05.15.14

In Parallel Universes. Two of the nation’s cities – one in California and one in Michigan – are each in a federal courtroom this week as part of the exceptional process of exiting municipal bankruptcy, trying to obtain federal judicial seals of approval that their respective plans of adjustment constitute equitable allocations of their respective debts amongst their creditors. Each is struggling with overwhelming pension debt, and each has achieved significant agreement from almost all its creditors on its respective plans for successfully exiting municipal bankruptcy. Each city is at a crossroads. The outcomes, in each case and in their respective federal courtrooms, could have profound implications for every state and local government: a critical issue in each instance is whether their respective public pension system obligations can be impaired―although, interestingly, they are coming at this issue from opposite directions. U.S. Bankruptcy Judge Christopher Klein Tuesday noted that Stockton’s public pension obligations are a “festering sore”—a sore, he added, which “We got to get in there and excise.” Yesterday his court took testimony with regard to how tangled a web that is—thanks to our extra special correspondent in Sacramento. Nevertheless, as parallel as the respective efforts are, the twin proceedings as each city moves towards exiting bankruptcy, are profoundly different—offering lessons to be learned by state and local leaders all across the nation. In Michigan, the legislature continued its efforts to rewrite the state’s relationship with one of the nation’s largest cities, even as the Motor City heads back to the federal bankruptcy court this a.m., while the issue of state-local relationships in California was considered from a profoundly different perspective in yesterday’s hearing before federal Judge Klein. These twin cases about the future of these cities and their respective plans—especially with regard to their daunting pension obligations—are certain to have significant repercussions for almost every state and local government because of the potential impact on the $3.7 trillion municipal bond market: decisions in these municipal bankruptcy cases could have a contagion effect by sharply raising the perceived threat to investors, thereby comparably raising the cost of capital finance for all states and local governments.

 

Taking Stock on Stockton, Day II. On the second day before U.S. Bankruptcy Judge Christopher Klein, David Lamoureux, the Deputy Chief Actuary of the California Public Employees’ Retirement System (Calpers), was summoned to testify in the face of a demand by one of the city’s creditors how any approval could be granted of a city’s plan of adjustment that included no adjustment whatsoever for its biggest creditor. Mr. Lamoureux testified that the city of Stockton could not reduce its $29 million in annual pension contributions without facing dire consequences, advising the court that any reduction would trigger termination of its pension plan. Moreover, he testified, unless the city paid an exit fee of several hundred million dollars, its employees and retirees would likely suffer scaled-back benefits. Moreover, Mr. Lamoureux warned, like a spider’s web, non-payment by the city could well impact all other Calpers state and local governments and agencies―potentially triggering forced increases in contributions, telling the court: “It goes to the fundamental premise of funding a pension plan…We need a constant flow of contributions.” He added that the city’s failure to pay its annual pension contributions could result not only in the exclusion from Calpers, but also the reduction in benefits to Stockton’s retirees, based on a pool of funds devoted to municipalities that have left the system.

The Capitol Connection, Day II. Midway across the nation, the second day of hearings in Lansing on the proposed “grand bargain” package of 11 bills in the Michigan legislature before the Detroit Recovery and Michigan’s Future Committee on the potential $195 million state contribution to the Motor City’s insolvent pension funds, made clear that it will take more work to modify the package before the legislative package can be considered, in the wake of committee members and union officials raising questions on several pieces of the package—warning that, in some instances, there were discrepancies between the proposed legislation and the agreements that had been reached with Detroit Emergency Manager Kevyn Orr and incorporated in Detroit’s plan of adjustment—a plan awaiting consideration by U.S. Bankruptcy Judge Steven Rhodes. The hearings, which began Tuesday, when Detroit emergency manager Kevyn Orr pled with lawmakers to approve legislation that would send the city $194.8 million from the state’s rainy-day fund, testifying that, without it, the agreements from foundations would fall apart, as would the entire settlement. Yesterday, supporters of the grand bargain package testified. Sandy Baruah, president and CEO of the Detroit Regional Chamber, however, testified: “You are engaged in what is perhaps the most important economic issue facing Michigan in more than a generation,” noting the chamber’s support of the grand bargain so long as it leads to approval of the bills in Lansing—similarly, Tim Sowton, vice president of government affairs and public policy for Business Leaders for Michigan, urged support, testifying that his organization’s recent poll that found 66 percent supported the state’s financial contribution, with more than 20 percent opposing it. George Orzech, who chairs the Detroit Police and Fire Retirement System, testified in support of the state’s sending financial assistance in the form of a lump sum payment rather than the original proposal of sending $17.5 million annually for 20 years, advising the special committee that the system currently pays out $25 million a month in benefits. Despite the apparent broad business and bipartisan support, however, a number of issues appear certain to require modifications:

  • A Snag: Labor. Nick Ciaramitaro, director of legislation and public policy for the American Federation of State, County and Municipal Employees Council 25, said letters were written and signed by union leadership to be sent to AFSCME members urging them to support the plan of adjustment. But things began to unravel last week, he said; those letters have not yet been sent to membership. He said that after seeing the plan of adjustment, it did not meet some of the agreements reached during mediation regarding other court cases, outsourcing and pensions. In addition, many points in the proposed legislation were at odds with what had been agreed to with Mr. Orr and on which Gov. Rick Snyder had signed off, so that, as he testified to the committee: “We felt the grand bargain had been derailed.” Mr. Ciaramitaro apparently believes that the issues can be resolved, but that they will take time and further discussions. AFSCME retirees plan to attend tomorrow’s hearing so committee members can meet those whose lives would be affected.
  • Oversight. State Rep. Harvey Santana (D-Detroit, a member of the committee) said he has a number of concerns with HB 5567, with regard to the hiring of a CFO for the Motor City. He said that if Detroit Mayor Mike Duggan were to leave office early, some mechanism should be added so that the new mayor would have the ability to either retain the CFO or hire a different CFO. Rep. Santana also stated he believed it important to make clear in the legislation what the duration of the proposed CFO language would be. Rep. Santana also expressed concern about the proposed mandate for the city to start a four-year budget cycle. Committee Chairman Walsh (Rep. John Walsh, R-Livonia) said he would work with Rep. Santana on his concerns. Questions also were raised about the oversight committee that would be created through HB 5566, sponsored by Chairman Walsh, with Rep. Thomas Stallworth (D-Detroit) urging the committee to consider providing for a spot on the oversight committee for a member of the Detroit City Council, expressing some concern about an imbalance, with Michigan Governor Rick Snyder largely in control of determining the selection of six of the seven slots on the committee, with Detroit Mayor Mike Duggan allotted the seventh. Rep. Mike McCready (R-Bloomfield Hills) concurred, stating he agreed that the council should have a voice to appoint a member to the committee and that possibly even the pension funds should have a representative. Subsequent to yesterday’s hearing, Chairman Walsh said the reason the state has such a say over the oversight committee is that the point is for the state to have oversight of the city’s financial operations, because state funds are being used to help the city out of bankruptcy. Chairman Walsh’s also noted that in a related issue, Mayor Duggan had expressed concern to him that the proposed oversight provision in the package mandating that all city contracts totaling more than $750,000 be subject to approval by the oversight committee could end up consuming the committee’s work. The Chairman said he expects Mayor Duggan will present the committee with an alternative.
  • Fine Art. No questions arose from the committee on HB 5571, sponsored by Rep. Ken Goike (R-Ray Township), which would prohibit the Detroit Institute of Arts from renewing its existing three-county millage — or approving a new one. Chairman Walsh has said previously that one reason for the bill is that the ownership structure of the DIA will change into an independent body, though still a non-profit, and some lawmakers were uncomfortable with a private entity receiving tax dollars. The 10-year, 0.2-mill levy brings in $23 million annually to the DIA to help fund operations. The DIA has not commented on the bill and did not appear to have a representative in attendance at Wednesday’s hearing.

The hearing resumes today with Mayor Duggan expected to testify, along with members of the public. Next Tuesday, the committee will hear from Richard Ravitch, who worked on similar bankruptcy legislation in New York City.

The Fine Art of Municipal Bankruptcy. South of today’s Detroit hearings in Lansing, the spotlight reverts to the U.S. Bankruptcy courtroom, where the fight over the world class art at the city-owned Detroit Institute of Arts will be the focus of arguments before Judge Steven Rhodes: the issue is: has the Motor City properly valued that art—in the face of motions filed by creditors Syncora and Financial Guaranty Insurance Co., municipal bond insurers for the city, demanding that Detroit consider outside financial offers for the art and seeking an order from the federal court that DIA provide access to all of its voluminous historical records. The two creditors, who stand to forfeit in excess of $1 billion under the Motor City’s pending plan of adjustment, have told the federal court that Detroit’s plan of adjustment significantly undervalues the art―art which now is the centerpiece of the hearings continuing today in Lansing as part of the so-called grand bargain, under which contributions from the state and the DIA would provide for a contribution of $816-million into the city’s pensions. Detroit has countered the creditor claims by telling the federal court that its assessment is based upon an estimate by Christie’s auction house that found the value of the approximately 2,700 works at the DIA purchased with city funds was less than $900 million. In stark contrast, Syncora and FGIC claim the entire collection is worth billions of dollars. The two creditors claim they have lined up four potential bidders willing to spend up to $2 billion for all or portions of the collection. The two creditors said they should be given access to DIA art and records for matters of due diligence. In contrast, the DIA has filed a motion before Judge Rhodes seeking to block creditors from removing thousands of works from walls and archives—as the creditors are seeking permission to snap digital pictures of the front and back of each piece. The DIA, in its filing, warned the court that moving so much art in a short amount of time would “invite[s] disaster” and “pose[s] serious risk,” adding that the demand was overly burdensome, effectively requiring two or three staff members to oversee each operation and necessitating closing of portions of the museum for long stretches. The DIA said it already provided creditors with nearly 90,000 pages of records and argued that it was unreasonable and risky to have to provide more than a million additional pages, many of them old and in poor condition and not easily accessible.

Take me for a Ride. Even as the DIA’s future will be on display in Judge Rhodes’ courtroom today, the three U.S. automakers with historic ties to Michigan, including two who are previous beneficiaries of both federal bankruptcy protection and federal bailouts, are considering donating millions to the Detroit Institute of Art as part of a plan to protect the city-owned art collection while raising money for Detroit’s pensioners. General Motors Co., Ford Motor Co., and Chrysler Group LLC are contemplating donations of as much as $25 million or more, with a Ford Fund spokesperson adding: “We are having confidential discussions with the DIA and are considering the matter very carefully.” According to reports, the DIA approached the automakers a few weeks ago with a request that they donate up to $50 million. The museum has pledged to raise $100 million as part of a so-called grand bargain crafted by bankruptcy court mediators and state officials. The proposal calls for a group of private foundations to raise at least $366 million and the state to give $195 million, in addition to the DIA’s $100 million. All the contributions would go into the city’s two pension funds—albeit, some creditors, including holders of $1.4 billion of the city’s pension certificates of participation, have objected to the plan as discriminatory against non-labor creditors.

A Blessing on Your House.  The nation’s two largest quasi-federal housing regulators, Fannie Mae and Freddie Mac, whose fate in Congress remains uncertain, have announced a pilot program, scheduled to commence in the Motor city next month, to keep families in their current homes through loan modifications, match distressed properties with non-profit organizations for resales, and assist in building demolition. Former Congressman and now new Federal Housing Finance Agency Director Mel Watt said borrowers who owe more than their home’s market value could see “deeper loan modifications” than currently available through a program for refinancing loans owned or guaranteed by Fannie Mae or Freddie Mac. According to an FHFA fact sheet, severely delinquent loans may be transferred to non-profits to find alternatives to foreclosure; non-profits could buy foreclosed properties or take them as donations. 28 percent of owner-occupied homes in the Motor City have mortgages in negative equity compared to 19 percent for the United States as a whole, according to Zillow. In response to the announcement, U.S. Rep. John Conyers (D-Mi.), the ranking member of the House Judiciary Committee, and whose District is in Detroit, responded by writing to Director Watt requesting that the twin agencies go further, urging a six-month moratorium on foreclosures of mortgages where borrowers had been current on their loan payments before Detroit started its bankruptcy proceedings last summer: “While FHFA actions including a short-term moratorium on foreclosures and longer-term loan modifications would not be a panacea, they would go a long way toward stabilizing the city’s housing market, which would, in turn, facilitate the rebuilding of the tax base, easing the city’s persistent cash flow problems.”  The potential quasi-federal housing assistance comes as Motor City Mayor Mike Duggan this week announced Detroit would increase the number of homes on its auction web site each week to 14 from five, after the first auction last week met strong demand. The houses in that auction, which were each abandoned for at least three years, fetched bids ranging from $30,000 to $42,100. Detroit is seeking to sell 400 vacant homes by the end of 2014, according to City Council President Brenda Jones.

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