The Crushing Costs of Municipal Bankruptcy


December 3, 2014
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Escaping from Municipal Darkness. A major power failure struck downtown Motown yesterday, darkening City Hall and other municipal buildings, blocking fire stations, and forcing evacuations of workers—and closing schools. Fire trucks were parked in front of City Hall after reports that people were stuck in elevators; traffic signals downtown were dark. According to the Detroit Lighting Department: “The city’s public lighting grid suffered a major cable failure that has caused the entire grid to lose power at approximately 10:30 this morning…The outage is affecting all customers on the PLD grid. We have isolated the issue and are working to restore power as soon as possible.” Power went out about 10:30 a.m. just as about 900 school children were visiting the Detroit Institute of Arts, forcing their evacuation. The post-exit municipal bankruptcy event cast a shadow over the restoration of municipal power to the Mayor and Council, who await a final approval from U.S. Bankruptcy Judge Steven Rhodes as early as Monday. Yesterday’s blackout illustrates the challenges of implementing the city’s plan of debt adjustment, which involved the elimination of billions of its municipal debt, but also as Matt Posner of Municipal Market Advisors warns, likely significantly impedes the city’s access to capital borrowing—risking the city’s ability to invest enough in its future to lure in new investment and population, or, as Mr. Posner wrote: “MMA believes that barring a major population boost in the city that it could re-enter bankruptcy in the next five years…” The functioning of basic infrastructure, a critical factor if the Motor City is to reverse its sharp population decline, comes as some 40 percent of the Motor City’s 88,000 street lights have been ruined, many by scavengers who stole wiring. The city has almost 150,000 vacant parcels, abandoned as the population fell by half over six decades to fewer than 700,000 people.

Arrivaderci. In one of his last opportunities to talk about his experiences managing the largest municipal bankruptcy in American history, soon-to-depart Detroit Emergency Manager Kevyn Orr yesterday at the annual Oakland County Business Roundtable spoke about Detroit’s path to and emergence from the nation’s largest Chapter 9 municipal bankruptcy filing and the plan of adjustment, which Judge Steven Rhodes approved last month—noting that he plans to return to the private sector and might submit his letter of resignation to Michigan Gov. Rick Snyder within days. Mr. Orr, who was named by Governor Snyder to handle the city’s affairs as it labored through a record $18 billion municipal bankruptcy, said he was not interested in repeating his act in another troubled city, but hoped he had put the City of Detroit in position from which it can continue to prosper after decades of bad management, telling the crowd: “Somebody asked me, ‘How do you define success in Detroit?’…I said, ‘Getting out without getting indicted.’” Referring to Gov. Snyder’s decision to name Mr. Orr as the city’s quasi-local government in March of 2013, just as former Detroit Mayor Kwame Kilpatrick was being convicted in federal court of corruption while in office, Mr. Orr said the Governor “decided he was going to take on one of the most long-standing, troublesome issues in his state for the benefit of his residents by starting a review of Detroit,” in the wake of which, with Gov. Snyder’s permission and under Mr. Orr’s direction, Detroit filed for Chapter 9 municipal bankruptcy protection on July 18, 2013, claiming debts and projected long-term obligations of $18 billion. Mr. Orr then described to the audience the challenge—especially for an attorney from Washington, D.C. who had never served in any municipal capacity, of abruptly being named as a quasi-mayor of a fabled city (far from his home and small children) which had lost some 225,000 residents between 2000 and 2010, and legacy costs — payment to long-term creditors and retirees — that were 40% of the city’s billion-dollar general fund budget, and rising, noting: “You would not have been able to run this city…The numbers were nonsustainable.” Mr. Orr also spoke of his calls with Judge Rhodes’ appointed chief mediator, U.S. District Chief Judge Gerald Rosen, as negotiations persisted, and how the two had ended three calls contentiously one evening: “Anybody who says this was not robust…I wish I could’ve recorded some of those phone calls,” noting that the goal was to shed debt, improve city services, and leave the city in a sustainable fashion that would allow it to move out of the bankruptcy. Key for that continued success would be regional cooperation. He praised Oakland County Executive L. Brooks Patterson, who kicked off the meeting, for coming to the table with leaders from Detroit, as well as Wayne and Macomb counties, to form what is now the Great Lakes Water Authority.

The Terrible Cost of Municipal Bankruptcy. One of the remaining, festering issues in Detroit’s bankruptcy is on this morning’s docket in Judge Steven Rhodes’ federal court where closed-door negotiations are scheduled to proceed with regard to the reasonableness of more than $140 million in legal fees charged by the Motor City’s lawyers and consultants—with accounts that one of Detroit’s highest-paid bankruptcy lawyers charged the city Detroit almost $34,000 to travel between the bankrupt city and his Florida vacation home. According to the Detroit News, attorney David Heiman, a $1,075-an-hour partner at the Motor City’s bankruptcy law firm, Jones Day, also billed the city for private cars to ferry him between Detroit and his home in Cleveland, Ohio, and transportation between Florida airports and his vacation home near Fort Myers, Florida. Indeed, Detroit Mayor Mike Duggan is concerned that escalating legal fees could consume critical fiscal resources needed to revitalize Detroit—a point, if ever, hammered home by yesterday’s blackout. Today’s federal court session comes as U.S. Bankruptcy Judge Steven Rhodes has ordered the city and its team of professionals to participate in private negotiations which could result in lowering some of the outstanding bills. Mr. Heiman, one of Kevyn Orr’s legal team’s highest-paid bankruptcy lawyers has received a $100-an-hour raise since Detroit filed bankruptcy in July 2013; two other Jones Day partners bill at that same $1,075 hourly rate: Corinne Ball and Bruce Bennett. The News reports that Mr. Heiman has charged the city at least $33,837 for traveling to and from his Florida vacation home — or more than the average annual pension of retired Detroit police officers and firefighters ($30,607) and almost twice as much as a non-uniform retiree’s pension. The pay and travel add up, as the firm has—to date—charged Detroit’s taxpayers $52.3 million for its legal services in the city’s bankruptcy case. Nevertheless, there remains uncertain accounting to date with regard to how much the city’s hired guns have been paid since Detroit filed for bankruptcy in July of 2013—matters to be discussed today where the bills are detailed in thousands of pages of bills filed in Judge Rhodes’ federal court. This accounting of legal costs today comes as Mayor Mike Duggan and the City Council confront the task of revising the city’s two-year budget to incorporate the spending plans outlined in its plan of debt adjustment or bankruptcy structuring plan—including an accounting for the massive legal bills—all an element critical to clearing the way for the completion of financing to fund key creditor settlements—all to be settled so that Judge Rhodes can 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.

Firing an Architect. The San Bernardino City Council Monday night voted 5-2 not to renew a contract under which Michael McKinney had been selected to serve as the chief of staff to San Bernardino Mayor Carey Davis. The one-year agreement, with two one-year options, carried an annual price tag of $125,000. The arrangement between Mr. McKinney and Mayor Davis was unusual in that rather than having the city hire him in a staff or personnel contract position, his firm was hired to provide chief of staff services. Prior to that municipal action, Mr. McKinney had served as Mayor Davis’ political consultant during his successful election campaign. The stumble comes as the city is working under a federally imposed deadline set by U.S. Bankruptcy Judge Meredith Jury to put together its proposed plan of debt adjustment in order to seek approval to exit municipal bankruptcy—and comes in the wake of the city’s decision late last month to hire former Stockton city manager, Bob Deis, who was one of our crack panelists in Austin last month on our panel on “Lessons learned from Municipal Bankruptcy” at the National League of City’s Congress of Cities, 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 had 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.

Gambling on a City’s Future. Senate President Steve Sweeney, New Jersey’s highest- ranking Democratic state lawmaker, and Senator Jim Whelan, a former mayor of Atlantic City, yesterday introduced proposed legislation intended to keep Atlantic City out of municipal bankruptcy. Under the proposal, the bill would channel taxes on gambling revenue to help pay down Atlantic City’s unsustainable municipal debt―and grant greater oversight to the state over the city’s public school system. The actions fall in the wake of Governor Chris Christie’s efforts over the last few months to implement a five-year plan to turn around the former East Coast gambling capital—where casino revenue has come up with more lemons of late than municipal tax revenues, plummeting from a peak of $5.2 billion in 2006 to $2.9 billion last year—leading Moody’s to reduce the city’s credit rating to junk last July because of its dependence on the casino industry. Atlantic City is dependent on casinos, whose earnings account for as much as 70 percent of the shore city’s tax base. Last month, Gov. Christie suggested the possibility of appointing a state emergency manager, noting that some of his potential reforms would require enactment of state legislation. Senate President Sweeney yesterday noted that since then conditions have “only gotten worse,” adding that: “My plan is designed to protect Atlantic City from bankruptcy and position the city for future economic growth.” The pair’s proposed legislation would authorize the casinos to make payments in lieu of taxes for a guaranteed revenue stream, redirect the Investment Alternative Tax to pay as much as $30 million annually in municipal debt, give the state a role in school oversight, and require casinos to provide health and retirement benefits. As the fabulous Matt Fabian of Municipal Market Advisors put it last month: “It looks like (municipal) bondholders were tying their fortunes to the casino, and that was an unfortunate bet.” The souring bets, as Moody’s has opined: “signal continued deterioration of the city’s taxable base and are credit negative” for Atlantic City: “Prospective purchasers of its [municipal] 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.”