What Is an End Game for Municipal Fiscal Distress?

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eBlog, 5/12/16

In this morning’s eBlog, we wonder if the end game is nearing in Atlantic City. We observe the corrosive, criminal behavior by public school officials in Detroit’s public school system—and the potential consequences to efforts in the Michigan Legislature by Governor Rick Snyder—asking again—whether lessons were really learned from Detroit’s epic municipal bankruptcy. Finally, in the wake of U.S. Treasury Secretary Jacob Lew’s visit to Puerto Rico early this week—and Puerto Rico Governor Alejandro Garcia Podilla’s visit with House Speaker Paul Ryan, whether Congress is ready to act on legislation to avert a critical insolvency by July 1st.

The End Game for Atlantic City? Assemblyman Vincent Mazzeo of Atlantic County Tuesday said Democrats in the N.J. State Assembly have negotiated the basic framework for a compromise bill to address Atlantic City’s nearing insolvency—considering legislation that would give the municipality at least 150 days to “get its house in order” under a quasi-control board composed of five state and local officials—in effect a compromise version comparable to that offered by State Sen. President Steve Sweeney, who has been clear that a municipal bankruptcy by the city would be the “worst thing that could happen to the State of New Jersey.” The emerging proposal would allow Atlantic City some period of time to get its finances under control before a state takeover would trigger and add an element from the alternative bill introduced by Assembly Speaker Vince Prieto—one supported by Atlantic City Mayor Don Guardian, which would provide for a five member oversight panel to steer the city through a series of financial benchmarks. Assemblyman Mazzeo said the compromise under discussion would include some form of immediate aid to the city in the form of a loan or possibly the redirection of casino funds which have been long promised by the state to plug a $33.5 million hole in the city’s budget, noting: “We made a lot of progress as far as the details of the compromise.” The Assemblyman’s announcement could mark a significant breakthrough—especially because he had previously garnered significant apprehension by Atlantic City leaders due to his alignment with other South Jersey Democrats who have advocated for a full state takeover of Atlantic City.

Nevertheless, the Assemblyman has made clear that structural cuts in the city’s labor contracts will have to be made, but added that his new approach was considerably more realistic than previous state initiatives—noting, for instance, the original Senate “compromise proposal” giving Atlantic City 45 days to cut its budget nearly in half was unrealistic—albeit it is unclear whether any 50 percent cut is; but his new proposal would extend the 45 days to 130, even as he reports he is trying to understand “what is the number for the budget that Atlantic City can provide services to the residents.” His position seems at significant odds with Gov. Chris Christie, who, under his proposed state takeover plan, would have the state usurp power to end union contracts for municipal employees, excluding the teachers union, and preempt all municipal authority with regard to the sale of municipal assets. Finally, Assemblyman Mazzeo said his proposal to create a Payment in Lieu of Taxes system for casinos would likely be included in a future bill, not the compromise plan under discussion.

Detroit’s Unlearning Curve. Even as retired U.S. Bankruptcy Judge Steven Rhodes, the Emergency Manager for the Detroit Public Schools (DPS) has been working around the clock to secure state aid, the criminal behavior of some of the system’s former and current employees is consuming precious fiscal resources in the form of pensions and political support critical to DPS’s future. Now thirteen former and current Detroit Public School principals who have been charged with a felony involving a $2.7 million kickback and bribery scheme at DPS remain, nevertheless, eligible for their state pensions. More names are likely to be posted: U.S. District Judge Victoria Roberts yesterday asked Norman Shy, the alleged mastermind in the DPS bribery and kickback scheme at Detroit Public Schools, if the conspiracy extended to 13 former and current DPS principals, all of whom have been charged in the case, to which Mr. Shy responded: “I paid school officials monies and other things of value for their assistance…” adding there “may have been others. I don’t recall,” as he plead guilty to two felony charges: conspiracy to commit federal program bribery, a five-year felony, and income tax invasion, also a five-year felony. Mr. Shy, a graduate of the DPS system, was ordered to pay $2,768,846.23 in restitution; he will be sentenced in September. In addition, former DPS principals Ronnie Sims and Gerlma Johnson appeared yesterday to plead guilty to their roles in the scheme: Ms. Sims, a former principal at Fleming Elementary and Brenda Scott Middle schools from 2005-12, is accused of accepting 24 payments from Mr. Shy totaling $58,519.23—most in the form of bribes and kickbacks to a shell company he created called Educational Consultants USA, according to prosecutors: the 23-year career DPS employee appears poised to move from the classroom to prison. The dishonor roll continues to unroll: a grim unrolling even as the system is looking to the Michigan House and Senate for aid critical to opening the schools in the fall and offering a brighter future to the cities families.

But the harm is even greater—and, mayhap, irreparable: The U.S. Attorney’s Office does not have standing to request a federal court order to revoke the pensions of these individuals—or, as that office yesterday noted: “They will all be ordered to pay restitution, and, maybe they can use their pensions to pay that, but we don’t have any legal standing to take [their] pensions,” referring to the Michigan Public School Employees Retirement System fund pensions for both school administrators and teachers. Caleb Buhs, a spokesman with the Michigan Department of Technology, Management and Budget, which is in charge of the Office of Retirement Services and Michigan Public Employees Retirement System, said state statutory language provides that if an employee is found in violation of the public trust, a court can order a revocation of his or her public pension. But the determination with regard to whether the charge faced by the DPS administrators is considered a violation of the public trust is up to a judge. According to Mr. Buhs, in Michigan, “There is not a listing of crimes that fall into the category. It’s at the discretion of the judge.” One outcome does appear clear, a different judge, retired Judge Rhodes in his acting capacity as Emergency Manager at DPS, is committed to leaving no stone unturned in his Don Quixote quest to “investigate legal options for recovering the stolen funds.”

The disquieting DPS news, however, can hardly be expected to be good news for DPS even as Michigan Treasurer Nick Khouri warned the package of bills passed by the state Senate in an effort to avert a DPS municipal bankruptcy would provide insufficient revenues “to transition to the (new district).” Treasurer Khouri added that the “House passed package leads to a projected cash flow deficit of $22 million in August, rising to $80 million in September,” warning that, absent significant change, the proposed new, debt-free Detroit school district under the pending bill could become insolvent by its second month in existence under the House-passed $500 million debt-elimination plan—a warning to which Michigan House Speaker Kevin Cotter took exception. The Treasury Department analysis of the House plan concludes the new Detroit Community School District would have a $22 million deficit by the end of August and would continue to run deficits each month next school year with $33 million in startup cash. In contrast, the Senate version to eliminate DPS’s operating debts and provide the new school district with $200 million in transitional funding would leave the new district with a low balance of $86.9 million in September, according the Treasury analysis. The Speaker, additionally, noted he was “discouraged” to see the analysis come out five days after the House had voted—questioning the timing so long after he had requested the information—information based upon revisions of DPS Emergency Manager Steven Rhodes’ earlier request for about $200 million for transitional costs—some $125 million the new school system would need “at inception” to pay vendors and employees, and open school buildings in September, the one month Michigan school districts do not receive a payment from the state, according to the Treasury document. In addition, the Governor’s office has noted that the new DPS will need $65 million for deferred maintenance, school security equipment, and building-closing costs—with the Treasurer’s office adding a final $10 million in transition costs would finance “investment in key academic programs that have been deferred due to financial constraints and austerity measures.”

Speaker Cotter, last week, said House Republicans could not support the Senate’s proposal for $200 million in startup costs, because members were not given enough details about how the funding would be used, a position he reiterated Tuesday—that is before the startling revelations that emerged yesterday. The Speaker noted: “The taxpayers of the state are being asked to make an investment, and I don’t think it’s unreasonable to ask for at least something that resembles a business plan, to say how this money is going to be used,” with his spokesperson disputing the Treasury’s conclusion that the proposed House plan would lead to a quick insolvency. Perhaps trying to better inform all sides—and in compliance with Michigan’s emergency manager law, Judge Rhodes Tuesday convened a public informational meeting on his Fiscal and Operating Plan in Detroit at which he said his goal was “to set DPS on a path to long-term success” and added some of the $200 million would be used “to substantially upgrade our buildings and facilities to make them more efficient,” noting: “We also need transitional and working capital…We have certain minimum cash requirements in order to pay our bills until the first state-aid payment arrives in late October. We want to enhance our academic programs and to retain the ones we have…We absolutely need that minimum amount from our Legislature in order to set DPS on a course for success.” Nevertheless, Senate Majority Leader Arlan Meekhof (R-West Olive) warned that the that startup funding remains one of the main sticking points between the two houses—deeming the $200 million “critical,” even though he did not rule out negotiation.

State Treasurer Nick Khouri detailed the $200.2 million in transition costs Detroit Public Schools needs to create a new debt-free school district as part of a larger $670 million rescue plan:

Operation cash: $125 million
■ $58 million for cash flow based on timing of bills and lack of September state aid payment.
■ $55 million for accrued payroll costs, other pending contingencies and claims.
■ $10 million for professional transition costs in the information technology, human resources, financial and legal departments.
■ $2 million for academic and instructional support.
Building improvements: $65.2 million
■ $19 million for heating, ventilation and air conditioning.
■ $16 million for roof repairs.
■ $15 million for windows.
■ $10 million for upgrading school security equipment.
■ $3 million for lighting.
■ $2 million for school building closing and reorganizing.
■ $250,000 for fencing and paving.
Academic improvements: $10 million
■ $5 million for “educational enhancements” in art, music and gym
■ $3 million for literacy programs and libraries
■ $2 million “investment in innovation” for science, technology, engineering, arts and mathematics programs
Source: Michigan Treasury Department

Puerto Rico. Even as Major League Baseball and its players union have cancelled scheduled games in Puerto Rico due to fears about the Zika virus, House Speaker Paul Ryan’s efforts to pass and send legislation to address the U.S. territory’s looming insolvency—especially to meet a July 1 deadline payment of $800 million to holders of Puerto Rico general obligation bonds backed by the commonwealth’s constitution—in addition to some $1.2 billion in other municipal bond payments—are continuing to struggle after the House Natural Resources Committee yesterday postponed its scheduled release of revised legislation, albeit there is some hope Chairman Rob Bishop (R-Utah) will release it today—and the Committee still seems set to vote next Wednesday. The setback came as Ranking member Rep. Raul Grijalva (D-Ariz.) said: “We are making progress, but we are not there yet…The situation in Puerto Rico is dire, but a bill that doesn’t solve the problem, or doesn’t pass, won’t help anyone.” A Committee spokesperson noted that despite the many delays in moving the bill to date: “I would say that in the interest of protecting U.S. taxpayers, mitigating a humanitarian crisis, and avoiding any potential spillover and borrowing costs from a massive default that results in decades lost for American citizens on the island, yeah we want to get something before that deadline.”

Revisions to the bill, coming in the wake of visits by U.S. Treasury Secretary Jacob Lew and Puerto Rico Governor Padilla’s visit with House Speaker Paul Ryan (R-Wis.), are likely to be similar to the current version, but incorporate changes based on feedback Treasury and Puerto Rican officials, as well as creditors: there has been considerable discussion with regard to the proposed oversight board—with concerns about sovereignty and the potential authority to affect public pension obligations. Thus, refinements are expected to focus on those issues as well as clarifications with regard to maintaining the protection of the existing debt hierarchy.

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