Exceptional Governance & Intergovernmental Challenges

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4/12/16

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.

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