The Steep Road to Recovery from Municipal Bankruptcy

October 7, 2015

The Hard, but Critical Road to Recovery & Fiscal Sustainability. Few municipalities, especially compared to other corporations, go into bankruptcy. But for those that do, they do not disappear, as is the outcome in many corporate bankruptcies; rather they do not miss a beat with regard to providing essential services, even as they began the long and expensive process of putting Humpty Dumpty back together again by means of assembling a plan of debt adjustment in negotiations with their thousands upon thousands of creditors. While each of those plans must receive approval from a federal bankruptcy court—and the respected and respective judges do look to see that such proposed plans incorporate long-term fiscal sustainability provisions; nevertheless, those municipalities are not starting on a level playing field. So the question with regard to their ability to fully recover remains a story to be learned—because never before in American history has there been such a spate of major municipal bankruptcies. Ergo, unsurprisingly, Detroit—with its plan approved and the Mayor and Council restored to governance authority—in effect starts at a disadvantage compared to other municipalities: its road to climb is steep.

There is good news, however: a new report, “Estimating Home Equity Impacts from Rapid, Targeted Residential Demolition in Detroit, Michigan: Application of a Spatially-Dynamic Data System for Decision Support,” from the Skillman Foundation, Rock Ventures LLC, and Dynamo Metrics has found that the valuations of homes within 500 feet of a demolition funded by the U.S. Department of Treasury’s $100 million in Hardest Hit Funds have increased by an estimated 2.4 percent between December 2014 and May 2015. Indeed, blight removal has been a core element of any route to Motor City recovery: in May of 2014, the Detroit Blight Removal Task Force — which includes representatives from Detroit Public Schools, U-SNAP-BAC Inc. and Rock Ventures — identified more than 78,000 properties in need of sales, repair, or demolition. That is, federal help seems to have sparked a critical revival of affected assessed property values and, ergo, the Motor City’s revenues: the report found demolitions have increased the value of surrounding homes within 500 feet by 4.2 percent, or an average of $1,106. Citywide, that amounts to an increase in home values of more than $209 million. The bad news is that even as this innovative federal program is beginning to demonstrate its ability to contribute to Detroit’s comeback, the assistance in financing the demolition is drying up.

The report also suggests that combined with other efforts by the city—efforts which include code enforcement and sales of public assets such as side lots—have also begun to make telling fiscal differences: the value of homes nearby increased by 13.8 percent, or an average of $3,634. Citywide, that amounts to an increased assessed property value of about $410 million—or as Mayor Mike Duggan describes it: “The numbers are extraordinary,” noting that eliminating blight has allowed “good homes and good vacant homes” to increase in value: from January of last year until last, 5,812 blighted structures in the city were demolished thanks to funding from the federal “Hardest Hit” fund—a now drying up fund focusing nearly $8 billion in post Great Recession assistance foreclosure prevention in 18 states, including Michigan, with where Michigan’s share was over $498 million, of which Detroit received just over one fifth. Because those funds will be depleted this year, Mayor Duggan is planning to travel to Washington soon to meet with White House officials and others to lobby for the next round of money—especially since the demolitions to date have only addressed some 10 percent of the city’s blight.

Good Gnus. In its review of Chicago’s proposed FY2016 Budget, Kroll Bond Rating Agency (KBRA) reports it believes Mayor Rahm Emanuel’s budget includes “reasonable actions for closing the projected fiscal 2016 operating shortfall, and represents clear progress in confronting the challenges of unfunded pension liabilities.” The Budget closes the city’s FY2016 gap via proposed savings and reforms, efficiencies, and significantly increased property taxes from a four-year phased-in $543 million increase in the property tax levy, earmarked to specifically address rising police and fire pension liabilities. The rating agency wrote it believes the choice of a property tax levy increase demonstrates the Chicago’s political will to craft an effective and sustainable solution. Nevertheless, the agency noted there still remain numerous unresolved issues, which could potentially undermine budgetary goals: first, will the City Council, in an election year, approve the Mayor’s proposed budget? Second, the big shoulder city is relying on State action to increase the size of the home-owners property tax exemption, which would exempt homes valued at less than $250,000 from the increase—this a state legislature which is locked in a stalemate with the Governor. The phased-in property levy increases assume that Senate Bill 777, which reforms police and fire pension funding, will be enacted into law—and not be rejected by the Illinois Supreme Court. If not enacted, Chicago’s police and fire pension funding obligation would immediately rise from approximately $328 million to $550 million, and the city would have to identify and act on additional funding sources.

Not the Odor of Verbena. The Securities and Exchange Commission (SEC) has settled its almost six-year-old pay-to-pay case against two ex-JPMorgan bankers involved in hold-your-nose, soured sewer deals that thrust Jefferson County, Ala., into municipal bankruptcy. The SEC, according to a notice filed in federal court this week, reported it had reached agreement with Charles LeCroy and Douglas MacFaddin via mediation which resolves securities fraud charges against the two, albeit the actual terms of the settlement will not be made public until it is presented to the full commission for approval, with the independent federal securities agency advising the federal district court that, if the Commission approves the report, that would end litigation on the case. The long, simmering case dates back just about six years to when the SEC filed a civil suit alleging that Messieurs LeCroy and MacFaddin had improperly arranged payments to local broker-dealers in Alabama to assure that certain Jefferson County commissioners would award $5 billion in county sewer bond and swap deals to JPMorgan. The SEC suit, which charged that the two men “privately agreed with certain county commissioners to pay more than $8.2 million in 2002 and 2003 to close friends of the commissioners who either owned or worked at local broker-dealers,” sought declaratory and permanent injunctions against the two for federal securities law violations, as well as disgorgement of all profits they received as a result of their legal misbehavior, plus interest. The SEC had brought the suit simultaneously with its settlement of municipal securities fraud charges with the investment bank. Without admitting or denying the SEC’s charges, JPMorgan agreed to pay $75 million in penalties eventually turned over to Jefferson County, and to forfeit more than $647 million of claimed swap termination fees. In January, the SEC sought summary judgment in the case, leading U.S. District Court Judge Abdul Kallon to determine the five-year-old case was appropriate for mediation—this all in a case involving some nearly two dozen municipal elected officials, contractors, and county employees involved in Jefferson County’s sewer bond sales or construction of the sewer system who were jailed for bribery and fraud—and which led to what was, at the time, a filing for the largest municipal bankruptcy in U.S. history.

Wither Its Future—and Who Decides? Facing decades of structural budget gaps and unsustainable legacy costs, the City of Pittsburgh entered two forms of state oversight in 2004. In the subsequent decade, that engagement appeared to have been key to a turnaround in the city’s structural deficits, leading to annual positive fund balances, as the then-partnership helped restructure its crushing debt load, streamline an outsized government, and earn a triple-notch bond rating upgrade. Nevertheless, the Steel City still carried a $380 million pension liability, leaving questions with regard to whether the city was ready to graduate from state oversight – especially given the extra relief from restrictive state laws that the state’s Act 47 provides to city officials. Now that state-local tension seems to be back, with the Pennsylvania Intergovernmental Cooperation Authority (ICA), the city’s overseer, an authority state lawmakers formed in 2004 to oversee Pittsburgh’s finances, at a time the city was on the precipice of municipal bankruptcy, claiming it is justified by state law in withholding Pennsylvania gambling revenue from the city (ICA is invoking Act 71 of 2004, a state statute which grants, according to ICA, has “exclusive control” of the gaming revenues dedicated for Pittsburgh, the only second-class city under the commonwealth’s system of categorizing cities.), because, as the Intergovernmental Cooperation Authority’s Henry Sciortino, reports: “They haven’t met certain benchmarks.” Indeed, the former amity is now gone: Pittsburgh is suing the state agency in the Allegheny County Court of Common Pleas, accusing it of illegally withholding $10 million in annual gambling host city revenue funds the past two years related to the Rivers Casino—a costly dispute triggered by state agency claims that Pittsburgh Mayor Bill Peduto is backing off his commitment of $86.4 million to fully fund current payments to retirees – separate from the city’s overall unfunded pension liability estimated in the hundreds of millions. In addition, Mayor Peduto requested that Pennsylvania Auditor General Eugene DePasquale conduct an audit of the ICA—a request putting Mr. DePasquale now in a most awkward position in the wake of the city’s decision to file suit. Moreover, the city-state dispute—itself now becoming a costly court battle—arises even as the city faces daunting pension challenges: returns on the city’s employee pension funds have, according to the State Auditor, deteriorated from 16.3% in fiscal 2013 to 5.5% this year, reflecting the slowdown in financial markets, who estimates the city’s funds’ assets to be $675 million versus liabilities of almost $1.2 billion. Indeed, the Public Employee Retirement Commission considers Pittsburgh’s pension fund “moderately distressed.” In a letter to Gov. Tom Wolf and top legislative leaders a week ago, ICA Chairman Nicholas Varischetti called pension underfunding “one of the most serious barriers to Pittsburgh’s fiscal stability.” That statement comes in the wake of Pittsburgh’s efforts just five years ago to avoid a state takeover of its pension funds by earmarking nearly $750 million in parking revenues over three decades to prop its funding level above a state-mandated 50%. Keeping this growing state-local dispute constructive could matter: over the last decade, Pittsburgh has received 11 upgrades, most recently in early 2014 when S&P elevated its general obligation rating to A-plus, and Moody’s, just a year ago, revised its outlook to positive on the steel city’s general obligation bonds. The city’s suit alleges the ICA has been illegally withholding $10 million in annual gambling host city revenue funds the past two years, whilst, for its part, ICA officials claim Mayor Peduto is backing off his commitment of $86.4 million to fully fund current payments to retirees. Indeed, in an epistle to Gov. Tom Wolf, ICA Chairman Nicholas Varischetti wrote that pension underfunding was “one of the most serious barriers to Pittsburgh’s fiscal stability.” The state-local tension over the city’s pension liabilities is hardly new–five years ago Pittsburgh avoided a state takeover of its pension funds by earmarking nearly $750 million in parking revenues over 30 years to prop its funding level above a state-mandated 50%; however, once again, state apprehension is on the uptick that the city is, as one expert, David Fiorenza, a Villanova School of Business professor and a former chief financial officer of Radnor Township, said: Pa., said “[O]nce again the municipality is only fixing the leak and not curing the flooding problem of pension debt and other unfunded liabilities looming around like an albatross,” adding that he believes the state ICA can be a force to persuade cities to devote gambling revenues to other areas of the budget, such as pensions.

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