What Is Critical for a Municipality’s Sustainable Future?


March 31, 2015
Visit the project blog: The Municipal Sustainability Project

Gambling on Atlantic City’s Future. Atlantic City yesterday was granted a 60-day extension on a $40 million state loan that was due today, with Atlantic City Revenue Director Michael Stinson, noting that the city has been working with the state for the last month to seek more time for the loan payment. New Jersey had provided Atlantic City with the $40 million emergency loan after the city delayed a $140 million bond issue last November. Mr. Stinson noted that the extension marked a “first step,” and that it would be helpful in the city’s ability to “move forward.”

Keeping the Island’s Lights on. Michelle Kaske of Bloomberg yesterday wrote that Puerto Rico’s Electric Power Authority, or Prepa, the Commonwealth’s main electricity utility, won an agreement with its creditors to extend negotiations for 15 days over what could be the largest-ever U.S. municipal-debt restructuring in U.S. history. The extension provides the junk-rated public utility more time to negotiate with its creditor banks, bondholders, and insurance companies beyond the original deadline of tonight, according to a statement yesterday by Prepa—which had signed an agreement last August with its creditors that delayed repayment of $696 million of bank loans through the end of this month. Prepa’s chief restructuring officer, Lisa Donahue, yesterday noted: “All parties believe advances have been made, and there is merit to continue conversations with our creditors to find feasible solutions that will transform Prepa into a modern and sustainable utility.” Prepa, the largest U.S. public-power authority, has $8.6 billion in debt, and it is facing a July 1 deadline by which it must pay investors about $400 million in principal and interest. If bondholders agree to take a loss, it would be the largest debt restructuring in the $3.5 trillion municipal-bond market. Creditors have agreed not to take any enforcement actions while the pact to negotiate remains in effect, according to Prepa’s statement. The utility last year used funds designated for infrastructure improvements to purchase fuel. It had $1.75 billion of overdue accounts in September as residents, businesses, and government entities fail to pay bills on time.

A Fiscal & Children’s Municipal Bankruptcy? As we have written previously, a critical issue to the fiscal sustainability of post bankrupt Detroit is to rebuild its public school system as an integral part of reversing the tide of emigration by young families out of—instead of into the Motor City. The 36-member Coalition for the Future of Detroit Schoolchildren yesterday issued a report for the state of Michigan to return control of Detroit Public Schools to an elected school board, assume $350 million of the Detroit Public School (DPS) debt, and give a mayoral-appointed commission control of all school closures and openings in the city. The report, coming in the wake of three months’ of private meetings to examine the Motor City’s fractured system of public education and persistent financial problems at DPS—the largest school district in the state, and one which has been under state-controlled emergency management for six years―provides recommendations to Gov. Rick Snyder, proposing that all Education Achievement Authority schools be returned to DPS control and that the interlocal agreement between the DPS emergency manager and Eastern Michigan University be terminated. (This refers to the authority Gov. Snyder created in 2011 to turn around the state’s lowest performing schools, including 15 former DPS schools.) Yesterday’s report calls for allocating funding based on student need, as opposed to school governance type, and developing a strategy to recruit, develop, and retain high-quality educators citywide, with co-chair John Rakolta stating: “Detroit will never again be a world-class city if we don’t fix the schools…These recommendations preserve choice for families and are bold and comprehensive. They will get the DPS debt resolved and raise the standards of excellence for all schools in Detroit.” Among the recommendations, the coalition proposed changes to state law or local practices that would have charter authorizers and charter school boards improve transparency, focus more on quality, and better coordinate all charter schools, and for authorizers to ensure independence of charter boards from management companies. The report recommends the creation of a nonpartisan coordination entity, the Detroit Education Commission, or DEC, with authority to coordinate and rationalize citywide education functions, in partnership with regional councils, to incorporate neighborhood-level input. Its members would be appointed by the Mayor. The DEC’s primary function would be to serve as a gatekeeper for opening, closing, and siting all new schools in Detroit; but it would not be authorized to interfere with school decisions about hiring, budgets, or curricula: the DEC would coordinate citywide services to help parents take advantage of their options such as transportation, enrollment, and special education. The Coalition distinguished what their proposal vis-à-vis Mayor Duggan’s proposed role in the appointment of commissioners would be than in some other cities: “It’s not like in Chicago where (Mayor) Rahm Emanuel is down in the bowels of the schools….We will not operate the schools.” Rather, as coalition co-chair Wendell Anthony said: “We want the school board to be returned and the EAA infused back in to DPS. The timeline is based on what comes out of this, but sooner than later because the process needs to change.” Last evening, Gov. Snyder noted: “These are ideas that sprouted from people across the city, including educators, union leaders, business leaders and the philanthropic community. Their common traits are a love for Detroit and its people and the belief that we can and must do better as we prepare the next generations of leaders…There must be higher standards for all schools. Detroit can only be a stronger, more vibrant city if its schools provide the opportunity for all students to be successful academically and in life.” In addition to addressing its governance views of returning power to an elected school board and dissolving the EAA, the coalition also sought to address what it described as the “mediocrity in our schools,” recommending:
• closing low-performing schools,
• giving schools more autonomy (including the freedom to decide specific pathways to achieve a “world-class, rigorous and relevant education”), and
• ensuring that 90 percent of all students graduate from high school.

In finding that Motor City schools are in major trouble, not just financially, but academically, the report determined that only five schools serving Detroit students exceed the state average in reading, and only seven schools in math, including DPS schools, public charter schools inside the city, EAA schools, and the 25 suburban schools where Detroit students represent 75 percent or more of enrollment. To address these D- academic results, the coalition proposes to create 150 high-performing schools in the next 15 years with “essential supports, small classes, and quality staff that are generally retained over time.,” with high-performing schools described as those in which at least 80 percent of students show one year’s growth every school year; 80 percent of students read at or above grade level; 80 percent of students demonstrate grade-level proficiency in writing; 90 percent of students graduate from high school; and 90 percent of students attend school every day. Other recommendations include creating a city student data system to support school choice and quality neighborhood schools; establishing a citywide system to improve student transportation; and providing “high-quality wraparound services to support children’s social, emotional and physical needs.” Dan Quisenberry, president of the Michigan Association of Public School Academies, said the report calls for accountability, autonomy, and choice to fix Detroit’s educational environment, but expressed apprehension at what he called putting “a gatekeeper between parents and their schools by putting a politician in charge of when and where schools open.” Detroit Public School Emergency Manager Darnell Earley told the Detroit News he was pleased to see that the coalition’s work parallels, reinforces, and ultimately supports DPS’s own restructuring strategy. In a statement, Gov. Rick Snyder promised to “thoroughly review the coalition’s recommendations” as the state works on a “comprehensive approach to reform,” pledging to seek “areas of alignment and common ground in the weeks ahead.” Nevertheless, it appears far more likely that the Governor’s team will draft its own sweeping reforms—reforms which Detroit News columnist Daniel Howes wrote are “likely to be as sweeping as the historic bankruptcy he ordered for the city of Detroit,” noting the Gov. was hardly likely to fully endorse recommendations which “aim to reassert a status quo that culminated in emergency management in the first place. Second, they effectively demand the state abandon its efforts to reform education in Detroit.” Or, as Mr. Howes noted, the Coalition’s proposed reforms “do project an unmistakable grab to restore power and control to local hands without the kind of governance and managerial reform that could instill confidence and signal a fresh start,” adding that: “If any town should know better, it’s this one, the national epicenter of reckoning, restructuring, and bankruptcy. A timeless rule in all three is that financial and public support are tied to radical change in operations, management, and business model.”

Windy City Blues. With Chicago Mayor Rahm Emanuel awaiting the outcome against Cook County Commissioner Jesus “Chuy” Garcia in the first mayoral runoff election in Chicago history next Tuesday, Dick Ravitch, a former Lieutenant Governor of New York and an adviser to now retired U.S. Bankruptcy Judge Steven Rhodes who presided over Detroit municipal bankruptcy proceedings, yesterday wrote about the Windy City’s grave public pension challenges in an epistle to the Wall Street Journal:

I had the privilege of working with New York Gov. Hugh Carey in 1975 to avoid the bankruptcy of New York City, and I am currently assisting the Control Board overseeing the city of Detroit. Throughout these years, I have observed, researched and commented on the growing fiscal stress our cities and states have faced.

In Chicago, Detroit and across the U.S., local and state governments have made promises in good faith to their 19 million employees to provide retirement benefits and, in many cases, health-care benefits as well. Many government officials didn’t realize that the cost of these promises would rise faster than the tax revenues that were being generated to cover their operations.

As a result, the shortsighted strategy of using borrowed money or the proceeds from the sale of public assets to balance operating budgets has grown at a rapid rate. But such unwise and unsustainable practices are insufficient to avoid bankruptcy in some cases, and cuts to education and infrastructure in others. Above all, they jeopardize the sanctity of public commitments.

Chicago is the third-largest city in the U.S. It has a massive, diverse economy anchored by educational, financial and health-care institutions of national significance. It has the lowest per capita tax burden of any major city in the U.S., and the largest unfunded pension obligation on a per capita basis. It is located in a state that competes with New Jersey for the lowest credit rating in the nation.

The city’s indefensible practices came to a head in 2008, when Chicago hocked its parking revenues for 75 years and used some of the proceeds to balance its budget. But since Rahm Emanuel’s election as mayor in 2011, the city’s seemingly insoluble and growing structural deficit has finally been taken on directly. He sought legislation that slows the growth of pension obligations and has pursued employee contributions as well.
Mr. Emanuel has also taken the politically risky step of raising taxes and has said that he is prepared to do so again. He has made it clear that he doesn’t believe the burden of insolvency should be relieved exclusively on the backs of public employees, but that taxpayers should share in the solution to enable Chicago to grow and prosper.
He has also brought to City Hall a level of professional financial management and a determination to make sure the public understands the seriousness of the problems the city faces.

If Chicago were to reach the point of having insufficient cash to meet its obligations and defaulted, chaos and endless litigation would ensue. Municipal bankruptcy is not an option for Chicago under Illinois law, as it was for Detroit under Michigan law. But even if it were, it would be a sad acknowledgment that democracy can’t solve its problems.

In New York City in 1975, banks, unions and politicians came together to make extraordinary concessions that would avoid just such a lamentable outcome. Mayor Emanuel is trying to adjust obligations through the same process that we used 40 years ago in New York: Negotiations as a result of which politicians raised taxes, union leaders agreed to wage freezes and layoffs, and bankers agreed to defer interest payments and modify debt obligations.

No politician ever got elected on a platform of raising taxes. No politician who believes in government and the value of the services government provides runs for office with an eagerness to deprive public employees of deserved benefits. When the actions of one’s predecessors leave no alternative, that particular politician is always vulnerable to a competitor who runs for office by appealing to those citizens who paid more or received less.

Mr. Emanuel faces an April 7 runoff election against Cook County Commissioner Jesus “Chuy” Garcia. The mayor has laid out a clear program for restoring the city’s fiscal health, while his opponent so far has not. Chicago voters would do well to demand answers from Mr. Garcia, who hasn’t said how he intends to turn cloth into gold. Otherwise the choice appears to be a simple one, between a responsible future or one when even bigger, more ruinous bills finally come due.

What Happens if Municipal Bankruptcy Does Not Work?


March 30, 2015
Visit the project blog: The Municipal Sustainability Project

The Prospect of Failure. As the federally imposed deadline for San Bernardino to submit its plan of debt adjustment or bankruptcy exit plan approaches, there is an increasing possibility the city’s auditor will not have all of the city’s financial statements audited. Notwithstanding that, U.S. Bankruptcy Judge Meredith Jury last week noted she would be “shocked” if the consultants the city brought in had not managed to have the city’s finances in order—the way every other city and county in a major municipal bankruptcy has, because reliable financial statements are critical to the kinds of negotiated settlements that characterized other municipal bankruptcies. Nevertheless, the seeming uncertainty with regard to who can really speak for the city—in addition to the lack of reliable financial information, means the risks of non-performance are increasing, albeit, San Bernardino City Attorney Paul Glassman advises the importance of keeping the “the audit in perspective,” noting that “[W]hile the city is working very hard to get its audit done…there is no legal requirement that audit be in place (to submit a Plan of Adjustment).” In fact, as Mr. Glassman has stated, Stockton had two years of unaudited financial statements when it filed its bankruptcy municipal plan of debt adjustment, putting it in a comparable position to San Bernardino if it missed both its audit targets, which he does not anticipate. He added that in the Vallejo and Detroit municipal bankruptcies, both were also behind. Ergo, Mr. Glassman believes there is little question but what the city will timely meet Judge Jury’s deadline. It is possible that the more serious problem relates to governance, or, as Counselor Glassman said before Judge Jury: “First of all, in mediation, I have gotten to know and worked with the mayor, city manager, city attorney―all smart, competent, well-intentioned people. And I say that without qualification…However, as a group, working with the City Council, we have a very ineffective form of governance and (lack of a) collective approach…We can’t say in depth what’s going on…and that’s part of the problem.”

Disparate Treatment. At the federal bankruptcy hearing, Mr. Glassman also provided further details with regard to an “interim agreement” between the city and the California Public Employees’ Retirement System (CalPERS), an agreement first announced last June, with greater details provided to the U.S. Bankruptcy Court last November with regard to the $13.5 million in payments the city owed to CalPERS in the wake of the city’s halt of pension payments for the first year of its bankruptcy. Under the agreement, the city first paid $1.5 million in last May, after which it agreed to make equal monthly payments of just over $600,000 per month for two years until the missed total and interest were repaid. Mr. Glassman told the court that under the city’s agreement with CalPERS, the state public pension agency had committed it would not pursue its challenge of the city’s eligibility for bankruptcy protection. Although, Mr. Glassman told Judge Jury, other creditors have characterized the city’s agreement with CalPERS as a “surrender” to CalPERS, he stated it was necessary to avoid having CalPERS reduce the benefits paid to current and future retirees and to avoid an “exodus” of employees that would leave the city unable to serve its residents.

Is There a Jewel in the Crown? What if the San Bernardino Fails to Meet Judge Jury’s Deadline? With the ongoing governance turbulence and uncertainty in San Bernardino with regard to whether the city can get its act together—and the very real apprehension that should it not, Judge Jury may not grant an extension: what will happen? Should the city fail and be denied an extension, the city’s federally granted protection from its creditors will expire—likely leading to a race to the courthouse by those creditors to secure default judgments against the municipality for failure to pay its obligations. The race will be serious, because all creditors understand the city has far fewer assets than claims against such assets. Moreover, the city’s former redevelopment assets are not part of the city budget, so they are already off limits: they have to be liquidated through other means with the bulk of the assets reverting to the state―some nearly $500 million dollars according to the State Treasurer’s Office. Virtually every other asset in the city is fully encumbered: San Bernardino City Hall is not only currently assessed at less than what is owed on the current notes, but it is sinking in additional debt: San Bernardino refinanced the edifice in the 1990’s, and then was confronted with mandated earthquake retrofits of nearly $20 million in additional debt: the architectural design for City Hall was banned in California in the wake of the 1972 Santa Ana Earthquake. The city does have two assets that would be on creditors’ hit lists: the Trash Department and the City’s Water Department: each could be worth in excess of $200 million if the perpetual water rights and potential operating profits were counted. There are estimates that the value of the city trash fleet is in the range of $25 to $35 million dollars, and that operation of the service could be exceptionally profitable if privatized. But the biggest jewel in the crown, as it were, would likely be the municipality’s water rights and water department. The city owns most of the water rights in the basin over which it is built: it is residents’ primary source of water—and with California in an ongoing drought situation, water is the city’s jewel in its crown: one creditor likened the value of the water service to be astronomical.

Gambling on Atlantic City’s Future. New Jersey State Senate President Stephen Sweeney (D-Gloucester), in the wake of state-appointed emergency manager Kevin Lavin’s report last week on Atlantic City, said the emergency financial managers were only making things worse, giving Wall Street a crisis of faith. Sen. Sweeney warned that any further ratings decline on Atlantic City’s debt “would make it even harder for the city to work its way out of its dire fiscal problems.” He complained that the Christie administration was warned months ago that decisive action was needed to stabilize Atlantic City’s finances and re-position the casino industry, adding: “They have held three summits and issued three reports, but they have done little to nothing to restore financial stability, protect local taxpayers, maintain public services, or to give the gaming industry the ability to rebuild its business opportunities: They seem to want to keep playing a losing hand.” Joseph Seneca, an economist at Rutgers University, noted that the reaction to the report from credit rating agencies should come as no surprise: “These are realistic assessments of the depth of the fiscal problems that has built over a period of time. The decline property tax base loss is just staggering…There’s fundamental erosion in the fiscal capacity of the city and that’s the reality…The fiscal realities here and now though are pretty dire: The drop of more than 50 percent drop in the tax base is stunning. It has to have deep and significant financial implications.” Perhaps the greatest concern is over time: Moody’s has warned that the state plan also relied on quick state legislative action, state aid, and timely property tax payments from already struggling casinos―an unlikely scenario as both the Revel and Trump Taj Mahal were delinquent on their property tax payments in 2014. As Moody’s succinctly put it: “Given the city’s cash flow projections and assuming pension and health benefit payments are delayed or deferred, the state legislature will have only three months to adopt the two bills before the city reaches a liquidity and debt service crisis…Debt service payments due on August 1 and December 15 may be at risk if the two bills are not adopted swiftly and the revenue infusion does not come in time.”


March 27, 2015
Visit the project blog: The Municipal Sustainability Project

Taking Stock in Stockton. Franklin Templeton Investments has filed its first brief (Appeal from the United States Bankruptcy Court for the Eastern District of California, Case No. 12-32118, U.S. 9th Circuit Court of Appeal) to U.S. Bankruptcy Judge Christopher Klein’s approval, last October 30th, of Stockton’s plan of debt adjustment—allowing the city to exit municipal bankruptcy and to begin to implement its fiscal recovery plan. Franklin’s brief follows in the wake of its November request to the city’s exit plan—a rejection Judge Klein formally rejected last month, writing that Stockton could proceed in implementing its recovery plan and opining that Franklin’s likelihood of winning on appeal was slim. In its revised brief, Franklin Templeton asserts that Judge Klein erred in approving Stockton’s plan of debt adjustment, because, according to Franklin, the plan was “discriminatory and punitive” against Franklin. Stockton has until May 28th to respond. The city, which declared bankruptcy in July 2012, has developed a long-range financial plan for the duration of the agreements in its federally approved plan of adjustment, some of which extend out to 2053. Franklin’s objections center on the significant disparity between how it is treated under that plan versus the California Public Employee’s Retirement System (CalPERS), with Franklin getting back about one cent on the dollar of what it is owed, versus CalPERS being fully repaid. Absent a success on its challenge, Franklin will remain at risk of nearly a 99% loss on the $35 million of the city’s municipal bonds which it owns. All other major creditors settled with the city ahead of the bankruptcy confirmation. Whilst Franklin has asserted its recovery rate on its unsecured municipal bonds was less than 1%, the city’s attorneys have responded in a filing that Franklin’s total recovery rate on secured and unsecured claims is closer to 17.5%. Franklin will receive $2.1 million in collateral from the bond reserve account that is not accounted for in Judge Klein’s opinion, $4.05 million from the sale of a golf course, plus the $285,227 on its unsecured claim for a total of $6.4 million — equal to a 17.5% total recovery on the $36.6 million claim, according to the city’s filing. Stockton Record columnist Michael Fitzgerald, writing about how the city’s leaders handled its bankruptcy process and the opportunities which are now possible, emphasized lessons that public officials, municipal employees, city residents, and policy makers can take away from Stockton’s Chapter 9 Federal bankruptcy process, with the most significant being to keep politics from policy making. “If I could boil the lessons of Stockton’s crash down to one point, it would be this: Don’t allow city fiscal policy to be politicized.” He stresses that strong fiscal policy cannot be crafted under the pressure of special interests. From these lessons, Stockton can look to the future, and begin to reimagine its downtown and create new economic development….the city is now running on a smart fiscal model, the economy is recovering, and, for that matter, it’s spring. Stocktonians are looking at a new beginning.”

Getting Moody in Atlantic City. Credit rating agency Moody’s has responded moodily to New Jersey’s state-appointed emergency manager’s report with regard to Atlantic City’s fiscal crisis, calling the plan a credit negative which could pave the way to default. Analysts Josellyn Yousef, Orlie Prince, and Naomi Richman wrote that in addition to opening up the possibility of the city defaulting on its debt, the timeline proposed by emergency manager Kevin Lavin relies on rapid legislative action, state aid and “timely tax payments from struggling casinos―” adding that Atlantic City is also at fiscal risk of losing access to the capital markets by next Tuesday if it does not receive an extension of $40 million loan payment from the state. Noting that the Lavin report calls for the legislature to pass two bills proposed late last year which would direct $17.5 million in excess investment alternative taxes on gaming revenues and $30 million of Atlantic City Alliance marketing funds to the city, Moody’s noted that debt service payments due on Aug. 1st and Dec. 15th may be at risk if the two bills are not “swiftly” adopted and the state does not provide a timely revenue infusion. The analysts also noted that Mr. Lavin proposed that Atlantic City delay or defer $42 million in state health and pension benefits for the year―but such a delay could require state approval: “Given the city’s cash flow projections and assuming that pension and health benefit payments are delayed or deferred, the state legislature will have only three months to adopt the two bills before the city reaches a liquidity and debt service crisis.” The three Moody musketeers added, referring to Mr. Lavin: “His potential options for long-term restructuring include potential impairment to bondholders in the form of restructuring amortization schedules and the extension of maturities. We may consider any of these events to be a default or distressed exchange…” The trio expressed concerns, in addition, with regard to the odds (no pun) for late or delinquent property taxes from casinos—an apprehension, they noted, not reflected in what they termed “already dire liquidity projections” in the Lavin report.

Keystone Municipal Fiscal Sustainability. Even as the State of New Jersey is divided and legally unclear what its role and responsibility is with regard to the fiscal fate of Atlantic City, right next door, the Keystone State’s Senate Appropriations Committee yesterday gave close consideration to issues and concerns relating to stabilizing municipal fiscal distress. Legislators wanted to know whether state economic development incentives were working; they want cost-benefit analyses; they want to understand whether and how economic development incentives are working. Referring to Pennsylvania’s Neighborhood Improvement Zone program, State Rep. David Argall (R-Berks/Schuylkill) told the state’s acting Department of Community and Economic Development (DCED) Secretary Dennis Davin, referring to the program which was designed to help revive Allentown: “I haven’t seen that kind of revitalization in a community since Berlin Wall came down…but you don’t sound like you’re a fan.” Sec. Davin responded noted: “My only response was, essentially, based on…the Governor’s proposal and different look at tax structure, perhaps there will be a time when it might not be necessary,” adding that he has the same views with regard to the Community Revitalization Zone program. The Secretary noted his department is slated to receive funding restored to levels of two years ago for its Keystone Communities economic development programs, and intends to partner with universities to encourage research and training for the manufacturing sector. A different kind, but mayhap greater concern was expressed with the purported $8 billion municipal public pension debt, with Sen. Randy Vulakovich warning: “They (Pa. municipalities) are never going to get out of it. We’re going to have to do to bring something together on the state level.” Sen. Vulakovich subsequently elaborated, stating he thinks the state should force severely distressed pension funds (those with less than half costs projected for retirees and retirement payments to working public employees, once retired) into the Pennsylvania Municipal Retirement System (PMRS). PMRS manages about 600 of the state’s approximately 2,000 local pension funds; the remainder deposit their funds with private firms, an appointed board, or both. The state also provides aid to distressed local pensions, basically offsetting the required minimum amount the municipality (as employer) must pay into the pension fund in any given year. The fiscal dilemma comes as DCED has another $1 million this fiscal year for its early intervention program―less than half a percent of DCED’s total allotment of the state’s general fund budget, yet sufficient to boost funding for early intervention by 50 percent: the intervention program attempts to help cash-strapped local governments avoid a full-blow fiscal crisis. DCED’s most able Local Government Center Executive Director Fred Reddig reports the extra funding will let the state help more municipalities—help which could prove increasingly critical given the local pension situation. This comes, moreover, as Mr. Reddig is charged with realigning the state’s Act 47 program (the next step in state intervention), which, under changes enacted last year, now limits cities to five years, before a municipality may be dissolved.

The Critical Nature & Tie of Education to Municipal Fiscal Sustainability


March 26, 2015
Visit the project blog: The Municipal Sustainability Project

Detroit’s ABC’s of Bankruptcy. In Monopoly, if one gains a “Free Get Out of Jail” card, one’s chances of winning are improved. But gaining federal judicial approval to exit from the largest municipal bankruptcy in history offers no such equivalent benefits. In all the juggling Michigan Gov. Rick Snyder, Detroit Mayor Mike Duggan and the Detroit City Council must now confront if Detroit is to have a sustainable human and fiscal future, getting the ABC’s of fixing the city’s school system are critical. That promises to be a tall order: “By most measures, Detroit’s school system (DPS) remains in a financial free-fall,” Shawn D. Lewis of the Detroit News wrote yesterday. The system is $53 million behind in its public pension obligations—an unexcused tardiness that has triggered the already virtually bankrupt entity $7,600 a day in interest penalties; DPS is on pace to be $81 million behind in mandatory pension contributions by July 1, according to Michigan state records, but that is before counting in the additional late homework debt of $78,000 in fees for each month the Motor City’s system DPS remains delinquent — a sign Ms. Lewis writes of “worsening finances for Michigan’s largest school system as it continues to rack up debts and hemorrhage students and cash. Forgoing required contributions for pension payments mirrors a cash-hoarding tactic the city of Detroit pursued in November 2012 — nine months before declaring bankruptcy.” DPS now has a projected fiscal deficit of $166 million this year; at the same time, DPS is running an increasing human deficit: its enrollment has dropped to 47,238 students this year, less than a third of a decade ago―and this notwithstanding state oversight for 12 of the past 15 years and the recent arrival of its fourth state-appointed emergency manager, or, as Ms. Lewis writes: “The Detroit district has run a deficit in nine of the last 11 fiscal years, sometimes papering over its debts with borrowing against its future school aid revenues. It has resulted in a net accumulated deficit of $1.28 billion during that period.” Is a meaningful, long-term recovery from municipal bankruptcy and a fiscally sustainable path to the future for the Motor City’s fiscal future absent a reversal of its nearly two-thirds population decline – and its fiscally deteriorating and unsustainable perception of its public school system possible? The gravity of this fiscal challenge to Detroit’s future now, it appears, lies not with retired U.S. Bankruptcy Judge Steven Rhodes, but rather with the Coalition for the Future of Detroit Schoolchildren, formed to look for ways to try and address—and turn around―Detroit’s long-troubled educational system. The coalition has been examining how the city’s fragmented school systems impact student outcomes and efficiency in operations; it is looking to outside education experts from Detroit and across the country in an effort to identify the best ways to improve the city’s broken education system. The leaders of the 31-member Coalition, which include Skillman Foundation President and CEO Tonya Allen; the Rev. Wendell Anthony, Fellowship Chapel and President of the Detroit branch of the NAACP; David Hecker, president of AFT Michigan/AFL-CIO; John Rakolta Jr., CEO of Walbridge Aldinger Co.; and Angela Reyes, executive director of Detroit Hispanic Development Corp. expect to issue its findings and make recommendations for making Detroit’s school system more equitable, accessible, and successful for all Detroit children next Monday―a report Ms. Allen notes in which the coalition will “share a common belief that Detroiters should have a say in coming up with solutions that can make Detroit schools work for kids, and that now, as the city is recovering in so many other ways, is the time to make real change happen.” The coalition appears to understand that Detroit’s road to economic recovery will be neither sustainable, nor even possible if people do not have confidence in the city’s education system: “Detroit’s vitality and global competitiveness is linked to its schools, which are educating our future workforce.”

Borrowing that Could Bankrupt Detroit’s Future. High administrative and special education costs and debts―nearly $1,200 in DPS funds now are diverted―per student―toward paying off past operating deficits: an unsustainable fiscal road to perdition that officials report will handcuff DPS at least until 2022: this is debt service burden which is reported to be higher than virtually any other Michigan school district, according to state officials, with the debt—and late fees―owed to the Michigan Public School Employees Retirement System. That means that of the amounts left for actual classroom education of the Motor City’s children, out of the $14,444 DPS budgeted per child last year, just 27 percent went toward basic classroom instruction—a signal disparity from other school districts in the metropolitan region, and less than half the statewide average, according to a Detroit News analysis of the 2013-14 spending data. In contrast, the Detroit school system has among the highest per-pupil costs for administration ($1,963 per student) in the state, among districts with more than 1,000 students, with Ms. Lewis noting: “Even with cost-cutting state emergency managers, the district’s 204 central office employees last year are more than the 200 it had a decade ago when there were 100,000 more students and 5,000 more teachers.” Even though DPS drastically undercuts its investment in the city’s future workforce, it faces a special needs population considerably higher than the state average: close to one in five DPS five students receives some form of special education services: “Special-needs students have been a rising share of Detroit’s enrollment since 2003. And a geographically large footprint and the district’s competition with charter schools and suburban districts for students compound its transportation costs. Its average cost to bus a student — $651 — is twice the cost elsewhere in Wayne County, according to state data.


March 25, 2015
Visit the project blog: The Municipal Sustainability Project

Rolling the Die on Atlantic City’s Fiscal Fate. New Jersey Governor Chris Christie’s appointed emergency manager Kevin Lavin yesterday issued his assessment (please see opening part below) and recommendations as directed under the state executive order which tasked him, along with former Detroit emergency manager Kevyn Orr, with determining whether the city should be forced into municipal bankruptcy or not. Noting that “[B]ankruptcy is not something that we are contemplating,” Mr. Lavin instead said, “We think that this process can be done without that necessity.” That is, the report and recommendations mean there will continue to be a hybrid form of municipal government between the city’s mayor and council and the state-appointed emergency manager for the forseeable future. The report, as one expert notes, “kicks the can down the road,” and offers no specifics with regard to specific steps the city could take to grow its eroding tax base so that it could someday have a fiscally sustainable path to a viable future. Mr. Lavin’s report indicates that, even taking adjustments into account, including deferring municipal contributions into pension funds, operational cuts and the addition of $77 million of state aid―Atlantic City’s cash flow would still dip below zero twice by August, or, as he put it yesterday: “Absent the continuation of significant state assistance…the city simply cannot stand on its own.”

In the report, Mr. Lavin wrote: “The decline in revenues has exceeded the worst estimates that were published earlier this year. Moreover, absent the continuation of significant state assistance, the City is simply incapable of self-funding even its reduced budget for the coming fiscal year and this incapacity will only continue and worsen throughout the following years. The City simply cannot stand on its own. Thus, one thing is clear: there is no reasonable likelihood that these headwinds will abate at any point in the near future. In fact, as discussed in detail herein, all reasonable forecasts confirm that these troubling factors will continue to beset the City for the foreseeable future and, absent immediate and urgent corrective action, the City’s ability to function as a thriving and viable municipal enterprise is imperiled. In short, the acute financial distress facing the City is imminent and the causes of such distress are not transitory. Absent an urgent, material realignment of revenues and expenses, this crisis will rapidly deepen and will threaten the City’s ability to deliver and maintain essential government services impacting the health, safety and welfare of its residents. Lastly, the taxpayers of the City need and deserve a much more efficient and financially stable place to live and work. Atlantic City is a beautiful place with great people and tremendous potential. Indeed, I believe we all would like to see investors and developers aggressively pursuing investment opportunities here. Together we need to fix these challenges the City is facing and to that end I look forward to continuing to work closely and collaboratively with Kevyn Orr, the Mayor and his team, City Council, Atlantic County (the “County”) and the State of New Jersey (the “State”) personnel as well as all other City stakeholders.”

Mr. Lavin’s report notes the city will confront a liquidity crisis by the third quarter of this year and that its ratable tax base has declined 64% to just $7.35 billion in 2015 from $20.5 billion in 2010, as its casinos suffered from competition in neighboring states, noting the city’s fiscal deterioration is actually “a lot more severe than we thought when we first started.” About 85% of Atlantic City’s budget is derived from property taxes. Four Atlantic City casinos have closed since the start of 2014. The city’s gambling revenue has dropped from $5.2 billion in 2006 to $2.6 billion in 2014, as casinos have proliferated across the region. Casinos also have appealed their property-tax bills and often won rebates, creating “significant refunds and unsustainable debt load,” the report said. Mr. Lavin said he would appoint a mediator to negotiate with stakeholders, including labor unions and casinos. Atlantic City currently is projecting a deficit of $101 million. Without significant change, Mr. Lavin noted, the cumulative deficit will be $393 million over five years. The cuts, he noted, will have to come from a combination of operational cuts and a 20 percent to 30 percent reduction of the city’s 1,150 or so full-time employees. That warning comes as six of Atlantic City’s labor contracts have expired and are already in negotiations. Those negotiations will also have to address public pension obligations—not only of the employees, but also with regard to the separate retirement plan for the city’s lifeguards. The report said bondholders may need to consider negotiating lower interest rates for the city. And it called for possible changes in benefits for certain city retirees. The emergency managers did not specify whether discussions had taken place about layoffs or cuts to employee benefits. The city’s workforce of about 1,100 has already been trimmed by Mayor Don Guardian. The emergency managers said another 20% to 30% of the workforce might need to be cut. The city’s school system also has about a $45 million budget gap, according to the report. They recommended possible layoffs in the school system and said the state probably would need to help keep the system afloat.Their ideas for fixing the city’s troubled finances were largely dependent on state assistance and reductions in expenditures—not on additional revenue. While city and state officials have emphasized a need for diversification in the city’s economy beyond casinos, the report proposes taking money that was used to do that through a tourism and marketing agency, and using it to close the budget gap.

Governance. Mayor Don Guardian yesterday said he had been working with the Lavin—Orr team, which will consider long-term solutions in a second phase of work. But the nature of this quasi-shared governance is not addressed in Mr. Lavin’s report. Ergo, the nature or balance of power remains unclear—especially as very hard choices have been deferred. The decision, however, not to direct or mandate Atlantic City to file for chapter 9 municipal bankruptcy in federal court indicates the state has a vested stake in trying to make Atlantic City come out whole instead of throwing the city to the federal bankruptcy court. That could be an important step to the prevention of further fiscal contagion for other New Jersey municipalities.

Governor Chris Christie appointed me as Emergency Manager and Kevyn Orr as Expert Consultant to the City of Atlantic City on January 22, 2015. This action was taken only after numerous reports analyzed and described the dire financial status of the City that currently threatens the City’s ability to provide the crucial services that the citizens, businesses, visitors and stakeholders of the City expect and deserve. Since my appointment, I have met with numerous stakeholders, including: elected officials, business partners, taxpayers, union representatives and other interested parties to discuss their observations and concerns about the financial and operating state of the City. Commendably, the City, County, and State have made great efforts to confront these headwinds and develop plans to address the significant revenue shortfalls that are a direct consequence of the precipitous decline in both the City’s ratable tax base and other limited revenue sources, a decline that has become even more severe within just the past 90 days. Indeed, the decline in revenues has exceeded the worst estimates that were published earlier this year. Moreover, absent the continuation of significant state assistance, the City is simply incapable of self-funding even its reduced budget for the coming fiscal year and this incapacity will only continue and worsen throughout the following years. The City simply cannot stand on its own. Thus, one thing is clear–there is no reasonable likelihood that these headwinds will abate at any point in the near future. In fact, as discussed in detail herein, all reasonable forecasts confirm that these troubling factors will continue to beset the City for the foreseeable future and, absent immediate and urgent corrective action, the City’s ability to function as a thriving and viable municipal enterprise is imperiled. In short, the acute financial distress facing the City is imminent and the causes of such distress are not transitory. Absent an urgent, material realignment of revenues and expenses, this crisis will rapidly deepen and will threaten the City’s ability to deliver and maintain essential government services impacting the health, safety and welfare of its residents. Lastly, the taxpayers of the City need and deserve a much more efficient and financially stable place to live and work. Atlantic City is a beautiful place with great people and tremendous potential. Indeed, I believe we all would like to see investors and developers aggressively pursuing investment opportunities here. Together we need to fix these challenges the City is facing and to that end I look forward to continuing to work closely and collaboratively with Kevyn Orr, the Mayor and his team, City Council, Atlantic County (the “County”) and the State of New Jersey (the “State”) personnel as well as all other City stakeholders.

Chinese Municipal Fiscal Distress. The Economist this week notes that severe municipal fiscal unsustainability is not unique to the U.S., writing that China’s finance ministry has proposed measures to address still another cloud looming over the heretofore booming economy: local government debt, which, the Ministry reports, has ballooned to over 40% of GDP. To help (this is where China is profoundly different than the U.S. federal government), local Chinese governments will now be permitted to refinance $1 trillion yuan (about $160 billion) of exiting high-interest municipal debt for lower cost municipal bonds—federal government assistance which could save these cities as much as 50 billion yuan in interest costs alone this year. 哇!


March 24, 2015
Visit the project blog: The Municipal Sustainability Project

Getting Ready to Rumble. Today is likely to be D-Day for Atlantic City: emergency manager Kevin Lavin is expected to issue his report and recommendations with regard to whether he and Kevyn Orr will recommend to New Jersey Governor Chris Christie whether or not the city should file for federal chapter 9 municipal bankruptcy protection. A spokesperson for the New Jersey Department of Community Affairs said he thought it was unlikely the report would recommend a declaration of bankruptcy, noting: “It is my understanding that Kevin Lavin and Kevyn Orr were sent here to help [Mayor] Don Guardian restructure short-term and long-term debt so we can find a long-term solution and not a band-aid fix,” adding that he had spoken with Mr. Orr in recent days: “Obviously their goal is to restructure the debt, analyze the city’s ratable base, and ensure the city’s finances are stable without hitting hard-working families over the head with a tax increase or a municipal bankruptcy.”

York Distress. Pennsylvania Auditor General Eugene DePasquale yesterday, standing next to York Mayor Kim Bracey, warned that York, known as the White Rose City, will need to come up with $10 million by the end of this year to meet its minimum pension payment obligations. Like other Pennsylvania municipalities, the AG noted the city has fallen behind on its required annual payments: based upon its most recent audit, Mr. De Pasquale reports the municipality owes more than $4.13 million to its employee pension funds for missed payments for the last two years—and, another $5.7 million is due by the end of 2015―$3.4 million for the police fund, $1.5 million for the firefighter fund, and $757,667 for the non-uniform fund. Failure to make up the payments, the AG warned, could trigger withholding of state aid. Nevertheless, the Attorney General noted that, “[D]espite Mayor [Kim] Bracey’s best efforts, York simply does not have the money, and there is no realistic way the city will ever catch up without help.” Mayor Bracey asked for state help, stating: “The system is simply broken. Unfortunately, our situation in York is not unique.” She and the AG urged the legislature to act on a bill which would shift new state hires to a cash-balance hybrid pension plan, and require the calculation of pensions based on base pay and a small percent of overtime to curb the practice of “spiking,” or increasing final average salary with excessive overtime and unused sick or vacation days.

Municipalities in Crisis. In response to a request from House Judiciary Committee Ranking Member John Conyers (D-Mi.) of Detroit and Sen. Gary Peters (D.-Mi.), Rebecca O’Connor and Peter Del Toro of the U.S. Government Accountability Office submitted a report, http://www.gao.gov/products/GAO-15-222, Municipalities in Crisis, advising Congress that municipalities in fiscal crisis confront diminished abilities to manage federal grants because of: workforce reductions, decreased financial capacities, and outdated information technologies. The report was compiled after interviews with grant administrators at the federal, state, and local levels; local officials in Detroit, Flint, Camden, and Stockton, as well as academic researchers and practitioners (including this author) with expertise on the topics of local government administration, local fiscal distress, and Chapter 9 municipal bankruptcy. In the GAO report, the dynamic duo examined eight federal grant programs in housing, transportation, and public safety to better understand the repercussions of municipal fiscal distress on their ability to access and utilize such federal grants—finding, for instance, that in Detroit, Flint, and Stockton, downsizing directly affected staffing responsible for grant management and oversight―Detroit’s Planning and Development Department, which administers CDBG and HOME Investment Partnerships Program grants received by the city, lost more than one third of its workforce between 2009 and 2013, according to the report, undercutting the ability of the remaining staff to carry out all of the grant compliance and oversight tasks; similarly, staff attrition created by the respective municipal fiscal distress led to “grant management skills gaps” in the Detroit, Flint, and Stockton workforces: in Detroit and Stockton, turnover in senior and mid-level staff particularly created challenges―the skills shortages sometimes led to violations of grant agreements or unspent grant money in Detroit and Flint. In both cities, according to the report, decreased financial capacity undercut the municipalities’ abilities to apply for certain federal grants. To the extent there were lessons learned, the GAO noted that Flint, Stockton, and the Motor City have consolidated management processes—especially writing that under Kevyn Orr in Detroit, Mr. Orr had directed Detroit’s CFO to establish a central grant-management department. The GAO report also found that Detroit, Flint, and Camden have collaborated with local nonprofit organizations to apply for federal grants, helping them deal with limited staffing. The duo also examined eight federal grant programs: they reported these programs “used, or had recently implemented, a risk-based approach to grant monitoring and oversight.” When federal officials of such grant programs found deficiencies, they often required grantees to take corrective actions, but the municipalities did not always take these actions. The report also determined that a White House Working Group on Detroit and individual federal agencies had taken steps to improve collaboration with municipalities in fiscal crisis: “These actions included improving collaboration between selected municipalities and federal agencies, providing flexibilities to help grantees meet grant requirements, and offering direct technical assistance.” Nevertheless, the report notes that federal agencies have not formally documented and shared the lessons learned from the federal efforts to help Detroit, adding: “If these lessons are not captured in a timely manner, experiences from officials who have first-hand knowledge may be lost,” recommending that OMB mandate federal agencies involved in the Detroit working group to collect good practices and lessons learned and share them with other federal agencies and local governments.

What Happens If a Municipality Misses its Federally-imposed Deadline for Filing its Municipal Plan of Debt Adjustment?


March 23, 2015
Visit the project blog: The Municipal Sustainability Project

Trying to Create a Sustainable Future. With San Bernardino’s federal court deadline bearing down on it, the municipality has sought to balance messaging to its citizens and taxpayers about the city’s straits and how it is trying to reemerge—even as the odds increase that its municipal bankruptcy submission might fail because of its inability to meet U.S. Bankruptcy Judge Meredith Jury’s deadline. The city’s auditor, Macias, Gini and O’Connell, LLP, has disclosed that it may not have all work completed in time for submission of San Bernardino’s plan of debt adjustment to the federal bankruptcy court by May 30th. Failure, Judge Jury has been explicit, will mean dismissal of the city’s bankruptcy petition―a dismissal that would put the bankrupt city in a legal twilight zone; dismissal would open the door to the figurative dismemberment of the municipality, as it would remove the bar imposed when its petition was accepted to creditors from going after the city’s assets: it would almost certainly force the MIA State of California to act, as such a catastrophic fiscal event would appear certain to mean the municipality would no longer be viable.

Democracy & Bankruptcy. Unlike states, such as Michigan and Rhode Island, where the elected leaders of a municipality which has filed for federal bankruptcy protection are summarily removed from authority unless and until the federal bankruptcy court approves said municipality’s exit plan, or plan of debt adjustment; in California—as in Alabama—the elected officials remain responsible for the operation of the municipality during municipal bankruptcy. Thus, they bear a responsibility to communicate to taxpayers and citizens throughout the formulation of the putting together a plan of debt adjustment. That is a singular challenge—indeed, it is one of the reasons some citizens in San Bernardino have suggested the Mayor and Council should hire a public relations firm: to both help citizens and taxpayers understand the process, and to avoid the peril of serious opposition from those who might “lose” under the city’s proposed plan of debt adjustment. Democracy carries burdens quite different than those confronted by a receiver or emergency manager. Notwithstanding, the San Bernardino Council has voted 4-3 to reject a proposed two-year contract, $215,000 contract with the public relations firm Tripepi Smith, with Councilman John Valdivia stating: “I think this is another wasteful, wanton abuse of the taxpayer,” who opposed the agreement along with Council Members Virginia Marquez, Benito Barrios and Henry Nickel: “I will not support this.” The vote came in the wake of interviews by a panel consisting mostly of city staff of potential firms.

The Unanticipated Costs of Municipal Distress. Hillary Russ of Reuters has reminded us of the harsh costs imposed by municipal fiscal distress—costs that, as we have seen in Michigan and Rhode Island—can fall upon the state, as well as the municipality. In New Jersey, the Ernst & Young tab for its analysis of Atlantic City’s financial distress will be in excess of $250,000—and that is only part of what the final tab will be. The state has hired E&Y on behalf of state-appointed emergency manager Kevin Lavin, who was appointed in January. In making its selection, New Jersey’s Law Department selected the firm on behalf of its client, the Department of Community Affairs, for which Mr. Lavin works, citing the firm’s experience working closely with Detroit’s bankruptcy team, with DCA spokesperson Tammori Petty stating that Ernst & Young’s Detroit experience included “all aspects of that city’s financial and operational restructuring and financial forecasting, and expert support and guidance, functions similar to the services they are providing” in Atlantic City. The tab so far is to finance the first phase of Ernst & Young’s work, which includes Mr. Lavin’s much anticipated report which is anticipated to be released any day now. But, in addition, E&Y will bill the state $455 per hour for longer-term services, such as liquidity forecasting, developing options to deal with cash flow problems, analyses of debt and revenues, and helping develop a restructuring plan, according to the agreement. On top of that, New Jersey is paying Mr. Lavin an annual salary of $135,000. The tab is likely to escalate, as that does not cover the services of Kevyn Orr—brought in after his work in Detroit, much less other professionals―especially if Messieurs Lavin and Orr recommend municipal bankruptcy for Atlantic City.


March 20, 2015
Visit the project blog: The Municipal Sustainability Project

Honoring an Unsung Leader. Chief U.S. District Judge Gerald Rosen’s famous doodle which led to extraordinary “grand bargain” between Michigan Governor Rick Snyder and bipartisan leaders in the Michigan Legislature and the Detroit Institute of Art to both preserve the world renowned museum in Detroit, but also to leverage an unprecedented package of a state and non-profit assistance to protect public pension obligations for some of Detroit’s lowest income retirees in Detroit’s historic bankruptcy will be featured at the Detroit Institute of Arts during a private event next month. The DIA is hosting an invitation-only event April 10th to celebrate the sketch by Chief U.S. District Judge Gerald Rosen, who, at the request of now retired U.S. Bankruptcy Judge Steven Rhodes, led a federal mediation team. The doodle laid the conceptual foundation for creation of a fund to shore up city pensions and protect DIA artwork from sale during the bankruptcy. The $816 million deal included contributions from state taxpayers, private foundations, and DIA donors. On a legal pad, Rosen drew a box, labeled it “ART,” wrote “State” to the left and “Pensions” to the right. Who said the art of exiting municipal bankruptcy did not require artistry?

Trying to Create a Sustainable Future. The pace is quickening in San Bernardino as U.S. Bankruptcy Judge Meredith Jury’s May 30th deadline approaches: A proposed realignment of elected officials’ responsibilities and authority will be presented to the City Council for agreement on April 6th as the first concrete suggestion from the group that met Wednesday and Thursday to help the city adopt a long-term strategic plan; and Judge Jury has ruled the city can reject its bargaining agreement with the city’s police union―an agreement the city first asked for authority to do two years ago, so that it could impose a new contract that would leave more funds in its budget—funds critical to assembling the city’s plan of debt adjustment for the federal court. Judge Jury, in her decision, said she was not deciding whether the city may legally make union members pay part of their pension costs—a disputed issue, which, San Bernardino Police Officers Association attorney Ron Oliner contends would violate state law; nevertheless, it is similar to an earlier September ruling that San Bernardino could reject its contract with firefighters. Judge Jury explicitly wrote then that she was not blessing the city’s plan to impose a contract on firefighters to replace the one she was rejecting. Nevertheless, in the wake of that decision, Mayor Carey Davis had cast a tie-breaking vote in City Council to impose a contract on the fire union, which is suing the city on several related fronts. In its filing this week, San Bernardino claimed that five of its seven unions had agreed to “modifications,” including paying half of the cost of the CalPERS, with the fire and police unions resisting, noting: “As Mr. (consultant Michael) Busch pointed out in his most recent declaration, absent those modifications, the City would have continued to run a deficit in its General Fund,” the city’s attorneys wrote, while the Police Officers Association (POA) did not agree to the new Memorandum of Understanding: “Clearly, the POA MOU is a burden on the City and its ability to reorganize.” The legal action came after more than a year of attempting to work through a mediator to come to a consensus. It also comes because of deep and costly frustration because, under the city’s charter, San Bernardino may not directly reduce police or firefighter pay. Despite an effort supported by many city officials to change that, through Measure Q, citizens rejected the effort, in effect voting to continue setting pay as the average of 10 like-sized cities. On the realignment front, a proposed realignment of elected officials’ responsibilities and authority will be presented to the City Council for agreement on April 6th, marking the first action in response to recommendations emerging this week from this week’s meetings in the city to develop a long-term strategic plan: the three-page “interim charter agreement” is intended to address what the 17-member group recommended to address inefficiencies in the city charter—with the draft agreement noting: “It is very apparent to us that the City’s Charter is a compendium of conflicting provisions, a recipe for inefficiency and finger pointing given the overlapping of legislative (policy making) and managerial responsibilities between the Mayor, Common Council, the City Attorney and City Manager…It is unclear who is in charge and whom to hold accountable.” Group members, chosen by Mayor Davis as part of San Bernardino’s strategic planning process, reported that the city’s bankruptcy “confirms” the need to replace the city’s charter, albeit they understand that a replacement likely cannot absent a vote of the people in November 2016. Until then, City Council members will be asked to formally agree to an alignment of duties more closely matching the typical council-manager form of government: the council adopting policy, the mayor serving as a spokesman, the city attorney providing legal advice, and the city manager having sole authority for managing and directing staff. Mayor Davis, City Attorney Gary Saenz, and most of the six council members who attended at least some of the discussion explicitly agreed they support the document and would vote in its favor. Although California’s open meeting law prohibits a majority of the council discussing items that could come to them for a vote, City Attorney Saenz pointed to a provision indicating the law does not purport to prevent council members from attending a gathering open to the public and discussing policy “as part of the scheduled program.” Group members at the meeting, in addition to agreeing among themselves to follow the “interim charter agreement,” agreed the city should submit the document and its plans to replace the city charter to Judge Jury as part of its plan of debt adjustment.

Uh oh. The turnaround progress in San Bernardino has taken a stutter step, according to Reuters, which reports that San Bernardino has defaulted on nearly $10 million in payments on its privately placed pension bond debt since it filed for federal municipal bankruptcy protection nearly three years ago. Reuters added that the city has not negotiated with its bondholders since September, at least according to what the firm claimed based upon information from “a person familiar with the stalled negotiations.” The issue—and dispute—relate to the ongoing federalism challenge between state constitutions, such as in California, Michigan, and Illinois, which treat public pension obligations as contracts—versus the federal municipal bankruptcy law, which, as both U.S. Bankruptcy Judges Christopher Klein and Steven Rhodes have opined, trump the state constitutions. These had been issues on the road to the respective 9th and 6th U.S. Circuit Courts of Appeal coming out of the Detroit and Stockton municipal bankruptcy cases—but have since withered. Nevertheless, with San Bernardino’s declaration last year that it intends under its plan of debt adjustment or municipal bankruptcy exit plan to fully pay CalPERS―something the city has continued to pay monthly―in full, the issue will re-present itself to Judge Jury, as San Bernardino has withheld interest payments to its bondholders for nearly three years, according to the interest payment schedule on roughly $50 million of pension obligation bonds issued by the city in 2005.

Municipal Contagion. New Jersey Senate President Steve Sweeney fears that the appointment of an emergency manager in Atlantic City is creating financial repercussions for other cities in the state. In a statement yesterday, Senate President Sweeney yesterday said Gov. Chris Christie’s appointment of Kevin Lavin as emergency manager and Kevyn Orr as his advisor is “a principal factor” in Moody’s placing seven municipalities in New Jersey “on review for a possible credit downgrade.” Atlantic City has already seen its credit rating reduced following the appointment of Messieurs Lavin and Orr. Sen. Sweeney called on state officials to move forward on a recovery plan he and other state legislators have crafted for Atlantic City: “The administration has held three summits and has issued two reports, but has taken no real action in over a year. By appointing ‘bankruptcy experts’ who are identified with Detroit’s bankruptcy, they sent an alarmist message that had an impact on Atlantic City’s financial position and now threatens to harm the financial health of other cities in New Jersey.” The statement came in the wake of Moody’s warning of a possible credit downgrade for Trenton, Newark, Paterson, Asbury Park, Union City, Kearney, and Weehawken, with the credit rating agency citing both the appointment of the emergency manager in Atlantic City and the state’s problems funding pensions and other financial difficulties for the warning. “Of course, the immediate fallout from the appointments was Atlantic City’s bond rating falling close to junk bond status,” said Senator Sweeney: “Now, all of New Jersey’s financially-strapped cities could have their credit hurt, which will result in higher costs just to keep them operating.”

Lawrence of Massachusetts. Massachusetts Secretary of Administration and Finance Kristen Lepore has announced that Sean Cronin, the senior deputy commissioner of Local Services within the Mass. Department of Revenue, will take over the position as state overseer for the City of Lawrence, a city of 75,000 about 25 miles north of Beantown, replacing former overseer Robert Nunes, who Secretary Lepore credited for providing “valuable guidance and leadership to the City in achieving this goal” of helping Lawrence get back on its feet after decades of financial hardship. The Bay State does not specifically authorize its municipalities to file for federal bankruptcy protection—and, no municipality in the state has sought to in the past 30 years. Mr. Cronin, who in January had been named the senior deputy commissioner of Local Services, an agency within the Department of Revenue, after serving 17 years working in Brookline, the last 12 of them as deputy town administrator, appears likely to be warmly received: Mayor Daniel Rivera notes; “I think he has a good pedigree. All I’ve heard is that he has been great. People at the Statehouse were fighting for him. I’m glad he brings a strong mind to the game and a strong reputation, because that can only help Lawrence.” Mayor Rivera said his administration had a positive relationship with both Nunes and Pamela Kocher, who served as the city’s interim financial overseer from November until this week. Massachusetts had appointed Mr. Nunes to the position in 2010 as part of an agreement that allowed the municipality to borrow $27 million to pay off its operating deficit. Under his oversight, the city’s credit rating rose to its highest level in 29 years: he oversaw four consecutive balanced budgets, though he voiced opposition to some of former mayor William Lantigua’s more controversial financial decisions. Mr. Nunes concluded in a report that the city violated state procurement law in a car deal orchestrated by former Deputy Police Chief Melix Bonilla, who was recently acquitted of criminal charges and reinstated as a sergeant. Mr. Nunes also ordered reforms in the way the city collects parking garage fees after an attendant was indicted for allegedly skimming proceeds. In a recent Moody’s credit rating report, Moody’s moodily raised the city’s credit rating, with analysts noting a lower unemployment rate, but added that an “adoption and adherence to comprehensive financial policies” could boost the rating further. In its upgrade to an A3 from Baa1, the analysts wrote: “Since the appointment of the overseer, the city has stabilized its financial position through the issuance of deficit notes and the adoption of more conservative fiscal management practices, resulting in an improved reserve and liquidity position.” Mr. Nunes had ordered the city to adopt a capital budget annually for big ticket, one-time expenditures such as the new police cruisers the city purchased recently; nevertheless, this year will be the 11th year in a row that Lawrence operates without one. In a statement, Mr. Cronin said he plans to make that a priority.

Trying to Create Sustainable Futures

March 19, 2015

Visit the project blog: The Municipal Sustainability Project 

Re-entering the Municipal Market in the Wake of Municipal Bankruptcy. Yesterday, the Michigan Senate voted 46-36 to pass and send to the House S160, legislation which would provide holders of bonds issued by Detroit with an intercept and statutory lien on the city’s income tax-backed bonds in anticipation of the city’s first post-bankruptcy bond re-entry this spring. SB 160 would amend the Home Rule City Act to allow a city with a population of more than 600,000 (in effect limiting the bill only to Detroit) to remit all its income tax revenue to a trustee for the benefit of the holders of financial recovery municipal bonds, before releasing any remainder back to Detroit. That is, the legislation would provide bondholders a superior, statutory lien on the city’s income tax revenue until the bonds were paid off. The revenue held in trust would be exempt from being levied, taken, sequestered, or applied toward paying the debts or liabilities of Detroit―other than those expressly specified in the agreement. In her fiscal analysis for the legislature, Michigan Senate fiscal analyst Elizabeth Pratt noted that the lien and intercept could save the city between $2 million and $3 million annually on debt service over the 10-year life of the bonds, adding: “Bond rating agencies have stated that a statutory lien on the income tax revenue pledged to repay the bonds would improve the bond rating and result in lower interest costs.” Should the bill become law, it would mark the Motor City’s first issuance in the public market since its emergence from municipal bankruptcy. As passed by the Senate, the bill would apply to $275 million of income tax-backed municipal bonds which the Motor City privately borrowed from Barclays last December as part of its plan of adjustment exit from Chapter 9 bankruptcy. The bonds, now in a variable-rate mode, are to be resold on the public debt market in a fixed-rate mode within 150 days of the Dec. 10th placement date, unless Barclays grants an extension. The one-day secondary market sale, coming as soon as April, will be similar to a primary offering, with credit ratings from at least two agencies. The $275 million of bonds are the only case in which Detroit has pledged its income tax revenue to a borrowing. The measure is intended to gain an investment-grade rating from at least one major rating agency.

Trying to Create a Sustainable Future. San Bernardino, as part of its ongoing effort to incorporate citizen input, involvement, and participation in shaping both a long-term strategic plan, as well as its plan of debt adjustment by May for the U.S. Bankruptcy Court, held a citizens’ meeting yesterday—which will continue today. Yesterday, the focus was on the challenges and opportunities for the city’s future, including possible solutions. The meeting featured 17 local leaders from various fields who were so-called “official participants,” including elected leaders from San Bernardino, as well as participants from colleges, businesses, and religious organizations. The attendees praised the engagement and emphasis on the positive, which they believe has been generated by and from those meetings. But what also emerged was a recognition that while San Bernardino’s revenue per capita and expenditures per capita are each in line with comparable municipalities in California, the city’s exceptional rate of turnover is not. San Bernardino has experienced a 24 percent annual turnover for executives since 2004, including five city managers, police chiefs, and public works directors. There appeared to be agreement with the assessment of our report [San Bernardino Full Case Study] that the city’s charter is a critical contributor to these problems, creating confusion and a lack of accountability: the responsibilities of the mayor and city manager often conflict; the elected city attorney has unusual power; and the City Council’s role is not well defined. Former Mayor Pat Morris, pointedly asked at the meeting: “Who’s in charge in this city?…That is the base question…I think the time has come for this group to decide we’re simply going to vote out the sucker — eliminate the charter and start again with a modern construct.” In reviewing the results of the survey of the city’s residents, the meeting also disclosed significant concerns: Asked to rate how likely they would be to recommend San Bernardino to a friend, on a scale of 1 to 10 with 10 being the highest, only 1.49% said 10.  31% responded 1. The majority who rated it below 8 were then asked what they would change. The top response was:

  • safety―89%,
  • clean streets—77%.

Muncipio or Municipal Fiscal Distress in Puerto Rico. While we have mostly focused on the Commonwealth of Puerto Rico’s desperate fiscal status—and its inability because it is not a state to authorize any of the island’s 78 municipalities to file for federal bankruptcy protection, we have not previously looked at how the Commonwealth’s municipalities are fiscally faring. Now Marc Joffe, a principal consultant at Public Sector Credit Solutions, has completed a preliminary review of recently released audited financial statement data, which, he writes, reveals widespread financial distress, noting that several may require extraordinary financial assistance from the Commonwealth, and raising the apprehension that a significant portion of Puerto Rico’s $4 billion in municipal debt could become a concern for holders of Puerto Rico general obligation bonds. Mr. Joffe scoured financial data obtained by the Centro de Investigación y Política Pública (CIPP), a Puerto Rico-based not-for-profit which operates the government transparency site ABRE Puerto Rico, reporting that the financial statements as well as summary statistics will be posted on ABRE Puerto Rico by late April. (Puerto Rico municipalities file audited financial statements with the federal and Commonwealth governments, and it appears that all 78 Puerto Rican municipalities – including those with less than 10,000 in population – meet the filing threshold. The reports are in English, are presented in accordance with GASB standards, and contain opinions from third party auditors.) According to summary data obtained by CIPP and spot-checked by Mr. Joffe, more than half of Puerto Rico municipalities have negative general fund balances, and few meet the GFOA recommendation for fund balance, i.e. enough to cover two months of spending. San Juan, the capitol, or as it is known there, Municipio de la Ciudad Capital San Juan Bautista, reported a positive general fund balance of $11 million―just over 2% of annual expenditures; however, Mr. Joffe notes that none of these funds are available for discretionary spending. After subtracting the $110 million in Non-spendable and Restricted General Fund balances, San Juan is left with an Assigned and Unassigned General Fund balance of negative $99 million. San Juan recorded general fund revenues of $420 million versus expenditures of $470 million. Ponce, the territory’s fourth largest city, has run substantial deficits during each fiscal year since 2008, accumulating a negative general fund balance of $36 million—a level, Mr. Joffe notes, equivalent to that reported by San Bernardino in the wake of its 2012 bankruptcy filing. Nevertheless, not all Puerto Rico cities are experiencing fiscal distress. Carolina, the third largest city, reported a roughly balanced budget in 2013 and significant unrestricted general fund reserves. Bayamon, the second largest, reported a 2013 surplus and a positive assigned/unassigned general fund balance, but reported a negative unrestricted net position on its government-wide statement of net position. Some smaller municipalities, he writes, reported “alarming results:” Maunabo, a 12,000-resident municipality on Puerto Rico’s southeast coast, as of June 30, 2012, reported a general fund balance of negative $2.9 million—an imbalance, moreover, which worsened to negative $3.5 million as of June 30, 2013. Most of the Maunabo’s revenue comes from the Commonwealth or federal government. In fiscal 2013, the city had total revenues of $14.4 million of which $11.2 million took the form of intergovernmental grants and subsidies. Since the community lacks the ability to support the level of service provided by the local government, spending cuts at either the federal or Commonwealth level could be devastating. The auditor found problems with how Maunabo accounts for its USDA Community Development Block Grants, which, at $1.7 million, is the largest federal grant it receives. The most serious finding was that “the Program did not maintain accurate accounting records of the financial transactions and did not reconcile, the cash account with the quarterly reports submitted to the pass-through-entity (which is OCAM – the Office of Commissioner of Municipal Affairs).” The auditor also gave a qualified opinion of Maunabo’s financial statements because the city does not have “complete, updated and accurate records of [it’s] capital assets.” Footnotes to the financial statements reveal that the city has overdrafts in its bank accounts and that it has missed $400,000 in interest and principal payments on a 2006 Department of Housing and Urban Development loan. These defaults have been covered by OCAM. Several other small municipalities had audit exceptions, negative general fund balances and/or a majority of revenues from intergovernmental sources. Unless Puerto Rico experiences an unexpected turnaround, these municipalities will be unable to service their substantial debts without extraordinary assistance from higher levels of government.


March 18, 2015
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Nearing a Fiscal Precipice. Even as San Bernardino is struggling to try to catch up on its audits―a critical prerequisite to completing its plan of debt adjustment by the deadline imposed by U.S. Bankruptcy Judge Meredith Jury, the bankrupt city is beset by the endless federalism-Constitutional California battle between the California Public Employees’ Retirement System (CalPERS) and its other creditors. So even as the city is girding up for battle in Judge Jury’s federal courtroom, it is—simultaneously—defending its plan to fully repay its debts to CalPERS, asking in a separate federal bankruptcy court for dismissal of a lawsuit by creditors demanding equal treatment. The precursor of the municipal bankruptcy war likely to be waged in Judge Jury’s courtroom comes as the city’s auditor has revealed it might be impossible to finish auditing the city’s financial statements in time for them to be used in its plan of debt adjustment―potentially opening the city to crippling attacks by creditors. A partner at the city’s accounting firm has requested another $490,000 to finish the city’s audits for FY2012-13 and 2013-14, more than double the original cost estimate, and warned further delays might be encountered later. He advised the city the 2012-13 audit would probably be done by April 30th, giving the city a month upon which to construct accurate financial and fiscal data critical to completing its plan of debt adjustment. The FY2013-14 audit, however, appears unlikely to be ready by then. While that more recent audit, according to City Manager Allen Parker, is not necessarily required by the charter committee, he has concurred with council members who said it would allow the municipality’s creditors to attack it as unprepared and undeserving of federal bankruptcy protection―or, as City Attorney Gary Saenz warns, without that protection, creditors will be able to collect the millions they are owed, leaving too little for basic city services: “If you don’t approve (the contract increase), I can probably guarantee we won’t make (the court’s deadline)…That would be devastating for the city.” But, it appears, the delays in completing the audit might be only the tip of an iceberg: the new auditing firm laid out for Council, in a detailed explanation, a much gloomier assessment, beginning with its test of San Bernardino’s internal controls, reporting it found no such controls, meaning the new auditors had to instead go through a much more time-consuming process, called substantive testing, or as it testified: “We virtually had to start from scratch, start from zero, and go through, system by system, department by department.” The firm noted that while certain areas presented their own specific, sizeable problems, such as the San Bernardino Employment and Training Agency, which, the firm reported, was disrupted by the California Legislature’s dissolution of such agencies; the firm noted that many of the issues came because of a combination of limited record-keeping and the lack of current employees who were employed by the city when the decisions being audited were made—an issue created by staff turnover. But under the persistent Council questioning with regard to why fiscal information had not been provided by the city to its auditors, it also became clear that the problems were higher up: City Manager Parker told the Council that City Finance Director Scott Williams had told the auditor he needed to review information, holding onto it for weeks―despite instructions from Assistant City Manager Nita McKay. The refusal, apparently, triggered the city’s decision to put Mr. Williams on administrative leave, and then to dismiss him this month, just months after the city had hired him. The exchanges led Councilman John Valdivia to state that the city manager, Mr. Parker, should be held ultimately responsible for all the delays, stating: “Citizens hold me accountable for your inactivity…Get your act together, Allen.” In response, City Manager Parker replied that the city’s fiscal problems went back decades, and that there was no way they could be resolved in the two years since the council had hired him: “You can make me the scapegoat; that’s fine…(but) you have learned that our problems are systemic.” That led Councilmember Jim Mulvihill to say the gravity of the problems should be the citizens’ take-away: “The reality is the city is in a quagmire, and the audit is just symbolic of it, a little piece of it.”

The Resumption of the Federalism Challenge. Even as San Bernardino is struggling to finalize its plan of adjustment to file in a federal bankruptcy court in southern California, the city is in another U.S, bankruptcy court in Riverside, California, seeking dismissal of a suit filed against it by Ambac Assurance Corp., a New York bond insurer, and EEPK, a Luxembourg bank, in which the insurers claim San Bernardino should not be paying its CalPERS debt when it has not paid them a dime on debts totaling more than $59 million to them. Now San Bernardino has responded, claiming the creditors’ suit “transcends novelty” and is “made out of whole cloth.” The court has is set a hearing for May 11, just weeks short of U.S. Bankruptcy Judge Meredith Jury’s deadline for the city to file its plan of debt adjustment with her. While the city, ergo, has not detailed any plan with regard to how it would treat EEPK and Ambac’s debts, much less its other obligations, it seems beyond peradventure that San Bernardino’s plan of debt adjustment will not call for full repayment of those debts. Rather, as San Bernardino City Attorney Gary Saenz told Reuters last January, the city will propose a repayment plan that includes reductions to those creditors in “an amount that is fair and reasonable.” The challenge reflects San Bernardino officials’ insistence they would pay the city’s $24 million-a-year CalPERS bill in full—and the revelation the city had begun repaying millions of dollars in past-due obligations to CalPERS, debts that arose when San Bernardino halted payments to the pension fund for several months after filing for bankruptcy in 2012. Perhaps ironically, San Bernardino had indebted itself to the two firms to help pay its pension costs to CalPERS. Because of that, EEPK and Ambac said the bonds are part of a “single pension obligation”―the equivalent of the city’s relationship with CalPERS, so that, they claim, whatever payments San Bernardino makes to CalPERS, the municipality must make comparable payments to EEPK and Ambac. In response, San Bernardino has countered that cutting payments to CalPERS would trigger substantial reductions in pension payments to current and future retirees, driving many of its municipal employees to leave for jobs elsewhere, or, as City Attorney Saenz puts it: “You can’t have a workforce without pensions.” Nevertheless, in the wake of U.S. Bankruptcy Judge Christopher Klein’s ruling that it would have been legal for Stockton to reduce its pension plan, this bedeviling issue which pits state constitutions versus the federal chapter 9 municipal bankruptcy law show no sign of simply fading away.

Thirsty Motor City. Detroit’s water department this week plans to step up its enforcement of overdue business accounts in a renewed effort to collect tens of millions in lost revenue. Nevertheless, the department will not shut off residential water unless and until a proven safety net is in place. Although there are 26,000 residential accounts with outstanding balances, department officials have opted to target commercial accounts first, with the Detroit Water and Sewerage Department (DWSD) seeking compliance from 2,044 delinquent commercial accounts to avoid shut-offs: these customers owe DWSD about $20 million, according to Bill Nowling, now the spokesperson man for the new, post-municipal bankruptcy regional water authority, set to go into effect in July. In addition, DWSDD will also take action with regard to some 8,355 accounts that have been deemed illegal hookups — in which the water has been shut off at a meter, but is still showing water usage: water thefts that account for about $13.6 million—or, as Mr. Nowling reports: “We know where those properties are…We are going to start processing those.” On the residential side, a more sensitive issue on which now retired U.S. Bankruptcy Judge Steven Rhodes had previously opined, the authority is poised to consider how and when to resume shutting off water to delinquent residential accounts; however, Mr. Nowling said, the city wants to be certain all eligible residents know about — and take advantage of — payment assistance programs: “There’s no plan currently to go after the residential (accounts) until we have gotten a handle on whether the Detroit Water Fund assistance program is working…We think it is working, but we think it could work better.” The revised, or mayhap post-Rhodes chastened approach, will certainly be in stark contrast to the widespread residential shut-offs that raised such a storm a year ago―and which spurred former Detroit Emergency Manager (and now Gov. Chris Christie Atlantic City advisor to its emergency manager) Kevyn Orr to give Mayor Mike Duggan more control over the water department—in response to which Mayor Duggan vowed to help needy customers pay their water bills, while holding those who can afford to pay accountable. He implemented a temporary moratorium and assistance fund for low-income residents in a 10-point plan to educate and expand assistance options for those struggling with delinquency. Since last August, the city has enrolled some 25,464 residents in the Mayor’s plan, which offers a streamlined payment plan and includes the creation of the $2 million Detroit Water Fund to help low-income residents, administered by the United Way for Southeastern Michigan. To qualify, residents must have an outstanding balance of $300 to $1,000; maintain average water usage for household size; and have an income at or below 150 percent of the federal poverty level. Eligibility provides one year of assistance to residents and will account for about $700,000 of the money in the fund that officials believe is underutilized. Nevertheless, collecting lost municipal revenue is a priority as the water department transitions to the newly created Great Lakes Water Authority, set to go into effect next July 1. The authority, created as part of the city’s landmark bankruptcy, is designed to maintain Detroit’s ownership of the water system while giving suburbs more of a stake in its operations: under the agreement, the city will lease infrastructure to suburban communities for a 40-year, $50 million annual fee and an annual $4.5 million payment assistance fund. DWSD will still be responsible for Detroit billings, collections and debts. The authority will handle operations in outlying communities―with mediated discussions over the details of the lease agreement being overseen by U.S. District Judge Sean Cox. For the lease agreement to be completely operational, bondholders of DWSD have to approve the plan. “Making sure that DWSD itself in its current state is as sound fiscally as it can be is very important in the minds of creditors, which are ultimately going to approve a regional deal,” according to Mr. Nowling.

Putting Municipal Bankruptcy into Context. Last year, according to the Federal Reserve and the American Bankruptcy Institute, nearly one million Americans filed for bankruptcy—a significant decline from the number who used to seek federal bankruptcy protection before the law was made tougher a decade ago (see chart). Nevertheless, some fear this reform may have done more harm than good: The aim, after all, of the federal bankruptcy law is to give families—just like municipalities under chapter 9―relief from unpayable debts. Some two-thirds of individual bankruptcies are due to a lost job. Just like municipalities, many citizens and families need time to get back on their feet. In the mid-2000’s, federal Chapter 7 bankruptcy rules made it easier to forego such debts—an issue which upset credit-card firms, which claimed that spendthrifts abused the system. Ergo, in 2005 Congress toughened the law with the intent to shift people to a Chapter 13 bankruptcy, where they would have to repay some of the debt. The reform, it appears, had a significant impact. At least at first, Chapter 13 filings rose relative to Chapter 7 filings. A new paper, from Stefania Albanesi, of the prestigious New York Federal Reserve, and Jaromir Nosal, of Columbia University, has determined that the reform led to a permanent drop in the bankruptcy rate. Other recent research suggests, however, that this is not necessarily a good outcome. Will Dobbie, of Princeton University, and Jae Song, of the Social Security Administration, examined Chapter 13 bankruptcies before the reforms of 2005: they link half a million bankruptcy filings to tax records and employed a novel technique to analyze them. Because some U.S. bankruptcy judges are more lenient than others, people in similar straits may end up with different bankruptcy decisions. The dynamic duo argue that easier bankruptcy laws may have positive microeconomic effects: if a creditor may no longer claim large portions of a bankrupt individual or family’s income, that may increase her or his incentive to work—and decrease the incentive to slip out of town, change jobs, and shut down bank accounts: On average, those granted federal bankruptcy protection earned over $6,000 more in the subsequent year than similarly-placed plaintiffs who were rejected. In contrast, Michelle White of the University of California, San Diego and colleagues found that bankruptcy reform caused the default rate on prime mortgages to rise 23%. Figures released on earlier this month (March 6th) by the Federal Reserve show that consumer debt rose for the 41st straight month.