“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.

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