Responding to Municipal Fiscal Emergencies

Financial Emergency. Wayne County is in a financial emergency, the state’s five-member independent review team has concluded after less than three weeks of pouring over the county’s books. The finding, coming in response to the request of Wayne County Executive Warren Evans, by the Michigan Department of Treasury, indicated that Wayne County’s past four audits “revealed notable variances” between revenue and expenditures in the county’s $500 million general fund as first budgeted, then as amended, and then as actually realized. The response, while not unexpected, marked the first time in the state’s history for a county; nevertheless, it was a finding Mr. Evans had sought as a means to gain leverage in his efforts to move forward on his proposed recovery plan. Under a consent agreement with the state, which such a consent agreement would appear to provide, he is proposing to reduce employee benefits as part of an ambitious plan to achieve $230 million in spending cuts over the next four years. Under the review team’s own assessment, Wayne County is projecting a $171.4 million deficit by FY’2019. Yesterday’s finding now starts the stopwatch: Gov. Rick Snyder has ten days in which to declare an emergency—a declaration which, if he so makes, would trigger four options for Wayne County: a consent agreement, a state appointment of an emergency manager, a neutral evaluation, or municipal bankruptcy.

Highlights of the review team’s findings in its 18-page report:

  • Wayne County’s last four annual financial audits revealed notable variances between General Fund revenues and expenditures as initially budgeted, as amended, and as actually realized.
  • In addition, County officials underestimated actual expenditures in three of the fiscal years by amounts ranging from $16.7 million to $23.7 million;
  • Wayne County officials engaged in unbudgeted expenditures in violation of Public Act 2 of 1968, the Uniform Budgeting and Accounting Act;
  • although there was agreement among county officials that existing detention facilities are inadequate, there is no consensus about whether to complete construction on a new jail or to renovate existing facilities.

The state report also cited several other issues, including the county’s healthcare liabilities and underfunded pension system; the fact that county budget disagreements have often been resolved through litigation; and the one-time assessment that county property taxpayers are being forced to pay this summer in a pension case. The review team also mentioned ineffective communication as an issue in the county. As examples, they cited the lack of response unions said they had received from the county on their counter proposals to requests for concessions, as well as the fact that several county commissioners said they learned of Mr. Evans’ request for a state review through the media.

Because Detroit is part of Wayne County (Detroit accounts for 47% of Wayne County’s population as the largest of its 43 municipalities), Mr. Evans, prior to the state’s announcement yesterday, in his first ever appearance before Detroit’s City Council, testified that Wayne was not necessarily on its own path to municipal bankruptcy—but he did tell them the county was broke—so that the expected state declaration would open the way for the county’s elected leaders to vote upon the critical fiscal path to sustainability: “There’s no way I see Wayne County needing an emergency manager or bankruptcy at this point…We have a defined recovery plan that anyone can look at, and if this recovery plan is followed, then the structural deficit is gone…The county is in a significant financial situation, but the needle may move a little bit today [with the review team’s declaration]…The strength of the consent agreement is that it gives us the ability to impose on collecting bargaining agreements that have expired. The reality is, if we can’t [come to terms with the unions], we’re going to go off the edge of the bridge financially.” Mr. Evans’ presentation marked his first appearance before the council since he took office last January. In response, some Detroit council members, as well as some residents, warned that a consent agreement had been Detroit’s first step toward a full state takeover and eventual bankruptcy.

In a rejoinder, Detroit Council President Brenda Jones noted: “We did not ask for a consent agreement, but we got one…We were told if we followed it [we would remain in control], and we did, but guess what? We got an emergency manager…That’s probably why citizens are saying to you what they are saying, because it seems like déjà vu to some when they saw what happened in the city.” In response, Mr. Evans stated: “I say very, very clearly that that is absolutely untrue: Any problems we have is shown in our recovery plan, and how we get out of this is in our recovery plan, “ adding that his goal is to get the state in, but then to “hurry up and get them out: We don’t want them there lingering…I’ve spent over 40 years in Detroit and Wayne County, and I know we can fix our own problems. We’re halfway home, the problem with the rest of the way home is it’s the heavy lifting that can’t be done unilaterally by a county commission or executive’s office. It’s the powers conveyed in the consent agreement that at least gives us the leverage to finish.” In his presentation to the Council, Mr. Evans listed the county’s main financial problems: a $52 million structural deficit, a $900 million unfunded pension liability tied to a 45% funded plan, and a $1.3 billion retiree health care obligation. The health care liability makes up 40% of the county’s long-term debt: “There are significant liabilities out there, but if we get rid of the structural deficit we’re on a path to have a balanced budget and get our credit rating upgraded: We’re in government, you have to be able to borrow money, you have to be able to complete projects.”

Jailhouse Rock. During his session with the Detroit City Council, Mr. Evans address the notorious, half-finished jail project in downtown Detroit, which the county abandoned a year ago amid cost overruns and now cannot afford to finish, noting everyone wants to know what is going to happen to the jail: “The answer is, without a balanced budget and with our bond rating, I can’t do anything about it because whatever we’re going to do is going to take more money.” Indeed, the state report specifically pointed to the abandoned jail project and lack of agreement as to how to move forward as one of the several conditions that led to a determination of a financial emergency.

Preserving Autonomy. The Detroit City Council yesterday voted 5-4 to reverse itself and raise water and sewer rates 7.5%, responding to warnings from both city and state officials that failure to do so would generate additional state oversight of the city—and further derogation of its own authority. Michigan Treasurer Nick Khouri had warned the city leaders that rejecting the rates would mean the loss of $27 million out of a $79 million budget and likely trigger action by the state-appointed review board—and put in peril final negotiations of the Great Lakes Water Authority, a bond-issuing body that is poised to take over the Detroit Water and Sewerage Department—an agreement which still awaits bondholder approval, approval which might be difficult to gain were there a large budget shortfall. Perhaps more potently, Detroit COO Gary Brown warned prior to the vote: “If it doesn’t get done by Jan. 1, it falls apart….If you don’t approve the rate increase, the layoff notices are going to be going out: We need the rate increase in order to move forward and invest in this system.”

Adding Insult to Fiscal Injury.  Sometimes, when it rains, it pours: so it is that San Bernardino’s municipal leaders yesterday learned that the San Bernardino Employment and Training Agency (SBETA) is likely to be found ineligible for reimbursement of $1.2 million the city had counted on—an adverse surprise that could well spell the doom of the 40-year-old agency. Nevertheless, the bankrupt city’s City Council voted 4-3 to appropriate $135,000 out of the city’s general fund — funds sufficient to keep the center open for one month — and then meet again next week to assess possible options—a decision that temporarily protects not just ten full-time and fifteen part-time jobs, but, possibly more importantly, insures the agency can continue to provide job placement and other counseling services. But the harsher fiscal message from the Executive Director of the California Workforce Investment Board to Mayor Carey Davis appears to mean that the city’s hopes of recouping the $1.2 million it has already expended for the agency will be unmet—and that any hopes for future assistance have gone up in smoke. While the city can appeal, Councilman Fred Shorett said he had spoken to officials at both the county and state level, reporting: “I believe that the die is cast, and there is no hope of keeping SBETA alive. At this point, we’re just throwing good money after bad…We talk about ‘fiscal sanity.’ This is fiscal insanity. When we’re closing fire stations, we’re not funding other things you’d like, yet we fund this with money we don’t have.” The state placed the cash hold on the city, because San Bernardino was overdue on its FY2013 audit—a very overdue audit, which the city’s accounting firm, Macias, Gini and O’Connell LLP, this week indicates could be completed by the end of this week.

What Happens when the Money Runs Out?  Puerto Rico’s approved budget allocation for appropriation and Government Development Bank for Puerto Rico debt is just under 20% short of the amount requested by the Governor Padilla, likely guaranteeing a missed debt service payment by Puerto Rico Public Finance Corp. as early as today. The likely non-payment comes as the working group for the economic recovery of Puerto Rico is seeking to cobble together recommendations with regard to how the U.S. territory could distribute a reduction of $63 million to its appropriation debt holders at the end of next month—recommendations which will be subject to approval by the legislature, according to a spokesperson in the Puerto Rico Senate. In the nonce, the missed debt service by Puerto Rico Public Finance Corp. signaled the likely default as early as next week on a payment due—a default which would mark the first monetary default by Puerto Rico and the beginning of the unprecedented process of trying to restructure as much as $72 billion in debts outside of a federal bankruptcy court. That is, absent action by Congress, Puerto Rico is now entering an uncharted fiscal Twilight Zone—as are its millions of municipal bondholders. In addition to some $275 million for appropriation and Government Development Bank debt, the island’s budget allocated $1.011 billion for general obligation debt, $117 million for commonwealth-guaranteed Administration for Infrastructure Financing debt, $46 million for the last payment for the FY2014-2015 tax and revenue anticipation note, and $26 million for some other debts, according to the Puerto Rico Office of Management and Budget. A key issue is whether holders of Puerto Rican debt have any legal recourse—or, as one expert notes: For Puerto Rico’s perspective: “[D]efaulting on appropriation debt would be the least painful way to conserve cash as the government can claim it has no obligation to appropriate…Based on our reading of the bond documents, the bondholders have no right to compel payment.” That is, even though Puerto Rico has taken difficult fiscal steps to increase revenues by hundreds of millions of dollars, while at the same time reducing expenditures by hundreds of millions of dollars in its recently approved budget; the steps are woefully short of the fiscal chasm that now make clear defaults could commence as early as September.

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