Past & Future Municipal Bankruptcies: the Curious Role of States

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eBlog, 5/06/16

In this morning’s eBlog, we consider the likely municipal bankruptcy—the first in more than a year—and mayhap the first ever in Ohio—by East Cleveland. Then we turn to the fate of Atlantic City—and the most curious and damning role of the state. A suit raises serious allegations with regard to what might be deemed worse than ‘contributory negligence.’ Then we go to school in Lansing, where the state House and Senate are going to school over how to fiscally and physically fix the city’s broken public school system. We note the wonderful honor, yesterday, to be able to, in Chicago, meet with Judge Steven Rhodes’ substitute, U.S. Bankruptcy Judge Frank Bailey—who presided over Central Falls’ or Chocolateville’s chapter 9 municipal bankruptcy, as well as former Providence Mayor Angel Taveras—with whom are genius class of senior No. Virginia local government employees who wrote a GMU fiscal recovery guidebook, Financial Crisis Toolkit (created with digital tabs), had met in Providence—at the very night the decision not to file for municipal bankruptcy was made! Finally, we visit Lansing, where the future of Detroit’s kids and the city’s future with regard to its public schools is at stake. The complex business of public school finance draws at the intersections of state and local finance—and has immense operating and capital implications—not to mention political.

Teetering on the Edge of Municipal Bankruptcy. The City of East Cleveland has asked the State of Ohio—a step which, under Ohio’s municipal bankruptcy law (§133.36), requires approval of its municipal tax commission—to approve a petition for municipal bankruptcy. East Cleveland, which is a charter city of about 18,000 granted its authority under the home rule provisions of the Ohio constitution, has seen its population fall dramatically over the years, from 39,600 in 1970 to the most recent census figure of 17,843 for 2010—even as its minority population has grown to 94.5 percent. The city’s median household income of $20,660 is less than half the statewide $48,849—indeed, based on median taxable income, the East Cleveland school district, which includes a small portion of Cleveland Heights, has the highest poverty rate in Ohio: 42.1 percent versus 15.9 percent statewide. Worse, the rate for the city’s children in poverty is higher at 60.2 percent, nearly thrice the statewide rate of 22.7 percent. The median home value (county appraisals) is $36,900—and the city currently has a vacancy rate of 37.1 percent—more than thrice the statewide 11 percent. In short, East Cleveland is a municipality not just with a past history of fiscal challenges, but now a point of perhaps no return.

Formerly under a Commission and City Manager form of government, city residents and taxpayers, frustrated with that form of government in the wake of having two of its former commissioners charged with theft in office, and after a revolving door of city managers resulted in little stability and a reduction in services; Citizens for Sound Government, a group of East Cleveland residents, led a petition drive to elect a strong mayor and to create a five-member city council. Attorney Darryl E. Pittman, thus, became the first mayor to lead the city since 1908. Yet, during his second term, the Ohio State Auditor in the autumn of 1988 declared the municipality to be in a state of fiscal emergency in the wake of finding that the city’s water and sewer fund were found to have deficits in excess of $2 million. Subsequently, under the next Mayoral administration, the city increased its borrowing in an effort to recover from its fiscal emergency—a state in which it remained over the next eight years—culminating in the conviction on charges of racketeering and corruption of former Mayor Emmanuel Onunwor. Ergo, in his letter to Ohio Tax Commissioner Joseph Testa, current Mayor Gary Norton wrote, the city is in a trying effort to keep payroll going and to maintain services. Council President Thomas Wheeler said even if approved, filing for chapter 9 municipal bankruptcy would be a “Band-Aid” to keep the city going, not a solution. The Mayor, in his epistle, wrote that, based on the city’s fiscal projections, “the City will be unable to sustain basic fire, EMS, or rubbish collection services,” adding that the municipality’s Financial Recovery Plan, approved by the City Council, would have the effect of “decimating our safety forces.”

In Ohio, where no entity had previously filed for municipal bankruptcy protection, such a petition requires the approval of a municipality’s tax commission. While the Ohio Tax Commissioner’s office said it was preparing a response, it has yet to offer any public comment. For his part, Mayor Norton said that the municipal bankruptcy filing would be a temporary fix for the cost side of the city’s economic distress, but the real problem was with income—there simply, he warned—was insufficient revenue coming in to support the city—and that raising tax rates or imposing new fees would not provide an immediate solution. The request from the city can hardly come as a surprise to the state: State Auditor David Yost’s office last year had issued a statement that municipal bankruptcy or merging with the City of Cleveland were probably the most viable options for the city.

State Duplicity & Increasing Fear of Fiscal Contagion in New Jersey. Weeks of mounting political tension over how to save Atlantic City from financial collapse came to a head Thursday in a dramatic day at the Statehouse that ended with opposing sides once again pointing fingers at each other. State Assembly Speaker Vincent Prieto abruptly canceled an anticipated vote on his proposed and sponsored plan to provide a fiscal life-preserver to Atlantic City in the wake of realizing he lacked sufficient votes to get it passed. That opened the door to Gov. Chris Christie and New Jersey State Senate President Stephen Sweeney to declare it was time for Speaker Prieto to allow the Assembly to vote on their rival proposal: for the state to take over the city for five years—a plan the Senate has already approved—but which the Speaker opposes—with Sen. Sweeney noting: “I’ve had enough of this now…The Speaker proved he cannot pass his own bill,” warning that, otherwise, Atlantic City could face municipal bankruptcy in as little as 10 days, when they predict the local government will run out of money. Ramping up the ugly state war, Gov. Christie charged that Speaker Prieto’s opposition to the Senate plan had been “a waste of time and a waste of money and much too much drama,” with the former Presidential contender adding unironically: “Today we had a vanity exercise by politicians preening for higher office, rather than a solution for folks who really need it in Atlantic City.” In response, Speaker Prieto claimed he had a sufficient number in the House; however, four of his majority had been unable to “make it” to Trenton, adding that when he had asked his members of the Assembly for a show of hands whether they would support the Christie/Sweeney bill to impose a state takeover of Atlantic City: “Not one hand went up.” Ergo Speaker Prieto promised there would be another vote as early as next Wednesday on a new compromise bill—one to which, the Speaker said, he hoped the Senate President would be a party.

The Governor’s stance, however, is undercut by the apparent actions of the state—especially the New Jersey Department of Community Affairs. In a suit filed in Superior Court—with the Department of Community Affairs, the suit notes that “In 2013, the Local Finance Board again assessed the financial condition of {Atlantic} City as well as the good faith efforts of the City Administration in working with the State and determined that no additional regulatory conditions were necessary,” adding that the state had been “integrally involved in the financial decisions of the City and imbedded in its Fiscal operations…,” but that “[B]eginning in 2015, the Director of DGLS began a series of initiatives, ostensibly to aid the City of Atlantic City, but which ultimately would prove to be disastrous for the fiscal stability of the city.” The suit notes that the Department—for the 2015 city budget, “bypassed the governing body of the City of Atlantic City, and presented the 2015 Atlantic City budget directly to the Local Finance Board for approval and adoption…Through this unprecedented action, the DLGS deprived the City Council, as the elected representatives of the people of Atlantic City, the opportunity to have any input into the expenditures for Atlantic City for the upcoming budget year,” a budget in which DGLS, according to the claim, “inserted the sum of $33.5 million dollars in anticipated revenue,” the amount sufficient to achieve a balanced municipal budget—creating, understandably, the firm impression of a state commitment for that amount.

Indeed. DLGS Director Cunningham last September—in seemingly direct contradiction of claims by Gov. Christie—noted: “I feel the need to make sure that both the record and my colleagues on the Board know that the cooperative relationship that the Division has had with the City of Atlantic City in recent months, at least certainly during my tenure in this position. It’s been extraordinary.” Notwithstanding, however, the Twilight Zone state $33.5 million, has not only not been provided—but not even a bridge loan as requested by the City for that amount due to its reliance on that amount—or, as the suit notes: “By depriving the City of the requested information, the DGLS deliberately deprived the City of the tools necessary to fully comply with its own request. DGLS then used that deprivation against the City by asserting that the City failed to produce a plan.”

The suit has not been litigated, so the issue involves a the state’s judicial branch or third part of state government to weigh the demerits or merits with regard to the state’s contributory culpability, the outcome. By any measure, this goes to the issue of trust. A finding against the state, after all, would add to the increasing apprehension of fiscal contagion: some fiscal experts are warning that other New Jersey municipalities may experience municipal credit downgrades should Atlantic City become the first municipality since Fort Lee 78 years ago filed for chapter 9 municipal bankruptcy—even as Gov. Christie claimed that some Republicans believe that municipal bankruptcy may be the better option: “Bankruptcy is preferable to kicking the can down the road.” Credit rating agency S&P Wednesday noted that “a default or debt restructuring appears to be a virtual certainty even under the most optimistic circumstances.”

Detroit’s Kids’ Future. With the school year coming to a close in Detroit and the city’s public school system (DPS) beset by teacher sickouts and fiscal and physical insolvency—retired U.S. Bankruptcy Judge Steven Rhodes, at the behest of Gov. Rick Snyder, is once again stepping into the breach by accepting appointment to serve as DPS’ Emergency Manager—hopefully to end a year-long debate over the future of the recovering city’s public schools—schools whose fiscal future now appears transfixed between Republican lawmakers over the proliferation of charter schools and the amount of fiscal resources critical to help the state’s largest public school district avoid municipal bankruptcy. The Michigan House before dawn yesterday adopted a $500 million rescue plan—a plan which includes controversial provisions curtailing union rights and which would impose tougher anti-strike measures, measures without doubt triggered by the teacher-staged “sick-outs,” but a plan directly the obverse of Gov. Rick Snyder’s—a plan which proposes to pay off $515 million in DPS debt and provide a new, debt-free Detroit school district with another $200 million to anticipate continued declining enrollment.

Michigan Senate Majority Leader Arlan Meekhof (R-West Olive) yesterday said the House plan was passed “under duress,” suggesting the House version would not receive a passing grade in the legislature, but noting: “We don’t do our best work at 4 in the morning.” The Senate-passed version establishes a Detroit Education Commission to regulate the opening of traditional public and charter schools in the city. Now, as the legislature debates — something community leaders have requested — Sen. Goeff Hansen, who represents Muskegon, Newaygo, and Oceana Counties, now notes: “We need Detroit to buy-in. This has to be Detroit’s solution.” Sen. Hansen has taken the lead in the Senate to overhaul Detroit’s broken school system. However, given the chasm between the House and Senate positions, if the House or the Senate were to fail to act on the other body’s proposed DPS package, legislative leaders would likely send negotiations into conference. Nevertheless, the ever-patient Judge Rhodes deemed the House plan “an important step in the right direction for Detroit and Detroit’s children;” however, he suggested the Senate’s plan would be better for the 45,786-student school system’s long-term viability, telling the Detroit News: “In order for the new district to be set up for success, it will need the $200 million that was originally advanced in the Michigan Senate’s bill package.” Similarly, Detroit Mayor Mike Duggan told The Detroit News that the House plan would “end up being a waste of $500 million” without restraints on the number of charter schools in the city, adding that the House version would continue the state’s track record of “abysmal results” for Detroit’s children following seven straight years of emergency management: “Instead of sitting down and working on a transition plan this time, last night was basically ‘throw up your arms and send it back…’ No reforms in place, not enough money. It’s disappointing.” House Republicans did not include the Senate-proposed commission in their plan in the wake of heavy charter school lobbying. It appears the battle in the city between public versus charter school advocates is reverberating in Lansing to the detriment of the city’s children. A 2014 City Council resolution prohibited the city’s land bank from selling any of DPS’ 77 vacant former school buildings to charter operators that directly compete with traditional public schools.

Thus, yesterday, Democrats and Detroit legislators united against the House plan, adopted to help DPS avert insolvency—but impose new limitations on collective bargaining rights and prolong state oversight. The House’s proposed funding, which would be drawn from Michigan tobacco settlement revenues, would help the district pay down about $467 million in debt over seven years and provide another $33 million to cover start-up costs and avoid potential cash flow problems in coming months. House Appropriations Chair Al Pscholka (R-Stevensville) noted that the full Legislature recently approved some nearly $49 million in stop-gap funding for DPS, adding the new plan would free up another $50 million in annual funding by helping the district avoid debt payments, with the Chairman noting: “There’s plenty of money there, and I think there’s enough to not only make them debt-free, but to help them going forward.” The state actions are critical, after all, not only to the educational rehabilitation of DPS, but also its physical collapse: as part of the $200 million in start-up costs, DPS would spend $75 million making immediate improvements to schools after city inspectors found mold and other dangers lurking in occupied buildings.

The House vote came with provisions which seemed in response to the week’s teacher so-called “sickouts,” by including tougher anti-strike policies designed to crackdown on the massive teacher sickouts that closed most DPS schools Monday and Tuesday—and deprived our conference session in Chicago yesterday of the formidable, if electronically musical, presence of retired U.S. Bankruptcy Judge and now DPS Emergency Manager Steven Rhodes. House Speaker Kevin Cotter noted: “There was a desire for accountability, and to say strikes are illegal in Michigan for teachers, but there are no teeth to it…So what we did in this package is beef it up so it can be enforced.” Indeed, House Republicans have been tracking Detroit teacher sickouts since last month, when 18 Detroit public schools were closed while educators protested in Lansing as the Governor unveiled his plan to bail out DPS; moreover, all 97 DPS schools have been closed at least two days over the past year due to the “sickouts,” amounting to 1.4 million hours of lost instruction time, according to data from House Republicans. Nevertheless, the ever optimistic Gov. Rick Snyder described the House plan as a sign of “positive progress,” adding, however, “there is still more [home]work to do.”

As the two versions await reconciliation, there is a discrepancy of over $200 million in funding and restoration of authority to DPS from the Detroit Financial Review Commission created in the wake of Detroit’s municipal bankruptcy. The House would change teacher pay to merit—as opposed to seniority, and would make so-called sickouts more difficult to call. The Senate version would provide for school board elections in November—and have the Detroit Financial Review Commission oversee schools and review contracts. It proposes creation of a Detroit Education Commission to regulate the opening of new traditional public or charter schools in the city, requiring that only high-performing charters could “replicate” without approval of a Mayor-appointed commission. And, it would create an A-F letter grading system to grade all traditional and charter schools in Detroit: consistently failing schools could face intervention or closure.

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