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In this morning’s eBlog, we discuss a critical challenge to Detroit’s long-term emergence from municipal bankruptcy–its public pension challenge. We continue to follow the status of the recently drafted bipartisan legislation to address the looming insolvency of the U.S. territory of Puerto Rico; and we look at the challenges to public school financing which would appear to make municipal bankruptcy not the most effective avenue in Detroit or Chicago.
The Last, Full Measure? Detroit has taken a key step to addressing a significant, nearly $200 million threat to its full emergence from the nation’s largest municipal bankruptcy: the city is inching nearer to determining how to address a hole in its public pension obligations—a hole much larger than it had anticipated as part of its plan of debt adjustment—and a hole discovered subsequently when the city determined some of its bankruptcy advisers had used outdated life-expectancy tables in projecting the city’s total pension obligation.
The challenge of any city’s plan of debt adjustment relies, after all, on 30 year projections—not just of spending, which can be largely controlled, but also revenues. Detroit’s pension funds, for instance, assume its pension funds’ assets will earn 6.75% a year on its investments settled on by former emergency manager Kevyn Orr and pension officials in the city’s bankruptcy mediation talks. Today, however, that appears to have been a bar too optimistic; thus a lower average rate of return over the next several years could further inflate the city’s pension fund obligations starting in 2024 and beyond.
Unlike an annual budget, specifying long-term obligations in an era when retirees are living longer than previous generations has been—and will be—an exceptional challenge. To help, Detroit last March put out RFP’s seeking national firms with expertise in public pension plans to advise the city on how best to address its $195-million payment to the city’s two pension plans that comes due in 2024, under terms of the city’s approved plan of debt adjustment. That plan, which the U.S. Bankruptcy Court approved in December of 2014, included assumptions that the city would have two years in which to make to make payments to its two pension plans, the General Retirement System and the Police and Fire Retirement System—that is enough time so that increasing recovery tax revenues would enable a resumption of deposits into the funds, so that the city could begin making pension payments with a $112.6 million installment in 2024. Using a kind of forensic accounting, however, the city determined the actuarial assumptions used in its plan of debt adjustment were inaccurate and outdated; the city reports that actuarial reports last year by the Gabriel, Roeder, Smith & Co. firm project the Motor City may have to pay $491 million over a 30-year period commencing in 2024, including the $195-million payment the first year—marking a severe fiscal blow to the city’s recovering budget equal to about 8% of its general fund—potentially forcing the diversion of critical investment in essential services. Mayor Mike Duggan now says Detroit’s pension adviser will help determine whether it would be wisest to direct resources directly to the pension funds, set it aside to pay into the funds later, or use other alternatives: “We’re doing two things: We’re developing a plan to start making supplemental contributions to the pension funds, so we get ahead of the problem that’s facing us in 2024, and we’re working on our legal options…We’re working on both options intensely…One way or another, we’re going to make sure the pensions are properly funded.”
One still open option, to which Mayor Duggan had alluded in his State of the City speech last February, would be to sue Detroit’s bankruptcy consultants, noting they had been paid $177 million and ended up leaving the city with a $491-million hole in pension funding—an option under review by the city’s Law Department. Detroit officials have told the Financial Review Commission, the oversight fiscal review board created as part of the city’s approved exit from municipal bankruptcy, to monitor the city’s fiscal conditions and actions, that Detroit could end up paying $30 million to the pension funds through an amendment to the 2016-17 budget, three times what it had initially proposed, using the city’s budget surplus. Mayor Duggan has been prescient in warning that the long-term impact of an estimated $491-million pension shortfall could force the city into unmanageable, ballooning payments to the city’s two pension funds beginning in 2024.
A second, but key related governance challenge will be the evolving role of the Financial Review Commission, created as part of the plan of debt adjustment, and granting significant oversight authority—including a final say on the city’s budget for years to come. Executive Director Ronald Rose, in an interview with the Detroit Free Press said original forecasts submitted in the city’s municipal bankruptcy showed the city paying roughly $92 million into the pension funds from now through 2024, plus help from the proceeds from the so-called grand bargain, a plan in which $816 million was donated by foundations, the Detroit Institute of Arts, and the state to the two pension funds to stave off any potential selling of DIA artwork. Now city officials are considering paying between $60 million and $70 million more over the next four years in an effort to help make up part of the expected shortfall, according to Mr. Rose—albeit those numbers are not expected to be finalized until the new consultant hired by the city has an opportunity to test the assumptions made by Gabriel, Roeder, Smith in its reports last fall. Gabriel, Roeder, Smith is also expected to provide the pension funds a new valuation report by next month that comes up with an updated estimate of the city’s unfunded pension liability. Ergo, according to Mr. Rose, he is uncertain what kind of projections they are going to make, meaning it will likely not be until November that the city will have sufficient information to set its pension payments over the next four years in its long-term budget. Nevertheless, Mr. Rose noted the Financial Review Commission is comfortable with Detroit’s approach to assessing its new pension obligations, telling the Free Press: “I think the city is approaching it in exactly the right way…I think it’s facing up to the issue. There is not any denial. It’s facing a difficult problem and the mayor clearly understand it in total and is reacting to it.”
The Promise of Promesa. The House Natural Resources Committee will meet tomorrow to vote on the recently revised Puerto Rico PROMESA legislation, H.R. 5278, to help the U.S. territory address it roughly $70 billion in debt and $46 billion in unfunded pension liabilities. The introduction of the bill after difficult negotiations with the Treasury makes clear the path forward will encounter numerous challenges—from hedge funds and others. Even Rep. Pedro Pierluisi, Puerto Rico’s non-voting member of Congress, has noted the new bill “is not perfect,” but rather the product of bipartisan compromise. The timeline is tight, however: Congress is scheduled to meet only 16 days between now and July 1st, when Puerto Rico has a $2 billion debt payment due, roughly $800 million of which is for general obligation bonds backed by Puerto Rico’s Constitution. Absent Congressional action and the President’s signature, Puerto Rico will default on the July 1 payment.
Schooling on Municipal Bankruptcy. The marvelous Chicago Civic Federation teaches us that the Chicago Public Schools face a potentially devastating financial crisis, including a current unbalanced fiscal budget, in no small part, because of reliance on the dismal hope that the State of Illinois would provide $480 million for pension relief; ergo, it now has a pending FY2017 budget that may have a gap of as much as $1 billion or more. The system has an ongoing structural deficit due to the CPS’s pension funding crisis, increases in long-term liabilities, decreases in general state aid, employee compensation increases, and operational problems—including a cash flow crisis, repeated use of one-time revenues to balance its budget, and the depletion of its reserve funds. The Federation notes that in recent years, CPS has been able to use budget gimmicks to achieve short-term balance at the cost of long-term financial stability. Now, however, CPS has run out of ways to delay its day of fiscal reckoning—unlike in nearby Detroit, however, filing for chapter 9 municipal bankruptcy protection is not an option: Illinois, like an overwhelming majority of states, does not authorize municipal bankruptcy. Indeed, as the Federation notes, “Since 1954, only four school districts have filed for bankruptcy: San Jose, California; Copper River School District, Alaska; Richmond Unified School District, California; and Chilhowee School District, Missouri. In these cases, chapter 9 has been used primarily as a tool to assist in bringing parties to a negotiated settlement.
Part of the distinct challenge as municipal bankruptcy relates to public school systems is that under current law (municipal bankruptcy), the jurisdiction of the federal bankruptcy court is limited to debt adjustment: the federal bankruptcy court has no jurisdiction over other matters, such as operations or academic issues—issues, as we have noted in this eBlog, which are often critical factors in developing a plan of debt adjustment. (This is, of course, especially important when one recognizes that not so very far away, the now retired U.S. Bankruptcy Judge Steven Rhodes who presided over the nation’s largest municipal bankruptcy is serving as the Emergency Manager for the virtually insolvent Detroit Public School System.) The Dean of municipal bankruptcy, Jim Spiotto, notes that public school districts facing fiscal crises historically have been restructured and refinanced under local or state supervision—whether in Philadelphia, Los Angeles, or Detroit—no doubt in some significant part because, unlike municipalities, state funding for public school districts is tightly entwined with public school finance in the U.S. Mr. Spiotto notes that state supervision allows for a more comprehensive approach to recovery than municipal bankruptcy: it enables the supervisory authority to undertake budget adjustments, modify personnel practices, make curriculum revisions, and to revise operating standards and processes—more comprehensive actions essential to ensuring not just longer term solvency, but also teaching ability. Moreover, state intervention (except, maybe, in nearby Kansas) has a longstanding track record of resolving school district financial crises.
In the case of the Chicago Public Schools, Wizard Spiotto argues that the best approach to developing a solution to CPS’ fiscal crisis would be to establish a Local Government Protection Authority (LGPA)—a quasi-judicial body to provide a supervised forum to assist the CPS Board and administration in finding solutions to stabilize the District’s finances. Such solutions would include consideration of options such as expenditure reductions, revenue enhancements, employee benefit changes, labor contract negotiations, and debt adjustment. Plans facilitated by an LGPA would be an alternative to bankruptcy, allowing key stakeholders to negotiate a workable fiscal solution. If the stakeholders could not find a solution, the LGPA would be empowered to enforce a binding resolution of outstanding issues.