Municipal Bankruptcy & Alternatives for Distressed Cities

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April 15, 2015
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Fire in the Hole. The union representing San Bernardino’s firefighters has sued the city in a pair of lawsuits, alleging city officials are violating San Bernardino’s charter in an ongoing pay dispute. The union had so threatened last October in the wake of San Bernardino’s imposition of changes in their public pensions—a critical issue the city has to address as part of any plan to exit municipal bankruptcy—but where its ability to do so has been threatened not only by the legal objections, but also by charter requirements that make San Bernardino the only city in the State of California which must base its police and firefighter pay on the average of 10 similarly sized cities (all, however, larger in this instance)—a mandate or requirement, nevertheless, which a majority of the city’s voters, last November, rejected the opportunity to change, when they voted by a 55% majority to reject a change which has left the city as the only one in the state to set police and firefighter salaries by comparison with other cities, rather than by collective bargaining. At the time, the Mayor had urged voters to adopt the new measure, arguing that the bankrupt city could ill afford to pay wages dictated by the wealthier cities that are used to setting police and firefighter pay under Charter Section 186. San Bernardino’s fire union chief, in a press release, noted: “We want to stop these violations and ensure that city leaders follow the laws that they have pledged to uphold.” In the suits, filed late last week in U.S. Bankruptcy Court in Riverside, the union asks the federal court to roll back last fall’s changes. San Bernardino City Manager Allen Parker noted, referring to the fire union: “They threatened to do this, and it was just a matter of time…They have been unhappy with the rulings of the bankruptcy court all along, and the bankruptcy court judge is the one who approved the action, so they ought to be angry with the judge, not us.” The intriguing intergovernmental clash before the U.S. Bankruptcy Court, following in the wake of Judge Meredith Jury’s ruling last September that San Bernardino could reject its then-existing contract with the firefighters—but not granting the city’s request that it be granted the authority to impose its own contract—has created a kind of legal limbo. Only, this time, the legal limbo and suit add still another legal hurdle to the city’s ability to cobble together its plan of adjustment to meet U.S. Bankruptcy Judge Meredith Jury’s May 30th deadline to submit its plan of debt adjustment.

Chapter 9 Municipal Bankruptcy & Alternatives for Distressed Municipalities & States. In an unprecedented session hosted by the New York Federal Reserve yesterday, and co-hosted by the Volcker Alliance and the George Mason Center for State & Local Leadership, the three U.S. Bankruptcy Judges of the largest municipal bankruptcies in U.S. history spoke of the lessons learned from Detroit, Stockton, and Jefferson County: with Judges Steven Rhodes (Detroit) and Christopher Klein (Stockton) noting the critical appointment of the “right” mediator, Judge Rhodes driving home the importance of what he termed “pedal to the metal,” and noting that an ‘adversarial process will not work,’ so that the appointment of a “feasibility” expert was invaluable. With Judge Klein noting the “dynamic” nature of municipal bankruptcy resolution, Judge Thomas Bennett, who oversaw the Jefferson County bankruptcy, spoke of the importance of “long-term municipal sustainability” as a key outcome of any successful municipal distress outcome—in addition to an effective restructuring of a city or county’s debt. For municipal leaders, Judge Rhodes noted that any such long-term sustainability had led him to abjure Detroit’s citizens to “remember your anger,” as we discussed the uncertain future of this generation of cities and counties that have—or appear to be en route—to emerging from municipal bankruptcy to what Judge Bennett defined as “long-term sustainability,” a plan which must entail a structuring of a recovering municipality’s pensions and debt service, and which Judge Klein noted might mean there ought to be consideration of some sort of “enforcement mechanism.” Judge Klein, noting that “bond financing is a really good business,” suggested this might be an arena in need of adult supervision, echoing concerns expressed by both the Urban Institute and Judge Bennett (speaking of states which do not give home rule authority to municipalities—a decision, he noted, which precipitated Jefferson County’s historic municipal bankruptcy), and warned could become especially problematical for municipal leaders in ‘no new tax states.’

Municipal DNA. The participants concurred that while there are commonalities or a DNA that connects all municipalities amongst distressed and bankrupt cities and counties; nevertheless, each is unique: in almost every instance, there has been a slow, gradual decades-long demise which begins with the governing body—council or board—based upon financial dealings with labor, developers, financiers—and not with the eyes on long-term fiscal sustainability—or, as one of the experienced federal bankruptcy judges explained it, how, in a triangle of employees, finances, and taxpayers: who has to give up what? –especially, in an era, as Judge Rhodes noted, when the challenge of valuing liabilities of a municipality is its most difficult hurdle with such signal consequences towards a municipality’s long-term fiscal sustainability. The judges emphasized that critical steps required that elected leaders of a bankrupt municipality had to take ownership of a resolution; the value of the adversarial process of municipal bankruptcy; and—in stark contrast with a business, as opposed to municipal corporation bankruptcy; chapter 9 is a “dynamic” process in which the goal is, as Judge Bennett explained, “long-term sustainability,” echoing the guidance of the Boston Federal Reserve’s important paper about the exceptional challenge of state and local leaders “[W]alking a Tightrope: Are U.S. State and Local Governments on a Fiscally Sustainable Path?”

At the session, we were treated to the municipal leadership perspective from the bird’s eye view of Atlantic City Mayor Don Guardian, Syracuse, N.Y. Mayor Stephanie Miner, and former San Jose Mayor Chuck Reed—with Mayor Reed warning of reverse incentives for municipal leaders in the budget process—a process governed by too much secrecy, and Mayor Miner describing the real world consequences that fall on an urban Mayor whose city has already experienced 130 water main breaks so far this year—a year in which the state has continued a long-term process of disinvestment in its municipalities—but her city has seen a 400% increase in its pension and OPEB liabilities—imposing a greater and greater burden on communicating with her constituents, noting: “The truth shall set ye free’”—albeit potentially encumbered by ever increasing legacies of debt. Mayor Guardian spoke eloquently of what it means to be a newly elected Mayor of a city with an 88% reliance on the property tax—but where the assessed value of his city’s properties have declined by 85 percent.

Federal Reserve Bank of New York President and chief executive officer William Dudley opened yesterday’s historic session by warning that municipalities are getting into fiscal trouble by borrowing to cover operating deficits: “When a jurisdiction borrows to invest in infrastructure, the cost of the debt to local residents — and those considering locating in the jurisdiction — is offset by the value of the services that the infrastructure provides. This tradeoff is part of the ‘fiscal surplus’ that a jurisdiction offers: the value of the services minus the tax price that residents have to pay. A well-run capital budget will match these costs and benefits over the life of each project to ensure that the jurisdiction remains attractive to current and future residents.” Nevertheless, Mr. Dudley warned that some municipalities are putting themselves in trouble by borrowing to cover operational deficits and achieve “balanced” budgets, just as New York City did in the 1970’s leading up to its famous fiscal crisis: “The key distinction between these two types of borrowing is that in the former case an asset is producing services that help to offset the cost of the debt, but this is not so in the latter case…Indeed, using debt to finance current operating deficits is equivalent to asking future taxpayers to help finance today’s public services.” Mr. Dudley said that residents of a municipality managing its finances that way could react by leaving, shrinking its tax base and exacerbating its fiscal problems; he directed significant focus to the underfunding of public pensions, a practice which the Securities and Exchange Commission has targeted for enforcement actions, and which regulators and market participants alike have said could be a serious threat to state and local finances and bondholders in the future—noting that the need to compromise with pensioners during Detroit’s recent bankruptcy proceedings, for example, cost the insurers of the city’s bonds millions of dollars—and, warning participants that the Motor City’s experience, as well as that of Stockton, Ca., could be emblematic of more systemic problems: “While these particular bankruptcy filings have captured a considerable amount of attention, and rightly so, they may foreshadow more widespread problems than what might be implied by current bond ratings…We need to focus our attention today on addressing the underlying issues before any problems grow to the point where bankruptcy becomes the only viable option: state and local governments have enormous financial obligations, as well as critical service delivery responsibilities. Managing their liabilities in such a way as to ensure that these vital services continue to be provided, and citizens’ view[s] that they are getting appropriate value in exchange for their taxes is a daunting challenge.”

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