Federalism, Governance, & Municipal Bankruptcy

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November 23, 2015. Share on Twitter

Leadership & Governance—and Contracting Out in Municipal Bankruptcy. San Bernardino’s pursuit of exiting municipal bankruptcy amid changing leadership and an absent state government has witnessed the resumption of an effort that commenced before it even filed for chapter 9 bankruptcy, with the Council voting 6-1 to contract out its waste services–a part of its proposed plan of debt adjustment in bankruptcy: outsourcing or contracting out its trash services. While, in the scope of the challenges to fiscal sustainability, the move might appear small; it displays some finesse and appears to have gained the support of not only the affected 100 employees—who will not lose their jobs, but rather work for Burrtec—the winning bidder, but also provide for a $5 million upfront payment from the corporation to the city and then a steady stream of $2.8 million annually in franchise fees. Who says that cities cannot be part of the emerging, sharing economy? As part of its agreement with the bankrupt city, Burrtec pledged to keep all 72 existing full-time employees, move 28 part-time employees to full time, retain salary levels and benefits, and provide employees a bonus of another $500,000 total (which would be $6,900 per full-time employee if split evenly). An added bonus, from San Bernardino’s perspective: the city projects it will also save some $20 million it would have had to set aside for equipment depreciation.

Offering a Potential Alternative to Municipal Bankruptcy. With Congress seemingly unwilling to consider providing Puerto Rico the option of bankruptcy available to every other corporation in America, the Senate Environment and Public Works Committee, which has jurisdiction over the U.S. territory, is developing a legislative proposal which it believes could help Puerto Rico via what one staffer likened to a federal control board, such as was facilitated for the District of Columbia—albeit, as the Romans would put it, tempus fugit, or the time to act is fast fleeting: ever moody Moody’s credit rating service expects Puerto Rico to default on a portion of a $354 million payment due next week; the Commonwealth has already defaulted on municipal bonds issued by its Public Finance Corp. The potential proposal in Congress comes as the Puerto Rico legislature last week approved legislation to establish a local fiscal adjustment board, whose five members would be appointed by the Governor. Delegate Pedro Pierluisi, Puerto Rico’s non-voting Member of Congress, opposes the concept of a federal board to oversee the territory’s finances: he believes the idea smacks of colonialism—although it appears to have been a successful alternative to municipal bankruptcy in both New York City and Washington, D.C.—and is not all that different than the Financial Review Commission created to oversee Detroit’s recovery from municipal bankruptcy over a decade. Indeed, the emerging concept, successful in D.C. and New York City under the incomparable leadership of former Empire State Lt. Governor Dick Ravitch—as well as consistent with the suggested approach of Senate Judiciary Committee Chair Charles Grassley (R-Iowa)—who will hold a hearing on Puerto Rico on December 1st —the same day the U.S. territory could default on some $355 million in municipal bond payments coming due—to learn “more about the root cause of the problem and discussing possible solutions,” according to his spokesperson, might point towards increasing consensus, even as the Obama Administration’s plan, supported by Congressional Democrats and the Puerto Rican government, focuses on granting Puerto Rico broad municipal bankruptcy powers—seemingly, to date, a non-starter in Congress.

Moreover, any alternatives appear unlikely: Gov. Alejandro Garcia Padilla’s calls for concessions by the island’s municipal bondholders scattered across every state has made little headway. In addition, the territory is experiencing an increasing rate of emigration from the island to the mainland—but an emigration that is leaving behind those in greatest poverty—in effect imposing greater fiscal demands on the government even as its fiscal resources are bleeding faster.

The lead electric guitar player from the Indubitable Equivalents, retired U.S. Bankruptcy Judge Steven Rhodes, who oversaw the bankruptcy trial of Detroit, and who has been in Puerto Rico trying to use his experience and skill to help, in an interview with the Bond Buyer, said Puerto Rico needs to be put on life support and the way to do it would be through municipal bankruptcy—or for the appointment of a central control person or board, preferably designated by the federal government, to spearhead the proceedings in place of Puerto Rico’s Governor and legislature, noting: “It is very tough on the people on the island, it is very tough on existing politicians, but the closest analogy is that when an entity like Detroit or like Puerto Rico goes into bankruptcy, they are on life support…And extraordinary measures have to be taken to assure the survival of the patient,” adding that Puerto Rico’s fiscal sustainability challenges of unpayable bond debt and unfunded pension liabilities closely resembled those of Detroit, where, he stated: “In Detroit, we contracted democracy to a significant extent. When it was over, we handed it back to [city officials] and told them it was their responsibility to make it work…That is what I advocate for Puerto Rico.” Judge Rhodes, in the interview, noted that in every type of bankruptcy case, whether it is corporations, consumers, or municipalities; structural reforms have to be coupled with bankruptcy to help solve whatever problems got the debtor into insolvency in the first place: “There has to be a complete top to bottom review of everything the island does, from water to electricity to tourism to manufacturing to shipping and see where efficiencies can be obtained and where the opportunities are and pursue them with vigor…That is exactly what Detroit and its emergency manager did and it’s working.”

Balancing Essential Public Services & Debt. Judge Rhodes, in his interview, noted that a key element of any plan of debt adjustment involves balancing paying back the debt and providing citizens with essential services: “The advantage of bankruptcy is that people will still continue to get their police, their fire, their emergency medical, their roads, their educations, their power, their water, even though the defaults are taking place.” Now, as Puerto Rico nears a fiscal cliff in the coming days, Judge Rhodes noted that Congress could still make a difference by passing chapter 9 municipal bankruptcy legislation—even if it acted after Puerto Rico had begun defaulting—a key point, with the territory almost certain to default on some of its debt by next Tuesday. Indeed, Plato-like, Judge Rhodes posed the question: “Does there come a time when bankruptcy can’t help? I don’t think so…The conventional wisdom is that the longer an entity that is insolvent waits to file bankruptcy, the more challenging and more expensive the bankruptcy becomes.”

Investing on the Motor City’s Future. Detroit’s two multibillion-dollar pension funds for its employees and retirees are poised to invest funds for the first time since the Motor City emerged from chapter 9 municipal bankruptcy and a public corruption scandal which not only landed its former mayor in prison, but also savaged the pension funds of more than $97 million. Six pension fund officials and businessmen were found guilty of crimes following a corruption trial last year. Now, in the wake of the city’s emergence from the largest municipal bankruptcy in history, the two funds, which control some $5 billion in assets, are preparing to invest assets critical to more than 25,000 retirees, active workers, and beneficiaries—almost all of whom received pension and benefit cuts as part of the city’s approved plan of debt adjustment by Judge Rhodes. The return to the market for the funds comes in the wake not just of a lengthy review of the funds’ investment portfolios and changes made in asset allocation, but also the implementation of new overseers and investment rules incorporated in the plan of debt adjustment to prevent the kinds of bribery and kickback scandals that contributed so significantly to precipitating Detroit’s fiscal collapse.

The city’s General Retirement System, with assets of $2 billion, but liabilities of $3.2 billion, is faced with another problem: the city’s declining population—upsetting the teeter totter, because of the imbalance of greater numbers of retirees un-offset by smaller numbers of employees paying in. Ergo, a key part of the city’s approved plan of debt adjustment is a strategy to reverse the human ebb tide, and bring back more people to live and work in Detroit. One can glean that with 5,389 current active members in its retirement system, but 9,737 retirees. The balance is hardly equal. Thus, there are multiple challenges, including the key steps to ensure and protect the funds: All investments are being overseen by independent committees made up of individuals with finance and investment backgrounds, including members appointed by Gov. Rick Snyder—that is, a new level of oversight—one intended to replace the system that contributed so precipitously to the city’s default: pension fund boards approving investments with, in some cases, friends, acquaintances, and businesspeople who lavished board members with cash, gifts, and free trips to the Caribbean. That means changing investments too: dropping individual real estate investments—important contributors to the corruption scandal. The General Retirement System pension fund is likely to hire multiple firms to oversee the fund’s fixed-income portfolio early next year as part of a broader restructuring.

By the end of November, the Police and Fire Retirement System pension fund, which has assets of $3.3 billion, and liabilities of $4 billion—and a fiercer teeter-totter imbalance of 3,164 active members compared to 9,228 retirees—could hire two firms to manage a $150 million investment in global low-volatility stocks—or 5 percent of the pension fund, aimed at protecting against the kind of losses seen during the 2008 global financial crisis: the Police and Fire Retirement System’s fund investments are being overseen by a nine-member board, the majority of whom were appointed by the state as part of Detroit’s plan of debt adjustment—as well as part of the ongoing effort to eliminate the chance politically connected or bribe-paying business persons could, once again, obtain multi-million-dollar deals from the pension funds, according to officials.

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