Can Municipal Bankruptcy Not Work?

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eBlog, 5/09/16

In this morning’s eBlog, we consider, again, the likely municipal bankruptcy of East Cleveland—a potential – and likely—municipal bankruptcy that would demonstrate the limitations of chapter 9 municipal bankruptcy, because the city has so little outstanding debt; so it is unclear whether chapter 9 can even be a serious remedy. Then we turn the roulette table to Atlantic City—site of a visit today by former Mayor Bernie Sanders, where the clock is running out amid questions with regard to quasi-state owned property exempt from critically important property tax revenues. Finally, we try to untangle the arithmetic so critical to the fiscal soundness of the Detroit Public School System—an invaluable foundation for any long term certainty for Detroit’s recovery from the largest municipal bankruptcy in U.S. history.

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 Finance Director Jack Johnson said that Chapter 9 bankruptcy would protect the cash East Cleveland has in the bank and allow the city to continue providing services. According to Mr. Johnson, creditors owed legal judgments could choose to drain the city’s bank account at any moment through attachments or garnishments—noting that the city would lose an entire month of operating funds if a $638,000 judgment owed to a provider of photo traffic enforcement services, Nestor Traffic Solutions, were removed from its bank account. A $73,000 judgment related to unpaid overtime is another matter of concern, as is a separate ongoing dispute in which East Cleveland has been racking up $750 per day in fees related to unpaid overtime since April 15. Even if creditors continue to refrain from claiming their funds, financial Armageddon is close at hand. Johnson said that by the end of 2017, East Cleveland’s finances will be so dire that it will have to choose between having a police department and having a fire department, and in 2018, it won’t have enough money for either one.

East Cleveland has struggled financially for decades. Ohio’s state auditor, Dave Yost, declared a state of fiscal emergency there in 2012; the city previously operated under a fiscal emergency declaration between 1988 and 2006. Sharon Hanrahan, the Financial Planning Commission Administrator at Ohio’s Office of Budget and Management, painted a stark picture of East Cleveland’s finances in an April 18 presentation: As of Dec. 31, the city had a deficit totaling $3.4 million, past-due accounts payable of more than $3.4 million and a bank balance just under $639,000. Unpaid vendors include its employee healthcare provider, Kaiser Permanente, which is owed $741,000.

Nevertheless, Mayor Gary Norton has said the move is necessary in order to maintain the city’s payroll and essential services, calling it a temporary fix for the cost side of the city’s economic distress. He reports, however, that the real problem is that there is insufficient revenue coming in to support the city. The request came as an 11-year-old child was among several wounded in separate shootings late last night on the city’s East Side, and as municipal police officers also took fire. Mayor Gary Norton says it would be a temporary fix for the cost side of the city’s economic distress. The move, in some ways, is not a surprise: last year Ohio State Auditor David Yost’s office reported that chapter 9 municipal bankruptcy or merging with Cleveland were probably the most viable options for the city. Should its petition be approved, East Cleveland would be the first municipality in the state ever to file for bankruptcy protection.

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. In its request to the state of its petition for chapter 9, the city notes that “Despite the city’s best efforts, East Cleveland is insolvent. Based upon financial appropriations projections for the years 2016, 2017, 2018 and 2019, the city will be unable to sustain basic fire, police, EMS [emergency services] or rubbish collection services…The city has tried to negotiate with its creditors in good faith…It has been a somewhat impracticable effort.”

East Cleveland, which currently has no outstanding municipal debt, but does have $3.4 million in outstanding accounts payable, including several judgments from lawsuits that have been settled, sees little light ahead on its revenue front, and fears that its state-approved recovery plan—a plan intended “to restore the city to fiscal solvency,” instead runs the risk of its critical public safety capacity. Indeed, in the wake of last night’s horrific killings, the city is apprehensive the plan “intended to restore the city to fiscal solvency,” would likely, instead, “have the effect of decimating our safety forces. Hence, our goal to effect a plan that will adjust our debts.” The problem is that with no municipal debt outstanding, it is unclear how municipal bankruptcy could really help the city: its fiscal challenge is not debt; rather it is a lack of revenue. Currently, the city realizes revenues from municipal income taxes, Ohio general revenue sharing (the Local Government Fund), property taxes, and trash collection fees, as well as a street lighting assessment. The state aid, however, has been disproportionately reduced in recent years, even as the city’s tax base has eroded. The state revenue sharing has been on a five-year downward slope—contributing to projections that East Cleveland’s revenues will decline by more than 10 percent this year from more than $11 million in 2015, according to a report from the state auditor that examined city finances and the impact of various fiscal options. East Cleveland has considered a merger with neighboring communities, such as Cleveland; however, according to the Ohio Tax Commission, the courts have not accepted such a proposal.

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 two 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.

Running the Chapter 9 Tables in New Jersey. New Jersey Gov. Chris Christie late last week said he would rather Atlantic City file for chapter 9 municipal bankruptcy than to provide any state fiscal support. The Governor’s remarks, which came in the wake of both a failure by the Assembly to consider a Christie-opposed rescue package by House Speaker Vincent Prieto (D-Secaucus), which would have provided for a state takeover of Atlantic City, but only if the municipality failed to meet annual benchmarks, and the guesstimate of state officials that Atlantic City will run out of cash at the end of this week. Instead, Gov. Christie urged the legislature to back the Senate-passed package, which would empower New Jersey’s Local Finance Board to renegotiate outstanding debt and municipal contracts for as long as five years if the city failed to close its estimated $102 million budget deficit in 130 days: “If they come up with something: great. If they do not, then you know bankruptcy will be the only option, and, while I would regret having to go down that road, it is a road that I will have no choice but to go down: I am not sending any more money to Atlantic City without the authority to fix the underlying problem.” For his part, Speaker Prieto noted: “I’m looking for a bill that protects Atlantic City’s civil liberty, protects the workers that are there, protects their self-governance…We’re going to work, Monday, Tuesday, [to] hopefully get something that all the Assembly came come together on.”

Indeed, today promises to be an interesting day in Atlantic City, as it will gain attention with the visit of Sen. and Presidential contender Bernie Sanders (I-Vt.) and a renewed effort by the City Council for an alternative avenue to fiscal relief: it is seeking the payment by the State of New Jersey of property taxes by the Casino Reinvestment Development Authority (CRDA) on unimproved land it owns in the city—up to 100 percent of the assessed value of such parcels after seven years of ownership, with resolution author Councilmember Jesse Kurtz noting: “This is the first time, to best of my knowledge, that a formula has been developed and proposed to treat this situation.” Councilman Kurtz claims the resolution’s goal is to prod CRDA to sell or auction off their vacant parcels—a policy for which, unsurprisingly, the CRDA has registered little enthusiasm. The agency which, by state law, is exempt from property taxation, responded, noting it has spent more than $1 billion in improvements in the city: “The role, as a policy matter, of redevelopment authorities is to collect and remediate and clear property and remove hazards and assemble parcels…I think it’s a bad precedent to begin to pay taxes.” The tax dispute—in a municipality which has seen its property tax revenues careen from $20.5 billion six years ago to $6.6 billion today—is aggravated by the land-banking practices of the Authority: purchasing properties in the city, with no plans to sell or develop them—ergo eliciting Councilmember Kurtz’s resolution to note: “The City of Atlantic City recognizes the value of CRDA assembling real estate parcels in particular instances, but opposes the general practice of holding vacant lots off of the [city’s] tax rolls indefinitely.” Of the 111.5 acres or 5 percent of the city’s total land area, the CRDA owns, 75 are developed and would not be subject to the council’s proposed policy. CRDA claims 26 of its acres have a potential for development. CRDA’s vacant lots have a total assessed value of $51.6 million before tax appeals—e.g., at today’s market or assessed appraisals, Atlantic City could collect some $1.8 million in taxes. While that would be a small chip in the city’s $550 million in debt and $100 million budget deficit, it is CRDA’s developed lots that would make the much greater difference: if taxed at current assessed values, the Convention Center alone would generate $13.5 million per year in total taxes; Boardwalk Hall would generate $4.5 million before tax appeals. In fact, Gov. Christie’s own appointed Emergency Manager Kevin Lavin recommended that CRDA privatize those properties, something CRDA Chairman Robert Mulcahy has said the authority would consider. Under the Council proposal, CRDA would pay taxes on 20 percent of the assessed value of a vacant parcel starting in the third-year it owned the property; taxes would increase 20 percent each year until the seventh year, when the authority would pay on 100 percent of the assessed value.

Detroit’s Learning Curve. Against the backdrop of teacher sickouts and the admission by a former Detroit Public School (DPS) board president and union activist—one recently released from federal prison in Alabama for stealing $200,000—that a lack of oversight by DPS makes it far too easy to siphon money from public coffers, one can surely imagine the seemingly impossible challenge which retired U.S. Bankruptcy Judge and now DPS Emergency Manager Steven Rhodes confronts in trying to support prompt action by the Michigan legislature of Gov. Rick Snyder’s request for $200 million to create a new debt-free Detroit school district—a package the Michigan Senate has approved for startup and transitional costs to help DPS operate after shedding $515 million in debt that would be paid off over the next decade—but a package which has not gained passing grades in the House, which has instead approved $467 million for debt relief and $33 million for transitional costs. Judge Rhodes had proposed five areas where state funds for DPS are critical to keep the state’s largest public school district solvent in the new fiscal year that begins July 1 as well as to improve school buildings and educational programs in a bid to reverse decades of declining enrollment. The request includes $75 million for capital improvements to school buildings; $50 million for academic and instructional support and transitional costs for legal services, human resources, accounting and information technology; $25 million for “other pending contingencies and claims that may need to be funded” by the new school district, according to the plan; $25 million for improving academic programs; and $25 million for cash on hand at the inception of the new school district, because Michigan public schools do not receive a state aid payment in September, when the new school year begins and districts incur more monthly expenses. However, House Speaker Kevin Cotter (R-Mount Pleasant) claimed House Republicans had received insufficient information about how the proposed $200 million would be spent prior to its 4 a.m. vote last Thursday—so that, they instead only agreed upon $33 million for transitional costs—claiming their plan would erase $52 million in debt payments DPS owes in July and August and would appropriate $33 million to cover an expected deficit through the end of September.

Republican businessman John Rakolta Jr., who has studied DPS’ finances in depth as a co-chair of the Coalition for the Future of Detroit Schoolchildren, noted that the startup costs for academic needs include filling 180 teaching positions in DPS that were left vacant this year because of budgetary constraints, causing class sizes to swell to 40 and even 50 students in some classes—and that there are schools in Detroit which do not have math and science teachers. All of which has kept Judge Rhodes studiously at work with the Governor’s Office and the Michigan Treasury Department to refine the estimated transitional costs: the scholastically challenging process of paying off accumulated debts and providing competent educational opportunities.

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