May 26, 2015

How Can Municipalities Share in the Emerging, Sharing Economy


What Are the Signs of Municipal Fiscal Unsustainability?

Visit the project blog: The Municipal Sustainability Project 

The Trials & Tribulations of Sharing. Getting into municipal bankruptcy can be painfully easy; getting out is exceptionally painful and hard; and following through on one’s plan of debt adjustment can be equally challenging. Thus, metropolitan leaders in the Motor City region are racing to meet a mid-June deadline to complete and sign the dotted line to create a regional water authority — one of the final steps necessary to complete Detroit’s plan of debt adjustment. The plan, as approved by the U.S. bankruptcy court, included a key provision under which Detroit would lease its Water and Sewerage Department assets to a new Great Lakes Water Authority (GLWA) within 200 days. (Under the initial agreement, a six-person board was established for the GLWA, comprised of one member from each County, one from the State of Michigan and two from the City of Detroit. All board members were appointed by January 7, 2015. A “super majority” of five votes is required to approve major decisions, such as those involving rates, capital improvements and other matters as set forth by the Authority.) But sharing, it turns out, is a challenge: neighboring Macomb County Executive Mark Hackel is bridling about what he perceives as too tight a timeline. The proposal, which came from former Detroit Emergency manager Kevyn Orr—with strong support from Gov. Rick Snyder, was initially opposed by Macomb County and Oakland County Executive L. Brooks Patterson, who were concerned about what was perceived as a plan to force suburban ratepayers to subsidize city government operations and debt repayment. Nevertheless, under federal bankruptcy court mediation, an agreement was reached last September to create a new metropolitan authority, which would lease Detroit’s water and sewer infrastructure, with the proviso that the new authority’s $50 million annual lease payments to Detroit could be used only for water and sewer infrastructure improvements: they could not be used to support the city’s operating budget as Mr. Orr had originally proposed. Yet, as the Flag Day deadline draws nigh, city and suburban officials and a team of consultants are running up against it, as they are trying to finalize audits of the Detroit water system’s finances and its pension liabilities. Moreover, they are seeking to complete a financial feasibility study on the impact of the water authority making the annual lease payments to Detroit. Moreover, the pressure is coming from this weekend’s Mackinac Policy Conference, where planners hope to highlight Detroit successful emergence from the largest municipal bankruptcy in American history at a special panel discussion (“Detroit: Architects of Prosperity”) featuring Mr. Orr, retired U.S. Bankruptcy Judge Steven Rhodes, Ford Foundation President Darren Walker, and Chief U.S. District Court Judge Gerald Rosen, who served as the breakthrough mediator for Judge Rhodes. Under the plan, the Detroit Water and Sewerage Department will retain control of the Detroit’s water and sewer lines and become a retail-oriented city department focused on collecting bills, but to get there, some 150 local officials and consultants are working out details related to the pension liabilities of the Detroit water system and other long-term financial projections for the water authority, plus finite details of splitting the Detroit water department in half. That is: there is waning time, but a plethora of inconvenient details critical to meeting the deadline. It might help that all three levels of government are seeking to make this work: last February, U.S. District Judge Sean Cox, the mediator, ordered Detroit and its neighbors to convene confidential talks about the authority in the wake of criticism by county executives about the validity of the information the city provided on the water department: Judge Cox prohibited all parties from divulging information about the negotiations.

A Hard Trek Ahead. Cassie Macduff of the Press Enterprise has written a brief description of the exceptional challenging road San Bernardino has just entered, as it begins its long and expensive journey through the U.S. Bankruptcy court to seek Judge Meredith Jury’s approval of its proposed plan of debt adjustment. Ms. Macduff noted that San Bernardino is the poorest large city in California; it is the second poorest city in the nation, after Detroit. Its Parks and Recreation Department offers no youth recreation programs. It has no funds to buy books for its public library. Its police and firefighters have salaries lower than their peers in like-sized California cities. Its non-public-safety employees have gone without raises for a decade—or, as she wrote: “Any one of those points is cause for concern. Cities with high poverty and crime rates, like San Bernardino, need recreation programs to keep kids out of trouble. As for the library, if any city needs a vibrant one, San Bernardino does. Families who can’t afford to buy books to read to their toddlers need to be able to check them out of a library. Reading to children improves how they will do in school, putting them on the path to a productive life. People who don’t own computers need access to library computers to search job postings, fill out applications, write resumes and more. Libraries offer literacy programs for adults who can’t read. Reading skills enable them to get better jobs…”

Authorizing Municipal Bankruptcy: What Is or Could be the Role of States? With discussion underway in the Illinois Legislature about potential state legislation to authorize local governments to file for municipal bankruptcy (House Bill 298, endorsed by Illinois Gov. Bruce Rauner; CivicPartners LLC and Marc Joffe, an independent state and local government research analyst, after examining financial statements of all but the state’s smallest municipalities filed with the state controller, and considering government-wide unrestricted net position and general fund balances, determined that some 20 Illinois municipalities were distressed enough to qualify or be eligible for municipal bankruptcy under the proposed provisions Their analysis came as the legislation is currently under consideration by the House Rules Committee. In their report, after examining financial statements of all but the state’s smallest municipalities filed with the state controller, and considering government-wide unrestricted net position and general fund balances, the dynamic duo determined these municipalities were distressed enough to qualify or be eligible for municipal bankruptcy under the proposed provisions, and identified five of the more than 1500 municipalities in the Windy City metropolitan region as most vulnerable to a Chapter 9 filing, based on the financial measures coupled with additional evidence, such as negative auditor opinions or media reports. The common ingredient, according to Mr. Joffe, was fiscal mismanagement: “That’s one reason I felt strongly about highlighting those communities; there’s confirming evidence above the numbers…I’m not saying these are absolutely the five most likely cities to default or get a bankruptcy, but clearly they’re among a very small number of municipalities which are vulnerable to bankruptcy given their extremely bad position.” Mr. Joffe added: “A lot of times these things flow off the radar because they’re not rated.” Nevertheless, the legislative efforts to offer these municipalities a route to address their looming insolvencies have become enmired in the Illinois House Rules Committee, where, it seems, according to a spokesperson for House Speaker Michael Madigan (D-Chicago), the legislation has “failed to stir up enough support.” While Gov. Rauner has already cited the Chicago Public Schools as a possible candidate for municipal bankruptcy should the proposed enabling legislation be enacted. For his part, Mr. Joffe cited five municipalities: Dolton, Country Club Hills, Sauk Village, the Village of Maywood, and the City of Blue Island—with the most visible evidence, according to Mr. Joffe: “You can see property prices crater in a small area, and they have no margin of error they’re very vulnerable.” Dolton, south of Chicago with a population of 23,000, reported a small negative net unrestricted position in its 2013 finances and a general fund balance that was positive but well below Government Finance Officers Association guidelines that general fund balance should equal two months’ of expenditures. Dolton’s general fund balance would cover less than a month of expenditures, according to the report. Unsurprisingly, leaders of some of those cited municipalities see things differently, with one leader noting that at the time he took office in 2012, Dolton was “a poster child for bankruptcy…Mayor [Riley] Rogers inherited a nightmare,” but since his taking office, the village is now less than a year behind in its annual audits and expects to file its latest audit in August, adding that the municipality’s home-rule powers make a municipal bankruptcy unnecessary: “If we were in dire straits – which we are not – the board can raise real estate tax or a cigarette tax or motor fuel or a you-name-it tax that would assist in any financial woes which we would have.” The report also cites Maywood, a village of about 25,000 in Proviso Township in Cook County as a top municipal bankruptcy candidate: the municipality has a crime rate 1000 percent the statewide rate, has struggled for years with falling revenues, and has high unemployment: it has been unrated since 2011 when Moody’s withdrew its rating due to lack of timely information, and the village failed to file audited financial information from fiscal 2008 through 2013. Nevertheless, Maywood issued $16.8 million of unrated general obligation bonds earlier this year, promising as part of the issuance it would file annul audited financial statements.

The report says Sauk Village, another municipality in Cook County with average annual income of about 80% of the Illinois average, and which has an unrestricted net position of negative $36.7 million, a negative general fund balance, and currently has $2.1 million of interest costs, which account for more than 15 percent of revenue, according to the report, or, as Mr. Joffe wrote: “To the extent that interest expenses crowd out spending on resident priorities, political leaders have an incentive to default on debt obligations as a way to shift spending to more popular purposes.” The report also names Blue Island, still another small municipality in Cook County, this one with a population just under 24,000 with average income about 70% of the statewide average. The municipality has a general fund balance of negative $10.5 million with only $16.3 million in general fund revenue as of fiscal 2013, according to the report.  Nearby Country Club Hills, a municipality in Cook County, with a population just under 18,000, was the most delinquent in filing audited financial statements among all the municipalities Mr. Joffe reviewed: the municipality had not yet filed for FY2013: its FY2012 financial statements show a large negative general fund balance, leading the municipality’s auditor to say it could not verify the accuracy of the city’s statements, because the city did not maintain accurate accounting.

What Are a State’s Options? Illinois has not enacted legislation to permit its municipalities to file for chapter 9 municipal bankruptcy; it has two statutes to address distressed local governments: the Financially Distressed City Law and the Local Government Financial Planning and Supervision Act. While some municipalities have availed themselves of the former, it appears that no financially stressed municipality has ever sought to use the financial planning and supervision act. The quasi godfather of municipal bankruptcy knowledge and expertise, together with the exceptional fiscal wizards at the Chicago Civic Federation have been pressing for the creation of an early intervention program: that is, in what ought to be unsurprising, they believe it is critical to address fiscally faltering municipalities before they reach a crisis point—fully aware of the exceptional short and long-term costs to a municipality of going through municipal bankruptcy. Thus, they have proposed the creation of an Illinois Municipal Protection Authority: a quasi-judicial authority to help Illinois governments deal with pension-related and other fiscal burdens, not unlike New York’s early-intervention program: a fiscal scoring system that alerts the state of distress. For his part, Mr. Joffe says: “We hope that local leaders and active members of each community review the financial records we have referenced and begin to pursue policies that bring their municipalities back from the brink.”

Is There a chocolately, Post-Bankruptcy Fiscally Sustainable Path Forward? Moody’s has upgraded the general obligation rating of post municipal bankruptcy Central Falls, Rhode Island to Ba2 from Ba3, while maintaining a stable outlook. The move, which still leaves the bonds at speculative grade, affects $7 million of the city’s outstanding debt, but is, needless to write, as its Mayor James Diossa says: “[E]xciting news for the city and its residents who have worked hard to help the city recover from the corruption and mismanagement of the past…During my administration, Central Falls has seen several positive ratings and outlook upgrades that reflect the forward direction the city has taken. Gradually, we have achieved milestones like this ratings bump that will have longstanding effects on the future of the city.” The municipality, which we visited in its earliest days under a state appointed receiver—and about which we published a report and guidebook [Financial Crisis Toolkit (printable, created without digital tabs)], of just under 20,000 and walking distance from City Hall in East Providence, filed for Chapter 9 municipal bankruptcy in August 2011, reporting an $80 million unfunded pension liability. It exited 13 months later after exacting benefit cuts of up to 55% for its retirees—cuts which the state subsequently assisted in partially restoring. In its upgrade, Moody’s noted the upgrade “reflects a multi-year trend of favorable operating results [before capital transfers] since its emergence from Chapter 9…The bankruptcy process resulted in material financial relief to the city through a reduced labor force and restructured pension and [other post-employment benefits],” adding that Central Falls’ recent operating results have generally exceeded the projections of its plan of debt adjustment. Nevertheless, Moody’s moodily opined: “The city continues to face significant challenges, however, including high fixed costs [comprising pension, OPEB and debt service expenses], weak projected revenue growth, significant capital needs, and weak socioeconomic indicators,” adding that its rating also factors in the municipality’s “very narrow,” unrestricted operating reserve position at 2.9% of general fund revenues, driven largely by a requirement in the city’s bankruptcy recovery plan that most of the operating surpluses be transferred to a restricted capital fund through fiscal 2017. According to the rating agency, its rating also incorporates additional credit strength from the 2011 Rhode Island law creating a priority lien for GO bondholders that essentially set up Central Falls for a clean bankruptcy filing. The Moody’s outlook came more than two months after S&P had revised its long-term outlook on Central Falls to positive from stable while also affirming its junk-level BB long-term rating.


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