Transitioning back to self government after Municipal Bankruptcy & Trying to adopt a post bankruptcy budget

             July 30, 2014

Visit the project blog: The Municipal Sustainability Project 

Transitioning Power in the Motor City. Detroit Emergency Manager Kevyn Orr yesterday issued his 31st Order, this one relinquishing control over the Detroit Water and Sewer Department to Mayor Mike Duggan. The order restores to the city the authority to manage the utility and make appointments to the Board of Water Commissioners. In his statement, Mr. Orr wrote, “As the Detroit Water and Sewerage Department works to operate more efficiently and communicate more effectively with customers, it is important to ensure there are clear lines of management and accountability;” however, the order includes a proviso: “The EM may modify, amend, rescind, replace, supplement, or otherwise revise this Order at any time.” In one sense, this is the transfer of a hot potato, U.S. Bankruptcy Judge Steven Rhodes and others have harshly criticized the emergency manager’s handling of water shutoffs to Motor City residents who owe more than $150 or are at least two months behind on their payments—as his office has sought to gain control over and recoup nearly $90 million, including more than $43 million from some 80,000 overdue accounts from residents. In his order, Mr. Orr noted: “This order provides additional clarity to the powers already delegated to the Mayor… This order ensures a common focus on customer service and sound management practices that reflects the city’s commitment to refocusing its efforts to help DWSD customers get and remain current on their water bills.” Mr. Orr’s spokesperson, Bill Nowling, further clarified the boundaries of the transition yesterday when he said it was “important to note that Order 31 does not delegate to the Mayor any authority over negotiations on creation of an authority or any other restructuring issue.” The transition comes at a tricky moment: the city’s water and sewer department, suburban officials, and the Motor City were ordered into mediation last April – under a gag order. Nevertheless, Mayor Duggan yesterday wrote that he had met Monday evening with the leadership of the Detroit Water and Sewer Department (DWSD), adding: “We need to change a number of things in the way we have approached the delinquent payment issues, and I expect us to have a new plan shortly…There are funds available to support those who cannot afford their bills — we need to do a much better job in community outreach to tell our residents how to access those funds. We will be developing a plan that allows those who are truly needy to access financial help and allows those who want to make payment arrangements to do so with shorter wait times. As for those who can pay and choose not to, we won’t force other Detroiters to pay their bills.” Because the Department serves the metro area, its board is representative of its service area, including: four members from Detroit and one each nominated by the Wayne County Executive, the Oakland County Water Resources Commissioner, and the Macomb Public Works Commissioner. With Mr. Orr’s appointment subject to termination by Detroit’s Mayor and Council on October 1st, the delicate process of transition—an issue distinct from the Jefferson County, Stockton, Vallejo, and San Bernardino municipal bankruptcies—where state laws do not provide gubernatorial authority to preempt municipal authority through the appointment of emergency managers—the order yesterday would appear to be an early effort to try and ensure a smooth transition.

Gambling on the 6th.  The 6th U.S. Circuit Court of Appeals today will entertain oral arguments on an appeal by bond insurer Syncora Guarantee Inc. of U.S. Bankruptcy Judge Steven Rhode’s decision last August denying the insurer access to the Motor City’s casino tax revenues, finding that those revenues, because they were part of the bankruptcy estate, were subject to the code’s automatic stay provisions—a ruling confirmed by the U.S. District Court earlier this month—and a vital ruling, as it has meant the Motor City has been able to continue to have access to what has proven to be one of the city’s most reliable revenue streams.

Fire in the Hole. U.S. Bankruptcy Judge Meredith Jury yesterday heard arguments on the San Bernardino firefighter unions’ attempt to sue in state court over alleged legal violations relating to layoffs and other reductions the City Council approved as part of its FY2015 budget. The adopted budget calls for two layoffs and four demotions that are scheduled to take effect in September, but the union is arguing the city’s budget action targets specific individuals for political and retaliatory purposes, with its attorney, Corey Glave, stating: “The cuts to the fire department, which contradict recommendations by the City’s own experts, put both firefighters and the general public at risk and are being viewed as retaliatory as they directly target no less than four members of the Board of Directors for the San Bernardino City Professional Firefighters…It is becoming clear that the City is seeking to gain some form of an advantage over the union in the Bankruptcy Court by disrupting the union’s board of directors.” As we reported early this month, San Bernardino, at its 11th hour, adopted some $2 million in cuts to its Fire Department budget as part of its $22 million in savings it adopted, including the closure of one fire station. In its response, San Bernardino City bankruptcy attorney Paul Glassman and City Attorney Gary Saenz, wrote that the laid-off employees can — and did — schedule hearings with the city’s Civil Service Commission, adding: “The tempest in the teapot that the SBCPF has created about the layoffs is a ruse for their goal of obtaining state law and state court jurisdiction over the rejection of their contract and the adjudication of the claims arising from the rejection,” adding they believe the accusations of bias are unsupported and unfair: “The (fire union’s) Stay Relief Motion, with its incendiary and irresponsible attacks on Chief Drasil, personal and professional, alleging anti-union animus, is nothing more than an effort to undermine Chief Drasil’s credibility as a witness for the City’s contract rejection motion,” the filing states. “The Court should not abide such scurrilous tactics and should reject the Stay Relief Motion for that reason alone.”

In response, U.S. Bankruptcy Judge Meredith Jury yesterday denied permission for the union to sue San Bernardino in California state court, but said she would entertain the union’s arguments in federal bankruptcy court, also finding that the union’s plea was “premature,” because the effective date for the cuts is scheduled for Sept. 23rd, although Judge Jury noted: “I put it (blame) on the city, that they didn’t communicate with the fire chief.” Judge Jury said she might later allow relief from the stay, but she repeated previous comments that she is “really reluctant” to have another court whose timing she cannot control get involved in the city’s efforts to address its fiscal situation and put together a plan of adjustment in order to emerge from municipal bankruptcy: “The city is doing this to try to balance the budget, in order to propose a way to go forward in a Chapter 9 proceeding.” Judge Jury noted that San Bernardino filed for federal bankruptcy protection, because it was insolvent: it could not meet payroll, but—describing the dilemma, added: “I also agree with you (the union): they can’t violate the (city) charter in order to do what they have to do in a Chapter 9 plan.”

On Monday evening, San Bernardino proposed a new contract, which Mr. Glave yesterday told the federal court he considered to be the city’s first proposal on a new contract. In response, Judge Jury said that while that proposal may have come arrived a little late, it did appear to her that the city had been attempting to negotiate with the union: “I see the stonewalling coming from the firefighters…And maybe that’s unfair, but that’s what I see, because no one else looks like they’re being stonewalled by the city.” (San Bernardino has reached agreements with most of its employee groups, and officials with the city and police union say they are close to an agreement.) Nevertheless, Judge Jury ordered the two sides to come to the bargaining table: “You’ve all got the message that this needs to happen as soon as you can.”

Can the Weed in San Bernardino be a Twofer? San Bernardino City Attorney Gary Saenz is proposing that the municipality be the first city in California’s San Bernardino County to allow some medical marijuana dispensaries — in the hope of both raising revenues, as well as enforcement with regard to illegal dispensaries that seem to have achieved little impact, notwithstanding the municipal ban. Mr. Saenz’s plan, which he first proposed at a city Council meeting last week, was sent to the city’s legislative review committee for review this Monday—with a draft ordinance and public hearing scheduled for a presumably weedless committee meeting scheduled for a week from Saturday. According to Mr. Saenz’s office, Palm Springs, the only municipality in the region that currently permits such dispensaries (it has authorized four for its 44,500 population), anticipates getting a little high from the projected weed revenue gained by means of a 10 percent tax—$500,000 annually—an amount approximately equal to what the city expends annually on enforcement. Under Mr. Saenz’s draft proposal, there would not be a cap on the number of such dispensaries, but the proposal would limit which zones allow dispensaries and prohibit them from being within certain distances of “sensitive uses” such as schools (1,000 feet), substance abuse rehabilitation centers (500 feet), and residential uses (150 feet). In addition, as the city noted, any ordinance would have to take into account federal laws: “It is important to the federal government that any state or local regulatory framework contain robust controls and procedures on paper as well as in practice…If the City of San Bernardino does enact a regulatory scheme for marijuana dispensaries, the regulatory framework will need to be thorough with regards to federal priorities and consistently enforced. Critical to such a regulatory scheme will be sufficient resources allocated to enforcement.”

Is Detroit’s Bankruptcy Contagious?

             July 28, 2014

Visit the project blog: The Municipal Sustainability Project 

Is Detroit’s Bankruptcy Contagious? Moody’s, the credit rating service, on Friday wrote that Detroit’s municipal bankruptcy—if approved by the federal bankruptcy court, “could serve as an example other distressed local governments in Michigan might follow,” with the agency’s Vice President, Genevieve Nolan, stating: “The final outcome of this bankruptcy will likely have broader implications for future bankruptcy cases involving distressed local governments in Michigan, potentially setting an important benchmark for the relative position of debt versus pensions.”  Moody’s, noting that Michigan has a relatively high number of municipalities in distress compared to other states, and that the resolutions achieved so far in Detroit’s case have created the appearance that retirees have emerged in better shape than the city’s municipal bondholders, reported that: “The settlements reached in this case may guide future negotiations between Michigan local governments and their creditors and pensioners.”  Moody’s added that the Motor City, in its confirmation trial set to begin on August 14th, “is now likely to ask the [federal bankruptcy] court to ‘cram down’ the city’s proposed plan of adjustment on creditor classes that rejected the plan. Because not all classes approved the plan, the court will have to conduct additional analysis on the question of whether the plan discriminates against some creditor classes.” The Motor City’s plan proposes different levels of recovery for different classes of its creditors, and, of course, includes a unique “grand bargain’ proposal for its retirees—so that, while some retirees would realize relatively small reductions, and holders of Detroit’s general obligation unlimited tax bonds would realize a 74 percent recovery; the city’s plan proposes far steeper cuts to holders of the city’s certificates of participation and general obligation limited tax bonds: the city proposes recoveries for these creditors varying from zero to 13 percent. No city has filed for federal bankruptcy protection since Detroit filed last year; Moody’s does not take into account that no municipal elected official wants to admit failure and to affirmatively file for federal bankruptcy.

Motor City Monitor. In submitting his fifth, updated plan of adjustment to U.S. Bankruptcy Judge Steven Rhodes on Friday, Detroit Emergency Manager Kevyn Orr proposed that the federal court appoint a long-term finance professional with broad authority, including subpoena power, to monitor whether the post-bankruptcy Motor City abided by the terms of its federally-approved plan of adjustment. Under Mr. Orr’s proposal, such an independent oversight monitor—who would be parallel to the state monitor, would hold that position until the federal bankruptcy court officially terminated Detroit’s municipal bankruptcy. Under Mr. Orr’s proposal, the independent monitor would:

  • provide quarterly reports to the federal court with regard to how the post-bankruptcy Motor City Detroit disbursed funds to creditors,
  • complied with the approved plan of adjustment agreements on debt reduction, city pension funds, and retiree health care obligations, and
  • whether Mayor Duggan and the Council were meeting the terms of the $816-million grand bargain to modify pension cuts and spin off ownership of the Detroit Institute of Arts.

The revision in the updated draft appears to reflect an effort to respond to Judge Rhodes questions to the city’s attorneys with regard to how he could best exercise oversight with regard to how a post-bankruptcy Detroit is compliant with its own, judicially approved plan of adjustment. In its modification, Mr. Orr’s revision recommends that such a monitor be:

  • a neutral party, “independent of the city and the state and free of all conflicts;”
  • not an elected or appointed official in Michigan, and
  • an individual with an accounting or finance background and experience in municipal finance, with preference given to such persons with experience overseeing municipal governments or agencies annual revenues of at least $250 million in addition to experience with complex financial and operational restructuring.

How many Overseers & at What Cost? Mr. Orr, whose appointment expires at the end of September, releasing him to return home to the Washington area to re-acquaint himself with his spouse and children, theoretically would mean the full restoration of the authority of Mayor Mike Duggan and the City Council to oversee and operate the Motor City—albeit under the purview of a new state oversight commission and now, potentially under separate, independent federal court oversight. Mr. Orr’s spokesperson described it this way:  “It’s not about governance or oversight of elected officials, but it’s about how can the [federal bankruptcy] court be reassured that the details and the fine points of the plan will be implemented to the satisfaction of the court.” The issue in this complex recovery involves the federal government, the State of Michigan, and Detroit—with both the State and the federal bankruptcy court—having invested extraordinary resources into ensuring the Motor City’s recovery and long-term sustainability—seeking to find a way to ensure the plan is on track in its implementation.

Debt, or Copping a Plea. The incomparable Jim Spiotto, the nation’s godfather of municipal bankruptcy, poses a fundamental question with regard to Detroit’s municipal bankruptcy: The question is whether the repudiation of $1.4 billion is going to help Detroit regain financial credibility or will it sour the municipal markets against Detroit and possibly government debt in general. . Writing that in the Motor City’s municipal bankruptcy that a key, unresolved issue is whether the $1.4 billion in certificates of participation (COPs) issued by the City of Detroit can be repudiated by Detroit in its Chapter 9 bankruptcy: “There is no dispute that, when issued, the COPs were represented in the market to be valid, binding and enforceable obligations of the City of Detroit.  No one from the City or the State of Michigan at the time of issuance or prior to the Chapter 9 filing instituted any legal proceeding to void that debt or to request that the $1.4 billion received by Detroit be returned to investors in order to void the debt obligations.” But, Mr. Spiotto asks, would the repudiation of that debt help the Motor City to return to solvency and sustainability, or, instead, might it risk not only the Motor City’s future access to the credit markets critical to its future, but also adversely affect access by all cities, counties, and states to the nation’s credit markets. 

To oversimplify the City of Detroit’s position, it seeks to repudiate the debt because it claims Detroit had “a bad mayor and a bad administration” at the time of issuance and therefore should not be responsible for that debt.  As we all know, if a corporation or an individual issues debt in the public market claiming that the debt is a valid, binding and enforceable obligation and then later, when it is inconvenient or difficult to pay, claims it was never authorized to incur the debt, there would be serious consequences.  That corporation or individual would be open to a flood of litigation, if not criminal investigation, claiming fraud on the investors. 

In a remarkable paragraph, he adds:

Our Founding Fathers, led by Hamilton and Washington, knew that financial credibility was one of the building blocks of a strong nation.  Part of the exceptional success of our state and local governments has been their ability to borrow money in the municipal market at a low cost so they can decide, as a state or a city, what the improvements or essential services should be for their constituents.  These decisions and the implementation and funding of the decisions can all be done by local action without the need of approval, review and acceptance by some higher government.  That ability to make decisions and fund them locally is one of the unique attributes of our government and one that has, in the past, allowed us to create the world’s best infrastructure and the world’s largest economy. 

Indeed, he notes that state and local repudiation of debt is not new, but dates back more than two centuries, noting: “By the 1840’s, eight states and one territory defaulted.  Those that defaulted then experienced either an inability to borrow additional funds or, if they could obtain financing for needed governmental improvements and services, the imposition of a 32%+ yield.  By the late 1840’s, seven of the eight states had renounced their repudiation and resumed payment on the debt in order to obtain market access at a lower cost.” 

Consequently, he presciently warns, with regard to the proposed debt repudiation:  “[T]he inevitable consequences to Detroit and to the municipal market upon which all states and municipalities rely for funding their long-term capital improvements and sometimes their essential services, cannot be tolerated.  If past history is a judge, the difference in the market between, the better credits and the weaker credits may range from 150-200 basis points or more.  Given Detroit’s need to reinvest in the city and borrow significant sums to do so in the future, Detroit could possibly pay at least 200 basis points or 2% more a year for future borrowings.  Over the normal life of a bond (30-year period), this is 60% more of the principal borrowed that does not go to pay for infrastructure or essential services, public workers’ salaries or pensions, other creditors or tax relief to the taxpayers.  While the legal and political correctness of past administrations can be argued, there should be no doubt that good funds were provided by investors, that benefits were received by the City through its use of those good funds to pay down pension obligations and a public benefit was achieved.  It strains the notion of fairness and justice if a benefit can be retained but the consideration for it can be repudiated.  Repudiation of the COPs may have little public benefit and long-term public pain.  Washington and Hamilton warned, and as history has demonstrated, “no pecuniary consideration is more urgent than the regular redemption and discharge of public debt.” The best test of a fair and just result is whether the outcome can be explained to a young child.  It is doubtful a third grader would expect that a party could retain the benefits of a transaction without paying the agreed-upon consideration.”

Bridge over Troubled Waters. The Detroit City Council is considering the transfer of 301 city-owned properties to the Michigan Land Bank in exchange for $1.4 million from the Canadian government as part of plans for a proposed $2 billion international commuter bridge, with a special Council session set for this morning. The new bridge, the New International Trade Crossing, is to span the Detroit River between Detroit and Windsor, Ontario, with the bridge’s Detroit footprint on the Motor City’s southwest side. Canada is paying most of the $2 billion project’s cost on both sides of the border and hopes to recoup the money through the imposition of tolls—with a projected opening in 2020.  

Fiscal Sustainability & Service Solvency after Bankruptcy

             July 22, 2014

Visit the project blog: The Municipal Sustainability Project 

Detroit’s Fiscal Sustainability & Future Service Solvency. U.S. Bankruptcy Judge Steven Rhodes Friday cleared for release yesterday a report (please see attached) from a special team he requested to examine Kevyn Orr’s proposed plan of adjustment to determine whether the assumptions that undergird the plan’s cash-flow projections and forecasts are reasonable and whether its overall plan to deal with city debts and exit Chapter 9 is feasible, asking: “Is it likely that the City of Detroit, after the confirmation of the Plan of Adjustment, will be able to sustainably provide basic municipal services to the citizens of Detroit and to meet the obligations contemplated in the Plan without the significant probability of a default?” The report, submitted by Martha Kopacz and Phoenix management Services, concludes: “It is likely that the city of Detroit, after the confirmation of the Plan of Adjustment, will be able to sustainably provide basic municipal services to the citizens of Detroit and to meet the obligations contemplated in the Plan without the significant probability of a default.” Ms. Kopacz wrote that “by most accounts, there is forward progress being made in the city” on the administrative front with the team finding that the combined efforts of Emergency Manager Kevyn Orr and Mayor Mike Duggan “are addressing service shortfalls.” Nevertheless, noting the throughout her report for the court that “there is not one controlling set of projections that will provide a financial road map to the City, its constituents, and the Financial Review Commission,” she recommended Detroit “immediately produce an integrated plan, which includes the expected initiatives, deferrals, and other items, by department and fund. This will provide a longer term roadmap and assist the Mayor, the Financial Review Commission and other interested parties in understanding how the City is making progress towards the forecast detailed in the Plan.” The report offers some qualifications and raises concerns on projections in some areas, making suggestions that could enhance the feasibility of the plan.

& The Votes Are In: About 82 percent of the Motor City’s current and retired police and firefighters voted in favor of the city’s proposed plan of adjustment; about 73 percent of general city workers and retirees supported it—in effect casting their votes to accept cuts to their pensions and health-care benefits as part of the overall plan to eliminate some $7.4 billion in debt. Even though the tally is not binding on the federal court, it will form an important consideration for Judge Rhodes when he presides over next month’s trial to weigh whether to approve the Motor City’s plan—along with the votes of the city’s bondholders―creditors who are divided: holders of Detroit’s limited tax obligation bonds rejected the plan, according to a filing yesterday in the federal bankruptcy court, whilst unlimited tax bond holders voted in favor by the necessary majorities. Under the City’s proposed plan, current and retired city employees, as well as investors or bondholders, would be forced to take less than the $10.4 billion they are owed if the court approves the plan, with some of the city’s municipal bondholders potentially receiving as little as 11 percent of their claims. Retired police and firefighters are to collect all of their current monthly pension checks, while general employees would get about 95 percent of theirs. The police and firefighters would see future cost-of-living increases reduced, while general employees would lose that benefit entirely. The plan proposes reductions in health care benefits for both current and retired employees, with the plan proposing a 74 percent reduction in the city’s total OPEB, or post-employment benefits. The Motor City’s unions, and groups representing retired city employees, urged their members to vote in favor of the plan—and they did: more than 5,800 current and retired police and firefighters voted in support, while fewer than 1,300 voted in opposition, according to yesterday’s filing. Among the city’s current and retired general workers, the vote was nearly three to one in support out of the 8,500 votes cast. Among investors who hold the Motor City’s general obligation bonds, those with $174.9 million in limited tax bonds rejected the plan, while those with $366.2 million in unlimited tax bonds voted to accept it. The strong support demonstrated by the retirees appears to pave the way for the so-called Grand Bargain, which will trigger a spinoff of the Detroit Institute of Arts to become an independent institution, no longer owned by Detroit, and trigger the combined state—Detroit Institute of Arts $816 million plus package of assistance to ensure no Detroit retiree’s income falls below federal poverty levels. Detroit Emergency Manager Kevyn Orr issued a statement after the release of the vote tally: “The voting shows strong support for the city’s plan to adjust its debts and for the investment necessary to provide essential services and put Detroit on secure financial footing…I want to thank city retirees and active employees who voted for casting aside the rhetoric and making an informed positive decision about their future and the future of the City of Detroit.” Nevertheless, not all the creditors exhibited the same level of support. 119 classes of Detroit Water and Sewer Department secured bondholders voted “no,” compared to 32 that voted “yes,” with the no’s apparently representing bondholders upset that even though they will be paid 100% of their principal, they are opposed to the city’s plan to redeem their bonds early. In addition, four groups of unsecured creditors voted “no,” including bond insurers and hedge funds which control $1.4 billion in pension debt issued by former and now convicted Mayor Kwame Kilpatrick’s administration in 2005—making clear that a contested issue when the trial commences next month will be the pitting of the city’s bondholders and bond insurers versus its employees and retirees—not to mention its smaller unsecured creditors, including people who sued the city and are owed settlements. These creditors also voted to oppose the city’s plan. Nevertheless, now armed with the sustainability and solvency report and the voting results, Judge Rhodes is more equipped to assess—in the trial commencing next month—whether Mr. Orr’s Plan of Adjustment is legal, fair, and feasible—the three hurdles the city must clear to emerge from bankruptcy.

Won’t You Be My Neighbor? U.S. Bankruptcy Judge Steven Rhodes yesterday granted Macomb County’s request to be deemed a creditor granted an opportunity to vote on Detroit’s proposed plan of adjustment, ruling that a claim the county’s public works commissioner is seeking against the city is worth $26 million for purposes of voting on the city’s plan of adjustment, rejecting Detroit’s position that the claim should only be assessed to be worth one dollar. The neighboring county’s request involves its $26-million claim against the Motor City over fraudulent overbilling on a 2004-05 sewer line repair in Sterling Heights after a collapsed line created a giant sinkhole, with the issue focused on Macomb County Public Works Commissioner Anthony Marrocco’s 2011 lawsuit against former Motor City Mayor Kwame Kilpatrick, members of his administration, the former mayor’s friend and contractor Bobby Ferguson, and others over the sewer repair. Ferguson was among the contractors working on the project that Commissioner Marrocco alleges was overbilled by $26 million. In the wake of the federal corruption convictions against Messieurs Kilpatrick, Ferguson, and former Detroit Water and Sewerage Department Director Victor Mercado, Macomb County later amended its suit to include the City of Detroit. The difference to readers between $1 and $26 million might be readily measurable; for municipal bankruptcy purposes—because creditors’ votes are weighted so that not only must there be a majority of creditors who cast ballots who vote yes, but also because the yes votes must represent two-thirds of claims in order for the plan to be approved.  Commissioner Marrocco’s claim is in Class 14, a group of unsecured creditors with total claims of about $150 million; Macomb County has opposed the plan of adjustment based on concerns about Detroit shifting responsibility for water department pensions onto suburban customers. Nevertheless, in announcing his decision, Judge Rhodes noted that his ruling would not have an impact with regard to whether Macomb eventually prevails: “This estimation will carry absolutely no weight in actually fixing the amount of the claim, which will be done at a later date.”

Trials & Tribulations. Even as the momentum towards the trial of the century next month builds, municipal bond insurer and Motor City creditor Syncora yesterday sought in Judge Rhodes’ courtroom to move back the commencement of the trial to October—requesting the federal court to grant a six-week delay in the trial, because, the insurer charged, Detroit has not been forthcoming with the production of  documents it claims it needs: “We have a right to object to the plan, but right now we don’t know what that plan is,” the firm’s attorney charged, telling Judge Rhodes that the information the city has provided has been incomplete about matters such as the $816-million grand bargain to reduce pension cuts and spare the Detroit Institute of Arts from selling its masterpieces. In response, Motor City’s attorney Heather Lennox testified the city has released detailed information to creditors and continues to do so as agreements with creditors are reached, telling the court a six-week delay “completely unwarranted,” and advising Judge Rhodes that Detroit expects to release an updated version of its plan of adjustment sometime this week. Any delay into October, such as Syncora is seeking, would not only add significant costs to the city, its taxpayers, and its future; but also would create an added complication—Emergency manager Kevyn Orr’s appointment is scheduled to end on October 1st.

Detroit: One Year into Municipal Bankruptcy

             July 18, 2014

Visit the project blog: The Municipal Sustainability Project 

Happy Anniversary. Exactly one year ago—this afternoon, the City of Detroit filed for federal bankruptcy protection. Today, it is 27 days away from the commencement of its confirmation trial to exit municipal bankruptcy. The path to reversing more than a quarter century of decline has been marked by a truly remarkable coalition of not just an electronic federal bankruptcy judge, Steven Rhodes, and his U.S. District Court cohort, Gerald Rosen, the crazy Washington, D.C. suburbanite, emergency manager Kevyn Orr, whose spouse told him God only offers us one chance in a lifetime to truly make a difference; but also a broad coalition of leaders in business and philanthropy, city and suburban elected leaders, Governor Rick Snyder, the Michigan Municipal League, and bipartisan leaders of the state legislature—and outsiders like Richard Ravitch, who volunteered his experience, time, and commitment for free. To have been able to meet some of these characters and be able to observe this process—in such vivid contrast with the federal government’s exceptional dysfunction—in ways that seem to be unique in American history, has been transfixing. When the magnificent Jim Spiotto and I sat in the U.S. Senate Judiciary room as Chairman Howell Heflin (D-Ala.) and Ranking Member Strom Thurmond (R-S.C.) reported PL 100-597 on that summer day in 1988, we never, ever anticipated how it would someday be critical to ensuring essential public services to this revered American city. This is not to write that there is not a long way to go, nor that there can be certainty that the city’s plan of adjustment, if confirmed in the pending trial, will enable the citizens of Detroit to have a sustainable fiscal future with service solvency, but rather to celebrate that, as Daniel Howe of the Detroit News yesterday opined, “both sides of the political aisle, are pulling together (and in the same direction) in ways few have ever seen here.

Moody Motown Blues. Moody’s has issued a new report that determines under the Motor City’s current Plan of Adjustment, recovery rates favor the city’s retirees over its municipal bondholders, with the credit rating agency estimating the recovery on the unfunded portion of the city’s pension liabilities could reach 52%, which would likely exceed the recoveries on other unsecured claims. The report notes that recoveries for pensioners are assisted from a number of sources, including dedicated outside funding and some contingent restoration of benefits—especially from the so-called Grand Bargain of more than $816 million from the state and donations to the Detroit Institute of Arts over 20 years, which could provide nearly triple the recovery rate for the city’s bondholders.  Moody’s notes that these funds would be “in return for shielding the city’s art collection from creditors’ claims and for pensioners accepting the plan,” but writes that recoveries on unfunded pension liabilities absent such an unprecedented arrangement, adding that without the grand bargain, pension recoveries could be as low as 18%. In contrast, the recoveries on certificates of participation issued to fund pensions could be nil if U.S. Bankruptcy Judge Steven Rhodes determines the Motor City can repudiate them―a stark contrast to what the credit rating agency writes with regard to pension recoveries as measured by aggregate liabilities (described as that is both funded and unfunded pension claims), where the recovery could be as much as reach 82%, higher than 74% settlement announced for general obligation unlimited tax (GOULT) bonds.

Not the Odor of Verbena.  Judge Rhodes yesterday indicated he will determine on Monday how much of a claim he will permit Detroit’s neighbor, Macomb County, to use in voting as a creditor in Detroit’s bankruptcy. The county’s creditor status relates to Macomb County’s legal contention with Detroit with regard to what the county claims were gross overcharges for repairs after a major sewer line collapsed in Sterling Heights in 2004, creating a giant sinkhole—so giant that seven years later, Macomb County Public Works Commissioner Anthony Marrocco sued former—and now imprisoned―Mayor Kwame Kilpatrick, members of his administration, contractor Bobby Ferguson, and others over the 2004-05 repair project that Commissioner Marrocco claims cost $26 million more than it should have because of fraudulent overbilling. In the wake of the subsequent federal corruption convictions against Messieurs Kilpatrick, Ferguson, and former Detroit Water and Sewerage Department Director Victor Mercado; the suit was subsequently amended to include the City of Detroit. The issue is significant in not only dollar terms―the County is seeking $26 million; the Motor City is offering $1―but also in terms of what Judge Rhodes’ decision could mean for the creditors’ votes: A claim of $26 million would mean Macomb County’s vote would carry much greater weight: the County’s claim is in class 14, a group of unsecured creditors with total claims of about $150 million; and the County has opposed Mr. Orr’s proposed the plan of adjustment based on its apprehensions that the plan shifts responsibilities for water department pensions onto suburban customers. In testimony before Judge Rhodes yesterday, Commissioner Marrocco’s attorney testified: “They breached a contract and they acted in bad faith…The wrongdoers are gone, but their actions cost other people significant amounts of money that need to be recouped and compensated.” The attorney testified that it was clear by the time of the sale that federal investigators were questioning Detroit Water and Sewer Department employees about the drain repair project, but failed to notify Macomb County of potential liabilities. Judge Rhodes responded he will release his estimate on how much the claim will have for voting purposes: if he rules the claim is valid, Macomb County would be subject to the same treatment of other creditors in its class, receiving a pro-rated share of the city’s final approved offer that could be as low as 10 cents on the dollar.

Four Lemons in Atlantic City. While casino revenues have played an important role in Detroit’s bankruptcy, they play a critical role in the New Jersey seacoast city: they constitute 70% of Atlantic City’s property tax base, and are critical to jobs. Atlantic City had a 14.9% unemployment rate in May, one of the highest in the United States; now the closure of four of its twelve casinos will have a significant impact not just on the workforce, but almost certainly on assessed real estate values. Thanks to Atlantic City’s draw, demand for housing skyrocketed throughout the Shore among casino employees and their families, but now the bad spin of the dial means the fiscal pain will radiate well beyond the city’s limits: Jersey Shore towns are now having to support Atlantic City as tax revenue from the casinos dwindles, a trend that began seven years ago, but is now accelerating. Of 23 Atlantic County municipalities, 22 had tax increases from 2012 to 2013, mainly because Atlantic City contributed less revenue to the county budget, according to data from the Atlantic County Board of Taxation last week, with the biggest drop coming from Atlantic City the largest: 17.5 percent. Keith Szendrey, of the county’s taxation board, last March noted that “Everything in Atlantic City lost value, partly because the casinos lost value, and with the jobs they’ve pared, there is less demand for housing and commercial properties in Atlantic City.” The new round of closure mean, according to the Associated Press, that 7,000 casino workers have been told their jobs could disappear within 60 days: more than 1,000 employees who will lose their jobs at Trump Plaza, 1,600 were laid off from the Atlantic Club, 2,100 will be let go when the Showboat shuts down at the end of August, and 3,100 will be on the street if the Revel closes—a grand total of approximately 7,800 workers. As recently as three years ago, the casinos employed a total of 33,000—in a city with a population of less than 40,000. Although not all of the casino workers live within the city limits, one can appreciate the devastating human and fiscal impact on the city and its surrounding municipalities.  For the near future, Atlantic City leaders have reached settlement agreements on tax appeals with the owners of three of the four closing casinos for them to make payments this year and next, but over the long term, Moody’s has already reflected that the closures will erode the city’s primary source of revenue, as well as its long-term sustainability. With a median family income just above 50% of the United States average, the upsurge in unemployment and foregone benefits will impose significant new costs on the county, while further eroding tax revenues. Moody’s rates Atlantic City’s general obligation bonds Baa2 with a negative outlook. Standard & Poor’s rates them A-minus with a stable outlook. The state, through its Local Government Services office, has awarded $13 million in transitional aid to the city—assistance in addition to an already awarded grant of a $7 million essential services grant. But the sharp disruption mean the city is still working on its fiscal year 2014 budget, even though the city’s fiscal year began Jan. 1—a budget which is expected to include large tax increase, with the size dependent upon what the state determines to provide with state aid—a decision expected to be finalized next month.  

Ola Plebiscite. Puerto Rico Gov. Alejandro García Padilla announced the commonwealth will prepare a plebiscite on its status by 2016 to decide the future of the island’s political status, with the Governor reporting his Popular Democratic Party is working on a definition for the enhanced commonwealth status it supports. Governor Padilla has previously said he would support a constitutional assembly to decide the U.S. territory’s status—any decision on which would be subject to Congressional approval. The Obama Administration has pledged $2.5 million to finance a plebiscite, the ballot for which would have to be approved by the U.S. Attorney General Eric Holder before going to voters. The Commonwealth last Puerto Rico held a nonbinding, two-part referendum in November 2012 whose results have been disputed. Nonbinding referendums also were held in 1967, 1993 and 1998. Seeking statehood has never garnered a clear majority. Such a ballot could offer Puerto Rican voters options of statehood, remaining a commonwealth, or becoming an independent nation. Were voters to opt for statehood, it would lose its current ability to sell municipal bonds that are exempt from state income taxes in every state. If Puerto Rico bonds lost their tax-exemption, this would reduce the number of people interested in buying the bonds and force Puerto Rico to offer higher interest rates. At a press conference Wednesday, Gov. Padilla said he supported unspecified changes in the Commonwealth’s current status so that Puerto Rico would have an improved commonwealth status, stating such a plebiscite would occur before his current term ends at the start of 2017.


Fire in the court. The Detroit Fire Fighters Association, the Motor City’s last remaining major labor union that has not reached an agreement over the city’s proposed plan of adjustment, nor agreement on a contract yesterday testified in federal bankruptcy court before Judge Steven Rhodes that the city’s proposed plan violates its members’ collective bargaining rights—telling the court that the new hybrid pension plans that went into effect at the beginning of the month would effectively suspend Michigan’s collective bargaining for the next 10 years and not allow the union to bargain for better pension benefits. (The city has proposed a complex new formula for calculating the value of active pension plans. The city’s largest police union has accepted the proposal, leaving firefighters [DFFA] as the largest remaining Detroit union that has not reached at least a tentative contract with the city.) The new plans require employees to contribute to their retirement accounts. The Association testified that the federal bankruptcy court does not have the authority to permit the city to ignore the State of Michigan’s public employee collective bargaining law: “However noble this court’s intent is, you haven’t been licensed to control wages and benefits for 10 years.” Noting that permitting the union to bargain for better benefits could undercut the Motor City’s ability to stabilize its finances, Detroit attorney Heather Lennox said Detroit’s plan of adjustment relies upon assuming pension costs will remain at a fixed cost for the first 10 years after exiting bankruptcy: “The whole 10-year plan is based on these crucial assumptions…They’re looking at this through a prism of ordinary bargaining and ordinary times. These are extraordinary times in a financial emergency.” Ms. Lennox noted to the court that at the end of the ten year window, unions would, once again, be free to bargain with city management over pensions—and that in the meantime, they were free to bargain over other economic issues: “This,” she testified, “is not a wholesale suspension of bargaining.” The testimony yesterday came as part of two days’ of hearings Judge Rhodes has scheduled this week with regard to questions and issues related to Kevyn Orr’s proposed plan of adjustment. The court was also scheduled to hear from attorneys from the surrounding counties of Oakland, Macomb, and Wayne with regard to their contention that they have legal standing to object to Mr. Orr’s proposed Detroit’s plan of adjustment. Continue reading


What Does Municipal Bankruptcy Mean to the People? U.S. Bankruptcy Judge Steven Rhodes yesterday heard testimony from a number of the 600 individuals who have filed objections to the Motor City’s proposed plan of adjustment, inviting approximately 80 to have their day in court, granting each five minutes, with the city’s attorneys given 30 minutes to respond. For the judicial musician, who has demonstrated a profound interest in trying to understand the implications of the city’s downfall and proposed exit plans, these hearings have served an important role to help the judge reflect on the implications of the emergency manager’s proposals from a very different perspective―after all, when Kevyn Orr and his staff and consultants leave next October, it is these people, the citizens of Detroit, who could be left behind. This is not an unusual move for Rhodes who set aside court dates prior to the eligibility hearing into Detroit’s bankruptcy last fall to hear from residents and other individual stakeholders. Rhodes appeared moved by their stories and referenced them in subsequent hearings. As the Detroit Free Press reported live from the testimony, one witness, Gisele Caver, a retired police sergeant, who is now disabled, fears losing her health care insurance, telling Judge Rhodes: “There is no cure for my disease.” In tears, she begged Judge Rhodes to make sure the city does take away her pension and insurance as she seeks to be comfortable in her remaining years. Similarly, another retiree, who was diagnosed with cancer last year, expressed apprehension about the implications of her annuity clawback.  Retiree Jo Ann Cooper, who worked for the municipal library for 30 years, said there is a lot of blight in her Detroit neighborhood, but she does not want to the leave city: “I do not believe the city of Detroit is broke, but I have no proof of it…I should not have to worry about a handout. At the rate this state is going, it could easily become a welfare state.” “I know that some sacrifices have to be made, but I never thought I would be struggling to get health care,” Jesse Florence, a retired city bus driver, told U.S. Bankruptcy Judge Steven Rhodes today in federal court in Detroit. Florence’s health-care premiums jumped from $152 a month to $1,026, he told Rhodes. “This is devastating.” In response, the city’s attorney said: “That effect cannot be minimized…Our plan isn’t perfect. It’s certainly not all we wish it could be. But it does reflect the fiscal reality we have today.”

Tapping. One outcome of the morning’s hearing was a request from Judge Rhodes that the city provide a representative to testify yesterday afternoon with regard to questions and apprehensions he had heard about the Detroit Water and Sewerage Department’s program of shutting off water to delinquent customers, which critics say has cut off water to thousands of the city’s poorest residents. Although the Judge stated he was uncertain whether the issue was actually under his jurisdiction, he decided to bring it up after a couple of retirees had expressed apprehension about it in their testimonies: “It’s a problem that’s affecting this bankruptcy.” Since its recent inception this spring, Detroit has stopped water service to more than 15,000 households in the city, leading the Judge to state the Motor City was “getting a reputation not only in this country but around the world” for the shut-offs — causing “a lot of anger” and hardship among residents. In late June, three United Nations experts said Detroit’s shut-off policy may violate international human rights. So, yesterday afternoon, Deputy water director Darryl Latimer was in hot water before the Judge to explain the Department’s new policy of shutting off water to customers more than 60 days late or $150 behind in their bills, testifying that the average residential delinquency is $540, while the average monthly household bill is about $75: “We’re trying to control the rates in the city of Detroit for all of our customers,” Mr. Latimer testified. “For those with affordability issues, we’re asking them to come forward so we can assist them,” adding that the department has restored water to thousands of delinquent customers within 48 hours after paying overdue bills or enrolling in a payment plan. (Detroit residents behind on their water bills can choose a plan that typically involves paying 30 percent of the outstanding bill and then the remainder — while keeping current on the present bill — over as long as 36 months.) In addition, he told Judge Rhodes that, this month, the department announced a Detroit Residential Water Assistance Program with $1 million in funding to help customers who cannot afford water―financed by a voluntary 50-cent surcharge the department has collected for several years. To which Judge Rhodes responded: “It sounds like to me the problem is informing and encouraging people what their options are to maintain their water services…If that’s what it is, that’s a solvable problem. I encourage you to work within your department to come up with a much more aggressive plan to solve that problem.” Judge Rhodes requested Mr. Latimer to return Monday with further options for those who cannot afford to pay their water bill.

Sync or Swim. The 6th U.S. Circuit Court of Appeals has set an accelerated schedule of two weeks to hear Detroit’s municipal bond insurer Syncora Guarantee Inc.’s appeal of Judge Rhodes’ decision last August that the Motor City’s casino tax revenues are part of the bankruptcy estate, and therefore subject to bankruptcy’s automatic stay, setting a hearing for two weeks from today to hear oral arguments, according to Syncora attorneys—the same date on which the appeals court is scheduled to entertain a series of appeals from labor groups to the U.S. bankruptcy court’s decision finding Detroit eligible for Chapter 9 protection. Syncora is appealing last Friday’s ruling by U.S. District Court Judge Bernard Friedman affirming Judge Rhodes’ decision that Syncora may not access the city’s casino tax revenue—revenue on which Syncora relies upon for collateral for interest-rate swaps it insures. Judge Friedman found that the casino tax revenues are not part of the bankruptcy estate, rejecting Syncora’s claims and affirming Judge Rhodes’ ruling that the automatic stay exemption cited by Syncora does not apply in the case, holding that the exemption statute “has no bearing on the use of the casino tax revenues to secure the City’s swap obligation payments,” writing that one of the main purposes of the exemption is to ensure the protection of a pledge of special revenues pledged to bonding and the city’s swap obligation was not a form of indebtedness issued to either the swap counterparties or Syncora.

Taking Stock in Stockton. Credit rating agency Moody’s has now opined [Stockton Bankruptcy Judge Raises Possibility of Pension Impairments in California: Mixed Impact on Bondholders] that were U.S. Bankruptcy Judge Christopher Klein to decide to permit Stockton, as part of its plan of adjustment, to reduce its pension liabilities, in contravention to California’s state constitution, but consistent with Judge Steven Rhodes’ decision that federal la (chapter 9) preempts a state’s constitution (an issue pending, currently, before both the 6th and 9th U.S. Circuit Courts of Appeal), such an outcome would be a positive development for municipal bondholders in ongoing municipal bankruptcies; however, the agency acknowledged that such a ruling could also act as an inducement for other California local governments to file for federal bankruptcy protection: “A ruling in favor of pension adjustments would incentivize some distressed California local governments to file under Chapter 9, but local governments would still have to fulfill the requirements of the bankruptcy code for becoming a Chapter 9 debtor…These requirements, combined with the high legal costs and protracted process of a bankruptcy filing, would still make additional filings rare.”  But the report also noted that if the authority of cities and counties in bankruptcy to treat pensions and post-retirement health care benefits in the same manner as other creditors, municipal employees could well be more amenable to concede enough on compensation and benefits to protect pensions and avoid bankruptcy altogether, noting: “Ultimately, this would be a positive development for bondholders if issuers are better able to target compensation expenses, rather than filing for bankruptcy and cutting debt principal.” The brief came in the wake of Judge Klein’s note that he could decide that the California Public Employees’ Retirement System (CalPERS) is a fiduciary, rather than a creditor—a decision that would bar the imposition of a lien on Stockton’s assets in the event of a pension payment delinquency or plan termination, or, as the analysis put it: “Such a ruling would provide Stockton with the opportunity to significantly reduce its pension liability and annual pension payments — an opportunity that it may still decline…Alternatively, Judge Klein could confirm the city’s proposed plan of adjustment as constituted, even if he decides that the city’s pension liabilities are vulnerable to adjustment in bankruptcy.” Under Stockton’s current plan of adjustment, its bondholders’ recoveries would be around 50%, on average, while the plan proposes no reductions in either pensions or post-retirement health care benefits.

Transfixed between a city and a state. Puerto Rico, a U.S. territory, is confronted by a year-long debt crisis—serious enough that last month Governor Alejandro García Padilla signed a new law establishing a de facto bankruptcy regime for state-owned enterprises—but with its Puerto Rico Electric Power Authority (PREPA), a cash-strapped utility, teetering on the brink of default, the new system may face its first test soon. Or, as William Glasgall, the State and Local program and editorial director at the Volcker Alliance in New York, wrote this week: “With federal debt relief or restructuring assistance to Puerto Rico unlikely in the immediate future, investors who eagerly bought its government corporations’ debt for years had better be prepared to hunker down for a long, anxious wait should defaults occur. In the future, lenders to high-risk states and territories ineligible for U.S. bankruptcy court protection may want to insist on the same kinds of formal default-resolution frameworks and independent monitoring that international banks and governments have imposed on riskier sovereign nations as a precondition for gaining access to their credit.” [“Puerto Rico’s Debt Mess May Spur Solutions for High-Risk Territories”]. From 1976-2006, businesses on the island were exempt from federal tax on their local profits. But once that carve-out expired, the economy fell into an eight-year recession. Thus, subsequent to Detroit bankruptcy filing last year, investors fled risky municipal bonds, which escalated Puerto Rico’s financing costs. Now the territory insists that it “cannot default”, because its constitution gives debt payments first priority; however, this only applies to its general-obligation and guaranteed bonds. The remaining public debt is backed by specific revenues like highway tolls or, in PREPA’s case, electric bills. Thus darkness is looming: the $800m of bank credit lines PREPA uses to buy fuel come due in August. Unless it can renegotiate quickly, it will either default or turn out the lights. No one knows what would happen then, because, as a governmental creature between a municipality and a state, Puerto Rican state agencies fall in a gap in America’s bankruptcy code: they are excluded from the bankruptcy protections provided to private and municipal corporations. Now, with looming, missed payments on the near-term horizon, one can anticipate a Caribbean hurricane of litigation—a risk so great the territory has sought to institute a new insolvency system for its companies, offering them nine months to negotiate a settlement acceptable to holders of 75% of their debt, after which, were the parties unable to reach resolution, local courts would impose a solution. But to holders of the territory’s municipal bonds, the signal received was that PREPA was set to restructure its $8.6 billion of liabilities; thus, the system’s two biggest creditors, the mutual-fund firms Franklin Templeton (which is a challenging creditor in Detroit’s municipal bankruptcy)  and Oppenheimer Funds, have challenged the law, arguing that the constitution gives Congress exclusive control over bankruptcy. But that challenge, as Mr. Glasgall writes, “is unlikely to provide immediate relief, as federal court challenges on the constitutionality of the legislation by mutual-fund managers Franklin Templeton Investments and Oppenheimer Funds Inc. will only complicate the territory’s quest to ease its unsustainable $73 billion public-debt burden and almost guarantee a legal quagmire that will take years to resolve. In that regard, both Arkansas and Argentina provide roadmaps to what may lie ahead.” Continue reading


Is the Motor City Contagious?  One question that continues to crop up is whether the Motor City’s municipal bankruptcy could adversely affect the cost of capital for other cities and counties across the nation—in effect sharply escalating the interest rates cities and counties will need to offer in order to issue debt. The answer appears to be no. Detroit Emergency Manager Kevyn Orr’s adjustment plan reduces Detroit’s pledged payments to its limited-tax general obligation bondholders by 66% on its $164 million of those municipal bonds not secured by a lien of state assistance—although the details of the final plan are not expected to be revealed until Detroit files its updated plan of adjustment with the U.S. Bankruptcy Court next week. That plan is expected to retain the proposed cut of 36% on the city’s unlimited-tax general obligation bondholders. The ever so prescient Richard Ciccarone, the president of Merritt Research Services, notes that the severity of these cuts is unlikely to be contagious because of some of the unique characteristics of Detroit’s bankruptcy, including its exceptionally low income and property tax collection rates (both at 50% or higher), as well as the lack of voter approval for LTGOs that the unlimited-tax GO bonds enjoy. Therefore, if there is any message for local leaders, it is to be careful in assessing the certainty of the pledge her or his local government is offering to prospective purchasers of the debt, or, as Mr. Ciccarone notes: “If the security is deemed to be inferior, as it appears to now be, then one shouldn’t get comfortable with a limited-tax bond issue in which the amount you can collect on a limited basis nudges up against the amount you need for debt service, which is obviously what’s happened in Detroit.” Nevertheless, as Municipal Market Advisors has noted, the Motor City’s proposal marks a major loss for an investment that has traditionally been considered safe, so that the unprecedented cuts together with the anti-Wall Street rhetoric running through the bankruptcy reporting could lead investors to be “far more careful before lending fresh dollars to local governments in Michigan.” However, the advisory firm notes there is, to date, little evidence of disaffection, reporting that S&P and other credit rating firms have remained bullish on state and local credits, notwithstanding the municipal  bankruptcies in California and Detroit—or the significant number of Michigan municipalities in distress, adding: “Non-professional investors have been given almost no information on which they might change their behavior with respect to Michigan GO bonds…So while we can attribute at least some of investors’ un-dulled enthusiasm for non-Detroit MI paper as a strength of tax exemption, credit analysts looking for a better, more disciplined industry response are likely to be disappointed.” Continue reading