The Unexpected Fiscal Challenges to Sustainability

July 16, 2015

Putting the Pieces together to Achieve Savings. U.S. Bankruptcy Judge Meredith Jury yesterday ruled that nothing in San Bernardino’s city charter prevents the city from outsourcing its Fire Department—a ruling which the city’s fire union immediately said they would appeal. Nevertheless, the decision paves the way for the city to implement its plan to achieve significant savings by replacing its firefighters—savings which, under its proposed plan of debt adjustment—could be as much as $7-$10 million annually. Judge Jury’s ruling, however, was not a carte blanche: she warned that the union’s attorneys may be able to convince her subsequently that California law requires San Bernardino to go through a formal “meet and confer” process with union officials prior to outsourcing. Indeed, the attorney for the fire union, Corey Glave, responded to Judge Jury that her decision was “not unexpected,” adding the union regarded the city’s bankruptcy case as “an anti-labor case from the beginning and it continues as such.” To which Judge Jury replied: “I don’t buy that, but go ahead.” For its part, the union is alleging that the city’s charter contains a number of provisions which mandate the municipality to have a Fire Department composed of city employees—including a 24-year old opinion from former City Attorney James Penman, who had once advised the city leaders that its charter did not permit outsourcing the police or fire departments—a piece of advice, however, countered by an opinion of current City Attorney Gary Saenz. Notwithstanding, Judge Jury noted that Mr. Saenz’s recent opinion should not be a factor: “Quite frankly, almost none…I know that case law says I’m to give them (city attorney opinions) weight unless they’re ‘clearly erroneous.’ I guess I think it’s a flawed analysis of the law (to say the charter prohibits outsourcing), and if that makes it clearly erroneous, if that’s the words I’m supposed to say, I find it clearly erroneous.” The union argued, however, that among the charter provisions are requirements mandating a fire chief and as many other employees as the city finds appropriate and outlining how city officials supervise the Fire Department—to which Judge Jury noted there was no such thing as an “implied” restriction in a city charter…Unless something is specifically prohibited by the charter, a city may do it.”

What Happens when the Money Runs Out? Melba Acosta, the President at Government Development Bank for Puerto Rico, yesterday said the bank, a financing unit of the Puerto Rican government, had failed to make a $93.7 million debt-service payment, because the Puerto Rico legislature had failed to appropriate the funds as part of the budget: “In accordance with the terms of these (municipal) bonds, the transfer was not made due to the non-appropriation of funds.” The non-payment leaves uncertain whether Puerto Rico will make a $36.3 million payment due on August 1st for bonds maturing on that date—a non-payment, were it to occur—that would mark the U.S. territory’s first default. In this instance, the Public Finance Corporation, which the government created to assist in addressing Puerto Rico’s chronic budget deficits, currently has slightly more than $1 billion in outstanding bonds—municipal bonds backed by a promise that the Puerto Rican legislature will appropriate the cash needed to pay them down—but a promise unmet—because the legislature did not appropriate the funds, or, as Ms. Acosta stated: “In accordance with the terms of these bonds, the transfer was not made due to the non-appropriation of funds.” While appropriation bonds are generally considered a weaker credit than GO bonds (full faith and credit) – especially in Puerto Rico where, in addition, these bonds are backed by an unusual constitutional promise to pay such bonds before any other expenditures. Ergo, to date, Puerto Rico has been making its scheduled payments on its $13 billion of general-obligation bonds. But with the clock ticking and the funds dwindling, Puerto Rico faces a growing list of obligations, including $276 million by the end of September to a fund which collects cash to distribute to Puerto Rico’s GO bondholders, not to mention a key payment on August 1st, when the Government Development Bank, is scheduled to repay $140 million of principal—mayhap explaining the well-financed opposition by hedge funds to any approval by Congress of legislation to allow Puerto Rico the same access to municipal bankruptcy as each state: in the past year, much of Puerto Rico’s GO debt has been acquired at deeply discounted prices by hedge funds, which stand to make a profit if other types of debt go unpaid, leaving more cash to pay the general-obligation bonds.

Might Help Be on the Way? Yesterday, Sens. Chuck Schumer (D-NY) and Richard Blumenthal (D-Conn.) introduced legislation to would allow Puerto Rico municipalities and state-owned corporations to restructure their debt under Chapter 9 municipal bankruptcy—warning that if Congress fails to act to provide the U.S. territory the authority to restructure its $73 billion in public debt, a default could trigger a humanitarian crisis, warning a shutdown of government services would risk the lives and property of the 3.5 million American citizens who live and work in Puerto Rico, with Sen. Schumer noting: “The fact of the matter is the $73 billion in debt that Puerto Rico can’t resolve could lead to a humanitarian crisis unlike any Puerto Rico has ever seen…We are talking about the potential loss of critical public services, schools shutting their doors, ultimately the shutting down of government across the island.” Thus, the Sen. told his colleagues, Congress should give Puerto Rican municipalities the ability to file for bankruptcy under Chapter 9 of the U.S. Bankruptcy Code—an option already open to cities and counties in all 50 states. Similarly, Sen. Blumenthal warned that “Failure to pay that debt without an orderly workout would in effect begin a cascading series of chaos, and litigation would ensue all around the U.S., maybe around the world, in courts throughout the states here on the mainland, as well as in Puerto Rico…Seventy percent of Puerto Rican debt is owned by people who live on the mainland…The litigation costs alone would be substantial,” adding that the cause of this looming disaster likely rests with Congress: “Congress really enabled, and perhaps encouraged, a lot of the debt that is now burdening Puerto Rico so heavily through the tax incentives that allowed businesses to move there and then move away.” Consequently, he added, Congress “has a responsibility” to make sure Puerto Rico resolves its debt. As of yesterday, seven other Senate Democrats had co-sponsored the legislation, including Senate Minority Leader Harry Reid (D-Nev.).

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