Juggling Creditors, Public Safety, & Democracy in the Midst of Municipal Bankruptcy

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December 24, 2015. Share on Twitter

Balancing or Imbalancing.  U.S. Bankruptcy Judge Meredith Jury yesterday warned San Bernardino’s bankruptcy attorneys they will have to explain why, in the city’s proposed plan of debt adjustment, the city plans to pay some creditors only 1 percent of what they are owed—and why the city cannot raise new or additional revenues to pay for more. The back and forth came as a precursor to what is expected to be San Bernardino’s third and final version of its plan of debt adjustment, which the city expects to file on February 10th. (See:Revised Recovery Plan as submitted to the bankruptcy court on 11/23/15.) In response, City Attorney Gary Saenz, advised Judge Jury he did not expect that to be a problem, as the respective parties gird themselves for the confirmation trial—the last step to San Bernardino’s exit from chapter 9 municipal bankruptcy.

Nevertheless, even as San Bernardino, unlike Detroit, the post-terrorism city in the midst of an election campaign and awaiting a new city manager, can surely expect a multifaceted battle—one waged both by external creditors—such as the owners and insurers of pension obligation bonds, the city must also be responsive to its own citizens, employees, and retirees. As Ron Oliner, an attorney for the San Bernardino Police Officers Association, yesterday noted: “There will be a confirmation fight here. It will be long; it will be bloody; and somebody will be unhappy.”

As hard as the city and its thousands of creditors have negotiated amongst themselves in the seriated versions of the city’s plan, the final gladiators’ battle lies ahead. Or, as Mr. Oliner described it: “The trope — Wall Street versus Main Street — is real in this case,” noting that while some creditors are likely to be held nearly whole—especially in the wake of the terrorist attack, others are likely to receive only one percent of what they are owed. There will likely be no winners, but there will be many significant losers.  A sense of the stakes emerged yesterday in the courtroom when Ambac attorney Thomas R. Kreller asked how San Bernardino came up with and how it could continue to contend the most San Bernardino could afford to pay to his clients—as part of its plan of debt adjustment—would be 1 percent of the debt it owes, adding: “We’ve seen shifts not just of tens but of hundreds of millions of dollars…Yet somehow that 1 percent remains in stone.”

Unsurprisingly, as the city has updated and revised the various versions of its proposed plan of debt adjustment, both negotiations with its creditors and external forces have influenced the process. For instance, two of the most significant shifts in the respective versions have been made with regard to increased police staffing and equipment—to which the city is now proposing an increase over the next two decades of $159 million, and the creation of a municipal bankruptcy reserve fund. Indeed, according to City Attorney Saenz,  two of the big “shifts” to the plan since May are a plan to increase police staffing and equipment — which the city projects will cost $159 million over 20 years — and $24 million for a bankruptcy reserve fund. Or, as Mr. Saenz said yesterday, after the hearing, any additional money the city acquires has to go to basic city services: “Any dollar we have has to go to addressing our severe service insolvency…I think the creditors’ problem is not so much the amount of information we have produced, but what that information shows: that we don’t have any money to spare.”

The Challenges of Municipal Debt Crises

As the U.S. Treasury, the U.S. Territory of Puerto Rico, and Congress struggle to address the looming Puerto Rico insolvency—and as new House Speaker Rep. Paul Ryan (R-Wisc.) vows a resolution by March, instructing the relevant House Committees with jurisdiction over Puerto Rico before Congress recessed to work with commonwealth officials to come up with a “responsible solution” to the debt crisis by the end of March—there are increasing questions with regard to what Constitutional and legal hurdles exist—questions so serious that it is unclear whether legislation (The Puerto Rico Emergency Financial Stability Act of 2015) introduced by Senate and House Democrats before Congress recessed to temporarily halt litigation over Puerto Rico debt are even constitutional. Indeed, the ever prescient municipal bankruptcy guru Jim Spiotto likened the proposed bills to the moratorium New York State had imposed in 1975 on lawsuits and demands for payment of debt—a moratorium which the Empire State’s highest court reversed two years later, holding that the New York Constitution required debt payments to be made. Under the U.S. Constitution, if the government takes one’s property, that government must pay fair market value—and the Constitution requires due process. Part of the signal problem with barring Puerto Rico access to chapter 9 bankruptcy is that it removes its access to a federal bankruptcy courtroom where there is, in effect, a judicial referee.

In their instruction of the proposed bill in the Senate, the authors stated the purpose was two-fold: first, to “provide a limited period of time to permit Congress to enact comprehensive relief for the commonwealth, providing it the necessary tools to address its economic and fiscal crisis,” and to “provide the commonwealth government with a tool it needs to address an immediate and imminent crisis that is unprecedented in the history of the United States.” The legislation notes that the U.S. commonwealth’s debt is unusually complex with 18 different but inter-related issuers.

Having dilly-dallied for far too long, the growing question is when it might be too late.

December 23, 2015. Share on Twitter

Sharing Fire Services. U.S. District Judge Otis Wright II yesterday, once again, affirmed the City of San Bernardino’s authority to outsource—or share, as it is doing, the provision of fire services. Judge Wright’s decision, similar to that of U.S. Bankruptcy Judge Meredith Jury, who, in her court had previously concluded that nothing in San Bernardino’s city charter or California law prevents the city from sharing services or outsourcing its Fire Department. The proposal to have San Bernardino County assume responsibility for fire and emergency protection is now a “key” part of San Bernardino’s plan of debt adjustment. Indeed, in the wake of the horrific terror killings, the coordination or sharing of essential public safety services in a region demonstrated how invaluable such sharing can be to not just saving fiscal resources—but, more importantly, lives. Thus, the affirmation by the court could mean as much as $11 million towards the city’s pending plan for achieving fiscal sustainability—with as much as $8 million of that coming from a parcel tax that would be implemented as part of the shift.

In his opinion, Judge Wright wrote: “The Court agrees with the bankruptcy court’s determination that (the city charter section) simply empowers the City to establish a fire department; it does not require the City to create a fire department, let alone a fire department staffed by City employees…The Court, on the other hand, concludes that because sections 180 through 186 only govern the operation of an internal fire department once created, those sections simply do not apply if the City chooses to outsource firefighting services.” In its suit, the city’s fire union had relied in part on a 1991 opinion by then-San Bernardino City Attorney James F. Penman in which he had written that the charter prohibited the city from outsourcing police services (and the same provisions used in that opinion existed for firefighting services, too). Judge Wright wryly noted: “This is the fifth appeal taken by the City of San Bernardino’s firefighters in the City’s ongoing bankruptcy saga.”

Juggling & Imbalancing. With U.S. Bankruptcy Judge Meredith Jury convening a status hearing on San Bernardino’s chapter 9 filing today, the court will, no doubt, witness a sharp contrast between the city’s bondholders and insurers, both of whom are criticizing what they describe as San Bernardino’s lack of coherent financial disclosure and the city—one in the midst of grieving in the wake of the first terrorist attack on a U.S. city since 9/11, and in the midst of not only a declared state of emergency, but also a re-election campaign for a city council position, and a series of changes for the absent and departing City Manager (The City Council will discuss a proposal Monday to appoint Police Chief Jarrod Burguan as interim City Manager in January with Mark Scott, currently Burbank’s city manager, taking over as interim in February, according to the agenda.).

In his filing with the federal bankruptcy court, Ambac Assurance Corp. attorney Thomas Kreller noted, referring to the city’s updated disclosure statement: “The revised disclosure statement still falls woefully short of containing the ‘adequate information’ to which creditors are entitled before being asked to vote on the revised plan.” (Ambac is the municipal bond insurer on $50 million in pension obligation bonds held by Erste Europäische Pfandbrief-und Kommunalkreditbank AG, the bondholder.) In their objections, Mr. Kreller questioned how it was that San Bernardino was able to decide on its “draconian” plan of only paying 1% owed on the pension obligation bonds and general unsecured claims when its financial disclosures were so “murky;” while EEPK Attorney Vincent Marriott, III, wrote that San Bernardino had failed to explain an additional $200 million in expenses and reserves mentioned in supplemental filings—with the referenced new items including a $24 million bankruptcy reserve fund, an additional $14 million for police fleet replacement, and $159 million for the “police services master plan.”

Mr. Marriott wrote that despite the “enormous size” of these new spending and reserve items, he said the amended disclosure statement only provided partial or cursory explanations, thereby, leading him to tell the court: “The enormous size of these changes calls into question the validity of the city’s financial projection methodology, and certainly warrant clear disclosure in the body of the amended disclosure statement and significant analysis and explanation by the city,” Marriott wrote in the filing. In fact, San Bernardino’s filing acknowledges that it “provides for substantial impairment of unsecured claims.” Under the proposed plan, holders of $50 million of unsecured pension obligation bond claims would receive payments of $655,000 plus interest over time, with the city’s filing noting: “The city believes that the plan provides the greatest and earliest possible recoveries to holders of claims while preserving necessary city services and operations.” Indeed, the city noted that any alternative debt adjustment or restructuring would result in additional delay, uncertainty, and expense.

One if by land, two if by sea…Standard and Poor, the credit rating agency, continues to keep it eyes on Atlantic City, the city by the sea—and, with a credit watch negative, pending a resolution with regard to Gov. Chris Christie’s conditional vetoes of a rescue package approved by the New Jersey legislature last June—vetoes which, last month, Presidential contender Christie claimed he wanted to be made before he would sign them—without explaining the very long delay in providing feedback. In their analysis, S&P analysts Timothy Little and Lisa R. Schroeer said that the Garden State, in their view, has until the end of the current legislative session to resolve the conditional vetoes and release a long-term plan Atlantic City—meaning sometime in the next three weeks, noting: “Atlantic City’s ability to address its structural imbalance and long-term liabilities has been a significant concern that weighs on its fiscal future…The decision to conditionally veto several bills intended to stabilize the city’s revenues continues to leave the city’s finances in a vulnerable and tenuous position.”

Moody Grading. Moody’s dropped the Windy City’s ailing Chicago Public Schools system, one beset by a cash crisis, one more notch into junk territory, to B1 from Ba3 and reported it would keep the credit under review due to headwinds bearing down on the district over the next 90 days, noting the downgrade reflected “the precarious liquidity position of the district…CPS has increasingly relied on market access and cash flow borrowing to maintain ongoing operations.” The bad credit report card affects $5.5 billion of the CPS’ $6 billion in debt, and followed in the wake of a non-term paper from a CPS consultant earlier this month warning that CPS could exhaust operating cash as soon as next month, making its ability to get a $1 billion sale done and tap a new credit line before then the more urgent. CPS’s CEO Forrest Claypool has warned of major layoffs if the state, itself a fiscally failing state in disarray, does not provide the requested assistance. However, CPS’ problems remain far from the top of the card in faraway Springfield, where a feud between the legislature’s majority Democrats and Republican Gov. Bruce Rauner has left the state without a budget for nearly half a year. Moreover, even though Gov. Rauner did sign school aid appropriations, grant funding of $150 million has been delayed. CPS could realize another misfortune as early as February now that Chicago teachers have given their union authorization to pursue a strike, which could occur as soon as late February if a new contract cannot be brokered. Indeed, there appears, increasingly, a risk of a kind of fiscal whirlpool, or as the ever prescient Chicago vet, Richard Ciccarone, president at Merritt Research Services, noted: “Doing a billion dollar financing won’t be easy even with the help of yield-hungry investors. How they structure the security will matter a lot.”

Free at Last! Perhaps it is appropriate that for the first time in a decade and a half, no city in Michigan is under the state’s emergency financial management, leading Michigan Governor Rick Snyder yesterday to note: “This is a great day, not only for the City of Lincoln Park, but for the entire State of Michigan.” In his statement, Gov. Snyder praised the leadership of Emergency Manager Brad Coulter, who the Gov. had designated as the EM in July of 2014: “Brad has provided a shining example of how the system can work; first, collaborating with local leaders to address the city’s financial emergency, then working to enhance economic development to help ensure continued financial stability for Lincoln Park.” Lincoln Park, a municipality of 38,000, is one of 34 cities and 9 townships in Wayne County—the county which includes Detroit, and was, itself, on the verge of bankruptcy. The successful exit yesterday means that the state’s fiscal emergency oversight is now narrowed to three school districts: Detroit, Muskegon Heights, and Highland Park.

In the case of Lincoln Park, the path to fiscal solvency was through renegotiated city employee contracts, the elimination of employees’ ability to purchase years’ towards pension service, and the elimination of post-retirement health care benefits and Medicare Part B reimbursements. The agreement also eliminated cash for unused sick days when an employee leaves employment with the municipality. The results are like a pre-wrapped Christmas gift: Mr. Coulter departs, leaving behind a two-year budget, and a surplus of nearly $187,000—a stunning turnaround from the more than $1 million general fund deficit he started with at his appointment—or, as City Councilman Elliott Zelenak said yesterday: “Regardless if I was with him 100 percent of the time or not, I do think he did what was best for the city, what his job was asked for…He had a tough job and I think he did his job really well.” Mayor Thomas Karnes said Lincoln Park leaders and officials worked closely with Mr. Coulter to ensure Lincoln Park regained its financial footing. Now that the city “is in better shape now than it was when he came in,” Mayor Karnes said, the goal is to continue that course while moving forward with more direct oversight: “The people of Lincoln Park elected us to represent them and to lead their government, so I’d like to get back to doing that…I want everybody to know we’re ready to take the helm again and are looking forward to it.” At the height of the economic downturn, Lincoln Park lost one-third of its property tax revenue. It could take, Mr. Coulter noted, require “a good 10 years” before property values return to what they once were.

The Twin Challenges of Terrorism & Municipal Bankruptcy

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December 22, 2015. Share on Twitter

Readying to Recover from Terrorism and Municipal Bankruptcy. The San Bernardino City Council yesterday unanimously chose the current Burbank, California City Manager, Mark Scott, to be the new city manager—with San Bernardino Police Chief Jarrod Burguan to serve in the interim effective January 1st—the date on which current Manager Allen Parker’s resignation (by mutual negotiation) becomes effective. Under the apparent agreement, according to Chief Deputy City Attorney Jolena Grider, Mr. Scott has signed a one-year contract, for $248,000, with a 30-day notice to terminate, about a seven percent increase over the current salary, but a significant reduction from the salary he had been receiving at the time he offered his resignation last month. In accepting the offer, Mr. Scott told the San Bernardino Sun he had expressed interest in the San Bernardino city manager position just a few days prior to the Dec. 2nd terrorism attack and that he had experienced the city’s heart since then: “I’m at the point in my career where I’m looking to join a high-functioning team…and I believe you’ve got many people here — including yourselves (elected officials), including people in the audience — who are capable of fulfilling the promise.” Mr. Scott will continue in Burbank until the first week of February, but he intends to try to devote a significant amount of time in San Bernardino in the interim. Councilman John Valdivia proposed removing housing assistance from Scott’s compensation. But when City Attorney Gary Saenz said it would be helpful to keep it — given that relocation for a year can be expensive, and it’s good to have a city manager who lives in the city — and no other council members supported the idea, Valdivia joined the unanimous vote.

Meanwhile, Chief Burguan, who has been widely praised for his leadership in response to the terrorist attack in the city—but who has led a department with significant challenges, was approved without discussion, notwithstanding concerns several Council Members had earlier expressed when his role as interim city manager was first proposed. There was, however, no public discussion yesterday before he was approved unanimously, for a salary of $19,104.88 per month, not quite $1,000 more than he now makes as police chief.

The attacks in San Bernardino at the Inland Regional Center affected not just the city, but also other responding governments. Yesterday, each ratified emergency proclamations, a key step to ensure their eligibility to seek state and federal funding to recover expenses. The costs for San Bernardino already are nearing $1 million. The unanimous votes yesterday came in the wake of each jurisdiction’s unanimous proclamation last by executives designated as director of emergency services: San Bernardino Mayor Carey Davis, Redlands City Manager N. Enrique Martinez, and San Bernardino County CEO Greg Devereaux. The San Bernardino City Council voted unanimously yesterday to ask the state for financial help. Despite San Bernardino’s municipal bankruptcy, outgoing City Manager Allen Parker reported the city’s budget could accommodate overtime and other costs created by the attack. Mr. Parker referenced unanticipated savings from spending less than expected on salaries, because the municipality had prepared and adopted its budget with the expectation that 5 percent of positions would be vacant. Instead, approximately 15 percent of positions are vacant. What remains unclear, in the wake of the tragedy, is how the mass shootings might impact assessed residential and business property values.

Rocky Start & Juggling Diverse Claims. Mr. Scott will have homework aplenty to prepare for his new position and responsibilities—not just to help San Bernardino try to recover from the terrorist attack and the attack’s potential fiscal impact via fear and intimidation to undercut the city’s economy, but also from parallel attacks from the city’s municipal bondholders and insurers—who, in challenging San Bernardino’s most recent financial disclosures in U.S. Bankruptcy Judge Meredith Jury’s court have written about what they assert constitute a lack of coherent financial disclosure, with Ambac Assurance Corp. attorney Thomas Keller writing: “(San Bernardino’s) revised disclosure statement still falls woefully short of containing the ‘adequate information’ to which creditors are entitled before being asked to vote on the revised plan [of debt adjustment],” in the firm’s filing in preparation for a status hearing Judge Jury has scheduled for tomorrow—a hearing at a time when the city, unsurprisingly, is not just transfixed by the terrible terrorist shootings, but also in a governance flux: it is most difficult to imagine that Chief Burguan, in addition to the awful responsibilities and burdens he carries in the wake of the shootings, but now also with being the interim manager, will be able to devote to these claims.

Indeed, the city two weeks ago, declared a state of emergency: it is seeking reimbursement from the federal government for costs associated with the attack. It is difficult to imagine the fiscal and time and attention juggling sought by some of the city’s creditors—in this instance Ambac and Erste Europäische Pfandbrief-und Kommunalkreditbank AG (EEPK), the former being the municipal bond insurer of some $50 million in pension obligation bonds held by EEPK—whose attorneys each filed further objections to San Bernardino’s financial disclosures in response to the amended disclosure statement San Bernardino November 25th—just one week before the terrorist attack in San Bernardino. In their claim, the creditors asked challenged the city’s proposed “draconian” plan to pay only paying 1 percent of its owed promises on its pension obligation bonds and general unsecured claims—especially when the city’s financial disclosures are so “murky,” adding that, in its filing, San Bernardino had failed to explain an additional $200 million in expenses and reserves mentioned in supplemental filings—new provisions, including a $24 million bankruptcy reserve fund, an additional $14 million for police fleet replacement, and $159 million for the “police services master plan.” Notwithstanding what one of the challengers claimed to be the “enormous size” of these new spending and reserve items, he said the amended disclosure statement only provides partial or cursory explanations: “The enormous size of these changes calls into question the validity of the city’s financial projection methodology, and certainly warrant clear disclosure in the body of the amended disclosure statement and significant analysis and explanation by the city.” Under San Bernardino’s proposed plan, holders of $50 million of unsecured pension obligation bonds would receive payments of $655,000 plus interest over time; holders of general unsecured claims between $130 million and $150 million would receive a pro rata share of about one percent—or $1.3 million after the plan became effective, according to the city’s filing—with the plan before Judge Jury noting: “The city believes that the plan provides the greatest and earliest possible recoveries to holders of claims while preserving necessary city services and operations.” One struggles to imagine the task confronting Judge Jury: already charged with the responsibility to weigh whether San Bernardino has put together a plan of debt adjustment which, if approved, would provide for fiscal sustainability, she too has to be keenly aware that the terrorist attack has imposed a whole different and unique set of creditors for whom the city will have to bear responsibility.

Waiting for Godot. Standard & Poor’s retained Atlantic City on credit watch negative, pending, the credit rating agency reported, a long-awaited resolution of Gov. and still-Presidential contender Chris Christie’s conditional vetoes of a rescue package for Atlantic City approved by the legislature last June. Gov. Christie announced nearly six weeks ago that he wanted changes to bills that would have established a payments-in-lieu of taxes program for casinos over a 15-year period and reallocated New Jersey’s casino alternative tax to pay debt service on Atlantic City-issued municipal bonds; yet he has not acted. Thus, even in the wake of the rating agency’s knocking Atlantic City’s credit rating more than three months’ ago because of uncertainty over whether it could meet its near-term fiscal obligations, the Governor has yet to provide any clarity to his intentions, thereby risking exacerbating the city’s fiscal plight. In their report, S&P analysts Timothy Little and Lisa R. Schroeer wrote that, in their view, Gov. Christie and the legislature have until the end of the current legislative session to resolve Gov. Christie’s conditional vetoes and to release a long-term plan for the South Jersey city—a city still in the awkward situation of having an elected Mayor, but also a state-appointed emergency manager (Gov. Christie appointed corporate restructuring attorney Kevin Lavin as Atlantic City’s emergency manager last January. Mr. Lavin, however, has not released any new updates since a March 23rd report in which he urged “shared sacrifice” among stakeholders, including the possibility of extending maturities for bondholders.) In its newest report, the S&P dynamic duo wrote: “Atlantic City’s ability to address its structural imbalance and long-term liabilities has been a significant concern that weighs on its fiscal future…The decision to conditionally veto several bills intended to stabilize the city’s revenues continues to leave the city’s finances in a vulnerable and tenuous position.” Atlantic City faced a $101 million budget gap before adopting a 2015 fiscal plan in late September which relied partly on anticipated revenues of $33.5 million in redirected casino taxes included in the rescue package.

4th Down Congressional Punt. Who could possibly forget the great strip by cartoonist Charles M. Schulz of Lucy’s repeated promises she would not swipe the ball before Charlie tried to kick it? So too Congress appeared to be poised to not bail out Puerto Rico, but rather to provide the territory with options, such as those available to General Motors, Chrysler, Detroit—or any other U.S. corporation, to file for federal bankruptcy—options which would have imposed no costs on the federal budget, but would have, potentially, affected large campaign contributions. Instead Congress bailed out of Washington without taking any action to ensure or provide Puerto Rico with any fiscal tools or authority to address its onrushing insolvency, rejecting various proposals offered by Democrats which would have granted some form of municipal bankruptcy authority to the U.S. territory. The $1.1 trillion omnibus appropriations bill Congress passed and the president signed only included two smaller provisions related to Medicare funding in Puerto Rico, as well as a provision allowing the Treasury Department to use some of its budget to give technical assistance to the Puerto Rico government. Puerto Rico Gov. Alejandro García Padilla said: “Once again Wall Street has demonstrated its control over Congress; Wall Street rules Congress…That power is clearly factored into the fundamental analysis of hedge funds and vulture funds that control our democracy.” In fact, chapter 9 municipal bankruptcy negotiations between Democrats and Republicans to include provisions, such as extending Chapter 9 municipal bankruptcy to the commonwealth’s public authorities, continued until the final votes—with Republicans, in both houses, Senate Judiciary Committee Chair Charles Grassley (R-Iowa) leading uniform opposition to authorizing the U.S. territory access to municipal bankruptcy—especially in the face of a torrent of opposition from wealthy, donor hedge funds. Chair Grassley claimed the U.S. territory’s problems were too complex to be fixed solely through restructuring; yet, he offered no alternative.

Promises, Promises. While Congress scurried out of town without offering any avenues for either the Commonwealth of Puerto Rico or its fiscally struggling municipalities, new House Speaker Paul Ryan (R-Wis.), prior to departing, said he was instructing all House committees which have jurisdiction over Puerto Rico to work with Commonwealth leaders to come up with what he termed a “responsible solution” to the fiscal and debt crises by the end of March. In addition, Speaker Ryan promised to hold a hearing on Puerto Rico on Jan. 5, according to House Minority Leader Nancy Pelosi (D-Ca.), noting: “While we could not agree to include precedent-setting changes to bankruptcy law in this omnibus spending bill, I understand that many members on both sides of the aisle remain committed to addressing the challenges facing the territory.”

You made me promises, promise
Knowing I’d believe
Promises, promises
You knew you’d never keep

During the last minute negotiations in the House, Minority Leader Pelosi introduced legislation to provide a short-term stay of legal actions by certain creditors while Congress considered debt restructuring legislation: Leader Pelosi sought a moratorium on legal action which would last until March 31st—in order to ensure sufficient time to comply with Speaker Ryan’s proposed and promised timeline. Rep. Pelosi, however, was unable to gain the requisite unanimous consent.

When the second session reconvenes next month, it, thus, remains unclear what steps Congress might take—or how any steps might come prior to either a default by Puerto Rico, or legal actions taken by some of the island’s creditors. In the Senate, Chairman Grassley, Finance Committee Chair Orrin Hatch (R-Utah), and Natural Resources Committee Chair Lisa Murkowski (R-Alaska) have proposed legislation to create a financial oversight authority for the Commonwealth, similar to means used to prevent defaults in New York City and Washington, D.C., and which would authorize authority to borrow, as well as make $3 billion of unallocated Affordable Care Act funding available to help Puerto Rico stabilize its budget and debt in the short-term. In the House, fellow Badger of Speaker Ryan Rep. Sean Duffy (R-Wis.) has proposed legislation to provide public authorities in Puerto Rico with Chapter 9 municipal bankruptcy protection in exchange for the Commonwealth’s acceptance of oversight from a Presidentially-appointed five-member Financial Stability Council. The disappearance of Congress and repudiation of any fiscal responsibility in the meantime appears likely to force Puerto Rico Governor García Padilla to call for a special session of the Puerto Rico legislature to meet before its currently scheduled next meeting on Jan. 11th.

Human & Fiscal Disruption in Municipal Bankruptcy

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December 16, 2015. Share on Twitter

Human & Fiscal Disruption and Municipal Bankruptcy. The attacks in San Bernardino at the Inland Regional Center affected not just the city, but also other responding governments. Yesterday, each ratified emergency proclamations, a key step to ensure their eligibility to seek state and federal funding to recover expenses. The costs for San Bernardino already are nearing $1 million. The unanimous votes yesterday came in the wake of each jurisdiction’s unanimous proclamation last by executives designated as director of emergency services: San Bernardino Mayor Carey Davis, Redlands City Manager N. Enrique Martinez, and San Bernardino County CEO Greg Devereaux. The San Bernardino City Council voted unanimously yesterday to ask the state for financial help. Despite San Bernardino’s municipal bankruptcy, outgoing City Manager Allen Parker reported the city’s budget could accommodate overtime and other costs created by the attack. Mr. Parker referenced unanticipated savings from spending less than expected on salaries, because the municipality had prepared and adopted its budget with the expectation that 5 percent of positions would be vacant. Instead, approximately 15 percent of positions are vacant. What remains unclear, in the wake of the tragedy, is how the mass shootings might impact assessed residential and business property values.

The Trials, Challenges, & Criticisms on the Road to Chapter 9 Recovery. As any number of other observers have begun to examine Detroit’s progress and challenges in its post-municipal bankruptcy year, one of the key issues remains dealing with its emptiness—both its sharp reduction in population and its corresponding, frenzied efforts to try to demolish nearly 50 percent of its 80,000 blighted or deteriorating structures, or nearly one in three. Detroit has hit the fiscal targets it laid out in its plan of debt adjustment, and is on course to complete a long-planned shift of its water and sewer debt to a new regional authority. Assessed property values are, indeed, rising: according to Dynamo Metrics, assessed values of occupied Motor City homes rose 4.2 percent on average between April 2014 and March 2015 near federally funded demolitions. Clearly, now retired Judge Steven Rhodes’ approval of the city’s exit from municipal bankruptcy, because it provided for the elimination of $7 billion of municipal debt, was the key to giving the city a new start—and the ability to begin the implementation of its plan of debt adjustment. After all, unlike a private corporate bankruptcy, the city had to continue to operate 24/7 from the very moment its petition was accepted by the federal bankruptcy court; thus, in some sense, the greater test is now.

Based on a critical priority in the city’s court-approved plan, Mayor Duggan set a weekly demolition goal of 100 homes, which has Detroit destroying derelict properties at almost quadruple the pace of any other recipient of federal “blight-removal” dollars, according to federal records. The focus on the city’s blight and abandoned homes and buildings was a key we identified in our special report early on: if there was to be a turnaround in assessed property values and reduced crime and arson: any plan of debt adjustment would have to address abandoned homes and buildings: they had become a magnet for arson and assessed value erosion. But, in a city whose path to the largest bankruptcy in U.S. history was paved by criminal behavior by a former Mayor and others, apprehensions about contract favoritism in the Mayor’s blight remediation program have triggered both federal and city investigations. Christy Goldsmith Romero, Special Inspector General for the federal Troubled Asset Relief Program (SIGTARP), from which Detroit is receiving federal blight-relief dollars, is investigating Detroit’s demolition program: federal agents have visited the Michigan State Housing Development Authority, the state agency serving as a pass-through for the federal funds. Likewise, Detroit’s Inspector General, James Heath, began his own investigation last October—an investigation with regard to which Mr. Heath reports he has not partnered with federal law-enforcement agencies.

Concerns arose last year over the now-discontinued bulk-demolition program, where contractual arrangements and fees were discussed with four contractors before the $19.9 million project that razed 1,453 homes was publicly offered: three of the four were the only bidders on the deal. Mayor Duggan has said the city did nothing improper in awarding the contracts; nevertheless, the connection between campaign donations and contract awards have not escaped attention: Executives for two of the companies which were awarded contracts have, collectively, donated nearly $18,000 to Mayor Duggan since a year ago last May according to campaign records.

For Mayor Duggan’s part, he believes the demolitions have already made an invaluable difference, noting that the number of arsons reported around the city’s “Devil’s Night” celebrations around Halloween have dropped nearly 900 percent: municipal records indicate that at its peak, there were 810 incidents of arson in October of 1984, compared to only 52 suspicious fires this October.

But Beauty May Be in the Eye of the Beholder. Detroit, in effect, has to focus not just on its own citizens, services, critical efforts noted above with regard to blight; but also on its fiscal future and its ability to leverage investment in its infrastructure. That is, notwithstanding its exit from municipal bankruptcy, it still faces steep odds—especially from the municipal market—whose investors—and rating agencies—after all, are measuring the city not against itself, but rather against all other cities and counties across the country. That is, rating agencies and municipal bond investors will not just weigh their perceptions with regard to whether the city is truly recovering, but also how it compares to every other city and county in America—that is, those which did not, after all, go through bankruptcy. And they will likely weigh it from a somewhat jaundiced perception: when push came to shove, Detroit’s plan of debt adjustment was heavily focused on getting the city back on its fiscal feet and addressing the kinds of blight, arson, and public utility issues discussed above. Not unsurprisingly, municipal bondholders were not in the top tier of issues on which former Emergency Manager Kevyn Orr or Mayor Duggan focused. Or, as the indubitable wizard of chapter 9, Jim Spiotto noted: “Detroit is on the road to recovery, but it would be shortsighted to say it has recovered. Recovery for a distressed municipality like Detroit is better determined five or ten years later and judged by the extent of addressing the systemic problems that lead to the financial distress.”

Nevertheless, whether from the sharp reduction in blighted properties, the increasing property assessments, the nearly 33% reduction in unemployment, or the city’s projected $35 million budget surplus—its road to fiscal sustainability seems remarkable. Or, as Detroit CFO John Naglick puts it: “We’ve been very disciplined.” That discipline might be rewarded by the impending takeover by the State of Michigan of processing for individual income tax returns: Detroit’s income tax is its single greatest source of revenue—but one where collections from commuters—either into or out of the city—has been a significant fiscal problem.

Paying the Pipers. Detroit’s fiscal sustainability will depend upon its ability not just to address its mistakes of the past, but also to invest in its future. Even though CFO Naglick reports that “The city doesn’t have any borrowing plans over the next several years,” the state oversight commission notes: “[Detroit’s] debt service, even after the debt relief provided in the plan of adjustment, remains substantial.” The city’s last tranche of current city debt matures in FY2044, and the current annual debt service requirements through FY2025 average $147.4 million. That low tab matters—or, as the incomparable Matt Fabian of Municipal Market Analytics notes: “[Municipal] market perception is only hardening that Detroit’s municipal bankruptcy was an overtly political restructuring that favored art patrons, local businesses, and employees over bondholders…There is little trust that any new Chapter 9s would be any better, so any whiff of bankruptcy talk—as in Chicago, Atlantic City, and Puerto Rico—is enough to capsize that city’s bond prices.” Detroit, in its record chapter 9 bankruptcy, became the nation’s largest municipality to default on unlimited tax general obligation bonds. The old expression is ‘once burned, twice shy,’ or as one expert noted, referring to any consideration of purchasing Detroit bonds today: “This is not a credit that we would consider at this point, and we suspect that many in the market will continue to view Detroit as a speculative grade name and choose to sit on the sidelines.”

Uh Oh. Jefferson County, Alabama Circuit Judge Michael G. Graffeo, ruling there insufficient votes at the time, held that the “Isolation Resolution with regard to HB 573 was never adopted,” effectively striking down an Alabama state statute which was intended to permit the recovering, post municipal bankruptcy Jefferson County to return to the municipal bond market. (See: Jefferson County et al v. Taxpayers and Citizens of Jefferson County, Circuit Court of Jefferson County, #01-cv-2015-903133.00, December 14, 2015,) effectively finding that bill signed by Gov. Robert Bentley last May is unconstitutional: because House Bill 573 had not received a three-fifths quorum of representatives present when the vote was taken: 35 abstained; 13 voted to approve; and 3 voted no. In the court, Jefferson County’s attorneys had argued that under an Alabama House rule, the law was validly passed by the number of lawmakers who actually voted. Judge Graffeo, however, ruled that the Alabama state constitution controlled in this circumstance, because the vote on the bill occurred before the Legislature approved the budget, requiring the quorum to be determined by the number of legislators present for the vote, even if they abstained. Had Judge Graffeo ruled the other way, Jefferson County would have received a green light to refund about $595 million of limited obligation school warrants: the existing warrants are structured so any local tax revenues in excess of debt service requirements are used for early redemptions. The planned refunding authorized by HB 573 would have allowed Jefferson County to enact a replacement sales tax—the proceeds of which the county could have dedicated to pay debt service on the refunding warrants, as well as to fund various capital expenses—effectively clearing the way for what the county had hoped would have been its first issuance since its 2013 municipal bankruptcy exit financing to market before this year ended.

Going Back to the Roots of Its Bankruptcy. Jefferson County, which went through the nation’s largest municipal bankruptcy prior to Detroit, had, like Stockton, sought to raise taxes to avert default. That effort, however, was derailed when a county resident—a resident who had previously challenged the 2009 law which authorized Jefferson County to enact an occupational tax that supported its general fund budget—was successful when the court struck down the occupational tax, because Alabama legislators had failed to advertise it properly. That is, little steps can make seeming unbelievable differences—especially when combined with the lack of home rule authority in the state, which meant the county could not help itself, but rather was forced to rely on the legislature—so that any new local taxes must be authorized by the Legislature. It was that inability to get an ok from the legislature that contributed to forcing the county into chapter 9 bankruptcy in 2011. Jefferson County Commission President Jimmie Stephens has said that county revenues from existing sources available to the county are improving, but the additional revenue from the refunding was needed to address deferred maintenance and capital needs.

Human & Fiscal Disruption and Municipal Bankruptcy

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December 11, 2015. Share on Twitter

Human & Fiscal Disruption and Municipal Bankruptcy. Even as the City of San Bernardino is trying not just to get back to normalcy and resume efforts to finalize its proposed plan of debt adjustment to submit to U.S. Bankruptcy Judge Meredith Jury in the wake of last week’s terrorist attack, the aftershocks of the event—in the form of bomb threats—have surged. The calls are exacting a fiscal toll: Hours after the rampage which left 21 dead and 14 wounded, and even as some of those victims were being treated, a code yellow bomb threat was called in to the Loma Linda University Medical Center, according to a hospital spokeswoman. Even though fire and police officials have been unable to find any connection between the threats from multiple sources, and all the threats had been cleared without any weapons found; the threats themselves are imposing not just unanticipated costs, but also fiscal instability and erosion: the mere existence of the threats can hardly, after all, serve to enhance the city’s tax base or encourage either business or residential investment—but they do exact a fiscal and emotional toll, even if assessing the fiscal toll is intangible.

Rather, as Jim Buermann, president of the Police Foundation, notes, the threats themselves are dangerous — and despicable: “You can’t evacuate patients in ICU or critically injured patients unless you truly believe something will happen, because you could be endangering them. They literally could be causing someone to die…Especially in this time when so many people are on edge. This has had a very traumatic impact on the Inland Empire.” The most recent example came Wednesday with a hoax when one student called another student at Carter High School in Rialto, leading Rialto Unified School District officials to put the school on lockdown for an hour—just two days after the school had been had been searched in the wake of finding multiple photos of the high school on the cell phone of Syed Farook, the health inspector responsible for most of the district’s schools until he and his wife Tashfeen Malik killed 14 people and wounded 21 others, according to investigators—and just prior to the arrest by San Bernardino Sheriff’s deputies of another person on suspicion of placing bomb threats to three separate places — Loma Linda University Medical Center, Grand Terrace High School, and a San Bernardino apartment complex, according to the department. The San Bernardino City Unified School District is investigating a set of messages falsely claiming on Snapchat and Instagram that all schools in San Bernardino and Redlands would be closed. This is a city in municipal bankruptcy—and now on the precipice of fear.

While Mr. Buermann told the San Bernardino Sun that these kinds of threats are not necessarily common in the wake of a traumatic event, they can make an adverse event more likely: “The shooting, pursuit, that whole thing, that sets people on edge…And sometimes it’s enough to nudge someone who’s a very unreasonable human being toward doing something that’s just irrational or criminally mischievous to see if I can add to the angst that people have…Or, in the worst case scenario, it’s someone trying to test responses.” San Bernardino County Sheriff John McMahon warned, in a public statement: “Citizens should be wary of possible hoax messages and follow verified law enforcement social media accounts and press releases. Our primary responsibility is to make sure our communities are safe and we are committed to continue to ensure that.”

Last week’s mass shooting in San Bernardino was, reportedly, planned up to a year in advance—that is, almost simultaneously with the city’s planning of its plan of debt adjustment to submit to U.S. Bankruptcy Judge Meredith Jury. Put another way, there have been parallel, meticulous plans: one to devastate a municipality and maim its people, and one to give it a sustainable future. The attack was not an event which could have been anticipated—much less incorporated into the city’s plan of debt adjustment to submit to Judge Jury. It raises the question with regard to mass tragedies and their impact on municipal coffers: after all, San Bernardino could hardly afford such devastation and loss of lives in the midst of the longest municipal bankruptcy in U.S. history: are other municipalities prepared for comparable tragic eventualities?

The Precipitous to Recovery. Matthew Dolan, the fine Detroit Press columnist, this morning marked Detroit’s “one year of freedom today from the nation’s largest bankruptcy,” noting, nevertheless, that not every Motor City resident is necessarily overjoyed. He acknowledged that while Detroit is financially solvent, that it has thousands of new streetlights and its world class Detroit Institute of Art, and a balanced budget; yet it still “is struggling to find new solutions to old problems: endemic blight, vacant land, high crime, struggling schools, and a looming pension bill that city leaders are struggling to pay off.” Or, as he quotes the godfather of municipal bankruptcy, Jim Spiotto: “[I]t would be shortsighted to say that it is already recovered.” Indeed, Mr. Dolan noted that on Wednesday night at a community event at Wayne State University featuring the architects of Detroit’s bankruptcy plan of debt adjustment, organizers were forced to halt the event after about an hour—and the evening’s scheduled, featured speaker, Mayor Mike Duggan, never even reached the stage.

The event, sponsored by the Detroit Journalism Cooperative and Detroit Public Television had invited Mayor Duggan, Gov. Rick Snyder, and retired U.S. Bankruptcy Judge Steven Rhodes, who oversaw the court case, to provide their insights and assessments of the city’s progress; however, the event was brought to an early close after interruptions by some upset members of the crowd of more than 200 who questioned whether the nation’s largest ever municipal bankruptcy had been legitimate and successful—protests which apparently reached their zenith after Gov. Snyder began speaking about his appointment of Detroit’s emergency manager, Kevyn Orr, and defended the city’s entrance and exit from chapter 9 municipal bankruptcy as a last resort but a necessary one, telling the audience: “We eventually got to bankruptcy, but that was after three years” of efforts to fix the city’s balance sheet outside of court.

The session was brought to its untimely end when the celebrated lead rhythm guitar player of the ever judicious Indubitable Equivalents, retired U.S. Bankruptcy Judge Steven Rhodes, could no longer be heard by audience members—with the end coming after he expressed some of his concerns about Detroit’s looming public pension liabilities and its near bankrupt public school system. Mr. Spiotto, unsurprisingly, provided a broader perspective—especially in light of the near decade-long efforts we joined in nearly three decades ago to get the current version of chapter 9 municipal bankruptcy signed into law by former President Ronald Reagan: he noted that since then, there have been 295 Chapter 9 municipal bankruptcy filings, most of which involved municipal utilities and special tax districts: only 54 involved cities, counties, towns, or villages—and most of those ended up having their bids rejected by the court or came to an alternate solution outside of a bankruptcy judge’s approved plan of debt adjustment. Mr. Spiotto told the audience: “The real test is going to be five or ten years from now,” when, he said, the key issues will involve whether the city has under control the spiraling costs and dwindling tax revenue that forced its march into bankruptcy court.

Human & Fiscal Disruption & Mayhem and the Importance of Municipal Bankruptcy

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December 10, 2015. Share on Twitter

Human & Fiscal Disruption and Municipal Bankruptcy. Last week’s mass shooting in San Bernardino, in which 14 persons were killed, was reportedly planned up to a year in advance. It was not an event which could have been anticipated—much less incorporated in the city’s plan of debt adjustment to submit to U.S. Bankruptcy Judge Meredith Jury. It raises the question with regard to mass tragedies and their impact on municipal coffers: after all, San Bernardino could hardly afford such devastation and loss of lives in the midst of the longest municipal bankruptcy in U.S. history: are other municipalities prepared for comparable tragic eventualities? Now the city will have to bear not just the costs of its responses to this tragedy, but also significant new costs in the wake of it and to prepare for the future. What will these tragic events imply for the city’s residential assessed property values? Just as the elimination of blight and violent crime was a critical issue for Detroit’s plan of debt adjustment before now retired U.S. Bankruptcy Judge Steven Rhodes, so too San Bernardino will have little choice but to modify any proposed plan of debt adjustment to take into account the events with which it was beset. Might the federal government or the MIA State of California step in to provide some fiscal assistance?

It appears the suspected killers devoted as much time as the city has on its plan of debt adjustment in devising their own plan of human and fiscal destruction, commencing nearly two years ago, practicing with guns and making their own kinds of financial preparations in 2014: Syed Farook and Tashfeen Malik began honing their own fiscal and firearms skills last year at a shooting range in nearby Riverside, according to NBC, citing two sources, even as counter-terrorism officials said the pair began making monetary savings for their child and Mr. Farook’s mother during the same period—or, as one official noted; “[They wanted to] take care of both Grandma and the baby…They had purposely thought through that problem…[Some transactions] would be consistent with them making preparations for grandma and the kid.” The FBI is now investigating the incident for potential ties with terrorist organizations including the Islamic State in Iraq and Syria.

A week after the terrorist attack at the Inland Regional Center in San Bernardino that killed 14 people and left 21 wounded, more details have begun to emerge about the married couple the FBI believes to be responsible for the attack, Redlands residents Syed Farook and Tashfeen Malik, along with Farook’s former Riverside neighbor, Enrique Marquez. In testimony before the U.S. Senate Judiciary Committee yesterday, FBI Director James Comey said Farook and Malik had discussed jihad and martyrdom as early as 2013 and that both had embraced extremist Islamic ideology before their relationship had even begun — even before ISIS separated from Al-Qaida in 2014. Ironically, of course, these discussions and plan-makings were occurring even as the Congressionally imposed sequesters were reducing resources which might have helped save lives.

Letting Puerto Rico Help Itself. Sen. Orrin Hatch (R-Utah) yesterday blocked an effort by Sen. Charles Schumer (D-N.Y.) to pass to pass legislation to give the U.S. territory access to U.S. bankruptcy courts and allow Puerto Rico to restructure its debts in the same fashion as Detroit, Jefferson County, Central Falls, and other municipalities—rather than a bailout such as General Motors received. Indeed, Sen. Schumer specifically stressed that his proposal was not a “bailout,” warning that Puerto Rico’s fiscal and financial crisis will worsen absent action from Congress to permit the island to help itself: “If we fail to offer Puerto Rico assistance now, the problem will not be contained to the island…We have the tools to fix the problem. They’re sitting in the toolbox. The problem is Puerto Rico isn’t allowed to use them.”

Sen. Schumer’s comments came as the Chairs of three U.S. Senate committees, Sens. Orrin Hatch (R-Utah), Lisa Murkowski (R-Alaska), and Charles Grassley (R-Iowa) with jurisdiction over Puerto Rico and bankruptcy introduced a bill yesterday, the Puerto Rico Assistance Act of 2015, to create an authority which could issue municipal bonds and provide up $3 billion in resources to help Puerto Rico stabilize its budget and debt. While the proposed legislation would, if enacted, render some fiscal resources, it would not, however, provide the kind of bankruptcy protection available to every other U.S. corporation in the U.S.; rather, the bill would make clear that the U.S. is not bailing out Puerto Rico or pledging its full faith and credit to any bonds issued by the Financial Responsibility and Management Assistance Authority, whose six members would be appointed by the President; instead the measure would provide a 50% cut in the employee side of the payroll tax for five years and reduce the employee share of the tax to 3.1% from 6.2%. It proposes a number of studies, including on the Commonwealth’s pension plans and liabilities and the commonwealth’s healthcare treatment by the federal government. The legislation proposes to provide assistance to the island in improving its accounting and disclosure practices.

There was, mayhap, more constructive movement in the House yesterday, where Rep. Sean Duffy (R-Wis.), Chair of the House Financial Services Subcommittee on Oversight & Investigations, introduced legislation, the Puerto Rico Financial Stability and Debt Restructuring Choice Act, which would, if enacted, provide public authorities in Puerto Rico with Chapter 9 bankruptcy protection in exchange for the commonwealth’s acceptance of oversight from a Presidentially-appointed five-member Financial Stability Council, with Chairman Duffy stating: “This bill empowers the Government of Puerto Rico with the choice to partner with the Federal Government and put the island on a path towards balanced budgets and a return to fiscal security. If Congress does not act, it would have a devastating effect on the people of Puerto Rico and countless Americans throughout the states who stand to lose billions in the bond markets…This is a multi-pronged approach and a long-term solution. It cannot happen without adoption of legislation by the Puerto Rico Legislative Assembly which must be signed by the Governor. We know bailouts do not change spending habits. We need all sides to be fully committed to changing the way Puerto Rico manages its budgets, tax collection and finances.”

Chairman Duffy added: “The Puerto Rico Financial Stability and Debt Restructuring Choice Act gives the island’s leadership a choice: through the adoption of legislation passed by the Assembly and signed by the Governor, the Government of Puerto Rico will have access the same chapter 9 bankruptcy process that America’s States do if it also agrees to an independent Financial Stability Council to oversee the island’s path toward balanced budgets and a return to financial stability…The Puerto Rico Financial Stability and Debt Restructuring Choice Act will restore Puerto Rico’s access to an orderly debt restructuring process, without which the result would be disorderly litigation which is neither good for the island or its bondholders.”

In addition, the proposed bill would permit the appointment of a Puerto Rico Financial Stability Council: “In order to restore investor confidence and improve tax collection and budgeting practices, the Government of Puerto Rico may choose to accept the establishment of a 5-member Financial Stability Council with the authority to oversee the island’s financial planning and annual budgets. Unlike the D.C. Control Board of the 1990s, this Council will not be imposed on Puerto Rico – the island’s elected leaders in San Juan must agree to accept the Council. The Council’s duration will also be limited and it will not have the blanket authority to impose changes to Puerto Rico’s government. Rather, the Financial Stability Council will focus on just that: restoring financial stability to Puerto Rico.” Under the proposed bill, members of the Financial Stability Council would have to have knowledge and expertise in finance, management, and the organization or operation of business or government and would have to either have a primary residence in Puerto Rico or have their primary place of business on the island, according to the bill’s text. They could not provide goods or services to the commonwealth’s government and could not be a member of the government. Once established, the council would review an annual financial plan and budget from the governor and would have to approve it before the materials would be sent to Puerto Rico’s legislature. Any borrowing the commonwealth plans would also have to go through the council.

Gov. Alejandro García Padilla, speaking at the Puerto Rico Federal Affairs Administration in Washington yesterday, stressed that an extension of Chapter 9 municipal bankruptcy protections to Puerto Rico’s public authorities would not constitute a federal bailout; rather it would simply be a way to give Puerto Rico the “tools” it needs to fix its problems, adding that Puerto Rico is a lost ship of 3.5 million people sending a distress call to the federal government: “We are not asking for a bailout; we are asking for the tools to do the job,” adding that it was up to the federal government whether it wishes to answer the commonwealth’s calls. Nevertheless, he warned, if Congress continues its inaction, there will be a humanitarian crisis on the island.

Puerto Rico’s problem extends further than its $72 billion public debt and includes a lack of health care funding and federal tax credits that can put a halt to the large out-migration of its citizens and bolster the commonwealth’s economy. The governor, who has continually said the government does not have the funds to repay its debt, signed an executive order on Dec. 1 to pay $355 million in Government Development Bank notes that were due. But the order implemented claw back procedures that would take funds away from some lower priority bonds to pay back obligations backed by the commonwealth’s constitution. Puerto Rico has to pay $1 billion of debt service by Jan. 1 and the fate of that payment is uncertain with the lack of action from Congress. Gov. Padilla said he plans to meet with Treasury officials this week to further discuss the commonwealth’s position, but he did not have specific details on the meeting at the press conference.

The Drain. As we experienced in Detroit, a spiral of fiscal distress drains a municipality’s resources, costing streetlights, police response time, etc.—events and changes in fiscal capacity that can cause families to leave—that is, those that can afford to. Just as Detroit experienced a signal exodus before its filing for municipal bankruptcy, so too more than 200 Puerto Ricans leave the island for the mainland U.S. each and every day—those most able to afford to move, leaving behind those least able to make their own way and further sapping the Puerto Rican economy. At 5.7 percent, the unemployment rate in the Motor City is now ten percent below what it was six years ago—in a city where, between 2000 and 2014, 90,000 of its citizens moved out. The critical loss, of course, and most critical cause of its largest municipal bankruptcy in U.S. history, was the out-migration of its labor forces. As in Puerto Rico, key population shifts come from those most able to move—leaving those too old or too poor and dependent behind—and, of course, adding to the upside down imbalance on a city – or, in this instance – territory’s pension obligations. Puerto Rico biggest pension program has sufficient funds today to meet just 0.7 percent of its future obligations.

Forty percent of Puerto Rico’s citizens live below the poverty line. It is difficult, albeit, unfortunately, not impossible, to imagine the federal government ignoring the humanitarian crisis that would probably follow. But the longer Congress waits, the more vicious this cycle of those who can most afford to emigrate to the mainland and leave behind an ever accelerating shrinking tax base, rising taxes, and curtailed essential services will be. As U.S. citizens, the island’s migrants will be eligible for public support of various kinds on the mainland. There is no question, in other words, that the U.S. will end up bearing much of the cost of Puerto Rico’s past profligacy. The only question is how considered and efficient its assistance will be.

From Detroit to Havana: Challenges to Fiscal Futures

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December 9, 2015. Share on Twitter

The Motor City Road to Recovery. Detroit’s efforts on blight removal as part of its plan of debt adjustment and fiscal resiliency appears to be working: assessed property values in Detroit are beginning to increase in areas where blight has been removed, according to a new report by Rock Ventures and the Skillman Foundation released yesterday, which notes that demolitions have increased the value of surrounding homes within 500 feet by 4.2 percent, or an average of $1,106—an increase which, citywide, amounts to an increase in home values of more than $209 million—an increase which Mayor Mike Duggan yesterday described as “extraordinary,” adding that the city’s efforts to rid blight has allowed “good homes and good vacant homes” to increase in value. The report also suggests that, combined with other efforts by the city, including code enforcement and sales of public assets such as side lots, the value of homes nearby has increased by 13.8 percent, or an average of $3,634. Citywide, that amounts to an increased property value of about $410 million. From January 2014 until July of this year, 5,812 blighted structures in the city were demolished. The bad news is that the federal grant funding from the Treasury’s “Hardest Hit” program is running out: the federal grant program, which in 2010 provided grants of $7.6 billion available for foreclosure prevention in 18 states (Michigan received nearly $500 million, with 20 percent of its share going to Detroit for demolition of blighted residential structures and remediation.). Mayor Duggan plans to travel to Washington, D.C. soon to meet with White House officials in an effort to obtain a share of the next round of funding—a round dependent upon final Congressional action this week. The funding matters: Detroit has successfully used the funds so far to take on about 10 percent of its blight in the city.

Moody Blues: Lessons from recent Municipal Defaults and Chapter 9 Bankruptcies. Moody’s Investors Service yesterday noted that whilst municipal bankruptcies will remain rare, they will not be “unthinkable,” albeit the report added that “there is a waning taboo associated with municipal bankruptcy (please not story below on Hillview, Kentucky), so that its authors noted: “[W]e believe bankruptcy will increasingly be considered by extremely distressed entities as a tool to deleverage and reorganize liabilities, especially in the face of a pending service insolvency.” Indeed, in an uncharacteristically upbeat tone, the report added that Detroit’s “ability to enter and exit bankruptcy within 16 months with dramatically reduced liabilities and a path forward may be the template for future bankruptcies,” adding that the mere consideration of chapter 9 municipal bankruptcy by Detroit’s surrounding county, Wayne County, and Atlantic City, New Jersey appear to have triggered “state support and oversight” which have forestalled actual Chapter 9 filings, adding: Most recently, Hillview (please not item on Hillview below), Kentucky filed for municipal bankruptcy in order to avoid paying an $11.4 million legal judgment—a la the Town of Mammoth Lakes, Ca., Boise County, Idaho, and the Township of Westfall, Pennsylvania, which also cited legal judgments in their respective Chapter 9 filings. The report noted that “Of the recent bankruptcies, municipal bondholders have only came out ahead of pensioners in Central Falls, Rhode Island, adding that San Bernardino, which is currently holding the record for the longest period in municipal bankruptcy, “is seeking to substantially impair unsecured bondholder claims while leaving accrued pension liabilities untouched,” adding that “retiree healthcare benefits (also known as other post-employment benefits or OPEBs) essentially double what is at stake for retirees. They belong to the same creditor group as pensions, but have constituted separate legal claims within Chapter 9. As a result, they have emerged as an effective bargaining chip and have helped shield pension benefits by taking the biggest losses.”

The report warns that recovery rates for municipal bondholders will likely “be below historical levels…given the rise of preferential treatment for pensions: Detroit’s bondholders took deep losses during its bankruptcy. Holders of the city’s certificates of participation recovered a very low 12% and overall recovery was only 25%. In comparison, pension recovery was quite high at 82%”–and adding that “San Bernardino has recently proposed a 1% recovery for its pension certificate holders and an all-in recovery of 19%, while proposing no cuts to pensions. These rates are striking relative to the 64% historical average recovery on Moody’s-rated bonds.”

On the issue with regard to the role of states in the minority of states which permit municipalities to file for federal bankruptcy, Moody’s commented that “State aid intercept programs have thus far worked, but often depend on notification and well-functioning state governance: State aid intercept programs have thus far succeeded in preventing or curing a local government default,” but noted that state intercepts are “rare,” noting: “Intercept programs depend on strong underlying mechanics and the state’s commitment to ensure they work as intended. For example the State of Pennsylvania has not yet passed a budget for FY2016: The budget impasse has prevented state aid from being appropriated, which has called the reliability of that state’s intercept program into question and contributed to a downgrade of the program in November 2015.”

City on a Hill of Debt. In John Winthrop’s 1630 sermon on the good ship Arbella, he urged that the City of Boston be as a “city on a hill,” watched by the world. Fewer eyes are on a different city on a hill, Hillview, Kentucky, that is; nevertheless, it is a municipality that could change municipal bankruptcy, as that city seeks to use chapter 9 as a means to avoid making a full, court-ordered $15 million legal judgment payment to one of its creditors. Indeed, Hillview is utterly dissimilar to the municipalities we have covered; rather it is a growing municipality—a suburb of 8,000, which appears at little risk of insolvency, and is not claiming in its filing with the U.S. Bankruptcy Court an inability to pay its debt. Rather, as Moody analyst Nathan Phelps puts it: Hillview’s filing is “more evidence that municipalities increasingly consider Chapter 9 as a way to cure balance-sheet problems.” Thus it will be interesting to follow the court’s reactions as the trial commences this week in the wake of unproductive negotiations mediated by the ever electronically musical maestro of Detroit’s chapter 9 municipal bankruptcy, retired U.S. Bankruptcy Judge Steven Rhodes, the lead guitar for the Indubitable Equivalents. Unlike each of the other municipal bankruptcies we cover, Hillview’s issue relates to a decade-old dispute with Truck America Training LLC, which was awarded $11.4 million for business the company said it lost when Hillview took control of the land the company owned and from which it was evicted. Thus the issue is paying the award—something which Mayor Jim Eadens told the ever nimble Bloomberg reporter Tim Cook: “I don’t think they can shut us down as a city, and I don’t think they can put this burden on the taxpayers,” in an interview at Hillview City Hall. Indeed, Tammy Baker, Hillview’s city attorney, told Mr. Cook it was “financially irresponsible” not to file for municipal bankruptcy because of mounting interest costs—a filing made instead of any consideration of tax or fee increases, service cuts, or budget cuts. Nor does there appear to be any issue with regard to the municipality’s debt obligations. Jonathan Steiner, the Executive Director of the Kentucky League of Cities told Mr. Cook: “This is a unique situation…It’s not a city that spent itself into this situation or saw the collapse of an industry.” Unlike Detroit, which for decades endured an industrial collapse and a population exodus, Hillview’s population has grown more than 5 percent since 2010. The median household income, $48,000, exceeds the Kentucky average, and the percentage of people in poverty is less than half the state rate of 19 percent, according to U.S. Census data. From a fiscal perspective, Moody’s last summer noted that Hillview could issue municipal bonds to pay its court-levied debt and has “considerable ability to increase its two largest sources of operating revenue, occupational license taxes and property taxes.”

Hillview, however, begs to differ—or, as City Attorney Baker told Mr. Cook: “They think we can just go and raise taxes through the roof, and it won’t drive away business and it won’t hurt the citizens of Hillview…It would be possible to raise the occupational tax and the insurance premium tax to high amounts. That would be a heavy burden on our industry and a heavy burden on our citizens.” But as the ever prescient Dick Ravitch notes, Hillview could have a very tough day in federal bankruptcy court: “You have to prove you’re totally broke and can’t pay your debts.” Or as the greatest expert on municipal bankruptcy, Jim Spiotto told Mr. Cook, because of Chapter 9’s costs and unpredictability: “It’s going to be expensive, and that’s just the beginning…this will sound heretical, but there are better things to do than spending your money on lawyers.”

Shocking Municipal Bondholders. Puerto Rico’s Electric Power Authority (PREPA) gained another week from its municipal bondholders—time to get insurance companies to sign onto an agreement to restructure the agency’s $8.2 billion of debt and for commonwealth lawmakers to approval the proposal: the new agreement extends termination dates on an earlier agreement between the Authority and investors owning about 35 percent of the agency’s bonds to the middle of next week, according to the utility, marking a third extension—as all parties await a call for an extraordinary session of the legislature, a prerequisite for consideration of legislation to authorize a restructuring of PREPA—a restructuring which would be the largest ever in the $3.7 trillion municipal-bond market. The additional time came just days after the U.S. Supreme Court agreed to hear an appeal by Puerto Rico to reinstate a local debt-restructuring law that would allow some island agencies, including PREPA, to ask its municipal bondholders to take losses: the disputed law would affect $22 billion of Puerto Rico’s $70 billion in debt, including $8.2 billion owed by PREPA. The issue involves the authority of the Puerto Rican government to fill what it asserts is a gap in federal bankruptcy law, which bars filings by Puerto Rico’s public utilities. (PREPA owes $196 million of interest to investors on New Year’s Day, but U.S. Bank, the bond trustee, has approximately $24 million in a reserve account, according to a Dec. 7 event filing on EMMA, and the utility had, as of Sept. 30th, $252 million in deposits at the Government Development Bank for its reserve account, construction fund and operating account, according to a Nov. 6th financial filing. PREPA’s restructuring support agreement with bondholders “contemplates that some or all of the January 1, 2016 interest payments would be paid with funding provided to the authority, but it remains premature to predict whether and to what extent that will occur,” according to the EMMA filing. “The trustee is currently not holding other funds in the sinking fund that will be available to pay interest on the bonds due on January 1, 2016.” Under the restructuring support agreement, investors would take losses of about 15 percent in a debt exchange. Bond insurance companies which guarantee repayment on $2.5 billion of PREPA’s municipal bonds have yet to agree to the plan.

Cuba. In Havana, Monday, I asked about the city’s fiscal condition, but the answer was that the city is such an integral part of Cuba that it does not really have a separate fiscal existence. What it does have is remarkable vibrancy and a seeming lack of fiscal disparities, while it does have the most remarkable stream of vintage and colorful antique U.S. automobiles. Our visit came amidst a time of significant change, with U.S. and Cuban officials meeting the very next day in Havana for their first round of talks on billions of dollars in competing financial claims, one of the most contentious challenges in the process of normalizing relations—negotiations which are part of a broader agenda of discussions aimed at normalizing relations between the two countries after 50 years of enmity: there are 5,913 U.S. individuals and companies with claims which have been certified by U.S. officials against the Cuban government for property confiscated after the 1959 revolution, claims originally valued at $1.9 billion, with the bulk coming from corporations. Cuba says it has about $121 billion in counterclaims for damages stemming from the U.S. economic embargo. The two sides were scheduled to discuss “a wide variety of claims,” including those certified by the U.S. Foreign Claims Settlement Commission, government claims, and claims related to unsatisfied U.S. court judgments against Cuba, according to the State Department—for talks likely to last beyond President Obama’s presidency. The two sides also have continued pre-existing talks that have been under way on migration issues. The discussions come in the wake of last December’s announcement by President Obama and Cuban President Raúl Castro that the U.S. and Cuba would begin to normalize relations after decades of frozen ties. While only Congress can fully lift the trade and travel embargoes, the White House has taken several steps on its own to loosen regulations. The U.S. removed Cuba from its state sponsor of terrorism list earlier this year, and Washington and Havana restored diplomatic relations and reopened embassies in both capitals this summer.

Fiscal & Physical Resiliency in the Wake of Terrorism

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December 8, 2015. Share on Twitter

Fiscal & Physical Resiliency. In its first public City Council meeting since the violent events last Thursday in San Bernardino when San Bernardino County employee Syed Rizwan Farook stormed the Inland Regional Center in San Bernardino with his wife Tashfeen Malik, killing 14 and injuring 21 others, Mayor Carey Davis stated: “Our community has proven that it will not be paralyzed by the acts that were committed that day…It is our hope and goal that our community remains united and calm as the investigation continues, and as we continue to recover from the loss and suffering generated from the events that unfolded that day.” The council had met in an emergency, closed session the night of the shooting.

The Council session began with prayers, praise for the city’s first responders, and declarations that San Bernardino would remain strong—as well as with comments by U.S. Rep. Pete Aguilar (D-Ca.), with all stressing that the city had not been beaten. Mayor Davis alluded to multiple signs of support for the families and victims, and he announced charity picnic and blood drive planned for December 19th. Each of the seven City Council members offered condolences, and added that the response by police, firefighters and others — and the acclaim they had received nationally — put a positive face on the city. Councilman Rikke Van Johnson noted: “San Bernardino has displayed in the past a resiliency unparalleled during times of adversity. We will once again…Because of the horrific events that occurred, Dec. 2, 2015 will be a day San Bernardino will forever remember. But I guarantee you this: San Bernardino will be better. San Bernardino will be united. Together, we will be San Bernardino Strong.” City Clerk Gigi Hanna told attendees that in addition to 10-foot boards covered with messages which were displayed at the meeting, a memorial book collecting residents’ thoughts, prayers, encouragement or remembrance after the attack would be bound and placed in the city’s archives.

The harder question now is whether and how the horrifying event might impact the city’s fiscal future as its current City Manager prepares to depart and as questions arise with regard to how perceptions about public safety might impact assessed property values. Indeed, at the close of the portion of the meeting devoted to the horrific events, the council turned to its fiscal future—beginning with an update on its ongoing chapter 9 municipal bankruptcy and the efforts staff is working on to pull together a plan of debt adjustment composed of budget reductions and tax increases. But, at least for last week, all hearts were with the victims, and all uncertainty was with regard to how those events might impact the city’s future.

The Motor City Road to Recovery. An uncharacteristically upbeat Moody’s yesterday reported that Detroit’s economic and fiscal health are stronger a year after the largest municipal bankruptcy in U.S. history, but warned that daunting challenges remain, noting that employment in the city is growing, and Detroit’s revenue estimates are ahead of projections with Thursday marking the city’s first year anniversary of exiting bankruptcy and beginning the implementation of its plan of debt adjustment. Nevertheless, Moody’s Assistant Vice President Matthew Butler wrote, Detroit faces serious public pension challenges and risks. Mr. Butler noted: “City leaders and management are taking aggressive steps to revitalize the economy and sustain the current positive trends…These efforts are aimed at generating much-needed revenue growth to meet notable expenditure obligations over the next eight years.” In its report, Moody’s noted that Detroit’s unemployment rate had declined to 11.5 percent in September from 16.3 percent a year earlier—and that employment could realize further improvement, especially noting General Motors’ plans to add 1,200 jobs at its Detroit-Hamtramck assembly plant—adding these trends need to accelerate and Detroit needs to generate new revenue over the next decade to pay for high fixed costs.

We can too easily forget that while municipal bankruptcy provides a means for a municipality to shed some of its debt in order to ensure continuity in the provision of essential public services, it comes at a burdensome cost—and leaves residual fiscal challenges.

In Detroit’s case, notwithstanding reductions in its public pension obligations, the city, still carries very substantial debt and is at the bottom of an upside down pyramid where retirees from a much larger workforce – and who are projected to realize longer lifespans – create a looming fiscal challenge – especially as the city must budget for its resumption of contributions to its pension funds in 2024. And those contributions have been re-estimated, as we have previously noted, so that what had been projected to be $111 million in 2024, now appears to be nearly 75 percent greater at as much as $195 million, according to Moody’s, or, as Mr. Butler wrote: “Favorable pension plan investment performance between now and 2023 would reduce projected pension cost…Conversely, the cost would be even higher if plan performance falls short of the 6.75% average annual investment return currently assumed by the pension plans, which has likely already occurred in 2015. In the absence of substantial economic expansion and revenue growth, the requirement to resume funding pensions from general operations risks posing serious financial challenges for Detroit.”

Detroit closed its most recent fiscal year with an estimated operating revenue exceeding budgeted revenue by 1 percent, according to the Detroit Financial Review Commission. Revised estimates in September indicate that fiscal 2016 revenue is on track to exceed budgeted revenue by nearly 3 percent. Nevertheless, Mr. Butler noted that Detroit’s “formidable challenge” is maintaining economic growth while meeting high fixed costs.