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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.

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