The Challenge to Fiscal Sustainability of Public Safety

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

The Fiscal Challenge of Public Safety. The gun shots that caromed in Ferguson, Missouri last year in the wake of riots which broke out after a white police officer shot and killed Michael Brown, a black teenager, echoed this week with the death of a young black man, Freddie Gray, in Baltimore. How the city, which has demonstrated remarkable fiscal resiliency, but which now confronts a more challenging fiscal future, responds will be a grave fiscal, human, and governing challenge. What can the Mayor and Council do to quell the violence and not only prevent families from leaving the city and eroding its tax base, but also not discourage other families and businesses from coming in? The President has condemned as inexcusable the looting and arson that spread across the streets, even as U.S. House and Senate negotiators yesterday agreed to a joint budget resolution which not only retains a sequester on domestic discretionary spending, but also specifically bars, “except in the case of Federal assistance provided in response to a natural disaster, any entity of the Federal Government from providing funds to State and local governments to prevent receivership or to facilitate exit from receivership or to prevent default on its obligations by a State government.” In a federal budget under which federal spending for defense will grow more than $100 billion and spending on every other category of spending will grow, the conferees focused on the smallest part of the federal budget to exact a toll. President Obama implied that the Baltimore Police Department had “to do some soul-searching,” as can be understood from a meticulously reported investigation by The Baltimore Sun of lawsuits and settlements that had been generated by police-brutality claims―and which have imposed nearly $6 million in settlements and legal costs on the city’s budget since January 2011. The Sun report noted: “Over the past four years…more than 100 people have won court judgments or settlements related to allegations of brutality and civil rights violations.” For his part, the President this week said: “This has been a slow-rolling crisis…This has been going on for a long time. This is not new, and we shouldn’t pretend that it’s new.” The President added that addressing the problem would require not only new police tactics, but also new policies aimed at helping communities where jobs have disappeared, improving education, and helping ex-offenders find jobs. The big mistake, he warned, is that we tend to focus on these communities only when buildings are burning down. But the message to Baltimore from Congress this week was unequivocal: ‘don’t count on us for anything but further disinvestment.’

In our report on six cities in fiscal distress, we found that Baltimore, like Detroit and other major U.S. cities confronting serious fiscal challenges, had experienced a severe population erosion: the city reached a peak population of 949,708 in 1960—a time when 30% of Maryland’s population resided in the city, but by 2010, the population had dropped to 620,961 and the city’s share of the state’s population fell to 11%. Like Detroit and many Eastern and Midwestern cities, a significant portion of this loss in population is attributable to the decline of its industrial base and suburbanization: Baltimore lost 110,000 jobs between 1990 and 2010—about 24% of all jobs―with some seventy percent of those lost jobs in manufacturing and related industries. The combination of job losses and population declines left the city with approximately 16,000 vacant and abandoned properties in the city—the equivalent of one blighted property for every 40 residents; it left the city with a median household income 44% lower than that of the state, but with crime 86% higher. Nevertheless, unlike other cities in our report, Baltimore was never in a fiscal emergency: it has maintained a relatively healthy balance sheet. Its largest categories of spending are public safety (30%) and the transfer to the local board of education (13%)—compared to just 6% for debt service. The city’s primary sources of revenue are the property tax (44%), state grants (15%), local income tax (13%), and federal grants (10%). The latter, of course, is declining—while the city’s single most critical source of revenues, property taxes, has abruptly been rendered at greater risk by the recent events. In our studies for the MacArthur Foundation, we determined that what set Baltimore apart from our other case studies (San Bernardino, Providence, Pittsburgh, Chicago, and Detroit) was the absence of financial emergency. The city’s adoption of a 10-year financial plan in 2013 provided a blueprint to demonstrate the difference between projected levels of spending and revenue (if no changes were made in policy or operations). That action provided a substantive basis for proposing changes to policies and operations. That is, despite significant challenges related to poverty, blighted housing and the need for broad economic development throughout much of the city, we found that “Baltimore is on solid financial ground. It has an AA- bond rating and holds an unrestricted fund balance of $216.5 million (equal to approximately10% of the city’s budget).” The city’s pension liabilities for police officers and fire fighters were funded at 82% and for other city employees at 73%―figures comparable to national averages for local governments nationwide—or, as we noted at the time: “Baltimore serves as a valuable case study in that it provides an opportunity to distill key factors that have contributed financial resiliency spite of significant declines in population and employment.” Key factors in the city’s fiscal sustainability, we found, related to its five-member Board of Estimate, which plays a particularly strong role in developing the city’s budget and monitoring monthly finances of the city: under Baltimore’s charter, the City Council cannot increase the overall budget from what the Board proposes; it can only decrease it. The Board has three members who are elected at-large by voters: the Mayor, Council President, and Comptroller. The remaining members are the Director of Public Works and City Solicitor—both of whom are appointed by the Mayor. The Board is constituted so that all members have a citywide perspective (rather than a ward-based perspective); it holds public meetings weekly to approve all contracts and oversees all purchasing in the city. Finally, we concluded: “the confluence of professionalism in budgeting and financial administration combined with a political culture where the advice and guidance of those professionals is heeded by elected officials contributes to Baltimore’s fiscal resiliency.” That resiliency now will be tested as mayhap never before.

In Like Flint. Michigan Gov. Rick Snyder yesterday declared the four-year long state of financial emergency is over in the city of Flint—the same day on which a state board approved a $7 million emergency loan, which Flint plans to use to plug a general fund deficit. As part of the Governor’s declaration, a receivership transition advisory board made up of five state appointees will now replace Jerry Ambrose, Flint’s emergency manager: the board will oversee the city for an undetermined period of time, but Mayor Dayne Walling, the city administrator, and city council will assume authority and responsibility over most daily operations. Michigan has taken over Flint, located 60 miles from Detroit, twice in the last 10 years, most recently in 2011. For his part, Mayor Walling yesterday said: “The citizens are back at the table,” while Deputy Treasurer Wayne Workman noted that it is routine for Michigan to give local governments a loan as they exit emergency management. In restoring local control, the state said that Flint had achieved several goals under emergency management, including reducing long-term liabilities more than 70% from $850 to $240 million. The restoration of authority comes in the wake of the city council and mayor having enacted several long-term fiscal sustainability measures―including the adoption of a two-year budget, five-year projections, a strategic plan, establishment of a fund balance reserve, and a budget stabilization fund. In making the announcement, Michigan Gov. Rick Snyder noted; “This is a new day for Flint, and the city is ready to move toward a brighter future…These are important steps as we work together to transition back to local control in the city.” Nevertheless, the road ahead promises to be arduous: Flint’s retirees have filed suit against the municipality to block post-retirement health care benefit: should they prevail, the city could find itself back in a fiscal quagmire. Moreover, in the wake of its separation from the Detroit public water system, the city is encountering new, unanticipated fiscal challenges: in moving to draw its municipal water from the Flint River, the city has been found to be in violation of the Safe Drinking Water Act due to high levels of trihalomenthanes.

Ill Fiscal Winds in the Windy City. Nuveen Asset Management LLC , in a new research report, warns that the City of Chicago could sink into speculative-grade territory if it fails to make quick headway in tackling its pension and long-term budget challenges, with author Kristen DeJong writing: “Chicago faces many fiscal challenges, and failure to swiftly address these issues could lead to further rating downgrades into sub-investment grade territory…How the city addresses its unfunded liabilities, including a looming pension payment spike next year, will be key to the city’s fiscal trajectory.” Looming over Mayor Rahm Emanuel’s new term is the city’s $19 billion in unfunded pension obligations, including a $550 million public safety pension payment spike, and a roughly $400 million operating deficit. The ever insightful Ms. DeJong adds that Moody’s moody downgrading last Winter added fiscal insult to financial misery because it triggered termination events on four interest-rate swap contracts, exposing Chicago to payments totaling $60 million if demanded by the counterparties: Chicago has renegotiated the terms of one of the swaps, avoiding a potential $20 million payment, and is working with Wells Fargo to address another. But it is the city’s pension challenge that poses the greatest threat to the city’s fiscal sustainability, with Ms. DeJong noting that balancing the budget and addressing the Windy City’s massive pension strains after years of underfunding poses a formidable task―a task so formidable she warns that it makes a “property tax increase inevitable.” If inevitable, it confronts the wily Mayor with a different kind of challenge in the wake of his election-runoff reelection, during which he campaigned on a promise to balance the city’s budget without a property, sales, or gasoline tax increase—even going so far as to call a property tax hike a last resort if state lawmakers fail to come through on a wish list that includes reform legislation that phases in the public safety spike, approval of a casino, and other tax proposals. A critical challenge for the city, as Nuveen notes, is the city’s reliance on the Illinois legislature—as, absent favorable action, the city loses control of its own revenue destiny: “Additional revenue raising opportunities such as a Chicago-based casino or expanding the sales tax to apply to services would require legislative action by the state and may take too long to implement to fund the looming pension payment.” In one bright spot, the Nuveen report cited recent studies by the prestigious Chicago Civic Federation, which has reported in a recent analysis that determined Chicago has the lowest effective tax rate among cities in Cook County and was among the lowest in a larger five-county region. Yet, even such a property tax increase—notwithstanding the Mayor’s campaign pledge and the sheer challenge of gaining city council approval—would have to be very significant if the city is unable to gain some public benefit reductions. Ms. DeJong notes that the size of any property tax increase would, absent other governmental relief, be exorbitant: a Chicago homeowner of a $400,000 property with a current property tax bill for $6,873 would be confronted with a $3,355 increase to fully fund the city’s growing public pension liabilities. While Mayor Emanuel has gained support for reform legislation for laborers’ and municipal employees’ pension funds that raised contributions and cut benefits, even those gains could be at risk: they are the subject of a legal challenge and await final decisions by the Illinois Supreme Court. The gravity is such, Ms. DeJong notes, that the scope and growth of Chicago’s unfunded liabilities raise the question whether solvency is at risk.

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The Hard School Odds against Recovering from Municipal Bankruptcy

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April 29, 2015
Visit the project blog: The Municipal Sustainability Project

Going to School on Municipal Bankruptcy. Detroit’s road to recovery from the largest bankruptcy in U.S. history was never projected to be easy, but actions by the Michigan House yesterday and the desperate fiscal status of the city’s Detroit Public Schools (DPS) have added significant obstacles. Yesterday, the Michigan House passed and sent to the Senate a $37.8 billion general government spending plan that slashes state revenue sharing for Detroit by $4.1 million. In its 59-51 vote, House Republicans rejected a Democratic amendment to adopt Gov. Rick Snyder’s recommended $1.7 million increase in funding for Detroit’s municipal operations. The rejection of the Governor’s funding request came as the Governor is poised to release a plan tomorrow to address the teetering fiscal situation of the Detroit Public Schools—a plan to overhaul the troubled district, which has been under state control since 2009, yet still faces a $160 million deficit. Absent a fix for the city’s troubled school system, Detroit’s ability to attract families to move to the city appears dim. Thus, in the wake of months of work by Michigan local and state officials, Gov. Snyder is expected to announce his legislative package―a package that is already drawing opposition from the Detroit Federation of Teachers, who yesterday protested what they anticipate to be a plan to expand charters and the Education Achievement Authority in Detroit, and against what the union termed “all the destruction that 15 years of state mismanagement has brought Detroit Public Schools.” Last week, the Detroit News reported the Gov. was considering splitting DPS into two districts: one which would educate 47,000 students under a new structure, and one which would use DPS’s 18-mill non-homestead levy to pay off the district’s debt. The “new district” would have a board named by Gov. Snyder and Detroit Mayor Mike Duggan. Under such a revised structure, one would take on legacy debt and the other educational responsibilities. Adding to the already severe fiscal challenge confronting the city, however, Municipal Market Analytics, in its weekly “Municipal Issuer Brief,” on Monday suggested that holders of municipal debt issued by DPS would “likely [realize] more to gain from selling than holding [DPS debt] at this point,” noting that schools in Michigan and Illinois, so far this year, have accounted for 13% of all super downgrades—in large part because of state level fiscal challenges: “[A]ll Michigan local school bondholders are effectively long the risk that the governor of Michigan will not look to impair bondholders in a hypothetical DPS Chapter 9. That is not a good bet,” noting that the school system’s emergency manager is positioned to recommend a filing for municipal bankruptcy “if no reasonable alternative exists to repair the existing financial emergency,” and adding that [Gov.] “Snyder’s demonstrated ‘contempt’ for bondholders in Detroit’s bankruptcy, where the city’s unlimited-tax general obligation bonds were treated as unsecured, was hardly reassuring.” In its warning to holder of DPS municipal debt, the firm noted that no Michigan school district has ever filed for federal bankruptcy protection, the fate of enhanced municipal bonds would be most uncertain. According to DPS’s official statement: “In the absence of a legal precedent addressing the obligation of the State Treasurer to make an Act 92 payment in the context of a Chapter 9 proceeding, no assurance can be given that if the school district were to become a debtor under a Chapter 9 proceeding, the obligation of the state Treasurer to pay principal and interest on the municipal obligations post-bankruptcy filing would not be impaired”―a statement which the firm notes marks a “dramatic shift,” adding that “Michigan’s recent actions vis-a-vis bondholders give us little reason not to assume the worst.”

Superdowngrades. Municipal Market Analytics this week also provided a fiscal storm alert for Illinois municipalities, where Gov. Bruce Rauner has proposed a 50 percent cut in state income tax revenues provided as aid to local governments—a cut, which MMA notes, if agreed to by the legislature, “would be the kind of event to trigger superdowngrades.” While MMA considers such an event as “unlikely,” because there is no precedent for such action in the state and rarely have such actions occurred in other states; nevertheless, it is a fiscal warning.

Fiddling in Congress While Puerto Rico Squirms. Presidential candidate and former Florida Governor Jeb Bush, in a visit to Puerto Rico yesterday stated that Puerto Rico’s public agencies should be able to seek bankruptcy, during a visit to the U.S. territory. His visit came as yields on Puerto Rico’s newest general obligation bonds are setting record highs as lawmakers struggle to resolve a debate on tax changes that might pave the way for a $2.9 billion bond sale needed to ease a cash crunch. With about two months left in the fiscal year, the U.S. territory’s House of Representatives is not ready to vote on a plan to revamp its levy on goods and services, even as yields on tax-exempt Puerto Rico general obligation bonds maturing in July 2035 traded early this week with an average yield of 10.36 percent, according to data compiled by Bloomberg. The yield reached 10.42 percent last week, the highest since the bonds’ sale in March 2014. Mr. Bush’s visit came as the Government Development Bank, which warned last week that the government risks shutting down within three months, warned that tax overhaul is essential to attract investors to the planned bond sale. Without cash from the new bonds, Puerto Rico may fail to shield its general obligations and sales-tax debt, dubbed Cofinas, from restructuring. Philip Fischer at Bank of America Merrill Lynch, in not an understatement, said: “They’ve run out of many of their options…The administration has indicated very strongly that it would like to preserve the integrity of Cofina and the general obligations. When you’re in a situation of a possible insolvency, it’s not clear how much you can control it.” The territory and its state agencies have amassed $73 billion of debt―more than any U.S. state except California and New York, even as it is losing population; its public power utility, PREPA, is negotiating with creditors and may ask them to take a loss, which would be the biggest restructuring ever in the U.S. municipal-bond market. Gov. Bush’s visit came as the Puerto Rico House may vote as early as this week on a plan to boost the island’s sales and use tax by nearly 40% in June to 10 percent from 7 percent; then a new 14 percent levy, to be called a goods-and-services tax, would expand the sales-tax base beginning in January―the proposed tax plan would also include tax breaks for lower-income individuals as soon as July 2015. The projected changes could reap as much as $900 million of new revenue in the fiscal year beginning July 1, and would go toward paying debt service and retirement costs for public workers; the proposed $2.9 billion in new borrowing, to be backed by oil taxes, would repay loans the highway agency owes the Government Development Bank. The bank’s net liquidity fell to $1.1 billion as of March 31, from $2 billion in October. In his visit, Mr. Bush told Puerto Rican leaders: “Puerto Rico should be given the same rights as the states…In order for Puerto Rico to eventually become a state, it must begin by being treated as a state.” Like U.S. states, Puerto Rico, a self-governing island of 3.5 million, cannot file for bankruptcy, but, unlike states, Puerto Rico cannot authorize its municipalities to file for bankruptcy—and, to date, as Mr. Bush noted, Congress has demonstrated no willingness to consider amending the law to provide for such protections for Puerto Rico’s municipalities.

Taking Steps to Avert Municipal Bankruptcty

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April 28, 2015
Visit the project blog: The Municipal Sustainability Project

Avoiding Municipal Bankruptcy. Wayne County Executive Warren Evans yesterday proposed a “recovery plan” to address the dire fiscal sustainability crisis in the county which surrounds Detroit, proposing cuts of $230 million over four years. He warned: “The county is in a very dire financial situation…(The plan), in my opinion, represents the most equitable and efficient attempt to eliminate the county’s unsustainable fiscal future: If we go on with business as usual, the money is going to run out in 2016…This plan will prevent bankruptcy even though in some areas we are worse off [than when] Detroit was pre-bankruptcy.” Since 2008, the county has plugged its general fund shortfall by shifting funds from its pooled cash fund, a move that has amounted to what the County Exec termed “robbing Peter to pay Paul.” By next summer, the county will not be liquid enough to rely on fund transfers anymore and will be entirely out of money, he warned: “This is a plan that will fix it if we come together as Wayne County…If not, it will come to the next level, whether that’s an emergency manager or a bankruptcy; trust me, it’s going to get fixed.” He blamed many of Wayne County’s problems on a loss of property tax revenue and “fiscal and managerial mismanagement:” The county receives 60% of its general fund revenue from property taxes, which fell nearly 33% to $289 million by FY2013 from $408 million in FY2008. Under his proposal, he said he assumes no increase in property tax revenue until 2018, and then only a $4 million boost.

Mr. Wayne’s proposed plan projects it would eliminate the county’s $52 million structural deficit; it does not address a $200 million, bond-funded jail project in downtown Detroit that the county abandoned half built due to lack of money. Mr. Evans said those problems would be tackled within a broader deficit elimination plan, but erasing the County’s structural deficit was the first step toward recovery: “We’re not going to be to do any of the projects we’ve talked about; we’re not in a position to borrow money or to do anything new until we get rid of the structural deficit.” Over the past six years, Wayne County has transferred millions of dollars from the county treasurer’s delinquent tax revolving fund to bolster the general fund. In 2014 and 2015, respectively, $91.6 million and $78.9 million was moved from the delinquent tax fund to the general fund, covering the county’s operating deficit for each year. Without the cash from the delinquent tax fund, however, which is dwindling, Wayne County has a structural deficit that has averaged nearly $52 million each of the last four years, according to Mr. Evans, so that adding to the deficit, the county has taken about $20 million from its general fund each year to help buck up its public pension system. But with the measures in his recovery plan, Mr. Evans projects annual general fund surpluses totaling $36.8 million from 2016-19.

Nevertheless, a key union leader deemed the proposal “essentially a nonstarter.” Under his proposal, the County Executive’s package proposes: pay and benefit cuts for current employees: All county employees would see 5% salary cuts; the end of post-retirement health care benefits for future retirees; and a restructured pension system. Mr. Evans described his proposed plan as “strong medicine” \which is necessary to fix an annual structural deficit that has grown to $70 million and a public pension fund that is funded at less than 50 percent. Absent action, he warned, Wayne County will be insolvent by August of next year. Under his proposal, there would be a 5 percent wage cut for most union and nonunion county workers, except for police officers; prosecutors, and nurses, would be exempt. He proposed changing labor agreements to allow work performed by county employees to be outsourced; cutting health care benefits for employees, as well as retirees, with retirees who retired before 2007 offered stipends to received health care. The county projects the health care cuts would save the county $28.4 million in 2015, with savings growing every year and hitting $49.8 million by 2020. Mr. Evans proposed restructuring Wayne County’s pension system, including cuts in future benefits and raising the minimum retirement age to 62 (currently, employees can retire at age 50 with 25 years of service, or 60 with five years of service). In response, Al Garrett, president of AFSCME Council 25, said the County Executive’s plan leaves out possible sources of new revenue, such as a millage request, and it unfairly exempts employees of the sheriff’s and prosecutor’s offices from cutbacks. Mr. Garrett also noted that he wished AFSCME had been asked for its input while the County Executive developed the plan, instead of being presented with it and then asked for suggestions; nevertheless, he allowed that the union had suggested a couple of ideas yesterday during its briefing with Mr. Evans and officials “seemed to be interested in them.”

Governance Issues. While the County Executive reported that his plan does not require approval by the Wayne County Commission, provisions, such as those related to collective bargaining agreements, would require board approval. Those provisions could be submitted to the board within a few weeks, depending on whether the county’s unions accept the plan. County Executive Evans warned that Wayne County’s pension fund is less than 50 percent funded and needs $910 million to become fully funded—even as, since 2008, property tax revenues have dropped $100 million annually. Thus, he warned: “Health care costs have to be significantly reduced for employees and retirees: For example, we have to eliminate health care for future retirees. And we’re going to have to move to high-deductible plans for employees and some retirees.” Since he took office this year, the County Executive has proposed a series of initiatives aimed at shrinking the county’s unsustainable fiscal situation, including the consolidation of three departments and a division, and a countywide spending and hiring freeze―all measures which are incorporated as part of the recovery plan. He added that last week, the county had offered AFSCME Council 25 a four-year contract with the 5 percent wage cut, the elimination of vision coverage, and an increase in employee contributions for health care insurance. He reported the union plans to file an unfair labor practice charge against him with regard to the proposed wage and benefit cuts; AFSCME’s local president Al Garrett said Wayne County workers have already taken 20 percent wage cuts and furloughs, and have gone six years without raises. The plan would eliminate health care for future retirees. It would move most employees and some retirees to high-deductible insurance plans and provide retirees with fixed and limited subsidies for the purchase of supplemental insurance, likely under the new federal health care law, similar to a move Detroit made in its plan of debt adjustment, shifting retirees to the national exchange. Mr. Evan’s plan would lift the retirement age to 62 and reduce future pension benefits by changing the pension multiplier, as well as increase the number of years used to determine compensation to 10 years from the current three- to five-year level. Altogether the cuts would mean $60.3 million in savings for the county’s funds, including $53.4 million in the general fund. Mr. Evans noted that county officials are working on revenue-generating ideas, but that he will not rely on them to balance the budget. Finally, the County Executive stated that he had delivered the plan to unions and elected officials yesterday prior to the press conference, making clear he expects a “lot of dialogue…But at the end of the day, the numbers have to total $52 million, and if they don’t, it’s a nonstarter.”

The Profound Challenge of Municipal Bankruptcy and Municipal Democracy

April 27, 2015

Visit the project blog: The Municipal Sustainability Project 

Post Municipal Bankruptcy Planning. Even as San Bernardino’s elected and appointed leaders are desperately working to meet U.S. Bankruptcy Judge Meredith Jury’s May 30 deadline to submit the bankruptcy city’s plan of debt adjustment, they are also trying to chart of post-bankruptcy future—and trying to accomplish this exceptional challenge in public meetings and discussions. The city’s-hired consultant Friday noted that San Bernardino’s charter is a significant obstacle, calling  it not only “unusual,” but also the greatest obstacle to the city’s fiscal, or post-bankruptcy future, saying its structure and vagueness “leads to turf fighting, friction, and difficulty getting things done.” The consultant, Andrew Belknap, a regional vice president for San Jose-based Management Partners, told the public meeting the city’s charter is a contributing factor to the city’s operational structure being “more complicated than other cities of its size.” Mr. Belknap presented a 19-page draft document: a draft which included priority goals in several areas: public safety, education and workforce development, quality of life, infrastructure and housing, business development and job creation, community engagement, public relations, and governance. This was not a new issue to the 17 gathered local leaders from various fields, including elected leaders, education, and business when they began this profound effort to remap a municipality’s future last March, but reaching some agreement has become increasingly urgent as the clock is ticking down. Unlike a private corporate bankruptcy, where the issue is about dissolving, municipal bankruptcy is a complex process that must encompass ongoing operations, exceptionally complex negotiations between all the creditors in order to put together and submit to a federal court a proposed plan of debt adjustment—but also a sustainable fiscal map for the future. Or, as San Bernardino County CEO Greg Devereaux, a committee member, and a former Ontario city manager put it: “It’s one thing to have goals, but there needs to be a decision about what is the job of the city and the role of the city in these goals.” Thus, interestingly, at the public meeting Friday, city staff also proposed, as part of the draft Strategic Action Plan: spending $1.7 million on ongoing additional emergency response personnel; $1.5 million for improved library hours, technology, and resources; and $300,000 annually for a repaid response team to rehabilitate vacant and boarded-up structures. Mike Gallo, president of the San Bernardino City Unified School board, and a member of the 17-member citizens group described that as “the most encouraging and surprising thing to come out of the meeting…It was the first time I have seen the city staff engaged in the planning process with the community…I could hear in their voices and see in their eyes that they were excited.” A related part of Friday’s discussion was to review the six guiding principles for the city’s strategic action plan, including the plan to form “a sustainable local government delivering a competitive mix of municipal services” and the city forming a “system of governance that is proven to ‘support satisfactory performance by other municipal corporations of comparable size and complexity.’” But, as Mr. Gallo responded: “This is the lowest expectation I can possibly imagine: We want to prosper. Not just set the floor.” An intriguing part of this discussion came near the end with a discussion between the city’s former and current mayors: former Mayor Pat Morris said he agreed with Mr. Gallo that the proposed mission statement was “mundane in the extreme;” he said the strategic plan needed to align more closely with the ambitions of the priority goals. Nonetheless, the former Mayor praised the meeting overall: “This process is unique in the city’s history…This process is important not just for the strategic plan, but for the advocacy for change.”

Running Out of Time. Standard & Poor’s has significantly downgraded Puerto Rico’s general obligation debt from a B rating down to a CCC plus grade, meaning S&P now grades the U.S. commonwealth’s debt rating four notches above the lowest possible grade of “default.” With Congress set to recess at the end of this week, the U.S. territory’s options for avoiding insolvency and default are waning. S&P reasoned that the island’s access to markets has further weakened, and that political problems, particularly a lack of consensus on elements of the 2016 budget, could further worsen fiscal pressure on the territory: “We base our downgrade…on our view that the commonwealth’s market access prospects have further weakened and Puerto Rico’s ability to meet its financial commitments is increasingly tied to the business, financial, and economic conditions on the island. Absent improvement in those conditions, we believe debt and other financial commitments will be unsustainable.” S&P’s sovereign downgrade came in the wake of the credit rating agency’s earlier downgrade of the Puerto Rico Electric Power Authority (PREPA) to CCC-minus from CCC, with S&P analyst Jeffrey Panger writing that a default seemed inevitable within six months. S&P reported it is concerned by PREPA’s repeated draws on its debt service reserve: PREPA withdrew $42 million in July of 2014, $9 million in October, and then $9 million this month, leading Mr. Panger to write: “We believe a default, distressed exchange, or redemption appears to be inevitable within six months, absent unexpected significantly favorable changes in the authority’s circumstances.” Mr. Panger also noted PREPA had a structural shortfall of revenues compared to expenses and a questionable access to the capital markets―and that it is unclear if PREPA could draw on the $236 million it has on deposit at the Government Development Bank for Puerto Rico. The public utility has $8.3 billion in bonds outstanding. Additional debt brings its debt total to over $9 billion. Both Moody’s and Fitch Ratings predicted a PREPA default is likely.

April 24, 2015

Facilitating Recovery from Municipal Bankruptcy. Stating that “We need to ensure Detroit’s debt is repaid under the terms of the bankruptcy to allow the city to continue its recovery,” Michigan Gov. Rick Snyder yesterday signed into law SB 160, new legislation, adopted overwhelmingly (107-3) in the House last Wednesday, which will provide the city’s municipal bondholders a statutory lien and intercept on Detroit’s income tax. The Governor added: “The savings from lower interest costs will allow Detroit to reinvest in critical areas like public safety and municipal services.” The state actions will likely not only pave the way for the Motor City’s reentry into the municipal bond arena, but also avert any potential adverse credit contagion for other cities and counties across the state. It marked still another sign of essential state support for the city’s future. SB 160 was enacted to create support for some $275 million in municipal income-tax backed bonds that the city privately placed with Barclays last December when it emerged from municipal bankruptcy. The agreement with Barclays required Detroit to roll its debt into long-term municipal bonds within 150 days of the placement—marking the key event of the city’s first post-bankruptcy public financing. While Gov.   Snyder called the bill a “technical fix,” it marks not just a milestone in the city’s return to the municipal market, but also a legal step which could save the city and its taxpayers some $20 million and $30 million in interest costs over the life of the bonds. Under Detroit’s agreement with Barclays, it will have to obtain at least two credit ratings; consequently, city officials hope the new statutory lien and intercept feature will win investment-grade ratings for the debt―currently all of the city’s bond debt is junk rated. Fiscal analysts reviewing the new law said the lien and intercept could save the city between $2 million and $3 million a year on debt service: the $275 million of bonds, which currently feature eight- and 10-year maturities, are Detroit’s only debt backed by an income tax pledge.

It Ain’t Over Until It’s Over. The U.S. 11th Circuit Court of Appeals yesterday ruled that Jefferson County, Ala., can proceed with an appeal related to the county’s plan of debt adjustment in which the County is challenging last year’s decision by U.S. District Judge Sharon Blackburn to reject Jefferson County’s position that its successful exit from municipal bankruptcy cannot be unwound, because its plan of adjustment has been largely consummated. While the appeal is specific to the county’s municipal bankruptcy, its outcome could have reverberations for cities and counties across the nation: in this case, both the Securities Industry and Financial Markets Association and the National Association of Bond Lawyers have filed amicus briefs claiming that a determination by the 11th Circuit Court of Appeals is essential to the stability of the municipal bond market and the certainty of future Chapter 9 bankruptcy cases—briefs accepted by the court this week. The issue revolves around U.S. Bankruptcy Judge Thomas Bennett’s confirmation of Jefferson County’s plan of debt adjustment from two and a half years’ ago—a confirmation which cleared the way for Jefferson County to proceed with the sale of $1.8 billion in sewer refunding warrants to write down $3.1 billion in related outstanding debt. That plan, as approved by the federal court, included provisions to protect new bondholders, including what some believe to be a precedent-setting provision under which that the federal bankruptcy court would continue to oversee promises made by Jefferson County to raise sewer rates over the next 40 years in order to service the sewer debt. But Judge Bennett’s confirmation was appealed by former broker-dealer Calvin Grigsby, a financial advisor and attorney representing a group of local residents and elected officials who are ratepayers to the county’s sewer system—an appeal which Jefferson County sought to dismiss; Jefferson County argued the appeal was constitutionally, statutorily, and equitably moot, because its approved plan of debt adjustment had been largely consummated, and because the ratepayers failed to ask the federal court to issue a stay which would have delayed implementation of the plan during the pendency of an appeal. Nevertheless, Judge Blackburn last September held that the ratepayers could continue their challenge, and that she could find some portions of the confirmation plan unconstitutional. In its amicus brief, the Securities Industry and Financial Markets Association wrote that a prompt review of the lower court’s decision was “imperative to the continued stability and accessibility of the municipal bond market…Accepting the petition will resolve the uncertainty caused by the challenged order about the finality and integrity of confirmed, non-stayed plans of adjustment that contemplate an emerging debtor’s issuance of new bonds or warrants to finance governmental projects and operations, thereby enhancing market acceptance.” The National Association of Bond Lawyers, in their amicus brief, wrote that resolving uncertainties with regard to the finality of U.S. Bankruptcy Court decisions with regard to cities’ or counties final plans of debt adjustment “would assist other financially challenged municipalities who are considering using the Chapter 9 plan process as a way of successfully accessing the public financial markets and to purchase of bonds proposed to be issued under confirmed Chapter 9 plans.”

How Do City’s Leaders Communicate to Citizens & Taxpayers in Preparing a Municipality’s Plan of Debt Adjustment to Exit Municipal Bankruptcy? Meanwhile, in San Bernardino, which is struggling to complete its own plan of debt adjustment under an-ever approaching deadline set by the U.S. Bankruptcy Court, the challenge of juggling the completion of that plan with the city’s responsibility to keep in communication with its citizens and taxpayers has continued to prove to be an exceptional challenge. How, after all, can one fashion a plan that attempts to divvy up far less than what one owes to thousands upon thousands of a city’s creditors—many of whom, after all, are city residents or businesses and taxpayers, in public? Would it be like a football team televising its deliberations in the huddle before the next play? This challenge of democracy in municipalities like Stockton and Jefferson County—and unlike in Detroit or Central Falls, Rhode Island—cities where the state municipal bankruptcy law, by means of the imposition of a receiver or emergency manager removed traditional obligations of transparency with citizens and taxpayers—is a more difficult hurdle. To give an idea of how difficult the process is, a struggle has erupted in San Bernardino with regard to whether a public meeting of the group leading the city’s strategic planning process last night should have been recorded or not — but not broadcast live — has consumed endless hours and emotions. Until Wednesday, City Manager Allen Parker had told City Council members and residents who requested a video recording of the daytime meeting — a meeting, after all, intended by key San Bernardino leaders to both communicate and secure support from the city’s citizens and taxpayers for any final plan of debt adjustment it will submit to U.S. Bankruptcy Judge Meredith Jury next month, that only an audio recording would be available. The decision, Mr. Parker wrote in an email Tuesday night, was made by school Superintendent Dale Marsden, whose San Bernardino City Unified School District both hosted and paid for the event and facilitator, because that facilitator was concerned participants would not speak candidly were it televised live—a decision that appeared to do more harm than good: it outraged Council Members and residents on both sides of the political aisle that divides San Bernardino citizens—or, as one city resident wrote: “We have been told repeatedly that our involvement in the Plan of Adjustment is critical to the success & implementation…Why the decision on this is not at city level is baffling. Why you have decided contrary to the city administration request to televise is mind numbing. The decision to not televise damages the credibility of the process and further amplifies the growing apathy in our city.”

“I did not want to become known as the judge on Detroit’s first bankruptcy case.”

eBlog

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

A Reprise: the Electronic Rhythm of Municipal Bankruptcy. The current leader of the Indubitable Equivalents and retired U.S. Bankruptcy Judge Steven Rhodes who oversaw the largest municipal bankruptcy in U.S. history yesterday reflected on his experiences over the 17-month trial and provided insights and perspectives with regard to much of his decision-making process, describing this municipal bankruptcy, from his experiences, as one that sprang from his belief in the “mission of the City of Detroit. It’s who we are…We always love to give people a second chance, a fresh start, to forgive them. That is, after all, what bankruptcy is about.” Speaking at an event to honor his many years of civic service, Judge Rhodes emphasized his desire to have allowed the media to broadcast directly from his courtroom during the Motor City’s bankruptcy proceedings: “I believe in a public case like this, the judge in charge should have the discretion to open it up to the media,” adding he wished the media had pushed the issue of camera access to the courtroom: “I wish that someone in the media had made a formal issue out of this by filing a First Amendment motion…It’s likely that I would have granted that motion but it never happened.” In detailing the process of Detroit’s long and painstakingly expensive journey leading up to bankruptcy, Judge Rhodes was explicit that the city’s lack of municipal services “was causing its residents real injury and real hardship.” Moreover, he noted, many Detroiters felt angry and disenfranchised by an emergency manager appointed by Michigan Gov. Rick Snyder that they felt was racially motivated. Nevertheless, he said he believed that, in the end, “the bankruptcy resulted in a plan most of Detroit’s retirees, employees and its financial creditors supported.” The city’s 120-page plan of adjustment dissolved more than $7 billion of the city’s $18 billion of debt, enhanced the city’s moribund credit rating from junk status to investment grade, and, critically, included “a 10-year, $1.7 billion investment to set (the city) on a path to restore municipal services and to revitalize itself.” Judge Rhodes reported Detroit is now ready to address blight, explore information technology development, fix street lights, and improve fire and EMS training, buses and parks. In his presentation yesterday, Judge Rhodes repeated one of his “lessons learned” from the session at the New York Federal Reserve when he told the audience that the “smartest thing” he did during the bankruptcy was to appoint U.S. District Chief Judge Gerald Rosen as mediator in the case, noting: “He put together a team of great mediators and that team deserves much of the credit.”

In a massive trial that stretched over nearly a year and a half and involved nearly 100,000 creditors, Judge Rhodes noted that, unsurprisingly, some parties were left disappointed by the bankruptcy results, even as most creditors, employees, and retirees supported the plan: “The city’s plan paid 10 percent” to general unsecured creditors, including people with injury claims against the city, he said, and citizens opposed to water shutoffs were also disappointed, he noted, referencing a ruling he had made in the case that “there is no constitutional right to affordable water,” comparing it to the lack of right to affordable housing, food or heat, albeit adding: “I had very mixed feelings about that outcome…Obviously, people need water to live.” Nevertheless, he made clear his focus from day one of the historic trial was to keep the municipal bankruptcy proceedings open and transparent, so residents could stay informed and involved in the process: “One of the hardest parts of the case for me was the fact that it was as much a political case as it was a legal case.” He noted that he had invited people into the courtroom to speak on their concerns, and 93 unrepresented parties took him up on the offer during the eligibility phase, of whom nearly half appeared in his courtroom to address Judge Rhodes: “Although it was a bit burdensome, it sent a powerful message about the openness of my process.”

Judge Rhodes yesterday said that he devoted much of his focus to ensuring any proposed plan of debt adjustment be feasible, able to be implemented by the city, and enduring: “I did not want to become known as the judge on Detroit’s first bankruptcy case.” That is, he was intently focused on seeking to ascertain that any plan he approved would be one which would put Detroit on a fiscally sustainable path—so that it would never have to revert to municipal bankruptcy. Thus, he noted the key importance with regard to his goal of preserving the artwork housed at the Detroit Institute of Arts: “To sell the art would be to forfeit Detroit’s future.” Subsequently, he also noted the important role the Detroit Financial Review Commission will play in overseeing the implementation of the plan over the next decade. But he closed with a critical warning that, in the end, it will be the people of Detroit and “their memory of that anger (toward emergency management) is what will prevent this from happening again.” In looking to the city’s fiscal future, Judge Rhodes also warned the Detroit Public Schools need attention. He said Detroiters should vote for candidates who will “continue this commitment” to the city’s revival.

Getting Schooled on Detroit’s School Finances. Judge Rhodes’ apprehensions about the Motor City’s school system and its perilous fiscal status happened to emerge nearly simultaneously with comments and recommendations in a new report (The full report is available here) titled “State Assumption of School Debts,” in which the very fine Citizens Research Council of Michigan, an independent public policy research group, urges the Michigan Legislature to craft a clear policy for addressing distressed school districts prior to taking on the Detroit Public Schools (DPS), where the issue is whether the state should assume much of the city’s school district’s municipal bond debt, as well as some of its pension liabilities. The report comes as Gov. Rick Snyder is expected to unveil, as early as today or tomorrow, a proposal to reform the fiscally-challenged district. The plan is expected to divide DPS into two districts, an ‘old’ one which exists only to service outstanding state-aid backed operations debt, and a ‘new’ one which would assume overall educational responsibilities as well as the remaining bond debt. DPS’ debt, which totals $2.1 billion, has become a major target for Gov. Snyder and a high-profile coalition of Detroit leaders who are pressing for the state to take over at least $300 million of the state-aid operations debt. The cross-cutting fiscal dilemma arises as the Coalition for the Future of Detroit Schoolchildren has recommended that Michigan assume $124 million annually of Detroit Public Schools’ (DPS) financial obligations: the obligations include debt service payments for long-term notes issued to finance current operations as well as required payments to the school employee retirement system for employee “legacy costs.” If the state takes on these debts, DPS would see an almost $2,500 per-pupil increase in the amount of money available for classroom instruction; however, the report warns, this would come at the expense of $124 million fewer state dollars available to share across all other public schools in the state, noting: “While DPS is currently the most recent financially and academically struggling district requesting direct state assistance with its debts, 55 other school districts across the state began the current fiscal year in a deficit situation…A request from any one of these districts, some of which are under the control of state-appointed emergency managers, may not be too far off.” The issue of state assumption of school district debts is not exactly new in Michigan: the state has assumed the debts of four financially struggling school districts since 2012 – Muskegon Heights (2012), Highland Park (2012), Inkster (2013), and Buena Vista (2013); however, it did so without a specific policy in place. Instead, emergency managers in Muskegon Heights and Highland Park were able to gain access to additional state assistance to pay off school debts by “charterizing” the entire districts. The Michigan Legislature passed a state law to allow the dissolution of the Inkster and Buena Vista school districts and for the debts to be assumed by the state. State policymakers, however, are still dealing with the consequences, both intended and otherwise, arising from the actions taken in these instances and from the lack of a statewide policy, leading key study author Craig Thiel to write: “Before dealing with the immediate situation involving DPS debts and in anticipation of future requests for state assistance, policymakers should give consideration to the lack of a long-term policy for state assumption of school debts…In developing a policy, the state must be cognizant of criteria such as transparency, fairness, accountability, and consistency….Even in Detroit, under an emergency manager, he (Kevyn Orr) realized he couldn’t do it and took the city into bankruptcy, and at the end of the day, with the grand bargain, the city received additional money…The policy as it’s spelled out in the emergency management law is that we’ll solve these problems without any additional resources, but all of the problems by this date have been solved by additional resources.” Mr. Thiel, not given to understatement, noted: “Debt is a huge issue…Detroit Public Schools has been under emergency management for the last half-dozen years and it can’t solve its problems without additional resources.” Nevertheless, he warned that if the state is going to provide additional resources: “don’t do it this back-door way.” The report warns that such a model is unlikely to work in Detroit, where most of DPS’ $300 million of state-aid backed debt was originally issued by means of short-term notes which were subsequently refinanced into long-term bonds—municipal bonds which were financed by means of an 18-mill non-homestead local school operating tax, which makes up the local contribution to the state’s school aid fund. Mr. Thiel adds that while some believe the existing Detroit local levy would continue to pay for the servicing of the debt, he adds that Michigan is required to make up for the shortfall with state funding—creating an awkward problem: if Michigan were replace the local funds with school aid fund revenues, it would mean the loss of $50 to every student across the state—or, as the Citizen’s Research Council reports: “So while the use of the 18-mill tax appears to be a ‘local’ solution to school district debt relief, it is undeniably a state-financed solution…At the end of the day, the borrowing, when originally done just to meet cash needs, there’s an equity issue here when you have students in the future paying for the borrowing associated just with operations today.” None of this is music to the ears DPS’ current emergency manager, Darnell Earley, who wants to roll over $85 million of one-year notes issued last August into longer term debt, warning that DPS cannot afford to repay the loan by this summer.

Fundido? Puerto Rico’s top finance officials report the government of the U.S. territory will likely shutdown in three months because of a looming liquidity crisis. Such an insolvency, they warned, would have a devastating impact on the U.S. island’s economy. Governor Alejandro Padilla wrote yesterday to leading lawmakers, warning that neither action by Congress to permit the territory to file for bankruptcy protection nor any other financial rescue appeared likely, so that there would need to be significant layoffs and elimination of many essential public services. The head of the Government Development Bank and the Treasury Secretary, in a letter yesterday to the heads of Puerto Rico’s Senate and House as well as the Governor, wrote: “A government shutdown is very probable in the next three months due to the absence of liquidity to operate…The likelihood of completing a market transaction to finance the government’s operations and keep the government open is currently remote…A government shutdown would have a devastating impact on the country’s economy, with payroll and public service cuts, with a painful recovery and of a long duration…” The territory, which has a total debt of more than $70 billion, is trying to raise $2.95 billion in financing, while pushing through unpopular tax reforms such as a higher VAT or value-added tax and increasing a levy on crude oil. The territory’s outstanding municipal bonds have been experiencing signal declines in recent weeks as uncertainty grows over the implications for its 3.6 million citizens: as of yesterday, its benchmark general obligation bonds traded at an average 79.982 cents on the dollar, close to an all-time low. Puerto Rico securities, which are tax-exempt nationwide, have traded at distressed levels for more than a year amid speculation the commonwealth and its agencies won’t be able to repay $73 billion of debt. Municipal bonds sold in Puerto Rico lost 0.72 percent this year through April 21, the worst start since 2011, according to S&P Dow Jones Indices. Yesterday, former Puerto Rico Gov. Luis Fortuño once again urged the U.S. Congress to allow the island’s troubled public entities to restructure their debts under the U.S. Bankruptcy Code’s Chapter 9 provisions: writing on behalf the Puerto Rico Financial Stability Coalition, a group which seeks “a fair and balanced approach to Puerto Rico’s debt crisis” and which is co-chaired by Mr. Fortuño and Puerto Rico’s Senate President Eduardo Bhatia — the former governor emphasized his support for H.R. 870, the Puerto Rico Chapter 9 Uniformity Act, which was authored by Resident Commissioner Pedro Pierluisi: “H.R. 870 offers Puerto Rico a road to recovery that will both honor its obligations to American investors and lead to safe investment and economic growth in years to come…Without the right for troubled government entities to restructure obligations, collective debt may overwhelm Puerto Rico as a whole, and a federal bailout will be required.” Puerto Rico’s exclusion from Chapter 9 municipal bankruptcy authority led the island’s government, last July, to enact the Puerto Rico Public Corporation Debt Enforcement & Recovery Act, which sought to allow financially strained public corporations to restructure their debts; however, last February, the U.S. District Court for Puerto Rico, in a 75-page decision, held that the Recovery Act is preempted by the U.S. Bankruptcy Code and is therefore invalid under the supremacy clause of the U.S. Constitution. According to the coalition’s website, the long list of supporters for the initiative, both locally and stateside, include: the National Bankruptcy Conference; the editorial boards of the Washington Post and Bloomberg; several renowned law professors; Fitch Ratings; Banco Popular; Government Development Bank President Melba Acosta; the P.R. Legislature; most of the island’s trade organizations; National Hispanic Caucus of State Legislators; and various investment firms, among others.

What Is the State Role in Severe Municipal Fiscal Distress?

eBlog

April 22, 2015
Visit the project blog: The Municipal Sustainability Project

Balancing Municipal Sustainability vs. Municipal Bondholders’ Interests. Fitch Ratings is warning that Illinois Gov. Bruce Rauner’s support for making municipal bankruptcy more available to the state’s larger municipalities and school systems might have corrosive impacts on those larger municipalities’ bondholders. In a special report, Fitch warned that recent developments in Illinois and New Jersey could reduce the chances of state intervention—intervention that, according to the rating agency, could result in better outcomes for the respective municipal bondholders than allowing distress to lead to municipal bankruptcy: “We believe efforts to resolve looming budget deficits and ensure the affordability of long-term obligations would be more productive than focusing on easing laws or practices to allow bankruptcy.” The special report comes as Illinois Governor Bruce Rauner has recently proposed amending Illinois laws to grant authority to larger municipalities to file for federal bankruptcy protection, and, because of his growing apprehension about the credit quality of Chicago Public Schools (CPS), Governor Rauner this week said he is apprehensive CPS may need authority to file for bankruptcy as a solution to its large budget imbalance. According to CPS analysis, the system’s reserves will likely be fully depleted by the end of FY2016. (Giving a sense of a system beset by apprehensions with regard to its fiscal solvency and its leadership, the Chicago Board of Education yesterday sold $300 million in municipal bonds with a 25 year maturity—but at a top, prohibitive interest rate of 5.63%–a severe fiscal penalty.)

With regard to New Jersey, the agency noted that the recent appointment of corporate restructuring experts—including Kevyn Orr, who served as the Emergency Manager overseeing Detroit’s largest municipal bankruptcy in U.S. history―to assist Atlantic City in addressing the seaside city’s fiscal crisis appears at odds with New Jersey’s “strong history of aiding local governments to prevent the type of stress that could lead to bankruptcy,” noting: “Of US states, New Jersey has historically provided among the strongest levels of early intervention to local governments with financial strain, [but] recent developments in Illinois and New Jersey are lessening the chances of state intervention that could result in better outcomes for bondholders than allowing distress to lead to bankruptcy…We believe efforts to resolve looming budget deficits and ensure the affordability of long-term obligations would be more productive than focusing on easing laws or practices to allow bankruptcy.” The April 20th Fitch report comes on the heels of Gov. Bruce Rauner’s recent proposal to add a Chapter 9 provision to state statutes as part of his Illinois turnaround agenda—a proposal which has incurred strong opposition in the legislature from unions, who have charged that the Governor is using the threat of municipal bankruptcy to give local governments greater leverage in negotiations on pensions, benefits, and wages. The rating agency noted that the Governor’s apprehensions follow in the wake of the increasingly failing fiscal grades of the Chicago Public Schools district, which has been slammed by a steep credit rating slide as it confronts a $1.1 billion deficit and some $9.5 billion of unfunded pension obligations—and mounting public pension debts for Chicago’s police and fire retirees, where public safety pension payments are set to achieve an unaffordable trajectory next year under a state mandate to stabilize those funds. Fitch’s perspective is that while state fiscal intervention mechanisms vary from state to state, the majority focus on helping local governments recover from distress, rather than preventing it, with authors Managing Director Amy Laskey and Senior Director Rob Rowan noting that restrictions on states’ ability to impact some union collective bargaining agreements, including pension obligations, “limits their ability to remediate financial distress.” The special report appears as the prestigious Chicago Civic Federation is pressing Illinois’ legislature to consider a measure developed by the incomparable municipal restructuring expert Jim Spiotto to create an authority designed to intervene before a government’s fiscal strains reach crisis stage.

The State Role in Municipal Fiscal Distress. In our studies, states have played singularly disparate roles with regard to severe municipal fiscal distress—with the State of Alabama becoming a precipitator of Jefferson County’s then largest municipal bankruptcy in history, California playing an agnostic-to-negative role in its triple set of recent municipal bankruptcies, but both Rhode Island and Michigan evolving into constructive roles—roles which could be significant factors in the long-term fiscal sustainability of post-bankrupt Detroit and Central Falls. New Jersey, however, appears to leaning away from its previous record of strong support. Now Illinois is debating whether it ought to change its role. Part of the issue relates to whether a state does or does not even allow a municipality to file for federal bankruptcy protection (12 states do specifically; 12 do conditionally; three provide limited such authority; two specifically prohibit; and the remainder are silent.). Now as New Jersey and Illinois debate changing their respective state policies and maybe statutes, Fitch Ratings frets that recent developments in the two states are reducing the chances of state intervention to help municipalities in severe fiscal distress, writing that: “We believe efforts to resolve looming budget deficits and ensure the affordability of long-term obligations would be more productive than focusing on easing laws or practices to allow bankruptcy.” The new views come as Illinois Governor Bruce Rauner has recently proposed granting authority to local governments to file for federal municipal bankruptcy protection (current Illinois law bars municipalities with populations over 25,000 from filing a Chapter 9 petition.), and New Jersey continues to debate whether the state ought to force Atlantic City into municipal bankruptcy. In its recent views, Fitch noted it believes the needs of a distressed municipality are a better indication of the possibility of bankruptcy than whether current state law allows it, writing: “In New Jersey, the recent appointment of corporate restructuring experts to assist Atlantic City in resolving the city’s fiscal crisis appears at odds with the state’s strong history of aiding local governments to prevent the type of stress that could lead to bankruptcy. Of U.S. states, New Jersey has historically provided among the strongest levels of early intervention to local governments with financial strain.” With regard to the Windy City, Fitch notes the increasing failing fiscal grade of the credit quality of the Chicago Public Schools (CPS), noting that Governor Rauner this week said that he fears the district may need municipal bankruptcy as a solution to its large budget imbalance, adding that, according to the school system’s own analysis, their reserves will likely be fully depleted by the end of FY2016. The dichotomy Fitch likens almost to a teeter-totter: “Fiscal intervention mechanisms vary by state. Most focus on helping local governments recover from distress, rather than preventing it. Many can approve or reject financial plans, budgets, and certain government contracts under state control. Their powers, however, are constrained by laws governing labor contracts, benefits including pension obligations, and service provision. Fitch believes this limits their ability to remediate financial distress.”

The Challenge of Communicating about Municipal Bankruptcy. In a corporate bankruptcy, the company or corporation usually simply ceases to exist; in a municipal bankruptcy, the municipal corporation seeks federal court protection to ensure its continuity—and, of course, the city remains open and operating. In states which authorize municipalities to file for chapter 9 protection, there are significant variations—with some, such as Michigan and Rhode Island, for instance, authorizing the state to appoint an emergency manager or receiver, an individual who effectively displaces any and all elected officials—and who bears little onus or responsibility to communicate to the city’s citizens. But in others, such as Alabama and California, the elected municipal leaders remain in office—and retain significant responsibilities to communicate to citizens and taxpayers what is happening in or to their city or county—an especially vital role under a federal-state-local situation intended to ensure continuity and the provision of essential public services. Thus, after significant struggle, San Bernardino last evening selected Monica Lagos to serve as the voice of the city. Ms. Lagos, who since last October served as a senior account executive at Westbound Communications, was appointed in the wake of a 6-1 vote, but only after an extended and sometimes heated discussion. Her task is to “tell the city’s story” as it struggles to cobble together its plan of debt adjustment by the end of next month’s federally-set deadline by U.S. Bankruptcy Judge Meredith Jury. As San Bernardino City Manager Allen Parker, in seeking to justify the diversion of virtually non-existent fiscal resources for such a new position, put it to the Mayor and Council before the vote: “Transparency, transparency, transparency…I am looking less at image-making than I am at telling a story that gets us through the bankruptcy.” Prior to the Council’s vote, Ms. Lagos said the specifics of her approach to the city’s municipal bankruptcy would need to be worked out after she was hired: “I think we all know that it’s extremely important for the city, and it’s been a long time coming…Honestly, for me in particular, it’s a position that will help connect each of the departments, help connect what the city’s efforts are currently with the public’s need to know this information.” Prior to the vote, City Attorney Gary Saenz advised the Council that Judge Jury had said it is important for the public to be informed and involved in the city’s Plan of Adjustment, noting: “This is not a plan of adjustment that is just something that happens at City Hall…It’s something we get the whole community engaged in, and they have to be a part of getting San Bernardino out of bankruptcy…It needs to be a consistent message that informs the public exactly where we are, particularly with regard to the bankruptcy.” The lone dissenter, Councilman John Valdivia, said he agreed with residents that the focus should be directly fixing problems in the city rather than “image.”

Out of Fiscal Sustainability

eBlog

April 21, 2015
Visit the project blog: The Municipal Sustainability Project

Out of Sustainable Control. North Las Vegas, which faced near insolvency, but which is barred from seeking municipal bankruptcy protection because such protection is not authorized by Nevada law, yesterday received a nod for its fiscal efforts: Fitch Ratings revised its outlook for the municipality of 222,000 to stable from negative for $414.4 million of North Las Vegas, Nev. bonds, and affirmed the rating at B—revisions affecting some $284.7 million of limited-tax general obligation water and wastewater improvement bonds and $129.7 of LTGO bonds. Fitch said the junk-rated bonds warranted a revision to a stable outlook because of “successful negotiation of labor concessions needed to balance fiscal 2015 and 2016 budgets.” The slight upgrade reflects well on the city’s fiscal efforts; last year Fitch likened the city’s fiscal plight to Detroit and Stockton. Nevertheless, one fundamental has not changed: the municipality’s ability to recover by itself—or, as Fitch notes: “The B rating continues to reflect Fitch’s view that the city has virtually no remaining budget flexibility…Given tax caps and the scope of service cuts already made, Fitch believes any meaningful solutions are outside the city’s control.” The rated municipal bonds are backed by the full faith and credit of the city, subject to Nevada’s constitutional and statutory limitations on the aggregate amount of ad valorem property taxes. In addition, the city’s bonds are backed either by an irrevocable pledge of and lien on certain consolidated tax revenues (15% of these revenues) or by water/wastewater system net revenues. In adjusting its rating, Fitch wrote the uptick reflected successful negotiation of labor concessions needed to balance fiscal 2015 and 2016 budgets; yet remarked that the B rating reflected “that the city has virtually no remaining budget flexibility. Given tax caps and the scope of service cuts already made, Fitch believes any meaningful solutions are outside the city’s control,” noting that unrestricted balances in the municipal utility fund serve as the city’s only meaningful source of liquidity and are expected to be drawn down to just adequate levels to support governmental operations over the intermediate term. The rating agency also determined the city’s and region’s economy were among the hardest hit in the U.S. by the collapse of the housing market with a combined loss of 56% of taxable assessed valuation. Fitch also found that the city’s debt is high relative to its tax base, amortization is slow, and debt service is escalating in the intermediate term. Worryingly with regard to fiscal sustainability, Fitch added that carrying costs, including debt and retiree liabilities, are expected to increase with rising debt and pension payments. Fitch omitted age—but those pension payments are most likely to be for considerably longer duration than previous generations. The rating agency noted that its rating could improve “if the city is able to develop a realistic strategy towards near-term deficit reduction as well as a medium-term plan to address the required reduction in utility transfers by fiscal 2021,” but that “the economy is fragile leaving the city ill-prepared to manage any further contractions. A down cycle in the economy from this point would likely result in further financial stress and a rating downgrade.”

Caught Between a Dry Rock and a Hard Place. Fitch believes North Las Vegas retains virtually “no additional expenditure flexibility.” The city has eliminated about 800 full-time equivalent positions (35% since the peak in 2009) through attrition and voluntary separation and layoffs. The credit rating agency added that, according to the city, the city’s current staffing level is unsustainable:

• Revenues bottomed out in fiscal 2013 at $86.95 million, a drop of 47.2% since their fiscal 2008 peak, and remain just 61% of the peak level.
• Property taxes continue to decline and are off 70% from their peak, comprising only 7.4% of revenues compared to 17% in fiscal 2009.
• Fitch estimates that carrying costs currently consume 20.7% of governmental spending. The burden approximates full funding of the actuarally required contribution to the state plan, which the state does not currently require. Fitch expects the burden to increase as both debt service and retirement benefit costs rise.