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.” 

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