Municipal Fiscal Precipices: Governance & Long-Term Sustainability

eBlog

March 12, 2015
Visit the project blog: The Municipal Sustainability Project

Nearing A Fiscal Precipice. With its federal bankruptcy court deadline hurtling towards it, San Bernardino is fiscally stuttering, taking one step forward, then two steps backward. This week, with—now—just over two and a half months to meet the deadline imposed by U.S. Bankruptcy Judge Meredith Jury to complete and submit the city’s plan of debt adjustment to her court, Scott Williams, the Finance Director brought on board just last December as a key architect, was put on administrative leave—for reasons city officials say they cannot discuss. Thus, even as the Mayor appears to be leading San Bernardino through a Strategic Plan towards adoption and submission to the federal court of a plan of debt adjustment, there appears to be continued turmoil in the organization. Not only has the CFO been placed on an unexplained administrative leave, but also the city has lost the bulk of its professional finance staff. The City is unable to complete its closing of the books for 12-13 and 13-14―ominous signs both for repairing the organization and complying with Judge Jury’s order. The city’s finance director is on administrative leave after just months on the job, with next week projected to be his last according to City Manager Allen Parker. According to Mr. Parker, the abrupt void will affect the city “not at all” in its attempts to finish two years’ of audits and financial projections for its plan of debt adjustment: “His boss, Nita (McKay, assistant city manager), is very qualified…She’s already taken over with the auditors, and we’re bringing in temporary people on a contract basis to make sure we make that deadline. There’s no time to go through a full recruitment.” Nevertheless, the City Manager admitted he does not yet know who the city will employ to work as consultants between now and the rapidly approaching deadline — nor the cost. By the federal deadline, the city must complete its audits for the 2012-13 fiscal year — audits due in March of last year, but still incomplete — and for the 2013-14 year. Those are integral parts of the federally required plan of debt adjustment. San Bernardino’s previous finance director, David Cain, resigned in September after almost 18 months in the position.

Hurtling into the Motor City Future. Detroit “achieved three main successes during its Chapter 9 filing, including substantially reducing long-term debt and retirement liabilities, but it also has a robust plan to reinvest in its tax base and services and a strong new management team that will benefit from ongoing state support,” Moody’s Vice President, Senior Analyst Genevieve Nolan, wrote yesterday in a new report: “Detroit Emerges from Bankruptcy Stronger, but Economic Hurdles Persist.” Nevertheless, Ms. Nolan warned the “city’s challenges are largely ones that bankruptcy could not immediately fix and may still result in weaker credit quality over the near to medium term.” Ms. Nolan noted that whilst the Motor City has made important strides in its credit fundamentals as it emerges from its record municipal bankruptcy, it continues to face a number of fiscal and economic headwinds that could limit its future growth,” noting that revitalizing the city’s economy and improving its city operations are crucial to its long term success. In addition, Ms. Nolan noted that Detroit’s ability to balance budgets amid its ongoing economic challenges burdens the credit in the intermediate term. On the plus side, Moody’s wrote that Detroit is dedicating resources to revitalize and strengthen its tax base through a proposed $1.4 billion reinvestment plan focusing on Detroit Police, Detroit Fire, Finance Department, General Services, and blight removal―with the reinvestment to be funded with proceeds from a $120 million quality of life note issued during bankruptcy, and as well as some funds from Detroit’s $275 million post-petition financing issued as it exited chapter 9 bankruptcy. Moody’s also noted that Detroit was able to significantly reduce its long-term liabilities in bankruptcy, with its net direct debt outstanding dropping to $1.8 billion from $2.5 billion—and believes the city’s new management team will also benefit from ongoing state oversight and support. However, the rating agency notes that Detroit’s economy and tax base continue to suffer amid valuation declines, weak demographic statistics, and a dwindling population: unemployment is still high (13.0% as of November 2014), and its decline from a peak of 25% in 2009 is partly attributable to a persistently shrinking labor force. On the real estate revenue front, the rating agency reports the Motor City expects assessed valuation declines to persist through 2020 as the State of Michigan and city management reviews its assessment process. While income tax receipts are estimated to rise 2.1% annually, Moody’s wrote that key revenues from property taxes are projected to drop by 1.3% annually over the same period. By the end of 2023, expenses and revenue projections estimate an ending cash balance of $65.8 million, a positive yet still narrow liquidity position. Negative variations from these projections could jeopardize Detroit’s fiscal blueprint. Moody’s noted that while fixed costs, including annual debt service and retiree benefit contributions, were reduced during bankruptcy, they will commence to grow again after 2023 when the city is required to begin making pension contributions again.

Trying to Close on Foreclosure. A key issue confronting the Detroit metropolitan area—where, as we have observed above, Detroit faces fiscal challenges, but also surrounding Wayne County is working furiously to avert its own municipal bankruptcy, remains foreclosure: Detroit could be forced to seize as many as 52,000 properties for unpaid taxes on March 31st, including as many as a fifth of all occupied homes. Michigan agreed this year to allow for payment plans that include capping tax debt at 25 percent of a property’s market value and interest rates of 6 percent instead of 18 percent, according to David Szymanski, the chief deputy for the Wayne County Treasurer’s office. Of the 62,000 properties that were in line for foreclosure, tax bills were paid off for about 10,000 and another 17,000 were put on payment plans, according to Mr. Szymanski. About 18,000 owner-occupants were on the list, but 7,500 have signed up for payment plans, Mr. Szymanski said, while about 40 percent of property owners in the past failed to keep up with payment arrangements. Of the 50 largest U.S. cities, Detroit has the highest property-tax burden for a $150,000 home, at $4,988 on average, according to a 2014 study by the Minnesota Center for Fiscal Excellence. Alan Mallach, a senior fellow at the Center for Community Progress, describes the Motor City as “at risk of becoming two different cities, one thriving and one continuing to decline,” noting that the city’s “tax auction says is that tens of thousands of people are either unable or unwilling to hold onto their properties. And can a city be viable if its property owners aren’t paying the taxes that the city needs to maintain itself?” Detroit’s land bank already owns about 20,000 properties, many from previous tax foreclosures, while the local government demolishes blighted houses at a pace of about 200 a week. The Motor City’s assessed property values are years out of date, adding to distortions in the market. Detroit’s tax base was flattened by the housing crash, which led immediately to a wave of mortgage foreclosures. The city’s median home value in December was $40,700, down from a peak of $78,800 in 2005, according to Zillow Group Inc. In the metropolitan area, which includes the wealthier suburbs, it was $115,700, up 9.8 percent from December 2013. This is a critical challenge for any sustainable fiscal future for a municipality which, decades ago, sported one of the highest home ownership rates in the U.S. Now, Detroit has the highest poverty rate, and an economy wrecked by crime, corruption, and lost manufacturing jobs. It also has the highest property tax rates of any big city―rates pegged to assessments that are out of kilter with the 48 percent plunge in home values over the past decade. Thus, Detroit and Wayne County officials are urging Motor City homeowners in foreclosure to come forward and take advantage of a “one-time break” to save their homes. Detroit Mayor Mike Duggan and Wayne County Treasurer Ray Wojtowicz, during a joint news conference at City Hall, praised a landmark package of foreclosure prevention bills the Michigan Legislature approved last November. The bills, signed into law by Gov. Rick Snyder in January, allow county treasurers to cut the interest rate on overdue taxes from 18 percent to 6 percent. In many cases, homeowners also can have taxes capped at a quarter of the market value of the home. “We went through a lot of effort to get homeowners the ability to stay in their homes in a way that’s never been available before in the state of Michigan,” Mayor Duggan said, noting the option will be available only this year and next: “This truly is an historic break. We are here today to say, ‘You have three weeks left.’ ” City officials this week reported that more than 40 percent of 18,000 Detroit families facing foreclosure on the homes they own and occupy have signed up for payment plans or other agreements. In addition, the owners of about 10,000 properties — mainly rentals — have entered into stipulated payment plans to avoid foreclosure. Thousands more have paid their taxes in full on vacant houses and lots they own in the city. In all, 27,000 properties are no longer facing foreclosure. Now, with a deadline in two weeks, another 10,000 Detroit homeowners could still sign up for a payment plan and avoid foreclosure. To qualify for the agreement, Motor City residents have to own and occupy the home and have a deed in their name. They will have up to five years to pay off multiple years of delinquencies and must also keep current taxes paid. As of Jan. 1, there were 62,000 properties in Detroit facing tax foreclosure. Of those, it is estimated that nearly half are either vacant houses or lots, according to officials; of the roughly 35,000 occupied properties facing foreclosure, 18,000 are owned by the individuals or families who live in them. To slow the rate of foreclosures, Mayor Duggan in January had stated that residential property assessments citywide will decline 5-20 percent, the second consecutive year he has cut taxes. The changes followed years of complaints from homeowners that home assessments, on which taxes are based, bore little relation to market value, significantly increasing taxes and leading to waves of tax foreclosures. Michigan agreed this year to allow for payment plans that include capping tax debt at 25 percent of a property’s market value and interest rates of 6 percent instead of 18 percent, according to David Szymanski, the chief deputy for the Wayne County treasurer’s office. Of the 62,000 properties that were in line for foreclosure, tax bills were paid off for about 10,000 and another 17,000 were put on payment plans, according to Mr. Szymanski. About 18,000 owner-occupants were on the list, but 7,500 have signed up for payment plans, Mr. Szymanski said, while about 40 percent of property owners in the past failed to keep up with payment arrangements.

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