State & Local Tugs of War: What Do they Imply for Future Fiscal Sustainability?

January 22, 2016. Share on Twitter

What About Detroit’s Future? The Michigan Court of Claims yesterday refused to issue a temporary restraining order sought by the Detroit Public Schools (DPS) to halt the recurring teacher sickouts which have closed dozens of schools—and, no doubt, begun to discourage families from thinking about moving to Detroit—a key goal, after all, of the so-called “Grand Bargain,” which saved the Detroit Institute of Art, the jewel in the city’s crown. The court also scheduled a hearing for 11 a.m. Monday in the lawsuit filed by DPS against 23 teachers, the Detroit Federation of Teachers, interim DFT president Ivy Bailey, and organized sickout supporters such as DPS Teachers Fight Back and By Any Means Necessary—at the hearing, the court will hear DPS’ request for a preliminary injunction barring further sickouts.

The increasingly failing grades of the governing, fiscal, and physical conditions of DPS pose a significant threat to Detroit’s future—and raise questions about the state role. Of the $7,450-per-pupil grant DPS will receive this year, $4,400 will be spent on debt service and benefits for retired teachers, according to the Citizens Research Council. That leaves an insufficient investment for Detroit’s future—and a D- message for any family with young children thinking about moving to Detroit. But it also raises hard and harsh questions about the state role.

In denying the request for a restraining order, Court of Claims Judge Cynthia Diane Stephens wrote that DPS had failed to meet court rules governing requests that are made without notifying the other parties. According to DPS’ complaint, more than 31,000 of the district’s 46,000 students have missed a day of school or more as the result of sickouts. The complaint requests a court order requiring teachers to follow Michigan law, which prohibits strikes by public employees, as well as damages of more than $25,000. All DPS schools were open yesterday, a day after a sickout forced the district to close 88 of its 97 schools. But in their current physical condition, it is, increasingly difficult in a harsh winter to imagine how much learning is taking place.

Rather than address the fundamental issues, however, which have impacted the city’s physically failing schools, majority Republicans in Michigan’s Legislature yesterday proposed, and promised to quickly pass, state legislation to make it easier to deem such work stoppages illegal strikes. (Teacher strikes are illegal in Michigan.) The proposed legislation would shorten the 60-day deadline for the state Employment Relations Commission to conduct a hearing on complaints to two days—it would do nothing to address the severely deteriorated physical or fiscal state of the schools—its nearly bankrupt finances, dilapidated buildings, overcrowded classrooms—much less its growing attendance of rats.

Spinning the Dial for Municipal Bankruptcy. Atlantic City leaders have scheduled a session for Tuesday to discuss the possibility of filing for chapter 9 municipal bankruptcy protection at an emergency city council meeting: Mayor Don Guardian announced the meeting yesterday in the wake of Gov. Chris Christie’s rejection of an Atlantic City financial rescue package which had been approved by the state legislature—a rejection which undercut the city’s FY2015 budget adopted last September in reliance on $33.5 million in anticipated revenues from redirected casino taxes included in the rescue bills to address a $101 million deficit: the state legislation would have enabled the city’s eight remaining casinos to enter into a payment-in-lieu of taxes program for 15 years and aggregately pay $120 million annually over 15 years instead of a traditional property tax. In his statement, Mayor Guardian noted: “With the veto of the Atlantic City PILOT bill earlier this week by Governor Chris Christie, the City of Atlantic City has been left with no other option but to explore bankruptcy…The time is now because the State has failed to deliver on their promises.”

In one sense, the action will at least remedy the double-headed governance system in the city since last year’s appointment by Gov. Christie of a so-called “emergency manager,” Kevin Lavin (a term the Governor’s office created out of whole cloth, since it does not exist under any state statute). Rather the appointment came via the New Jersey Local Finance Board’s authority under the state supervision law (the so-called “trigger” law). Prior to Gov. Christie’s appointment of Mr. Lavin, the Board, in fact, had its own “monitor” in place who was overseeing contracts and personnel actions and looking for savings. That, however, proved to be only a modest effort and ignored the toll of the impact of the dramatic fall-off of assessed property values that started in the Great Recession. The Christie administration did little to prod the former administration to act, but waited until the next Mayor (white Republican, replaced African-American democrat) took office in 2014.

Atlantic City, indeed, has been under state supervision since 2010—the beginning, as it were, of the end—or the “triggering” event.” The next step would be for Atlantic City to come to the New Jersey Local Finance Board (which would be acting under circa 1940’s law as the “Municipal Finance Commission”) to consider permitting Atlantic City to file a chapter 9 municipal bankruptcy application with the courts—a first-time route for the state—where the New Jersey statute to be invoked has never been used. Ergo a new process will have to be invented from scratch.

Castling? In the game of chess—much as in the political game of chess underway in New Jersey today—the thin line between the middle game and endgame is often not clear: it may occur gradually or with the quick exchange of a few pairs of pieces. The endgame, however, tends to have different fiscal and physical characteristics from the middle game, and the players have correspondingly different strategic concerns. In particular, pawns become more important as endgames often revolve around attempting to promote a pawn: the king, which has to be protected in the middle game owing to the threat of checkmate, becomes a strong piece in the endgame. It can be brought to the center of the board and act as a useful attacking piece. So what we are observing now are chess moves: Over the last year since the state’s appointment of Mr. Lavin, he and other New Jersey state actors have been pushing Atlantic City to monetize the municipal utility authority (MUA) asset to bring in cash to deal address the accumulating debts—a monetization which will likely be offset by increased water rates (while the MUA’s costs can be reduced by a savvy operator, the Garden State tradition has been to add a so-called “concession fee” to fund the deficits which the buyer receives back through rate increases). The City, however, said no; Gov. Christie said he would not sign the legislation into law; Senate President Stephen Sweeney, observing the gathering fiscal storm (both the one descending in a few hours and the fiscal one right behind it), reckons that the legislature will have to act on a takeover bill.

Bottom line, at least according to our brilliant, on site analysts: Atlantic City has no real way out: The state has a plan. Atlantic City needs to negotiate the best deal it can accomplish via asset sales and the state’s role in operations (which are burdened with overpriced labor contracts). Indeed, New Jersey has a long, hard-earned reputation in the muni markets for averting municipal bankruptcy—effectively acting to preempt chapter 9. The state’s alternative has been a state takeover—e.g., addressing the looming insolvency not via municipal bankruptcy and the federal courts, but rather without bankruptcy—which, in any event, would require the state’s affirmative approval. Stay tuned.

Puerto Rico. Financial Guaranty Insurance Co. (FGIC) filed suit in U.S. federal District Court against Puerto Rico Gov. Alejandro García Padilla and members of his government, the latest challenge over their diversion of revenues from Puerto Rico authority municipal bonds, charging that §8 of Article VI of the Puerto Rico Constitution and the Territory’s Management and Budget Office Organic Act, Act No. 147 of June 18, 1980 (the so-called “OMB Act”), and the executive orders (the “Executive Orders”) issued last November 30th and December 8th by the Governor are unconstitutional—and seeking a declaratory judgment that §8, the OMB Act, and the Executive Orders are preempted by the U.S. Constitution and federal law and are, ergo, without force and effect.

In the suit, FGIC also seeks an injunction enjoining Puerto Rico from taking or causing to be taken any and all actions pursuant to §8, the OMB Act, or the Executive Orders, claiming such actions would constitute violations of FGIC’s constitutionally-protected property interests and contractual rights—and adding that both the U.S. Constitution and federal law preclude Puerto Rico from enacting a bankruptcy law that adjusts the debts of its municipalities or public entities and binds non-consenting creditors, noting: “The United States Congress has enacted a federal Bankruptcy Code, expressly providing that States have no power to enact their own laws for adjusting debts, see 11 U.S.C. § 903(1), and excluding the Commonwealth’s instrumentalities from participating in the federal bankruptcy system, see 11 U.S.C. §§ 101(40), (52), 109(c). Despite these prohibitions, Section 8 of Article VI of the Commonwealth Constitution, the OMB Act and the Executive Orders purport to (a) authorize the Commonwealth to adjust debts, to defer repayment and to decrease interest and principal owed by the Commonwealth’s instrumentalities and public entities and to bind non-consenting creditors, (b) permit the Commonwealth to seize and use Plaintiff’s collateral without providing adequate protection, and (c) establish an overriding priority scheme to distribute Plaintiff’s collateral in contravention of binding contractual obligations and federal law.”

U.S. District Court Judge United States District Judge Gustavo Gelpi yesterday consolidated FGIC’s suit with a similar suit filed earlier this month by Assured Guaranty and Ambac Assurance in the same court: Judge José Fusté will hear the case. Here, Puerto Rico’s so-called claw-back was from the pledged funds for Puerto Rico Highways and Transportation Authority, the Puerto Rico Convention Center District Authority, and Puerto Rico Infrastructure and Finance Authority bonds. According to the Government Development Bank for Puerto Rico. Through the beginning of the year, Puerto Rico had clawed back $164 million from these municipal bonds for use for the January 1 general obligation bond payment: according to FGIC’s filing, the company had an exposure of close to $1 billion by different Puerto Rican authorities and a total outstanding bond principal of $$6.4 billion—adding that, in some instances, municipal debt service reserves have been exhausted—and that FGIC, as the insurer of some of these bonds, paid at least $6.4 million in claims. This complaint adds that the government rested its claw-back on §8 of article VI of Puerto Rico’s constitution, the Puerto Rico Management and Budget Office Organic Act of 1980, and gubernatorial executive orders of last Nov. 30th and December 8th—claiming, further, the Puerto Rico constitution and the orders violated the United States Constitution, specifically citing Article I, §10 of the U.S. Constitution, the Contracts Clause, writing: “[T]he authority bondholders are subject to payment first of public debt, that does not authorize the defendants to ‘claw back’ or divert the pledged funds under the circumstances described in the executive orders, namely where other available resources exist from which the public debt could be paid.”

In addition, the suit cited the “taking clause,” of the 5th Amendment, the due process clauses of the 5th and 14th Amendments, and the equal protection clause of the 14th Amendment—and, for good measure, that the Commonwealth’s actions are preempted by federal law–asking the federal court to void the two executive orders authorizing the claw-back of revenues and to bar Puerto Rico from introducing a claw-back of authority bond revenues in the future. FGIC asked the court to block Puerto Rico’s government from diverting revenue pledged to repay debt issued by some agencies—an action coming in the wake of Gov. Padilla’s decision last month to force Puerto Rico’s Infrastructure Financing Authority (PRIFA) to miss a $35.9 million interest payment due at the beginning of the month—an action which triggered FGIC to pay 22 percent of the $6.4 million in interest which it guarantees. FGIC’s suit follows in the wake of comparable suits filed by Ambac Financial Group Inc. and Assured Guaranty Ltd. this month—diversions which allowed the U.S. territory to avoid defaulting for the first time on its general-obligation bonds, which, under Puerto Rico’s constitution, have the highest legal priority. The court consolidated FGIC’s complaint with Ambac and Assured Guaranty’s suit yesterday. The insurers say the roughly $9 billion of revenue the island expects to collect in the fiscal year ending in June exceeds Puerto Rico’s $1.87 billion of debt-service costs, showing that it does not need to redirect funds away from PRIFA and other agencies. Gov. Padilla has said he has an obligation to protect residents from deep public and essential service cutbacks needed to cover its debts. (FGIC insures repayment of $768.8 million of PRIFA’s principal and interest through 2045: as of the end of last September, according to its website. It insures $10.6 million of debt service in 2016, according to Edward Turi, FGIC’s general counsel.

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