Might San Bernardino’s Exit from Municipal Bankruptcy Offer Lessons for Puerto Rico?

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eBlog, 4/29/16

In this morning’s eBlog, we consider the nearing end game of the longest municipal bankruptcy in U.S. history—with U.S. Bankruptcy Judge Meredith Jury noting the end is “in view.” We note, moreover, especially in view of the looming issues in Puerto Rico, the resolution emerging in San Bernardino as between the city’s retires and municipal creditors, and the resilience of the city despite these unprecedented fiscal challenges and still unsettled from its terrorism attack to persevere.

Emerging from the Longest Municipal Bankruptcy in American HistoryU.S. Bankruptcy Judge Meredith Jury Wednesday said San Bernardino’s exit from municipal bankruptcy is “in view,” at what was expected to be one of the final federal court hearings before the confirmation process begins. Judge Jury set a hearing for June 16th to discuss the third version of its disclosure statement, which she said will probably be noncontroversial — in no small part because nearly all the city’s creditors have already agreed to support it. At that hearing, Judge Jury said she would probably set a date about three months after that for the final stage of the city’s chapter 9 municipal bankruptcy—the longest process of any American city. In setting the date for the hearing, Judge Jury noted: “I appreciate all the progress the city has made. This case has gone at the speed it has to go. Now we have confirmation in view, and we’ll get there when we are supposed to get there. We are not Detroit; we are not Stockton; we came into this case in a very different posture, and therefore, the fact that it took much longer to get to confirmation was to be expected.”

Judge Jury added that only a few changes will be needed to the version of the plan of debt adjustment the city filed last month, noting San Bernardino will have to clarify how it will handle lawsuits of more than $1 million filed against it — personal injury claims and civil rights lawsuits, including the families of individuals killed by police officers prior to the chapter 9 municipal bankruptcy filing, as well as to resolve a number of issues with a committee representing retirees, leading City Attorney Gary Saenz to note San Bernardino could exit municipal bankruptcy by the end of the year.

Judge Jury has set a hearing 45 days ahead—a hearing which she said could serve as be the tentative confirmation hearing, albeit noting: “I don’t want to say for sure at this point that it is the ‘tentative confirmation hearing,’ because there are still a few issues to be resolved, but it seems like most of the larger issues have already been settled.” San Bernardino has reached agreements with all of its major creditors, which include its retirees, CalPERS, and its police and fire unions—with the final major settlement agreement reached with its pension obligation bondholders a month ago. The confirmation hearing, Mr. Saenz confirmed, was set for mid-September, after which, he noted, would come the confirmation effective date: “That could get us out of bankruptcy by the end of the calendar year.”

Counselor Saenz noted his appreciation of Judge Jury’s comments with regard to the long duration of the city’s case, because there had been so many comments made about how much longer it had taken San Bernardino than any other municipal bankruptcy in American history—it will surpass four years at the end of July. Mr. Saenz added that the reason it took longer is that the city worked to reach settlement agreements with all of the creditors, rather than springing cram-downs at the end: “We wanted to reach settlements ahead of time, rather than have long evidentiary hearings…I believe it was more cost-effective this way,” adding that negotiating agreements that both sides could agree to helped bring certainty for both sides, rather than rolling the dice on what the federal judge might decide.

In terms of the agreement with the city’s municipal bondholders, Mr. Saenz said San Bernardino was able to give its bondholders 40 cents on the dollar of what the city had been obligated to pay—as opposed to the 1% it had originally proposed, because the agreement will permit the city to stretch out payments over two decades: San Bernardino has drafted a 20-year business plan after determining it would be able to feasibly make those payments without the city ending up in municipal bankruptcy again down the road—leading him to note: “One [consideration] Judge Jury will look at is the feasibility of the confirmation plan…We believe we found a model that is dependable.” The pension obligation bond agreement continues a trend of a municipality’s bondholders faring worse than its retirees in municipal bankruptcy resolutions: under the plan of adjustment COMMERZBANK Finance & Covered Bond S.A., formerly Erste Europäische Pfandbrief-Und Kommunalkreditbank AG, and municipal bond insurer Ambac Assurance Corporation, agreed to drop their opposition to San Bernardino’s plan of debt adjustment—under which holders of $50 million in pension obligation bonds will receive payments equal to 40% of their debt on a present value basis, discounted using the existing coupon rate, according to city officials.

The timing of the nearing resolution came against a backdrop yesterday of the arrest of three relatives of San Bernardino terrorist Syed Rizwan Farook—the three were charged yesterday in an alleged marriage-fraud scheme that was uncovered in the wake of December’s attack on a gathering of county employees—making clear the extraordinary situation for a municipality in bankruptcy—and the importance of chapter 9 in ensuring a municipality is able to provide essential, life-saving public services whilst in bankruptcy. The Islamic State had reported in a broadcast on al-Bayan Radio last December that the two main suspects in the San Bernardino shootings were “supporters” of their organization and called them martyrs.

In Like Flint? The U.S. Senate Environment and Public Works Committee yesterday approved (19-1) a $220 million assistance package for Flint—a key aid as the city struggles to address its unsafe, lead-tainted drinking water crisis and consequent apprehension about the impact of lead fear depreciating its assessed property values and, ergo, its property tax revenues vital to the city and its public schools. The bill would authorize $100 million in grants and loans to replace lead-contaminated pipes in Flint and other cities with lead emergencies, as well as $70 million toward loans to improve water infrastructure across the nation; it also would authorize $50 million to bolster lead-prevention programs and improve children’s health nationwide. It authorizes $300 million over five years to remove lead pipes from houses, schools and day care centers nationwide. In addition, it would mandate that EPA warn the public about high lead levels in drinking water if a state or locality fails to do so. The House has passed similar legislation. Chairman James Inhofe (R-Okla.) stated the measure builds on a similar 2014 law and would provide “needed investments in America’s infrastructure to support our communities and expand our economy.” Currently, nearly 1,500 water systems serving 3.3 million Americans have exceeded the EPA’s lead cap of 15 ppb at least once in the past three years. Indeed, if the state of Michigan’s newly proposed standard of 10 ppb were applied across the nation, that number would jump five-fold to more than 2,500 systems with 18.3 million customers according to the Associated Press’s analysis of federal data.

Driving a Municipality into Municipal Bankruptcy?

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eBlog, 4/28/16

In this morning’s eBlog, we consider the critical fiscal situation confronting Ferguson, Missouri—where the small municipality—confronted with seemingly prohibitive federal sanctions in the wake of the killing of Michael Brown, an unarmed man, by a police officer, in the wake of which there were riots and subsequent U.S. Justice Department sanctions imposed on the municipality—fiscal sanctions that risk the municipality’s viability.

Federally Driven Municipal Bankruptcy? Moody’s has further downgraded Ferguson, Missouri’s bond ratings into junk territory as the small city, amid tries to address the fiscal strains of dealing with fallout from the controversial 2014 fatal police shooting—the rating agency assigned the municipality a negative outlook in the wake of the city’s voters approving a sales tax for economic development, but voting down a property tax hike—meaning the city is likely to fall short of the revenues it projects it will need in the wake of the police shooting of Michael Brown in 2014. It seems the federally imposed fiscal penalties are further imbalancing the municipality’s chances of survival. The small city already faced imposing odds: Brookings analyst Elizabeth Kneebone last year had noted that at “the start of the 2000s, the five census tracts that fall within Ferguson’s border registered poverty rates ranging between 4 and 16 percent…However, by 2008-2012 almost all of Ferguson’s neighborhoods had poverty rates at or above the 20 percent threshold at which the negative effects of concentrated poverty begin to emerge.” But now, in the wake of voters’ approval of a 0.5% sales tax hike for economic development, but rejection of a proposed $0.40 per $100 of assessed value property tax hike that would have generated $640,000 annually, or 22.6% of the city’s projected budget deficit, the fiscal dilemma appears certain to deteriorate. The property tax increase would have cost about $76 annually for a home worth $100,000.

Ferguson, which has been experiencing a declining population, has average per family income of $36,645 annually. Thus, it can hardly seem surprising that its voters shot down a proposed $0.40 per $100 of assessed value property tax hike that would have generated $640,000 annually, or 22.6% of the city’s projected budget deficit. In contrast, voters approved the sales and use tax hike–expected to raise about $1 million per year, or 28.2% of the deficit. Ferguson operates on a $14.5 million budget. Thus the city’s leaders had warned both tax increases were needed to address the city’s deficit and the costs of compliance with the unfunded federally mandated police and municipal court reforms under a consent agreement the city recently reached with federal authorities.

As Moody’s moodily noted: “The downgrade reflects the continued pressure on the city’s finances from a persistent structural imbalance and incorporates the recently approved US Department of Justice consent decree, projected to increase annual general fund expenses over the next several years.” That pressure comes from the city’s projections that compliance with the federally-imposed implementation mandates could run as high as $1.5 million in the first year with costs falling under $1 million in subsequent years. Moody’s analysts further noted that, in the wake of the election: “both ballot measures were integral to city management’s proposed solution to close a large general fund budget gap that existed before accounting for the additional consent decree costs.” To make matters more fiscally grim, the credit rating agency expressed apprehension with regard to further credit erosion in the wake of the vote—as it will likely be forced to cut spending even further to meet the federally imposed penalties—with the agency apprehensive that the combination of unfunded federal mandates, reduced revenue, and substantial liabilities could lead not just to still further downgrades, but also potential default. City leaders say measures associated with the agreement will cost Ferguson $2.3 million over three years, including $1 million in year one—a seemingly overwhelming level for a municipality already facing a $2.9 million deficit due largely to fallout from the shooting, such as sales tax declines, skyrocketing legal costs, and the imposition of hundreds of thousands of dollars in court fines and fees from reforms already in place.

The pending FY’2017 budget calls for across-the-board pay cuts of 3 percent—but, in the wake of the voters’ actions, the city will likely be forced to lay off members of the police force, firefighters, and consider closure of a fire station—potentially imperiling the city’s implementation of the type of community policing mandated under the Justice Department settlement. Revenues to pay for requirements such as software and hiring of police record analysts would also be hard to come by. Indeed, the federal requirements could force the city into receivership or to file a chapter 9 petition, as provided for under Mo.Ann.Statute§91.730.

Post Municipal Bankruptcy Innovation

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eBlog, 4/27/16

In this morning’s eBlog, we consider—again—post-municipal bankrupt Detroit—as the city uses innovation in place of disproportionately reduced fiscal resources to address critically neglected areas for redevelopment. Ironically the lessons learned from this innovative experimentation might provide valuable fodder for city and county leaders across the country. We also—with D-Day looming for Puerto Rico and Congress set to leave town—consider the critical inaction and disagreement in Washington, D.C. over the fiscal fate of Puerto Rico. In some key ways, the inability to act serves to confirm how valuable chapter 9 municipal bankruptcy has worked. Finally, we look at the intersection of state politics—and its implications for the fiscal fate of Atlantic City.

Pink Post Municipal Bankruptcy. One of the hardest challenges for a municipality emerging from municipal bankruptcy is the comparative dearth of fiscal resources. So it is that Detroit is attempting to address a critical set of issues: how to revitalize neglected areas—which are extensive in a city with one-third of its former population in one the largest land areas of any city in the U.S. Such revitalization is critical both to enhanced assessed property values, but also to reducing crime. Ergo, the city is trying to act outside the box: it is adapting by lifting its development regulations—what developers might call outdated rules—to create zones, which the city calls “pink zones,” where red tape will be cut to help small developers and entrepreneurs open new businesses and revive aging commercial strips. The goal: to ease some of the constraints confronted by developers, from environmental impact statements to parking rules. Thanks to a grant from the John S. and James L. Knight Foundation, the Detroit planning department intends to recruit designers and planners to come up with a general framework for anyone who wants to start a new business or build in such areas: e.g. a process to accelerate development and maybe bubble up some innovation, or, as the city’s Planning Director Maurice Cox describes it: “You can create a great place, and you won’t have to go through months of red tape.” The innovative concept might have a second benefit: it will reduce city staff demands to enforce some of its rules.

Critical Inaction. U.S. Treasury Secretary Jack Lew yesterday warned that Congress is running out of time to act on Puerto Rico, telling Univision: “The crisis is now…There is an urgent need for Congress to act because the alternative to Congressional action…is chaos for 3.5 million Americans who call Puerto Rico home. That’s not acceptable.” The dire warning came as the U.S. Territory appears set to default on a payment of over $420 million which is due on Sunday. That precedes a multi-billion dollar payment due July 1st. Nevertheless, the Administration has not yet signed off on the House Natural Resources Committee legislation championed by House Speaker Paul Ryan(R-Wis.)—even as Congress is scheduled to break for a ten-day recess beginning this Friday. Notwithstanding the Treasury’s pressing, the Treasury has yet to come out in support of House Natural Resources Committee Chair Rob Bishop’s (R-Utah) draft bill, while Senate leaders appear to have no inclination to act until the House sends them a package. If anything, the delays appear to have spurred greater complications: the AFL-CIO and the Service Employees International Union, unsurprisingly, want any final legislation to protect pension and worker rights. The situation has reached a stage where every day of delay now means there will be less fiscal resources to divvy up amongst the island’s creditors. House Majority Leader Kevin McCarthy (R-Ca.) said yesterday that he does not see any way Congress can get a bill done by May 1st, but he thinks a bill could be wrapped up by July 1. The key is that every day of delay now means there will be not just a greater threat of the Zika virus in Puerto Rico taxing its diminishing resources, but also whatever fiscal resources will be remaining to be divvied up amongst thousands and thousands of creditors.

Wherefore Atlantic City? Somehow an entire city’s future has become a pawn to state politics—at an awful cost in both fiscal resources and the trust and respect of American voters. Carl Golden, who served as press secretary for former Govs. Thomas Kean (R-N.J.) and (as Communications Director) for Gov. Christie Whitman (R-N.J.) yesterday framed the fate of Atlantic City as part of the “ongoing confrontations between the Democratic leaders of the Senate and Assembly, while presumably over weighty matters of public policy, in reality mask an early political strategy designed to establish a frame of reference for the 2017 gubernatorial campaign,” describing it as “a calculated effort to tie Senate President Steve Sweeney (D-Gloucester) closely to Gov. Chris Christie, to portray him as a willing ally of a governor whose record and philosophy are anathema to Democrats and particularly to the long-time party activists who control the primary election process.” He wrote that “for [Senate President] Sweeney, the more he shares with [Gov.] Christie, the farther away he moves from the Democratic Party base—organized labor in general, public employee unions in particular, women, minorities, urban leaders, and advocates for a broad array of social-service programs which have been curtailed by the Governor.” Key: he wrote that “Their previous cooperation on other issues has been overshadowed by their disagreements over the proposed state assumption of Atlantic City government—a step supported by Sweeney and Christie but opposed by [Mayor] Prieto and city government…” noting the battles have been framed by “dueling press conferences, edgy language in news releases, and accusations of political gamesmanship.” Interestingly, he wrote there had been “speculation as well—not entirely misplaced—that resentment has been simmering in the Assembly over a feeling it’s been treated unfairly, that it’s been ignored while Christie and Sweeney strike deals and present them to the lower house for approval.”

Thus, the ugly head of politics—rather than the fiscal fate of Atlantic City—have loomed—or, as he wrote: “It was not altogether without credibility when Christie accused Prieto of doing the bidding of Jersey City Mayor Steve Fulop, a potential gubernatorial candidate, in blocking legislation for state involvement in Atlantic City in an attempt to deny union support to Sweeney. Whether the Governor’s implicit defense of Sweeney helped the Senate President or provided another opportunity to depict him as too cozy with the chief executive is open to debate.”

Further discussing the politicization of the looming municipal bankruptcy, he added: “It places Prieto—and, by extension, Fulop—squarely on the side of public-employee unions while serving as a subtle reminder that it was Sweeney who joined forces with the Governor in 2011 to muscle a series of pension-system reforms through the Legislature, including mandating an increase in employee contributions to the benefits system. The greater contributions and the freeze on cost-of-living adjustments (COLA) for retirees are all that remains of the reforms after the administration—with support from a Supreme Court ruling—failed to meet its funding obligations in their entirety.”

He notes that Sen. President Sweeney has sought to re-ingratiate himself with organized labor by proposing a state constitutional amendment to guarantee pension and benefits rights, while Mayor Prieto—perhaps focusing on moving from City Hall to the Statehouse—has also expressed his opposition to eliminating the state’s inheritance or estate taxes except as part of a larger package to increase the motor-fuels tax to replenish the state’s dwindling state Transportation Trust Fund. The two potential gubernatorial combatants—but current critical players in determining Atlantic City’s fiscal future—have met several times in unsuccessful efforts to resolve their differences. Thus, Mr. Golden wrote that the Speaker has “dismissed suggestions that gubernatorial politics underlie the impasse. Prieto, they say, is merely attempting to wield his power to protect the contractual rights of Atlantic City municipal workers as well as ensuring that the revenue stream from the estate and inheritance taxes continues to support programs to benefit middle class New Jerseyans,” adding—most critically: “Time, though, is short: Atlantic City and the trust fund are running out of money rapidly. Should the apparent governmental dysfunction continue and lead to a failure to resolve the problems, the North will point South, and the South will point North.

Municipal Bankruptcy Can Work!

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eBlog, 4/25/16

In this morning’s eBlog, we consider the track of post-municipal bankrupt Detroit—especially following the positive real estate changes—noting that while property taxes are less important to Detroit than most U.S. cities; nevertheless, they are a sign that—notwithstanding the terrible state of the city’s schools, all signs are that the city’s unrolling of its plan of debt adjustment helps us to appreciate how well put together it was…one might even say to those procrastinators in the Congress: municipal bankruptcy worked. Because, as we note, Congress is showing itself singularly unable to act on legislation to avert the onrushing fiscal crisis in Puerto Rico. Notwithstanding the leadership efforts of House Speaker Paul Ryan and House Natural Resources Committee Chair Rob Bishop in their efforts to coordinate with U.S. Treasury officials to address the nearing insolvency in Puerto Rico, the Senate has only been able to criticize—not act; and both Houses of Congress have made recess a priority over acting: Even with a critical deadline looming next Sunday, the House and Senate are firmly committed to their fifth recess of the young year. Finally, this morning, we look at efforts to undo a municipal part of the emerging, sharing economy in San Bernardino—where some unhappy citizens remain upset at the provisions in San Bernardino’s plan of debt adjustment provide for consolidating fire services with San Bernardino County.

Post Municipal Bankruptcy. Even though, unlike almost any other major U.S. city, property tax revenues are not the most important source of revenues to Detroit; the rapid appreciation in value seems to be a clear sign that the city’s plan of debt adjustment that permitted it to exit the longest municipal bankruptcy in history is working: Since January 2013, the for-sale inventory in the four-county Detroit metro region has fallen by 16.3%; demand among homebuyers is starting to outstrip supply locally: today in the metro area the time a home stays on the market has dropped by 33% from three years ago—and the median sale prices have climbed 85 percent in that period, from $80,000 to $148,000, according to Realcomp. During the foreclosure crisis, 30,000 or more homes were up for grabs at any one time. During the foreclosure crisis, Detroit had only eight people per acre, down from 21 per acre in 1950. Nevertheless, fiscal challenges remain: Detroiters who bought their homes at the height of the real estate market in the early to mid-2000s remain underwater or upside down: they still owe more on mortgages than their home is worth. But the tide is turning: There is a disparity between supply and demand, especially for homes valued under $250,000, according to data from Real Estate One. All signs appear strong: Real Estate One had more than twice as many showings (12,829) in February of this year than it did four years ago, the company said, and the company notes it is up 14 percent year-over-year. The company reports it has added more than 11% new real estate agents last year. While Detroit’s decline into municipal bankruptcy predated the housing crisis (the Citizens Research Council reported the overall loss of 15,648 business establishments from 1972 until 2007—before the severe 2008 recession, or the bankruptcies and subsequent recovery of General Motors and Chrysler and the restructuring of the automotive supplier network) when jobs left Detroit as auto plants moved to the suburbs and to other countries with globalization (manufacturing jobs in Detroit fell to fewer than 27,000 in 2011 from about 296,000 in 1950, leaving Detroit with eight people per acre, down from 21 per acre in 1950); nevertheless, the remarkable increase in aszsessed values woul seem a strong reaffirmation of not just the remarkable pressure and musical ear of U.S. (now retired) Bankruptcy Judge Steven Rhodes, but also the tenacity of former Emergency Manager Kevyn Orr.

Critical Inaction. Congress appears more and more certain to fail to act to address the Puerto Rico debt crisis before breaking for still another recess at the end of this week—even as the U.S. territory faces a looming default this Sunday, Mayday. Notwithstanding the strong leadership of House Speaker Paul Ryan (R-Wis.), House Natural Resources Committee Chair Rob Bishop (R-Utah), and the Treasury; U.S. Senate inaction and some Republican opposition to doing anything—combined with Congressional misperceptions that allowing Puerto Rico to receive some quasi bankruptcy relief would somehow open the doors to state bankruptcy—mean that the Puerto Rico Government Development Bank will almost surely default Sunday on a $422 million payment. The House Natural Resources Committee abruptly called off a markup two weeks ago due to a shaky vote count; the Committee has not rescheduled a new meeting since. If anything, however, the Senate outlook is worse—and more irresponsible. Key Senate Republicans and Democrats have expressed strong skepticism of the House—even as they have signally failed to offer any constructive alternative. Indeed, the Senate failure is fully bipartisan: Senate Minority Leader Harry Reid (D.-Nev.) said in a joint statement with Sens. Maria Cantwell (D-Wash.), Charles Schumer (D-N.Y.), Dick Durbin (D-Ill.), Bob Menendez (D-N.J.), Patrick Leahy (D-Vt.), Ron Wyden (D-Ore.), Elizabeth Warren (D-Mass.), Richard Blumenthal (D-Conn.), Kirsten Gillibrand (D-N.Y.), and Bill Nelson (D-Fla.) that the House bill “falls short.” While not offering their own proposal, the group stated: “We have concerns about whether the debt restructuring process provided for in the bill is workable, and we believe that — despite improvements — the oversight board has excessive powers and an unacceptable appointment structure.” Similarly, Sen. Finance Committee Chairman Orrin Hatch (R-Utah) last week told reporters the House bill was not “satisfactory…We’re not going to be able to pass it over here.” Indeed, it is clearer and clearer the Senate seems incapable of acting in any responsible way: even though Senators from both parties have introduced legislation to try to address the looming insolvency, Chairman Hatch has not even scheduled a markup.

Meanwhile, in Puerto Rico, the fiscal crisis appears to be accelerating—even as a desperate human health crisis threatens. The island is experiencing an outflow of population—an outflow which appears to be quickening—and dominated by those who are the highest educated and most able to afford the move. The economy is closing in on something close to a free fall: a major indicator is Puerto Rico’s Economic Activity Index, a monthly figure compiled by the Government Development Bank that tracks payrolls, cement sales, power production and gas consumption. In 2015, that index decreased 1.8 percent to the lowest in more than 20 years. That means Puerto Rico is experiencing not just a population decline, but also a surge in inequity: the island’s unemployment rate is more than twice that of the U.S. mainland, poverty is three times as severe (about 46.2 percent of Puerto Ricans live below the poverty line, compared with 14.8 percent in the U.S., according to Census Bureau data.), and assessed property values (he number of foreclosures is up 89% from 2008, according to data from the Commissioner of Financial Institutions of Puerto Rico.) are less than they were a decade and a half ago: so municipal revenues are collapsing, and the government’s future economic prospects are threatened. Added to the grim picture: tourism, a key source of the island’s economy where hotel occupancy is the strongest in a decade, is imperiled by an outbreak of the Zika virus. Thus, the island confronts a triple fiscal whammy: debt, a signal health care crisis, and a loss of its most critical work force.

On the debt front, in the wake of Governor Alejandro Garcia Padilla’s decision to have Puerto Rico issue $3.5 billion of municipal bonds two years ago, an amount believed at the time to be sufficient to tide the island over until last June, instead finds that Puerto Rico’s debt had escalated to $70 billion—or the equivalent of about $20,000 for every one of its 3.5 million residents. With Congress set to break without having taken any action, the stage appears increasingly ineviatable for defaults on Puerto Rico’s debts. Already full faith and credit municipal bonds backed by Puerto Rico’s full taxing power which mature in 2022 traded last week for only 57 cents on the dollar. For all the bitter whining by hedge fund lobbyists in Congress that the efforts led by Speaker Ryan and the House Natural Resources Committee would not provide them full restitution, Chairman Bishop’s proposed bill would provide them some.

Protest Vote Fails to Impede Progress on Exiting Municipal Bankruptcy. A preliminary count appears to indicate that an effort to undercut San Bernardino’s plan to exit the longest municipal bankruptcy in U.S. history has failed. The effort by city taxpayers to seek to reverse a parcel tax and the move to consolidate the city’s fire department with that of San Bernardino County shows 846 registered voters and 1,070 landowners formally protested—well short of the requisite amount (an election is only called if protests are received from 25 percent of either registered voters or landowners) needed to trigger an election—and clearing the way for the outsourcing and tax, which commences at $148 per parcel in the 2016-17 fiscal year and can go up as much as 3 percent per year, remain set to become effective July 1—and, critically, leave unmolested the city’s plan of debt adjustment pending before U.S. Bankruptcy Judge Meredith Jury. Nevertheless, the Local Agency Formation Commission, which oversees the process, will need to certify the results, according to its executive director, Kathleen Rollings-McDonald. Nevertheless, upset residents and landowners said at a protest hearing last Thursday that the form they received in the mail from the city was unclear or easy to mistake for junk mail: they accused the municipal officials behind the move of voter suppression. Notwithstanding opposition from nearly all of the 21 members of the public who spoke before Council at last Thursday’s hearing, Mayor Carey Davis said afterward that the move would benefit residents: “This,” Mayor Davis said, “helps the city to provide better fire service. It also gives us access to swift water rescue, maintenance for engines, CONFIRE (the county fire dispatch system), which will improve dispatch times.” The Mayor further reminded citizens that, because the city had been forced to close two fire stations as part of its proposed plan of debt adjustment, this would give residents access to county fire stations. The City Council, county Board of Supervisors and Local Agency Formation Commission for the county have approved the plan in a series of votes going back to August 2015, saying the move benefits the county and is vital to the city’s plan to exit bankruptcy.

Balancing a Municipality’s Past Versus Its Future

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eBlog, 4/21/16

In this morning’s eBlog, we continue to follow Atlantic City’s blues—and the racing deadline the city faces in the midst of uneven state leadership—but remarkable state power and authority over the city—all without, however, any obligation to provide fiscal assistance. We continue to follow the unprecedented leadership efforts of House Speaker Paul Ryan and House Natural Resources Committee Chair Rob Bishop in their efforts to coordinate with U.S. Treasury officials to address the nearing insolvency in Puerto Rico—mayhap with insolvency looming at the same time as in Puerto Rico. We look back at the test of time since former President Reagan signed the 1988 municipal bankruptcy amendments into law: how has it worked? How has it balanced municipal public pension obligations versus a municipality’s bondholder obligations—and with what potential consequences for a city’s future? As we head down this morning to the Southern Municipal Conference in Norfolk, this seems like a lot to ponder upon.

Atlantic City Blues. New Jersey’s key state legislative leaders met privately yesterday to discuss their competing options for helping Atlantic City avoid insolvency and municipal bankruptcy, but were unable to reach any agreement: the city is beset by the closure of four casinos in recent years; it has about a $100 million budget deficit; and it is more than $550 million in debt. The closure of the casinos and drop in the assessed values of the remaining properties have combined to reduce the city’s property tax base by more than 50 percent in the past five years—forcing it under State supervision pursuant to the Local Government Supervision Act. However, notwithstanding State supervision and imposition of Emergency Manager Kevin Lavin, Atlantic City currently faces a revenue shortfall that could render the municipality insolvent in the near future. Added to the governance challenge, according to an analysis last week by the state’s Office of Legislative Services, there is no New Jersey statute which obligates the State to financially assist Atlantic City in case of an imminent default on its municipal debts—an opinion confirmed by the fact that the State is not listed on the bond covenants as a guarantor; rather the state law pledges the taxing authority of the municipality alone to “pay the interest on bonds issued.” The opinion notes, however, that under the state law: “Once a municipality is under State supervision, the Local Finance Board may impose certain restrictions on the city, including limitation on debt and limitations on expenditures.” The epistle adds that the state has “broad authority to order the city to liquidate or refinance its current debts, and, if the city does not comply with those orders, the Local Finance Board may perform those actions itself or through its agents.” Finally, the letter notes that while the state statute directs the state to “extend all possible consultation and assistance to municipalities,” the state is “not aware of any interpretation of that statute that requires the assistance to be in the nature of state aid or the assumption of the city’s debts.” The letter confirms that not only does the state regard itself under no obligation to help, but that any such help is unlikely.

Similarly, in the wake yesterday of an hour-long discussion between New Jersey Assembly Speaker Vincent Prieto and Senate President Stephen Sweeney, the two reported no progress had been made and stressed that there is now increasing apprehension the city is headed toward insolvency, with President Sweeney noting: “I think we’re going to face bankruptcy…I’m very concerned what’s going to happen to other communities because of this.” It appears the Speaker recognizes the potential for contagion: Atlantic City defaults on its debt or filing for chapter 9 municipal bankruptcy could trigger downgrades to the credit ratings of other municipalities across New Jersey.

For its part, in the wake of Tuesday’s rejection by a New Jersey Superior Court judge of a state request to freeze Atlantic City’s spending until the city makes all the payments it owes to its school district over the next three months, the city turned the tables by filing a counter lawsuit demanding the state pay the city with $33.5 million in aid — funds which local leaders say they were promised, but which Gov. Chris Christie vetoed in January. In addition, the city is requesting the court to designate a special master to be appointed to oversee the state monitor the Christie administration placed in city hall six years ago to oversee the city’s finances—or, as Atlantic City Council President described it: “We have to fight back…We believe to balance this thing out, we have to go in front of a judge. The facts will play themselves out in our favor.” In addition, the suit calls for the state to hand over key documents related to the quasi-state takeover, including the report filed by the Governor’s appointed emergency manager—and that the court bar the state from taking any “punitive, retributive, or adverse action against the city of Atlantic City.”

Meanwhile in Trenton, State Senate President Sweeney has been pushing a plan backed by the Governor which includes an aid package for the city and a bill that would allow a five-year takeover of many city functions—even as in the House, House Speaker Vincent Prieto has announced his own rescue bill—noting, with its introduction yesterday—“Atlantic City needs help…but they need to be treated fairly.” The action came as Sen. Sweeney said he had offered a second compromise in private yesterday, although a spokesperson for Speaker Prieto said no such offer was made. Gov. Christie added in what might herald the commencement of a “blame game” that Speaker Prieto “is going to be responsible for the bankruptcy of Atlantic City.” Sen. Sweeney noted that the Speaker “doesn’t feel Atlantic City can go bankrupt,” because he believes the state is required under law to step in. Senate President Sweeney, however, noted that “Nowhere does it say the state has to write a check,” a position seemingly supported by a different analysis from the state’s Office of Legislative Services—albeit that opinion does note that under New Jersey law, when a municipality defaults for more than 60 days on outstanding notes or bonds, the court “shall require the state to exercise its powers and duties to stave off bankruptcy.”

Maybe A Little Good Gnus. Meanwhile, Atlantic County Superior Court Judge Julio Mendez has ruled that Atlantic City is in compliance with payments owed to its school district, a judge has ruled, denying the state’s request that Atlantic City be forced to freeze spending until outstanding property tax payments owed to its school district through June 30 are paid. The city made an $8.4 million payment to the public schools on Tuesday and needs to pay an additional $25 million over the next two months. In the wake of Judge Mendez’s ruling, Atlantic City announced a counterclaim against New Jersey demanding it provide $33.5 million in aid that had been approved by a state monitor for the FY2015 budget—funds to be derived from a bill in the state legislature vetoed by Gov. Chris Christie that would have enabled the city’s eight casinos to make payments-in-lieu-of-taxes for 10 years—legislation the Governor has said he will not sign without an approval of legislation enabling a state takeover that would empower New Jersey’s Local Finance Board to renegotiate outstanding debt and municipal contracts for up to five years.

Puerto Rico. Congress seems increasingly unlikely to take action to help Puerto Rico ahead of a May Day deadline for the Commonwealth to default on a nearly half-billion-dollar debt payment—a failure to act which could push Puerto Rico and its 3.5 million American citizens further into crisis, exacerbating not only a growing fiscal crisis, but also a potential humanitarian disaster—after House Natural Resource Committee Chairman Rob Bishop (R-Utah) was forced to abruptly cancel a vote on a Puerto Rico debt restructuring bill when it was short of votes last week. A revised version is not yet completed, although Chairman Bishop warned that: “I’m not sure that on May 2 Armageddon takes place, but clearly I think it will illustrate that there is a significant problem…There are still some people out there saying there’s not a problem…No, there is a problem, they will default on some portion.” The Chairman’s draft proposal would create a create a financial control board, not unlike comparable boards that were used to avert bankruptcies in New York City and Washington, D.C., to manage the U.S. territory. Now it appears committee action is unlikely before next week at earliest, risking chances of final passage through the House and the Senate before the end of next week.

Can Municipal Bankruptcy Work? Notwithstanding the naysayers on Capitol Hill, not to mention the deep apprehensions we had (and strong opposition from leaders in the National League of Cities) to the municipal bankruptcy amendments President Reagan signed into law in 1988, nor the significant string of municipal bankruptcies in Jefferson County, Central Falls, Stockton, San Bernardino, but, perhaps most of all, Detroit—where I met with Kevyn Orr, the state’s selected emergency manager, on the morning he filed for the historic city of soul to go into municipal bankruptcy—a city which had suffered not only criminal malfeasance from its own elected leaders, but also devastation by the Great Recession of its iconic auto industry—devastation of economic destruction and population loss so deep that it made one apprehensive that it could ever recover. Yet, today, in the wake of extraordinary leadership by a federal bankruptcy judge and his partner from a U.S. District court, and thanks in no small part to a $100 million pledge from JP Morgan Chase—a commitment that has leveraged, according to Mayor Mike Duggan, another $30 million, and dynamic leadership by the Mayor, the city is on the brink of a sparkling new bridge to Canada that could make Detroit a gateway over the years towards a recovery which only four years’ ago seemed almost unthinkable.

Future versus the Past? Notwithstanding phony claims by some Members of Congress that any form of municipal bankruptcy would amount to a federal bailout of Puerto Rico, municipal bankruptcy means on its face that there will be losers. Just think, Judge Steven Rhodes in Detroit had to opine over the city’s plan of debt adjustment with regard to how its assets would be divvied up between more than 100,000 creditors. His decision was further complicated by Michigan’s constitution, which protects contracts—contracts such as Detroit’s pension obligations. Unlike a non-municipal corporation, the importance of chapter 9 is to insure there is no disruption of essential municipal services; there are, however, exceptionally hard choices forced with regard to such cities’ municipal bondholders and retirees. The latter, after all, are taxpayers to the city—and steep cuts in pension obligations might make them wards of the city. In contrast, bondholders are spread all across the country: they are often neither constituents, nor voters. Yet, they are vital to any enduring fiscal and economic recovery. So, as Bloomberg this week wrote: [municipal] bondholders have reason to fear a fight in a federal bankruptcy court if an insolvent municipality or county files, because, as the piece noted: “recent cases show that when municipalities go broke, investors lose when pitted against municipal retirees,” adding, for instance, that San Bernardino’s proposed plan of debt adjustment pending before U.S. Bankruptcy Judge Meredith Jury provides for a 60 percent loss to the city’s municipal bondholders, but retains retirement benefits intact under the settlement which could pave the way for the terror-stricken municipality to exit nearly four years in municipal bankruptcy—the longest of any city in history. According to Black Rock Inc., the outcome in San Bernardino shows why municipal bondholders should be wary of distressed local governments which can petition to have debts reduced in federal bankruptcy courts, because, Peter Hayes, BlackRock’s head of municipal bonds, notes: “Pensions are faring far better than other creditors under Chapter 9…This reinforces the view that bondholders need to be extremely cautious dealing with distressed municipalities.”

The Risk of Fiscal Contagion

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eBlog, 4/19/16

In this morning’s eBlog, we continue to follow the unprecedented leadership efforts of House Speaker Paul Ryan and House Natural Resources Committee Chair Rob Bishop, who are working with U.S. Treasury officials to address the nearing insolvency in Puerto Rico—where the Speaker confronts misinformation and a heavy lobbying campaign intended to mislead and prevent any Congressional action to avert the U.S. territory’s looming insolvency. The misinformation spread by opponents could have broader, adverse consequences for states and local governments. Speaker and Minority Leader Nancy Pelosi are meeting with their respective caucuses in hopes of moving the proposed legislation to the full House by next week. We continue to follow the comparable timeline—and governance dysfunction—in New Jersey, where Atlantic City is on a timeline to insolvency not very different than Puerto Rico, but where little consensus appears with regard to the most effective resolution—and where state dysfunction could have broader fiscal risks for cities throughout the state. Then we become electronically musical and listen to the noted electric rhythm guitarist, retired U.S. Bankruptcy Judge Steven Rhodes, as he works to avert insolvency and turn around the Detroit Public Schools. Finally, we hope that last night’s confirmation of a new Finance Director in San Bernardino will provide the key leadership stability critical to paving the way for the city to successfully emerge from the longest municipal bankruptcy in American history.

Puerto Rico & Congressional Leadership: Paul Ryan (R-Wis.) and House Natural Resources Committee Chair Rob Bishop (R-Utah) were forced to cancel a committee vote on a bill to avert Puerto Rican insolvency at the last-minute last week: they blamed the delay on Democrats and the Obama administration, who, they said, had requested more time to negotiate; however, the real stumbling block appears to have been their own members—who somehow seem to believe the proposed legislation, the PROMESA or Puerto Rico Financial Stability and Debt Restructuring Choice Act, which key sponsor Rep. Sean Duffy (R-Wis.) described as legislation which would “empower the Government of Puerto Rico with the choice to partner with the Federal Government and put the island on a path towards balanced budgets and a return to fiscal security. If Congress does not act, it would have a devastating effect on the people of Puerto Rico and countless Americans throughout the states who stand to lose billions in the bond markets.”

Nevertheless, in the wake of a closed-door GOP conference last Friday, it became clear the legislation lacked sufficient support: too many Members remain confused and believe the proposed bill would amount to a federal bailout of the commonwealth—a misperception galvanized and inflamed by hedge funds and other groups allied with Puerto Rico’s creditors who have sought to denounce the House Leadership effort as a federal bailout, notwithstanding the proposed bill does not provide for any direct federal assistance.

Nevertheless, the delay does not appear to have deterred either House Speaker Paul Ryan, or House Natural Resource Committee Chairman Ron Bishop (R-Utah); rather, if anything, it seems to have increased their commitment to achieve passage of a bipartisan bill—albeit against a tighter and tighter deadline, because the U.S. territory reports its economy will soon deteriorate further, because it can no longer afford to pay some of its $72 billion in debt.

Rep. Duffy’s bill would create a federal board to provide fiscal oversight, give the island a temporary legal stay against lawsuits from creditors, and create a mechanism for the island to restructure its debts. The legislation and unique Treasury—House Leadership partnership matters, because Puerto Rico sits in a governance twilight zone: it is neither a state, nor a municipality. Moreover, Puerto Rico currently has nearly a dozen different classes of debt, each with different security pledges—pledges which make some classes more senior than others—and it has a significantly underfunded pension system—and is soon to be the first part of the U.S. to experience the devastating Zika virus. The Treasury Department has been pressing—and working with House Speaker Ryan—on legislation to make it easier for Puerto Rico to restructure its debt in recognition that only Congress can create an orderly framework to resolve debt. Treasury officials have also expressed apprehension that the pending bill has technical provisions which could hamper recovery, because they could allow the island’s creditors to string along the restructuring process.

Ironically, some bondholders have been working closely with the Republican Study Committee, to steer the bill away from enabling broad restructuring authority: they oppose any federal legislation which might allow the voiding or restructuring of Puerto Rico’s debts or contracts. They have not offered any constructive alternative. Among the leaders of the opposing groups are some familiar ones: Franklin Advisers and bond insurers Assured Guaranty and Ambac Financial Group, names we have seen previously opposing and challenging Stockton’s plan of debt adjustment using similar arguments. They are pressing for legislation to make it virtually impossible for Puerto Rico to restructure its debts or void contracts—effectively, ironically, pressing for a Congressional position which would lead to the very federal bailout they claim to oppose.

In contrast, as Rep. Raul Labrador (R., Idaho) notes: “You’ve got all these ads saying this is a bailout. There’s no taxpayer money going to it…My fear, and I think it’s a pretty well-founded fear, is that if we don’t give them the tools, there will be a bailout request because they’re going to go under.” Now Chairman Bishop estimates that modifications to the pending bill will not be completed until the end of the week; nevertheless, with a major bond payment looming in two weeks, the Chairman is pressing for a bill “as soon as humanly possible…If we all can’t get together by May 1 and there is [a default] and all of a sudden creditors start suing again, maybe this will reinforce that this is a serious issue.”

Our friends at Municipal Market Analytics continue to believe the fiscal reverberations from the Puerto Rico trials and tribulations will have limited impact on state and local debt issuances, albeit they warn there could be 1)greater municipal bond investor hesitancy to lend to (or purchase the bonds of) already distressed state or municipalities, for fear of redistributive-oriented, ad hoc restructuring efforts by local, state, or federal politicians; 2) an accelerated erosion of non-managed retail ownership in municipal bonds generally once Puerto Rico related investor lawsuits commence against their broker dealers; and 3) the potential for brief systemic price weakness, in particular in the high yield subsector, if the two remaining municipal mutual fund investors in Puerto Rico are faced with major outflows.

New Jersey & Fiscal Contagion Risk. The political stalemate in Trenton over the looming Atlantic City insolvency and potential municipal bankruptcy is increasing apprehension across the state that there could be lasting fiscal damage and risk throughout the state if the state were to impose a state takeover. That growing risk recognition might have both forced recognition—at least in the legislature, if not the Governor’s office, that some sort of compromise is ever more urgent—and that, perhaps, the agreement by state Senate President Stephen Sweeney to modify his plan for an immediate state takeover—and instead offer Atlantic City one last opportunity to structure its own recovery path with the benefit of a four-month extension—and the imposition of strict state fiscal benchmarks—might be critical to preventing spreading municipal fiscal risk. Ergo, state legislators now appear to be leaning towards granting the city a grace period of 130 days before a state takeover would be triggered. The emerging consensus marks a victory for Assembly Speaker Vincent Prieto, but, at the same time, puts increased pressure on both the Speaker and Mayor Don Guardian—especially with Sen. Sweeney’s proposed plan to mandate waves of layoffs and the sale of key parts of Atlantic City’s assets—such as its water utility—and a mandate to cut its municipal budget by nearly 50 percent. For a city which has already experienced a loss of more than 10,000 jobs and has experienced a loss of more than two-thirds of its tax base, the proposed state medicine might seem more like poison. Nevertheless, the toxic state-proposed medicine would still leave the city with a per capita budget greater than that of Newark, Trenton, and Camden. The other outstanding issue—as we saw in Detroit, Stockton, and San Bernardino—relates to bargaining agreements: to date, no meaningful reductions in force or benefits in the city have been negotiated—all key issues which became fulcrums to the plans of debt adjustment in Detroit and Stockton. Failure by Speaker Prieto—or too much delay in securing a House bill—will force the House to work with the Senate-passed bill which would authorize a quasi-state takeover by New Jersey’s Local Finance Board, which would be authorized to renegotiate outstanding debt and municipal contracts for as long as five years.

Grading Detroit’s Public Schools. Detroit Public Schools (DPS) transition manager, retired U.S. Bankruptcy Judge Steven Rhodes, yesterday reported he is not proposing to close any buildings in the next academic year, notwithstanding reports of the significant physical overcapacity (enough to support 40,000 more students than it currently enrolls). In his new 45-Day Financial and Operating Plan required under the 2012 Michigan state law that creates emergency managers for financially distressed schools and local communities, Judge Rhodes noted that the state’s largest school district “can look forward to enrollment stability” in the future and that decisions about right-sizing the district’s footprint to match falling enrollment are best left to an elected school board—one which could be elected or appointed later this year. Judge Rhodes added that the school system’s operating expenses are not sinking the district–nor are teacher salaries, “which,” he noted, “are significantly below suburban teacher salaries…Rather, the cause is DPS’ debt service. That debt service, $63,849,494, is sucking revenues away from our classrooms at the rate of approximately $1,394 per student.” As Judge Rhodes did the math, he said: “DPS simply cannot pay that debt while attempting to provide a quality education for its students.” Under a state restructuring proposal which would divide DPS into two entities and provide about $200 million for future operating costs, he estimated as much as $500 million in school debt could be retired. The Michigan House is currently considering two sets of bills that would reorganize the district after Judge Rhodes completes and submits his final report and recommendations next month.

The Coalition for the Future of Detroit Schoolchildren and others have previously contended DPS has capacity to seat 85,000 students in the buildings it continues to operate; but Judge Rhodes in the report notes that DPS operates 97 school buildings at about 78 percent capacity. Thus, while closing buildings would save on operating costs, such closings could risk creating further per-pupil state funding challenges, because officials have estimated about 30 percent of students in each closed building go elsewhere or do not remain enrolled in the traditional school district—or, as Judge Rhodes wrote: “I determined not to pursue any school closings for the 2016-17 school year…(T)his difficult and sensitive question is best left to the school board that will be appointed or elected later this year if the reform legislation is adopted returning the district to local control…DPS currently has 13 buildings that it is not using and does not maintain. We hope to negotiate an agreement to transfer these properties to the city of Detroit in the near future.”

Thinking about Tomorrow. San Bernardino, the city in municipal bankruptcy longer than any other in U.S. history, has chosen a new finance director, Brent Mason, who served as Riverside’s finance director until the beginning of this month. The City Council last night voted unanimously on his selection to head the critical department and increased the position’s compensation more than 10 percent. Mr. Mason, who will begin today in what is mayhap the most critical position—a position notably vacant now for more than a year—will start with a salary of $188,580 and benefits worth $61,587 per year—a significant step over the previous maximum compensation under the former salary range, which was based on a study done in 2007—so that, according to the report submitted to the elected leaders, the cost will be “absorbed” through savings because of other vacant positions in the department. It is hoped the appointment to the quasi-quarterback slot will provide some critical stability in a vital position which has experienced significant turmoil and turnover: three finance directors have left the city in the past three years: not exactly a good prescription for a municipality in bankruptcy. Reestablishing experience and stability in a municipality which has experienced high turnover in many departments since filing for municipal bankruptcy protection four years ago—especially in the Finance Department, could be vital to the city’s ability not only to gain U.S. Bankruptcy Judge Meredith Jury’s approval of its proposed plan of debt adjustment, but also to gaining some stability in the key city office, which will now be under its fourth finance director in three years.

So It Turns Out Chapter 9 Municipal Bankruptcy Can Work!

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eBlog, 4/15/16

In this morning’s eBlog, we continue to follow the unprecedented leadership efforts of House Speaker Paul Ryan—working with U.S. Treasury officials to address the nearing insolvency in Puerto Rico—where the Speaker confronts misinformation and a heavy lobbying campaign to mislead and delay final consideration. The Speaker and Minority Leader Nancy Pelosi are meeting with their respective caucuses in hopes of moving the proposed legislation to the full House by next week. If anything, the leadership by bipartisan House leaders surely contrasts with New Jersey, where Atlantic City is on a timeline to insolvency not very different than Puerto Rico, but where little consensus appears with regard to the most effective resolution. Finally, we look back to where it all began—in a sense—Orange County—the first municipality in the nation to file for chapter 9 municipal bankruptcy after the adoption of the 1988 municipal bankruptcy law, P.L. 100-597. Orange County’s fiscal collapse, moreover, because the County—at the time—was managing a pooled fund for over 200 California municipal school districts, cities, and counties, provided the first test with regard to whether the new federal law would work—or fail. There is nothing like the test of time.

Governing Amid Bankruptcy Misconceptions. House Speaker Paul Ryan has scheduled a policy meeting this morning in an effort to overcome resistance to the bill authored by House Natural Resources Committee Chairman Rob Bishop (R-Utah) as he seeks to gain sufficient support to get the bill reported to the full House, with the Speaker warning the Chairman “did not have votes on the other side of the aisle going into the markup.” Chairman Bishop and other sponsors of the bill will brief House Republicans this morning—emphasizing that—contrary to claims made by some Members and lobbyists for hedge funds—that the bill was specifically designed to prevent any federal bailout, with the Speaker adding that “the direction we’re headed with an oversight board” will help members appreciate and better understand the fiscal commitment. Part of the challenge is coming from Members such as Rep. Tom McClintock (R-Ca.), who warned his colleagues the bill was a bailout and warned it would lead other states to demand the same treatment—demonstrating both a lack of understanding of the outcome of the municipal bankruptcies in Orange County (please see below), Stockton, and San Bernardino in his home state—in no case has there been any bailout—and demonstrating an inability to understand the dual sovereignty of the U.S. Constitution. Indeed, Speaker Ryan has warned that absent swift action to address Puerto Rico’s looming insolvency, the federal government would be forced into a costly federal bailout, noting: “The need for Puerto Rico legislation is to bring order to chaos, and my number one priority as Speaker of the House with respect to this issue is to keep the American taxpayer away from this: there will be no taxpayer-funded bailout down the road.”

On the other side of the aisle, House Minority Leader Nancy Pelosi (D., Ca.) yesterday said Democrats have made “some substantial progress” working with Republicans and the Treasury Department to iron out her party’s remaining concerns with the bill, adding: “At the end of the day, any bill must have restructuring that works, an oversight board that is respectful of the people of Puerto Rico and does not undermine the restructuring part of the bill and does not contain extraneous provisions that harm working people.”

New Jersey & You. Atlantic City, facing insolvency—but less constructive state leadership—has made a $4.25 million payment to its school district in order to ensure its public schools remain open and the teachers paid. The payment came in the wake of a suit filed last week by the New Jersey Department of Education to force the fiscally beleaguered municipality to make all payments due the school district through July, some $34 million, or about $8.5 million per month. The school board did not support the lawsuit, noting that it had been working with the city to resolve their financial problems. A hearing on that suit is scheduled for Tuesday. The added costs and disruption from the state came as New Jersey Senate President Steve Sweeney (D-Gloucester) has proposed an alternative proposal aimed at saving Atlantic City from insolvency—one which proposes additional benchmarks for the city over and above what he had previously proposed. The revised compromise would allow Atlantic City:
• 130 days to address its $102 million deficit; and
• Mandate that the city, which is close to running out of cash flow, cut its current spending per capita from $6,700 to $3,500.

Failure to meet these conditions would trigger House action on the Senate-passed bill which would authorize New Jersey’s Local Finance Board to renegotiate outstanding debt and municipal contracts for as long as five years. In his statement, Senate President Sweeney noted: “This plan gives Atlantic City the opportunity to use all the tools at their disposal to finally reduce spending and reform government operations before the state asserts control over its municipal finances.” Unsurprisingly, Sen. Sweeney not only omitted mention the state role in naming an emergency manager for the city and that individual’s responsibility—nor what constructive suggestions he could contribute—even as the city has implemented a 28-day pay period suspension to allow time for May tax revenue to arrive to fund the next paychecks for city employees. The House Leader’s pressure adds to the increasing pressure from Gov. Chris Christie, who has warned he will not sign a companion bill that provides payments-in-lieu of tax (PILOT) funds from casinos absent this state takeover power.

In contrast, State Assembly Speaker Vincent Prieto (D-Secaucus) has, as we have noted, proposed Christie-opposed legislation which would create a quasi-financial control board, not dissimilar to that being proposed for Puerto Rico—and similar to ones utilized years ago in New York City and Washington, D.C.—under which a five-member committee would assume increased control if certain benchmarks were not met within a year. Speaker Prieto noted that Sen. Sweeney’s proposal was a “step toward compromise,” but still has collective bargaining concerns. For his part, the beleaguered Atlantic City Mayor Don Guardian responded that Speaker Prieto’s bill is “the most pragmatic” approach, adding: “We have enormous problems with legacy costs and debt service from previous tax appeals and other debts that must be addressed over the long-term…I am completely open to compromise and working together to find a solution, but it must be within a reasonable and practical framework.”

The End of the Beginning. With Orange County, Ca., on the verge of making its final payments based upon its plan of debt adjustment from its 1994 municipal bankruptcy—a municipal bankruptcy triggered by a devastating loss of nearly $1.64 billion on derivative investments—those payments will clear its slate and restore the county’s ability to devote its full budget to the county’s future—rather than the devastating financial investments it made more than two decades ago in derivatives that cost it in excess of $1.6 billion—and, because there were also pooled funds from other municipalities in southern California (The investment pool consisted of funds from the county as well as approximately 240 other local agencies, including school districts, cities, and special districts). The insolvency had risked much greater fiscal disasters. Orange County entered municipal bankruptcy after its investment pool reported the losses from highly leveraged positions that unraveled when interest rates rose. The county’s filing for chapter 9—the first filing in the wake of municipal bankruptcy amendments signed into law by former California Governor and U.S. President Ronald Reagan—was met at the time by consternation by the nation’s cities’ leaders. But the chapter 9 ensured there was no interruption of essential public services—and that a lesson was learned: Orange County Executive Frank Kim yesterday said the municipal bankruptcy experience “has made us more conservative in terms of being very careful to not issue debt where we don’t have to.” Orange County currently has plans to issue $68 million for a central utility upgrade at the end of May, according to Suzanne Luster, public finance director. The proceeds will be used to upgrade the heating and cooling infrastructure that supports the civic center campus, the Orange County Jail, and federal and state buildings. County supervisors will vote May 10 on that bond sale, which would be its first long-term debt issuance in 10 years.

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eBlog, 4/14/16

In this morning’s eBlog, we continue to follow the unprecedented efforts involving the Treasury and the House Leadership to address the nearing insolvency in Puerto Rico—where, despite significant progress towards reporting legislation critical to the U.S. territory’s fiscal and human safety, the unprecedented constitutional, legal, and political challenges are putting House Speaker Paul Ryan (R-Wis.), a Democratic administration, and Puerto Rican leaders in untested and shark-infested waters as they are seeking to construct a package the House could act on as early as next week that would be critical to avoiding a human and fiscal catastrophe. The contrast in the U.S. House of Representatives with the growing governance dysfunction in New Jersey over the fiscal fate of Atlantic City is palpable. There, rather than working together to fashion governance solutions, the state’s inability to lay out a constructive fiscal blueprint in the face of rapidly falling assessed property values risks signal fiscal contagion to other municipalities across the state. Meanwhile, in Michigan, importantly, despite all the Congressional finger-pointing in Washington, D.C. in efforts to shift the blame for the steep federal cuts in clean and safe drinking water funding, and thanks to the unique role contributed by Virginia Tech, we are seeing real progress in Flint according to new tests this week of its drinking water, albeit, unsurprisingly, not at the rate residents and state officials had hoped. Unsurprisingly, we have observed no constructive efforts in Congress to address a human health threat not just to Flint, but also to other cities, towns, and counties across the country with regard to safe drinking water.

Flint’s water system. Flint is not yet in like Flint: while the city has been reconnected to its traditional source for nearly six months now, new test results this week have not resulted in the rate of improvement residents and government officials had hoped for: despite indications of improvement, lead contamination is still at levels beyond what is accepted under federal standards—even as the system’s rebound from an 18-month stretch of using the corrosive Flint River has been slowed due to low water usage by city residents, according to the findings of a new round of sampling conducted by Virginia Tech researchers who first identified the city’s lead contamination problems last summer. Last month, the Va. Tech team returned to 174 of the 269 homes previously tested to assess the progress—and is now proposing a new flushing program to increase water flow and, hopefully, speed up improvements to the municipality’s water system. While, according to EPA standards, the drinking water safety has increased nearly 25 percent, the quality still means, according to Virginia Tech’s Marc Edwards, who leads the research team, that he recommends all homes still be considered at risk — even those that may have shown low lead levels in the past. Water advisories remain in place urging residents not to drink the water, but allowing them to use it for bathing and showering. An added impediment to recovery, ironically, may be due to Flint residents using so little water: the water pipeline system was designed to service far more residents than it now serves, so that low usage is, in effect, limiting the amount of corrosion controls and chlorine making its way through home plumbing—in effect reducing those chemical additions aimed at reducing lead and bacteria. According to the EPA last week, particulate lead — small scales that are flaking off damaged underground pipes — is an ongoing concern, so that the system remains “unstable.” That means, according to Mr. Edwards: “We have learned in the past few months it’s probably going to take months or years to get these deposits out of the pipes and clean these pipes out.”

Waiting for Godot. Despite the exceptional, bipartisan work and leadership from House Speaker Paul Ryan (R-Wis.) and the Treasury, the House Natural Resources Committee yesterday indefinitely delayed acting on the pending draft legislation to address Puerto Rico’s looming insolvency. Nevertheless, the Committee members and senior Treasury Department officials made clear they intend to continue to try to address the concerns raised about the measure and revise provisions in order to be able to report the bill in a way that could earn passage by the full House. Just as 99 years ago when the U.S. Senate was debating whether and how to bring Puerto Rico into the union, still today, as my friend and supreme municipal bankruptcy expert Jim Spiotto puts it: “[T]here was, at our nation’s founding, no precedent for a dual sovereign passing a law regulating the bankruptcy of the other.” The Committee is leading in not just uncharted waters, but waters where lurking hedge fund lobbyists—in an election year, are roiling the waters.

As drafted, the proposed legislation would create an oversight board, not unlike those used previously for both New York City and Washington, D.C., which would have the power to require Puerto Rico to balance its budgets, address the island’s pension liabilities, and file restructuring petitions on behalf of the commonwealth and its entities; under the draft, the board would be authorized to formulate a restructuring plan and negotiate with creditors. The Committee is drafting the legislation under the Constitution’s Territorial Clause. In his testimony yesterday, U.S. Treasury Counselor Antonio Weiss made clear there was bipartisan support for the Committee’s bill, noting there had been “significant progress in designing the elements of the bill,” albeit adding “more work is required to ensure a responsible solution to the escalating crisis in Puerto Rico,” adding that the nearly round-the-clock discussions would resume immediately after the hearing and would include Treasury officials along with House Natural Resources Committee Chair Rob Bishop (R-Utah) and his staff, adding: “The time to act is now. We are past every deadline.”

Key issues: Under a collective action clause, the majority of creditors in number and two-thirds of creditors in dollar amount of a particular class voting would be authorized to bind hold-outs to a restructuring plan. The two thirds agreement was intended to balance creditor interests who did not want to be unfairly bound in restructuring discussions while freeing Puerto Rico and its authorities from needing to secure too great a percentage to move forward with restructuring. Counselor Weiss indicated that the collective action clause could impose “an unworkable, mandatory process that will only delay the ability to reach a solution,” adding that a temporary moratorium on litigation over the debt of Puerto Rico and its authorities that the bill contains to give breathing room for restructuring may be too limited. (The moratorium would apply retroactively to actions begun on or before Dec. 18, 2015 and would continue until the earlier of Feb. 15, 2017, or the date that the first restructuring case is filed.) Counselor Weiss said: “A stay must…allow for a transition without interruption from voluntary negotiations to a period of restructuring, if needed. There is a risk the stay may terminate prior to the commencement of a restructuring, resulting in a chaotic race to the courthouse.”

In addition, there remains a governance issue: the draft would require at least five votes of the proposed seven-member oversight board to authorize the filing of a bankruptcy petition on behalf of the commonwealth or one of its authorities—raising issues with regard to whether such a super-majority would be too high a hurdle.

Unsurprisingly, there were also criticisms from some Committee members with regard to their opposition to the existing chapter 9 municipal bankruptcy law under which a federal bankruptcy judge can approve a voluntary restructuring under a voluntary plan of debt adjustment under which there is a so-called “cram down,” which some on the Committee mis-characterized as “a framework of bankruptcy [which would] result in a bailout.” Similarly, another Committee member claimed the proposed bill could have a wider effect, asking “If we rewrite these laws for Puerto Rico, why wouldn’t we also rewrite them for states?” It seems that the unique system of dual sovereignty created by the nation’s founding fathers in Philadelphia has been less than well understood by some Members of the U.S. Congress.

House Speaker Paul Ryan this week, in contrast, applauded the bill, noting: “Congress has a Constitutional and financial responsibility to bring order to the chaos that is unfolding in the U.S. territory — chaos that could soon wreak havoc on the American [municipal] bond market.” The Speaker added that the draft legislation would hold “the right people accountable for the crisis…and…Just as important for the long-term, this bill protects American taxpayers from bailing out Puerto Rico.”

The bill proposes seven instead of five Presidentially appointed members of the oversight board. It also broadens the number of people who would be recommending potential members. The President would now choose two individuals from those recommended by the House speaker, two from the Senate majority leader, one from the House minority leader, and one from the Senate minority leader. At least one of the two individuals chosen from the speaker’s list must have a primary residence or place of business in Puerto Rico. The earlier proposed process, which would have only had recommendations from leaders in the majority, was seen as too partisan. The draft bill also eliminates a provision from the earlier version which gave the oversight board power to unilaterally implement recommendations and binding regulations. Rep. Pierluisi said the earlier provisions were “clearly inappropriate and anti-democratic.”

The draft bill adds a collective action clause under which a majority of creditors in a given class would be provided a vote on debt restructuring, and it retains provisions giving the board power to approve a fiscal plan and budget for the Commonwealth if Puerto Rico’s government cannot create one which is acceptable. Under the draft bill, as long as the oversight board remained in operation, the territory could not, without oversight board approval, issue debt or guarantee, exchange, modify, repurchase, redeem, or enter into similar transactions with respect to its debt. On the public pension front, if the oversight board were to find Puerto Rico’s pension system was “materially underfunded,” it could mandate an independent actuary to evaluate the fiscal and economic impacts of its cash flows. In addition, the draft would permit the Governor, subject to the approval of the board, to designate a period of up to five years when employers in Puerto Rico must pay employees under the age of 25 as of the date of enactment a wage of at least $4.25 an hour.

New Jersey & You. The see-saw battle in New Jersey over the fiscal fate of Atlantic City continued between the State Assembly and Gov. Chris Christie yesterday, with the Assembly Budget Committee grilling the Christie administration with regard to a greater takeover than that which the state has held for nearly the past seven years. The House seems to be moving towards offering the beleaguered city up to 130 days before it would agree to the Governor’s proposed takeover. Increasingly, state leaders appear apprehensive that the city’s fiscal woes are contagious—a fear likely increased in the wake of RealtyTrac’s release of data yesterday that surrounding Atlantic County had the highest foreclosure rate of any major U.S. metropolitan area in the first quarter of 2016: according to data RealtyTrac released yesterday, one in every 106 housing units in Atlantic County had a foreclosure filing in the first quarter, compared to a nationwide rate of one filing per 459 homes: the closure of four Atlantic City casinos two years ago has been a key factor in the loss of jobs and homes. The county experienced the highest metro foreclosure rate for all of 2015. The RealtyTrac data listed Trenton, New Jersey’s capital city, with the second-highest metro foreclosure rate in the nation in the first quarter and Baltimore third. These latest released figures come in the wake—for the beleaguered city—of a drop in assessed property values from 2010-2015 of more than 50 percent: last year, the city would have needed to raise its property tax rates by 53.4 percent to balance its budget—an increase not just politically undoable, but also one which likely would have exacerbated the problem.

With the current governance and fiscal battle now at the state level, State Senate President Stephen Sweeney (D-Gloucester) and Gov. Chris Christie have been pressing the House to agree to state takeover legislation—that is virtually a complete state preemption of local authority, as opposed to the existing imposition of a state emergency manager. Or, as Sen. Sweeney put it: “For, years the Atlantic City government has made bold assertions regarding its ability to solve the problem…Despite those assertions, no solutions have ever been implemented in a material way. Our proposal gives the city one last chance.” In contrast, the House is proposing a compromise, under which the city would be given through the end of this summer to try to turn its fiscal condition around—a position which the House has honeyed by offering Atlantic City a bridge loan from the state if they would accept this offer. House Assembly Leader Lou Greenwald (D-Camden) noted; “Bankruptcy and financial ruin cannot be options for Atlantic City…Under this plan, the city will be able to maintain local control and will be given the summer to implement a legally binding, realistic, and responsible financial recovery plan.”

House Speaker Vincent Prieto remains dissatisfied, noting that no state proposal yet has resolved the “concerns about eviscerating collective bargaining, fair labor practices, and the civil liberties of the people of Atlantic City.” He is opposed to a mandatory breakup of union contracts.

For his part, Mayor Don Guardian notes that while he is applauding the “beginnings of a compromise,” the city confronts “enormous problems with legacy costs and debt service from previous tax appeals and other debts that must be addressed over the long-term,” adding he remains “completely open to compromise and working together to find a solution, [albeit one which] must be within a reasonable and practical framework…” noting he inherited, with his election, significant legacy costs and debt service from prior tax appeals and other debt.

Waiting for Godot in Puerto Rico

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eBlog, 4/13/16

In this morning’s eBlog, we consider the emerging and unprecedented development involving the Treasury and the House Leadership to address the nearing insolvency in Puerto Rico—where leaders in the U.S. House and Treasury—as well as in Puerto Rico—appear to have made significant progress towards imminent action critical to the U.S. territory’s fiscal and human safety. It is interesting that House Speaker Paul Ryan (R-Wis.), a Democratic administration, and Puerto Rican leaders have managed to construct a package the House could act on as early as next week that would be critical to avoiding a human and fiscal catastrophe—even as the Governor of New Jersey appears to be unable to offer any comparable fiscally constructive—or maybe even constitutional—hope for resolution, as Atlantic City nears insolvency.

Waiting for Godot. With Puerto Rico Governor García Padilla warning the U.S. territory is likely to default on some $422 million in debt payments owed next month, as well as on larger payments of nearly $2 billion owed in July—and as the island’s growing humanitarian and Zika crisis threatens the territory’s ability to protect public health and safety, House Natural Resources Committee Chairman Rob Bishop (R-UT) and bill sponsor Rep. Sean Duffy (R-WI) last night introduced H.R. 4900, the “Puerto Rico Oversight, Management, and Economic Stability Act (PROMESA),” noting the Committee had neared the conclusion of a long and collaborative drafting process in coordination with the U.S. Treasury, and stating: “This package of reforms will restore the guard rails of freedom and self-governance in Puerto Rico. It will hold Puerto Rico accountable to its debt, uncover audited financial statements, enforce fiscal responsibility and cut red tape holding down the Island’s economy. It provides tools to redirect Puerto Rico from a path of destitution towards a path of prosperity, preserving freedom and opportunity for the next generation…This is the constitutionally sound solution that will provide real, long-lasting reform to the Commonwealth while respecting the rights of all parties and creditors. It is the Island’s best shot to mitigate its financial collapse and future calls for a bailout, which would be untenable. Congress must act now to avoid a humanitarian crisis that will severely impact 3.5 million Americans living in Puerto Rico and millions of Americans on the mainland.” Please click HERE to view the bill. The proposed bill would give Puerto Rico authority to discharge debt and “cram down” or force its creditors to accept less than full payment on debts due—much as under chapter 9 municipal bankruptcy; the legislation, if enacted, would also halt most creditors’ lawsuits against Puerto Rico. In addition, the bill includes a provision for a federal oversight board—similar to boards used in New York City and Washington, D.C. when they neared insolvency—notwithstanding bitter opposition from Puerto Rican leaders. Nevertheless, Puerto Rico Governor Garcia Padilla last night said he believed that Congress had taken Puerto Rico’s complaints of federal overreach seriously and acted in good faith to tailor the oversight board to Puerto Rico’s situation—even as hedge funds and other opponents of the proposed bill claimed the bill essentially authorized municipal bankruptcy for the island. The Committee is scheduled to hold a hearing on the bill this morning and report legislation on Thursday—which could go to the full House next week.

Key Provisions:

• Under the proposed bill, the new oversight board that would have the power to require Puerto Rico to balance its budgets, address pension liabilities, and file restructuring petitions on behalf of the commonwealth and its entities.
• The bill outlines the board’s makeup, its power to unilaterally impose regulations on the commonwealth, and the required steps for an entity to undergo restructuring; however, it limits the authority of the board to filing restructuring petitions on behalf of the Commonwealth and its public authorities after the debtors sought to reach an agreement with their creditors through voluntary debt restructuring proposals and have provided the board with up-to-date financial statements.
• The bill proposes seven instead of five Presidentially appointed members of the oversight board. It also broadens the number of people who would be recommending potential members: The President would now choose two individuals from those recommended by House Speaker Ryan, two from the Senate Majority Leader, one from the House Minority leader, and one from the Senate Minority leader. At least one of the two individuals chosen from the Speaker’s list must have a primary residence or place of business in Puerto Rico.
• The bill eliminates a provision from an earlier version which provided the proposed oversight board power to unilaterally implement recommendations and binding regulations.
• The draft retains provisions giving the board power to approve a fiscal plan and budget for the commonwealth if Puerto Rico’s government cannot create one which is acceptable.
• As long as the oversight board remains in operation, Puerto Rico would be barred—without board approval—from issuing debt or guarantees, exchanging, modifying, repurchasing, redeeming, or entering into similar transactions with respect to its debt.
• Several other portions of the bill seek to put steps in place to assess the commonwealth’s fiscal health and lay groundwork for economic growth.
• If the oversight board were to find, for instance, that the territory’s pension system was “materially underfunded,” it could mandate an independent actuary to evaluate the fiscal and economic impacts of its cash flows. The bill details what the analysis is to cover.
• The bill also allows the Governor, subject to the approval of the board, to designate a period of up to five years when employers in Puerto Rico must pay employees as of the date of enactment a wage of at least $4.25 an hour.
• The bill would help revitalize Puerto Rico’s infrastructure by expediting permitting for “critical projects:” The governor would be authorized to appoint a “Revitalization Coordinator” from nominees put forth by the oversight board who would help with this process.

House Speaker Paul Ryan said the proposed bill would hold “the right people accountable for the crisis,” and that it would be key to shrinking the size of its government while getting Puerto Rico on a path to fiscal health—and that, over the long-term, it would protect “American taxpayers from bailing out Puerto Rico.” Similarly, Chairman Bishop noted the draft would be the “best shot to mitigate Puerto Rico’s financial collapse and future calls for a bailout, which would be untenable,” adding: “If we get this right, we have an opportunity to put the people of Puerto Rico on a path to economic opportunity; however, if we do nothing, the American people will be on the hook.”

Demonstrating some of the governance challenges, Rep. Nydia Velazquez (D-N.Y.), cautioned against a new provision in the draft bill which would require five board members to vote for a restructuring petition before it could move forward, noting to her colleagues that: “Given that four Board members will be appointed by Republicans, there is significant reason to believe that restructuring authority will never be granted…This concern is compounded by §601, a new provision, which adds a collective action clause to the bill. This clause requires two-thirds of creditors to voluntarily agree to restructure their debt, a hurdle that is not realistically achievable.” In addition, the draft retains a temporary moratorium imposed on litigation over the debt of Puerto Rico and its authorities—a moratorium which would apply retroactively to actions commenced on or before last Dec. 18th—and would continue until the earlier of Feb. 15, 2017 or the date that the first restructuring case is filed.

New Jersey & You. The New Jersey State Assembly Budget Committee yesterday grilled Gov. Chris Christie’s administration as the Governor continues his pressure for a state takeover—with the members wondering if the city’s problems were caused more by the Governor than Atlantic City’s elected leaders. The grilling came amid vituperative comments by the Governor about his fellow Republican leader, Atlantic City Mayor Don Guardian. Yesterday, the State Assembly Budget Committee questioned Department of Community Affairs Director Charles Richman with regard to how Atlantic City deteriorated financially in the wake of being placed under state supervision six years ago—with a state-imposed emergency manager: Now Atlantic City is weeks away from running out of cash flow and has invoked a 28-day payless period to allow time for May tax revenue to arrive to fund the next payroll. Assembly Budget Chair Gary S. Schaer (D-Passaic) noted: “Atlantic City’s financial problems were long ignored by the state and allowed to corrode to what we have today…It is the height of hypocrisy for the Governor to argue that Atlantic City’s best bet is for the state to take over its finances, when the city’s financial failures were exacerbated under the supervision of the state.”

Mr. Richman, in his testimony, stated that under state supervision, the Christie administration did not have power to contain all spending, since it only had oversight on new hires; it lacked authority to implement layoffs. Now, of course, Gov. Christie was told New Jersey House leaders he will not agree to sign into law a state Senate-passed rescue package that provides payment-in-lieu of tax revenues from casinos absent still another state intervention package approved by the State Senate—a package which would empower New Jersey’s Local Finance Board to renegotiate outstanding debt and municipal contracts for up to five years—an approach opposed by both the city and State Assembly Speaker Vincent Prieto (D-Secaucus), who, instead, has proposed an alternative approach—still another avenue opposed by the Governor—which would give a five-member committee increased control if certain benchmarks were not reached by the City. The “fiscicuffs” are now poised to enter the third circus ring next week, when Atlantic County Superior Court Judge Julio Mendez, after rejecting Gov. Christie’s request for a freeze in his courtroom last Friday, agreed to another hearing date next Tuesday.

Exceptional Governance & Intergovernmental Challenges

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In this morning’s eBlog, we consider the exceptional governance and intergovernmental challenges between state and local governments in Michigan and New Jersey—as well as the debt challenge in Puerto Rico—where leaders in the U.S. House and Treasury—as well as in Puerto Rico—are racing not just avert a debt time bomb, but also a rapidly accelerating human health threat. In Michigan, the physical and fiscal collapse of the Detroit Public School system has raised new issues with regard to state appointments of emergency managers—not to mention the growing recognition that the system’s physical and fiscal near municipal bankruptcies are intertwined with any serious chance for long-term solvency of Detroit—the state’s largest city. In New Jersey, state dysfunction and critical state constitutional questions are arising—where vituperative accusations by the Governor appear to offer little constructive—or maybe even constitutional—hope for resolution, as Atlantic City nears insolvency. Some mornings we wish we could clone the musical, retired U.S. Bankruptcy Judge Steven Rhodes so that he could bring his judicial rhythm and maturity to help the humans so adversely at risk, especially the young children in Detroit so critical to its fiscal future.

Unschooled Public Financing. The board of education for Detroit Public Schools (DPS) has filed a federal lawsuit against the State of Michigan over the state’s emergency manager law—a law the suit charges which has kept non-elected emergency managers in a position to run the district since 2009, alleging that emergency management in the district has violated the civil rights of children and naming more than 20 defendants, including Gov. Rick Snyder, two Republican state legislators, several former emergency managers, and a dozen former and current principals and a vendor recently indicted on charges of running a nearly $1 million kickback and bribery scheme. Like Flint, Detroit, and other cities in Michigan have been, DPS has been run by state-appointed emergency managers since 2009. Before that, the district was under a state takeover from 1999 to 2007.

The suit here seeks class-action status, which would have to be approved by a judge. The pro bono attorney on the case, Thomas Bleakley, stated that DPS’ physical and fiscal problems are inappropriately being blamed on local officials rather than state officials, charging that “The state should assume the burden of what has happened,” and noting that DPS had a near $100 million surplus at the time of the 1999 takeover, and its academic achievement was better than it is today—when it has a massive fiscal, physical, and academic deficit; the Legislature recently had to earmark $48.7 million to keep the district from running out of funds this school year, and test scores are among the worst, not only in Michigan, but nationally. The lawsuit alleges that the civil rights of DPS students have been violated, stating that the members of the class are 58,000 students enrolled in DPS and the Education Achievement Authority, who from 2011 “have experienced and will continue to experience serious and permanent damage caused by defendants’ willful and wanton, callous indifference to their educational needs.” The suit also names a dozen former and current principals, as well as a vendor who was indicted on kickback and bribery charges in a scheme is estimated to have syphoned off $1 million.

DPS’ elected board of education was stripped of its authority seventeen years ago when the city’s schools were placed under the charge of a “reform board” whose members were appointed by Detroit’s Mayor and Michigan’s governor—a change which took place when DPS had a surplus of nearly $100 million. Since then, however, DPS’s finances, education performance, and physical plant have severely deteriorated: DPS not only has some of the worst test scores in the state, but rats and physical deterioration clearly are discouraging families with children from wanting to move to the city. Moreover, the record of the various appointed emergency managers by the state has been abysmal: despite the huge surplus inherited by the emergency managers, the state legislature recently had to earmark $48.7 million to keep DPS solvent this academic year—or, as Michigan state Representative and former Detroit Public Schools teacher Sherry Gay-Dagnogo put it: “The emergency managers have directly helped to dismantle Detroit Public Schools.” The US Attorney’s office claims that phony invoices were submitted for supplies that were either not delivered or delivered in smaller quantities than billed—principals and administrators received kickbacks of more than $900,000.

The Board’s suit in federal court comes as the Michigan legislature returns from its recess and the Senate awaits the House response to its pre-recess proposed six-bill DPS restructuring which could significantly shape governance issues. The hearings on the bills will begin amid the recent filing of indictments by the U.S. Department of Justice against 12 current or former DPS principals, an assistant superintendent, and a vendor in an illegal bribery and kickback scheme—and exhortations from Gov. Rick Snyder not to let news of the indictments derail the DPS rescue, who exhorted: “We want to root out those kinds of issues. They should not happen…But to the degree they should not happen — and we all know that — should that take something away from helping 46,000 kids?”

As Rep. Gay-Dagnogo further noted to her colleagues: “Detroit taxpayers deserve a better system of accountability in lieu of a state managed free-for-all…The timing of the indictments will certainly exacerbate the mistrust that many out-county legislators feel towards the city of Detroit, and make the passage of legislation to address the DPS crisis a much more difficult task without an audit.” House Speaker Kevin Cotter (R-Mt. Pleasant) noted: “This is exactly why House Republicans were so adamant that strong fiscal oversight be a prerequisite to any additional state funding for Detroit’s corrupt and broken school administration. And it is why we will continue to insist that strong financial and academic reforms be a part of any long-term solution to decades of DPS failures.”

Part of the challenge will be managerial: should DPS be divided into two entities? Or, as the House proposed, left intact only to levy taxes and repay DPS’ existing bond debts, with a new school district, known as Detroit Community District, to own assets and operate the schools? The proposed bills would authorize $200 million in transition funds to form the new community district; an additional $515 million would be appropriated to fund the education needs and operation of the new community district. The debt load for the DPS, including operating debt, capital debt, unpaid pension and retirement obligations, and proposed transitional operating costs, totals more than $2.25 billion. With regard to fiscal oversight, the new DPS would remain under state control and would initially be overseen by the existing Financial Review Commission currently overseeing City of Detroit’s finances: two additional members would be added to the financial review commission to have input on the school district only—with those positions filled by the superintendent and school board president. And the task will seemingly be overwhelming: DPS, which has been under emergency management for the last seven years, has experienced its debt balloon under emergency state control: today, as its math teachers would note, the system’s debt includes $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.

Courting a State-Local Clash. Even as the Michigan legislature returns to the legislative schooling over DPS debt, the Detroit Board of Education last Friday filed a class action lawsuit against Gov. Rick Snyder, three former emergency managers, Jack Martin, Roy S. Roberts, and Darnell Earley, as well as individual Michigan legislators over poor financial, academic, and building conditions. This can only add to the unsyncopated, disharmonious rhythm for the beleaguered rhythm guitar player of the Indubitable Equivalents, retired U.S. Bankruptcy Judge Steven Rhodes, whom Gov. Snyder named as DPS’ “transition manager.” Judge Rhodes is responsible for the schools’ operations and finances, while an interim superintendent is supervising academics as lawmakers work on the long-term restructuring of the system.

Ungoverning and Fiscal Contagion? Despite his own appointment of Kevin Lavin as Emergency Manager for Atlantic City, New Jersey Governor Chris Christie, state legislators, and Atlantic City leaders remain locked in a dispute over how to avert insolvency as early as this month and under threat of a state takeover or municipal bankruptcy. While Gov. Christie yesterday dismissed criticism from a state Assembly committee which questioned whether the state should take over the city because of the inept way his administration has, under its state-imposed emergency manager, directed state supervision over the past five years, the Governor responded: “There will be people who say whatever I proposed failed because I’m not on their Christmas card list.”

Gov. Christie’s remarks came on a day when the general Assembly had grilled New Jersey Commissioner of Community Affairs, Charles Richman, accusing the administration of allowing Atlantic City to deteriorate while under a state monitor since 2010, with Assemblyman John DiMaio (R-Warren) pointedly noting: “It seems like there hasn’t been real conviction to deal with this problem” over the last half-decade; he questioned whether the state would have the “intestinal fortitude” to “make spending match the revenues that are available.” The to and fro blame and pass the buck game came as the city is projected to be insolvent as early as the end of this month—at which point the city would default or file for chapter 9 municipal bankruptcy—a filing which many fear would adversely affect the credit ratings of other New Jersey municipalities. The situation—and politics—are tainted by the state takeover of the city’s tourism district six years’ ago, when Gov. Christie had pledged to turn Atlantic City into “Las Vegas East,” and the year in which he imposed a state monitor in City Hall. Notwithstanding, Gov. Christie yesterday denied that the state takeover had failed. Instead he blamed Atlantic City’s elected leaders for not cutting spending enough and refusing to lay off employees—albeit omitting any recognition of the 10 percent cuts in the city’s budget under Mayor Don Guardian—instead insisting the only way the state will offer any state aid would be under a state takeover, such as that which the New Jersey state Senate has passed, but which has gained little support in the House—and where the Governor has made clear he is disinterested in any compromise.

Moreover, there are state constitutional issues with regard to any state takeover—or, as my colleague Marc Pfeiffer, Assistant Director of the Bloustein Local Government Research Center at Rutgers University and the former Deputy Director of the New Jersey Division of Local Government Services, describes it: “There is a significant risk that parts of the takeover legislation could be deemed unconstitutional.” Indeed, it appears a given that labor unions and civil liberties groups would file lawsuits challenging such a takeover, arguing that it violates the state constitution by allowing the state to break union contracts and goes against provisions which bar the State of New Jersey from operating municipalities. To all of which the Governor has responded: “I’ve been sued so many times, it really doesn’t matter to me,” adding that the state has “500 lawyers.” Judges might beg to differ: the New Jersey state constitution, after all, bars the Legislature from passing any bill “impairing the obligation of contracts, or depriving a party of any remedy for enforcing a contract which existed when the contract was made.” In addition, as Mr. Pfeiffer notes, the New Jersey Constitution also bans lawmakers from passing bills which apply to specific municipalities to prevent them from “interfering” with local governments. And that is before even getting to the U.S. Constitution and the issue with regard to its contract provisions.

While Gov. Christie and state Senate President Stephen Sweeney (D-Gloucester) have said they will provide aid to Atlantic City as long as lawmakers pass the takeover legislation, which would give the state broad powers over the local government for five years—including authority to break and renegotiate union contracts—and to bar collective bargaining—it remains unclear what their position would be otherwise. And, as Assemblyman Ralph Caputo (D-Essex) points out, there is a signal issue of precedent: would any state takeover become a blueprint for the state to take over other New Jersey municipalities in the future, noting the issue is “bigger than just collective bargaining…It’s a constitutional question of whether the state could really take over any municipality.”

New Jersey House Speaker Vincent Prieto (D-Secaucus) last week introduced legislation which would allow Atlantic City to try to reach benchmarks to receive state aid, and, were it to fail after two years, tools comparable to the equivalent of a state takeover could be enacted — such as breaking contracts—legislation that, as with the Governor’s proposals, raise issues with regard to state constitutionality. This growing debate over constitutionality threatens to run headlong into fiscal reality: not only would it be costly, it would consume time: a commodity that Atlantic City no longer has.

Waiting for Godot. Even as the U.S. House Natural Resources Committee is struggling to propose revised Puerto Rico fiscal reform legislation today and hold a hearing on it tomorrow, Puerto Rico’s legislators are working to exempt about 46 percent of the Commonwealth’s debt from the debt payment moratorium signed last week and in the wake of Puerto Rico House Rep. Rafael Hernández Montañez’s proposed legislation to change the U.S. territory’s moratorium law. Rep. Montañez, Chair of the House Treasury and Budget Committee, last Friday said he was confident his bill to amend the moratorium would pass, claiming he had a majority lined up and was seeking more. His proposal would exempt Puerto Rico’s general obligation, guaranteed, and any securitized debt from eligibility for the payment moratorium: meaning, according to his office, there could be no moratorium placed on the debt of the Puerto Rico Sales Tax Finance Corp. (COFINA), COFIM, Municipal Finance Authority, Puerto Rico Electric Power Authority, or Puerto Rico Aqueduct and Sewer Authority. The U.S. territory has offered a revised restructuring proposal to its municipal bondholders—an offer which includes paying more annually and extending the maximum maturity of debt by some 18 years—an offer which comes as a quasi-counter offer to those proposed last January by general obligation bondholders and by the Puerto Rico Sales Tax Finance Corp. (COFINA) bondholders. The maneuvering reflects efforts to try to reach some agreement with the island’s creditors—but leaves grave questions with regard how Puerto Rico’s economic challenges—and growing Zika threat—will be confronted. The simultaneous and twin sets of negotiations in Puerto and Washington, D.C. between the U.S. Treasury and the House Natural Resources Committee come as all sets of discussants are recognizing the increasing urgency of addressing the debt time bomb: Puerto Rico’s government last week authorized the governor to declare an emergency moratorium on debt payments, effectively increasing the pressure both in Washington, D.C. and Puerto Rico.

Puerto Rico’s new offer would reduce January’s proposed levels of “haircuts” on different types of municipal debt, and it would substitute what it terms capital appreciation bonds in place of its January offer of what it called “growth bonds”: municipal bonds on which interest would only be made if the Commonwealth reached specific revenue targets. The revised proposal includes a local bond option for those who reside in Puerto Rico. For the base bonds Puerto Rico is offering 80% of face value for GO, 71% for commonwealth guaranteed, 57% for COFINA, and an average of 50% for other debt types. This compares to the original offers of 74%, 65%, 49%, and 39%, respectively. The newly proposed capital appreciation bonds would ultimately pay out in an amount equal to the difference between current par value and the newly issued base bond par value; while the local municipal bonds would retain all of original par value, but would have a reduced 2% interest rate and would not mature until 2065 to 2069. Local bondholders would have the option of taking either the local bonds or the base bond/capital appreciation bonds. The base bonds would have 1.1% interest rate in fiscal year 2017, though there were conflicting indications as to whether interest would be paid on July 1, 2016. Interest would rise to 3% in fiscal 2018, 3.3% in 2019, 4.1% in 2020, and 5.0% thereafter. With the base bonds, principal payments would be suspended until fiscal year 2021. The base bonds’ maturities would continue until FY 2056. The capital appreciation bonds would mature between fiscal 2056 and 2067, partly dependent on how many locals opt for the local bonds. The proposal assumes that there will be a mechanism for Puerto Rico to force all bondholders to accept the terms being offered.