Officially Exiting Municipal Bankruptcy

November 25, 2014

Visit the project blog: The Municipal Sustainability Project 

Escaping from Municipal Bankruptcy. Detroit’s bankruptcy attorney Heather Lennox yesterday testified to U.S. Bankruptcy Judge Steven Rhodes that the Motor City will not officially end its bankruptcy before December 8th, telling the court that Mayor Mike Duggan and the City Council still must revise its two-year budget to incorporate the spending plans outlined in its plan of debt adjustment or bankruptcy structuring plan—an action which she said would pave the way for the completion of financing to fund key creditor settlements. Therefore, Judge Rhodes did not set an effective exit date. In addition, the city must also release detailed information about its debt restructuring plan to the municipal market before it can complete the settlements tied to the plan of adjustment, which will allow the city to eliminate $7 billion in liabilities and reinvest $1.7 billion over 10 years in key, municipal services. Ms. Lennox testified that the city expects to resolve remaining issues this week―including approval by the State of Michigan on agreements with Detroit bond insurers Syncora Guarantee Inc. and Financial Guaranty Insurance Co. under which the two will be finalizing proposals to develop city property as part of their settlements with the city—in part financed with nearly $100 million in city-issued taxable limited-tax general obligation (LTGO) bonds, which Detroit intends to pay off over the next dozen years with municipal parking revenues. In addition, the Motor City will allocate some $632 million of 30-year taxable LTGO bonds to various creditors, with the majority of the bonds going to voluntary employee beneficiary associations created under the bankruptcy plan to fund retiree healthcare. These bonds will carry 4 percent interest rates for the first 20 years, increasing to 6 percent for the last 10, with no principal payments for 10 years, according to Reuters. The state will also step in, lending its higher credit rating, for two other debt issuances via the Michigan Finance Authority to help finance the costs to Detroit to exit from its chapter 9 municipal bankruptcy—an issuance of nearly $300 million in tax-exempt and taxable LTGO municipal bonds secured by a statutory lien on Detroit’s municipal income tax revenue. The city must exit bankruptcy by the end of the year to ensure the grand bargain, which preserves the Detroit Institute of Arts and reduces pension cuts, stays intact.

Pensionary Considerations. Several processes are already under way to execute Detroit’s plan of debt adjustment to exit municipal bankruptcy. The state’s Financial Review Commission, which will have the power to reject Detroit’s spending and borrowing plans for at least a decade, has launched unofficial meetings. The city’s pensioners will receive a mailing in early December which will contain details on how to apply for income assistance if pension cuts will put them below the poverty line, according to state attorney Steven Howell. Pension cuts will take effect March 1. At yesterday’s session, advisers to Detroit’s two pension funds argued that they should not be subject to court-imposed scrutiny for the fees they earned during the bankruptcy case, with Robert Gordon, one adviser, testifying that the pension funds are independent of the city and should not be subject to fee examiner Robert Fishman’s review process. Mark Shapiro, an attorney for Greenhill, the pension funds’ financial adviser is set to receive a $3.55-million payment when the city exits bankruptcy. The testimony is at issue, because Judge Rhodes is reconsidering subjecting the pension fund advisers to the fee review process after previously deciding that their fees may cause the city of Detroit to pay more to fund pensions over the next decade. Ms. Lennox urged Judge Rhodes’ review, because, she testified, “the city is the sole bearer of those costs,” because the fees widen Detroit’s pension shortfall: “It matters not that the city doesn’t pay invoices directly.”

State Monitoring. The state oversight board, the Michigan Financial Review Commission, which will monitor Detroit’s finances after the city officially emerges from bankruptcy, has established its schedule of monthly meetings through which, with the able assistance of New York City financial guru Dick Ravitch, it will help make sure the city stays on solid financial footing. The nine-member state financial review commission will meet the fourth Monday of every month from 2:30 to 3:30 p.m. The commission includes five appointees of Gov. Rick Snyder, along with state Treasurer Kevin Clinton, state budget director John Roberts, Detroit Mayor Mike Duggan, and City Council President Brenda Jones. Under state law, the commission will have oversight of Detroit’s finances for at least 13 years, although the commission could go dormant if Detroit meets terms of its bankruptcy exit plan and keeps its budgets balanced three years in succession. The commission’s role could be significant: it includes broad powers to approve or reject city contracts, budgets, spending and labor contracts. The commission’s next meeting is from 9 a.m.-noon Dec. 5 at the Cadillac Place offices—meetings which are open to the public. The state commission, which was created as part of the “grand bargain,’ under which the state ponied up $195 million to help leverage the city out of bankruptcy, includes five gubernatorial appointees, of which three of Governor Rick Snyder’s are from Detroit. The commission has authority to approve Detroit’s four-year budgets, approve sizeable contracts, approve collective bargaining agreements, and report to the Governor twice a year for the next 13 years. The nine-member commission, the product of discussions involving U.S. Chief Judge Gerald Rosen, the Detroit Institute of Arts, and Governor Snyder and key, bipartisan legislators, is intended to protect nearly $200 million in state funding to Detroit by ensuring that city leaders budget money responsibly―in effect taking on a politically difficult role by risking any perception that it might be interfering with the ability of Detroit’s democratically elected officials to run the city. In this task, however, it is ably assisted by Dick Ravitch, whose experience as part of New York City’s state oversight board and previous service to U.S. Bankruptcy Judge Steven Rhodes gives the commission broad experience and perspective. In addition, under pressure from Mayor Duggan and Council President Brenda Jones, the Detroit City Council also has a representative on the commission, as well as a gubernatorial non-Detroit resident appointee. The commission is to receive $900,000 from this year’s state treasury budget for operations.

Hiring an Architect. San Bernardino has just hired former Stockton city manager, Bob Deis, who ably served on our Friday afternoon panel on “Lessons learned from Municipal Bankruptcy” at the National League of City’s Congress of Cities in Austin, and who is regarded as the architect of Stockton’s plan of adjustment approved last month by U.S. Bankruptcy Judge Christopher Klein. Mr. Deis was hired by the City of San Bernardino to help develop its plan of debt adjustment to exit municipal bankruptcy by the new deadline set by federal bankruptcy Judge Meredith Jury. The San Bernardino city council voted 6-to-1 to award a $300,000 contract to Management Partners, which under the direction of Mr. Deis worked on the Stockton “plan of adjustment” to cut debt and exit bankruptcy. The signing came in the wake of a court filing last week which officially revealed, after a mediator lifted a gag order, that under an agreement set last June, San Bernardino has begun repaying skipped payments of $13.5 million plus fees and interest to the CalPERS–and that the city will not reduce its pension payments to CalPERS as part of its proposed plan of debt adjustment. San Bernardino has, however, filed a notice with Judge Jury’s bankruptcy court noting that: “Just recently, the city and the retiree committee reached a tentative agreement regarding modifications to retiree health benefits, contingent upon the parties reaching an overall agreement on plan treatment of retiree claims.” Mr. Deis retired as the Stockton city manager last November and joined Management Partners in May. The consulting firm worked with San Bernardino from 2007 to 2011. Our George Mason University study last year reported that San Bernardino’s annual per capita income, $15,762, was about half of the state average, $29,634, and the city had “committed to salaries and pensions that were neither proportionate nor sustainable.”

Gambling on a City’s Future. Atlantic City’s precarious fiscal situation could be further clouded by some $119 million in municipal debt for a power plant serving the closed and forlorn Revel Casino, which, itself having rolled the dice, now appears to be nearing default. Demonstrating the complexity of state-local relations, Bloomberg reports that investors who rolled the dice in investing in the casino are scheduled to receive a $6.9 million interest payment next Tuesday—a payment related to municipal debt issued by the New Jersey Economic development Authority in 2011 to help finance a facility to keep the lights on and the air conditioners running at the now bedimming Revel Casino, its sole customer. The power plant in September reported it may have to file for bankruptcy itself, as Revel did last June. Or as the fabulous Matt Fabian of Municipal Market Advisors puts it: “It looks like (municipal) bondholders were tying their fortunes to the casino, and that was an unfortunate bet.” The souring bets, Moody’s this week opined: “signal continued deterioration of the city’s taxable base and are credit negative” for Atlantic City, writing that “Prospective purchasers of the Bonds should make an investment decision based on their assessment of the ability of Revel to operate the hotel and casino and to generate sufficient revenues to meet its obligations….“If the Resort, including the hotel and casino, or the retail shops cease operations, or if they are transferred to ownership other than Revel, there is no assurance that there will be a need for the energy produced by the Project Facility or that subsequent owners will not obtain required energy elsewhere.”

Detroit Nears an official Exit from Bankruptcy, while Illinois Faces an Epic Pension Challenge

November 24, 2014

Visit the project blog: The Municipal Sustainability Project 

The Municipally Costly Cost of Exiting Municipal Bankruptcy. U.S. Bankruptcy Judge Steven Rhodes could set an official date today for Detroit to exit chapter 9 municipal bankruptcy—officially confirming its ability to eliminate more than $7 billion in debt and reinvest $1.4 billion in services over the next decade after he receives an update this morning on the city’s efforts to complete its restructuring plan. At this morning’s hearing, Judge Rhodes is also expected to rule on whether to force the Motor City’s two public pension funds to submit their bankruptcy expenses for review by the fee examiner appointed to monitor bills during the case―the Detroit Retirement Systems were not previously subject to the fee-review process, because they are legally independent from the city; however, Judge Rhodes has determined they should be subject to fee examiner Robert Fishman’s review process, because the city may ultimately reimburse the pension funds for some of their expenses. Nevertheless, after the unions filed objections with the court, some believe Judge Rhodes might reverse his position. Part of the detritus of municipal bankruptcy is the extraordinary cost—cost that is additional debt (in Detroit’s case, those costs are projected to be somewhere between $150-$200 million) and that, more often than not, appears to go to attorneys and financial advisors who are neither local residents, nor taxpayers. Mayor Mike Duggan’s administration previously signaled concerns that fees could jeopardize the city’s financial position but later asserted that the mediation process would resolve those concerns. About 80 percent of the $146 million in professional services fees that a Detroit bankruptcy court mediator will review next week are already paid, and officials said odds are long that mediation will reduce the balance very much.

Pensionary Challenge. Even as the potential federalism challenges between the federal municipal bankruptcy law and the California and Michigan state constitutions appear less and less likely to be pursued in the 6th and 9th U.S. Courts of Appeal, Sangamon County Circuit Court Judge John Belz last Friday struck down Illinois’ landmark pension law, which the governor and state legislature had adopted to address the state’s $104.6 billion government retirement system debt. Judge Belz, however, declared the new law unconstitutional, likely leading to an appeal to the Illinois Supreme Court. Judge Belz wrote: “The state of Illinois made a constitutionally protected promise to its employees concerning their pension benefits…Under established and uncontroverted Illinois law, the state of Illinois cannot break this promise,” adding that it was “without question” that the law violates the state constitution’s provision that a public worker pension cannot be “diminished or impaired….The court finds there is no police power or reserved sovereign power to diminish pension benefits,” in voiding the legislation in its entirety and permanently barring not only the state from enforcing any part of it, but also making clear it extended to every local government:  “Membership in any pension or retirement system of the state, any unit of local government or school district, or any agency or instrumentality thereof, shall be an enforceable contractual relationship, the benefit of which shall not be diminished or impaired.” Illinois Attorney General Lisa Madigan said she will appeal the decision to the state’s high court, where cases go when a state law is declared unconstitutional. She will ask justices to expedite the appeal in order to seek resolution and “given the significant impact that a final decision in this case will have on the state’s financial condition.” For Illinois, it could mean going back to the legislative drawing board to address the state’s $111 billion pension deficit—an unexpected challenge for Governor-elect Bruce Rauner. For Chicago, the ruling is the obverse of R-o-l-a-i-d-s, as the Windy City faces a $550 million increase for police and fire pension funding in 2016 unless the General Assembly grants some relief. According to the grand wizard of municipal bankruptcy—and Illinois resident, Jim Spiotto, Illinois is one of seven states which has constitutional provisions which protect public worker pensions: “Labor and pension contracts under state constitutions and statutory provisions should not be interpreted as a mutual suicide pact…A recovery plan with reasonable adjustments to pension benefits to what is sustainable and affordable is the only path forward for all concerned.”

The Illinois-passed pension changes were aimed at shaving about $145 billion off state payments in the coming decades, including $1.1 billion in fiscal 2016, while bringing the system full funding in 30 years. About $21 billion would be, if the Illinois Supreme Court overturns the lower court, pared from the unfunded obligations’ tab. The legislation would limit cost-of-living increases, cap pensionable salaries, and raise the retirement age for some, while cutting employee contributions by 1%, shifting contribution calculations to a more actuarially sound method, and giving the pension funds enforcement rights over state payments. Much of the expected savings from the pension overhaul stems from the COLA increases annuitants now receive. Under the package, the state would shift to an actuarially based method that moves Illinois ‘system to full funding by 2044. State contributions are guaranteed and pension funds could ask the courts to compel the state to make the payments, although lawmakers can vote to change them.

The Uneasy Balance between Pension Obligations & Exiting Municipal Bankruptcy

November 19, 2014

Visit the project blog: The Municipal Sustainability Project 

The Challenge of Inequality. U.S. Bankruptcy Judge Meredith Jury has ruled that the City of San Bernardino has until May 30, 2015 to put together its proposed plan of debt adjustment. Judge Jury’s order came just a day after the city and its largest creditor, the California Public Employees’ Retirement System or CalPERS, released details of an interim agreement under which the city would fully repay CalPERS and require the city to file its plan to exit bankruptcy by September 2015. That agreement, which had been kept under a gag order from the public and U.S. Bankruptcy Judge Meredith Jury until yesterday, was released by both sides in advance of yesterday’s hearing today at which creditors had successfully sought to convince Judge Jury to impose a deadline for the city’s proposed exit plan. According to city officials and CalPERS, mediator Gregg Zive, a retired bankruptcy judge, authorized the disclosure.

Under the agreement, San Bernardino will make repayment of the full amount San Bernardino owes to CalPERS, or approximately $14 million, by means of 24 equal installments beginning retroactively to last July 1st and ending June, 1, 2016, or when the city’s plan of debt adjustment is accepted by the federal court and its plan of adjustment becomes effective. According to CalPERS, the city has, to date, paid $4.5 million of the money it owes. Judge Jury noted at the hearing: “I don’t know what took nine months to agree to pay CalPERS in full.” Under the new agreement, according to both the city and CalPERS, the city will make up all payments missed since the bankruptcy declaration — about $13.5 million — plus interest and fees in 24 equal installments over two years. The CalPERS agreement, however, has other creditors worried, including Erste Europäische Pfandbrief- und Kommunalkreditbank AG, the Luxemburg-based holder of municipal bonds the city issued in 2005 to pay its pension obligations. Based on U.S. Bankruptcy Judge Christopher Klein’s approval of Stockton’s plan of debt adjustment last month in which CalPERS received full payment, but creditor Franklin Templeton Investments received pennies on the dollar (and has appealed Judge Klein’s decision), the Luxemburg bank representative described the agreement as a “deal [that] is really more of a surrender…At worst, the city will find there is no feasible plan that could incorporate the deal with CalPERS.” On the matter of the deadline Judge Jury set for the city to submit its final plan, the judge stated: “I’d rather say this is a hard, hard deadline, and the earth is going to have to move under San Bernardino (to get an extension) — which, by the way, is not impossible.” In her comments with regard to setting the final deadline, Judge Jury was critical of San Bernardino, noting that the city’s reliance on the recently voter rejected Measure Q—which the city had assumed would be passed and provide significant labor savings―“was never going to be enough…“Good heavens, the attorneys’ fees in this case were probably several years of what you were going to get by adjusting the safety salaries.” Nevertheless, Judge Jury granted more time than CalPERS and the city’s unions had sought, because she wanted to allow time for a plan to be developed by Management Partners, the firm San Bernardino hired at the beginning of this week (at a cost of $300,000) to help develop its plan. Management Partners, however, has some experience under their belts from their recent work in assisting the City of Stockton put together its recently approved plan of debt adjustment. Moreover, the city has previous—albeit unacted upon—experience with the group from seven years ago—but the city followed up only partially on its recommendations, or as Judge Jury said Tuesday: “What I remember from the reports is the city didn’t do anything that was recommended.” If San Bernardino is successful in complying with the federal court’s deadline, it will have been in municipal bankruptcy for just short of three years—more than twice as long as Stockton, and four times as long as Detroit, but within striking range of the 31 months it took Vallejo, California to exit from chapter 9.

Retirees & Muni Bondholders. Notwithstanding the provisions in the Michigan and California constitutions protecting the pension contracts of municipal retirees in Detroit, San Bernardino, and Stockton; U.S. Bankruptcy Judges Steven Rhodes and Christopher Klein had each been clear that the federal chapter 9 municipal bankruptcy law trumped the respective state constitutional protections. Indeed, with appeals on the question filed with both the U.S. 6th and 9th U.S. Circuits Courts of Appeal—and with appeals pending in both Stockton and Detroit (please see below), it appeared we were on the road to a fundamental federalism challenge at the U.S. Supreme Court. That titanic, potential clash, however, has faded: In the Motor City, the “grand bargain” appeared to successfully garner the strong support of the city’s unions and retirees to support the acceptance of modest reductions in their pension benefits—especially compared to the cuts of some of the other financial creditors of the city; and in neither Stockton, nor, so far, in San Bernardino has there been any effort to seek cuts: first Stockton, and now San Bernardino have agreed to pay CalPERS in full and to keep their retirement plans intact, notwithstanding U.S. Judge Christopher Klein’s oral ruling last month. Had Stockton taken Judge Klein’s offered route and reduced payments to CalPERS, it would have triggered a mechanism that would have cut retirement benefits by as much as 60 percent—any amount that Stockton leaders feared would have led key employees to quit in droves, and, more importantly, maybe, rendered the city far less competitive in its ability to hire new employees. Stockton’s federally approved plan of debt adjustment fully protects its public pension obligations; San Bernardino’s filing with the U.S. Bankruptcy Court this week fully protects what Paul Glassman, an attorney for the city, this week said was the “800-pound gorilla in the case: CalPERS,” according to a report by Bloomberg. Nevertheless, the issue will not be over until it’s over; so that with both Judge Klein’s and Judge Rhodes’ decisions on the record, the possibility of the issue coming back in appeals to the respective U.S. Bankruptcy court decisions, the final balance might yet remain to be assessed. Indeed, Franklin Templeton has already appealed Judge Klein’s decision.  Or, as Dave Low of Californians for Retirement Security puts it: “I don’t think that we’re out of the woods.”

It Ain’t Over ‘til It’s Over. In approving Detroit’s modest reductions under its plan of adjustment to most city pensions earlier this month, U.S. Bankruptcy Judge Steven Rhodes said there was a 25 percent chance his ruling could be overturned on appeal. Detroit, being a casino city, might well have figured into the thinking of 133 holdout pensioners-creditors who are rolling the dice that they may be able to gain full restitution. This week they requested that U.S. Bankruptcy Judge Steven Rhodes halt the implementation of Detroit’s pension cuts approved under its approved plan of debt adjustment pending resolution of their appeal of his decision approving the Motor City’s plan of debt adjustment. Indeed, in their filing, the group of retirees, survivors and city workers cited the 4-to-1 odds the Denver Broncos will win Super Bowl XLIX next February 1st as part of their justification for time to appeal: “Therefore, there is a reasonable likelihood of prevailing on the merits,” retired Detroit police officer and attorney Jamie S. Fields wrote in a court motion for a limited stay of U.S. Bankruptcy Judge Steven Rhodes’ ruling. Their motion requested a limited stay that would not impact other settlements tied to Detroit’s plan to reinvest $1.7 billion in municipal improvements and eliminate close to $7 billion in debt, but argued that Detroit should not be able “to avoid any meaningful appellate review of the unprecedented approach” used to forge settlements with labor unions, retiree groups, the city’s pension funds, or its financial creditors. While Judge Rhodes has not yet set a date for Detroit’s plan of adjustment to become effective, Mayor Duggan and city leaders anticipate he will do so by the middle of next month—at which point the city can begin imposing its plan to reduce general retiree pensions by about 4.5 percent and modifying cost-of-living or COLA adjustments for retired police officers and firefighters from 2.25 percent down to about 1 percent. Under the so-called grand bargain, the State of Michigan and major foundations agreed to provide $816 million towards offsetting the pension reductions—especially for retirees who might otherwise fall below the federal poverty level over the next two decades, as well as to keep the world famous Detroit Institute of Art from being auctioned off—an action that led Detroit’s pension members and retirees in both the General Retirement System and Police and Fire Retirement System to vote overwhelmingly in favor of the city’s plan of debt adjustment, which includes deeper cuts for some GRS members who received excess interest earnings on an optional savings account. Nevertheless, in Judge Rhodes’s ruling approving Detroit’s plan of debt adjustment earlier this month, the federal bankruptcy judge acknowledged the pension reductions could be a “real hardship” for some retirees, although he reminded the court: “The pension reductions in the pension settlement are minor compared to any reasonably foreseeable outcome for these creditors without the pension settlement and the grand bargain.”

The Challenge of Inequality to Municipal Fiscal Recovery

November 18, 2014

Visit the project blog: The Municipal Sustainability Project 

The Challenge of Inequality. Even though the federal bankruptcy court has approved Detroit’s plan to exit municipal bankruptcy, the challenge it confronts is daunting. Nowhere is the challenge more apparent than in the disparity in assessed property values between the Motor City and its surrounding suburbs. Even though year-over-year sales in the Detroit metropolitan region declined 6.3%, median sale prices for homes in Wayne, Oakland, Macomb, and Livingston counties rose by 14.2% to $145,000, according to a new report from Farmington Hills-based Realcomp Ltd. II. Inside the city, however, the average price of a residential property declined from $57,000 in 2006 to an average price of $7,000 in 2009—with the Lincoln Institute of Land Policy reporting that the “current excess would likely suppress house price recovery in the coming years even if the population were to stabilize.” Nearly a quarter of the city’s housing stock of 380,000 parcels is abandoned—making one of the city’s most urgent recovery challenges to deal with some 80,000 blighted properties, over-assessments, property tax delinquency, and foreclosures.  Some 15 percent of parcels are now empty—and nearly 25% of the city’s land area is not subject to property taxes. Indeed, according to the city’s audit reports, general fund property tax revenue—in 1960 at $800 million, and by far the overwhelmingly largest source of municipal revenue—had by 2012 dropped more than 75% to a level below $200 million annually. City tax foreclosures are exceeding the pace of home purchases to an extent where in some neighborhoods the delinquency rates are in excess of 75%. The Realcomp data is further evidence of what Federal Reserve Chair Janet Yellen last Friday spoke (“Perspectives on Inequality and Opportunity from the Survey of Consumer Finances.”) about in outlining the inherent problems of growing income inequality: “The extent of and continuing increase in inequality in the United States greatly concern me…The past several decades have seen the most sustained rise in inequality since the 19th century after more than 40 years of narrowing inequality following the Great Depression…I think it is appropriate to ask whether this trend is compatible with values rooted in our nation’s history, among them the high value Americans have traditionally placed on equality of opportunity.” As continued evidence has shown, income inequality rates have soared over the last few decades, with the average income of the one percent rising more than 175 percent since 1980, while the bottom 90 percent hardly moved.

Post Municipal Bankruptcy Ruling Challenges


November 14, 2014

Visit the project blog: The Municipal Sustainability Project

Unsung Contributors. It is one incredible accomplishment to get out of municipal bankruptcy, but the price of exiting can be burdensome. Unsurprisingly, Motor City Mayor Mike Duggan is alarmed at the amount of fees Detroit taxpayers will have to pay lawyers and consultants — the bulk of whom are neither taxpayers nor residents of Detroit, who guided the city through its historic bankruptcy proceedings. The tab: as much as $200 million or enough to potentially jeopardize Detroit’s fiscal capacity to meet the terms of its now federally approved plan of debt adjustment. Detroit deputy city attorney Charles Raimi this week requested that U.S. Bankruptcy Judge Steven Rhodes provide more time for the city to review fees charged by Jones Day, the law firm that shaped and argued the city’s petition in federal court, as well as the fees charged by Detroit’s other firms which provided financial and restructuring advice to the city―none, notably, selected or hired by the city or its elected leaders—but rather by the State of Michigan through its appointment of an emergency manager. Nevertheless, Judge Rhodes has ordered confidential mediation over the fees paid to the professional firms, with those discussions scheduled to commence the week after next. Bill Nowling, a spokesman for emergency manager Kevyn Orr, notes that those fees are encompassed in the city’s court-approved plan of adjustment—a plan also approved by Mayor Duggan and the city council, stating: “They’re entitled to their opinion on this. The trial is over, so the only fees that are left are the fees incurred in November, and any fees incurred in implementing the plan. I just think it’s without merit to suggest the fees are going to reach $200 million.” From the city’s perspective, as a spokesperson for Mayor Duggan put it: “Every dollar spent on consultants is a dollar that could be spent to hire a police officer. We will work with the court to handle this through mediation in a timely manner.” Some of the attorneys and consultants working on the case agreed to work at discounted rates, with many billing the city at between $500 and $1,000 an hour. One exceptional consultant from New York with eons of experience in municipal fiscal distress donated his time. Robert Fishman, the U.S. court-appointed fee moderator has not ascertained when he will complete his final tally for bankruptcy expenses.

Unappealing. Late Wednesday, the City of Stockton’s holdout creditor Franklin Advisors filed an appeal (Case 12-32118) of U.S. Bankruptcy Judge Christopher Klein’s forthcoming order confirming Stockton’s First Amended Plan For The Adjustment of Debts of the City of Stockton, telling the federal court: “The appeal raises important questions regarding the nature, extent, and scope of a municipality’s ability to impose an adjustment of bond debt upon a dissenting creditor in a Chapter 9 proceeding, while at the same time leaving vastly-larger liabilities for unfunded pensions untouched and unadjusted.” In its appeal, Franklin’s attorneys wrote that the federal bankruptcy court had failed to show that the plan was in the best interest of creditors, writing that Stockton could pay Franklin far more than it did from future revenues: “Indeed, there are no facts establishing that a one-cent recovery for Franklin is ‘all that could reasonably be expected’ or that the amount of the city’s probable future revenues devoted to the payment of Franklin’s claim under the Plan — i.e., $0 — is ‘fair.’” Franklin’s attorneys, in the firm’s brief, write that Stockton’s initial proposal or “ask” proposed future payments representing a present value recovery of more than 50% to Franklin—far above what Franklin claims to be closer to 1% under the plan approved by Judge Klein. Further, Franklin, in its brief, asserts that the future payments to be received by all other material creditors under the plan have a present value exceeding 50%, so that Franklin is the “only material creditor in this case — or to Franklin’s knowledge, any other successful Chapter 9 case — to receive no meaningful recovery at all.” The challenge also raised the big kahuna issue pitting the California constitution against the federal chapter 9 municipal bankruptcy law―an issue on which both U.S. Bankruptcy Judge Steven Rhodes in the Detroit case and Judge Klein have orally ruled the federal municipal bankruptcy law trumps the respective Michigan and California constitutions. Franklin notes in its challenge that this issue is in the interest of every California municipality and every municipal bondholder, as it sought a stay in Judge Klein’s confirmation order. Franklin has expressed apprehension that if Judge Klein’s confirmation order were allowed to stand without any review by an appellate court, important questions would remain unanswered: “The potential consequences of this are unpredictable, but potentially significant…It is well worth the wait of a few additional months to ensure that whatever those consequences may be, they are the result of a legally sound decision regarding confirmation of the plan.” Franklin had objected to taking a significant loss on the $35 million of bonds it holds — a recovery rate it estimated amounts to about 1% — even as Stockton’s plan of debt adjustment proposed no reductions at all in its contributions to the California Public Employees’ Retirement System or CalPERS—and settlements were reached with all other major creditors.

The Perils of Municipal Bankruptcy Recovery

November 12, 2014

Visit the project blog: The Municipal Sustainability Project 

The Burden of Recovery. As we noted yesterday, notwithstanding U.S. Bankruptcy Judge Steven Rhodes’ sign-off of Detroit’s plan of adjustment, the road to recovery will be both precipitous and strewn with perils for the unwary. Two key challenges will be how to pay the accrued bills the city owes to its legions of lawyers and consultants the city’s former, state-appointed emergency manager hired to help put together the eight versions of the Motor City’s bankruptcy exodus plan—a cost which may be as steep as $200 million, and how to meet the inverted pyramid costs of its public pension obligations at a time when the ratio of retirees to contributing employees is teetering in the wrong direction. In the case of the burgeoning fees, one of the Motor City’s city attorneys had requested that Judge Rhodes provide the city with more time to review fees charged by the bankruptcy law firm, Jones Day, and other firms providing financial and restructuring advice to the city—a request that did not receive a positive response from the court—but one which reflected apprehensions on the part of Mayor Mike Duggan that those fees could be as steep as $200 million―a level the Mayor is apprehensive could be large enough to jeopardize the city’s ability to meet the very terms of the recovery plan approved by Judge Rhodes last week—and an amount nearly twice as much as had been anticipated. The issue will remain a cloud on the horizon, as Judge Rhodes has ordered confidential mediation over the fees paid to the professional firms contracted for Detroit’s bankruptcy, with negotiations scheduled to begin in early December. Detroit Corporation Counsel Melvin Hollowell yesterday stated: “The mayor made it crystal clear that he was extremely concerned about the millions in cost overruns of the bankruptcy consultants…Every dollar spent on consultants is a dollar that could be spent to hire a police officer. We will work with the court to handle this through mediation in a timely manner.” Indeed, with concerns about the spiraling fees for outside hired guns an issue from the initial decision by the Governor to appoint Kevyn Orr as emergency manager in March 2013 and the state’s unfunded mandate to the city to hire consultants to analyze the Motor City’s finances and operations and, ultimately, to shepherd the city through a 16-month bankruptcy trial, concerns have mounted over how a bankrupt municipality could afford those rising bills even as it was struggling to cut retiree pensions and health care benefits for its own employees and retirees. Robert Fishman, whom the U.S. Bankruptcy Court hired to serve as the court-appointed fee moderator, has not set a date when his final tally for bankruptcy expenses will be completed.

& an Inverted Pyramid. Moreover, even as Mayor Duggan and the Detroit City Council contemplate options for paying the city’s accumulated legal bills, they also confront an unvenly balanced teeter totter: in a retirement system—which like in most other cities, counties, and states across the country is indelicately balanced on a fulcrum with one end a growing number of retirees with the temerity to live longer than had been projected, but, on the other, a smaller number of contributing participants. In the case of the Motor City, notwithstanding the reduced payments to which retirees agreed to as part of the city’s approved plan of debt adjustment, Mayor Duggan and the Council confront an annual tab of over $500 million annually for Detroit’s 32,000 current and future retirees—or, as the ever insightful Mary Walsh Williams of the New York Times notes: “more than twice the city’s annual municipal income-tax receipts in recent years.” Or, as Judge Rhodes in his approval of the Motor City’s plan to exit municipal bankruptcy last Friday afternoon warned, his greatest apprehension for the city “arises from the risks that the city retains relating to pension funding.” Ms. Walsh notes that contributions to the system will “not be nearly enough to cover these payouts, so success depends on strong, consistent investment returns, averaging at least 6.75 percent a year for the next 10 years”―with any shortfalls an issue Mayor Duggan and the Council will have to confront. One can appreciate from Detroit’s own writing on the proverbial wall just how steep a challenge its elected leaders confront:  its general pension fund is scheduled to decline from its current 74% funded level to 65% thirty years—its police and firefighters’ pension obligations are projected to grow over the same period—before, under the city’s approved plan by the court, achieving full funding by 2053—some thirty years after the State of Michigan is scheduled to terminate its contributions, and a score of years after the contributions from the city’s “grand bargain” have finished. (The state’s contribution to the grand bargain is scheduled to continue through 202s, with the foundations and the art museum continuing to contribute until 2033.) Current Motor City employees have already shifted to a hybrid pension plan: they will begin to bear most of the new plan’s investment risk; however, Mayor Duggan and the city council have inherited the responsibility to provide for decades of payments for retirees under the old plan—or, what Judge Rhodes’ independent hired fiscal expert warned could be the “potential to be saddled with an underfunded pension plan…The city must be continually mindful that a root cause of the financial troubles it now experiences is the failure to properly address future pension obligations.” she said in her report. In approving Detroit’s exit plan, Judge Rhodes, last Friday, warned the state that it will have to serve in an unwanted role as a watchdog over Detroit’s handling of its public pension obligations: “History will judge the correctness of this finding.” But the federal judge—who had early on opined that federal municipal bankruptcy law trumped Michigan’s state constitutional protections of pensions, last Friday warned Michigan’s state elected leaders that the state must “assure that the municipalities in this state adequately fund their pension obligation. If the state fails, history will judge that this court’s approval of that settlement was a massive mistake.”

Lessons of Municipal Bankruptcy

Veterans’ Day, 2014

Visit the project blog: The Municipal Sustainability Project 

Unsung Contributors. Unlike the municipal bankruptcy resolutions in Jefferson County, Central Falls, Vallejo, Ca., and Stockton, Ca.; Detroit’s successful exit was the product of an intricate web of intergovernmental governance that involved not only all three layers of government in the country, but also the judicial, legislative, and executive branches. One might think that unsurprising given that the federal bankruptcy judge to whom the case was assigned, Judge Steven Rhodes, the electric rhythm guitar player of the Indubitable Equivalents clearly appreciated the importance and value of contributors coordinating together to make extraordinary music. One of Judge Rhodes earliest actions in Detroit’s municipal bankruptcy case was to select U.S. District Chief Judge Gerald Rosen to fill a unique role—sort of a plenipotentiary ambassador at-large to think and act way outside the box—but almost always behind closed doors—to fashion not only unexpected partners, but also unexpected coalitions. Now Marion Walker of the Detroit Free Press has done us a marvelous rendition by writing about Judge Rosen’s own impressions, about which he spoke on Sunday at Christ Church in Grosse Pointe at the church’s Rector’s Forum Lecture Series, noting: “Detroit is a good stock. I’m confident.” Judge Rosen spoke for nearly an hour about the behind-the-scenes events—events in which he played an unprecedented and largely unsung leadership role—but the role which in the end became the lynchpin which allowed the Motor City to successfully exit bankruptcy―including the grand bargain, which saved art at the DIA and saved many city retirees from deep cuts originally planned for their pensions. According to Ms. Walker, Judge Rosen spoke of the selection of Judge Rhodes as the presiding judge for the case, and how municipal bankruptcies are the only time in federal cases where the judge is not decided through a random draw process―explaining how it was tradition that the chief judge for the federal circuit court would call the chief judge of the federal district court (Judge Rosen in this case) for a recommendation with regard to whom should handle the proceedings: “Things were happening very quickly as Detroit was careening toward bankruptcy…There was, I believe, about 8 weeks of cash left. It was pretty obvious to me that (bankruptcy) was, unfortunately, going to happen. Judge Rhodes and I have known each other a long time. Without diminishing the skills or abilities of any of the other bankruptcy judges, in my mind, there was really only one guy who could do this, by virtue of his experience, case management, intellect and sharp focus.” According to Ms. Walker, Judge Rosen then shared a story from later in the mediation process involving a phone call with Darren Walker, president of the Ford Foundation, at Walker’s New York office, and how Mr. Walker announced to him that Ford would be making its largest-ever donation,  $125 million, to the grand bargain, to contribute to Detroit’s future—and to ensure the preservation of the world famous Detroit Institute of Art, as well as protect the most vulnerable of Detroit’s retirees: “I almost fell out of my chair…And that was the first moment where I thought ‘you know, this thing may get some legs.’” Indeed, as Judge Rosen noted, that moment—a moment which seemingly grew from a doodle he had made on a blank piece of paper with two boxes, one labeled foundations, the other pensions, osmosis seemed to take over: $100 million from the Kresge Foundation, $40 million from the Knight Foundation―in all, the doodles translated into $370 million in foundation commitments. Like a fox to the chase, Judge Rosen met with Michigan Governor Gov. Rick Snyder—a meeting which produced its own indubitable equivalent, as the Governor and bipartisan legislative leaders fashioned together what became known as the grand bargain. On Sunday, Judge Rosen noted that his conversation with Gov. Snyder included a question and answer portion where people sought his opinion about the Motor City’s ability to lead itself following the bankruptcy. One participant, Judge Rosen reported, simply wanted to applaud him and others involved in the process for getting the job done, telling the Judge: “Thank you in proving that men of good will can come together and move mountains.” To which, the Judge appended in his inimitable style: “Amen to that with only one amendment, which is: ‘and women.’”

Reading Detroit’s Tea Leaves. In the wake of Judge Rhodes’ affirmation of Detroit’s plan of adjustment, there are questions for state and local leaders across the country with regard to:

  • What lessons ought to be learned?
  • How are the tensions between cities’ and counties’ pension obligations, especially in states where state constitutions appear to guarantee those pension commitments, to be balanced against a city or county’s promise of full faith and credit to its general obligation bond holders?
  • Will the federally approved plans in Stockton and Detroit actually work to guarantee sustainable futures for these respective municipalities?

Time will, of course, tell. An eminent panel of experts, next week at the NLC Congress of Cities in Austin Texas, will offer some acute and insightful perspectives and experience—as well as a guidebook for municipal leaders. In the nonce, two of the major rating agencies have offered divergent views of the ruling: Moody’s has termed Detroit’s plan of debt adjustment approved by Judge Rhodes to be a credit negative for holders of the State of Michigan general obligation bonds. Moody’s Genevieve Nolan wrote that approval of the plan was negative for municipal investors, because it reinforces favorable treatment of pension claims over other unsecured claims. The firm’s analysts have fretted the Motor City case raised more questions than answers for investors, especially those who hold Michigan debt, and revealed their vulnerability in a bankruptcy court setting, with Ms. Nolan writing: “Confirmation of the plan is a credit negative for investors of Michigan general obligation bonds, not only because the pledges were impaired, but also owing to the lack of a ruling on the strength of the pledges.” Standard & Poor’s, in contrast, opines that the lack of legal precedent means the outcome will not affect its general obligation or GO municipal bond ratings. The ever insightful Richard Ciccarone, president and chief executive officer of Merritt Research Services LLC, yesterday told the Bond Buyer: “Detroit clearly indicates the sympathy the courts and the public will have to provide a fair deal for retirees and from that standpoint, it means that for bondholders to think they’re at the top of the heap and that’s all that matters is a dangerous way to think…There’s a natural tension there, but that tension is not really a clear and present danger until there’s a significant dose of fiscal stress.” In contrast, S&P analyst Jane Ridley, while acknowledging the favorable treatment of pension obligations over bond debt in Stockton and Detroit, wrote that the lack of legal precedents and the small number of municipal bankruptcies make it difficult to generalize about the treatment of GO bonds in a Chapter 9: “In our view, the Detroit and Stockton situations will likely not set a precedent – however high profile and attention-grabbing they may be – and we shouldn’t universally apply the lessons learned to all GO-bond debt ratings.” Ms. Ridley noted that “the most important outcome” from Detroit’s creditor settlements is the wide gap in treatment of pensions versus municipal bonds, as well as the “very different” settlements for LTGO, ULTGO. and pension obligation bondholders…Given the nature of a Chapter 9 bankruptcy, we expect that most municipal creditors will continue to settle, as was the case in Detroit, rather than risk a bankruptcy court decision…While a trend could be developing where local governments in bankruptcy favor bondholder haircuts rather than pension reductions, we believe that Detroit’s and Stockton’s bankruptcies remain too small a sample size on which to base widespread ratings changes.”

Municipal Recovery. The harder post-municipal bankruptcy question is with regard to recovery—a question which, ironically, has sparked a related issue: will the successful outcomes in Central Falls, Jefferson County, Vallejo, etc. lead other cities and counties to file for federal bankruptcy protection? In response, at least one advisor affirms, at least in the case of Michigan: “They all should be looking at it,” according to Pat O’Keefe, chief financial officer of restructuring firm O’Keefe and Associates: “The big issue is always the retirement benefits, and a shrinking population of retirees that are supporting it…I’m not a big fan of bankruptcy, because it’s costly and uncertain, and for businesses it’s uncertain, but when you’re dealing with residents who aren’t going anywhere, you’ve got to take a close look at it….Arguably there’s a certain cleansing that takes place in the bankruptcy process in terms of legacy liabilities…One could argue that Detroit is in a much better position to attract municipal bond financing, which is the lifeblood of every community.” But on the central issue with regard to whether Detroit’s plan will in fact provide for a sustainable future, Mr. Ciccarone notes: “Despite Judge Rhodes’ ruling that the plan presents a feasible path to long-term recovery, some experts warn that the depth of Detroit’s challenges and the uncertainty of future population growth threaten the recovery…They’ve still got a heavy load of legacy costs and it’s still going to be expensive to run the government…I think it’s really hard when you look at the numbers to say they’ve done enough to be on the path to recovery.” S&P, in its report, also cautioned that the city could have a hard road ahead. “Although the roadmap is set out in the plan of adjustment, it will still likely be difficult for the city to continue making the kinds of changes that will lead to the cost savings it needs to be operationally balanced…We believe that achieving this is the only way that Detroit will be able to stay out of bankruptcy in the future.” The eminent godfather of chapter 9, Jim Spiotto, the managing director of Chapman Strategic Advisors, commented that Detroit’s treatment of its general obligation municipal bond holders and, to a lesser extent, its revenue bond holders, could end up costing the city millions in increased borrowing costs over the years: “As the judge said from the beginning, it’s the long-term survival and reinvestment in Detroit that’s the most important thing…He wants to make sure that you’ve got that survivability; make sure that there is a not a repeat, which is extremely important, because another bankruptcy for Detroit could be significantly more difficult and painful.”

Public Trust. Former San Bernardino Councilman Robert Jenkins, who had won a special election to the San Bernardino City Council in July of 2011, but was charged while still in elected office 13 months ago in Riverside County with 30 felony and misdemeanor counts―leading to his failure to win reelection last November―has pled guilty in an alleged Internet stalking case involving his ex-boyfriend and another man. His plea bargain will result in a sentence of 180 days. The charges against Mr. Jenkins included stalking and identity theft related to placing personal ads directing sex partners to the home and work of an ex-boyfriend and that ex’s boyfriend. His charges carried a maximum potential sentence of 14 years and four months for the felonies and 12 years for the misdemeanors, which he could still face if he violates parole. His case had wound through hearings and closed-door negotiations since then—seemingly parallel to the city’s municipal bankruptcy. Mr. Jenkins was a special education teacher until he let his certification lapse last year. Under the decision, Mr. Jenkins also must pay $14,795 in restitution to the victims in the case.  Judge Rafael Arreola, in sentencing the former city elected leader, told Mr. Jenkins: “You’re probably very fortunate,” adding that elected officials have increased responsibilities.

Rolling the Municipal Dice. Atlantic City casinos would pay the municipal government $150 million annually over two years, according to a plan proposed by New Jersey Senate President Steve Sweeney to revitalize the tottering city’s finances. The state-administered Casino Reinvestment Development Authority would also direct as much as $30 million annually to cover Atlantic City’s debt payments. According to the proposal by Sen. Sweeney, the plan would require schools and the municipality to make $72 million in unspecified cuts: “One of the things we don’t want is for Atlantic City to become Detroit…Combined between schools and the municipal government in Atlantic City, it costs $377 million a year. That’s not sustainable.”’ Atlantic City, which lost its title as the second-largest U.S. gambling hub, has withered as surrounding states add casinos and erode what had been its primary economic engine. About 70% of all taxes collected there come from casinos, according to Moody’s. Sen. Sweeney made his proposal in anticipation of tomorrow’s summit to try to address the city’s future—a summit at which potential U.S. Presidential candidate Gov. Chris Christie and gaming executives will all participate.

Balancing Public Pension Obligations vs. Essential Public Services. The Grand Wizard of municipal bankruptcy, James Spiotto, with whom I worked for many years to ensure passage of chapter 9 and its signing into public law under President Reagan, has written a typically short piece, “How Municipalities in Financial Distress Should Deal with Unfunded Pension Obligations and Appropriate Funding of Essential Services” for the Willamette Law Review to discuss what a financially distressed city, town, or county “must do” to survive a financial crisis and how to develop a viable public recovery plan. He notes that “A practical approach is critical and must be based on a determination of what pension benefits and obligations are sustainable and affordable.” He warns that restructuring that “does not provide for adequate public services will be doomed to failure.”    He adds that: “Since our nation’s birth, units of local government have faced six panics, thirty-eight recessions and four depressions, the last being the Great Depression of the 1930’s and the Great Recession of 2008.” Somehow the women and men who have and continue to lead cities, counties, and towns have persevered through the hardest times by helping to make hard choices and leading the way to constructing solutions.

U.S. Bankruptcy Judge Rhodes Approves Detroit’s Exit from Bankruptcy

November 7, 2014

Visit the project blog: The Municipal Sustainability Project 

 Motor City Gets the Checkered Flag. U.S. Bankruptcy Judge Steven Rhodes, noting that “[T]his city is insolvent and desperately needs to fix its future,” this afternoon approved the City of Detroit’s plan of adjustment, ending the largest municipal bankruptcy in American history. Judge Rhodes, in his statement, reminded the court of the importance of the law, enacted under former President Ronald Reagan’s signature in 1988: “In Chapter 9 of the United States Bankruptcy Code, the federal government provides help” to cities,” he said: “Today this federal bankruptcy court grants that help…the court confirms the plan,” in effect determining the Motor City’s plan to be fair and feasible, and overruling the objections of a handful of retirees who still opposed it. The city, which, under emergency manager Kevyn Orr filed for federal bankruptcy protection a year ago last July, had—at that filing, listed $18 billion in liabilities. This afternoon, finding the city’s 8th and final version of its proposed plan to eliminate more than $7 billion in unsecured liabilities and reinvest some $1.4 billion over the next decade into a sustainable fiscal future for the Motor City to be equitable and feasible, the approval clears the way for the city – under state oversight – to eliminate close to 74% of its unsecured debt, a fiscal step that will free up critical resources to invest in a revitalized future, including investments to ensure much greater efficiency in the city’s essential public services. Judge Rhodes termed Detroit’s settlement with its retirees a nearly “miraculous” outcome. He overruled all objections to the city’s plan. In the end, thanks to the extraordinary and bipartisan leadership by Michigan Governor Rick Snyder and leaders of the Michigan legislature—together with foundations and the unrelenting work of Chief U.S. Judge Gerard Rosen―all of the city’s major creditors agreeing to support the plan of adjustment. The city is expected to officially emerge from bankruptcy within weeks. In some ways it almost seemed as Judge Rhodes had managed the kind of rhythm of his Indubitable Equivalents band to bring the disparate elements together in a process that last about 15 months. Detroit’s foundations this afternoon issued a statement acknowledging the sacrifice and innovative leadership of Detroit’s public unions: “It would not have been possible without the leadership and sacrifice shown by Detroit’s hardworking retirees and public sector unions, whose continued commitment to a better Detroit should be honored and acknowledged today…Today is a day of determination for Detroit. With Judge Rhodes’ confirmation, the city and its residents can focus on the important tasks of rebuilding institutions, repairing communities, reinvigorating the economy and restoring the trust of its citizens.”

The key to this afternoon’s decision came in the wake of a different outcome last week in Stockton, where U.S. Bankruptcy Judge Christopher Klein in effect rejected the objection of one of that California city’s major creditors in approving its plan of debt adjustment: In Detroit, the key remaining holdout creditors, municipal bond insurers Syncora and Financial Guaranty Insurance Co., dropped their objections to the city’s plan because, they claimed and argued repeatedly during the case that the city’s plan was illegal because it favored pensioners over other creditors. However, under the continued ministrations of Judge Rosen, the two firms dropped their objections after reaching settlements in the midst of what was a twenty-four day trial, including 41 witnesses and 2,327 exhibits on the viability of the city’s evolving plan of debt adjustment—so that, by this week, all the city’s major creditors backed the plan, including the U.S. government-appointed Official Committee of Retirees, Detroit’s two pension funds, its two major retiree associations, all of the city’s unions, and two global banks, UBS and Bank of America Merrill Lynch. General pensioners, who voted overwhelmingly to support the plan approved today, will receive reductions of 4.5% cuts to their monthly checks, the elimination of annual cost-of-living-adjustment (COLA) increases, and a clawback in excessive interest from annuity savings. Police and fire pensioners will experience a reduction in their COLA increases.

Transition. The successful outcome this afternoon will mark another chapter in governance—ending the tenure of the Michigan appointment of Kevyn Orr as the Motor City’s emergency manager—a position which Mr. Orr held for 18 months, before restoring power and authority to the city’s elected leaders, Mayor Mike Duggan and the City Council in September, even while he stayed at the helm to shepherd the city’s bankruptcy case through the federal court.  Nevertheless, the city will remain under state oversight for at least a decade, overseen by a Financial Review Commission — mostly controlled by gubernatorial appointees — to oversee the city’s finances. In addition, an investment committee will oversee decisions made by the city’s two pension boards. The Commission will have the power to veto the Mayor and Council’s spending and debt decisions. In addition, Judge Rhodes will hold a status conference hearing on the implementation of his order.

The Grand Wizard of municipal bankruptcy, James Spiotto, with whom I worked for many years to ensure passage of chapter 9 and its signing into public law under President Reagan, (Mr. Spiotto today serves as the managing director at Chicago’s Chapman Strategic Advisors LLC) noted some of the unique features of Detroit’s case, including its success in pressing the city utility’s water and sewer bondholders to make sacrifices, even though their debt was guaranteed by the Detroit Water and Sewer Authority, which was not in bankruptcy and has demonstrated an uninterrupted record of paying its debt on time. Detroit was also successful in forcing bondholders who held debt tied to property taxes to agree to take less than they were owed, something that municipal bond investors had assumed a bankruptcy court would never permit.

The Tests of Exiting Municipal Bankruptcy

November 6, 2014

Visit the project blog: The Municipal Sustainability Project 

Is the Motor City Poised to Take Off? With U.S. Bankruptcy Judge Steven Rhodes poised to issue his ruling on the Motor City’s proposed plan of debt adjustment tomorrow afternoon, Detroit posted a proposed order which it hopes could serve as a template. Judge Rhodes will determine whether the plan’s proposed elimination of nearly $7 billion in debt it owes to its creditors and $1.7 billion it is proposing to invest in the city’s long-term sustainability and economic future is equitable and balanced. The 163-page proposed order [see a portion below] outlines the legal arguments in defense of the plan. A key issue for Judge Rhodes in rendering his decision will be whether the city’s 8th version of its plan, under which its retirees would benefit from higher recoveries than its other unsecured creditors, is fair and reasonable, attorneys argue, for several reasons. Among them are that bondholders, as sophisticated investors, or, as the city, in its proposed order, suggests: “It would be practically impossible to confirm a workable plan without discriminating among unsecured creditors because, with respect to the pension claims in particular, the city’s recovery will turn in large part on its ability to marshal the support of its residents in general and its retirees, employees and their labor unions in particular.” (Detroit’s plan proposes that its retirees would receive a diminution of benefits of about 5 percent, but the proposed, draft order omits a specific amount.) In its draft proposal, the city suggests that Judge Rhodes that “[C]ritical business considerations justify the differential treatment of pension claims,” including the need for the city to maintain a “stable and motivated” workforce, address the “expectations of creditors” under the Michigan Constitution, and the need to confirm a workable plan of adjustment. The city’s plan proposes, in contrast, that the Motor City’s unlimited-tax general obligation bondholders would receive for 74% of what they are owed, and limited-tax general obligation bond holders would receive roughly 34%. The holders of $1.5 billion of the city’s pension certificates of participation, who were the last holdout creditors in the case, are proposed to receive a 14% cash recovery supplemented by various real estate development deals, vacant land, and long-term leases on city assets. In suggesting verbiage for Judge Rhodes to use, Detroit’s attorneys suggested: “The reasonable expectations of creditors further demonstrate that the differential treatment of pension claims is fair and reasonable because, while many of the city’s institutional creditors affirmatively chose to invest in the city and possessed both the experience and sophistication necessary to evaluate the risks related to such an investment, individual holders of pension claims had no meaningful opportunity to protect themselves from such risk because they had little control over how much the city contributed to pensions, how pension assets were invested and how the retirement systems were operated.” With regard to Detroit’s perennial concerns about revenue, the draft, proposed order notes that because tax increases could be counterintuitive to economic revival, the city’s plan of adjustment instead proposes to raise “multiple” sources of new revenue―chief among those derived from the so-called “grand bargain,” under which $816 million in public and private funds are proposed to protect public pension benefits and ensure the retention of the Detroit Institute of Arts in the city as an independent trust. The draft notes that the proposed plan to reinvest $1.7 billion over the next decade into the city’s sustainable future will be critical to “arrest the reinforcing trends of population loss, declining property values and declining revenues if adequate services are restored, blight is remediated and the city becomes a more attractive place to live and work.”


The City of Detroit (the “City” or the “Debtor”) having proposed its Eighth Amended Plan for the Adjustment of Debts of the City of Detroit (October 22, 2014) ([as modified by the Modifications,] the “Plan” or the “Eighth Amended Plan”), a true and correct copy of which (without exhibits) is attached hereto as Appendix I [, as modified by errata notices/modifications (collectively, the “Modifications,” true and correct copies of which are annexed hereto as Appendix II])]; the Court having conducted a 24-day evidentiary hearing to consider confirmation of the Plan on August 18, September 2-5, September 8-9, September 15-18, September 29 to October 3, October 6, October 14-16, October 20-22 and October 27, 2014 (the “Confirmation Hearing”); the Court having conducted a hearing on July 15, 2014, at which 46 individuals who (i) filed objections to Confirmation of the Plan with the Court and (ii) appeared in the Chapter 9 Case pro se made presentations with respect to such objections to the Court (the “Pro Se Hearing”) and the Court having considered the arguments of such parties at the Pro Se Hearing; the Court having conducted hearings on certain On May 5, 2014, the City filed its Fourth Amended Plan for the Adjustment of Debts of the City of Detroit (May 5, 2014) (the “Fourth Amended Plan”), which version of the Plan was included in the contents of the solicitation packages distributed to creditors entitled to vote thereon. All capitalized terms used but not defined herein have the meanings given to them in the Plan. See Notice of Hearing to Individuals Who Filed Plan Objections (Docket No. 5264) (June 10, 2014). Legal issues related to confirmation of the Plan on July 16, 2014 and August 19, 2014; the Court having considered: (i) the testimony of the 41 witnesses called at the Confirmation Hearing, as well as the affidavits and declarations included among the 2,327 exhibits admitted into evidence at the Confirmation Hearing; (ii) the arguments of counsel presented at the Confirmation Hearing; (iii) the pleadings filed by the City in support of the Plan.


Plan B in San Bernardino? With final votes still to be tallied in San Bernardino, it appears voters narrowly rejected a measure, Measure Q, which would have modified the mechanism which determines how the bankrupt city pays police and firefighters (For Measure Q, the “no” vote led 55.32 percent to 44.68 percent for “yes” as of yesterday, a difference of 1,692 votes.): it means that San Bernardino will be mandated to continue to set public safety salaries based on the average of 10 cities of similar population instead of by collective bargaining—likely dealing a blow to the city’s efforts to put together a plan of debt adjustment to present to U.S. Bankruptcy Judge Meredith Jury, as the apparent rejection means San Bernardino will be required to pay at least $1.3 million more for police salaries this year than budgeted, according to City Manager Allen Parker. In addition, the vote could impose higher cost burdens on firefighters’ pay and on overtime and benefits that increase alongside base salary—all of which carry implications for putting together a revised municipal bankruptcy exit plan, not to mention relations between the city and its public safety employees. The heads of both the police and fire unions, as well as many of their supporters, released statements after the apparent defeat of Measure Q calling it a mandate for public safety to be a priority. San Bernardino fire union President Jeff English said the city must now focus on bringing more money into the city: “The defeat of Measure Q is strong signal to the mayor and city manager to scrap their ‘budget cuts only’ approach to fiscal management…It’s time for city leaders to immediately begin working on solutions that will generate new revenues and economic development for the city.” Similarly, Councilwoman Virginia Marquez, a longtime proponent of setting pay by collective bargaining, said economic development could accelerate now that City manager Parker had specialists in his office to bring in businesses. She has also received calls from prospective businesses herself, she said, but the budget remains a challenge: “These are challenging times,” she said. “I believe that public safety is a priority. We have to have some kind of law and order in the city to maintain stability, but (the level of spending) is just not sustainable. So we need to change the way we do business.” Now a council-appointed citizen charter committee is scheduled to meet a week from Tuesday to study possible charter changes—a daunting task, given that when it met last May, it had recommended five amendments, including the two that became Measure Q and Measure R. Measure R, which changes the city charter so that terminated city employees are no longer paid while they wait for an appeal of their employment, was, as of yesterday, ahead 54.76 percent to 45.24 percent. That likely change is scheduled to take place after the City Council approves a resolution to that effect, which will come after San Bernardino County certifies the results, according to the City Clerk’s Office. The county’s legal deadline to certify the results is December 2nd.

Taking Stock in Stockton: Moody’s yesterday opined that U.S. Bankruptcy Judge Christopher Klein’s ruling approving Stockton’s plan of debt adjustment, because it does not impair pension obligations, is a credit positive for the California Public Employees Retirement System―CalPERS, adding that it is likely to set a precedent under which public pensions will realize better treatment than other debt in California municipal bankruptcy cases: “The inclusion of pension cuts in Stockton’s bankruptcy exit plan, in and of itself, would not have materially impacted CalPERS’ financial health, because Stockton would have been obligated to pay a substantial termination fee…However, it would have stood as the first pension impairment in a California Chapter 9 bankruptcy and established a new landmark precedent.” Such a ruling would have increased the risk that other distressed California municipalities would file for bankruptcy in an effort to extract cuts to pension liabilities, which would have had a negative effect on CalPERS’ financial health. It would also have had longer-term negative credit implications because it would have critically damaged the notion that CalPERS is an arm of the state and therefor exempt from federal bankruptcy court jurisdiction, Moody’s said. “Favorable outcomes for CalPERS in the Stockton, CA and San Bernardino, CA bankruptcy proceedings lend further support to CalPERS improving financial profile because it reduces the likelihood that other CalPERS contracting employers will race to declare bankruptcy to reduce growing pension liabilities,” the report said. CalPERS is rated Aa2 by Moody’s, after an upgrade from Aa3 in July. The upgrade was based on the system’s improving credit profile of the retirement plan’s main sponsor, the State of California, as well as the steps taken by CalPERS to increase contribution rates in an effort to remediate its funding gap over time. Moody’s said in a previous report that while Chapter 9 filings will remain rare, Judge Klein’s oral ruling that pensions can be impaired will give other local governments more negotiating leverage with labor unions. Standard & Poor’s also said Stockton’s experience with municipal bankruptcy is unlikely to cause other municipalities to view Chapter 9 as an attractive option.

What Are the Implications of Stockton for State & Local Leaders?

November 3, 2014

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Taking Stock in Stockton: Are there lessons learned for other state and local leaders? This morning, as we await Thursday’s decision on Detroit by U.S. Bankruptcy Judge Steven Rhodes, we wanted to look back at last week’s decision in Stockton—and what its broader implications are for state and local leaders across the country. Unlike other kinds of corporate bankruptcies, the purpose of a municipal bankruptcy is, after all, to ensure there is no interruption of public services—especially those affecting health and public safety. But municipal bankruptcy is a microcosm of our intergovernmental system—it involves every level of government in our country. Most fascinating too are some significant differences in the way states have fashioned the rules through which those cities may have access to federal protection and the U.S. Bankruptcy courts: some, for instance, such as Michigan and Rhode Island, empower the respective governors to appoint receivers (R.I.) or Emergency Managers (Michigan)―in effect imposing a state takeover, preempting all municipal authority. But in Alabama and California, it is municipal elected officials who are responsible for putting together their respective plans of debt adjustment and blueprints for their post-bankruptcy municipal futures—even as they continue to bear the responsibility for the day-to-day governance and oversight of their respective municipal corporations—and participate, both winning and losing—in municipal elections. So, in the wake of Stockton’s successful emergence last Thursday, we wanted to take a look at Stockton’s prospects for its future—and what this all might mean to state and local leaders across the nation. To do this, we were very fortunate to benefit from the views of an original architect of Stockton’s plan, Bob Deis, its former City Manager (please see below).

Recovery. In putting together its blueprint and plan of debt adjustment, Stockton did get some concessions as part of its collective bargaining agreements, including on employee salaries and the elimination of most retiree health benefits, but still has long-term unfunded liabilities that need to be addressed. The key now is to focus on its recovery. Under its federally approved plan, Stockton will emerge with lower employee costs per capita, a higher tax base, and less outstanding debt to pay. Michael Fitzgerald, a columnist for the Stockton Record, Friday night quoted U.S. Bankruptcy Judge Christopher Klein’s epitaph for the case: “In the cold light of day, I imagine that the industry overall will take a look at the cost of Chapter 9 cases and be sobered by the results and expenses in this case….It probably should be an object lesson in why the Chapter 9 process is not lightly to be entered into.” And the expenses—for any city or county contemplating filing for federal bankruptcy protection, are significant—a cool $14 million, made up of $10 million for attorneys, millions to consultants, $627,000 for the special election over Measure A, and a sales and use tax hike for the citizens. On the other side of the ledger, the higher taxes came even as the city lost a quarter of its workforce—and their respective services. Instead, the city now faces years’ of debts to pay off—with the debt to Ambac Assurance alone to be on the books until 2052.  Nevertheless, Mr. Fitzgerald predicted “labor-friendly state lawmakers will soon craft new hoops to make it harder for municipalities to reach Chapter 9. Such laws should be opposed.” Finally, in a key massage, he wrote: “Stockton’s bankruptcy is fraught with almost too many lessons to recount. Cities, don’t spend more than you make (duh). Be leery of bond debt. Don’t rely on rosy fiscal projections; bad times are just around the corner. Don’t allow City Hall to be hijacked by public employee unions or any other interest group at the expense of the institution’s broad public mission. And perhaps most importantly, fill your City Hall with whip-smart, seasoned, highly qualified public servants. Not populists who whip up the unwitting on Facebook. Not anti-tax ideologues. Not labor lapdogs. That is Stockton’s hard-earned wisdom. Wisdom you, reader, can take to the polls next week.”

From our special guest correspondent Stockton, Bob Deis, who has served at the local level for 35 years, fixing difficult financial issues in cities and counties in three states, California, Oregon, and Washington, serving during that brief period as a City Manager and County Administrator, managing organizations ranging from 200 to 5,000 employees. Bob recently retired as the city manager of Stockton, where he had inherited an insolvent city of 300,000 that was chaotic and in distress from operational, budget, and governance perspectives. In 3.5 years, he installed a new management team and created a new high performing organizational culture, worked with its elected leaders to try and put the city on a path to solvency by taking the severe but necessary step of seeking bankruptcy protection, restructured and eliminated massive short and long term obligations, and pass a unique revenue measure. He also oversaw the creation and implementation of a unique approach to a problem that has plagued Stockton for years, the Marshall Plan on Crime. Bob is now a Special Advisor to the national consulting firm Management Partners, helping distressed cities develop and implement transformational plans for recovery:

The question that I am often asked about Stockton is, “what does the future hold for that city?” given they just received approval for their Plan of Adjustment, their bankruptcy exit plan.

After investing 3 and a half years in a non-stop roller coaster ride, turning that organization inside-out while making sure the checks didn’t bounce, I can say with confidence the future looks brighter for Stockton. The reason why I am upbeat is because we took great pains to address the core of Stockton’s challenges and not just balance the books. I believe the last humbling act of filing for protection under Chapter 9 for many cities is just that, the last act on a long slow trip of missteps, negligence, gradual loss of good governance principles, and acceptance of mediocrity. These factors contribute to the ultimate “last” act and have to be addressed along with financial solvency.

The 12-step Alcoholics Anonymous model, one of the most successful models for personal change, provided the inspiration for Stockton’s recovery plan, including:

* Admit you have a problem

* Conduct a fearless inventory of yourself

* Are your mistakes 5 or 100% of the problem? (hint: it is never 0%)

* Make amends or fix

* Admit it when you were wrong

* The truth will set you free!

After all, individuals with strengths and weaknesses just like you and I make decisions good or bad. It is when “group think” kicks in and the bar gets lowered slowly over time is when cities get into trouble. There are current and former bankrupt cities that still haven’t been able to conduct that “fearless inventory” or “admit there was a problem”. What is the chance they will change bad habits after exiting bankruptcy? The roads to perdition and redemption start and end with the governing body and administration.

Unlike in states that have emergency managers or receivers, democracy in Stockton stayed alive throughout our bankruptcy process. Thus, we had to both own and “make amends” for past mistakes and still comply with a myriad of state laws e.g. labor relations, open meeting laws, etc., and as City Manager, I had no special authority to speed things along. We fashioned a complex bankruptcy exit plan that required the City Council’s understanding and approval every step of the way. In others words, the Council is well aware of what caused the bankruptcy and what it took to fix things. They were not swept aside by the state or an appointed receiver. Furthermore, Stockton’s form of governance made it easier to stay the course for exiting bankruptcy, as we had a majority turnover on the Council and we hardly skipped a beat in negotiating and implementing our improvement plans. Our Charter invested responsibility in me, the City Manager with the authority and responsibility of creating and negotiating the plan of adjustment.

Stockton’s organizational culture and its entire new management team is now based on good governance, transparency, fully assessing long-term implications of financial decisions, sharing the truth with the Council about their agenda, refusing to be bullied by special interests and demonstrating the highest professional standards.

In order to pass muster with the bankruptcy judge, the City had to provide a reasonable plan that assures the City will eventually be service solvent i.e. provide adequate services in the long-term. We hired outside actuaries and consultants to vet our cost and revenue trends. We received authority by the voters to increase taxes. We refused to be paralyzed by bankruptcy and concurrently developed a multi-disciplinary approach to address an extraordinary problem that has challenged Stockton for years, the Marshall Plan on Crime.

I think the only thing that we cannot influence directly is the election of City Council members. And with term limits, this is the only potentially troublesome area where special interests, the ones that contributed to Stockton’s problems, will attempt to further their agenda again. However, the leaders of the community have also learned a difficult lesson, and are committed and engaged to ensure future elected officials further the good work that we have started in repairing the city of 300,000, Stockton, California.

Note: We appreciate and are grateful for your insights, comments, guest contributions, and perspectives.