Uneducated about Municipal Bankruptcy?

February 29, 2016. Share on Twitter

Uneducated about Municipal Bankruptcy? Gov. Rick Snyder will end weeks of speculation today by bringing retired U.S. Bankruptcy Judge Steven Rhodes out of retirement to run the Detroit Public Schools on behalf of the state. Even though he will not be called an emergency manager — the new title is transition manager — a spokesman for the governor said he will handle most, if not all, of the duties previously assigned to Darnell Earley, the emergency manager whose resignation becomes effective today, with the Governor’s spokesperson stating: “The transition manager would fulfill the role of emergency manager under the laws, but Judge Rhodes is anticipating his tenure ending on July 1 under the current legislation.” Under Gov. Snyder’s proposed schedule, he expects an appointed school board to take over DPS and keep the schools running until a board elected in November can take over next Jan. 1; however, that is a scenario which relies upon the Michigan legislature adopting his proposed education restructuring package, which would provide $720 million over 10 years to erase the district’s long-term debt, by this summer and turning the district back to an elected school board. Lawmakers, though, are hung up on the creation of a Detroit Education Commission that would oversee the opening and closing of traditional public and charter schools. Gov. Snyder had initially wanted to appoint the members jointly with Detroit Mayor Mike Duggan, but the mayor and local education advocates want Mayor Duggan to make the appointees.

That election could happen as early as August—even as DPS is likely to be insolvent by spring. According to Gov. Snyder, Judge Rhodes will oversee DPS’ finances and operations, and is working to name an interim superintendent to oversee the improvement of academics. Under the proposed plan, according to Judge Rhodes, that amount would free $1,000 per student currently being spent on debt service to use in the classroom, noting: “We want to make sure the district’s resources are best spent in the classroom helping students and teachers.”

Gov. Snyder and Judge Rhodes, however, have yet to designate an interim DPS superintendent to foster academic improvement for the city’s 46,000 students. Tonya Allen, the Skillman Foundation President and CEO (a foundation which has donated millions towards the DPS district) who had been rumored to be in line for the job, on Friday said she had declined the job—adding that, as an adviser to help tailor the job, she believed any new DPS leadership should not come from outside the district: “We’re constantly looking for a heroic leader, and the district does not need a heroic leader: What the district needs is a revolt from inside.”

The appointment comes in the wake of time Judge Rhodes has already spent with Michigan lawmakers at the Governor’s request to help them better understand the precarious nature of DPS’ finances and the potential negative consequences of the school district filing for municipal bankruptcy. In addition, Judge Rhodes has met with teachers. And it comes in the wake of the early (no pun) departure of Darnell Earley as the DPS emergency manager—pressured to depart before his scheduled July 1 date based upon the significant fiscal and physical deterioration of DPS since his start—and given his apparent inability to perform well as the previous emergency manager in Flint, where he was also asked to step down. In each instance, not only did he preside over rapidly deteriorating fiscal situations, but also over health and safety issues risking the lives of young children.

While Judge Rhodes’ appointment is more than likely to impress upon state lawmakers the urgency of avoiding still another municipal bankruptcy in Detroit, the conflict between his previous federal judicial bankruptcy service and his newly appointed position would bar him from acting as an emergency manager and taking—as Kevin Orr did in Detroit, DPS into chapter 9 bankruptcy. For his part, Judge Rhodes said that even though the superintendent would report to him, he was looking for someone to “partner with me in running the Detroit schools…We’re vetting a number of candidates, some on the inside and some not…I guess it would be an advantage to get someone on the inside. I’m not sure that’s necessary, but it would be helpful.”

The naming of Judge Rhodes is also intended/hoped to break the abysmal record of emergency manager failures in DPS—with Mr. Earley, the fourth to depart early because, according to him, he “had completed his goals ahead of schedule.” Such a statement would lead a reasonable person to question just what his goals were. Robert Bobb had been the first DPS emergency manager: he had been appointed by the Governor in 2009, a year in which DPS served 172 schools, 85,000 students, and had a $219-million deficit. Today, DPS is comprised of only 97 schools serving 46,000 students, and it has a mathematically challenging $515-million deficit; DPS employment has declined over that time from 11,000 employees to 6,000—this in an academic year which has witnessed teachers stage sick-outs to bring attention to dilapidated, rat-infested, and unsafe buildings; and it comes in stark contrast to Mayor Mike Duggan’s efforts to rebuild post-bankrupt Detroit into a 21st-Century city.

As we have noted many times, perceptions and the reality of the quality of a city or county’s public schools are one of the most basic building blocks for that municipality’s long-term future. The quality of schools is inextricably interwoven into assessed property values: if a family does not perceive a positive outcome from their child’s attendance in such a public school system, they will choose to leave; they will choose not to move to such a jurisdiction. Thus, in Detroit, its leaders, and, now, Judge Rhodes, just over a year after Detroit exited the largest municipal bankruptcy in American history, confront what could be an even steeper set of challenges—the success, or failure, of which will be inextricably linked to Detroit’s future solvency.

Among the most difficult:

Governance: Who is responsible for a city or county’s schools, ultimately? Is it the state? Is it the city? Is it an elected school board? And who makes those decisions? People far away in the state capitol? It could be that the greatest gift Judge Rhodes might be able to bestow would be ownership of responsibility—and accountability for DPS. One Detroit publication described this challenge—with regard to our traditional concepts of electing school boards—this way: “While some board members have been insightful, smart and knowledgeable about education, others included a school board president who was functionally illiterate and fondled himself while meeting with the superintendent in his office and others who approved contracts that sent some people to prison.”

Leadership. The challenge for Judge Rhodes is to seek an absolute fiscal reversal from near-insolvency to a debt-free, repaired school district. Or, as Michigan State Education Superintendent Brian Whiston put it: “We have to fix the short-term problem of the debt, but the long-term problem of the students, or we’re going to be right back where we are five or 10 years from now.” The current education, physical, and fiscal insolvency will require leaders who will engage in long-term strategic planning and in non-traditional thinking about how to address issues such as systemic poverty and issues of poverty and dysfunctional literacy within the family and the community structure.

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February 26, 2016. Share on Twitter

Out Like Flint. The profound threats to human health and safety in Flint created in signal part by a state appointed emergency manager—especially for the city’s children—appear to have been issues brought to the state’s attention long before there was any action: key advisers to Gov. Rick Snyder urged switching Flint back to Detroit’s water system nearly a year and a half ago in October of 2014 in the wake of a General Motors Co. warning that Flint’s heavily chlorinated river water was rusting engine parts, according to governor’s office emails examined by The Detroit News: Valerie Brader, then Gov. Snyder’s environmental policy adviser, requested that the governor’s office ask Flint’s state-appointed emergency manager to return to Detroit’s system on October 14, 2014, three weeks before Gov. Snyder’s re-election. Moreover, Mike Gadola, then Gov. Snyder’s chief legal counsel—today a Judge on the Michigan Court of Appeals, appointed by Gov. Snyder– agreed Flint should be switched back to Detroit water nearly a year before state officials relented to public pressure and independent research demonstrated elevated levels of lead in the water and bloodstreams of Flint residents. Mr. Gadola’s memo reported: “To anyone who grew up in Flint as I did, the notion that I would be getting my drinking water from the Flint River is downright scary…Too bad the (emergency manager) didn’t ask me what I thought, though I’m sure he heard it from plenty of others.” Mr. Gadola added that his mother remains a resident of Flint, making his personal alarm part of his communication to Gov. Snyder’s Chief of Staff Dennis Muchmore, Deputy Chief of Staff Beth Clement, as well as then-Communications Director Jarrod Agen, writing: “Nice to know she’s drinking water with elevated chlorine levels and fecal coliform…I agree with Valerie (Brader). They should try to get back on the Detroit system as a stopgap ASAP before this thing gets too far out of control.”

The telltale emails make clear that that some of the Governor’s closest advisers were privately, but clearly put on notice of the human health threat to Flint—especially its children—long, long before the state began to act. The information comes in the wake of the Governor’s office this week releasing nearly 1,6oo pages of emails to The Detroit News related to Flint’s 2014 switch to river water—a switch which experts believe caused the deadly leaching of lead into Flint’s drinking water. If anything, the News notes, the emails make clear that the Governor’s aides discussed poor water quality in Flint as early as the fall of 2014 after the city issued limited boil-water advisories because of an outbreak of E. coli and total coliform bacteria in the water supply. Moreover, Ms. Brader’s email alluded to festering apprehensions with regard to how the chlorine used to kill the bacteria outbreak was causing the formation of a harmful disinfection byproduct known as trihalomethane, a carcinogen which can increase the risk of cancer, liver, kidney, and central nervous system problems—or, as she tellingly wrote: “Specifically, there has been a boil water order due to bacterial contamination…What is not yet broadly known is that attempts to fix that have led to some levels of chlorine-related chemicals that can cause long-term damage if not remedied (though we believe they will remedy them before any damage would occur in the population).” Two months later, the Michigan Department of Environmental Quality issued a Safe Drinking Water Act violation to Flint for the high levels of trihalomethanes in the water. According to state records, Flint violated the law twice more until coming into compliance on Sept. 2, 2015. Nevertheless, despite her concerns and other staff concerns about the city’s brownish water quality, the Governor’s staff never took a recommendation to him that Flint be switched back to Detroit water until the following October.

Perhaps unsurprisingly, the apprehensions by key members of the Governor’s staff were held in abeyance pending completion of the new Karegnondi Water Authority pipeline could be completed; however, Michigan Treasury Department officials seemed to feel that the cost to reconnect Flint to Detroit water — an extra $1 million per month — was more than the fiscally stressed city of Flint could afford, with, as one aide to the Gov. put it: “The assessment was you couldn’t do it, because it was a cost that should have borne by the system.” Nevertheless, Mr. Muchmore, in a subsequent email, advocated using a $2 million grant the state had given Flint to upgrade its troubled water plant toward reconnecting to the Detroit water system, tellingly writing: “Since we’re in charge, we can hardly ignore the people of Flint,” in an email he sent to communications officials in the Governor’s office, the state Department of Environment Quality, and the Treasury Department, adding: “After all, if GM refuses to use the water in their plant and our own agencies are warning people not to drink it…we look pretty stupid hiding behind some financial statement.” But when asked why the Governor’s office had not sought funding from the Michigan Senate and House appropriations Chairmen last winter for a supplemental appropriations bill to reconnect Flint to Detroit’s system, the former chief of staff told the Detroit News it would have been dead on arrival.

Indeed, the newly released trove of emails demonstrates that Ms. Brader learned of GM’s switch to Detroit water on October 14, 2014 from an aide in the office of Senate Minority Leader Jim Ananich (D-Flint): Ms. Brader sent a note that afternoon to other top gubernatorial aides writing that Flint’s water was “an urgent matter to fix.” By August and September 2014, the city of Flint had issued boil water advisories to residents after water tests revealed an outbreak of E. coli and total coliform in some parts of the city. To treat the outbreak, the city increased the amount of chloride added to the drinking water at the Flint water treatment plant—chlorine levels General Motors had cited when it disconnected from Flint’s water system and turned to nearby Flint Township’s water, which came from Detroit’s Lake Huron pipeline. The message, however, did not seem to impact Flint’s state-appointed emergency manager: On Oct. 16, 2014, the City of Flint reported that General Motors’ exit from Flint’s water system “ensures that Flint residents will continue to have safe quality drinking water but minimizes the impact on GM’s machining work.”

Puerto Rico. In the wake of two Congressional hearings this week, Congress appears to be leaning in support of creating a federal oversight control board for the U.S. territory of Puerto Rico—an oversight board not dissimilar to previous New York City and Washington, D.C. boards—authorized to restructure and oversee Puerto Rico’s debt, pension, and economic crises. The hearings come as House Speaker Paul Ryan (R-Wi.) has set a March 31 deadline for action by the full House—a critical timeline, as Puerto Rico risks insolvency as early as April. Legislators said the two hearings, one on the Treasury Department’s proposal for the commonwealth and the other on possible ramifications of a restructuring on the municipal bond market, were the last scheduled before they prepare to draft a legislative package before a March 31 deadline imposed by House Speaker Rep. Paul Ryan (R-Wisc.).

At one of yesterday’s two hearings, Antonio Weiss, a counselor to U.S. Treasury Secretary Jack Lew, testified the administration believes the best solution is for Congress to allow for territorial restructuring authority using the powers Congress has under the U.S. Constitution’s Territorial Clause: “This would give Puerto Rico the tools it needs to reach a resolution with creditors and adjust its debts to a sustainable level…Importantly, this authority would expressly not apply to states, which have an entirely different relationship with the federal government under the 10th Amendment.” Mr. Weiss’s testimony appeared to signal a shift in the Administration’s position to ask Congress to authorize Puerto Rico authority to restructure all of its debts under Chapter 9 bankruptcy protections—a proposal dubbed “Super Chapter 9,” which never gained support in Congress because of misplaced apprehensions and misunderstandings in Congress about the nation’s dual sovereignty. Mr. Weiss also dispensed with a second misapprehension with regard to Puerto Rico’s public pension liabilities, testifying that while the Treasury is “deeply concerned about the pensions in Puerto Rico,” he said there was no truth to some press reports that the administration is proposing to put the territory’s pension obligations above its debt obligations in a restructuring hierarchy. Instead he said everyone should come to the table in a restructuring. With regard to restructuring, the Administration believes it should be in three parts in addition to a balanced approach to any federal board’s authority: a temporary stay on litigation to allow for voluntary negotiations between creditors and the commonwealth; a voting mechanism to prevent a few hold-out creditors from blocking a reasonable compromise; and a court-supervised structure to assure an orderly resolution if negotiations fail. Mr. Weiss testified there would be room for further Puerto Rico proposals to address economic growth, territorial tax reform, and improving Puerto Rico’s access to federal healthcare programs, noting: “We believe it is for Puerto Rican legislators and the governor to identify the reforms that are needed structurally, but we think it is equally important that the oversight board makes sure that those reforms that are identified are implemented.” He also sought to address apprehensions about potential concerns which have been raised with regard to broader adverse impacts on the state and local municipal bond front, noting that a key focus was to ensure an orderly restructure of the islands debts precisely to avoid the kinds of “cascading defaults and litigation” over the next decade that could risk muni market destabilization, telling lawmakers: “The best thing for municipal bond markets is for this to be brought to an orderly solution.”

Chairman Rob Bishop (R-Ut.) of the Natural Resources Committee, in the wake of the hearing, seemed to concur that any entity given oversight authority in Puerto Rico would also need to have the power to restructure, stating: “Some organization that is going to do a restructuring in this situation has to be the logical solution and there’s no other way around it…But it’s not necessarily going to be a remake of other control boards that have happened in the past. It has to be dictated by the specific situation.”

In the companion, simultaneous hearing chaired by Rep. Sean Duffy (R-Wis.), Chairman of the House Financial Services Committee’s Subcommittee on Oversight & Government Reform, Mark Zandi, Moody Analytics’ Chief economist testified that the Chairman’s proposed legislation was “a very positive step in the right direction;” however, he said he believed it failed to be broad enough, noting that Puerto Rico needs a much broader restructuring of all of its debts—as well as its unfunded pension liabilities. (Chairman Duffy’s proposed legislation (HR 4199) would provide public authorities in Puerto Rico with Chapter 9 municipal bankruptcy authority in return for Puerto Rico’s acceptance of a newly created five-member Financial Stability Council to review and approve its financial plans, budget and borrowing plans.) Mr. Zandi testified that authorizing the territory to file for municipal bankruptcy might only help restructure 30% of Puerto Rico’s debt—and perhaps up to 75% if COFINA bonds were included, but the proposal could trigger expensive and lengthy litigation—consuming time that is running out; ergo, Mr. Zandi recommended a Financial Stability Council be authorized to implement a temporary stay of perhaps 12 to 18 months on all debt payments so that there would be sufficient time to “fashion a sustainable restructuring.”

Anne Krueger, a senior research professor of international economics at Johns Hopkins University who led a study on Puerto Rico’s economic situation and prospects, told lawmakers the Commonwealth needs to reform its financial policies to become sustainable, stressing that Puerto Rico must deal with its unfunded pension liabilities, reform its tax and business policies, and receive Medicaid equal to all other states. William Isaac, senior managing director and global head of financial institutions for FTI Consulting, testified that authorizing municipal bankruptcy authority to the territory, “would be unprecedented and would have far-reaching implications, including raising the costs of borrowers for the fifty states.” Subcommittee members responded that Iowa Gov. Terry Branstad had raised the same apprehensions in a recent letter to House leaders. But Rep. Nydia Velazquez (D-NY) noted: “There’s no evidence of this,” and asked Mr. Zandi for his perspective—in response to which, he replied: “Investors have said quite clearly that Puerto Rico’s situation is Puerto Rico’s situation and it’s no one else’s problem.”

Our respected and admired friends at Municipal Market Analytics this week provided their own key perspective on this tension we have observed in Detroit, Central Falls, Stockton, and San Bernardino, noting that by elevating Puerto Rico’s pension systems to a higher priority that its constitutional debt, the territory would be “abrogating its duty to creditors,” adding that such an elevation would also be picking one set of retirees over another—e.g., in this instance, Puerto Ricans, who own a significant amount of the U.S. territory’s debt: 30 percent of all outstanding Puerto Rico municipal bonds are owned on-island through retirement funds, leading MMA to write: “By choosing to support pensioners from the public employee system instead of debt, the Commonwealth would effectively be choosing public employees over private employees, biasing the system against retirees who saved in private markets in favor of retirees in the government-run program. Pension systems in PR are collectively underfunded by about $44 billion at present, according to the most recent actuarial estimates, and the contributions made by public employees into defined contribution plans have been liquidated alongside the contributions made for defined benefit plans in the past. Meanwhile, about 30 Puerto Rican credit unions (cooperativas) are on the brink of default due to losses incurred on PR bonds.” Thus, MMA worries: “If the stated purpose of a PR restructuring is to protect regular Puerto Ricans through shared sacrifice, proposals of the type advanced by the US Treasury (per Reuters) are not the route forward, as severe damage to the local financial system would ensue under such a plan.”

Seizing Atlantic City. If anything, the time line for insolvency could be direr in Atlantic City than Puerto Rico, potentially triggering a state takeover of the city even if the state fails to enact pending takeover legislation. The issue comes with regard to costs: according to a memo from the nonpartisan Office of Legislative Services (OLS), preventing a “catastrophe” would require significant, long-term state financial support. Such a situation could occur if the city defaulted on its bonds or were unable to transfer property tax payments to the state, local school district, or Atlantic County government. Atlantic City, which is on the edge of insolvency, has little to no ability to borrow: its credit rating is below junk-bond status. Under the Local Government Supervision Act of 1947 — the same law that allowed the state to imposed oversight of some parts of city government in 2010 — New Jersey has significant powers to intervene in the city’s finances, according to OLS. It also has additional authority because the local government receives transitional aid that is subject to a memorandum of understanding with the Division of Local Government Services. The memo notes: “At the point when Atlantic City cannot borrow, short-term, to pay its essential operating expenses and payments due to the county and other taxing districts, it is hard to envision the State refusing to exercise its powers under the Local Government Supervision Act (1947) to take control of the finances of the city.”

The new development comes as local leaders, led by Mayor Don Guardian, are pushing back against the takeover proposal sponsored by Senate President Stephen Sweeney and supported by Gov. Chris Christie, with Mayor Guardian and City Council members holding a press conference at the beginning of the week to oppose the legislation, with the mayor going so far as to describe it as a “fascist dictatorship.” Nevertheless, the Governor and Sen. Sweeney have stood their ground, albeit Assembly Majority Leader Lou Greenwald, the sponsor in the lower chamber, on Monday said he may not move forward with the proposal unless local leaders are on board. Nevertheless, Atlantic City’s leaders are rapidly losing leverage: Gov. Christie last month vetoed a bill that would have protected the city from the impact of court-ordered reassessments on the struggling casinos and injected millions of dollars in revenue in the near term. Now the new takeover proposal comes with similar legislation, which would create payments in lieu of taxes the casinos could pay to the city, the school district and county government.

If state lawmakers were to drop their takeover effort, some form of intervention increasingly seems inevitable, according to the legislative services memo, which asserts the state has “sufficient authority over the city’s finances to prevent a financial catastrophe.” In the short-term, the state could offer a low or no-interest loan. It could also force the city to liquidate debt and require the city’s financial officer to issue special reports and hold hearings, OLS says. While the state would not be able to unilaterally end existing collective bargaining agreements — a power included in the proposed takeover bill — it could negotiate new agreements with unions. But all that would not necessarily fix the city’s deep-rooted problems, according to OLS. The city owes hundreds of millions of dollars to bond holders and casinos that won tax appeals, and it also receives less money than it used to from the casinos. Referring to the pachyderms in the house, the memo notes: “Of course, the ‘elephants in the room,’ being the tax refunds owed by Atlantic City to the casinos and the corresponding loss of casino ratables to the city’s property tax base, will likely render the State’s financial supervision efforts insufficient to fully address Atlantic City’s financial situation without the provision of increased long-term financial aid to the city and school district.”

To make matters worse, federal bankruptcy protection — something that city had been mulling but would need state approval to seek — may not be able to solve the issue either. A judge may not have the authority to erase or “cram-down” the $170 million in debt the city owes the Borgata Hotel Casino & Spa, which had won tax appeals and is owed a refund. Because the casino is exercising its right to skip property tax payments until the city issues the refund, a judge might consider the debt a credit against future taxes, or, as OLS noted: “If the Borgata property tax refund can be characterized as a property tax prepayment for future tax quarters, then it is unlikely that the bankruptcy code’s automatic stay of action would apply.”

Marc Pfeiffer, the superb Assistant Director of the Bloustein Local Government Research Center, Bloustein School of Planning and Public Policy in New Brunswick, New Jersey, notes that generally, while New Jersey clearly has significant authority now, given the magnitude of Atlantic City’s immediate and long term problems, the traditional solutions may not work, pointing to immediate issues such as cash flow, the need for stability of calculating casino property values and the tax revenue they represent, and monetizing their accumulated debt and deficits. He wrote that the long term requires the city to restructure and rationalize the cost of running the city: the current cost structure (with a few exceptions) was effectively established when Atlantic City had 12 casinos of higher value (i.e., market value of $22B in 2007 and $7.4B today), adding that labor costs, staffing levels, and position allocations all need to be rationalized—and there is no adequate legal authority for that to happen. Further, he notes, city officials need to understand that the current and prior generations of elected officials could have done a better job of managing their resources. The city has traditionally been overstaffed with pay scales in excess. Historically the city has been rife with patronage appointments and expectation of privilege (he notes, for instance, that only in the last month did city council members give up their personal vehicles). That means they cannot do business as usual and blame the state; that does not win any arguments, adding that even though Atlantic City officials were aware of the drop in value, they did little to address it.

Similarly, he adds, New Jersey’s plans for the City over the last 6 years have not met expectations: political decisions along the way resulted in the today’s crisis: Instead of waiting until 2015 to engage via an emergency manager who only recommended actions, if stronger state action had been taken several years ago, the immediate crisis could have been avoided—adding that, nevertheless, the situation being as grave as it is, the parties need to quickly align and understand that dramatic action is needed now to avoid a municipal bankruptcy filing which would only prolong the problem and add more costs. He notes that while the state clearly has significant authority now, given the magnitude of Atlantic City’s immediate and long term problems, the traditional solutions may not work. The immediate issues: cash flow, the need for stability of calculating casino property values and the tax revenue they represent, and monetizing accumulated debt and deficits. Further, he wrote, city officials need to understand that the current and prior generations of elected officials could have done a better job of managing their resources. The city has traditionally been overstaffed with pay scales in excess.

He added that New Jersey’s plans for the City over the last 6 years have not met expectations: “political decisions along the way resulted in the today’s crisis. Instead of waiting until 2015 to engage via an emergency manager who only recommended actions, if stronger state action had been taken several years ago, we could have avoided the immediate crisis…But we are where we are, and the parties need to quickly align and understand that dramatic action is needed now to avoid a bankruptcy filing which will only prolong the problem and add more costs.”

Down the Road Questions about the State of the Motor City

February 24, 2016. Share on Twitter

State of the Motor City. In his third State of the City address, Detroit Mayor Mike Duggan described the significant changes in Detroit since its emergence from the nation’s largest ever municipal bankruptcy—but warned of serious challenges to the city’s fiscal sustainability. He outlined the significant human and public infrastructure gains since the city’s plan of debt adjustment was approved by retired U.S. Bankruptcy Judge Steven Rhodes, including significant reductions in violent crime and homicides, improved public safety responses, and the massive upgrading of bus service and street lighting. He pointed to ongoing blight removal and demolition efforts, adding jobs, and cutting car insurance rates. He noted his leadership efforts to restore the quality of Detroit’s public schools—an issue which, absent both significant state aid and a signal turnaround in the wake of abysmal leadership under the state-appointed emergency manager, threatens his goal of restoring the city to be one to which young families with children would want to move—reiterating the urgency of restoring an elected school board. He noted the city had successfully razed 8,000 abandoned homes—part of the city’s significant efforts to lure more people to Detroit. The city has cut ambulance response times in half from 18 minutes, and Mayor Duggan said the city will soon work on improving pay for emergency medical technicians and firefighters. Detroit will hire 200 officers this year, he said, and equip them with technology to recognize license plates in a bid to help arrest more than 1,000 people with outstanding warrants for a gun crime. Detroit Police Chief James Craig has put together a new fugitive apprehension unit to go after the more than 1,000 people with outstanding warrants for gun crimes, including car-jackings and armed robbery, Mayor Duggan, noting they will be using technology equipped with photos and license plate information of suspects: “We are tired of the gun violence. We are not putting up with it anymore.” The mayor added he will propose plans to continue with Detroit’s massive demolition effort with a goal of 20,000 houses by the end of 2017. In two years, the city has razed 8,000 houses and last week it was announced that Michigan was eligible for $323 million in federal funds to tackle blight. Starting Tuesday, residents can call 911 to report scrappers, he said, in still another sign of the city’s recovery since emerging from bankruptcy. “They’re going to arrest them and haul them away,” Mayor Duggan said. He also referenced several new initiatives unveiled in recent weeks. Last week, Mayor Duggan announced a $40 million fund to help 1,000 buyers obtain mortgages in Detroit and overcome a gap in property appraisals that has thwarted neighborhood revitalization.

Detroit’s Fiscal Sustainability. In his address, Mayor Duggan reported his office would submit its FY’2017 budget, one, which he noted: “will be balanced for a third straight year.” Nevertheless, the Mayor warned of serious fiscal threats to Detroit’s nascent recovery, especially with regard to the looming $491 million deficit in Detroit’s public pension liabilities, reminding listeners that if the city takes no action to reduce those obligations, the general fund will have to contribute $83 million more a year to the two funds, commencing in FY’2024. Noting that he did not intend to “panic” over the pension fund deficit, he said his office is acting to bring in an expert to review and analyze pension liability estimates used as part of the city’s plan of debt adjustment—and that his budget would include $20 million over two years from the city’s budget surplus specifically targeted to reducing that deficit: “We are going to get on it now…We are not asking anybody for a bailout. We are going to have to address this problem. We are going to do it honestly.”

The public pension warning comes in the wake of last fall’s report from the Detroit Financial Review Commission which found in its actuarial projections that Detroit’s required annual contribution or ARC to its two pension funds in FY2024 could increase by $80 million compared to the projections used in its federally approved plan of debt adjustment. Thus, while the city’s plan of debt adjustment provided significant pension relief to the city with regard to contributions to the General Retirement System and Police and Fire Retirement System through 2023, it is after that, beginning in FY2024, that the document requires the city to start funding a substantial portion of the pension obligations from its general fund—an amount projected under the approved plan to be $113.9 million, but raised more than 80% late last year to $196 million in a report by the actuarial firm for the city’s retirement systems—based in part on mortality data contemplated in the bankruptcy plan projections. Yesterday, Mayor Duggan said former Detroit Emergency Manager Kevyn Orr and the city’s bankruptcy consultants may have “used the wrong assumptions,” adding that he has directed the city’s Law Department to evaluate any claims against the city’s former bankruptcy consultants, who were paid $177 million dollars: “I don’t know whether it’s actionable or not, but we’re going to pursue it,” noting he had authorized the city’s chief litigation officer to review the bankruptcy consultants’ work during Detroit’s municipal bankruptcy to determine if there are possible legal claims. 

The Costs of Municipal Bankruptcy. Detroit Mayor Mike Duggan, in his address, said he would assess whether the City of Detroit should file suit against some of the city’s bankruptcy consultants for using what he said were outdated data—here creating a miscalculation of jaw-dropping proportions: the total $491 million pension fund shortfall. The Mayor, as noted above, aimed especially harsh criticism at former Detroit Emergency Manager Kevyn Orr and his consulting team, albeit adding: adding: “We’re going to manage it, and we are not going to ask anybody to bail us out…We are going to keep our pension funds solvent…We are going to keep our promises to retirees. They were broken once and we are going to make darn sure it doesn’t get broken again.” 

The costs to a city or county of filing for and going through municipal bankruptcy are costs for which there is little choice but to pay in order to ensure the provision of critical public services–yet, as we have seen in Stockton, San Bernardino, and Detroit–the costs are not just a signal drain on the city’s coffers–but they come at the expense of funds and investments critical to a municipality’s long-term fiscal sustainability. 

Michigan’s Role in Municipal Fiscal Fates

February 23, 2016. Share on Twitter

Out Like Flint. Does Flint have a fiscal future? University of Michigan-Flint Professor Marty Kaufman, who has been leading a research team studying the city’s denigrated water lines, has reported there are as many as 8,000 lead service lines—making the announcement yesterday at a news conference at City Hall, in the wake of his team’s painstaking analysis of handwritten records, paper maps, and scanned images to create a digital database of lead pipes. Professor Kaufman stressed that while the project is a full compilation of available data, the records, compiled from a 1984 survey, do not always indicate the types of pipes used—vastly complicating Mayor Karen Weaver’s efforts to get those lines removed as quickly as possible from what, once, was the state’s second largest city, but where, today, the fear of lead contamination, especially for children, can only threaten significant adverse fiscal consequences for the city as families with children become increasingly fearful of remaining in the city—not to mention the apprehension of other families about moving to Flint: fears that cannot bode well for the city’s assessed property values. Because at the time of the switch of its water supply, under then state-appointed emergency manager Darnell Earley, Flint did not treat the water with anti-corrosion chemicals: the omission allowed river water to scrape too much lead from aging pipes and into some residents’ homes. Nevertheless, yesterday, Gov. Snyder said 89 percent of water samples collected from key locations in Flint measured below the “action level” of 15 parts per billion for lead in an initial round of testing, adding that samples from the so-called “sentinel” sites will help determine when it is safe to drink unfiltered water again.

Out Like Snyder? Meanwhile, the Michigan State Board of Canvassers, which is responsible for canvassing and certifying statewide elections, elections for legislative districts that cross county lines and all judicial offices, except Judge of the Probate Court, conducting recounts for state-level offices, canvassing nominating petitions filed with the Secretary of State, canvassing state-level ballot proposal petitions, assigning ballot designations and adopting ballot language for statewide ballot proposals, and approving electronic voting systems for use in the state, has approved another petition seeking to recall Gov. Snyder, citing the governor’s declaration of a state of emergency in Flint after lead leached from the pipes into the city’s water supply. The Board approved the petition yesterday from the Rev. David Bullock of Detroit, who had filed his petition two weeks ago yesterday after the board rejected eight petitions to recall the Governor. Notwithstanding the approval, Rev. Bullock now must obtain at least 789,133 signatures. If approved, the recall effort would become a ballot question which would then need majority support from Michigan’s voters.

Schooling on Municipal Bankruptcy. As every city or county elected leader knows, the quality of a jurisdiction’s public schools are fundamental to such a jurisdiction’s fiscal balance: if the schools are excellent: they attract families to the city or county, with important, positive implications for assessed property values and property tax collections. If, in contrast, they appear to be physically dangerous or threatening, or incompetent; the schools can create the opposite fiscal outcome. Thus, even though many public school systems are nominally distinct from city or county-elected jurisdictions; those locally elected leaders have a very great stake in the perceived excellence of their public schools.

The city and Detroit Public Schools (DPS) have entered a consent agreement setting a timetable to address hundreds of safety and health violations in DPS’ school buildings. The agreement covers the first 26 schools inspected by the city that require repairs; additional schools will be added as inspections progress. Detroit Mayor Mike Duggan stated: “What we wanted was a commitment from DPS with specific time lines for making each repair and a binding agreement enforceable in court if those time lines are not met.” The action by the city comes in the wake of Detroit’s Building, Safety, Engineering & Environmental Department’s four-month inspection program for all 97 DPS buildings after complaints by teachers and parents about problems including water leaks, mold and heating—and rat infestation: at six schools with reported rodent infestations — Blackwell Institute, Clark Preparatory Academy, Cody High, Sampson-Webber Leadership Academy, Ronald Brown Academy and Spain Elementary-Middle — inspections are being done monthly by pest control contractors, according to the city report. Building checks were promptly conducted in 20 DPS buildings believed to be most problematic. Inspections of the remaining district buildings, plus Detroit charter schools, are to be completed by the end of April. The consent agreement, signed by Detroit’s City Attorney and Marios Demetriou, the DPS deputy superintendent of finance and operations, includes a spreadsheet listing progress on scores of projects and completion deadlines. City officials report that city inspectors have visited 64 DPS properties so far. In addition, the Detroit Health Department also conducted follow-up inspections in some cases. It is uncertain how the action taken by the city to deal with the dysfunctional DPS might impact—at least from a fiscal perspective—the suit filed last month by the Detroit Federation of Teachers with regard to building conditions, and seeking the removal of state-appointed Emergency Manager Darnell Earley, although Ivy Bailey, interim president of the DFT, said: “We do not plan to withdraw it until we are confident that the consent agreement’s commitments have been fulfilled.” Mr. Earley, who has previously served, or mayhap mis-served, as Gov. Rick Snyder’s appointed Emergency Manager for the City of Flint, will step down on Monday.

Recovery! Wayne County, the largest county in Michigan—and the home not just to Detroit, but also to 33 other cities and 9 townships—and where Michigan Gov. Rick Snyder last July had declared a financial emergency, and which is still operating under a consent agreement with the state—is now, according to the unmoody Moody’s, stable, with Moody’s Investors Service having revised its credit rating outlook on Wayne’s junk-level rating upward from negative in recognition of the Wayne County’s remarkable success in making substantial cuts to its public pension liabilities and other operating expenses, noting: “Revision of the outlook to stable from negative reflects diminished near-term fiscal challenges.” In response, Wayne County Executive Warren Evans noted: “Moody’s decision to upgrade our credit outlook to stable is a step in the right direction…Our successes last year in eliminating the structural deficit and reducing unfunded health care liabilities were definitely noteworthy, but, we aren’t resting on those successes. My administration continues to work to restore long term fiscal stability to Wayne County.”

The county has succeeded in reducing nearly $50 million in spending, achieved with elimination or modification of retirement benefits, a contraction of payroll, and other operating efficiencies over the last six months—having announced earlier this month that it is expecting $23 million in fiscal 2016 budget relief from cuts to retiree healthcare benefits—cuts which trimmed $850 million from its unfunded liabilities. In addition, the county now projects its annual savings are expected to grow, citing its post-employment benefit liabilities as one of the factors which had driven its deficit enough to raise the specter of municipal bankruptcy. Indeed, County Executive Evans noted: “The restructuring of the county retiree healthcare was the single largest contributor to restoring solvency.” Wayne County reduced its actuarial accrued OPEB liability by 65% in 2015, lowering it to $471 million from $1.32 billion, according to an actuarial analysis from Nyhart Actuary & Employment Benefits: the restructuring is projected to reduce Wayne County’s pay-as-you-go contribution this year down to $17.6 million from $40.4 million. In its upgrading, Moody’s analysts noted: “Enhanced control over expenditures was key to addressing the county’s fiscal concerns given limited options to raise revenue.”

Spinning the Debt Wheel in Atlantic City: “The city’s fiscal crisis is severe and immediate.” A new Atlantic City rescue bill, the “Municipal Stabilization and Recovery Act,” would give the State of New Jersey increased authority over Atlantic City’s finances as part of an effort to avoid the city going into chapter 9 municipal bankruptcy: the proposed legislation would empower the state to renegotiate Atlantic City’s outstanding municipal debt and municipal contracts for up to five years, while also giving the state the ability to leverage city assets and make staff cuts. Under the proposal, Atlantic City would be given one year to find a way to monetize its water authority. The quasi-state takeover of the city, coming in the wake of last month’s veto by then-Presidential candidate Gov. Gov. Chris Christie—a package which would have enabled Atlantic City’s eight remaining casinos to enter into a payment-in-lieu of taxes program for 15 years and aggregately pay $120 million annually during that period instead of a traditional property tax. The introduction of the bill came in the midst of ongoing governance confusion—with the role of the Governor’s appointed emergency manager for the city still in question. There has been, however, little question from the city’s perspective: Mayor Donald Guardian, joined by city council members and other elected officials, harshly criticized the takeover plan yesterday in a press conference, urging instead a new financial assistance bill which would allow the city to maintain “sovereignty,” with Mayor Guardian stating: “We cannot stand here today and accept any bill with the broad, overreaching powers as the one presented to us last week contained.” Or, as Atlantic City Council President Marty Small put it: “We were all troubled by this draft bill: It takes our sovereign right to govern our own city away.”

The legislation was introduced by New Jersey State Senate President Steve Sweeney (D-Gloucester), with Senators Kevin O’Toole (D-Wayne), and Paul Sarlo (D-Wood-Ridge), in an effort to avoid an Atlantic City chapter 9 municipal bankruptcy—with time beginning to run out at the home of the gaming tables: According to a January 21 report from Gov. Christie’s appointed emergency manager Kevin Lavin, Atlantic City could default as early as April absent a state rescue package. That is, there looms an Atlantic City fiscal hurricane—the red flag warnings of which now appear to have disrupted the year-beginning “new partnership” between Mayor Guardian, Gov. Christie, and Sen. Sweeney to avoid municipal bankruptcy—or, as Mayor Guardian described it: “The final piece of legislation that the State presented to us was far from a partnership…It was worse. Some would even say fascist.” Atlantic County Freeholder Ernest Coursey was no less upset, noting: “It will be a cold day in hell before we just stand by idly and just allow folks to run over the people of Atlantic City…I think we ought to work in partnership with the state of New Jersey and stop this hostile talk of a takeover.”

In Rome, they would say: tempus fugit, or time is flying: In this case, time is running out: in addition to addition to municipal bond debt, Atlantic City confronts a debt of $170 million to the Borgata casino from its tax appeals and a missed $62.5 million payment owed last December; moreover, Atlantic County Court Judge Julio Mendez ordered a 45-day mediation period commencing February 5th: Mayor Guardian yesterday said that if no resolution can be reached by then, he will have no choice but to petition the state’s Local Finance Board for a bankruptcy declaration, adding: “The sad irony is that we have a casino industry that wants to redirect their funds to the City of Atlantic City to help avoid all these doomsday scenarios,…There is a reasonable and practical solution out there, but that path has not been chosen by the state yet.”

Saving Puerto Rico. The U.S. House will convene simultaneous hearings on Puerto Rico Thursday as part of an accelerating effort to meet House Speaker Paul Ryan’s (R-Wi.) deadline for final House action by April first: The House Financial Services Committee’s Subcommittee on Oversight and Investigations will hold a hearing on the possible effects of Puerto Rico’s debt crisis on the municipal bond market; the House Natural Resources Committee will convene its hearing to discuss the Treasury Department’s analysis of the situation in Puerto Rico. The subcommittee hearing will feature three witnesses: Anne Krueger, a senior research professor of international economics at John Hopkins University who led a recent economic study of Puerto Rico; Juan Carlos Batlle, senior managing director of CPG Island Servicing, LLC; and William Isaac, senior managing director and global head of financial institutions for FTI Consulting. House Financial Services Subcommittee Chair Sean Duffy (R-Wis.) has, to date, been a key player in seeking to determine an exit from Puerto Rico’s looming insolvency: he introduced legislation last December to give Puerto Rico’s public authorities Chapter 9 bankruptcy protection in return for the creation of a five-person, Presidentially appointed financial stability council, seeking to balance the municipal bankruptcy authority Democrats have been pushing with the oversight authority for which Republicans have pressed. The Treasury proposal the Natural Resources Committee is scheduled to discuss is not dissimilar to Rep. Duffy’s, but it would propose restructuring for the entire commonwealth, a legislative concept deemed by some “Super Chapter 9” bankruptcy—a proposal which has not gained support in Congress over misplaced apprehensions by some that such a proposal could open up the possibility for states, such as Illinois, to try to restructure their constitutionally backed general obligation debts. These members are, apparently, unfamiliar with the dual sovereignty system unique to the United States of America. The Treasury position supports restructuring for the entire commonwealth, but that the extension of restructuring could come through Congress’s power under the Constitution’s Territorial Clause—a clause which gives Congress the power to “dispose of and make all needful rules and regulations respecting the territory or other property belonging to the United States.” U.S. Treasury Secretary Jack Lew has backed comprehensive restructuring legislation for the territory, partially to make it easier for its officials to bring all the commonwealth’s creditors to the table.

It Ain’t Over ‘Til It’s Over: One would think that after the long, tortuous, expensive process of gaining approval for a plan of debt restructuring from a U.S. Bankruptcy Court to exit municipal bankruptcy, a municipality could get back to focusing on recovery. But then you might be misjudging. Jefferson County, Alabama, however, finally at least has its new day in court set to determine whether its approved bankruptcy plan of debt adjustment is final: The 11th Circuit Court of Appeals has tentatively set the week of May 16 for its expected schedule of oral arguments in an appeal of the county’s successful exit from Chapter 9 municipal bankruptcy—albeit the 11th Circuit has no timeframe within which it must rule after arguments are heard. But one could anticipate a long and arduous road: it has taken well over a year to prepare the record for the court to consider hearing arguments, meaning that Jefferson County has now been in appeal longer than it was in municipal bankruptcy case. The lingering issue relates to the county’s approved plan of debt adjustment which .enabled it to issue $1.8 billion in sewer refunding warrants to write down $1.4 billion in related sewer debt two years ago last December—an approval which provoked a group of ratepayers on the sewer system to appeal U.S. (now retired) Bankruptcy Judge Thomas Bennett’s approval, and after, nearly 18 months ago, U.S. District Judge Sharon Blackburn rejected the Jefferson County’s contention that the ratepayers’ bankruptcy appeal was moot, based in part on the fact that the plan was largely consummated when the refunding debt was sold.

February 18, 2016. Share on Twitter

Schooling on Municipal Bankruptcy. Michigan House Speaker Kevin Cotter (R-Mt. Pleasant) yesterday told his colleagues that a municipal bankruptcy reorganization of Detroit Public Schools (DPS) “must remain on the table” if lawmakers are unwilling to impose “serious academic and financial reforms” on the troubled school district, noting that a state Senate plan to codify Gov. Rick Snyder’s $715 million request to help DPS escape crippling debt and funnel more money into classrooms is inadequate to address systemic issues in the district, adding: “I am interested, and my caucus is interested, in being problem solvers…But we’re not going to be problem enablers. Just simply cutting a check for $715 million and returning control, I believe, is only enabling the problem.” The Speaker’s statements came as Michigan House Republicans this week introduced a new Detroit school plan—a proposed plan which would implement various academic reforms in the district, including an A-F grading system for individual schools and a third-grade reading initiative that would require the district to hold back struggling students—a plan which, nevertheless, immediately drew ridicule from both Detroit Democrats and unions. The proposal would also limit collective bargaining rights for district employees, penalize teachers who participate in “sickouts,” and put new teachers into a 401(k)-style retirement plan. The proposed plan also seeks school board elections next November—a contrast to Detroit Mayor Mike Duggan’s plan, which seeks an even faster transition, while the pending plan in the Michigan House would not restore a fully elected school board for at least eight years. Nevertheless, the legislative task of reconfiguring Detroit’s fiscally and physically failing schools is encountering its own obstacles in the state legislature, with Senate Majority Leader Arlan Meekhof (R-West Olive) yesterday noting that the House package is unlikely to help ongoing negotiations in the Senate, where majority Republicans are trying to win over reluctant Democrats, especially members from Detroit. Sen. Goeff Hansen (R-Hart) is sponsoring legislation to create a new debt-free Detroit school district—telling his colleagues yesterday that he is focused on getting bills passed that fix the school district’s finances before tackling academic reforms.

The more than academic problem is the clock, which is ticking towards a municipal bankruptcy of DPS as early as April Fool’s Day. Indeed, yesterday, retired U.S. Bankruptcy Judge Steven Rhodes, who presided over Detroit’s chapter 9 municipal bankruptcy trial and has been serving as a special advisor to Governor Snyder on DPS’s looming insolvency, has warned lawmakers against allowing the district to go through a Chapter 9 reorganization. The Michigan Treasury Department has estimated a Detroit school district bankruptcy could leave the state on the hook for at least $1.5 billion of debt the district owes creditors, including the state’s own school employee pension fund.

With just weeks to reach consensus, the Speaker yesterday warned that Democrats in both chambers had spoken out against the Senate bills last month upon introduction, warning: “That tells me there probably isn’t a sweet spot in this one for a bipartisan plan…“I haven’t closed the door to it, but for Republican support, there are going to have to be some pretty serious reforms.” Speaker Cotter yesterday acknowledged that a DPS municipal bankruptcy would trigger significant state fiscal costs—more than a bailout, but he noted he was unwilling to put $715 million of additional taxpayer money into what he called a failed system: “To the extent that people want to hold out just for money and the return of control, I am perfectly comfortable keeping the option of bankruptcy on the table.”

Spinning the Debt Wheel in Atlantic City: “The city’s fiscal crisis is severe and immediate.” A new Atlantic City rescue bill, the “Municipal Stabilization and Recovery Act,” would give the State of New Jersey increased authority over Atlantic City’s finances as part of an effort to avoid the city going into chapter 9 municipal bankruptcy: the proposed legislation would empower the state to renegotiate Atlantic City’s outstanding debt and municipal contracts for up to five years—with a goal of allowing Atlantic City to regain access to the municipal bond market while, at the same time, achieving cost savings through reorganized government operations, consolidating agencies and engaging in shared services. Under the proposal, the state would also have authority to leverage city assets to gain needed revenue—or, as State Senate President Steve Sweeney (D-Gloucester), who introduced the bill with Senators Kevin O’Toole (D-Wayne), and Paul Sarlo (D-Wood-Ridge) put it: “The intervention plan will enable the state and the city to work together to accomplish what Atlantic City can’t do on its own: “The city’s fiscal crisis is severe and immediate.” Under the proposed legislation, Atlantic City would have one year to find a way to monetize its water authority before the state could act to use the assets to generate needed funds; Atlantic City would retain its decision-making authority unless New Jersey’s Local Finance Board acted to take control. The increasing urgency—as in Michigan—comes in recognition that Atlantic City is at fiscal risk of insolvency by early April absent state assistance, according to a Jan. 21 report from former emergency manager Kevin Lavin: Atlantic City is behind on a payment it owes the Borgata casino on $170 million in tax appeals and missed a $62.5 million payment it owed last month. As Sen. Sarlo warned last month: “If the city is allowed to go into bankruptcy, all the decisions would be imposed by a [federal] bankruptcy judge…This plan gives the city and the state a voice and a role in making the decisions that will impact the lives of the residents and the future of Atlantic City. This is a far better process than [chapter 9 municipal] bankruptcy.” A companion bill was also introduced that would enable casinos to make payment in lieu of taxes payments in an effort to end costly tax appeals. Gov. Chris Christie had rejected a financial relief package last month that would have enabled Atlantic City’s eight remaining casinos to enter into a PILOT (payment in lieu of taxes) program for 15 years and aggregately pay $120 million annually in that period instead of a traditional property tax. The amended bill shortens the PILOT period from 15 years to 10 and also would require casinos make additional payments based on their share of total gaming revenue that would be used for paying down the city’s more than $400 million in outstanding debt.

Saving Puerto Rico. Puerto Rico Tuesday released a draft version of its FY2014 CAFR as part of an effort to enhance Congressional support to help the U.S. territory avert insolvency as early as the end of next month—and in response to repeated calls by members of U.S. House and Senate, as Congress, under pressure from House Speaker Paul Ryan (R-Wi.) is pressing for some legislative resolution by then. Puerto Rico Gov. Alejandro García Padilla yesterday noted that with the release, Congress has sufficient fiscal data, adding that “The Commonwealth has provided an unprecedented amount of reliable and up-to-date financial information regarding the depth and imminent nature of Puerto Rico’s debt crisis.” Nevertheless, a representative of KPMG said Puerto Rico’s audited CAFR was still six to seven weeks away. Swift action in providing the data matters: Senate Finance Committee Chair Orrin Hatch (R-Utah) noted: “It’s been a real challenge to obtain verifiable financial information from Puerto Rico…The territory has taken positive steps forward…I plan to review the unaudited statements in their entirety, but I also hope the government of Puerto Rico fulfills my request for detailed audited financial statements as well as information regarding the territory’s public pension plans and other budgeting issues. As any entity that borrows with federal tax preference understands, unaudited statements or reports from groups hired by the government, complete with disclaimers against assured accuracy, are no substitute for audited, verifiable information.” In presenting the draft CAFR, Gov. Padilla said, “the Commonwealth has reiterated the critical need for Congress to provide Puerto Rico with a broad restructuring framework to address its unsustainable debt burden. The risk of Congress not providing such framework – which costs nothing to U.S. taxpayers – is condemning Puerto Rico to a legal morass that will jeopardize essential services for U.S. citizens living in Puerto Rico, further accelerate out-migration to the U.S. mainland and severely impair creditors’ ability to recover on their claims.” The draft CAFR demonstrates a widening in the island’s net deficit position of the commonwealth’s “primary government” to $49.2 billion as of June 30, 2014 from $46.7 billion a year earlier. Its “governmental activities” net deficit position widened to $50 billion from $47.5 billion in the same period—or, as Puerto Rico Treasury Secretary Juan Zaragoza, in a statement accompanying the draft CAFR put it: “The Commonwealth currently faces a severe fiscal and liquidity crisis, the culmination of many years of significant governmental deficits, a prolonged economic recession (which commenced in 2006), high unemployment, population decline, and high levels of debt and pension obligations…If management is unable to complete [a debt] restructuring by the end of FY2016, or to otherwise obtain additional funding or other arrangements with its creditors, the commonwealth’s management expects that the commonwealth and various instrumentalities will be unable to comply with their scheduled debt obligations.”

The Downhill View of Municipal Bankruptcy from Hillview. Meanwhile, farther north in the little municipality (population under 9,000) of Hillview, Kentucky, a suburb of Louisville, and Truck America—under orders from U.S. Bankruptcy Judge Alan C. Stout—have agreed to participate in federally court-ordered mediation talks on Monday, albeit some portions of the process will be kept secret; they are also under orders from Judge Stout to produce a mediation statement in advance of the talks which will include each party’s position and may include settlement information that is inadmissible in court, according to bankruptcy attorney John Whitlock, with Locke Lord LLP. Hillview is the first municipality in Kentucky ever to file for chapter 9 municipal bankruptcy; the city filed its petition last August, claiming it was intended to halt the 12% interest compounding annually on an $11.4 million breach of contract judgment it owed to Truck America. (By the time the city filed, the award had grown to $14.7 million.) However, Truck America said in a letter to the U.S. Bankruptcy Court last month that the correct amount is in excess of $15.23 million due to a computational error in calculating the interest. In addition to its largest creditor, the city also owes a combined $2.02 million on a pool bond issued by the Kentucky Bond Corp., and on outstanding municipal general obligation bonds that officials have said they do not intend to restructure. An evidentiary hearing was held last month to determine if Hillview is even eligible or qualified to pursue its chapter 9 municipal bankruptcy: a ruling is pending.

The federal orders come in the wake of earlier failed settlement negotiations: the mediation statement is to incorporate the municipality’s and Truck America’s, and may include settlement information not admissible in federal court, according to bankruptcy attorney John Whitlock: that is, under prodding from Judge Stout, this is stout reinforcement of his efforts to avoid the significant costs that a chapter 9 bankruptcy trial in his courtroom could engender—especially in a case where there appears to be significant doubt with regard to the municipality’s eligibility—a legal determination yet to be resolved. Hillview and Truck America, Hillview’s largest creditor, participated in settlement discussions earlier this year while the city waited for Judge Stout to stoutly rule on whether it qualifies to continue with its municipal bankruptcy case; Truck America rejected a settlement offer made by Hillview and issued a counteroffer last month. The Hillview City Council held a special meeting two weeks ago and approved an offer to accept a $5 million loan from the Kentucky League of Cities as part of its most recent settlement offer, according to the Pioneer News. In addition, the News reported Hillview has agreed to pay Truck America at least $100,000 annually over five years, plus “any carryover funds at the end of the fiscal year.” Hillview also owes a combined $2.02 million on a pool bond issued by the Kentucky Bond Corp., and on outstanding general obligation bonds that officials have said they do not intend to restructure. An evidentiary hearing was held Dec. 9 and Dec. 10 with regard to whether Hillview is qualified to pursue its Chapter 9 bankruptcy case, and objections filed by Truck America. A ruling is pending.

Governance in BankruptcyEven though major municipal bankruptcy filings experienced a pause last year, the extraordinary Boston Federal Reserve study on long-term municipal fiscal sustainability and the reporting on the current apprehensions with regard to Chicago, the Detroit Public Schools, and Puerto Rico appears to have, as our admired friends at MMA describe it, caused “municipal investors to worry more about state and local governments’ long-term fiscal condition (and whether or not defaults and bankruptcies will become more common).” This seems to be imposing greater stress on municipal leaders: how does Atlantic City or the Detroit Public School System, or Flint, Michigan provide for fundamental public services and capital borrowing in a system with ever increasing fiscal disparities? MMA described the nub of the issue: “[T]he security pledges on which our market is based are appearing increasingly brittle.” With federal–and, increasingly, state elimination of revenue sharing, we are noting ever increasing disparities in income between jurisdictions. Unsurprisingly, the Flints and Fergusons of the nation are experiencing disproportionate levels of poverty and fiscal stress–even as federal and state investment is declining–meaning that their respective costs of debt and investment are disproportionately greater–even as they have less and less access to low cost, long-term infrastructure financing. MMA notes that the current response seems to have been to reinforce existing security pledges with benefits such as statutory liens, special revenue status, and other legal protections. But these run the risk of being more like a band aid than a resolution–and, as MMA insightfully notes: these types of responses ensure neither:

  • full payment of principal and interest; nor
  • that politics, public policy considerations, or inequitable adjustments will not influence outcomes in a distressed situation.

MMA points to the outcomes in Jefferson County, Detroit, as well as in the proposals for Puerto Rico’s restructuring, putting it this way: “In other words, investors cannot afford to trade away material credit fundamentals for purely structural enhancements, in particular for GO and tax-backed securities. The power of the statutory lien for GO bonds: The presence of a statutory lien means that, in a chapter 9, bondholders are secured by a lien that is itself preserved, bolstering ultimate recovery. As a result, they are more likely to be unimpaired than unsecured creditors to the extent that tax revenues are sufficient to make payment on the debt.” 

Municipal Governance in Bankruptcy

February 16, 2016. Share on Twitter

Governance in Bankruptcy. Ronald Reagan, the former President and Governor of California, in his pre-political days, for General Electric, used to say: “Progress is our most important product.” Now, it appears, there might be some real governance progress underway in San Bernardino—perhaps presaging changes that will be critical not only to its hopes from emerging from the longest municipal bankruptcy in U.S. history, but also for realizing a sustainable fiscal future. Yesterday, a municipal committee tasked with reforming the city’s charter, made up of members whom the City Council and Mayor had appointed, provided an update on its progress toward a new charter—a key step as they are aiming at presenting final recommendations by April in order to ensure they may be put before the city’s voters in November.

In our original report on San Bernardino, we noted: “Everyone interviewed for this report made direct or indirect reference to the city charter one way or the other. And almost everyone indicated ‘I have never seen a more dysfunctional design for a city government than the provisions contained in the city charter.’ It is an understatement to say it is designed to diffuse power and prevent sound management, accountability, and transparency. It actually seems worse than the old commission form of government with all its fiefdoms. At least there you could hold a commissioner accountable. That being said, the people of the city have operated with that system for so long and they know so little about other options, that they cannot possibly understand it could be any other way. It is going to take some reformers to come along who can convince them to bring their system into the 21st (or even 20th) century. Then the political culture can start to change.”

Indeed, San Bernardino’s own, current version of its plan of debt adjustment, the committee in its written report to the City Council noted: “identified the city’s charter as a barrier to efficient, effective government, because it is overly complex, hard to understand, and contains elements that are inconsistent with best practices for modern municipal government…Subsequently, the charter committee has continued its work to develop recommendations for a new or substantially revised charter that reflects the principles of good governance and meets the needs of the community.” The draft plan notes: “the charter committee has continued its work to develop recommendations for a new or substantially revised charter that reflects the principles of good governance and meets the needs of the community.”

Nevertheless, any changes will confront challenges: it was just 14 months ago that the city’s voters rejected an earlier charter committee proposal to remove police and firefighter pay from the charter, which would have allowed those salaries to be set by negotiation, rather than a formula based on what other cities (larger municipalities with higher tax bases) pay, albeit voters did agree to a change to end the practice of paying terminated city employees while they wait for an appeal of their employment. (California law only allows changes to a municipal charter if approved by voters in a November election in an even-numbered year.) Nevertheless, there seems to be growing awareness of the need for governance change: In a survey the charter committee conducted last year, only 8% of 440 complete responses agreed that the charter should not be changed: 51% responded it should be revised; 42% said it should be replaced. For the committee members, of course, the harder question is just how voters—and leaders—believe it ought to be changed.

Schooling on Municipal Solvency

February 16, 2016. Share on Twitter

Schooled on Solvency. Marios, Demetrio the Detroit Public School (DPS) System’s deputy superintendent of finance and operations yesterday, in testimony before the Detroit City Council, warned that a “desperate” DPS is running out of cash, is unable to borrow, and urgently needs the state to approve legislation to provide financial relief. With a growing recognition by state and local leaders that a DPS insolvency could have harsh repercussions for Detroit’s nascent recovery from the nation’s largest municipal bankruptcy, the City Council hearing came in the wake of its approval of a resolution opposing legislation being debated by state lawmakers to reform DPS. But time is wasting: DPS guesstimates it could be insolvent by April. Mr. Demetrio warned the school system will need a cash infusion of $126 million by August “in order for us to survive,” adding DPS “is running out of cash. It can’t borrow anymore. We are desperate and need help right now…That is the urgency of why this legislation was introduced. It needs to pass.” Detroit Council member Raquel Castaneda-Lopez, who had requested the hearing, told her colleagues she had requested the presentation in part over concern for DPS’ parents and students, many of whom are unaware of the “pending crisis” this spring. Although DPS is currently under state control under a resigning emergency manager appointed by Gov. Rick Snyder, the Council clearly recognizes the growing implications to the city’s property tax base that a DPS default and bankruptcy would create. DPS confronts some $515 million in debt, and DPS has warned it may be unable to make payroll by April. For his part, Gov. Snyder has asked the state legislature for a $715 million package to pay off that debt and provide startup costs for a new Detroit school district—a proposal currently under discussion and debate.

The looming default creates hard governance issues and questions. Detroit’s City Council, in a resolution adopted last month, urged the Legislature to immediately restore an elected school board and “remove the remains of emergency management that has done so much to undermine the success of the city’s school system.” Gov. Snyder has asked the legislature to appropriate $72 million in his FY2017 budget and for the next nine years as part of his 10-year plan to pay down the school debt and restructure DPS—with the funds coming from the Tobacco Settlement Fund; he has also proposed a $50 million appropriation to keep DPS operating while state legislators debate the legislation to overhaul DPS. Under the Governor’s plan, funds from Michigan’s tobacco settlement would be dedicated towards DPS reforms to repay an estimated $515 million in operating debt: the state anticipates receipt of $284 million in FY2017—with the plan to allocate those funds ($193 million would be left after credits are paid to tobacco manufacturers and the state makes securitization payments related to bonds issued in 2006 and 2007 that helped Michigan through lean budget years): $17.5 million would go into the state’s Budget Stabilization Fund, or reserves, as reimbursement for Michigan’s contribution to the “grand bargain” deal as part of the approved plan of debt adjustment that secured Detroit’s successful exit from municipal bankruptcy (a payment which will be made over 20 years); $75 million is paid into Michigan’s 21st Century Jobs Fund; $72 million is proposed annually for a decade to pay for DPS reform—with the funds coming from a nearly $49 million fund balance in the tobacco settlement and money that previously paid for other programs. There does appear to be a bipartisan consensus in the legislature that urgent state action will be necessary if Detroit’s school system is to avoid defaulting on its debt and potential municipal bankruptcy—or, as Rep. Al Pscholka (R-Stevensville), Chair of the House Appropriations committee noted: “All of us agree that the financial piece has to get taken care of,” adding that he is considering a way to fund the DPS fix without school or general fund money—and that: “Bankruptcy is a terrible option for the district…The bankruptcy process is always uncertain, but in the end, it will cost the state more than double the cost of the proposed legislation.” DPS currently is paying about $50 million a year in debt service on some $515 million in debt it has accumulated from long-term municipal bonds, short-term borrowing to improve cash flow, unpaid payments into the state pension system, and late payments to vendors.

Here Come Da Judge. In a related development, Gov. Snyder has asked now retired U.S. Bankruptcy Judge Steven Rhodes, who masterfully oversaw Detroit’s bankruptcy trial, to play a key leadership role in helping DPS avoid bankruptcy and get back on its feet—asking Judge Rhodes to help guide Detroit Public Schools reform legislation through the state Legislature and then implement any new law’s changes to DPS—that is, a transitional role, steering a revised DPS until it can return to local control under an elected school board and superintendent, albeit details of the arrangement have yet to be finalized, except it appears unlikely Judge Rhodes would be designated as an Emergency Manager. Judge Rhodes has made clear that a strong school system is key to Detroit’s long-term success. In an interview around the time of the city’s one-year anniversary after leaving bankruptcy protection, designating DPS as one of the two or three remaining concerns, he had, with regard to the future of Detroit after its departure from federal bankruptcy court, noted: “I think it’s fair to conclude that families will only move back into the city after the schools are fixed,” in an interview last fall with the Detroit Free Press. DPS has been run by governor-appointed emergency managers since 2009. Despite state intervention, its financial problems have only worsened: the system which once had a peak of nearly 300,000 students is widely considered today the nation’s worst-performing urban school district in terms of academics.