The Coming Republican Convention: A Bird’s Eye View of Municipal Bankruptcy

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eBlog, 5/010/16

In this morning’s eBlog, we consider the steps necessary for East Cleveland to be eligible for municipal bankruptcy, even as the Republican convention to finalize the nomination in next-door Cleveland approaches, and we look at the intermix of state politics and special interests in affecting the fate of Atlantic City. Finally, we continue to try to follow the state politics in Lansing to see whether lessons were really learned from Detroit’s epic municipal bankruptcy.

Teetering on the Edge of Municipal Bankruptcy. In response to East Cleveland Mayor Gary Norton’s letter last month asking for the right to file for municipal bankruptcy, the Ohio Tax Commissioner responded yesterday, detailing the information needed to file for such approval and stating council must be the one to do it, because the Council is the “taxing authority” for the city. Mayor Norton said the city is thankful for the relatively quick response from the commissioner, and will prepare as much of the information the commissioner requires as possible, although he thinks outside assistance might be needed, noting the Council wants to “do this as thoroughly as possible.” With the Republican Convention coming up in neighboring Cleveland in July, there appears to be additional incentive to move towards a swift resolution. In addition, the City has scheduled a community meeting next week, on the 19th, to address city services and hold further discussions with regard to options for merging with the City of Cleveland.

Selling Atlantic City. A corrosive mix of state politics and municipal fiscal distress appear to mean that Atlantic City’s assets could be the steep price imposed upon the fabled city as the state has moved still another step closer to the state takeover championed by Senate President Steve Sweeney, Governor Chris Christie, and South Jersey Democratic boss George Norcross III—notwithstanding the efforts of state Assembly Speaker Vince Prieto. A key issue in the increasingly political—as opposed to governmental—fight over the city’s future between Senate President Sweeney, Gov. Christie, and Mr. Norcross against House Speaker Vincent Prieto, Atlantic City Mayor Don Guardian, and Jersey City Mayor Steve Fulop has focused on the Senate bill’s provision to immediately break public union contracts. Others, however, believe the real, underlying issue is control of Atlantic City’s beachfront property—with Messieurs Joseph Jignoli and Jack Morris, two politically connected developers with ties to Sen. Sweeney, most interested in finding a mechanism to be first in line as plots of beachfront properties fall into the state’s hands.

Under Sen. Sweeney’s Senate-passed legislation, the New Jersey Local Finance Board would immediately gain the requisite authority to sell off city properties and potentially offer more private investors significant state tax subsidies as incentives to move into the city. That approach contrasts with House Speaker Prieto’s pending alternative, which would offer Atlantic City seats on a committee with appointees from the governor, and two more years of financial benchmarks before that happens. Increasingly, however, with the state having preempted Atlantic City’s monopoly on gaming, Speaker Prieto’s bill would be likely to only offer Atlantic City a brief reprieve before that committee has to start awarding contracts to shore up its budget deficit. Moreover, with the Senate leader’s insistence that he that he has no plans to meet with Speaker Prieto to work out a compromise between their two proposals, the Speaker may be forced to concede and allow a vote in the House on the Senate-passed version: if the state does intervene sooner rather than later, these are the city assets set to set to be turned over to the state, and the private development projects that the state will need to work around: projects in which developers with deep, deep pockets are rumored to have great, great interest, including the Revel and Showboat. In addition, another spoil is suspected to be Bader Field—the country’s first airport, one which would have, before the Great Recession, sold for $1 billion or more—but which when the Atlantic City Council voted this year to put up for sale, setting the minimum bid at $155 million—a bid which, if realized, would have eaten up more than a third of the City’s more than $500 million in debt, fell when Mayor Guardian said he favored holding on to Bader Field until some of its former value could accrue back. Nevertheless, the building state takeover pressure may preempt any authority of the Mayor and Council over the city’s assets and future.

Detroit’s Learning Curve. Detroit Public Schools (DPS) is moving perilously closer to a possible default or Chapter 9 municipal bankruptcy filing as Michigan’s largest public school district awaits some resolution on a compromise between Michigan House and Senate differences to forward a state-subsidized rescue plan. Yesterday, Moody’s Investors Service, in a commentary, warned: “Without an infusion of a significant amount of additional cash beyond the district’s existing short-term borrowing authority in fiscal 2017, it would be highly unlikely that the district would have resources to make payroll and debt service throughout the year.” In Lansing, the state House and Senate have each passed their own versions of a restructuring; however, stark differences between the legislation passed by the two chambers must be resolved, and the clock is ticking with DPS projected to exhaust $50 million in state approved emergency funding by the end of next month—an exhaustion that has fueled fears among teachers they might not be paid this summer—and by parents and Detroit leaders about a failure’s consequent disincentives for families with children to want to live in or move to Detroit.

As Moody’s moodily noted, the legislature “now has less than two months to compromise on a reform package or the district’s financial position will possibly force a [municipal] bankruptcy filing: Failure to implement a solution increases risks to all of the district’s bondholders.” The rating agency noted it expects DPS’ $1.4 billion in general obligation unlimited tax bonds would remain unimpaired, because all of it is supported by the state’s School Bond Qualification Program, noting, however, that were DPS to file for chapter 9, “the state’s commitment to the program has never been tested under a Chapter 9 scenario,” and adding that holders of DPS’ $259 million in long-term state aid revenue debt from unrated series in 2011, 2012, 2014, and 2015 face risky prospects “given the district’s severely constrained reserves, despite a first claim on state aid.” In Michigan, municipal debt service is paid directly from a set aside of state aid that would otherwise be available for DPS’ general operations, contributing to DPS’ current cash flow crunch. Moody’s, displaying the kind of arithmetic that might make DPS envious, added: “The fact that outstanding debt has a senior lien on state aid drives the emergency manager’s (DPS Emergency Manager Steven Rhodes) conclusion that the district may not be able to make payroll after 30 June.” Debt service on existing state aid revenue debt totals $105.3 million in FY2017, which includes set-aside payments of $26.1 million in July and $26.2 million in August. After August, DPS would rely on its FY2017 state aid payments: DPS is budgeted to receive approximately $380 million in FY2016 state aid-or more than three times its annual debt service of $105.3 million currently due in the upcoming fiscal year, according to Moody’s analyst Andrew Van Dyck Dobos. 

With the outcome in Lansing between the House and Senate unsettled, it appears that Gov. Rick Snyder does not have an alternate plan if the conferees fail to agree on final legislation. Nevertheless, as Mr. Dobos noted: “Additional emergency funding would provide immediate cash flow relief, but would not solve the significant operating deficit…Alternatively, the district could seek bankruptcy protection under Chapter 9, which would require a recommendation by the emergency manager and approval by the Governor.” DPS Emergency Manager, retired U.S. Bankruptcy Judge Steven Rhodes has requested $200 million in state appropriations to cover the expenses associated with transitioning to a new school system to keep afloat in the fiscal year that begins July 1st as well as to improve school buildings and educational programs in a bid to reverse decades of declining enrollment. In Lansing, the negotiations between the House and Senate continue with the House proposing less funding for DPS’ transition costs; the Senate last month approved Gov. Snyder’s request for $200 million in transition funds and $515 million for debt relief, while the House last week approved $467 million for debt relief and $33 million for transitional costs—with both bodies proposing to divide DPS in two: the current DPS school district would be left intact only to levy taxes and repay existing bonds; the new district, the Detroit Community District, would own assets and operate the schools.

Daniel Howes, the eminent editorial writer for the Detroit News, this morning notes that “Evidently the players in the Detroit Public Schools end-game learned little from the epic bankruptcies of the city and its two hometown automakers: Instead of offering a package that could entice adversaries toward what could be a consensual settlement, House Republicans are pushing a bare-bones bailout that proposes to retire the district’s debt of roughly $500 million. But give it enough capital to stay out of debt, as the state Senate proposes, and to help rebuild the district? Naw, not when the majority can condition its rescue on accompanying anti-union legislation that would limit collective bargaining and stiffen penalties for illegal strikes, payback for the Detroit Federation of Teachers’ attitude in general and the union’s sickouts to protest the real prospect of payless paydays in particular…Several things are undeniable here: first, state control of DPS for much of the past 16 years, and state backing of district debt that the state allowed DPS to issue, means the state will be underwriting the workout. Second, the timing of the DPS corruption roll-up that netted a dozen principals and a Franklin businessman in a kickback scheme is a positive, not a negative, because it means the feds are watching — and acting.”

“And, third, the teachers union is a fact of life in Detroit public education. Any restructuring of DPS requires the support of the DFT, just like the restructuring of Detroit’s automakers required the support of the United Auto Workers. The ingredient that made it work is trust grounded in the reality of their predicamentAll sides in the DPS stand-off aren’t there yet, even as the dollars disappear and the prospect of an uncontrolled collapse increases. The teachers understandably want a forensic audit to understand where the money went; the Republican Legislature says no, an expensive process also likely to implicate the state in mismanagement of the district.”

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