Citizens’ Great Stakes in Municipal Bankruptcy

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February 26, 2014
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Blueprint for the Motor City’s Future. The newly retired judicial architect of Detroit’s fiscal future, Judge Steven Rhodes—honored yesterday in the Motor City along with his colleague, U.S. Chief District Court Judge Gerald Rosen and former emergency manager Kevyn Orr―noted: “The residents of the city had a great stake in the outcome of the case, a personal stake, each and every one of them…This is something that we in the bankruptcy court are totally unfamiliar with.” Judge Rhodes also cited another key element or outcome of the historic case, noting that, at his urging, Detroit’s bankruptcy reorganization spurred an agreement between city and suburban leaders to regionalize the governance of Detroit’s water and sewerage department (of which one component remains unfinished): “We have to find a way to build upon the momentum for regional cooperation …I think that is essential to the ultimate success of the city, and the region and the state.” Judge Rhodes, without his electric rhythm guitar, nevertheless made clear he was “very optimistic and enthusiastic about the city’s future: All of the ingredients for success are there. The balance sheet has been fixed.” Judge Rhodes, as well as his two colleagues, also discussed their concerns and shared thoughts about the broader topic of fiscal sustainability, with Judge Rhodes noting he remains “deeply concerned” ― in the wake of his experience in the Motor City approving reductions in pensions and health insurance for more than 32,000 Detroit retirees ― about the unfunded pension liabilities of other cities, suggesting Detroit and other cities need to consider moving away from costly pension plans and transition employees towards 401(k)-style defined contribution retirement plans. Judge Rhodes cited publicized estimates that cities and counties have unfunded pension liabilities ranging between $1 trillion and $4 trillion: “It flies largely under the radar and it doesn’t get a lot of attention and it doesn’t get a lot of management, and I’m deeply concerned about that…Because that’s money cities don’t have that they have promised to their retirees, and I think that solution across the country, and including in Detroit, has to be at some point defined contribution (plans).” The retired bankruptcy judge’s remarks, which drew protests outside the event, reflected on the Motor City’s federally approved plan of debt adjustment, under which non-uniform retirees will receive reductions of a minimum of 4.5 percent, while police officers and firefighters realized reduced COLAs―with the reduced benefits scheduled to begin showing up in retirees’ pension checks in March. The plan of adjustment does retain a hybrid pension plan under which new employees contribute more to their retirement.

Judge Rhodes suggested Detroit missed a chance to exit the traditional defined benefit pension business altogether—a reflection with which Mr. Orr did not concur. Mr. Orr, asked whether it was a missed opportunity for the city, said: “I don’t think so…Our general services pensions are modest, $19,400 (per person) on average.” (Police and firefighters receive pensions that average about $25,000 a year, but they are not eligible to collect Social Security like other retirees.) Under its plan of adjustment, as approved by the federal bankruptcy court, Detroit was able to reduce its $3.13 billion unfunded pension liability by 54 percent to $1.45 billion through reduced benefits and the 20-year “grand bargain” infusion of $816 million in contributions from state taxpayers, private foundations, and donors of the Detroit Institute of Arts donors. The approved plan provided for significantly greater savings through its profound cuts in promised retiree health insurance benefits―from $4.3 billion to $450 million.

Taking Final Stock in Stockton. “We have spent the last several weeks finalizing dozens of complicated legal and real estate documents and making preparations for thousands of checks that must be issued for the effective date…The stigma of bankruptcy is lifted and we can move our city forward toward recovery,” Stockton City Manager Kurt Wilson said yesterday, as the California city formally exited municipal bankruptcy—nearly one thousand days after filing for federal bankruptcy protection in July of 2012. Stockton’s route to exiting municipal was profoundly different than Detroit’s, as there was no state takeover; rather the elected leaders, as in Jefferson County, Alabama’s municipal bankruptcy, remained in charge and accountable to the citizens throughout the process—and, as in Alabama—despite, rather than with any assistance—such as was provided to Detroit and Central Falls from their respective states. U.S. Bankruptcy Judge Christopher Klein had lifted the stay preventing Stockton from exiting bankruptcy last month on January 20th, saying during a hearing that Franklin Templeton was not likely to win on its appeal of his decision. Manager Wilson said Stockton has developed a long-range financial plan for the duration of the agreements in its approved plan of debt adjustment, some of which extend out to as far as 2053. Thus, today marks a successful $2 billion municipal financial restructuring. Mr. Wilson and the city’s legal team will be in Judge Klein’s courtroom today for what is expected to be a routine conference updating the status of Stockton’s case, noting that the work in the city over the past three weeks to put the city’s plan of debt adjustment approved by Judge Klein into effect has been “heroic,” adding it has involved dozens of people, “not only people working on behalf of the city, but also people working on behalf of creditors. These are incredibly complicated transactions, and we were doing all of them and trying to get them completed on the same day.” Mr. Wilson said Stockton gave top priority to the 1,100 retirees who gave up some $544 million in lifetime medical benefits as their part or contribution in helping Stockton put together its plan of debt adjustment—with the final agreement providing the retirees a $5.1 million payout instead. Checks were mailed to retirees at the beginning of the week, with Mr. Wilson noting: “We’ve heard very clearly from some retirees that every day of delay has been a hardship…We made those a priority over everything else. They are ahead of everybody else.” Nevertheless, the city’s long municipal bankruptcy still will have another chapter: Franklin Templeton, the financial behemoth which had lent Stockton $36 million for a variety of projects in 2009, but which will receive only $4 million under the city’s approved plan of debt adjustment, is appealing Judge Klein’s decision to the 9th U.S. Circuit Court of Appeals—albeit, the appeal will not affect Stockton’s implementation of its restructuring plan. Mr. Wilson did note that few will discern any bright line etched in the sand of the precise moment in time when Stockton becomes a formerly bankrupt city; nevertheless, he remarked, it is a significant milestone: “We understand we’ll be under the microscope for every financial transaction we make for the next few decades…You’d be hard-pressed to find another city that has a handle on its finances going forward the way we do.” He added that it will be incumbent upon the city to make difficult spending choices going forward, even to deny increasing expenditures on universally popular services if those financial outlays do not fall within Stockton’s long-range economic projections: “In the past, the city sometimes made financial decisions based upon how worthy a cause was…The city used to make decisions where if something was worthy, just do it. We’re no longer in a position to just do it…We have to either make it fit into our model or reduce some other expenditure to get there. That will be difficult for people who say, ‘Hey, we’re out of bankruptcy.’ The reality is, where we were before bankruptcy was an unstable place.”

Hard Choices. San Bernardino, unlike Detroit, has no state-appointed emergency manager to make hard choices about the city’s difficult road to bankruptcy recovery—nor can it count on any assistance from the state. Nevertheless, it does appear that City Manager Allen Parker’s team might have the fiscally stressed city on the verge of a significant turnaround―a turnaround that marks a signal change in fiscal direction critical to the city’s hopes of completing and submitting its plan of debt adjustment to the federal bankruptcy court in three months—and to the city’s future sustainability. As Mr. Parker notes: “We stopped the bleeding…Revenue just exceeded — just by a bit — what we projected, and we were able to contain costs, so we’re on schedule to finish the year in the black.” Thus, the San Bernardino City Council has unanimously approved adjustments to the city’s budget—adjustments which are projected to actually provide for a small surplus, in part made possible by the politically difficult choice to shut three of the city’s five pools to the public this summer. However, as Assistant City Manager Nita McKay notes, even with the hard choices, the city’s successful efforts to balance its budget is different than in a normal, municipal budget process, because it relies upon the city’s chapter 9 filing as a key protection to prevent creditors from suing the city for money owed to them: “It is important to note that the city’s balanced General Fund budget for the fiscal year is made possible because the city is under the protection umbrella of Chapter 9 bankruptcy.” Moreover, City Manager Allen Parker warned there is as much as $15 million the city “hasn’t figured out how to pay yet.” With the ever-approaching May 30th deadline for the city to file its plan of debt adjustment with U.S. Bankruptcy Judge Meredith Jury, the city reports its sales and use tax revenue is expected to continue to climb to the highest level since 2006-07, which, along with property tax and administrative civil penalty revenue increases, are projected to provide the city $1.3 million toward $2.8 million in expenditure increases—leaving a surplus of about $113,000, with no reserves, according to budget documents. San Bernardino lists $5.2 million in “salary savings,” or money budgeted for positions that are now vacant. It is now trying to fill some of those positions, particularly police and firefighters, Ms. McKay said. Nevertheless, San Bernardino confronts significant budget burdens, including some $2 million for increased firefighter overtime, unanticipated, because, according to Mr. Parker, there was a three month delay before cuts to the Fire Department that were supposed to take effect last July 1st actually became effective. The city also approved general fund increases of $600,000 for 36 new police vehicles, $190,000 in part-time hours for the Parks and Recreation Department, $25,000 for Code Enforcement and $12,000 for the city treasurer’s office. The Council rejected, 4-3, a motion to add $60,000 to keep the other three pools open—notwithstanding a councilmember’s argument that these pools are the type of quality-of-life issues residents depend on a city for and that attract businesses, with Councilmember Valdivia noting the affected pools would be in minority areas. But, in rejecting the motion and noting the chapter 9 hanging over their heads, Councilman Fred Shorett responded that while a good argument could be made to keep pools open, and to reverse any of a number of cuts to “sacred cows” the city has made during bankruptcy; San Bernardino needed to put money toward paying deferred costs and emerging successfully from bankruptcy, adding: “I can balance my budget, too, if I don’t pay my cable bill or my gas bill or my electric bill.” In a sobering note, Councilmember Valdivia had requested staff to provide his colleagues with a summary of the municipal bankruptcy costs the city has accumulated since it filed for federal protection nearly three years ago: more than $9.3 million. Without those bankruptcy-related services, the city would have to pay significantly more than $9 million as creditors came after it, said Parker and City Attorney Gary Saenz.

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