Is Dissolution an Alternative to Municipal Bankruptcy?

April 17, 2015
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Classes of Creditors in Municipal Bankruptcy. The City of San Bernardino, beset by an ever nearing deadline to put together and submit a plan of debt adjustment by U.S. Bankruptcy Judge Meredith Jury’s May 30th deadline, has now requested dismissal of a suit filed against the municipality by two creditors that loaned money in good faith to the city. Unsurprisingly, the creditors are seeking the same repayment terms as the California Public Employee Pension System (CalPERS). That seems to have motivated San Bernardino to consider proposing its own bankruptcy reorganization sparing cuts to its CalPERS pensions. San Bernardino, which filed for Chapter 9 municipal bankruptcy in 2012 and stopped paying CalPERS $24 million-a-year obligations, announced last December that it planned to begin paying CalPERS’ annual payment as well as make past-due payments. That change of heart, however, has spurred Ambac Assurance Corp., a New York bond insurer, and EEPK, a Luxembourg bank, to file suit with the U.S. Bankruptcy Court, in an echo of legal challenges from Stockton’s municipal bankruptcy, with regard to the equity of full payments to one creditor—CalPERS, whilst it has halted payments to these two creditors: EEPK and Ambac claim their bonds are part of a “single pension obligation”–the equivalent of the city’s relationship with CalPERS, arguing in their briefs that whatever payments the City of San Bernardino makes to CalPERS, it must make equal payments to EEPK and Ambac. In response, San Bernardino’s attorneys have sought to have the court dismiss the suit, arguing that the argument being made by EEPK and Ambac “transcends novelty” and is “made out of whole cloth,” adding, with emphasis, that the city has yet to file a plan of debt adjustment detailing how it would propose to treat EEPK and Ambac’s debts, not to mention its debts to thousands of its other creditors. San Bernardino City Attorney Gary Saenz told the new agency Reuters that San Bernardino will propose a repayment plan which will propose reductions to certain creditors in “an amount that is fair and reasonable,” adding that cutting CalPERS would trigger substantial pension payment reductions to current and future retirees, driving many municipal employees to take jobs elsewhere: “You can’t have a workforce without pensions.” Judge Jury has scheduled a hearing for May 11th to hear arguments why San Bernardino should be allowed not to pay creditors on an equal basis.

Communicating Distress. A key challenge in a municipal bankruptcy is how a city and its leaders communicate to the public: think of a ship foundering at sea and the important mission and responsibility of the captain to communicate to the crew and passengers. Nevertheless, the issue has continued to be a sore one for San Bernardino—with part of the issue whether the bankrupt city should hire an outside firm or do the work in house. City leaders, indeed, say the city needs a professional to clearly articulate the city’s activities and plans, especially now, as the city nears its federally set end game to complete and adopt its exit plan for approval by the federal bankruptcy court. Having failed to gain consensus on this issue last March, when a majority of the City Council disapproved of an earlier proposal of a two-year contract for $215,000 with an Orange County firm, City Manager Allen Parker is, this time, instead asking the Council to recreate an in-house position for a “manager of communications” which he hopes could be in place soon as early as May Day—the hoped for date when the city hopes to be able to inform its citizens about its plan of debt adjustment. The issue of such communication to the public is another area in which municipal bankruptcies can have significant differences—for when a city’s elected officials, as opposed to a state-appointed emergency manager, remain responsible for the city, they also remain bound to be transparent and accountable to the citizens and taxpayers. Manager Parker said that if the City Council approves the position, he intends to hire a Spanish-speaking San Bernardino resident with 16 years of public relations experience, albeit he requested that the person not yet be identified, because the position has yet to be approved. Mr. Parker noted that the city has received proposals from public relations firms and that a firm, as opposed to hiring someone as an employee, remains the ideal choice; yet he said he did not think the council would approve any of the firms―a position with which Councilman John Valdivia does not agree, arguing that interested firms ought to be permitted to make the case they should be hired instead, and the Council be allowed to make the final choice: “Why don’t we have Motion 1 (to hire an individual), or motion 2, consider the remaining firms and allow them to give a three-to-five-minute presentation?…What can they offer, what can they bring to the city and what’s the plan?” For his part, Mayor Carey Davis noted that a spokesperson of some kind is overdue: “It’s important to have the voice of the city represented as correctly as possible…When you have that function in place, then that communication is focused and you can make sure that the other department heads know where that central voice is culminating and it gives us an ability to better manage, I think, the communication from City Hall with the community…As we move into adopting the Plan of Adjustment and its subsequent implementation there’s going to be a heightened need for clear messaging and clear information to be provided.”

Last January, CalPERS announced its solvency had improved and that its public pension plan was only $89.7 underfunded (see its “Rainbows, Butterflies and Unicorns” analysis, which purports the giant state public pension agency can pay 77 percent of its pension promises by compounding earnings at 7.5% for the next 30 years. Many analysts, however, counter that if CalPERS were only to realize 4.5% a year–a rate conservative private sector pensions aim for–the fund’s long-term liability could be staggering. In addition, some fear that an even bigger solvency risk for CalPERS is that its municipal clients are unable to continue making the contribution percentage required by statute, membership category and benefit formulas to fund their 1,126,133 covered employees’ pensions. Approximately 50 California cities that have not filed for bankruptcy have declared a financial emergency claiming they may not be able to meet their financial obligations.

Attacking Abandoned Housing in the Motor City. Detroit Mayor Mike Duggan yesterday announced a new mortgage program he has proposed to address a unique hurdle to the city’s future fiscal sustainability: its thousands upon thousands of empty, abandoned houses. For the Mayor, the financing not only offers a way to address the city’s severe challenge of abandoned housing, but also to address affordability, because rents in Detroit are so much higher than the cost of ownership: “You could be paying $800 a month in rent, but you can’t get a mortgage for a similar property when the payments would only be $400.” A critical challenge has been access to housing credit or mortgages: last year, just 10 percent of Detroit homebuyers were able to obtain a mortgage: the only alternative was cash on the barrelhead. Part of the difficulty is that the bulk of the abandoned properties require significant in order to be safe and habitable; yet, the cost of fixing them up is often in excess of their underlying value—this in a city where the median home price as of February was $26,000, according to RealtyTrac. Thus, in his remarks yesterday, Mayor Duggan noted: “We know that the desire to renovate these houses and rebuild our neighborhoods is there…What we haven’t had is enough lenders willing to take a chance on our city to show what’s possible.” Under the Mayor’s new program, the Detroit Neighborhood Initiative, Mayor Duggan has found partners with Bank of America, the Neighborhood Assistance Corporation of America, and the Detroit-based Opportunity Resource Fund to create a mortgage-type loan to overcome federal obstacles which, in most instances, bar lending for more than a home is worth. Under the new program, mortgages will be available for up to 110 percent of a home’s value―or even up to 150 percent if purchased through the Detroit Land Bank Authority home auctions. In addition, the new loans will offer favorable terms and be available to anyone who will live in the house and does not already own a property, including:
• 0 percent down
• No closing costs
• No fees
• No maximum income
• Credit score is not considered
• Below market fixed rates (currently 3.5 percent for a 30-year loan and 2.875 percent for 15 year)
• Ability to buy down the interest rates to near 0 percent
• Loans of up to $200,000

Gambling on Real Estate. A most difficult fiscal challenge for Atlantic City to avert municipal bankruptcy is the region’s reliance on property taxes: RealtyTrac reports that Atlantic County again led U.S. metropolitan areas in foreclosure activity rates in the first quarter of 2015—reinforcing the recognition of the region’s battered real estate markets on the city’s fiscal future. According to the company, Atlantic County, where one in every 113 housing units had a foreclosure filing, led the country, ahead of Rockford, Illinois, and Ocala, Florida. Moreover, that lead continued in the last quarter too. Foreclosures in all area counties and New Jersey rose in the first quarter from one year ago: Atlantic County was up 46 percent; Cape May County, 35 percent; Cumberland County, 16 percent; and Ocean County, 25 percent. New Jersey was up 17 percent in that period: the state had the fifth-highest foreclosure rate in the country in the first quarter, according to RealtyTrac. In South Jersey, the largest single jump came from notices of sheriff’s sales — the auctions listed in newspapers of specific properties lenders are preparing to sell. In the wake of the jobs attrition from Atlantic City casino closures, expectations are that short sales, distressed sales, and bank-owned properties will short the real estate market for the next five years. Already banks are putting more inventory out for sale, even as the market appears rife with abandoned properties. Combined with vandalism and stolen pipes and heaters, homes in bad shape are becoming a further hindrance to hopes for recovery. The RealtyTrac numbers put in statistics the very real fiscal challenge Atlantic City Mayor Don Guardian spoke so eloquently about at the New York Federal Reserve this week when he noted his city’s 88% reliance on the property tax—but where the assessed value of his city’s properties have declined by 85 percent.

The End of the Road, or an Alternative to Municipal Bankruptcy? Guadalupe, California, a small municipality of 7,080 established in 1840—a town where Father Junipero Serra brought some of the first cattle into a region of the state that has become a cattle mecca, appears at the end of its proverbial rope. In the wake of the fourth Grand Jury report since 2002 examining the city’s fiscal dysfunction, the findings and recommendations note there appear to be no bridges to solvency, concluding that the City Council of Guadalupe should take the necessary steps to disincorporate. In its report and findings, “Guadalupe Shell Game Must End,” the grand jury concluded that more than a decade of financial mismanagement, a declining tax base, and increasing debt obligations have all but ensured the fate of the municipality—slightly larger than formerly bankrupt Central Falls, Rhode Island: Guadalupe is a 1.3 square miles working-class town, which, according to the grand jury, is replete with well-intentioned, but incompetent bureaucrats, who “inappropriately” transferred about $7.6 million from restricted funds to cover budget shortfalls, but ignored the recommendations of city audits and prior grand jury reports to trim expenses. With costs projected to outpace revenue, the grand jury report determined that by “moving money from one account to another to keep the city afloat,” the city had engaged in a “shell game” that must come to an end with disincorporation. Nonetheless, City Administrator Andrew Carter said he doubted that the Guadalupe City Council would follow the grand jury’s recommendation, which is not binding―meaning that the state or the city’s voters, under California law, could force through the legal multi-stage process—in the likely event that the Council refuses to act on the recommendations (please see below). Indeed, Andrew Carter, Guadalupe City Administrator notes: “There’s nothing in the report that we don’t already know.” Mr. Carter faulted grand jurors for focusing on previous financial errors by past management and providing insufficient credit to recent efforts to turn the city around, noting that city employees have taken a 5% pay cut, and this winter, ground broke on a long-awaited housing and commercial development which is expected to boost tax revenue by adding some 800 homes. In addition, last November, voters overwhelmingly approved three tax initiatives that are expected to reap an additional $315,000 for the municipality, adding: “I doubt that any other community voluntarily imposed three tax measures on themselves (mayhap forgetting Stockton’s voters).” Mr. Carter added that additional changes in utility and other taxes should yield a balanced budget for the next fiscal year, noting that Santa Barbara County officials’ suggestion that Guadalupe disband strikes some Guadalupe citizens and taxpayers as discriminatory: “The demographics of Guadalupe are the exact opposite of the demographics of Santa Barbara’s.” According to the U.S. Census Bureau, about 87% of Guadalupe’s residents are Latino, of whom some 6 percent have a college degree. In Santa Barbara, about 42% of residents have a college degree; 38% are Latino. Dissolution of a municipality in the Golden State is rare, but not novel: The last city to dissolve itself was Hornitos in Mariposa County in 1973, one year after the city of Cabazon lost its legal status and was integrated into unincorporated Riverside County. In recent years, Jurupa Valley, Vernon, and Maricopa have edged close to dissolution. At a meeting Tuesday night — the first time the City Council has met since the report was issued last week — members were expected to appoint two of their peers to draft a response to the grand jury. The city’s response is due within three months.

Santa Barbara County Grand Jury Key Findings:
The Jury challenges the Guadalupe City Council to realistically consider the disincorporation recommendation when responding to this report.

FINDINGS AND RECOMMENDATIONS
Finding 1. Guadalupe does not generate enough General Fund revenue (sales tax, property tax, and bed tax) to pay for General Fund expenses, such as police and fire operations.
Finding 2. Guadalupe’s current debt payment obligations will increase annually until 2024 with insufficient corresponding increases in revenue.
Finding 3. The recent passage of Measures V, W, and X will not provide a long-term solution to Guadalupe’s financial issues.
Finding 4. There is no revenue to restore salary or benefits to employees who have agreed to furloughs and salary cuts, or to add staff.
Finding 5. There is no revenue to build up a reserve fund for emergencies or pay for needed infrastructure repair.
Finding 6. There is no revenue to eliminate the need for the City of Guadalupe to borrow an additional $330,000 per year to meet General Fund obligations.
Finding 7. Guadalupe is losing $4,000 per month in the Solid Waste Fund, due to faulty accounting practices, resulting in a $240,100 fund deficit as of August 18, 2014.
Finding 8. Guadalupe has, for over 12 years, charged up to 193 percent of overhead expenses through inappropriate inter fund transfers from its special funds and enterprise funds to the General Fund.
Finding 9. Guadalupe’s inappropriate transfers included money taken from the State Gas Tax Fund, which was used for purposes expressly forbidden in the Gas Tax regulations.
Finding 10. Guadalupe did not, until recently, follow rules that allow loans of funds from special funds to help finance General Fund activities which must be approved by the City Council, be documented, and include a repayment schedule.
Finding 11. Guadalupe has a large tax liability to the IRS, which started in 2006 as a relatively minor dollar figure, but over the past eight years, with penalties and interest, has grown to over $486,000,
Finding 12. Guadalupe’s decades long hope and expectation that future housing and commercial development will improve its financial situation have not been realized.
Finding 13. Disincorporation will freeze the existing debt of the City of Guadalupe at the current level.

Recommendation: That the City of Guadalupe disincorporate.
.
REQUEST FOR RESPONSE
Pursuant to California Penal Code Section 933 and 933.05, the Jury requests each entity or individual named below to respond to the enumerated findings and recommendations within the specified statutory time limit.

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