for the debts to be assumed by the state. State policymakers, however, are still dealing with the consequences, both intended and otherwise, arising from the actions taken in these instances and from the lack of a statewide policy, leading key study author Craig Thiel to write: “Before dealing with the immediate situation involving DPS debts and in anticipation of future requests for state assistance, policymakers should give consideration to the lack of a long-term policy for state assumption of school debts…In developing a policy, the state must be cognizant of criteria such as transparency, fairness, accountability, and consistency….Even in Detroit, under an emergency manager, he (Kevyn Orr) realized he couldn’t do it and took the city into bankruptcy, and at the end of the day, with the grand bargain, the city received additional money…The policy as it’s spelled out in the emergency management law is that we’ll solve these problems without any additional resources, but all of the problems by this date have been solved by additional resources.” Mr. Thiel, not given to understatement, noted: “Debt is a huge issue…Detroit Public Schools has been under emergency management for the last half-dozen years and it can’t solve its problems without additional resources.” Nevertheless, he warned that if the state is going to provide additional resources: “don’t do it this back-door way.” The report warns that such a model is unlikely to work in Detroit, where most of DPS’ $300 million of state-aid backed debt was originally issued by means of short-term notes which were subsequently refinanced into long-term bonds—municipal bonds which were financed by means of an 18-mill non-homestead local school operating tax, which makes up the local contribution to the state’s school aid fund. Mr. Thiel adds that while some believe the existing Detroit local levy would continue to pay for the servicing of the debt, he adds that Michigan is required to make up for the shortfall with state funding—creating an awkward problem: if Michigan were replace the local funds with school aid fund revenues, it would mean the loss of $50 to every student across the state—or, as the Citizen’s Research Council reports: “So while the use of the 18-mill tax appears to be a ‘local’ solution to school district debt relief, it is undeniably a state-financed solution…At the end of the day, the borrowing, when originally done just to meet cash needs, there’s an equity issue here when you have students in the future paying for the borrowing associated just with operations today.” None of this is music to the ears DPS’ current emergency manager, Darnell Earley, who wants to roll over $85 million of one-year notes issued last August into longer term debt, warning that DPS cannot afford to repay the loan by this summer.

Fundido? Puerto Rico’s top finance officials report the government of the U.S. territory will likely shutdown in three months because of a looming liquidity crisis. Such an insolvency, they warned, would have a devastating impact on the U.S. island’s economy. Governor Alejandro Padilla wrote yesterday to leading lawmakers, warning that neither action by Congress to permit the territory to file for bankruptcy protection nor any other financial rescue appeared likely, so that there would need to be significant layoffs and elimination of many essential public services. The head of the Government Development Bank and the Treasury Secretary, in a letter yesterday to the heads of Puerto Rico’s Senate and House as well as the Governor, wrote: “A government shutdown is very probable in the next three months due to the absence of liquidity to operate…The likelihood of completing a market transaction to finance the government’s operations and keep the government open is currently remote…A government shutdown would have a devastating impact on the country’s economy, with payroll and public service cuts, with a painful recovery and of a long duration…” The territory, which has a total debt of more than $70 billion, is trying to raise $2.95 billion in financing, while pushing through unpopular tax reforms such as a higher VAT or value-added tax and increasing a levy on crude oil. The territory’s outstanding municipal bonds have been experiencing signal declines in recent weeks as uncertainty grows over the implications for its 3.6 million citizens: as of yesterday, its benchmark general obligation bonds traded at an average 79.982 cents on the dollar, close to an all-time low. Puerto Rico securities, which are tax-exempt nationwide, have traded at distressed levels for more than a year amid speculation the commonwealth and its agencies won’t be able to repay $73 billion of debt. Municipal bonds sold in Puerto Rico lost 0.72 percent this year through April 21, the worst start since 2011, according to S&P Dow Jones Indices. Yesterday, former Puerto Rico Gov. Luis Fortuño once again urged the U.S. Congress to allow the island’s troubled public entities to restructure their debts under the U.S. Bankruptcy Code’s Chapter 9 provisions: writing on behalf the Puerto Rico Financial Stability Coalition, a group which seeks “a fair and balanced approach to Puerto Rico’s debt crisis” and which is co-chaired by Mr. Fortuño and Puerto Rico’s Senate President Eduardo Bhatia — the former governor emphasized his support for H.R. 870, the Puerto Rico Chapter 9 Uniformity Act, which was authored by Resident Commissioner Pedro Pierluisi: “H.R. 870 offers Puerto Rico a road to recovery that will both honor its obligations to American investors and lead to safe investment and economic growth in years to come…Without the right for troubled government entities to restructure obligations, collective debt may overwhelm Puerto Rico as a whole, and a federal bailout will be required.” Puerto Rico’s exclusion from Chapter 9 municipal bankruptcy authority led the island’s government, last July, to enact the Puerto Rico Public Corporation Debt Enforcement & Recovery Act, which sought to allow financially strained public corporations to restructure their debts; however, last February, the U.S. District Court for Puerto Rico, in a 75-page decision, held that the Recovery Act is preempted by the U.S. Bankruptcy Code and is therefore invalid under the supremacy clause of the U.S. Constitution. According to the coalition’s website, the long list of supporters for the initiative, both locally and stateside, include: the National Bankruptcy Conference; the editorial boards of the Washington Post and Bloomberg; several renowned law professors; Fitch Ratings; Banco Popular; Government Development Bank President Melba Acosta; the P.R. Legislature; most of the island’s trade organizations; National Hispanic Caucus of State Legislators; and various investment firms, among others.

What Is the State Role in Severe Municipal Fiscal Distress?

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April 22, 2015
Visit the project blog: The Municipal Sustainability Project

Balancing Municipal Sustainability vs. Municipal Bondholders’ Interests. Fitch Ratings is warning that Illinois Gov. Bruce Rauner’s support for making municipal bankruptcy more available to the state’s larger municipalities and school systems might have corrosive impacts on those larger municipalities’ bondholders. In a special report, Fitch warned that recent developments in Illinois and New Jersey could reduce the chances of state intervention—intervention that, according to the rating agency, could result in better outcomes for the respective municipal bondholders than allowing distress to lead to municipal bankruptcy: “We believe efforts to resolve looming budget deficits and ensure the affordability of long-term obligations would be more productive than focusing on easing laws or practices to allow bankruptcy.” The special report comes as Illinois Governor Bruce Rauner has recently proposed amending Illinois laws to grant authority to larger municipalities to file for federal bankruptcy protection, and, because of his growing apprehension about the credit quality of Chicago Public Schools (CPS), Governor Rauner this week said he is apprehensive CPS may need authority to file for bankruptcy as a solution to its large budget imbalance. According to CPS analysis, the system’s reserves will likely be fully depleted by the end of FY2016. (Giving a sense of a system beset by apprehensions with regard to its fiscal solvency and its leadership, the Chicago Board of Education yesterday sold $300 million in municipal bonds with a 25 year maturity—but at a top, prohibitive interest rate of 5.63%–a severe fiscal penalty.)

With regard to New Jersey, the agency noted that the recent appointment of corporate restructuring experts—including Kevyn Orr, who served as the Emergency Manager overseeing Detroit’s largest municipal bankruptcy in U.S. history―to assist Atlantic City in addressing the seaside city’s fiscal crisis appears at odds with New Jersey’s “strong history of aiding local governments to prevent the type of stress that could lead to bankruptcy,” noting: “Of US states, New Jersey has historically provided among the strongest levels of early intervention to local governments with financial strain, [but] recent developments in Illinois and New Jersey are lessening the chances of state intervention that could result in better outcomes for bondholders than allowing distress to lead to bankruptcy…We believe efforts to resolve looming budget deficits and ensure the affordability of long-term obligations would be more productive than focusing on easing laws or practices to allow bankruptcy.” The April 20th Fitch report comes on the heels of Gov. Bruce Rauner’s recent proposal to add a Chapter 9 provision to state statutes as part of his Illinois turnaround agenda—a proposal which has incurred strong opposition in the legislature from unions, who have charged that the Governor is using the threat of municipal bankruptcy to give local governments greater leverage in negotiations on pensions, benefits, and wages. The rating agency noted that the Governor’s apprehensions follow in the wake of the increasingly failing fiscal grades of the Chicago Public Schools district, which has been slammed by a steep credit rating slide as it confronts a $1.1 billion deficit and some $9.5 billion of unfunded pension obligations—and mounting public pension debts for Chicago’s police and fire retirees, where public safety pension payments are set to achieve an unaffordable trajectory next year under a state mandate to stabilize those funds. Fitch’s perspective is that while state fiscal intervention mechanisms vary from state to state, the majority focus on helping local governments recover from distress, rather than preventing it, with authors Managing Director Amy Laskey and Senior Director Rob Rowan noting that restrictions on states’ ability to impact some union collective bargaining agreements, including pension obligations, “limits their ability to remediate financial distress.” The special report appears as the prestigious Chicago Civic Federation is pressing Illinois’ legislature to consider a measure developed by the incomparable municipal restructuring expert Jim Spiotto to create an authority designed to intervene before a government’s fiscal strains reach crisis stage.

The State Role in Municipal Fiscal Distress. In our studies, states have played singularly disparate roles with regard to severe municipal fiscal distress—with the State of Alabama becoming a precipitator of Jefferson County’s then largest municipal bankruptcy in history, California playing an agnostic-to-negative role in its triple set of recent municipal bankruptcies, but both Rhode Island and Michigan evolving into constructive roles—roles which could be significant factors in the long-term fiscal sustainability of post-bankrupt Detroit and Central Falls. New Jersey, however, appears to leaning away from its previous record of strong support. Now Illinois is debating whether it ought to change its role. Part of the issue relates to whether a state does or does not even allow a municipality to file for federal bankruptcy protection (12 states do specifically; 12 do conditionally; three provide limited such authority; two specifically prohibit; and the remainder are silent.). Now as New Jersey and Illinois debate changing their respective state policies and maybe statutes, Fitch Ratings frets that recent developments in the two states are reducing the chances of state intervention to help municipalities in severe fiscal distress, writing that: “We believe efforts to resolve looming budget deficits and ensure the affordability of long-term obligations would be more productive than focusing on easing laws or practices to allow bankruptcy.” The new views come as Illinois Governor Bruce Rauner has recently proposed granting authority to local governments to file for federal municipal bankruptcy protection (current Illinois law bars municipalities with populations over 25,000 from filing a Chapter 9 petition.), and New Jersey continues to debate whether the state ought to force Atlantic City into municipal bankruptcy. In its recent views, Fitch noted it believes the needs of a distressed municipality are a better indication of the possibility of bankruptcy than whether current state law allows it, writing: “In New Jersey, the recent appointment of corporate restructuring experts to assist Atlantic City in resolving the city’s fiscal crisis appears at odds with the state’s strong history of aiding local governments to prevent the type of stress that could lead to bankruptcy. Of U.S. states, New Jersey has historically provided among the strongest levels of early intervention to local governments with financial strain.” With regard to the Windy City, Fitch notes the increasing failing fiscal grade of the credit quality of the Chicago Public Schools (CPS), noting that Governor Rauner this week said that he fears the district may need municipal bankruptcy as a solution to its large budget imbalance, adding that, according to the school system’s own analysis, their reserves will likely be fully depleted by the end of FY2016. The dichotomy Fitch likens almost to a teeter-totter: “Fiscal intervention mechanisms vary by state. Most focus on helping local governments recover from distress, rather than preventing it. Many can approve or reject financial plans, budgets, and certain government contracts under state control. Their powers, however, are constrained by laws governing labor contracts, benefits including pension obligations, and service provision. Fitch believes this limits their ability to remediate financial distress.”

The Challenge of Communicating about Municipal Bankruptcy. In a corporate bankruptcy, the company or corporation usually simply ceases to exist; in a municipal bankruptcy, the municipal corporation seeks federal court protection to ensure its continuity—and, of course, the city remains open and operating. In states which authorize municipalities to file for chapter 9 protection, there are significant variations—with some, such as Michigan and Rhode Island, for instance, authorizing the state to appoint an emergency manager or receiver, an individual who effectively displaces any and all elected officials—and who bears little onus or responsibility to communicate to the city’s citizens. But in others, such as Alabama and California, the elected municipal leaders remain in office—and retain significant responsibilities to communicate to citizens and taxpayers what is happening in or to their city or county—an especially vital role under a federal-state-local situation intended to ensure continuity and the provision of essential public services. Thus, after significant struggle, San Bernardino last evening selected Monica Lagos to serve as the voice of the city. Ms. Lagos, who since last October served as a senior account executive at Westbound Communications, was appointed in the wake of a 6-1 vote, but only after an extended and sometimes heated discussion. Her task is to “tell the city’s story” as it struggles to cobble together its plan of debt adjustment by the end of next month’s federally-set deadline by U.S. Bankruptcy Judge Meredith Jury. As San Bernardino City Manager Allen Parker, in seeking to justify the diversion of virtually non-existent fiscal resources for such a new position, put it to the Mayor and Council before the vote: “Transparency, transparency, transparency…I am looking less at image-making than I am at telling a story that gets us through the bankruptcy.” Prior to the Council’s vote, Ms. Lagos said the specifics of her approach to the city’s municipal bankruptcy would need to be worked out after she was hired: “I think we all know that it’s extremely important for the city, and it’s been a long time coming…Honestly, for me in particular, it’s a position that will help connect each of the departments, help connect what the city’s efforts are currently with the public’s need to know this information.” Prior to the vote, City Attorney Gary Saenz advised the Council that Judge Jury had said it is important for the public to be informed and involved in the city’s Plan of Adjustment, noting: “This is not a plan of adjustment that is just something that happens at City Hall…It’s something we get the whole community engaged in, and they have to be a part of getting San Bernardino out of bankruptcy…It needs to be a consistent message that informs the public exactly where we are, particularly with regard to the bankruptcy.” The lone dissenter, Councilman John Valdivia, said he agreed with residents that the focus should be directly fixing problems in the city rather than “image.”

Out of Fiscal Sustainability

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April 21, 2015
Visit the project blog: The Municipal Sustainability Project

Out of Sustainable Control. North Las Vegas, which faced near insolvency, but which is barred from seeking municipal bankruptcy protection because such protection is not authorized by Nevada law, yesterday received a nod for its fiscal efforts: Fitch Ratings revised its outlook for the municipality of 222,000 to stable from negative for $414.4 million of North Las Vegas, Nev. bonds, and affirmed the rating at B—revisions affecting some $284.7 million of limited-tax general obligation water and wastewater improvement bonds and $129.7 of LTGO bonds. Fitch said the junk-rated bonds warranted a revision to a stable outlook because of “successful negotiation of labor concessions needed to balance fiscal 2015 and 2016 budgets.” The slight upgrade reflects well on the city’s fiscal efforts; last year Fitch likened the city’s fiscal plight to Detroit and Stockton. Nevertheless, one fundamental has not changed: the municipality’s ability to recover by itself—or, as Fitch notes: “The B rating continues to reflect Fitch’s view that the city has virtually no remaining budget flexibility…Given tax caps and the scope of service cuts already made, Fitch believes any meaningful solutions are outside the city’s control.” The rated municipal bonds are backed by the full faith and credit of the city, subject to Nevada’s constitutional and statutory limitations on the aggregate amount of ad valorem property taxes. In addition, the city’s bonds are backed either by an irrevocable pledge of and lien on certain consolidated tax revenues (15% of these revenues) or by water/wastewater system net revenues. In adjusting its rating, Fitch wrote the uptick reflected successful negotiation of labor concessions needed to balance fiscal 2015 and 2016 budgets; yet remarked that the B rating reflected “that the city has virtually no remaining budget flexibility. Given tax caps and the scope of service cuts already made, Fitch believes any meaningful solutions are outside the city’s control,” noting that unrestricted balances in the municipal utility fund serve as the city’s only meaningful source of liquidity and are expected to be drawn down to just adequate levels to support governmental operations over the intermediate term. The rating agency also determined the city’s and region’s economy were among the hardest hit in the U.S. by the collapse of the housing market with a combined loss of 56% of taxable assessed valuation. Fitch also found that the city’s debt is high relative to its tax base, amortization is slow, and debt service is escalating in the intermediate term. Worryingly with regard to fiscal sustainability, Fitch added that carrying costs, including debt and retiree liabilities, are expected to increase with rising debt and pension payments. Fitch omitted age—but those pension payments are most likely to be for considerably longer duration than previous generations. The rating agency noted that its rating could improve “if the city is able to develop a realistic strategy towards near-term deficit reduction as well as a medium-term plan to address the required reduction in utility transfers by fiscal 2021,” but that “the economy is fragile leaving the city ill-prepared to manage any further contractions. A down cycle in the economy from this point would likely result in further financial stress and a rating downgrade.”

Caught Between a Dry Rock and a Hard Place. Fitch believes North Las Vegas retains virtually “no additional expenditure flexibility.” The city has eliminated about 800 full-time equivalent positions (35% since the peak in 2009) through attrition and voluntary separation and layoffs. The credit rating agency added that, according to the city, the city’s current staffing level is unsustainable:

• Revenues bottomed out in fiscal 2013 at $86.95 million, a drop of 47.2% since their fiscal 2008 peak, and remain just 61% of the peak level.
• Property taxes continue to decline and are off 70% from their peak, comprising only 7.4% of revenues compared to 17% in fiscal 2009.
• Fitch estimates that carrying costs currently consume 20.7% of governmental spending. The burden approximates full funding of the actuarally required contribution to the state plan, which the state does not currently require. Fitch expects the burden to increase as both debt service and retirement benefit costs rise.

Is Dissolution an Alternative to Municipal Bankruptcy?

April 17, 2015
Visit the project blog: The Municipal Sustainability Project

Classes of Creditors in Municipal Bankruptcy. The City of San Bernardino, beset by an ever nearing deadline to put together and submit a plan of debt adjustment by U.S. Bankruptcy Judge Meredith Jury’s May 30th deadline, has now requested dismissal of a suit filed against the municipality by two creditors that loaned money in good faith to the city. Unsurprisingly, the creditors are seeking the same repayment terms as the California Public Employee Pension System (CalPERS). That seems to have motivated San Bernardino to consider proposing its own bankruptcy reorganization sparing cuts to its CalPERS pensions. San Bernardino, which filed for Chapter 9 municipal bankruptcy in 2012 and stopped paying CalPERS $24 million-a-year obligations, announced last December that it planned to begin paying CalPERS’ annual payment as well as make past-due payments. That change of heart, however, has spurred Ambac Assurance Corp., a New York bond insurer, and EEPK, a Luxembourg bank, to file suit with the U.S. Bankruptcy Court, in an echo of legal challenges from Stockton’s municipal bankruptcy, with regard to the equity of full payments to one creditor—CalPERS, whilst it has halted payments to these two creditors: EEPK and Ambac claim their bonds are part of a “single pension obligation”–the equivalent of the city’s relationship with CalPERS, arguing in their briefs that whatever payments the City of San Bernardino makes to CalPERS, it must make equal payments to EEPK and Ambac. In response, San Bernardino’s attorneys have sought to have the court dismiss the suit, arguing that the argument being made by EEPK and Ambac “transcends novelty” and is “made out of whole cloth,” adding, with emphasis, that the city has yet to file a plan of debt adjustment detailing how it would propose to treat EEPK and Ambac’s debts, not to mention its debts to thousands of its other creditors. San Bernardino City Attorney Gary Saenz told the new agency Reuters that San Bernardino will propose a repayment plan which will propose reductions to certain creditors in “an amount that is fair and reasonable,” adding that cutting CalPERS would trigger substantial pension payment reductions to current and future retirees, driving many municipal employees to take jobs elsewhere: “You can’t have a workforce without pensions.” Judge Jury has scheduled a hearing for May 11th to hear arguments why San Bernardino should be allowed not to pay creditors on an equal basis.

Communicating Distress. A key challenge in a municipal bankruptcy is how a city and its leaders communicate to the public: think of a ship foundering at sea and the important mission and responsibility of the captain to communicate to the crew and passengers. Nevertheless, the issue has continued to be a sore one for San Bernardino—with part of the issue whether the bankrupt city should hire an outside firm or do the work in house. City leaders, indeed, say the city needs a professional to clearly articulate the city’s activities and plans, especially now, as the city nears its federally set end game to complete and adopt its exit plan for approval by the federal bankruptcy court. Having failed to gain consensus on this issue last March, when a majority of the City Council disapproved of an earlier proposal of a two-year contract for $215,000 with an Orange County firm, City Manager Allen Parker is, this time, instead asking the Council to recreate an in-house position for a “manager of communications” which he hopes could be in place soon as early as May Day—the hoped for date when the city hopes to be able to inform its citizens about its plan of debt adjustment. The issue of such communication to the public is another area in which municipal bankruptcies can have significant differences—for when a city’s elected officials, as opposed to a state-appointed emergency manager, remain responsible for the city, they also remain bound to be transparent and accountable to the citizens and taxpayers. Manager Parker said that if the City Council approves the position, he intends to hire a Spanish-speaking San Bernardino resident with 16 years of public relations experience, albeit he requested that the person not yet be identified, because the position has yet to be approved. Mr. Parker noted that the city has received proposals from public relations firms and that a firm, as opposed to hiring someone as an employee, remains the ideal choice; yet he said he did not think the council would approve any of the firms―a position with which Councilman John Valdivia does not agree, arguing that interested firms ought to be permitted to make the case they should be hired instead, and the Council be allowed to make the final choice: “Why don’t we have Motion 1 (to hire an individual), or motion 2, consider the remaining firms and allow them to give a three-to-five-minute presentation?…What can they offer, what can they bring to the city and what’s the plan?” For his part, Mayor Carey Davis noted that a spokesperson of some kind is overdue: “It’s important to have the voice of the city represented as correctly as possible…When you have that function in place, then that communication is focused and you can make sure that the other department heads know where that central voice is culminating and it gives us an ability to better manage, I think, the communication from City Hall with the community…As we move into adopting the Plan of Adjustment and its subsequent implementation there’s going to be a heightened need for clear messaging and clear information to be provided.”

Last January, CalPERS announced its solvency had improved and that its public pension plan was only $89.7 underfunded (see its “Rainbows, Butterflies and Unicorns” analysis, which purports the giant state public pension agency can pay 77 percent of its pension promises by compounding earnings at 7.5% for the next 30 years. Many analysts, however, counter that if CalPERS were only to realize 4.5% a year–a rate conservative private sector pensions aim for–the fund’s long-term liability could be staggering. In addition, some fear that an even bigger solvency risk for CalPERS is that its municipal clients are unable to continue making the contribution percentage required by statute, membership category and benefit formulas to fund their 1,126,133 covered employees’ pensions. Approximately 50 California cities that have not filed for bankruptcy have declared a financial emergency claiming they may not be able to meet their financial obligations.

Attacking Abandoned Housing in the Motor City. Detroit Mayor Mike Duggan yesterday announced a new mortgage program he has proposed to address a unique hurdle to the city’s future fiscal sustainability: its thousands upon thousands of empty, abandoned houses. For the Mayor, the financing not only offers a way to address the city’s severe challenge of abandoned housing, but also to address affordability, because rents in Detroit are so much higher than the cost of ownership: “You could be paying $800 a month in rent, but you can’t get a mortgage for a similar property when the payments would only be $400.” A critical challenge has been access to housing credit or mortgages: last year, just 10 percent of Detroit homebuyers were able to obtain a mortgage: the only alternative was cash on the barrelhead. Part of the difficulty is that the bulk of the abandoned properties require significant in order to be safe and habitable; yet, the cost of fixing them up is often in excess of their underlying value—this in a city where the median home price as of February was $26,000, according to RealtyTrac. Thus, in his remarks yesterday, Mayor Duggan noted: “We know that the desire to renovate these houses and rebuild our neighborhoods is there…What we haven’t had is enough lenders willing to take a chance on our city to show what’s possible.” Under the Mayor’s new program, the Detroit Neighborhood Initiative, Mayor Duggan has found partners with Bank of America, the Neighborhood Assistance Corporation of America, and the Detroit-based Opportunity Resource Fund to create a mortgage-type loan to overcome federal obstacles which, in most instances, bar lending for more than a home is worth. Under the new program, mortgages will be available for up to 110 percent of a home’s value―or even up to 150 percent if purchased through the Detroit Land Bank Authority home auctions. In addition, the new loans will offer favorable terms and be available to anyone who will live in the house and does not already own a property, including:
• 0 percent down
• No closing costs
• No fees
• No maximum income
• Credit score is not considered
• Below market fixed rates (currently 3.5 percent for a 30-year loan and 2.875 percent for 15 year)
• Ability to buy down the interest rates to near 0 percent
• Loans of up to $200,000

Gambling on Real Estate. A most difficult fiscal challenge for Atlantic City to avert municipal bankruptcy is the region’s reliance on property taxes: RealtyTrac reports that Atlantic County again led U.S. metropolitan areas in foreclosure activity rates in the first quarter of 2015—reinforcing the recognition of the region’s battered real estate markets on the city’s fiscal future. According to the company, Atlantic County, where one in every 113 housing units had a foreclosure filing, led the country, ahead of Rockford, Illinois, and Ocala, Florida. Moreover, that lead continued in the last quarter too. Foreclosures in all area counties and New Jersey rose in the first quarter from one year ago: Atlantic County was up 46 percent; Cape May County, 35 percent; Cumberland County, 16 percent; and Ocean County, 25 percent. New Jersey was up 17 percent in that period: the state had the fifth-highest foreclosure rate in the country in the first quarter, according to RealtyTrac. In South Jersey, the largest single jump came from notices of sheriff’s sales — the auctions listed in newspapers of specific properties lenders are preparing to sell. In the wake of the jobs attrition from Atlantic City casino closures, expectations are that short sales, distressed sales, and bank-owned properties will short the real estate market for the next five years. Already banks are putting more inventory out for sale, even as the market appears rife with abandoned properties. Combined with vandalism and stolen pipes and heaters, homes in bad shape are becoming a further hindrance to hopes for recovery. The RealtyTrac numbers put in statistics the very real fiscal challenge Atlantic City Mayor Don Guardian spoke so eloquently about at the New York Federal Reserve this week when he noted his city’s 88% reliance on the property tax—but where the assessed value of his city’s properties have declined by 85 percent.

The End of the Road, or an Alternative to Municipal Bankruptcy? Guadalupe, California, a small municipality of 7,080 established in 1840—a town where Father Junipero Serra brought some of the first cattle into a region of the state that has become a cattle mecca, appears at the end of its proverbial rope. In the wake of the fourth Grand Jury report since 2002 examining the city’s fiscal dysfunction, the findings and recommendations note there appear to be no bridges to solvency, concluding that the City Council of Guadalupe should take the necessary steps to disincorporate. In its report and findings, “Guadalupe Shell Game Must End,” the grand jury concluded that more than a decade of financial mismanagement, a declining tax base, and increasing debt obligations have all but ensured the fate of the municipality—slightly larger than formerly bankrupt Central Falls, Rhode Island: Guadalupe is a 1.3 square miles working-class town, which, according to the grand jury, is replete with well-intentioned, but incompetent bureaucrats, who “inappropriately” transferred about $7.6 million from restricted funds to cover budget shortfalls, but ignored the recommendations of city audits and prior grand jury reports to trim expenses. With costs projected to outpace revenue, the grand jury report determined that by “moving money from one account to another to keep the city afloat,” the city had engaged in a “shell game” that must come to an end with disincorporation. Nonetheless, City Administrator Andrew Carter said he doubted that the Guadalupe City Council would follow the grand jury’s recommendation, which is not binding―meaning that the state or the city’s voters, under California law, could force through the legal multi-stage process—in the likely event that the Council refuses to act on the recommendations (please see below). Indeed, Andrew Carter, Guadalupe City Administrator notes: “There’s nothing in the report that we don’t already know.” Mr. Carter faulted grand jurors for focusing on previous financial errors by past management and providing insufficient credit to recent efforts to turn the city around, noting that city employees have taken a 5% pay cut, and this winter, ground broke on a long-awaited housing and commercial development which is expected to boost tax revenue by adding some 800 homes. In addition, last November, voters overwhelmingly approved three tax initiatives that are expected to reap an additional $315,000 for the municipality, adding: “I doubt that any other community voluntarily imposed three tax measures on themselves (mayhap forgetting Stockton’s voters).” Mr. Carter added that additional changes in utility and other taxes should yield a balanced budget for the next fiscal year, noting that Santa Barbara County officials’ suggestion that Guadalupe disband strikes some Guadalupe citizens and taxpayers as discriminatory: “The demographics of Guadalupe are the exact opposite of the demographics of Santa Barbara’s.” According to the U.S. Census Bureau, about 87% of Guadalupe’s residents are Latino, of whom some 6 percent have a college degree. In Santa Barbara, about 42% of residents have a college degree; 38% are Latino. Dissolution of a municipality in the Golden State is rare, but not novel: The last city to dissolve itself was Hornitos in Mariposa County in 1973, one year after the city of Cabazon lost its legal status and was integrated into unincorporated Riverside County. In recent years, Jurupa Valley, Vernon, and Maricopa have edged close to dissolution. At a meeting Tuesday night — the first time the City Council has met since the report was issued last week — members were expected to appoint two of their peers to draft a response to the grand jury. The city’s response is due within three months.

Santa Barbara County Grand Jury Key Findings:
The Jury challenges the Guadalupe City Council to realistically consider the disincorporation recommendation when responding to this report.

FINDINGS AND RECOMMENDATIONS
Finding 1. Guadalupe does not generate enough General Fund revenue (sales tax, property tax, and bed tax) to pay for General Fund expenses, such as police and fire operations.
Finding 2. Guadalupe’s current debt payment obligations will increase annually until 2024 with insufficient corresponding increases in revenue.
Finding 3. The recent passage of Measures V, W, and X will not provide a long-term solution to Guadalupe’s financial issues.
Finding 4. There is no revenue to restore salary or benefits to employees who have agreed to furloughs and salary cuts, or to add staff.
Finding 5. There is no revenue to build up a reserve fund for emergencies or pay for needed infrastructure repair.
Finding 6. There is no revenue to eliminate the need for the City of Guadalupe to borrow an additional $330,000 per year to meet General Fund obligations.
Finding 7. Guadalupe is losing $4,000 per month in the Solid Waste Fund, due to faulty accounting practices, resulting in a $240,100 fund deficit as of August 18, 2014.
Finding 8. Guadalupe has, for over 12 years, charged up to 193 percent of overhead expenses through inappropriate inter fund transfers from its special funds and enterprise funds to the General Fund.
Finding 9. Guadalupe’s inappropriate transfers included money taken from the State Gas Tax Fund, which was used for purposes expressly forbidden in the Gas Tax regulations.
Finding 10. Guadalupe did not, until recently, follow rules that allow loans of funds from special funds to help finance General Fund activities which must be approved by the City Council, be documented, and include a repayment schedule.
Finding 11. Guadalupe has a large tax liability to the IRS, which started in 2006 as a relatively minor dollar figure, but over the past eight years, with penalties and interest, has grown to over $486,000,
Finding 12. Guadalupe’s decades long hope and expectation that future housing and commercial development will improve its financial situation have not been realized.
Finding 13. Disincorporation will freeze the existing debt of the City of Guadalupe at the current level.

Recommendation: That the City of Guadalupe disincorporate.
.
REQUEST FOR RESPONSE
Pursuant to California Penal Code Section 933 and 933.05, the Jury requests each entity or individual named below to respond to the enumerated findings and recommendations within the specified statutory time limit.

Creating City Futures

Motor City Master Plan. Detroit COO Gary Brown this week at “The Making of a Great City,” the first of six community meetings by Detroit Future City, said the Motor City needs a master plan to guide future development, but Mr. Brown also said Detroit needs to take a regional approach to revitalization—pointing to the Cobo Center authority and the so-called “grand bargain” fashioned by U.S. Chief Judge Gerald Rosen with Gov. Rick Snyder, bipartisan state legislative leaders, and non-profit leaders—especially in retaining the Detroit Institute of Arts. But Mr. Brown also recognized the new Great Lakes Water Authority (as did U.S. Bankruptcy Judge Steven Rhodes at the New York Federal Reserve in his remarks Tuesday) as examples of regional cooperation that are moving Detroit forward. Nevertheless, he warned that the city’s declining population will continue to drop until Detroit can solve its crisis in education and public safety: “Get over the numbers that we’re not growing…Let’s manage the city well. Let’s find regional approaches to fixing the problems as opposed to doing it all by ourselves.” Another speaker, Roxanne Qualls, former Mayor and city council member in Cincinnati, told the audience that during her three terms as Mayor of Cincinnati in the 1990s, she focused on revitalizing neighborhoods, increasing home ownership, and redeveloping Cincinnati’s central riverfront—leading her to advise the audience that her advice for Detroit was to have a vision, a plan, and leadership: “To make any of that meaningful you have to have capacity: Identify resources and make them significant.” Much of the focus of the evening was on the Detroit Future City plan, a framework to guide city revitalization: a 345-page book completed in 2012 that is seen by many as the core of a city master plan. The plan, which was originated as the “Detroit Works,” then renamed Detroit Future City, is an exhaustive effort to engage citizens, map the city, analyze land use and population, and make recommendations for the best ways to use land and the city’s water, people and other resources. At the session Mayor Dayne Walling, of Flint, which adopted the first city master plan in 50 years, said Detroit should make the process of adopting a city master plan as public as possible and give it time and work with those to get the work done.

Getting Ready for Tomorrow. Happy Birthday to the 9,000 U.S. citizens who turned 69 today. And yesterday. And tomorrow and tomorrow and tomorrow. The unfaltering progression of aging in the U.S. – and longer lifespans—means an increasingly inverted equation of fiscal contributions. Thus it was that Tuesday the California Public Employees’ Retirement System, or CalPERS, the country’s largest U.S. public pension fund, announced that the State of California and its schools will increase their contributions to employee pension funds by 6 percent, commencing on July 1st, noting that the increases were driven by payroll growth, salary increases, and retirees having the nerve to live longer than projected. For the state, that means it must pony up an additional $487 million to $4.7 billion; the state’s public schools must increase their contributions by $111 million to $1.3 billion. Richard Costigan, chair of the finance and administration committee, said in a statement: “As the fund matures, and the retired population grows, it’s important that the rates reflect the changing demographics of our members.” The growing cost of public pensions is a key issue for state and local governments across the nation as guaranteed payments to retired employees have often forced cuts in spending on public services. CalPERS has $300 billion in total assets and the pension fund was roughly 77 percent funded as of last June.

Municipal Bankruptcy & Alternatives for Distressed Cities

eBlog

April 15, 2015
Visit the project blog: The Municipal Sustainability Project

Fire in the Hole. The union representing San Bernardino’s firefighters has sued the city in a pair of lawsuits, alleging city officials are violating San Bernardino’s charter in an ongoing pay dispute. The union had so threatened last October in the wake of San Bernardino’s imposition of changes in their public pensions—a critical issue the city has to address as part of any plan to exit municipal bankruptcy—but where its ability to do so has been threatened not only by the legal objections, but also by charter requirements that make San Bernardino the only city in the State of California which must base its police and firefighter pay on the average of 10 similarly sized cities (all, however, larger in this instance)—a mandate or requirement, nevertheless, which a majority of the city’s voters, last November, rejected the opportunity to change, when they voted by a 55% majority to reject a change which has left the city as the only one in the state to set police and firefighter salaries by comparison with other cities, rather than by collective bargaining. At the time, the Mayor had urged voters to adopt the new measure, arguing that the bankrupt city could ill afford to pay wages dictated by the wealthier cities that are used to setting police and firefighter pay under Charter Section 186. San Bernardino’s fire union chief, in a press release, noted: “We want to stop these violations and ensure that city leaders follow the laws that they have pledged to uphold.” In the suits, filed late last week in U.S. Bankruptcy Court in Riverside, the union asks the federal court to roll back last fall’s changes. San Bernardino City Manager Allen Parker noted, referring to the fire union: “They threatened to do this, and it was just a matter of time…They have been unhappy with the rulings of the bankruptcy court all along, and the bankruptcy court judge is the one who approved the action, so they ought to be angry with the judge, not us.” The intriguing intergovernmental clash before the U.S. Bankruptcy Court, following in the wake of Judge Meredith Jury’s ruling last September that San Bernardino could reject its then-existing contract with the firefighters—but not granting the city’s request that it be granted the authority to impose its own contract—has created a kind of legal limbo. Only, this time, the legal limbo and suit add still another legal hurdle to the city’s ability to cobble together its plan of adjustment to meet U.S. Bankruptcy Judge Meredith Jury’s May 30th deadline to submit its plan of debt adjustment.

Chapter 9 Municipal Bankruptcy & Alternatives for Distressed Municipalities & States. In an unprecedented session hosted by the New York Federal Reserve yesterday, and co-hosted by the Volcker Alliance and the George Mason Center for State & Local Leadership, the three U.S. Bankruptcy Judges of the largest municipal bankruptcies in U.S. history spoke of the lessons learned from Detroit, Stockton, and Jefferson County: with Judges Steven Rhodes (Detroit) and Christopher Klein (Stockton) noting the critical appointment of the “right” mediator, Judge Rhodes driving home the importance of what he termed “pedal to the metal,” and noting that an ‘adversarial process will not work,’ so that the appointment of a “feasibility” expert was invaluable. With Judge Klein noting the “dynamic” nature of municipal bankruptcy resolution, Judge Thomas Bennett, who oversaw the Jefferson County bankruptcy, spoke of the importance of “long-term municipal sustainability” as a key outcome of any successful municipal distress outcome—in addition to an effective restructuring of a city or county’s debt. For municipal leaders, Judge Rhodes noted that any such long-term sustainability had led him to abjure Detroit’s citizens to “remember your anger,” as we discussed the uncertain future of this generation of cities and counties that have—or appear to be en route—to emerging from municipal bankruptcy to what Judge Bennett defined as “long-term sustainability,” a plan which must entail a structuring of a recovering municipality’s pensions and debt service, and which Judge Klein noted might mean there ought to be consideration of some sort of “enforcement mechanism.” Judge Klein, noting that “bond financing is a really good business,” suggested this might be an arena in need of adult supervision, echoing concerns expressed by both the Urban Institute and Judge Bennett (speaking of states which do not give home rule authority to municipalities—a decision, he noted, which precipitated Jefferson County’s historic municipal bankruptcy), and warned could become especially problematical for municipal leaders in ‘no new tax states.’

Municipal DNA. The participants concurred that while there are commonalities or a DNA that connects all municipalities amongst distressed and bankrupt cities and counties; nevertheless, each is unique: in almost every instance, there has been a slow, gradual decades-long demise which begins with the governing body—council or board—based upon financial dealings with labor, developers, financiers—and not with the eyes on long-term fiscal sustainability—or, as one of the experienced federal bankruptcy judges explained it, how, in a triangle of employees, finances, and taxpayers: who has to give up what? –especially, in an era, as Judge Rhodes noted, when the challenge of valuing liabilities of a municipality is its most difficult hurdle with such signal consequences towards a municipality’s long-term fiscal sustainability. The judges emphasized that critical steps required that elected leaders of a bankrupt municipality had to take ownership of a resolution; the value of the adversarial process of municipal bankruptcy; and—in stark contrast with a business, as opposed to municipal corporation bankruptcy; chapter 9 is a “dynamic” process in which the goal is, as Judge Bennett explained, “long-term sustainability,” echoing the guidance of the Boston Federal Reserve’s important paper about the exceptional challenge of state and local leaders “[W]alking a Tightrope: Are U.S. State and Local Governments on a Fiscally Sustainable Path?”

At the session, we were treated to the municipal leadership perspective from the bird’s eye view of Atlantic City Mayor Don Guardian, Syracuse, N.Y. Mayor Stephanie Miner, and former San Jose Mayor Chuck Reed—with Mayor Reed warning of reverse incentives for municipal leaders in the budget process—a process governed by too much secrecy, and Mayor Miner describing the real world consequences that fall on an urban Mayor whose city has already experienced 130 water main breaks so far this year—a year in which the state has continued a long-term process of disinvestment in its municipalities—but her city has seen a 400% increase in its pension and OPEB liabilities—imposing a greater and greater burden on communicating with her constituents, noting: “The truth shall set ye free’”—albeit potentially encumbered by ever increasing legacies of debt. Mayor Guardian spoke eloquently of what it means to be a newly elected Mayor of a city with an 88% reliance on the property tax—but where the assessed value of his city’s properties have declined by 85 percent.

Federal Reserve Bank of New York President and chief executive officer William Dudley opened yesterday’s historic session by warning that municipalities are getting into fiscal trouble by borrowing to cover operating deficits: “When a jurisdiction borrows to invest in infrastructure, the cost of the debt to local residents — and those considering locating in the jurisdiction — is offset by the value of the services that the infrastructure provides. This tradeoff is part of the ‘fiscal surplus’ that a jurisdiction offers: the value of the services minus the tax price that residents have to pay. A well-run capital budget will match these costs and benefits over the life of each project to ensure that the jurisdiction remains attractive to current and future residents.” Nevertheless, Mr. Dudley warned that some municipalities are putting themselves in trouble by borrowing to cover operational deficits and achieve “balanced” budgets, just as New York City did in the 1970’s leading up to its famous fiscal crisis: “The key distinction between these two types of borrowing is that in the former case an asset is producing services that help to offset the cost of the debt, but this is not so in the latter case…Indeed, using debt to finance current operating deficits is equivalent to asking future taxpayers to help finance today’s public services.” Mr. Dudley said that residents of a municipality managing its finances that way could react by leaving, shrinking its tax base and exacerbating its fiscal problems; he directed significant focus to the underfunding of public pensions, a practice which the Securities and Exchange Commission has targeted for enforcement actions, and which regulators and market participants alike have said could be a serious threat to state and local finances and bondholders in the future—noting that the need to compromise with pensioners during Detroit’s recent bankruptcy proceedings, for example, cost the insurers of the city’s bonds millions of dollars—and, warning participants that the Motor City’s experience, as well as that of Stockton, Ca., could be emblematic of more systemic problems: “While these particular bankruptcy filings have captured a considerable amount of attention, and rightly so, they may foreshadow more widespread problems than what might be implied by current bond ratings…We need to focus our attention today on addressing the underlying issues before any problems grow to the point where bankruptcy becomes the only viable option: state and local governments have enormous financial obligations, as well as critical service delivery responsibilities. Managing their liabilities in such a way as to ensure that these vital services continue to be provided, and citizens’ view[s] that they are getting appropriate value in exchange for their taxes is a daunting challenge.”

Fiscal Issues & Challenges for State & Local Leaders

State & Local Finance

On the Downslide. After a rebound to the plus side in February, Kansas revenues again fell below expectations last month, according to state Secretary of Revenue Nick Jordan. Though expectations for the current fiscal year were lowered in November, revenues for March still fell $11.2 million or 2.8% short of projections. Individual income tax receipts beat expectations by $8.7 million, but it was not enough to offset shortfalls in oil and gas severance, corporate income, and sales and use tax receipts, according to Sec. Jordan: Corporate income tax receipts were $8.2 million, or 18%, below expectations, while sales and use tax receipts were $7.8 million short, and oil and gas severance was $5 million lower than expected. In February, state revenues ran $22 million beyond expectations after falling $47.2 million below projections in January. The falling revenues are creating unnerving challenges in the state Legislature to erase a $600 million budget deficit. House Minority Leader Tom Burroughs (D-Kansas City) told the Topeka Capital Journal that sweeping state income tax reductions were marketed by the Republican-led Legislature and Gov. Sam Brownback as a “shot of adrenaline” to the heart of Kansas’ economy, but the Minority Leader likened said “shot” to be more akin to “an ax wound: Kansas continues to bleed revenue as is evident by this month’s numbers…How we resolve this issue remains unknown as the legislative session is nearly over and we haven’t seen a comprehensive balanced budget.” In February, the Kansas City Federal Reserve had reported that business activity moderated significantly during the month, likely related to the West Coast port disruptions as contributing significantly to the weakening. The composite index of 10th District factory sector activity fell to negative 4 in March, the lowest level since June 2013. The composite index is an average of the production, new orders, employment, supplier delivery time and materials inventory indexes. Kansas is rated AA by S&P, with a negative outlook after a one-notch downgrade last August. Moody’s rates the Sunflower State Aa2 with a stable outlook. With about $3.17 billion of tax-supported debt, Kansas’s per capita debt load of $1,112 is above the median of $1,074, according to Moody’s.

How Dry Can it Be? California’s long-running drought has officially reached crisis mode, with Gov. Jerry Brown yesterday ordering statewide water reductions for the first time in he Golden State’s history. Under the Governor’s order, state officials said household rationing will likely be implemented by some local water agencies to meet the new state goal of reducing overall water use in the state by a quarter over the next nine months. To put that herculean task in perspective, that would be the equivalent of enough water for a city of six million people for one year. A key focus will be on those ever so green lawns and other outdoor landscapes, which account for a large amount of water use, according to state officials: the Governor’s orders singled out large campuses, golf courses, and cemeteries as places where restrictions would be mandated. Electronic readings in the Sierra Nevada mountains in the state this week revealed the water equivalent of the snow in the range and other California mountains at 5% of normal―the lowest on record for that date: roughly one-third of the state’s water supplies come from snow that coats its ranges every year—and for which the state’s network of reservoirs was designed to capture the water from the annual spring snow melts; this year, however, those reservoirs are already near half-empty; they are not expected to see much more water. Mark Ghilarducci, Director of the California Office of Emergency Services, yesterday warned: “The situation is unprecedented and critical and requires the action of all hands on deck.” The new orders could have singular impacts on the state’s economy, especially agriculture, where imported water supplies have been cut to zero in some instances. California’s farmers left 400,000 acres of fields unplanted last year, resulting in a loss of 17,000 jobs; they will almost certainly farm even fewer acres this year, according to the state’s Secretary of the California Department of Food and Agriculture, Karen Ross. Gov. Brown’s order targets users that state officials say have not contributed their fair share of conservatism, especially in Southern California, where the concentration of estate-sized homes and golf courses, according to monthly surveys of water use by the State Water Resources Control Board, has been a significant drain, creating an imposing challenge to the Board, which is now charged with implementing the mandatory cuts. Felicia Marcus, chairwoman of the board, which will direct the state’s hundreds of local water agencies to achieve the reductions, notes that those that fail to meet goals may face penalties of up to $10,000 a day.

Should Illinois Cities Have Access to Muni Bankruptcy? Rockford Mayor Larry Morrissey (pictured below) testified this week before the Illinois Legislature that fiscally stressed Illinois local governments should have the option to file for municipal bankruptcy protection: “Simply put, if cities are put in a position where they can’t pay all of their bills, this provision would provide the best way amongst not a lot of good choices…to help cities continue to provide public safety to citizens while protecting our ability to access the financial markets and provide fairness to all creditors.” Mayor Morrissey, who currently serves as a Board Member and Presidents’ Circle Member of the Rockford Area Economic Development Council (RAEDC), not to mention Chairman of the Workforce Investment Board (WIB) and the Rockford Metropolitan Agency for Planning (RMAP), municipal member of the Chicago Metropolitan Mayors’ Caucus, Midwest High Speed Rail Association, and the Congress for the New Urbanism (CNU), stressed his city was not in need of the option. His testimony came during a recent hearing held by the House Judiciary-Civil Law Committee on House Bill 298, sponsored by Rep. Ron Sandack (R-Downers Grove), which would permit Illinois local governments to file for Chapter 9 municipal bankruptcy. Rep. Sandack said his proposed legislation would require municipalities to first demonstrate they truly are insolvent and have made a good faith effort to restructure their debts with creditors: “By sponsoring this bill, I am not encouraging municipalities to abandon efforts to regain financial stability on their own. The bill would simply provide municipalities with an additional tool to help them get their financial affairs in order.” The issue with regard to whether Illinois should amend its laws has gained traction since Governor Bruce Rauner proposed it; now the Judiciary Committee in Springfield has heard from representatives of the public finance community and civic organizations who pressed to make new options available for fiscally stressed municipalities and offered an alternative in the form of a new authority to assist local governments solve fiscal problems without bankruptcy. The proposals, however, have encountered opposition from police and fire unions, with a representative of the firefighter’s union testifying: “Our members provide critical service. It’s very convenient for people to place their woes at the feet of…police and firefighter pensions.” Nevertheless, the issue is becoming more pressing to local elected leaders: Illinois local governments confront big increases in their public safety pension contributions next year thanks to a pre-existing state unfunded mandate to shift to an actuarially required contribution level. The ever insightful and thoughtful Lawrence Msall, president of the Chicago Civic Federation, urged the legislators lawmakers to consider a measure backed by the Federation and developed by one of the nation’s godfathers of municipal restructuring, Jim Spiotto, to create an authority designed to intervene before a city or county’s fiscal strains reached a crisis stage: the quasi-judicial authority would help Illinois local governments deal with pension-related and other fiscal burdens threatening their solvency with a goal to avoid defaults and municipal bankruptcy while putting a government on a sustainable path, testifying: “Bankruptcy is a very dangerous place for us to be heading.” Illinois Finance Authority board Chairman William Brandt stressed the availability of help now through the existing Financial Distressed City Act; he warned of the toll bankruptcy takes on a city or county.
An Extraordinary Challenge to Governance: Local Government Consolidation and Unfunded Mandates Task Force. Every municipal leader is apprehensive about unfunded mandates—be they from the federal government or the state, so it was that one of Illinois Governor Bruce Rauner’s first actions upon taking office was to issue Executive Order 15-15, which created the Local Government Consolidation and Unfunded Mandates Task Force, charged to study “…issues of local government and school district consolidation and redundancy, and to make recommendations that will ensure accountable and efficient government and education in the State of Illinois―” challenges which, in many ways, go to the heart of some of the path-breaking analysis and work done by the Chicago Civic Federation, which has written about the recommendations included in the final report of a previous such commission under former Gov. Pat Quinn, the Local Government Consolidation Commission. Gov. Rauner’s Executive Order names Lieutenant Governor Evelyn Sanguinetti as chair of the Consolidation Task Force and directs that its members shall be appointed by the Governor and represent public and private organizations with additional membership made up of representatives from local governments, school districts, and members of the General Assembly. The Task Force is to make its recommendations to the Governor and General Assembly by December 31, 2015.
Dissolution of Coterminous Townships. Mirroring some of the path-breaking work done last year in Pennsylvania, Illinois State Representative Jay Hoffman recently introduced HB 3693, which would allow the dissolution of the township of Belleville via majority votes by the Belleville City Council and the Belleville Township Board (Belleville Township is coterminous with the City of Belleville), with at least some of the thinking that a consolidation could improve efficiency.

Any Port in a Fiscal Storm? Similarly, Illinois State Representative Elaine Nekritz has introduced HB 3758, which would transfer authority over the Illinois International Port District from the current governing board to the Chicago City Council and permit the Windy City to transfer the District’s open lands to the Forest Preserve District of Cook County and its golf courses to the Chicago Park District. Currently, the Port District is governed by a nine-member board of directors, five appointed by the Mayor of Chicago and four by the Governor of Illinois. In a 2008 report, the Chicago Civic Federation analyzed the Illinois International Port District’s finances and activities, contrasting them with five comparable ports along the Great Lakes – St. Lawrence Seaway. As a result of this investigation, the Federation concluded that the District appeared to be focused on golf, rather than shipping and port operations. (Harborside International Golf Center is the Port District’s only major construction project since 1981.) In contrast, the Federation found that none of the five other ports in the study focus their operations predominantly on recreational activities or entertainment facilities. Port authorities in the other cities derive most of their revenues from activities associated with the normal operations of a port, such as leases, rentals, contracts and grants. The Federation has recommended that the District be dissolved as a result of its findings.

Overcoming Wayne County’s Fiscal Path to Municipal Bankruptcy. Wayne County, Mich. (way down on the lower right) Executive Warren Evans is consolidating various departments and services in what he reports is the first phase of a restructuring to save money for the cash-strapped government―as part of an effort to stave off a fiscal crisis and state takeover of the county, which is on track to become insolvent as early as next summer. Mr. Evans yesterday reported the current reorganization would mean $3 million in general fund savings from various departmental reorganizations that include cutting 50 jobs: among them is the elimination of the Department of Economic Development Growth Engine, with the Michigan Economic Development Corporation taking over economic development for the county. Mr. Evans noted: “There are too many chiefs and not enough Indians.” He added that the county—which abuts and surrounds Detroit, needs to cut $70 million a year to achieve structural balance. Earlier last month he ordered a spending and hiring freeze across the county; he has also ordered $2 million in salary cuts. In February, Mr. Evans announced that the county’s fiscal condition was even grimmer than he had realized before taking office: a new Ernst & Young audit projects the county could run out of cash by August 2016 without major structural changes, showing the county’s operational deficit was higher than expected and, with a chronic structural shortfall, it was quickly burning through its remaining cash. The county for years has run a structural deficit, now projected at $50―$70 million; it has an accumulated deficit of roughly $161 million, and a pension plan with a funded status that has dropped to 45% from 95% ten years ago. A debt restructuring, state takeover, and even municipal bankruptcy are all on the table. Wayne County lost its last investment-grade ratings shortly after that, when S&P downgraded it into junk territory in mid-February. Moody’s dropped it into speculative territory in early February. Fitch Ratings, which already had junk ratings on the credit, downgraded it to B from BB-minus and kept the rating on negative watch in mid-March.

State Tax Expenditure Accountability. The fastest growing portion of the federal debt and budget comes from federal tax expenditures or breaks—federal expenditures which affect the federal deficit, but are not subject to the authorization and appropriations actions which govern federal assistance to state and local governments. They resemble a back door, secret way of spending that is outside the radar screen. Such budgeting unaccountability is not, however, limited just to the federal government: it has become an ever increasing feature of states. But maybe that will begin to change: Last month, Alabama State Senator Bill Hightower (R-Mobile) was successful in getting the Senate to unanimously pass his bill (SB 119) to require the state’s Legislative Fiscal Office to submit an annual tax expenditure report detailing the state’s tax incentives, credits, deductions, and exemptions—and estimating the costs associated with each. As David Brunori wrote this week: “In most states, the tax incentives are shrouded in mystery—there is little knowledge of who gets what. As a result, there is little accountability. For Alabama to consider adoption of a measure that would shed light on the practice is significant.” At the federal and state level, unsurprisingly, a disproportionate percentage of tax expenditures subsidize those least in need of state or federal subsidies.

As we observe the changing economy—what with the sharing economy, the impact of the internet on work hours and locations, we can anticipate it will lead to profound changes in transportation and housing. Because the internet is permitting more people to work from anywhere, anytime, the old model of cities and suburbs is becoming increasingly obsolete.
The Disruptive, but Sharing Economy: What’sApp? There was a time when we could connect two tin cans with string and sort of communicate, but now messaging services are exploding, with Facebook this week announcing at a conference in San Francisco that it has begun to convert its Messenger service into a “platform” that can carry, and be integrated with, all kinds of apps created by other software firms. So Facebook Messenger, which is itself an app for smartphones that run on Apple’s iOS and Google’s Android operating systems, will then be competing with those operating systems’ services for buying apps and downloads. According to Flurry, a market-research firm, the total number of users grew by more than 100% last year—that is, such phenomenal growth that texting seems on the wane, and now we have a surge of new messaging apps: In fact, according to the Economist, the ten biggest messaging apps, which include KakaoTalk, Viber, and WeChat, now include more than 3 billion users, with WhatsApp, the leader, boasting 700 million. Indeed, with the explosion, it appears the phenomenon will not be limited to just numbers, but also specialization: Snapchat snapped us to attention with its ability to enable the exchange of photos that disappeared in the wink of a blink; Secret, Whisper, and Yik Yak allow users to remain anonymous; Telegram incorporates strong encryption (creating apprehensions for police departments and national security services; FireChat works without cellular service: users’ phones communicate directly. WhatsApp handled more than seven trillion messages last year, about 1,000 per person on the planet. Across the pond in Merry Olde England, users spent as much time on WhatsApp as on Facebook’s social-networking app, according to Forrester, whilst in China subscribers to WeChat are estimated to use the app for about 1,100 minutes a month on average. Now the momentum seems to be moving to the corporate sector: Slack, a messaging service which works on both smartphones and personal computers, seems to be succeeding where other attempts to create “corporate social networks” have failed: it is replacing e-mail as the main communications channel inside firms, and claims that among its half a million users, they typically spend 135 minutes each working day on the service and altogether send 300 million messages a month—indeed, such a volume that the firm divides its communications into “channels,” each dedicated to a project or a team: users can create and subscribe to such channels, exchange messages, post links, and upload files—all of which are saved. Besides reducing the time everyone spends handling e-mail, the channels also help new employees to get up to speed quickly, instead of starting with an empty inbox. It is not clear, yet, whether states and local governments are using Slack—much less competing upstarts, such as Quip and HipChat, which offer similar features, but it is clear the Silicon Valley is paying attention: Cisco, a maker of networking gear, recently launched a service called Spark, which lets users switch to voice and video communication if needed; IBM will soon follow suit with Verse, a web-based e-mail service which lets users exchange instant messages, but also employs the firm’s artificial-intelligence engine, Watson, to sort messages and even reply, to reduce the communication burden.

Driving States Crazy. The National Association of Insurance Commissioners State regulators (NAIC) this week most helpfully provided insights into one of the significant new challenges in state and local governance in the sharing economy: insurance. NAIC approved a white paper for state legislators and regulators on insurance issues involved in what it calls “transportation network companies,” or TNC’s. The issue matters, because most current auto insurance policies exclude coverage involving the transport of passengers for a fee. But with the rise of Lyft, Uber, and other TNC’s which arrange transportation for a fee using a technology platform such as mobile application app or website, TNCs create online apps which connect riders and drivers, but the TNC terms and conditions generally indicate that TNC’s are not the transportation providers and, ergo, disclaim the safety of the driver among other disclaimers and notices. Thus, while TNC’s do, as a rule, have driver requirements, such as minimum age limits, valid driver’s licenses, current vehicle registration and insurance, at a minimum; there is apprehension with regard to insurance coverage, because ride-sharing drivers “use personal cars for that commercial activity, but do not have commercial auto insurance.” Participating drivers get some commercial coverage from both Uber and Lyft, but NAIC warns state legislators and other state and local policy makers there can still be coverage gaps which could affect the driver, the vehicle, and—perhaps most critically, the child or adult passenger—whether it be from an accident, or some kind of errant behavior by a driver. Personal automobile policies generally do not provide coverage when a car is used to provide transportation services for pay; indeed, some insurers believe that using a covered car thusly is grounds for cancellation at any time, according to the NAIC report. Commercial coverage, however, could be prohibitively expensive. Among insurers trying to fill the gap, USAA in February began a pilot program in the Mile High State offering specialized coverage for ride-sharing drivers. USAA said the coverage would add about $6 to $8 a month to policyholders’ bills; it now plans to extend the program to Texas in May. Geico currently offers ride-sharing coverage in Maryland and Virginia; MetLife is in Colorado. Last week, Uber said it and Lyft had reached an agreement with a number of major insurers and insurance industry associations on a model bill for state legislative action which is intended, they say, to address coverage gaps.

Driving Rents Crazy. Airbnb, the sharing service for short-term accommodations, has long been criticized for driving up apartment rents in cities and counties. Now, new research, commissioned by Airbnb by the University of British Columbia, appears to contradict that apprehension, indicating that Airbnb pushes up rents only slightly in some major cities across the country. The contretemps has arisen out of apprehension that people who lease apartments and rent them out to tourists through Airbnb are willing to pay more rent, driving up prices for everyone else and that landlords and ladies put units on Airbnb themselves instead of renting them, decreasing the supply of long-term rentals. However, research by Thomas Davidoff, an assistant professor at the Sauder School of Business, has undercut some of those fears. Mr. Davidoff determined, for example, that in the Big Apple, Airbnb increases the price of a one-bedroom unit by about $6 a month. In San Francisco, he determined that it increases rents by, on average, about $19 a month.
State & Local Leader of the Week

State & Local Leader of the Week. Christopher Lockwood, the Executive Director of the Maine Municipal Association for the past 36 years has announced his retirement effective this August. In a state comprised of many very small municipalities, Lockwood and MMA cast a long shadow not only in Maine state governance, but across the country. Mr. Lockwood engineered a significant growth in membership in MMA with 487 of the 492 Maine municipalities now as members. Much of that was accomplished by developing and delivering an array of programs making local policy makers and municipal employees able to focus on delivering high quality services to their constituents at affordable costs. When the Brookings Institution embarked on a lengthy research project “Charting Maine’s Future―An Action Plan for Promoting Sustainable Prosperity and Quality Places,” most assumed that one of the key findings would be the need for local government consolidation and calls for municipal efficiencies. Instead, when in 2006 the Report was issued, it instead stated “[f]or its part, local government appears rather frugal by comparison to national and rural-state norms.” Mr. Lockwood and his staff worked tirelessly supporting the research project and providing proof that small government governed through direct democracy can be among the most efficient forms and sizes of government. Over his tenure, Lockwood guided municipal participation in a series of citizen initiatives concerning the state-local revenue structure. MMA led the fight against local tax caps and even initiated its own referendum by challenging the actions of the state legislature which had diverted state funds pledged to reduce the property tax burden. They were so successful in these initiative struggles that they were sued to preclude them from lobbying and participating in such efforts. In what will be become a landmark decision, MMA proved that it – and governments and government associations across the country – are legally capable of such legitimate expression of government speech. Chris also took very seriously the MMA role in national government, through his active participation in the National League of Cities and directly with the Maine Congressional delegation. He will be sorely missed by his constituents in Maine and his compatriots across the country.

Double Your Pension. The Scranton Times-Tribune this week reports that the federal government has joined in the investigation into double pensions awarded to Scranton’s non-uniform workers, according to two people familiar with the probe. Joseph Schimes, a retired employee who waged a successful battle to qualify for the extra compensation, said he was interviewed Monday by a state police trooper and an FBI agent. The state/federal inquiry came in the wake of pension board officials discovering seven people were granted excess benefits, despite the fact they did not have 25 years of service as of Dec. 31, 2002, which was required to qualify for the incentive. According to Mr. Schimes: “They wanted to get information regarding the procedures that were followed.” The criminal investigation began in February after pension board solicitor Larry Durkin contacted state police based on questions that arose during his review of documents. The Pa. inquiry is among three investigations underway: Pennsylvania State Auditor General Eugene DePasquale’s office is also investigating the cases, as is Scranton’s composite pension board.

Politics & Public Pension Investments. While most of the attention to stat6e and local pension problems focuses on insufficient state or local contributions, James Bacon, Tuesday, in his Bacon’s Rebellion Blog, looks at the ticklish issue of politically motivated pensions: “State pension plans that manage their own U.S. equity investments tilt their portfolios to stocks located within their state. Amazingly enough, the in-state stocks tend to outperform the overall stock holdings ‘by a wide margin,’ conclude the authors of ‘The In-State Equity Bias of State Pension Plans,’ published by the National Bureau of Economic Research. The reason, they suggest, is that investing in companies close to home confers an informational advantage.” Mr. Bacon writes that the Virginia Retirement System is one of the 27 pension plans included in the study, although he noted that the paper did not break out the VRS’s performance, so there is no way for readers to know if “the pension system hewed to the general rule or was an exception from it.” But he did write: “The authors found evidence of political influence in the stock-selection process. But get this — ‘these politically motivated within-state holdings yield excess returns for the pension fund.’ The authors concluded that their results are ‘broadly consistent with the importance of networking in fund management.’” Tongue in proverbial cheek, he concluded: “My naive faith in the corruption of the system is shaken. Whatever happened to good old-fashioned cronyism, payola and screwing the public?”

Ethics & Public Trust
From the Richmond Times Dispatch: “Successful government relies on trust. The breakdown of comity at all levels reflects the citizenry’s lack of confidence in institutions and individuals. Washington’s woes are well documented. Local jurisdictions suffer self-inflicted damage as well.”

Federalism & Ethical Behaviors. U.S. Sen. Robert Menendez (D-N.J.) has been indicted on 14 federal corruption charges, including allegedly accepting hundreds of thousands of dollars in improper gifts and campaign contributions as bribes in exchange for using his office to help a close friend and donor. The 68-page indictment against Sen. Menendez was handed down by a federal grand jury in Newark yesterday afternoon. It includes eight counts of bribery against Sen. Menendez, as well as allegations of honest services fraud, violating the Travel Act and making false statements. Also indicted was Dr. Salomon Melgen, a longtime Menendez friend and close associate. The two men had been at the center of a lengthy criminal probe by the Justice Department and FBI. For this author, it brings back sad memories of the indictment and conviction of former U.S. Senator Pete Williams, for whom I served as an assistant counsel on the U.S. Senate Housing & Community Development Subcommittee. Sen. Williams was convicted on May 1, 1981, on nine counts of bribery and conspiracy for promising to use his office to further a business venture in which he had a hidden interest. He was fined $50,000 and sentenced to three years in prison, which he served at a minimum-security federal prison in Allenwood, Pa. It is characteristic of the former Senator that he devoted much of his time in prison to training minority prisoners how to take apart and put together truck engines—so that they would have meaningful employment opportunities after their releases.

Little Legalities

Can a Municipal Employee Run for Office? The Fifth Circuit this week affirmed the dismissal by the lower court of a challenge by Micah Phillips, a former 12-year veteran of the Dallas Fire Department, who had announced his candidacy in the Democratic primary for a seat on the Dallas County Commissioners Court. At that time, the city’s ordinance (as does Dallas County’s) barred city employees from seeking office in any county overlapping the city of Dallas [“If any employee of the city becomes a candidate for nomination or election to any elective public office within Dallas County; or elective public office in another county within the state, having contractual relations with the city, direct or indirect; or any elective public office that would conflict with his or her position as an employee of the city, the employee shall immediately forfeit his or her place or position with the city.”] The City subsequently terminated Mr. Phillips for violating those laws. In this suit, dismissed on the pleadings by the district court, Mr. Phillips challenged those laws both facially and as applied to him. Addressing Phillips’s as-applied challenge to the City’s Charter, the court first considered whether Phillips’s candidacy amounted to speech on a matter of public concern (that is, whether he maintains a First Amendment interest in his candidacy), and second whether that alleged interest is outweighed by the City’s interest in limiting its employees’ political ambitions, finding that: “[We hold today, in harmony with those decisions, that candidacy alone constitutes speech on a matter of public concern.” Satisfied that Phillips’s candidacy touched on a matter of public concern, the court then turned to an evaluation whether his interests are outweighed by those of the City. “Put simply,” the court wrote, simply, the “governmental interest in fair and effective operation of the…government justifies regulation of partisan political activities of government employees.” Phillips v. City of Dallas, 5th U.S. Circuit Court of Appeals, No. 14-10379, March 27, 2015.

Challenging State Tax Regulations. In a divided opinion, the U.S. Supreme Court, in a case important to online retailers in the Mile High State, this month addressed the Tax Injunction Act—deciding upon a narrow interpretation of the federal law to cases that directly affect assessment, levy, or collection—but one that could have significant repercussions for challenges to state tax regulations. Importantly, in Justice Ginsburg’s concurrence, she framed the issue around the precedent of “state-revenue-protective moorings,” framing the question before the court to be “whether the [Tax Injunction Act] was intended to insulate state tax laws from constitutional challenge in lower federal courts even when the suit would have no negative impact on tax collection,” effectively limiting the federal law to cases that directly affect assessment, levy, or collection—but which could significantly open the door to challenges to challenging state tax regulations. Direct Marketing Association v. Brohl, U.S. Supreme Court, No. 13-1032, March 3, 2015.