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.

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