Getting Schooled on Municipal Debt & Municipal Bankruptcy

February 5, 2016. Share on Twitter

Detroit’s Future. Detroit Mayor Mike Duggan yesterday laid down a gauntlet: Detroiters need to control the city’s schools if the state is really serious about wanting to see them turn around, he testified before the Senate Government Operations committee, as the legislature began debate over Gov. Rick Snyder’s $715 million debt relief plan for the nearly insolvent Detroit Public School (DPS) district—from which the Governor’s appointed state emergency manager, Darnell Earley, has just resigned. Gov. Rick Snyder’s plan relies on $715 million of state help: $515 million to eliminate DPS’ structural operating deficit, and help with overdue pension payments and unpaid bills, and another $200 million of start-up funding for the new operating entity—without which, the Governor’s office warns, DPS could be “virtually insolvent” by April. Sen. Geoff Hansen’s legislation would appropriate $250 million from Michigan’s general fund for the start-up costs; it would not, however, address the operating deficits.

The hearings mark the first steps toward advancing a plan that has failed to gain much traction since Gov. Snyder first unveiled a general outline last spring; the Governor is expected to add additional details on the funding scheme when he unveils his FY2017 budget recommendations next Wednesday—where the city’s schools will be fiscally pitted against the water contamination crisis in Flint, not to mention efforts to improve state pension funding. Gov. Rick Snyder’s plan relies on $715 million of state help: $515 million to eliminate DPS’ structural operating deficit, and help with overdue pension payments and unpaid bills, and another $200 million of start-up funding for a new operating entity—without which, the Governor’s office warns, DPS could be “virtually insolvent” by April. Sen. Committee Chair Hansen’s legislation would appropriate $250 million from Michigan’s general fund for the start-up costs; it would not, however, address the operating deficits.

The pending legislation would allow a new Detroit entity to be in charge of educating students and to continue to borrow and issue bonds for operating purposes on a longer-term basis. Instead of the typical ten-year term, borrowing terms would be stretched out to 25 years: DPS’ operating deficits have ballooned over the last four years to an expected $335 million at the end of this fiscal year from $83 million in 2012 as enrollment plummeted, according to the Citizens Research Council of Michigan, a superb, nonpartisan public affairs research organization. DPS began the current school year with legacy debts totaling almost $440 million. Moreover, in arithmetic terms, adding to DPS’s more recent fiscal deficit challenges is its heavy reliance on short-term notes to help with cash flow throughout the fiscal year. In FY2016, debt service payment obligations are projected to nearly triple to $2,982 per student from $1,105 last year, mainly because DPS pushed its 2015, $83 million cash-flow note repayment onto the current school year’s budget: the way DPS is set up today, debt service obligations compete directly with the critical resources that would otherwise go to classrooms to fund educational services—the services vital to beckoning young families with children to move into Detroit. That is, the City of Detroit’s continuing recovery is very much dependent on the kinds of rising property tax assessments that are very much at risk if families with school age children are discouraged.

Declining enrollment has been a key factor in slamming DPS’ balance sheet: a decade ago there were more than 127,000 students; this year, enrollment is 46,306. That combination has driven its general fund revenues down to $667 million this year from $1.13 billion in fiscal 2011. The payment mechanism under the restructuring proposal supported by Gov. Snyder is basically the same mechanism used in other debt-laden districts of the state, including nearby Highland Park, Inkster, and Buena Vista—where the state has permitted the local 18-mill school operating tax to be repurposed: instead of using it to fund the per pupil allowance, the funds were diverted to debt repayment. Currently the tax generates around $71 million per year.

In his testimony yesterday, Mayor Duggan noted that DPS is facing an historic crisis: The district is on track to run out of the fiscal resources it needs to operate by April—an insolvency which would force the system into chapter 9 municipal bankruptcy—a bankruptcy which would leave the state on the hook for billions of dollars in municipal debt backed by the state. The district has been under state oversight for the last seven years. The district’s debts include $1.5 billion of unlimited-tax general obligation bonds, $199 million in borrowing from the state’s School Loan Revolving Fund, and $259 million in limited-tax GO debt paid by district operating revenues, rather than a dedicated debt service levy. But the State—and Michigan municipal bondholders—have much at stake too: Unlike the city of Detroit, which emerged from Chapter 9 in 2014, nearly all of DPS’s debt is backed by the state under Michigan’s Qualified School Bond and Loan Program: That means that the state and its taxpayers could ultimately be on the hook for a good portion of DPS’s operating debt in a municipal bankruptcy.

Mayor Duggan asked senators to consider putting an elected school board in place right away with financial oversight, pointedly noting that after years under state-appointed emergency management, the district has seen debt increase and unimpressive academic results. Some state lawmakers have said that proposed Senate Bills 710 and 711 would help reduce the state’s losses and help the district get on track by means of state oversight to the district, and a state appropriation of more than $700 million to pay down debt and restructure. But Mayor Duggan responded: “The people of Detroit aren’t willing to accept the state’s standard. This isn’t right!”

Mayor Duggan warned that the legislation, at least from his vantage point, was insufficient to create an environment for long-term success; instead, he urged the creation of a Detroit Education Commission, which, he testified, would be made up of people the Mayor would appoint: the commission’s responsibility would be to analyze both public and charter schools based on academics and demand, noting that while many charter schools are succeeding, many are also failing; he added: “We have the lowest performing school district, and yet DPS is outperforming 24 charter schools.” He testified there are some neighborhoods in Detroit with far too many schools, and other neighborhoods with no schools, suggesting that a commission be given the authority to close schools and incentivize the opening of schools where they are needed to address these issues, adding that DPS cannot compete with the sporadic opening and closing of charter schools in neighborhoods where sometimes there is not even a need for another school.

During his testimony, Mayor Duggan further expressed apprehension about state control of local schools; he sharply questioned the performance of state-appointed emergency managers who have run the Detroit Public Schools and the Education Achievement Authority, which took over 15 of the district’s worst-performing schools in 2011: “The problem is that state control of local schools doesn’t work.” He asked legislators to restore authority to an elected school board, calling for an August election, and urged them to reconsider Gov. Rick Snyder’s call for a Detroit Education Commission that could open or close traditional or charter schools in the city, noting in comments after the hearing: “We’ve seen how the state has done in taking control of the schools in the city of Detroit…It’s been seven straight years of enrollment decline, deficits, and school closings. It’s time that Detroiters retake responsibility for the schools in our community.” He added that the lack of standardized oversight has led to haphazard decisions and inconsistent academics in Detroit, noting that more than 160 schools have opened or closed in Detroit in the past seven years, while district academics are the worst in the state, and that the city’s 24 charters schools have performed even worse.

Committee Chair Sen. Geoff Hansen’s bills would split Detroit Public Schools into two entities to help it avoid the system’s looming insolvency: One district would pay off existing debt, while a new Detroit Community Schools would be free to focus on operations and academics—a plan which would cost the State of Michigan about $715 million over the next decade—or, as Chairman Hansen put it yesterday: “The gravity of this situation is dire, and the consequences of inaction are very real: The sheer size of this debt far exceeds any other financially struggling district across the state.”

Under the proposed bills, Detroit voters would elect a new school board in November, but initial control would rest with an interim board appointed by the Governor and Mayor, which would select a superintendent. A financial review commission would have final say on most district decisions, including new contracts and collective bargaining agreements approved by the school board. The district would be mandated to meet several requirements to gain full autonomy, including deficit-free budgets for three consecutive years and ability to borrow in the municipal securities market. The proposed Michigan School Reform Office would also play a large role in determining whether there even ought to be a replacement of resigned, but unmissed Emergency Manager Darnell Early, as well as whether the current Education Achievement Authority should be disbanded. An intriguing statement from Mayor Duggan yesterday is that he said he would support an expanded role for the existing Detroit Financial Review Commission—created as part of the Grand Bargain which enabled Detroit to exit from the nation’s largest municipal bankruptcy, which was initially established to oversee city finances, noting: “If we could do this, give parents choice, give locals control of the public schools with the state making sure the budgets are balanced, I think we could have a quality system.”

Whatever final decisions emerge from the Gov. and Michigan legislature are certain to lead to a fiscal restructuring plan for the nearly insolvent Detroit Public Schools (DPS)—legislation vital not just to Detroit’s long-term fiscal recovery from the nation’s largest municipal bankruptcy, but also to the city’s sustainable future.

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