The Constitutionality of Michigan’s Emergency Manager Law. U.S. District Court Judge George Caram Steeh has ruled that a suit challenging the constitutionality of Michigan’s emergency manager law, Act 436, the Local Financial Stability and Choice Act, may proceed. Public Act 436 gives broader powers to emergency managers in municipalities and school districts in Michigan, including the right to modify or throw out union contracts The suit was filed nearly a year ago by 21 plaintiffs against Gov. Rick Snyder and former Michigan Treasurer Andy Dillon; the plaintiffs claim the law violates federal collective bargaining rights as well as due process, voting, and representative government rights under the U.S. Constitution. The case could impact not just the current situation in the Motor City, but also in the municipalities of Allen Park, Benton Harbor, Hamtramck, and Flint—and the school districts of Detroit, Highland Park, and Muskegon Heights.

A Key to Emerging from Bankruptcy in Detroit and completing the city’s plan of adjustment rests upon achieving consensus on a metro-Detroit water and sewer agreement, because such an agreement could sweeten the pot by as much as $300 million if the metro-wide discussants can work out an agreement on the refinancing of the estimated $5.9 billion of secured water and sewer debt now outstanding by the new authority to generate savings—an agreement which would require current bondholders to waive their call protections and agree to the refinancing. State officials have set a meeting for tomorrow in an effort to resolve outstanding issues with regard to the controversial $1.9 billion lease of Detroit’s water and sewer system in the wake of complaints from neighboring Oakland County officials that the Wolverine State was not doing enough to tackle the county’s greatest concerns about the proposed agreement―an agreement between the gang of four, Detroit, Oakland County, Wayne County, and Macomb County―to create a new regional authority to settle on a 40-year lease of the Detroit Water and Sewerage Department, an enterprise of the Motor City that serves customers in a 1,079-square-mile area, including the Motor City and some 127 suburban communities. The tentative pact would provide for a new regional authority to take over the system, and its $5.9 billion of outstanding debt―which would trigger an estimated $48 million back to Detroit, which would retain ownership. The session tomorrow is focused on Oakland County’s apprehensions with regard to the lack of adequate financial information from Detroit—and the apprehension that several of the governments in the system will not have sufficient resources to meet the financial requirements and looming large capital needs over the next ten years. Oakland County leaders are pressing for the state to offer some kind of backup pledge—especially because of the number of cities to be served that are experiencing significant fiscal distress, including those already under the state’s emergency manager law, including: Flint, Hamtramck, Pontiac, and Highland Park―the latter of which already owes $18.5 million to Detroit for unpaid water and sewer bills.

A Heart of Darkness? In Joseph Conrad’s 1899 novel, The Heart of Darkness, Mr. Conrad wrote: “The word ‘ivory’ rang in the air, was whispered, was sighed. You would think they were praying to it. A taint of imbecile rapacity blew through it all, like a whiff from some corpse. By Jove!” Now, in the Motor City, there is concern and suspicion about a different kind of “ivory”―in this case the 2005 pension related deal or borrowing of $1.44 billion from investors by means of COPs or certificates of participation, in that instance used to inject funds into the city’s two pension funds.

The issuance of the COPs was followed—in a manner eerily similar to the triggering event in Jefferson County’s municipal bankruptcy—by an interest rate swaps deal layered on top of $800 million of the debt, in which Detroit traded, or “swapped,” a variable interest rate for a fixed rate in a swap—a deal which initially provided reduced borrowing costs for the Motor City—but blew up a few years later, with Detroit’s annual payment ballooning from an estimated $5 million to $50 million annually. Last week Detroit, claiming the trust funds and service corporations used to funnel the money into the pension funds were a “sham” and “conduits” designed to bypass the city’s statutory debt limits, asked U.S. Bankruptcy Judge Steven Rhodes to invalidate the entire deal, claiming the service corporations’ contracts with the city were illegal, officially ending an interest-rate swap termination agreement with its counterparties, but claiming to preserve its right to pursue legal action against the banks. A disposition of the swaps is one of the biggest hurdles Detroit must overcome to exit Chapter 9 bankruptcy. The city is continuing to negotiate with the counterparties, UBS AG and Merrill Lynch Capital Services, Inc., to try to reach an agreement, according to Bill Nowling, spokesman for Detroit emergency manager Kevyn Orr. In addition to seeking to have the federal court terminate the $1.4 billion pension, Emergency Manager Orr is seeking to question a former finance director of the Motor City from the administration of former Mayor and now convict, Kwame Kilpatrick, about his relationship with a banker whose firm profited from the lucrative financial arrangements. Mr. Nowling said the city’s legal team would explore the motives of all the players and companies involved in the transaction, should the lawsuit proceed to the evidence-gathering discovery phase: “We’re going to vigorously pursue the city’s rights and we think that was bad debt and the city didn’t have the right to do that.”

New Leaders Assume Responsibility. San Bernardino voters have elected a new slate of leaders who have pledged to try to reduce pension costs and take on vested interests. The changing of the guard arrived as the city enters into a fourth month of mediation with its creditors in an effort to exit municipal bankruptcy and chart a sustainable future. As in the Motor City, San Bernardino faces a deadline by the end of the month to offer a plan of adjustment. Voter elected Carey Davis, a political novice, as their new mayor—rejecting former Councilmember Wendy McCammack, who had been recalled in last November’s city elections. Mayor Davis ran in part on a campaign to reduce the city’s pension obligations, warning voters last year the city would have to cut spending on police and fire departments, which currently make up more than 70 percent of the bankrupt city’s budget. Voters also elected another newcomer to the council, Henry Nickel, who campaigned on a promise to take on special interests—who defeated Randy Wilson, a police sergeant endorsed by the police union, the only candidate for that seat who did not support pension reform efforts. The new Mayor and Council now include six of seven council members who promised to consider options to reduce San Bernardino’s pension obligations, in addition to new Mayor Davis, and a new city attorney, Gary Saenz.

Puerto Rican Blues. Moody’s has downgraded the Commonwealth of Puerto Rico’s credit rating to junk status, writing that the fiscal issues that confront the island commonwealth are many years in the making, and include years of “deficit financing, pension underfunding, and budgetary imbalance, along with seven years of economic recession,” so that today Puerto Rico has an increasingly onerous financial burden, a high load, high fixed costs, and diminishing liquidity—even as the rating agency reports that the Commonwealth has “taken strong and aggressive actions to control spending, reform the retirement systems, reduce debt issuance, and promote economic development.” Nevertheless, Moody’s writes: “Despite these accomplishments, however, in our view, the commonwealth’s credit profile is no longer consistent with investment grade characteristics. While some economic indicators point to a preliminary stabilization, we do not see evidence of economic growth sufficient to reverse the commonwealth’s negative financial trends. Without an economic revival, the commonwealth will face difficult decisions in coming years, as its debt and pension costs rise. The negative outlook signals the remaining challenges facing the commonwealth.”

Nevertheless, Moody’s found that Puerto Rico’s economy is large–with its gross product exceeding that of 15 states and population exceeding that of 22 states, that it has broad legal powers to raise revenues, adjust spending programs, and borrow to maintain fiscal solvency. What it does not have, however, is authority to file for bankruptcy—to allow it to put a freeze on payments to creditors while it reorganizes its debt. Moreover, as Moody’s points out, Puerto Rico confronts very large unfunded pension liabilities relative to revenues, even after major reforms to two main plans that helped reduce cash-flow pressure, and very high government debt, equal to more than 50% of its gross domestic product.


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