March 16, 2015
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Nearing a Fiscal Precipice. Atlantic City Emergency Manager Kevin Lavin is scheduled to issue his report on the city’s finances a week from today—a report so far shrouded in secrecy, so that neither Mayor Don Guardian nor members of the City Council have any idea whether the report will recommend the city file for federal municipal bankruptcy protection or not, much less whether it would significantly affect the level of state support the municipality receives. Mr. Lavin, who is assisted by former Detroit emergency manager Kevyn Orr, is under a 60-day deadline, stipulated in the executive order issued by Gov. Chris Christie creating his position, to issue a report and recommendation; Gov. Christie has not issued an order extending Mr. Lavin’s tenure. There appears to be a growing potential there will be a delay—further interfering with the Mayor and Council’s ability to focus on the budget and the city’s fiscal sustainability. Should Mr. Lavin, as the appointment of Kevyn Orr appears to suggest, recommend municipal bankruptcy, New Jersey’s law—because it is quite different than Michigan’s, Rhode Island’s, Alabama’s, and California’s—would create a very different governance situation. Of the states which authorize municipalities to file for federal bankruptcy protection, New Jersey is unique, albeit comparable to Michigan: the Garden State’s Municipal Rehabilitation and Economic Recovery Act (2002, and designed for Camden, but applicable to others) authorizes the Governor to appoint a Chief Operating Officer to manage a municipality whose power supersedes the elected mayor and governing body. Under that law, if the elected officials disagree on formal matters, a judge serving as an arbitrator would be appointed to resolve the dispute. That makes New Jersey’s law different than Michigan’s in that there are sort of two executives co-ruling—unlike Michigan, or Rhode Island, where once the Gov. appointed an emergency manager (Mi.) or Receiver (R.I.)—the elected mayor and council were preempted of any legal authority. A separate law that dates back to the Great Depression allows the state to assume fiscal and management responsibilities. So New Jersey provides for a hybrid with options. New Jersey law is distinct also in that in certain situations, municipal bondholders of a New Jersey city may bring a court action to compel the city to perform what is termed a ministerial action. It also has a law that permits municipal bankruptcy, subject to approval of a state oversight board. In addition, the state has a history of using its authority, short of bankruptcy, to intervene in extreme cases of municipal fiscal instability to right the ship. So this means that there is a possibility of an odd duck situation in Atlantic City with a state-appointed COO co-governing the city alongside Mayor Guardian and the City Council, with a federal court in the position of naming a special arbitrator (think King Solomon) if there were a dispute.
In fact, the combination of the Governor’s decision to appoint a Chief Operating Officer for Atlantic City, an action creating a downward credit impact on municipalities across the state of New Jersey, comes as Moody’s analysts Josellyn Gonzalez Yousef and Julie Beglin wrote that the credit rating agency has placed seven New Jersey municipalities on review for a possible downgrade, citing a heightened risk of state aid cuts: Trenton, Newark, Paterson, Asbury Park, Union City, the Town of Kearny, and Weehawken Township, noting that the review was prompted by New Jersey’s financial constraints, which increase the risk of cuts to funding for municipalities such as transitional aid in the wake of the recent Superior Court ruling called for an increase of $1.6 billion in pension contributions for the 2016 fiscal budget. The Moody, but dynamic duo also noted that the January appointment of an emergency manager for struggling Atlantic City and possible adjustment of its debt may demonstrate a limit to New Jersey’s willingness to provide financial support to other distressed local governments, writing: “During the review, we will consider each city’s ability to absorb a potential loss of state support….Negative rating pressure may result due to each city’s current financial position, limited revenue raising flexibility under the state’s 2% property tax cap, weak tax bases, and low wealth indicators.”
On the pension front, New Jersey’s centralized system of six state-administered pension funds provides benefits for all of the hundreds of thousands of employees of state, county and municipal governments, school districts, public colleges and authorities also provides more stability than states with dozens or even hundreds of locally administered pension systems. New Jersey’s centralized pension system insulates local governments against the pension fund management issues that helped drive Central Falls (aka, Chocolate City), Rhode Island, into bankruptcy. It also leaves the state’s municipalities with relatively little ability to affect their future pension liabilities. New Jersey state law bars municipalities from setting aside money for prepayment, and municipalities simply wait every year for the state Division of Pensions and Investments to send them a bill. Gov. Christie has proposed pension reforms: the New Jersey State League of Municipalities is saying the proposed changes could disenfranchise workers and trigger a mass exodus of local workers—under which employees’ health care coverage would also be reduced and municipal employees would have to pay more out of pocket toward their health care. In exchange, the state would (subject to voter approval) constitutionally protect pension payments after decades of shortchanging them, but, as the N.J. League notes: “The proposal to freeze existing pensions, without qualification, could inspire the mass exodus of key local administrators and professionals, giving them no time to train and mentor their successors.”
A Perspective on the Motor City’s Future & the Unintended, Epic Consequences of Municipal Bankruptcy. Daniel Howes, the exceptionally gifted columnist for the Detroit News, on Friday wrote about what he called “the unintended consequences of Detroit’s epic bankruptcy,” noting: “two words can now be added: false expectations.” He was referring neither to the impact of the financial restructuring on Detroit’s financial situation, nor with regard to the way the restored power and authority of Mayor Duggan and the Council will be, but rather for what he deemed the “message Chapter 9 inadvertently sent to Michigan’s body politic: namely, that bankruptcy apparently proved contracts can be unilaterally restructured,” or at least that is how (no pun) a reader had chastised him. But Mr. Howes wrote: “Drawing the conclusion that such contracts can be diminished unilaterally distorts (if not willfully misunderstands) what bankruptcy is, what it does and where it cannot be used…So does suggesting that because Detroit’s pension obligations could be diminished in bankruptcy, the state’s obligations to honor its tax credits can be diminished because they are, well, politically inconvenient and financially expensive.” Rather, as he counsels, while municipalities in chapter 9 can restructure their debts and contracts in Chapter 9, states may not, because, unlike municipalities, they may not file for federal bankruptcy protection. Thus, unlike a city in bankruptcy, states may only modify contractual obligations through mutual agreement. That led Mr. Howes to note that even for a municipality—here specifically referring to the Detroit Public Schools―chapter 9 “may not always be the preferred remedy, even where it legally can be applied to restructure contracts and other obligations. The basket case of Detroit Public Schools, under their fourth emergency manager, are hurtling toward some kind of state-imposed remedy…What DPS is not likely to be is the state’s next candidate for Chapter 9. A blunt-force legal instrument, bankruptcy could use the power of a federal judge to restructure labor contracts — but not the district’s $420 million in bond and pension debt, because it is backed by the state of Michigan….However much the Chapter 9 cheering section may hunger to see DPS and its unions endure the harsh discipline of the bankruptcy process (and, believe me, such a section is not insignificant), the collateral damage and less-than-perfect application make it an unlikely option.” He wrote further that experts, including former Detroit Emergency Manager Kevyn Orr, are persuaded that neither Michigan’s Public Act 436 “nor federal municipal bankruptcy are well-suited to resolving the deep financial woes weighing on Wayne County.” Why? He notes that “the presence of five constitutionally elected officers — including County Executive Evans, the sheriff, the prosecutor and their separate budgets — creates a diffuse structure that cannot be easily subordinated to an emergency manager or the next logical step: Chapter 9 bankruptcy.”
Then Mr. Howes turned his attention back to Detroit and its future, noting the importance that that will necessitate starting with a plan, or what he called “a strategic approach that’s focused on redevelopment, economic stimulation and providing jobs: what exactly will this city do to address crumbling areas which were built and populated when the automotive industry was booming and have since drained themselves through 50-plus years of economic and residential disinvestment?” He added that he has been David Copperfield struck by an emerging tale of two cities—or “two Detroits: the “two Detroits” I’m seeing emerge are focused on the lack of economic development, stabilization and investment in certain neighborhoods versus other thriving areas of Detroit. If you haven’t lately (I have), drive up and down certain major thoroughfares and note the abandonment, empty lots and litter-strewn streets with unkempt lawns. Let’s be frank, some of those areas appear to be beyond repair, with houses barely standing and, in some cases, maybe less than a dozen still standing on a block.” This led him to ask: “What is the vision for neighborhoods and what will they look like in five years and beyond?…With a plan, the city can determine what to do with those areas most likely not to be repopulated. However, a strategic approach can be focused on “reurbanization:” In other words, finding unique and creative ways to repurpose those almost uninhabitable areas of the city. Yes, there’s talk of “urban farming” and the land banks, but those are tactics. Simply put, what’s the overall plan that ties it all together? Money aside, without a neighborhood vision and a strategic approach and implementation plan with key milestone dates, the “two Detroits” will continue to emerge. Until this happens, Detroit will continue to travel divergent paths and never truly reach the potential it can be. I, being a Detroit native who loves this city, believe it can and will continue its transformation successfully, but it has to be done in a thoughtful way with collaboration as part of a strategic plan. I realize it’s taken 50 years to bring Detroit to this point. However, I’m confident and with a cohesive plan, the next 50 years will lead Detroit back to rightful place as a city of leaders, innovation, and a post-industrial city which becomes the model for others domestically and internationally.”
What about Stockton’s Future? Moody’s, meanwhile, moodily opined about post-bankrupt Stockton’s future, with analysts Greg Lipitz, Thomas Aaron, and Naomi Richman noting that U.S. Bankruptcy Judge Christopher Klein decision clearing the city’s plan of debt adjustment conveys a mixed message for investors, writing that Judge Klein’s opinion that public pensions in California are not exempt from impairment in bankruptcy was a positive, but that the final confirmation that leaves Stockton pensions intact is a negative for bondholders: “We expect California local government bankruptcies to remain rare events, especially as the economy improves; however, those that do enter bankruptcy will now have more options in fashioning a reorganization, beyond impairing bonded debt.” However, they wrote that Judge Klein’s decision suggests that the right to cut pensions is limited, somewhat undercutting the importance of allowing bankrupt cities to reduce their pension liabilities. This suggests, according to the analysts, that cuts to bonded debt will remain a significant feature of future bankruptcies. They also deemed it negative that the judge compared overall recovery rates between capital-market creditors and city employees’ retiree pension and healthcare claims: “In so doing, the court may have provided a blueprint for future bankruptcies, in which cities cut debt and retiree health benefits, while leaving pensions untouched.”
Scrambling in Scranton. Pennsylvania’s elected fiscal watchdog, Auditor General Eugene DePasquale, has warned the state legislature the city will have to file for federal bankruptcy in less than four years unless the legislature comes up with a statewide solution to the Quaker State’s growing problem of municipal pension debt. Auditor General DePasquale has given recommendations to lawmakers about how to address municipal pension debt; however, the legislature, at least to date, has not made the issue a top priority. Scranton, a city of about 76,000, has been sliding into fiscal trouble ever since coal mining collapsed there in the 1950s. Like other cities that have lost their main industry, it has been suffering through an eroding tax base, aging population, and rising retiree and personnel costs. In recent years, political animosity among its leaders has exacerbated the city’s financial situation and led Scranton to default on a parking authority bond. Last September, Mr. DePasquale had warned that Scranton could be forced to file for municipal bankruptcy in three to five years, because its pension funds were poised to run out of money—news he delivered in the wake of an audit his office had conducted of the funds’ condition from January 2011 to January 2013, as a result of which he had determined the municipality’s pension funds faced paying out as much as $10.5 million owed to retired police and firefighters because of the $21 million back pay court award to active members—a report the auditor general’s office did not even evaluate in its audit. With a funding ratio of just 16.7 percent, the city’s firefighters fund was in the worst condition of any plan in the state—with benefits at risk in as soon as 2½ years. The intervening months have not changed the Auditor General’s apprehensions: he has reissued a warning, but accelerated the timetable, and, this time, to the Legislature, rather than City Hall. Testifying before the House Appropriations Committee that Scranton’s pension funds will run out of money to pay retiree benefits if funding levels remain the same, he also noted controversial double pensions awarded in 2002 to six non-uniform Scranton employees who likely did not qualify for the benefits. He testified he has sent a team of auditors to examine whether the benefits were awarded improperly to the retirees. The state police have also launched a criminal investigation of the matter. At last week’s hearing, Mr. DePasquale was asked if there was a need for a more extensive audit —a forensic audit (such audits require trained investigators who can follow a money trail by checking balance sheets and inaccuracies in reports of income and expenditures, including investigations or examinations of email trails). An audit, as our ever so insightful friends at MMA note, might have other benefits for Harrisburg, where sixteen years ago, the Harrisburg Redevelopment Authority issued about $17 million in zero-coupon bonds to purchase an office building secured by lease revenues—“unconditionally” guaranteeing the full and prompt payment on the note, according to the capitol city’s official statement. This year, the building’s main tenant, Verizon, opted not to extend its lease—digging the city’s hole deeper, and, as MMA succinctly notes: “The restructuring agreement is the most recent indictment of local government backup support for economic development projects.”
Will the Quaker State Help? Newly elected Pennsylvania Gov. Tom Wolf mentioned the need for municipal pension reform during his first budget address, but he offered no specifics, nor did he offer any specific municipal fiscal sustainability agenda per se—albeit he did propose $6 million for Auditor General DePasquale’s office, which monitors municipal pensions, as part of a multiphase technology improvement project meant to digitize and streamline what’s still a document-heavy system. Nevertheless, as Lancaster Mayor Rick Gray described it: “The whole budget address was a commitment to municipalities.” Under the Governor’s budget proposal, the state Department of Community and Economic Development would receive a $78 million boost from the general fund. While that would still be less than half of what it was before the Great Recession, it would—if agreed to by the legislature, nevertheless—be a 38% boost, enough, according to the ever astute Pennsylvania Municipal League Executive Director Rick Schuettler, to be “very meaningful.” The agency runs development programs meant to create jobs and boost the economy: it would oversee the industrial resource center manufacturing initiative, which would have $12 million to entice universities to focus research on manufacturing, for example. Mayhap more importantly, the agency is responsible for the state’s revised Act 47 municipal distress intervention program under the new legislation enacted last year which imposes a five-year timeline. The budget proposal adds $1 million to the Early Intervention Program for cities that are at-risk for a fiscal crisis – but not quite there yet, an increase which Mr. Schuettler notes “is probably a good thing because more and more communities are going to have to access it.” In addition, the Governor budget proposes education funding increases—increases that could reduce pressure on local property taxes. To receive such a benefit, school districts must spend their rainy day funds until the amount is down to no more than 4 percent of their budgets, according to state Budget Secretary Randy Albright. The Gov.’s budget also proposes increasing aid to municipalities and their authorities to address deteriorating water and sewage treatment systems expected to total as much as $30 billion in the coming decades, and proposes to add $11 million to be available for infrastructure and facility improvement grants. An intriguing initiative in the Governor’s budget is a proposal to add four classes of state trooper cadets to bring the total complement to its highest number since before the recession: this could help some smaller municipalities, which, especially in the wake of the chapter 47 changes and, perhaps, the recognition of the sharing economy, have opted for State Police coverage instead of paying in full for a local force, merging theirs into a consolidated regional one.