Are American Cities at a Financial Brink?

eBlog, 1/13/17

Good Morning! In this a.m.’s eBlog, we consider the ongoing fiscal and physical challenges to the City of Flint, Michigan in the wake of the disastrous state appointment of an Emergency Manager with the subsequent devastating health and fiscal subsequent crises, before turning to a new report, When Cities Are at the Financial Brink” which would have us understand that the risk of insolvency for large cities is now higher than at any point since the federal government first passed a municipal bankruptcy law in the 1930’s,” before briefly considering the potential impact on every state, local government, and public school system in the country were Congress to adopt the President-elect’s proposed infrastructure plan; then we consider the challenge of aging: what do longer lifespans of city, county, and state employees augur for state and local public pension obligations and credit ratings?

Not In Like Flint. Residents of the City of Flint received less than a vote of confidence Wednesday about the state of and safety of their long-contaminated drinking water, precipitated in significant part by the appointment of an Emergency Manager by Governor Rick Snyder. Nevertheless, at this week’s town hall, citizens heard from state officials that city water reaching homes continues to improve in terms of proper lead, copper, alkaline, and bacteria levels—seeking to describe Flint as very much like other American cities. The statements, however, appeared to fall far short of bridging the trust gap between Flint residents and the ability to trust their water and those in charge of it appears wide—or, as one Flint resident described it: “I’m hoping for a lot…But I’ve been hoping for three years.” Indeed, residents received less than encouraging words. They were informed that they should, more than 30 months into Flint’s water crisis, continue to use filters at home; that it will take roughly three years for Flint to replace lead water service lines throughout the city; that the funds to finance that replacement have not been secured, and that Flint’s municipal treatment plants needs well over $100 million in upgrades: it appears unlikely the city will be ready to handle water from the new Karegnondi Water Authority until late-2019-early 2020. The state-federal presentation led to a searing statement from one citizen: “I’ve got kids that are sick…My teeth are falling out…You have no solution to this problem.”

Nevertheless, progress is happening: in the last six months of water sampling in Flint, lead readings averaged 12 parts per billion, below the federal action level of 15 ppb, and down from 20 ppb in the first six months of last year. Marc Edwards, a Virginia Tech researcher who helped identify the city’s contamination problems, said: “Levels of bacteria we’re seeing are at dramatically lower levels than we saw a year ago.” However, the physical, fiscal, public trust, and health damage to the citizens of Flint during the year-and-a-half of using the Flint River as prescribed by the state-appointed Emergency Manager has had a two-fold impact: the recovery has been slow and residents have little faith in the safety of the water. Mayor Karen Weaver has sought to spearhead a program of quick pipeline replacement, but that process has been hindered by a lack of funding.

State Intervention in Municipal Bankruptcy. In a new report yesterday, “When Cities Are at the Financial Brink,” Manhattan Institute authors Daniel DiSalvo and Stephen Eide wrote the “risk of insolvency for large cities in now higher than at any point since the federal government first passed a municipal bankruptcy law in the 1930’s,” adding that “states…should intervene at the outset and appoint a receiver before allowing a city or other local government entity to petition for bankruptcy in federal court—and writing, contrary to recent history: “Recent experiences with municipal bankruptcies indicates that when local officials manage the process, they often fail to propose the changes necessary to stabilize their city’s future finances.” Instead, they opine in writing about connections between chapter 9, and the role of the states, there should be what they term “intervention bankruptcy,” which could be an ‘attractive alternative’ to the current Chapter 9. They noted, however, that Congress is unlikely to amend the current municipal bankruptcy chapter 9, adding, moreover, that further empowering federal judges in municipal affairs “is sure to raise federalism concerns.” It might be that they overlook that chapter 9, reflecting the dual sovereignty created by the founding fathers, incorporates that same federalism, so that a municipality may only file for chapter 9 federal bankruptcy if authorized by state law—something only 18 states do—and that in doing so, each state has the prerogative to determine, as we have often noted, the process—so that, as we have also written, there are states which:

  • Precipitate municipal bankruptcy (Alabama);
  • Contribute to municipal insolvency (California);
  • Opt, through enactment of enabling legislation, significant state roles—including the power and authority to appoint emergency managers (Michigan and Rhode Island, for instance);
  • Have authority to preempt local authority and take over a municipality (New Jersey and Atlantic City.).

The authors added: “The recent experience of some bankrupt cities, as well as much legal scholarship casts doubt on the effectiveness of municipal bankruptcy.” It is doubtful the citizens in Stockton, Central Falls, Detroit, Jefferson County, or San Bernardino would agree—albeit, of course, all would have preferred the federal bailouts received in the wake of the Great Recession by Detroit’s automobile manufacturers, and Fannie Mae and Freddie Mac. Similarly, it sees increasingly clear that the State of Michigan was a significant contributor to the near insolvency of Flint—by the very same appointment of an Emergency Manager by the Governor to preempt any local control.

Despite the current chapter 9 waning of cases as San Bernardino awaits U.S. Bankruptcy Judge Meredith Jury’s approval of its exit from the nation’s longest municipal bankruptcy, the two authors noted: “Cities’ debt-levels are near all-time highs. And the risk of municipal insolvency is greater than at any time since the Great Depression.” While municipal debt levels are far better off than the federal government’s, and the post-Great Recession collapse of the housing market has improved significantly, they also wrote that pension debt is increasingly a problem. The two authors cited a 2014 report by Moody’s Investors Service which wrote that rising public pension obligations would challenge post-bankruptcy recoveries in Vallejo and Stockton—perhaps not fully understanding the fine distinctions between state constitutions and laws and how they vary from state to state, thereby—as we noted in the near challenges in the Detroit case between Michigan’s constitution with regard to contracts versus chapter 9. Thus, they claim that “A more promising approach would be for state-appointed receivers to manage municipal bankruptcy plans – subject, of course, to federal court approval.” Congress, of course, as would seem appropriate under our Constitutional system of dual sovereignty, specifically left it to each of the states to determine whether such a state wanted to allow a municipality to even file for municipal bankruptcy (18 do), and, if so, to specifically set out the legal process and authority to do so. The authors, however, wrote that anything was preferable to leaving local officials in charge—mayhap conveniently overlooking the role of the State of Alabama in precipitating Jefferson County’s insolvency.  

American Infrastructure FirstIn his campaign, the President-elect vowed he would transform “America’s crumbling infrastructure into a golden opportunity for accelerated economic growth and more rapid productivity gains with a deficit-neutral plan targeting substantial new infrastructure investments,” a plan the campaign said which would provide maximum flexibility to the states—a plan, “American Infrastructure First” plan composed of $137 billion in federal tax credits which would, however, only be available investors in revenue-producing projects—such as toll roads and airports—meaning the proposed infrastructure plan would not address capital investment in the nation’s public schools, libraries, etc. Left unclear is how such a plan would impact the nation’s public infrastructure, the financing of which is, currently, primarily financed by state and local governments through the use of tax-exempt municipal bonds—where the financing is accomplished by means of local or state property, sales, and/or income taxes—and some user fees. According to the Boston Federal Reserve, annual capital spending by state and local governments over the last decade represented about 2.3% of GDP and about 12% of state and local spending: in FY2012 alone, these governments provided more than $331 billion in capital spending. Of that, local governments accounted for nearly two-thirds of those capital investments—accounting for 14.4 percent of all outstanding state and local tax-exempt debt. Indeed, the average real per capita capital expenditure by local governments, over the 2000-2012 time period, according to the Boston Federal Reserve was $724—nearly double state capital spending. Similarly, according to Census data, state governments are responsible for about one-third of state and local capital financing. Under the President-elect’s proposed “American Infrastructure First” plan composed of $137 billion in federal tax credits—such credit would only be available to investors in revenue-producing projects—such as toll roads and airports—meaning the proposed infrastructure plan would not address capital investment in the nation’s public schools, libraries, etc. Similarly, because less than 2 percent of the nation’s 70,000 bridges in need of rebuilding or repairs are tolled, the proposed plan would be of no value to those respective states, local governments, or users. Perhaps, to state and local leaders, more worrisome is that according to a Congressional Budget Office 2015 report, of public infrastructure projects which have relied upon some form of private financing, more than half of the eight which have been open for more than five years have either filed for bankruptcy or been taken over by state or local governments.

Moody Southern Pension Blues. S&P Global Ratings Wednesday lowered Dallas’s credit rating one notch to AA-minus while keeping its outlook negative, with the action following in the wake of Moody’s downgrade last month—with, in each case, the agencies citing increased fiscal risk related to Dallas’ struggling Police and Fire Pension Fund, currently seeking to stem and address from a recent run on the bank from retirees amid efforts to keep the fund from failing, or, as S&P put it: “The downgrade reflects our view that despite the city’s broad and diverse economy, which continues to grow, stable financial performance, and very strong management practices, expected continued deterioration in the funded status of the city’s police and fire pension system coupled with growing carrying costs for debt, pension, and other post-employment benefit obligations is significant and negatively affects Dallas’ creditworthiness.” S&P lowered its rating on Dallas’ moral obligation bonds to A-minus from A, retaining a negative outlook, with its analysis noting: “Deterioration over the next two years in the city’s budget flexibility, performance, or liquidity could result in a downgrade…Similarly, uncertainty regarding future fixed cost expenditures could make budgeting and forecasting more difficult…If the city’s debt service, pension, and OPEB carrying charge elevate to a level we view as very high and the city is not successful in implementing an affordable plan to address the large pension liabilities, we could lower the rating multiple notches.” For its part, Fitch Ratings this week reported that a downgrade is likely if the Texas Legislature fails to provide a structural solution to the city’s pension fund problem. The twin ratings calls come in the wake of Dallas Mayor Mike Rawlings report to the Texas Pension Review Board last November that the combined impact of the pension fund and a court case involving back pay for Dallas Police officers could come to $8 billion—mayhap such an obligation that it could force the municipality into chapter 9 municipal bankruptcy, albeit stating that Dallas is not legally responsible for the $4 billion pension liability, even though he said that the city wants to help. The fund has an estimated $6 billion in future liabilities under its current structure. In testimony to the Texas State Pension Review Board, Mayor Rawlings said the pension crisis has made recruitment of police officers more difficult just as the city faces a flood of retirements.

 

The Import of Accurate Municipal Revenue Projections in Addressing Municipal Insolvency

eBlog, 1/12/17

Good Morning! In this a.m.’s eBlog, we consider the ongoing challenges to Detroit’s long-term recovery from the nation’s largest chapter 9 municipal bankruptcy, before turning to the small Virginia municipality of Petersburg as it struggles to not just avoid bankruptcy, but rather to right its ship of state—both by its elected and appointed leaders.

Detroit Coming Back. Detroit, as we noted in our original report on the city, is quite different than most U.S. municipalities and, indeed, from other cities in Michigan in that its revenues, from taxes and state-shared revenues are higher than those of any other large Michigan municipality on a per capita basis, in part reflecting its reliance on a significantly broader tax base than most cities in the country: property taxes, income taxes, utility taxes, casino wagering taxes, and state-shared revenues. The property tax accounted for 13.3 percent of Detroit’s revenues in 2012, even though the city had the highest property taxes among big cities in the U.S. But it was the 22 percent decline in those revenues over the decade preceding its collapse into the nation’s largest-ever chapter 9 bankruptcy that appeared to precipitate the state takeover via the appointment by Governor Rick Snyder of an emergency manager to steer the city into—and then out of chapter 9 municipal bankruptcy. The exhaustion of the city’s revenues reflected the overall loss of 15,648 business establishments between 1972 and 2007—that is, even before the massive impact of the Great Recession, or the bankruptcies and subsequent recovery of General Motors and Chrysler and the restructuring of the automotive supplier network—companies bailed out by the federal government, unlike Detroit.

Today, still, despite its lower reliance on property tax revenues, the track of those revenues can reflect the city’s fiscal direction. Indeed, the city’s housing market faces numerous challenges as the city seeks to carve out a path toward less blight, increased housing preservation, and a better functioning residential mortgage market. Zillow reports that median sale prices for metro Detroit homes and condominiums rose 7.2 percent last month compared to the year before: the median home value in Detroit is $37,000, reflecting home values which have gone up even more, by 8.5% over the past year, according to Zillow, which predicts they will rise 4.2% within the next year. At the same time, the percent of Detroit homeowners underwater on their mortgages is 0.4%, some four times higher than Detroit Metro area; the median rent price in Detroit is $750, or about 75% of the Detroit Metro median of $1,050; nevertheless, sale prices across the city have continued to grow, while both the number and share of underwater loans has continued to decline. The average household equity for all Detroit loans reached 29 percent in Q4 2015; the shares of loans in serious delinquency, foreclosure, or REO (property owned by a lender—typically a bank, government agency, or government loan insurer—after an unsuccessful sale at a foreclosure auction) in Detroit are on pace to fall below pre-crisis levels. The data demonstrate a particularly sharp decline in the share of REOs.

However, sales of single family homes in the city in 2015 (about 18,522) dropped about 18% from the previous year, even as Detroit’s median rent stabilized at around $756 a month in December 2015. Unemployment fell again in the early months of last year, and labor force size edged up as well, according to the Detroit Housing Tracker (the Detroit Housing Tracker monitors the latest development in the Detroit housing and community development arena and is updated quarterly: the publication has two sections in which it presents comprehensive market indicators including sales prices and volumes, rental prices, household equity level, delinquencies and foreclosures.) In comparison, in the surrounding four-county area of Oakland, Wayne, Macomb, and Livingston counties, median sale prices jumped from $149,200 in December 2015 to $159,900 in December 2016. According to Realcomp Ltd. II, last month’s figures fall in line with the general trends of 2016: the number of on-market listings in the four-county region last month declined nearly 43 percent year-over-year, from 19,634 to 11,255; however, sales prices in all four of the surrounding counties increased, on average, by 10%.

In Overtime. The city of Petersburg, Virginia added another hefty bill to its payment list after a class-action lawsuit (Thomas Ewers, et al, vs. the City of Petersburg Bureau of Police) between members of the Bureau of Police and the city was settled last week, with the settlement agreement mandating the virtually insolvent municipality to make a payment of $1.35 million in recompense for law enforcement officers’ unpaid overtime. Of that amount, the City of Petersburg will have to pay $800,000, while the Virginia Division of Risk Management will chip in the remaining $550,000. For its part, Petersburg city spokesman Clay Hamner this week reported that that part of Petersburg’s payment is expected to come via a short-term $6.5 million loan secured by Petersburg from Wells Fargo last month; other funds could potentially come from the sale of the city’s municipal water and wastewater assets—especially in the wake of an unsolicited purchase proposal last month by Aqua Virginia, Inc., leading the city to advertise for competing bids. According to the city’s press release, the settlement applies to all current and former law enforcement officers employed between Jan. 11, 2013 and June 24, 2016, by the Bureau of Police at the rank of lieutenant or below who were denied overtime or other wage-related payments. The settlement came as the city’s expensive fiscal turnaround consultants reported the city’s fiscal condition remains, reporting that the fiscal plan Petersburg has been working from since the City Council’s first attempt to strip $12 million from an outsized budget last September no longer reflects its fiscal realities: some elements of those decisions, such as slashing funding for schools, canceling a youth summer program, and boosting trash fees, would provide savings; however, not every plan materialized, according to the consultant’s analysis. Moreover, when combined with the municipality’s past-due payments to companies taken from the current year’s budget for last year’s bills, the consultant’s reported the Council, next week, will likely be forced to take further actions to reduce spending or find other revenues—and will have to include a partial restoration of a 10 percent reduction in municipal worker salaries targeted toward making whole the city’s public safety workers, with Nelsie Birch, Petersburg’s interim finance director, advising: “The reduction of salaries has done significant damage to the city.”

It seems that the employee turnover and overtime costs have soared even as morale plummeted since the austerity measure was implemented: police, firefighters and emergency communications workers would see their pay rates restored this spring if the council approves the consultant’s plan. That would be important: the city’s violent crime rate is nearly 400% higher than the statewide average. On the upside, the consultant reported that of the $18.8 million that state auditors estimated Petersburg owed to vendors as of last July 1, only $6 million to $7 million remains overdue. That might help as, next month, the city is inviting about 400 of its creditors to meet for discussions relating to past-due bills, and inviting interested buyers to consider purchasing city-owned property—with both city employees and the city’s consultants taking inventory: counting cars, combing through old equipment, and tracking every nickel spent for a dime that could be saved. The consultant addressed one key issue of concern: its current inability by its tax assessors and collectors to provide administrators with accurate revenue projections.

At the same time, the consultants expressed apprehension that city council members must learn to demand that expenses not exceed revenues: in the municipality’s FY2016 books, Petersburg had a $9 million structural imbalance in the general fund used to cover the city’s day-to-day operations: the city had $67 million to work with and spent $76 million. Finally, the consultant noted what he believes to be the source of Petersburg’s fiscal crisis: for too many years (dating back to 2009) the city has spent more than it had, propping up shortfalls from a rainy day fund which had long since evaporated. In response, interim City Manager Tom Tyrrell said the Mayor and Councilmembers could meet with officials one-on-one or in pairs to discuss the details ahead of next week’s votes to balance the current year’s budget—with such sessions not triggering Virginia’s Freedom of Information Act. Under the law, an in-person or electronic meeting of three members of a public body constitutes a quorum.

How Can Learning from the Past Enrich the Fiscal Future?

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eBlog, 1/11/17

Good Morning! In this a.m.’s eBlog, we consider the post-election, post-chapter 9 governing future for Stockton, before heading to the wintry streets of Detroit, where the transfer of authority and governance of the Detroit Public Schools from state back to local control in the wake of the system’s previous physical and fiscal insolvency will make for a steep learning curve—but where getting it right will be invaluable for Detroit to have a sustainable fiscal future.

A New Post-Bankruptcy Beginning. A ceremony in the heart of downtown Stockton this week marked the beginning of a new era in post-bankrupt Stockton’s municipal governance with the swearing-in of Mayor Michael Tubbs and City Council members Jesaos Andrade, Susan Lenz, and Dan Wright.  Mayor Tubbs had chosen his grandmother, Barbara Nicholson to ceremonially swear him in—after, five years ago, being sworn in by his mother in the wake if his first election to the city council in November 2012. The City’s spokeswoman, Connie Cochran, said the election of Mayor Tubbs, the youngest mayor ever in a large American city and Stockton’s first black mayor, continues to receive national media attention. Mayor Tubbs appointed City Councilman Elbert Holman as his Vice Mator, replacing the previous Vice Mayor, District 5 Councilwoman Christina Fugazi, stating: “[Ms.] Holman is an exemplar of a public servant, whose experience as a law enforcement professional and 8 years of service as a councilmember will serve the city well…” adding: “I look forward to the work we will do together. We have a unique opportunity to make a real difference in our All-America City.”

Detroit’s Future Academic Solvency. Michigan Senate Education Committee Chairman Phil Pavlov (R-St. Clair) yesterday called for the repeal of the state’s so-called “failing schools” law, with his call coming as Gov. Rick Snyder’s administration is completing plans to shut down some chronically underperforming schools. Chairman Pavlov said the “goal posts” for struggling schools have too often moved under existing state law, which was developed under what he called a “heavy-handed” federal education policy that has changed considerably in recent years. At the same time, Michigan has adopted a new standardized test for students. Thus, Chairman Pavlov said the School Reform Office has used multiple “accountability measurement systems” for schools that land on the lowest-performing list, noting: “These districts don’t know how the data is going to be used, and so it’s creating a lot of confusion.” Stating that academic failure “must not be tolerated,” the Chairman told his colleagues that the current process for addressing the system’s failures is “deeply flawed,” and warned it has caused “great anxiety” for education officials across the state—as he announced plans to introduce a repeal bill today when the session resumes with the first day of the new two-year session, so that he can help initiate a public conversation over a potential replacement law. Nevertheless, the Senator stopped short of recommending the Governor halt any planned school closures, adding he wants the Governor’s office to be a “partner” in developing a replacement—even as he warned the law has created “confusion among all the parties that are administering this, including the school districts…We heard an announcement last August that up to 100 schools could be closed…Well, what is the process and how do you get to that point? I’m not interested in protecting schools that can’t deliver, but we have to have something everybody understands, metrics people can work toward for achievement and not be subject to on-the-spot discretion.”

Under the state’s current law, Michigan created a process by which the state has authority to close schools which perform among the state’s bottom 5 percent—or the state can mandate another form of intervention, such as the appointment of a chief executive officer. Finally, of course, the Governor can invoke the state’s notorious Emergency Manager law to appoint, as Gov. Snyder has done for the Detroit Public Schools (DPS)—where, as we have reported—in the wake of such appointments, the last being the recently retired former U.S. Bankruptcy Judge Steven Rhodes—an appointment which the state followed with last year’s $617 million state bailout of DPS with new state law which mandates the Michigan School Reform Office to force closure of any city schools which make the list three years running unless it would “result in unreasonable hardship to the pupils.”

Demonstrating how challenged DPS is, of the 124 Michigan schools which fell in the bottom 5 percent for academic performance last year, 47, or more than one-third, were DPS schools. (The Michigan Department of Education will release a new top-to-bottom list of academic performance by the end of this month, after which Michigan School Reform Officer Natasha Baker will subsequently lead a review of the bottom 5 percent of schools.) Getting the schools up to snuff matters: The current median household income for Detroit is $53,628: real median household income peaked in 2005 at $61,638 and is now $8,010 (13.00%) lower; nevertheless, from a post peak low of $51,606 in 2011, real median household income for Detroit has now grown by $2,022 (3.92%). Thus, continued progress in school improvement is likely to be telling in terms of attracting families with kids from the city’s suburbs and creating a fiscal foundation for Detroit’s future. 

New Governance. The events in Lansing come even as school governance is set to revert from state to local control, with a big crowd anticipated—notwithstanding brutal winter weather—tonight to attend Detroit’s first fully empowered school board in seven years—where the new board will elect officers, set bylaws, and hear a presentation from the interim superintendent. , according to meeting agendas posted online. Thus, even as the new session of the Legislature is meeting, the new school board in Detroit will confront the challenge of trying to shore up—fiscally and educationally—a 45,000-student district which has been in fiscal, physical, and governing turmoil for years under state control. Now, in the wake of last June’s $617 million state bailout and financial restructuring of DPS, the stakes are high for the Detroit Public Schools Community District. Indeed, new DPS board member Deborah Hunter-Harvill likely hit the nail on the head when, last evening, she said: “I’ve been engaging in dialogue and activities with six very astute individuals that seem to care a whole, whole lot about children…I know that this could be the last chance we have to get it right. We will be focusing on that.”

Municipal Challenges from State Control & Preemption of Local Authority

 

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eBlog, 1/0917

Good Morning! In this a.m.’s eBlog, we consider more outcomes from the Flint drinking water crisis—outcomes which raise issues with regard to the State of Michigan’s Emergency Manager law—and accountability, before taking a run to Atlantic City, a municipality in the midst of a state takeover, and, now, apparently caught between state-mandates to reduce police capacity amid an apparent dramatic surge in public safety concerns. Finally, we note a challenge to the Municipal Securities Rulemaking Board’s so-called pay-to-play rules, under which municipal advisors and broker-dealer firms would be mandated to wait two years before doing business with municipal entities to which they have made political contributions.

Out Like Flint. Michigan Gov. Rick Snyder Friday signed into law new state legislation mandating municipalities in the state to warn residents of dangerous lead levels in drinking water within three days’ notification by the state of contamination, marking the enactment of the first piece of legislation stemming from the Flint water crisis. Gov. Snyder described it as an “important step…This is not the last piece of legislation we should see on this. This is a good start of getting faster notification to the public when there is a water issue.” The bill, sponsored by state Rep. Sheldon Neeley (D-Flint), a former Flint council member, is aimed at strengthening water quality control in Michigan to ensure a water crisis such as Flint’s will not happen in a Michigan municipality again, or, as Rep. Neeley put it: “The water crisis in Flint has left the community and its allies reeling with a sense of urgency, and rightfully so…During this difficult time, I have valued the governor’s partnership in helping to steward legislation that will have a positive impact on the residents of Flint.” Previously, owners or operators of municipal water plants were legally required to notify customers of any noncompliance with state drinking water standards, within 30 days, according to the representative; now, under the new law, operators must issue a public advisory within three business days of notification from the Michigan Department of Environmental Quality. Such alerts may be disseminated via radio or television, notices delivered to customers or advisories posted in conspicuous areas throughout the community. The bill had been adopted unanimously in both the Michigan House and Senate. The new state law comes in the wake of criminal charges filed against more than a dozen government officials related to the Flint water crisis. Last month, the Michigan Attorney General’s Office filed criminal charges against former Flint emergency manager Darnell Earley, former emergency manager Gerald Ambrose, and two former city public works employees. Mr. Earley had served as Flint’s emergency manager from 2013-15, before going on to be named by Gov. Snyder as Emergency Manager for the Detroit Public Schools, where he resigned nearly a year ago in the face of severe criticism. Mr. Earley, who had refused to testify about his role and responsibility with regard to the Flint drinking water crisis, was subsequently charged with false pretenses, conspiracy to commit false pretenses, misconduct in office, and willful neglect of duty while in office–charges which carry up to 20 years in prison.

Recent testing of Flint water suggests lead levels have dropped, but residents in the city of roughly 100,000 residents continue to rely on bottled and filtered water for their daily needs.

A City’s Fiscal and Physical Safety. According to a review of crime data by The Press of Atlantic City, the two-decade long decline in crime in Atlantic city has not only halted, but reversed itself in 2015, according to the Press’s review of New Jersey state crime data, reporting that in 2015, crime increased in nearly every major category, including homicides, rapes, and aggravated assaults—with the homicide increase extending into last year. The city’s violent crime rate is more than 500 percent higher than the statewide average—the murder rate a thousand percent—posing a stark governing challenge as, last week, New Jersey’s Local Finance Board, which is managing the city, alerted the city’s police and fire unions that it would press drastic cuts, including reduced staffing and imposing longer shifts. The Board has the authority to hire and fire employees, authorize raises and promotions, renegotiate service and labor contracts, restructure or pay off debt, approve the municipal budget, and make changes with regard to the delivery of municipal services. The state is seeking to force a restructuring of the city’s police department, including salary reductions, higher health care benefit contributions, moving to 12-hour shifts, and a more aggressive police response to nuisance issues in neighborhoods. Nevertheless, Anthony Marino, a retired executive with the South Jersey Transportation Authority, who has studied Atlantic City’s crime figures, reports that crime statistics have been on the wane since a high in 1989 and that the trend shows Atlantic City is, for the most part, a reasonably safe city, noting that in 1977, before the city had casinos, its crime index, or the total number of the seven categories tracked by State Police, was 4,391. In 1989, it peaked at over 16,000 before declining almost annually. Nevertheless, the apparent turnaround—in addition to the state-mandated changes in the city’s police department could not only limit the city’s capacity to address the seeming turnaround, but also adversely affect tourism and assessed property values.

Paying to Play. Tennessee and Georgia Republican groups are challenging the Municipal Securities Rulemaking Board’s (MSRB) so-called pay-to-play rules under which municipal advisors and broker-dealer firms would be mandated to wait two years before doing business with municipal entities to which they have made political contributions (the pay-to-play rule also prohibits an investment adviser from soliciting contributions for a government official or the official’s political party at the same time the adviser is providing services to the government entity for which the official works.). The two political organizations have filed the suits charging that the rules violate their First Amendment rights; in addition, they claim that the Securities and Exchange Commission (SEC) and MSRB exceeded their authority and have not demonstrated a sufficient legal interest in restricting political contributions. In response, the Campaign Legal Center, in its brief to the 6th U.S. Court of Appeals, argues the rules are important to prevent municipal advisors from engaging in pay-to-play practices—and the rules are needed to address the potential for corruption in the municipal market. The amicus brief opposes attempts by the Tennessee Republican Party, Georgia Republican Party, and New York Republican State Committee seeking to have the court vacate the SEC’s approval of the rule changes.

Last summer, the SEC issued notice that it intends to approve the rules proposed by the MSRB and the Financial Industry Regulatory Authority, noting it would issue orders finding that the self-regulatory organizations’ rules impose “substantially equivalent or more stringent restrictions” on municipal advisors and broker-dealers than its own pay-to-play rule. The Center’s brief notes: “Substantial campaign contributions from a municipal advisor to officeholders with control over awards of municipal advisory business are likely to give rise to quid pro quo exchanges, or at a minimum, the appearance of such exchanges…That is the premise not only of the challenged amendments, but also the underlying rule, which was upheld by the D.C. Circuit.” Under the proposed changes to the rule, municipal advisors, like dealers, are barred from engaging in municipal advisory business with a municipal issuer for two years if the firm, one of its professionals, or a political action committee controlled by either the firm or an associated professional, makes significant contributions to an issuer official who can influence the award of municipal advisory business. As proposed, the modified rule contains a de minimis provision, which allows a municipal finance professional associated with a dealer or a municipal advisor professional to make a contribution of up to $250 per election to any candidate for whom she or he can vote without triggering the two-year ban. This is not a first: there was a previous challenge to an earlier version of Rule G-37 by an Alabama bond dealer in Blount v. SEC after it was first approved for dealers in 1994—a challenge which the U.S. Court of Appeals for the D.C. Circuit rejected, noting, in its opinion, the rule had been “narrowly tailored to serve a compelling government interest.”

Governance Insolvency?

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eBlog, 1/0617

Good Morning! In this a.m.’s eBlog, we consider the political and legal turmoil in the insolvent municipality of East Cleveland, before turning to the continued uncertainty with regard to Atlantic City’s future. Then we try to get schooled in the new governance set to commence for Detroit’s public schools, before returning to what appears to be a state of emergency declared this week by the new Governor of Puerto Rico.

Bankrupt Municipal Governance? The insolvent city of East Cleveland is confronted not just with fiscal insolvency, but, increasingly, governance chaos in the wake of the recall of its former Mayor and the city’s Law Director, Willa Hemmons, yesterday issuing a legal opinion that appointments made to the City Council last week were illegal. That opinion was countered late yesterday by East Cleveland Councilwoman Barbara Thomas, who issued a statement contradicting Ms. Hemmons’ opinion that appointments to council made in a December 29th meeting were illegal, writing that not only was there an absence of a quorum, but also the actions were in violation of the city’s charter. The Councilwoman, who represents Ward 2, and Nathaniel Martin, at-large council member, had selected Devin Branch and Kelvin Earby to fill the Ward 3 and at-large seats left open when voters recalled former Council President Thomas Wheeler and Mayor Gary Norton. Ward 4 councilwoman Joie Graham had left the meeting last week during executive session, because she did not agree with the interview process for new members. In response, Councilwoman Thomas, in a statement, claimed she had met with an unnamed attorney and believes that Law Director Hemmons has confused “charter positions which apply to organizational meetings of City Council following a regular election with the procedures Council is required to follow to fill a vacancy on Council.” In addition, the Councilwoman charged the document was improperly served. Thus, she stated: “I am disappointed, because I had hoped that having a new mayor would give us an opportunity for a fresh start and that the administration and Council would work together for the benefit of the citizens of East Cleveland.”

Confused Governance. Meanwhile, in Atlantic City—which has a Mayor and Council and a state appointed Emergency Manager, but which is under a state takeover, Mayor Don Guardian yesterday offered his now unofficial State of the City speech. Unsurprisingly, he listed the numerous challenges facing his city, including a state takeover and hundreds of millions of dollars in debt. Mayor Guardian also requested billionaire investor Carl Icahn to sell the abandoned Trump Taj Mahal Casino, stating the city cannot afford to allow such a critical component of its historic boardwalk to continue vacant indefinitely, deeming such inactions the “the worst of the worst” in terms of outcomes for the property—and the city’s tax rolls. The Tropicana, which was boarded up last October, not only hammered the city’s anticipated property tax revenues, but meant 3,000 people lost their jobs, and, of course, the city lost a key attraction for visitors. Mr. Icahn had shuttered it last fall in the wake of a strike by the casino’s workers’ union. Mr. Icahn, however, responded by saying he would be happy to sell the casino to the insolvent city, but only if the city made Mr. Icahn whole by paying him the $300 million he claims he had lost on his real estate gamble, adding Mayor Guardian was wrong to attack an investor who had previously rescued the city’s Tropicana casino and attempted to do the same with the Tropicana. Prior to last summer’s strike to restore health insurance and pension benefits—which had been terminated in federal bankruptcy court—and the subsequent closure, Mr. Icahn had promised to invest some $100 million into the casino—a promise never kept.

Learning to Govern in the Big D. With the retirement of former U.S. Bankruptcy Judge Steven Rhodes, who had so generously accepted the Governor’s challenge to serve as the Detroit Public School Emergency Manager, Detroit’s newly elected school board is planning a major celebration this month as it will assume control of city schools which have been under gubernatorial-appointed emergency managers for years. Moreover, with the state having creating a dual system of public and charter schools, the governing challenge for these new school board members promises to be daunting. Whom will the newly elected board select to be superintendent? Will a majority vote to file suit to prevent further school closures? How will the new board address the challenge of balancing state-created charter schools versus public schools? How can the new Board create balance so that there can be a smooth transition with long-struggling schools which will rejoin the district this summer?  The seven board members who were elected by Detroit voters in November have been doing some prep learning themselves: they have devoted the last two months in an intensive orientation on Detroit schools, trying to comprehend a complicated district which now serves about 45,000 children in 97 schools—children who will be future civic leaders, but, mayhap more importantly, a school system whose reputation will be critical in determining whether young families with children will opt to move into Detroit—or leave the city.

Extraordinary Governmental Authority & Promising Insurance? In Puerto Rico, Governor Ricardo Rosselló Nevares this week signed a decree which provides him extraordinary authority, similar to those granted a governor in the wake of a natural disaster. The new executive order declares a state of emergency, with the emergency creating a “risk of accelerating capital flight from the territory, putting at risk natural resources, and risking public health and safety.” The new Governor’s actions came as the U.S. territory of Puerto Rico and some of its instrumentalities failed to make municipal bond interest payments this week, Puerto Rico’s largest municipal bond insurer, Assured Guaranty Ltd. subsidiaries, made $43 million of interest payments to holders of insured general obligation and other municipal bonds. The payments came as Puerto Rico’s infrastructure financing authority PRIFA was unable to transfer funds to its bond trustee to pay debt due New Year’s Day on certain tax-exempt bonds, according to a regulatory filing on Tuesday, further confirmation of a default by the U.S. territory. The trustee for PRIFA’s series 2005B and 2006 bonds claimed it had not received sufficient funds from PRIFA for the payment of debt, although it held a small residual amount from prior payments that it allocated to pay interest. In addition, the trustee for its series 2005 C bonds reported it did not receive funds from PRIFA to pay debt service. The territory had said last week that PRIFA would have insufficient funds to make the full payment on its special tax revenue bonds, Series 2005A-C and Series 2006; ergo, $36 million was expected not to be paid. As of midweek, the island’s largest bond insurer, Assured Guaranty Municipal Corp. and Assured Guaranty Corp. had received and processed $43 million of claim notices for missed January 1 payments, out of $44 million of total expected claims, with the expected claims including $39 million of Puerto Rico general obligation payments and $5 million for Puerto Rico Public Buildings Authority payments. In addition, on Tuesday, the Puerto Rico Electric Power Authority made the full interest payment due on its bonds insured by Assured Guaranty; thus, no insurance claims were filed. In a statement, Assured President and CEO Dominic Frederico said: “While the outgoing Puerto Rico administration has once again chosen to violate Puerto Rico’s constitution by ignoring the senior payment priority securing the Commonwealth’s general obligation bonds, we look forward to working with the new administration, PROMESA Oversight Board and other creditors to achieve consensual restructuring agreements that respect the constitutional, statutory, contractual and property rights of creditors while also supporting the island’s economic recovery…We were pleased that PREPA made its bond interest payment, and we continue to join PREPA and the other participating creditors in seeking implementation of the consensual restructuring contemplated by the PREPA restructuring support agreement.” In its release, the company wrote that any obligor where amounts were due but no claims are expected, the payments were made by the obligor from its available funds or reserves, adding that municipal bond investors owning Puerto Rico-related bonds insured by Assured Guaranty will continue to receive uninterrupted full and timely payment of scheduled principal and interest in accordance with the terms of the insurance policies.

Governance in the Face of Fiscal Insolvency

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eBlog, 1/05/17

Good Morning! In this a.m.’s eBlog, we consider the political challenges encumbering the virtually insolvent, historic municipality of Petersburg, Virginia, before turning to the growing judicial disputes with regard to the respective rights and authority of municipal bondholders in Puerto Rico, even as the new administration of Governor Ricardo Rosselló has taken office and the PROMESA oversight board is attempting to get its arms around a long-term fiscal path to resolution.

The Right Fiscal & Governance Direction. Petersburg, Virginia’s City Council Tuesday voted 4-3 to elevate current Vice Mayor Samuel Parham to the position of Mayor—with the action coming amidst critics who have called for the criminal prosecution of the ousted incumbent W. Howard Myers, who had said last week he planned to run for another term—a declaration which appeared to accelerate maneuvering among his colleagues who are seeking to avoid more unrest from citizens unhappy with the city’s decline into near municipal bankruptcy last year. Nevertheless, when the clerk called the question, Mayor Myers nominated Vice Mayor Parham, later describing his action as a step towards much-needed continuity for the city at a critical time, adding that the dissent from his fellow Council members Treska Wilson-Smith, John Hart, and Annette Smith Lee was “horrific” at a time when the city needs to come together to address critical fiscal challenges. He noted: “This reflects poorly on all of us and hurts future opportunities.” The Council selected John Hart to be vice mayor. Both roles are largely ceremonial, but symbolic at a time when Petersburg has been battered by financial challenges. Indeed, good government advocates with the group Clean Sweep Petersburg have been targeting incumbents for removal from office, actively petitioning for their ouster. Nevertheless, new Mayor Parham pledged more transparency during his two-year tenure as mayor and fewer of the type of last-minute special meetings that had evoked such condemnation last November from the American Civil Liberties Union of Virginia. In addition, an organization spokesman has also criticized the city for holding the meeting at noon on a workday at a time when its governance has come under increased scrutiny. In response, council members voted to change the timing of organizational meetings to the half-hour preceding the first city council meeting in odd-numbered years.

Former Mayor Myers told his colleagues that the new designee, Mayor Parham, who is in his first four-year term on the council, has all the experience he needs to take the city to the next level: “He was my right-hand man for the last two years…I have every confidence in his ability to lead the city forward.” Nevertheless, the governance challenge looms: the city began its current fiscal year some $19 million in arrears and $12 million over budget, voting to slash employees’ pay, strip millions from the budget of the struggling public schools, and eliminate a youth summer program in order to try to balance the budget; meanwhile, the city’s credit rating tanked, and municipal workers fled to find other work, or, as new Mayor Parham put it: “Our locality was the first in the state to go through financial issues like we have.” In addition, late last year, the council voted to hire a turnaround team for $350,000 to take a short-term contract to try to bring the budget back above water and stabilize municipal operations. The contract expires in some eight weeks, but appears to have been instrumental in disentangling the layers of structural financial and fiscal problems that forced the city into insolvency—as well as helping to secure much-needed short-term financing for the city last month, or, as Mayor Parham described it: “In 2016, the government of Petersburg was supposed to be shut down, but we avoided that…We are moving in the right direction.”

Trying to Unpromise PROMESA? Meanwhile, in a letter to the PROMESA board, on behalf of Governor Ricardo Rosselló, the U.S. territory of Puerto Rico requested an extension of the January 15th deadline to prepare and submit its revised fiscal plan to the PROMESA board, seeking a 45 day extension—in order to ensure a credible plan which could return Puerto Rico to “fiscal responsibility within a decade.”  

Puerto Rico creditors presented arguments in federal court in Boston in an effort to lift a stay related to litigation over the U.S. territory’s debt. The courtroom request, in effect, seeks to challenge the provisions in the newly enacted federal legislation which imposed a stay on such suits in order to provide both Puerto Rico and the PROMESA oversight board with more time to put together a broad debt restructuring plan. The current stay is scheduled to expire next month on the Ides of February, with the possibility of an extension of 60 or 75 days or until the Oversight Board opts to file a petition to commence debt-adjustment proceedings, if that date is earlier. But complicating the promise of PROMESA has been this parallel process by some municipal bondholders and bond insurers in suing Puerto Rico—where a new Governor is just getting his administration underway. The new effort comes after last year’s U.S. District court ruling in two decisions concerning several cases that the stay should continue. That decision is now subject of an appeal in the U.S. First Circuit Court of Appeals, with the challenge asserting the burden of proof should be imposed upon Puerto Rico that any stay would not cause harm to bondholders, and arguing that the lower court’s decision should be overturned, because it had failed to hold an evidentiary hearing. For its part, the PROMESA Oversight Board has filed an amicus brief arguing in favor of continuing the stay, writing: “There can be no dispute that the amounts due will be paid during the pendency of the PROMESA stay, and the appellants will, therefore, suffer no material harm during the pendency of the stay.” Meanwhile, in its brief, the Commonwealth of Puerto Rico wrote: “It is not even clear how the stay is causing appellants any concrete injury, let alone the kind of substantial injury that would justify lifting a stay designed to help abate an unprecedented fiscal crisis affecting the health, safety, and welfare of millions of individuals.”

Emerging from Municipal Bankruptcy: a Rough Ride

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eBlog, 1/04/17

Good Morning! In this a.m.’s eBlog, we consider the ongoing challenges for the U.S. city emerging from the nation’s largest ever municipal bankruptcy, Detroit; then we veer into the warm Caribbean waters to observe the first days of the new administration of Gov. Ricardo Rosselló in Puerto Rico—where his new administration must adjust to coming to terms with its own PROMESA oversight board.

A New Detroit? The city emerging from the largest ever municipal bankruptcy is witnessing a string of major construction projects, from a massive hockey arena and street car line downtown to the resurrection of the Wayne County jail project: changes which will reshape the Motor City’s downtown in 2017—a level of activity and investment which seemed most improbable as the city shrunk and then dissolved into chapter 9 municipal bankruptcy. Today, the construction detours and closed sidewalks seem to offer a welcome sign of a new era for many who live and work near downtown. According to recent statistics, office vacancies in the downtown area are at their lowest point in a decade, and now the addition of the city’s new rail line could open demand in the New Center area, as well as increase demand for office space in neighborhoods near downtown such as Corktown and Eastern Market. Notwithstanding, the Detroit Financial Review Board, created as part of Detroit’s plan of debt adjustment to secure the U.S. bankruptcy court’s approval to exit bankruptcy, in its most recent oversight report, noted that the city continues to confront an unexpected gap in its public pension obligations and the absence of a long-term economic plan, reporting in its fourth annual report that could leave the city vulnerable to further fiscal challenges.(The next certification is due by October 1, 2017: under the plan of debt adjustment stipulations, the review board is charged with reviewing and approving annual four-year financial plans.) Both previous such plans have been approved. The most recent plan, submitted at the end of November, projects a general fund surplus of at least $41 million for FY2016, based on budget projections; Detroit expects to finish the current fiscal year with a general fund surplus of about $30 million. Nevertheless, the city faces a double-barreled fiscal challenge: its public pension liabilities and high costs of borrowing. Because its junk territory credit ratings from Moody’s and S&P, Detroit is forced it to pay disproportionately higher interest rates on its bonds.

With regard to its pension liabilities, where Detroit’s plan of debt adjustment approved by now retired U.S. Bankruptcy Judge Steven Rhodes left intact public safety monthly checks, but imposed a 4.5% cut on general employees—and reduced or eliminated post-retirement (OPEB) benefits, as part of a mechanism to address some $1.8 billion in post-retirement obligations, the approved plan nevertheless suspended the COLa’s only until 2024—so a longer term liability of what was originally projected to be $111 million pends. (Indeed, the city’s pension agreement withstood a challenge last Fall when a federal appeals court ruled in favor of Detroit in a lawsuit by city retirees whose pensions were cut as part of the city’s approved plan of debt adjustment, after some retirees had sued, claiming they deserved the pension which was promised before the city filed for bankruptcy in 2013, with U.S. Judge Alice Batchelder of the 6th Circuit Court of Appeals noting it was “not a close call.”)

But, as Shakespeare would put it: ‘There’s the rub.” Detroit’s actuaries, in their 2015 actuarial valuation reports, projected the liability in FY2024 and beyond to be nearly $200 million, based upon a thirty year amortization, with level principal payments and declining interest payments; however, as we have previously noted, those estimates were based upon optimistic estimates of assumed rates of return of 6.75 percent. In response, Detroit set aside $20 million from this year’s FY2016 fund balance, $10 million from its FY2016 budgeted contingency fund, and added an additional $10 million for each of the next three fiscal years—or, as Detroit Finance Director John Naglick told the Bond Buyer: “The city has six fiscal years to make an impact and close the gap on the [pension] underfunding. We don’t want to create such a cliff in 2024 where there is a big budget shock…The reality is to find those kind of monies over the next six fiscal years will cause some tradeoff in services.” Director Naglick added that last month Detroit completed an updated decade-long plan to update its approved plan of debt adjustment, adding: “The 10-year model will show the FRC that this incremental funding can be folded into the budget, but we aren’t naïve, it will also create some disruption in services to accommodate that…Think of it as a master plan on how we are going to make this stable.” Nevertheless, Mr. Naglick’s challenge will be hard: Moody’s last summer warned that the city’s “very weak economic profile” makes it susceptible to future downturns and population loss—threatening its ability “to meet its requirement to resume pension funding obligations in fiscal 2024.” Detroit’s next deadline looms: The City must submit its FY18-FY21 Four-Year Financial Plan to the Financial Review Commission by the statutory deadline of March 23rd.

Puerto Rico: A New Chapter? The new Governor of Puerto Rico, Ricardo Rosselló, yesterday, in the wake of his swearing in, acted straightaway on his first day in office to cut government spending and revenues, amid greater urgency to take steps to avoid a massive out-migration and end ten years of economic recession, and increase efforts to stem vital population losses which in 2013 alone witnessed some 74,000 Puerto Ricans leave the island. The new governor has already signed five executive orders, cutting annual agency spending by 20 percent, encouraging asset privatization, and proposing a zero based budgeting standard. Efforts like these, if actually implemented (a crippling risk in the context of historical Puerto Rico governance), could represent strides towards achieving fiscal solvency and help lay the groundwork for economic recovery. Governor Rosselló directed his agency heads to implement zero-based budgeting, under which agency heads start with a $0 and only adds to it when they can provide a justification for particular programs. Gov. Rosselló also created a Federal Opportunity Center attached to the governor’s office. The center will provide technical and compliance assistance to the office to make programs eligible for federal funds. For the new Governor, the three keys to recovery appear to be: how to revive the economy, fix the territory’s fiscal situation, and address the public debt.

The key, many believe, would be to opt for Title VI of the new PROMESA law, the voluntary restructuring portion. A growing concern is to create job opportunities—with one leader noting: “Many will leave if they cannot find jobs to search off the island for a better quality of life: our cities have to be habitable and safe…it has to be a place where the world wants to come to live…” Governor Rosselló also signed six executive orders, directing his department heads to cut 10 percent in spending from the current budget and to reduce the allocations for professional services by a similar amount—with even deeper cuts in other hiring; he imposed a freeze on new hires, noting: “We do not come to merely administer an archaic and ineffective scaffolding: Ours will be a transformational government.” Nevertheless, his task could be frustrated by the Puerto Rico House, where, yesterday, El Vocero reported that Puerto Rico House of Representatives President Carlos Méndez Núñez had told the newspaper last weekend that the legislature would cut Puerto Rico’s sales and use tax rate and the oil tax rate, reversing steps by the prior governor and legislature over the last four years. Governor Rosselló also pledged to work with the PROMESA Oversight Board in a collaborative way, as he departed the island to meet with members of the new Congress in Washington, D.C., where he planned to lobby for statehood for the U.S. territory.

With new administrations in San Juan and Washington, Gov. Rosselló will also have to work out a relationship with the PROMESA board, as the absence of cash to pay debt service, combined with the current payment moratoriums and federal stay on bondholder litigation appear destined to be extended deep into the year, albeit some anticipate that under the incoming Trump administration, one which will have much closer ties to creditor groups than the outgoing Obama administration, could lead to efforts to restart formal bondholder negotiations—negotiations which could become a vehicle by means of which creditors would increase their investment in Puerto Rico risks, by means of new loans and/or partial restructuring of liabilities in ex-change for a settlement which would be intended to improve long term municipal bond-holder recoveries and, most critically, work to enhance the price evaluations of Puerto Rico’s general obligation municipal bonds. Nevertheless, the territory’s structural, long-term budget deficit of nearly $70 billion over the next decade risks crowding out any medium-term payment of debt service absent serious spending reform as well as public pension reform—especially because of the ongoing outflow of young persons seeking better economic opportunities on the mainland.