The Promise of PROMESA

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eBlog, 6/30/16

In this morning’s eBlog, we applaud Sen. Majority Leader Mitch McConnell’s leadership in securing swift passage of the House-passed PROMESA legislation yesterday in the full Senate, clearing the way for the President to sign the bill into law and for the appointment of a financial control board.

Puerto Rico: Ensuring Essential Public Services. With Senate Majority Leader Mitch McConnell (R-Ky.) advising his colleagues: “The U.S. territory of Puerto Rico is in crisis, it owes billions of dollars in debt, and it could be forced to leave residents without essential services like hospitals and public safety resources without prompt congressional action…this bill [PROMESA] won’t cost the taxpayers a dime…What it will do is help Puerto Rico restructure its financial obligations and provide much-needed oversight to put into place reforms,” the Senate voted 68-30 to pass and sent the legislation for President Obama’s signature—avoiding default on a $2 billion debt payment due tomorrow. As enacted, the new law will create a process to guide what looms as the largest municipal-debt workout in U.S. history; it comes as Puerto Rico’s government has already commenced defaulting on $70 billion in debts. As enacted, the new neither authorizes nor prevents a default; rather it provides the U.S. territory with a stay against creditor litigation. In the wake of passage, President Obama called the bill “critical first step toward economic recovery and restored hope for millions of Americans who call Puerto Rico home,” adding “I look forward to signing the bill into law, and remain committed to working with Congress and the people of Puerto Rico to return to lasting economic growth and opportunity. U.S. Treasury Secretary Jacob Lew noted: “In a world where people have given up on Washington to deal with technical, complicated, controversial things, it ought to be a moment of some encouragement.” The Congressional action came against a background of increasing fiscal pressure: U.S. hedge funds, which own Puerto Rico’s most senior municipal bonds, had strongly opposed the Congressional legislation, and had even sued to block a local debt moratorium measure, had argued that their bonds were “required to be paid first in times of scarcity, ahead of even what government deems ‘essential services.’” Some municipal bond investors and outside political groups spent millions of dollars on a lobbying effort to kill the debt-relief bill, which could force them to accept larger upfront losses on their investments. U.S. Treasury officials had warned the lawsuit hinted at the likelihood that investors would seek an injunction in the event of a default that would force Puerto Rico to cut essential public services to pay its constitutionally prioritized debts. In an odd pairing, labor unions also opposed the legislation.

Some bondholders say the island’s government, with the blessing of the Treasury Department, has made Puerto Rico’s difficulties worse by threatening to default on debt. They say the territory has exaggerated its financial difficulties.

Pedro Pierluisi, Puerto Rico’s nonvoting member of Congress, applauded PROMESA’s passage and said he is “firmly convinced that it is the best legislative solution to a terrible problem” that his constituents have been forced to confront: “Once the President signs the bill into law, the next step will be to select the seven members of the oversight board,” he added: “I intend to play a role in this process, because it is critical that the board members be intelligent, hard-working, fair, and familiar with Puerto Rico. It is my hope and expectation that at least several of the board members, in addition to being highly qualified, will be of Puerto Rican birth or descent or have strong ties to Puerto Rico.” The legislation authorizes a seven-member oversight board, appointed by the President with input from Congress, with one of the board members required to either have a permanent residence or place of business in the commonwealth. The oversight board will be tasked with overseeing Puerto Rico’s finances and approving any court-supervised debt restructuring. The oversight board PROMESA would create would have the power to require balanced budgets and fiscal plans, as well as to file debt restructuring petitions on behalf of the Commonwealth and its entities in a federal district court as a last resort if voluntary negotiations do not succeed. It would also have the power to require Puerto Rico to follow recommendations it makes, even if the commonwealth’s government disagrees.

Republicans have been wary of the bill’s restructuring process for its similarity to municipal bankruptcy and the possibility it could create a precedent for fiscally troubled states, such as Illinois to come to Congress asking for similar treatment—members, that is, apparently unfamiliar with the nation’s dual sovereignty. Democrats have been concerned with, among other things, the way the oversight board would be structured and its unilateral decision-making power. They also have condemned a separate provision that would allow the governor of Puerto Rico to authorize employers to temporarily pay employees under the age of 25 a $4.25 per hour minimum wage instead of the federal minimum wage of $7.25.

Constructing Post Municipal Bankruptcy City Futures

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eBlog, 6/29/16

In this morning’s eBlog, we welcome Sen. Majority Leader Mitch McConnell’s leadership in taking up the House-passed PROMESA legislation today in the full Senate; Detroit gets a green light to refinance debt, enabling it to issue its first post-municipal bankruptcy general obligation debt; San Bernardino adopts its annual operating budget, marking its first steps towards a post-municipal bankruptcy fiscal sustainability; and Atlantic City hosts a public meeting to explain the steps it is taking to avoid a state takeover.

Puerto Rico: Ensuring Essential Public Services. The Senate will begin debate this morning on the House-passed PROMESA—with a final vote possible by this afternoon. Majority Leader Mitch McConnell (R-Ky.) started the process for consideration by filing for cloture late yesterday, so he will need 60 votes to bar any filibuster. U.S. Treasury Secretary Jack Lew is warning the Senate that any delay in acting on the House-passed PROMESA legislation to avert insolvency could carry severe repercussions for the U.S. territory, advising Senators that if Congress fails to pass a bill by July 1, a torrent of litigation from creditors could put the territory’s public services at risk. Puerto Rico has $2 billion in debt payments due, and government officials have warned they have insufficient funds, leading the Secretary to warn: “In the event of default, and if creditor lawsuits are successful, a judge could immediately order Puerto Rico to pay creditors over essential services such as health, education, and public safety…This could force Puerto Rico to lay off police officers, shut down public transit, or close a hospital.” Sec. Lew added that were Congress to miss the July 1 deadline and pass something retroactively, it would be unable to halt such a judge’s order, meaning the island’s essential public services would be at risk: “Doing nothing now to end the debt crisis will result in a chaotic, disorderly unwinding with widespread consequences…Some well-funded creditors are working hard to delay legislative action this week, even if it comes at the expense of the Puerto Rican people.”

A Motor City Thumbs Up! The Detroit Financial Review Commission, the nine-member Financial Review Commission, created nearly two years ago to ensure the City of Detroit is meeting statutory requirements, and to review and approve the city’s four-year financial plan created as part of its plan of debt adjustment, and to establish programs and requirements for prudent fiscal management, yesterday provided an all clear to proceed with a refunding of $660 million of general obligation debt—a key step which Detroit Finance Director John Naglick described as the last step in the process for the city to return to the municipal bond market: he anticipates a late July, early August issuance date. Yesterday’s approval clears the deck for Detroit to issue its first full faith and credit debt since exiting the largest municipal bankruptcy in U.S. history a little over a year and a half ago—with the projected savings estimated by Director Naglick to be as much as $40 million—savings which he said the city would use to provide budget and property tax relief. Detroit will refund up to $275 million of unlimited tax GO bonds the city sold in 2014, and as much as $385 million of limited tax GO bonds sold in 2010 and 2012. The bonds were issued through the Michigan Finance Authority and carry a backing of the city’s state distributable aid—in Michigan, a municipality can only pledge such distributable state aid on municipal bonds issued by the Michigan Finance Agency. Mr. Naglick added that the projected interest rate savings on the limited tax general obligation bonds will benefit Detroit’s general fund budget by as much as $15 million, while savings on the backed by the pledge of the issuer (generally a city or municipality) to raise taxes, without limit, to service the debt until it is repaid. Because of this feature, unlimited tax bonds may have higher credit ratings and offer lower yields than other comparable municipal bonds of the same maturity. The unlimited tax or UTGO bonds of $24 million, according to Mr. Naglick, will be used to lower the debt millage on the city’s property owners.

Roadmap to Sustainability. The Mayor and Council of San Bernardino have unanimously adopted a balanced budget for FY2016-17—a budget which, in stark contrast to recent years, includes no layoffs, or, as Councilwoman Virginia Marquez said after the vote: “Tonight really marks the first step in the right direction…Since the bankruptcy, we’ve lost a lot of great people. I’m glad to see that this year there are no layoffs needed.” As adopted, the operating budget (the capital budget is to be adopted later this summer) provides 752 employees—some 67 fewer than last fiscal year, but the difference is attributed to the city’s outsourcing of fire and refuse services—steps taken as part of the city’s plan of debt adjustment. In another sign of the city’s fiscal turnaround and steps towards sustainability, the budget includes $400,000 to finance step increases. City Manager Mark Scott presented the budget alongside an extensive list of items not included in the budget that could be wanted, including master plans for street lights and street paving, additional Code Enforcement Staffing and an expansion of the Quality of Life Team. He’ll bring groups of those suggestions to the City Council for possible addition later. Also coming up for discussion later are several items included in the budget that some council members indicated they might not approve. That includes $150,000 for “education” related to a proposed ballot measure to replace the city charter. The cost might be less than that, Mr. Scott said, once a potential expert in ballot item education — which is closely limited by law to prohibit advocacy in favor of the item — and Council members have the chance to approve or not approve the specifics once they are selected: “You’re not locking yourself into anything with your vote today,” Mr. Scott said. The budget projects $112.76 million in general fund revenue and $112.52 million in expenditures, a small surplus.

Betting on one’s City’s Future. Atlantic City Mayor Don Guardian yesterday reported that the city has hired public finance attorneys to restructure some of its $240 million of outstanding bond debt: the attorneys have been brought on to work on reducing the city’s debt load, much of which it took on to pay back casinos which had prevailed over the city on property tax appeals. The attorneys will be a key part of the city’s last gulp effort to put together a fiscal recovery/sustainability plan prior to October 1—where failure would doom the city to a state takeover. The Mayor and Council, at a public meeting last night, made clear the city will be seeking some assistance from surrounding Atlantic County. At the session, Councilman Kaleem Shabazz noted: “Bankruptcy scares investors away. It chills financial markets. Bankruptcy doesn’t solve our problems,” adding as a reminder, moreover, that whether or not the city can even seek municipal bankruptcy is a state rather than the city’s final decision. Thus, he noted: “Atlantic City is a functional, contributing part of the economic engine of the state, so we have to work together.”

For his part, Mayor Guardian spoke about steps the city has taken or is planning, including that the city will ask private companies for bids to see if they could save money on certain services, including trash and recycling, payroll, and towing. He said the city had also asked Atlantic County about sharing senior citizen transportation and some other services.

In describing actions the city has taken to ensure it can control its own destiny, he added the city has increased a number of fees, including for parking meters, which are expected to bring in nearly $800,000 this year, and double that amount next year. (The city’s fiscal year follows the calendar year.) Mayor Guardian said that since he took office in January of 2014, the city had reduced its workforce by 28 percent to 904 as of the end of April, with more employees leaving at the end of this week. The city will also receive $1.7 million for properties it auctioned off on June 23rd and, potentially, another $5 million combined for two other properties.

The Challenge to Congress to Essential Public Services

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eBlog, 6/28/16

In this morning’s eBlog, we consider the dwindling number of days for the U.S. Senate to act to avert a potential human catastrophe in Puerto Rico, already the Zike frontier for the U.S. We note U.S. Treasury Secretary Jack Lew’s epistle to the Senate—and we include a superb op ed by former New York Lieutenant Governor Richard Ravitch on the issue.

Ensuring Essential Public Services. U.S. Treasury Secretary Jack Lew is warning the Senate that any delay in acting on the House-passed PROMESA legislation to avert insolvency could carry severe repercussions for the U.S. territory, advising Senators that if Congress fails to pass a bill by July 1, a torrent of litigation from creditors could put the territory’s public services at risk. Puerto Rico has $2 billion in debt payments due, and government officials have warned they have insufficient funds, leading the Secretary to warn: “In the event of default, and if creditor lawsuits are successful, a judge could immediately order Puerto Rico to pay creditors over essential services such as health, education, and public safety…This could force Puerto Rico to lay off police officers, shut down public transit, or close a hospital.” Sec. Lew added that were Congress to miss the July 1 deadline and pass something retroactively, it would be unable to halt such a judge’s order, meaning the island’s essential public services would be at risk: “Doing nothing now to end the debt crisis will result in a chaotic, disorderly unwinding with widespread consequences…Some well-funded creditors are working hard to delay legislative action this week, even if it comes at the expense of the Puerto Rican people.”

Roadmap to Sustainability. In an op ed in today’s Wall Street Journal, former New York Lieutenant Governor Richard Ravitch, a member of the Detroit Financial Review Commission, wrote:

Citizens in democratic nations are right to worry when they see intrusions on self-government. Many Puerto Ricans thus are understandably concerned about the powers of the oversight board prescribed in legislation the U.S. House of Representatives recently passed to assist the commonwealth. The Senate is about to take up the proposed law, which has drawn criticism in Washington and Puerto Rico for impinging on its sovereignty.

The alarm is misplaced. Consider what happened in 2013 when the city of Detroit was facing circumstances frighteningly similar to those Puerto Rico is experiencing today: debt it couldn’t afford to pay; a population exodus; inadequate funds to pay contracted retirement benefits to employees; high risk of social disorder; and endless litigation. Michigan Gov. Rick Snyder appointed an emergency manager, pursuant to state law, to take over the city’s governance. The powers of the mayor and City Council were totally subordinated on all budget, financial and contractual matters.

There was a large public protest led by the Rev. Jesse Jackson. A lawsuit was brought in federal court by a number of plaintiffs, including unions representing public employees, alleging that the governor’s measure was unconstitutional. And there were crowds shouting that the man appointed to the emergency-manager job, Kevyn Orr, should leave town.

Had the protests succeeded, Detroit would not be going through the recovery that is now occurring. Public retirees would not be receiving benefits, bondholders would not have agreed to debt adjustments, people would not be buying real estate and opening restaurants. There would only have been litigation, social unrest, population decline and continued disinvestment.

Puerto Rico has a debt-service payment of $2 billion due July 1 that it cannot pay. The U.S. territory has a real chance of running out of cash, despite defaulting on its debt, by the end of the summer. Litigation in Puerto Rico and the U.S. promises to be endless and to consume scarce resources of the beleaguered commonwealth’s government. And more people will move to the mainland.

As much as I appreciate the concerns about the powers of the oversight board, the U.S. Senate should pass the bill by July 1, protecting the people of Puerto Rico from the dangers that loom if the legislation isn’t enacted. I had the privilege of working with the bankruptcy judge and the emergency manager in Detroit. As soon as the restructuring was accomplished through the negotiated consents of all the creditors, the return of power to the elected government was instant. Praise for the process was almost uniform. Those who want to stop passage of a law providing similar help to Puerto Rico should be prepared to take responsibility for the consequences of their shortsighted actions.

Saving Lives, Dollars, and Families’ Homes

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eBlog, 6/27/16

In this morning’s eBlog, we explore the signal change set to occur this week with the consolidation of San Bernardino’s Fire Department into that of San Bernardino County—a critical step to saving capital and operating costs, as well as earning new revenues—and, likely, saving more lives. The consolidation marks the successful execution of this key provision in the city’s plan of debt adjustment. Next, we turn to view the success of Wayne County’s apparently successful efforts to sharply reduce tax foreclosures in Detroit—a vital fiscal effort to restoring the city’s property tax base.

The Sharing Economy. Implementation of a key provision in San Bernardino’s plan of debt adjustment is slated to happen this week when the city’s 137-year old fire department will be taken over by San Bernardino County—producing an additional $7 million to $8 million for the bankrupt municipality, according to the city’s projections—with those estimates calculating savings from the economies of scale offered by a larger organization as well as the associated new parcel tax, which will be $148 per parcel in FY2017—and increasing by up to 3 percent each year. Because the annexation involved subsuming the city’s fire department being annexed into an existing fire protection district that already had a 3 percent tax, the tax was automatically triggered for city residents—unless 25 percent of city residents had submitted protest forms by last April 21st—the threshold to trigger a vote. Thus the San Bernardino County Fire Department will officially assume responsibility for San Bernardino’s fire, rescue, and emergency medical services this Friday, with the actual personnel changes going into effect on Sunday, July 3rd. The consolidation will involve about two-thirds of the city’s current fire personnel taking positions in the county — and an equal number of county firefighters transferring into the city. But that appears to be just the tip of the iceberg: Technical support changes have been ongoing for months, fire rigs have been reconfigured to communicate with the county communication center, and officials have met regularly to ensure a smooth transition, and, of course, the replacement of labels on the vehicles themselves has already been underway.

Trying to Foreclose on Tax Foreclosures. Wayne County Treasurer Eric Sabree expects as many as 18,000 properties will be headed to the annual tax foreclosure auction this fall, with the vast majority in Detroit—which seems like a large number until one recognizes it would mark nearly a 36 percent drop from last year’s 28,000, leading Mr. Sabree to note: “Collections are up all over the county, including Detroit. That’s a good sign. But people are still struggling. We have to stay vigilant.” Over the last year, Mr. Sabree’s office has partnered with a number of nonprofits, neighborhood leaders, and Detroit Mayor Mike Duggan’s office to reach out to delinquent owners, including mailings, personal visits and workshops. Homeowners with tax debt can still enter payment plans with the Treasurer’s office until Thursday. Of those properties headed to foreclosure this fall, 8,000 are estimated to be occupied. Half of those are renters, according to Treasurer Sabree, and the rest homeowners. Wayne County officials attribute the marked decline in part to new payment plans which sharply reduce interest rates for many homeowners from 18 percent to 6 percent, as well as assistance available to homeowners through the Step Forward Michigan program. Those interest rate reductions, however, expire in June; consequently he.is pressing the Michigan Legislature to extend the program. This month officials with Loveland Technologies visited nearly 9,000 homes believed to be occupied and surveyed about 1,800 occupants: the company was able to help 256 residents get on payment plans; a key finding by Loveland: of the nearly 2,000 homeowners they visited, 38 percent said they were unaware the property was in foreclosure.

The Critical Challenge of Restoring One’s Property Tax Base

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eBlog, 6/24/16

In this morning’s eBlog, we explore the key steps underway in San Bernardino to restore the city’s critical property tax base—an essential element not just to approval by U.S. Bankruptcy Judge Meredith Jury of the city’s pending plan of debt adjustment, but also for any meaningful, long-term fiscal recovery. Then we turn to the very different kind of federal role in Opa-locka, Florida—already under a state takeover, but now under the impatient eyes of the federal Securities and Exchange Commission.

Restoring a Municipal Tax Base. The City of San Bernardino, once the key gateway from the East and Midwest to Los Angeles basin and former home to Norton Air Force Base, Kaiser Steel, and the Santa Fe Railroad—but today in chapter 9 municipal bankruptcy longer than any other city in U.S. history, is experiencing returns from its efforts to revitalize its property tax base—a base that was devastated in the Great Recession—which left the municipality with nearly 50 percent of its residents on some form of public assistance and 56 percent of homes underwater: it reduced property tax revenues by 15 percent. In the years leading up to bankruptcy, San Bernardino suffered heavily as important sources of revenue fell, notably property taxes: the San Bernardino FY2006-2008 CAFR reports show that property taxes generally accounted for about 30% of the city’s total revenue, but the Great Recession demonstrated that reliance on property tax revenues can be volatile. In the case of San Bernardino, the city had experienced a huge housing boom from 2001-2007, and a consequent growth in property tax revenues; but what goes up can come down, so the city was one which was especially hard hit when the housing market crashed. While home prices around the country fell by 24% from 2005 to 2010, they fell by over double that in San Bernardino, which also experienced a foreclosure rate around almost four times the national average. From 2008 to 2011, property tax revenue fell from $74.7 million to $46.7 million, a steep 37% decrease. Meanwhile, adding fiscal insult to injury, the state’s Proposition 13 barred San Bernardino and all California cities from attempting to make up this lost revenue through increased property tax rates. The 1978 constitutional amendment pegs the statewide property tax rate to 1 percent of a property’s assessed value at the time Prop 13 was enacted or the sale price when the property changes hands. Annual increases of assessed value are limited to 2 percent in the years the property is not sold. Therefore, unsurprisingly, focusing on vacant and heavily vandalized houses has been a critical component of the city’s focus on a turnaround and exit from municipal bankruptcy—and the city’s program: RENU, or the Receivership Empowering Neighborhood Upkeep, which it initiated a year ago in April 2015, and is now seeking to expand. San Bernardino has now completed the first project, and funds from the sale of the property—which involve the court taking control of a property where the owner is unresponsive and appointing a receiver to fix it up—is then used to reimburse the receiver, the city, and others involved in the process, so that there is no cost to the city. From June 2011 to August 2015, the city issued 14 notices and several times secured the property where yesterday’s open house was held, with Deputy City Attorney Lauren Daniels noting the house had gone into foreclosure and become bank-owned: “We sent countless notices to the holder of the mortgage and trust, because there were issues of squatters, and schoolchildren at Serrano (Middle School) were nearby and they would come to the house…With the hazardous swimming pool, hazardous pieces of the ceiling coming off — there were numerous code violations.” The result: one year after the first San Bernardino house completed the receivership process, neighbors say it is still making a world of difference—or as one neighbor yesterday described it: “Peace and safety has been restored to our neighborhood, because of what the city did to our neighborhood. It’s a very, very good program.”

Unlocking a Municipality’s Fisc. The small Florida municipality of Opa-locka, which Florida Gov. Rick Scott declared on the first of this month to be in a state of financial emergency, now is also under investigation by the Securities and Exchange Commission, with the SEC requesting documents and emails relating to municipal bonds the city issued for the May 2015 purchase of an $8 million building. The federal probe came as Melinda Miguel, Florida’s Inspector General, whom Gov. Scott named to take responsibility for state fiscal oversight, convening her panel for its first meeting yesterday—and at which Acting City Manager Yvette Harrell, in giving the state financial emergency board an overview of the city’s finances, described Opa-locka’s fiscal situation as “dire,” noting: “We have an important job here to do.” That is a task, no doubt, made more difficult, because it marks the second state fiscal takeover of the municipality—so one key task will be to determine in what ways the first state takeover failed to produce long-term fiscal stability. In her presentation yesterday, Ms. Harrell told the state board of recently discovered information which appears to demonstrate that the city failed to budget a “$1.7 million prior debt obligation required to keep the city moving.” Ms. Harrell added that Opa-locka had: failed to budget extra money for staff it hired; that the city continued to budget and spend revenues it would not receive even though property values declined; and that the cash-flow deficit has fluctuated wildly, from $1.42 million to $4.5 million to $1.89 million in a matter of weeks—adding that the city needed help to “figure out where we are.” She noted that some key steps would involve enhancing efforts to collect past-due bills, although, with the city inside Miami-Dade County, a county with its own experience once on the brink of municipal bankruptcy, but today experiencing a booming economy and rapidly rising property values, a critical issue for Opa-locka is to get a handle on why it has been experiencing a consistent decrease in property values by as much as 60 percent.

For her part, IG Miguel named appointees to committees to examine different aspects of the city’s budgets and contracts, as she presses to meet an August 1st deadline for the board to submit a financial plan to Governor Scott—a task no doubt made even more challenging since Opa-locka has yet to begin work on its 2015 audit. Thus, unsurprisingly, questions were raised during the financial board meeting about the need to hire a new, independent auditor. The city had total long-term debt outstanding of $11.6 million, including $6.56 million of revenue bonds placed with a financial institution and state loans, according to its most recent, FY2014 audit. A financial assessment conducted by Miami-Dade County Auditor Cathy Jackson earlier this year found that as the city’s fiscal crisis had worsened, there were numerous irregularities with the city’s use of restricted funds, including debt service reserves—reserves which the Miami Herald last week reported the city had dipped into to cover payroll expenses—a disclosure which the city manager yesterday omitted to inform the financial emergency board.

The Long, Hard Road to Recoveryfrom Municipal Bankruptcy

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eBlog, 6/23/16

In this morning’s eBlog, we explore the City of Detroit’s successful steps to return to the municipal bond market with its first-post municipal bankruptcy issuance; we consider the looming electoral and fiscal challenges in not-so-far away East Cleveland in the wake of an expensive recall election in a municipality adjacent to next month’s GOP nominating convention—a small municipality awaiting some determination whether it might merge with the City of Cleveland or file for chapter 9 municipal bankruptcy. Finally, with its own clock headed to overtime, we look at the looming debate in the U.S. Senate over the House-passed PROMESA legislation—with, as the Romans would have said—tempus fugit.

Steps on the Road to Recovery from Municipal Bankruptcy. The Detroit City Council yesterday unanimously approved the issuance of up to $660 million of municipal refunding bonds—an action which is projected to save the city some $37 million as well as mark a key step towards the Motor City’s successful return to the municipal bond market in the wake of the largest municipal bankruptcy in U.S. history. The city is hoping to benefit from record-low yields in the muni market to refund the bonds, saving $15 million for the next two city budgets and about $20 million for property tax bills. In its first post-bankruptcy public debt offering last August, the city restructured $245 million of variable-rate revenue bonds backed by city income taxes into a fixed-rate mode. The issuance here is to refund up to $275 million of unlimited tax general obligation bonds sold in 2014 and up to $385 million of limited tax GO (LTGO) bonds sold in 2010 and 2012. The debt was enhanced with a statutory lien and intercept feature on Detroit’s income taxes; now the proposed sale must gain final approval from the Detroit Financial Review Commission, which meets next Monday. In other action yesterday, the City Council also approved the set aside of $30 million from a city budget surplus in order to enable it to address a potential public pension shortfall of nearly $500 million. The shortfall, which Mayor Mike Duggan had disclosed earlier this year as part of a discussion of potential litigation by the city against consultants who had worked on the city’s plan of debt adjustment—especially with regard to projected future pension payments—appears to be because of the use of outdated mortality tables. (Last week, the Detroit City Council agreed to hire actuarial consultant Cheiron to work on a new pension funding model.) The refunding bonds, backed by state revenue earmarked for Detroit, would be issued through the Michigan Finance Authority later next month. The sale would mark Detroit’s first post-chapter 9 bankruptcy general obligation or GO bond issuance since its exit from the nation’s largest-ever municipal bankruptcy a year ago last December—or, as Detroit Finance Director John Naglick put it yesterday: “We hope this leads to a better general obligation bond rating, which would help us in the future.” The city’s current GO bond ratings are B3 with Moody’s Investors Service and B with Standard & Poor’s. Director Naglick advised the Council that savings on the LTGO bonds will benefit Detroit’s general fund budget by approximately $15 million, while savings on the UTGO bonds of $24 million will be used to lower the debt millage on the city’s property owners.

Democracy & Municipal Fiscal Distress. With the GOP convention scheduled to meet next door in Cleveland in just weeks, there was an election—a recall vote—in next-door East Cleveland yesterday in which the city’s voters—at a cost of $10,634—and for the second time in the last seven months rejected a recall of City Council President and Ward 3 councilman Thomas Wheeler. The vote—one which cost the nearly insolvent municipality some $10,634.77, came as Council President Wheeler is heading up the City Council’s efforts to try and merge with Cleveland—even as the city awaits a response from Ohio with regard to its proposal to file for chapter 9 municipal bankruptcy. In surviving his second recall effort in seven months, Councilmember Wheeler yesterday noted: “The people of East Cleveland know my history and what I represent…It (the cost of the recall election) is taking away money from the taxpayers that we could use for something else.” The turnout—under 7 percent—of 267 ballots marked a decline from last December’s earlier failed recall election. In gaining the uncertain vote of confidence, Councilmember Wheeler said his first priority is appointing commissioners for potential East Cleveland-Cleveland merger conversations: “I know people want to stay the course.”

Running Out of Time. U.S. Senate Majority Whip John Cornyn (R-Tex.) yesterday said he expects the Senate to begin consideration of the House-passed PROMESA legislation [H.R. 5278] next week, with his comments coming in the wake of Federal Reserve Board Chair Janet Yellen this week having testified before the Senate Banking, Housing and Urban Affairs Committee that Puerto Rico’s nearing insolvency is “is inherently a matter for Congress,” adding that the Federal Reserve’s authority “is extremely limited” and that “it wouldn’t be appropriate for us to give loans to Puerto Rico: We have very limited authority to buy municipal debt and the authority we have, if we were [able to] buy eligible debt, I don’t think it would be helpful to Puerto Rico…Beyond that, we have no ability to make emergency loans.” With a looming $2 billion payment by Puerto Rico falling due a week from tomorrow, the timeline for Congressional action has become complicated: the House has adjourned and is not scheduled to be in session next week; thus, were the Senate—where Senate Minority Leader Harry Reid (D-Nev.) has indicated there are “some serious concerns” on his side of the aisle about the House version—apprehensions which he said would require consideration of amendments—the Congressional calendar abruptly carries signal implications—non-action could leave the U.S. territory vulnerable to creditor lawsuits in the wake of an almost certain default on a $1.9 billion debt payment due July 1st. While the House-passed bill includes a provision to stay such a suit, that provision only carries weight if PROMESA is signed into law by President Obama. Thus a default by the U.S. Senate would run the risk of the Commonwealth’s future being determined in federal courtrooms, including one that hedge funds holding Puerto Rican general obligation municipal bonds filed Tuesday in New York in the wake of municipal debt restructuring talks breaking down.

As the Senate awaits consideration of the House-passed PROMESA, the National Taxpayers Union wrote yesterday to urge the Senate to concentrate on “maintaining the taxpayer safeguards in the existing legislation, and, if additional changes are proposed, focus on: 1) Ensuring Puerto Rico’s government respects debt-payment priorities; 2) Strengthening provisions to encourage federal tax reform for the Commonwealth; and 3) Limiting the influence of the union-dominated ‘audit commission’ that wants bloated government pension debts to go to the head of the line.” In its letter, the Union favorably noted that while the House-passed version provided “provided greater detail over how the new federal oversight entity would certify voluntary debt restructuring agreements, and would modify the selection and confirmation process for members of the body,” the entity would also be empowered to take certain actions relating to privatization and commercialization of government assets, deeming that “a welcome addition to the bill that must be a priority for the island’s economic well-being.” With regard to debt restructuring, NTU wrote that the pending legislation “has made important progress on respecting the balance of rights between creditors and debtors…and, as a result, taxpayers. H.R. 5278 helpfully prevents inter-debtor transfers, and now requires the court to consider in a restructuring proceeding whether remedies available under other laws might offer a better recovery for creditors than whatever was being initially proposed. For its part, the oversight entity must also ‘respect lawful priorities or lawful liens’ as outlined in Puerto Rico’s constitution,” adding it would oppose any amendments to reverse these gains, but would support distinct language clarifying that in any restructuring action resulting from PROMESA’s new authorities, pension debt is subordinate to constitutional obligations.”

The Pressure of Looming Deadlines in Municipa Finance

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eBlog, 6/22/16

In this morning’s eBlog, we explore the difficult transition challenge in Detroit of the state’s public school system after 7 years of state control back to the city; we observe the deteriorating fiscal collapse of the small municipality of Opa-locka, Florida; and we observe the increasingly frantic negotiations, threats, and litigation in Puerto Rico as its big deadline approaches the week after next.

Public Schooling on Municipal Bankruptcy. Detroit Public Schools Emergency Manager and retired U.S. Bankruptcy Judge Steven Rhodes plans to meet with both Michigan officials and Detroit families this week to explain and discuss the implementation of the state’s $167 million “rescue” plan for the Detroit Public Schools (DPS) which Gov. Rick Snyder signed into law yesterday—which includes $467 million in debt relief and $150 million in start-up costs for creation of a new debt-free school district—at a meeting today at which key players from Gov. Rick Snyder’s office, the state Treasury, and the Michigan Department of Education are expected. Under the new laws, the school district will be divided on July 1 into two corporations as part of this plan enacted to prevent the system from filing for municipal bankruptcy: The existing DPS district will stay intact for tax-collection purposes to retire $617 million in debt over 8½ years, including $150 million for transitional startup costs to launch a new district and to ensure it has enough cash flow to operate. The new district, which will receive the $617 million infusion of state funds to cover the lost tax revenue, will educate students. A new school board will be elected in November, and a commission of state appointees that oversees city budgets will also review the schools’ finances. The new law splits the old DPS in two, leaving the old entity to pay off debt through existing millage, while a new debt-free district will receive its full state funding allowance to focus on education. Judge Rhodes is expected to serve as an official “transition manager” for the newly created school district. Under the legislation, the transition manager would run Detroit schools until new school board members take office next January after November’s elections. Judge Rhodes wants to ensure everyone “is on the same page as it relates to knowledge” of the legislation, so that participants can begin working together on a project management plan to implementing the state assistance package and launch of a new Detroit Public Schools Community District.

The learning curve will be challenging: the state assistance plan was adopted on a partisan vote without a single vote of any Detroit legislator: the greatest challenge is likely to be with regard to charter school proliferation in the city and the growing percentage of special education students who attend the traditional public school district. Because the new state law omits a proposed commission which would have had governing authority with regard to the placement of traditional and charter schools in the city, there are expected to be significant challenges for the new DPS. Indeed, Michigan Education Superintendent Brian Whiston yesterday noted: “The conversation isn’t going away,” adding that charter school proliferation is also causing challenges for other urban school districts in Saginaw, Benton Harbor, and Pontiac—or, as Mr. Whiston described it: work creatively to get more funding (for DPS) if we have to…and also to look at how we manage the opening and closing of schools — to do it in a way that provides parents’ choices, which is important, but also in a way that we manage those choices.” (One of the newly enacted state DPS provisions directs the state to develop an “A-to-F” grading system, so Detroit parents can better decide which schools, whether traditional or charter, are the best.

Will There Be a State Bailout? Opa-locka, Florida leaders have met in an effort to address critical financial crises which threaten to plunge the small municipality into municipal bankruptcy—with Commissioners voting earlier this week to dip into resources in the city’s wastewater reserve fund to make payroll this week—even as the small municipality has stopped payments to mechanics who work to keep the municipality’s old police cars working: Opa-locka is over $1 million in debt. But even that debt seems to pale compared to the growing, day-to-day challenge of operating, a challenge so severe the city commission had felt compelled to dip into the municipality’s sewer fund reserves. Florida’s Gov. Rick Scott has already declared a state of emergency for the city—and now recognizes it might have to act to bail the city out. Even the city’s governance has been challenged, with the commission appointing former mayor John Riley to fill an open commission seat after former commissioner Terence Pinder killed himself—as he was confronting bribery charges. The new Commissioner Riley told his colleagues: “First of all, I want to really find out the status of the city and what’s been done and what’s not been done.”

Tropical Fiscal Storm. Hedge funds Jacana Holdings, Lex Claims, MPR Investors, and RRW I yesterday filed suit in federal court in New York, seeking to have the federal court bar Puerto Rico from using its April-adopted Puerto Rico Emergency Moratorium and Financial Rehabilitation Act for its general obligation bonds—and to seek the court’s intervention to mandate that Puerto Rico prioritize the payment of the it general obligation (GO) bonds.  (The plaintiffs filing currently hold bonds from Puerto Rico’s $3.5 billion 2014 GO bond sale—municipal bonds for which the bond’s indentures specify the underlying bonds are to be governed by New York law and use New York’s courts to resolve disputes.) The suit charges that “Governor Alejandro García Padilla has willfully violated the first priority guaranteed to general obligation bonds by Puerto Rico’s constitution and has flouted centuries-old federal constitutional protections for contract and property rights…,” adding that the “Moratorium Act is transparently unlawful.” Unsurprisingly—and even as the U.S. Senate could act by as early as next week to take up and consider the House-passed PROMESA legislation—the U.S. territory of Puerto Rico decried the resort to litigation as a failure to “continue good faith negotiations…” much less to “acknowledge the reality of the commonwealth’s fiscal crisis: This attempt by hedge funds to disrupt the commonwealth’s ability to keep the lights on and provide essential services for the 3.5 million Americans on the island makes clear that the Senate must act and pass PROMESA before July 1.”

In filing suit—rather than awaiting Congressional action or working for good faith resolution, the plaintiffs, in their filing, charged that the “Puerto Rico legislature lacks the legislative authority to modify New York’s law of contracts…,” adding that “In case the available revenues including surplus for any fiscal year are insufficient to meet the appropriations made for that year, interest on the public debt and amortization thereof shall first be paid,” but also adding that Puerto Rico’s Moratorium Act breaks the contract and due process clauses of the U.S. constitution. The filing occurs in the midst not only of Congressional action, but also confidential creditor debt negotiations, including with some of the litigants and other holders and insurers of Puerto Rico GO and Sales Tax Finance Corp. (COFINA) debt—negotiations which the Puerto Rico Government Development Bank yesterday reported had broken down.

Yesterday’s hedge fund suit followed in the wake of a growing pile of suits against Puerto Rico: last month hedge funds holding more than $750 million of the debt of the GDB revived a lawsuit, accusing the U.S. territory’s government of “changing the rules of the game” by amending the Moratorium Act, seeking in the revived litigation to overturn the Moratorium Act and Law 40, which Puerto Rico amended last month. Last week, municipal bond insurer National Public Finance Guarantee sued Puerto Rico in the U.S. District Court for the District of Puerto Rico, seeking to overturn the Moratorium Act. The resort to federal court likely emerges from both the faltering confidential talks with some of Puerto Rico’s municipal bondholders, as well as perceptions that litigation might produce a richer outcome for hedge funds than the pending PROMESA legislation likely headed to the signature of President Obama. All this comes as the proverbial clock is running down to next week’s deadline for Puerto Rico to pay $2 billion it does not have in interest and principal due on a variety of securities, which Governor Alejandro Garcia Padilla has made clear Puerto Rico cannot pay in full. Bloomberg reported that Puerto Rico’s benchmark general-obligation bonds traded yesterday at about 66 cents on the dollar to yield 12.8 percent.

Is San Bernardino in the Home Stretch?

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eBlog, 6/20/16

In this morning’s eBlog, we welcome the good news that as San Bernardino holds its FY2017 budget hearing tonight, it will hear of an unexpected budget surplus, creating the option to finance municipal bankruptcy related services—and, lo and behold—compliment the city’s pending plan of debt adjustment.

The Last Full Measure? The San Bernardino City Council is scheduled to review the bankrupt city’s proposed FY2017 budget this evening—as it closes out a year in which revenues exceeded projections, even as spending was less than budgeted—so that, tonight, the Council will consider a motion to move some $2 million of the unexpected surplus into the fund the city has set up to finance municipal bankruptcy related services. The current, adopted budget had been projected to achieve a surplus of $18,608 by the end of the fiscal year; however, that is now projected to grow to a surplus of $12 million—with the savings attributed primarily to the city’s large numbers of vacancies, according to the Finance Department, but also from a number of one-time moves, including a franchise fee of $5 million for the sale of the San Bernardino’s Integrated Waste Management operation, as well as: some $3.2 million in greater sales and use tax revenues than projected; $600,000 in higher utility user’s tax revenues, and $1.2 million in higher than projected transient occupancy tax revenues—with the transient occupancy tax revenue 46 percent higher than the city had projected and some 20 percent over last year, reflecting increased occupancy at nearly all hotels and motels.

Is the End in Sight? The good news on the budget front compliments the city’s Recovery Plan, which, as of mid-May, rests on four key areas of change and improvement by the City, all aimed at improving the fiscal position of the organization: 1) Efficiency improvements – largely regionalizing or contracting for services; 2) Debt and Other Post-Employment Benefits (OPEB) restructuring; 3) New revenue and tax increases / extensions; and 4) Organizational improvements. In the wake of the city’s adoption of its plan of debt adjustment or Recovery Plan, San Bernardino has posted on its municipal bankruptcy site the table below [http://www.ci.san-bernardino.ca.us/home_nav/chapter_9_bankruptcy/default.asp], which provides a summary of where the City currently stands with respect to the major elements of the Plan. This Table is based on Table 1 – Cost Savings and Revenue Enhancement Actions and Estimates (General Fund) in the May 2015 Recovery Plan. The table shows for each opportunity area the estimated economic benefit, a summary of actions taken towards implementation and the currently anticipated economic benefit either realized or planned. Of note is that implementation is complete or underway on all actions targeted for 2015. In addition, implementation of several elements targeted for 2016 are already underway.

Cost Savings and Revenue Opportunities Estimated Ongoing (Annual) Savings unless otherwise noted Status 
Efficiency Improvements    
Regionalize or Contract fire and EMS services $7,000,000 – 10,000,000 Implementing – Council voted to annex into San Bernardino County Fire District. Local Agency Formation Commission (LAFCO) assessed and approved annexation, subject to conditions of approval, which included an annual parcel tax of $148.32, and protest hearing/votes. Less than 5% of landowners and registered voters submitted protest votes, moving the annexation forward to the implementation stage. Based on LAFCO and City estimates net economic benefit to the City ranges from $7.4 to $12.0 million annually of which approximately $7.4 million is expected to come from landowners new parcel tax contribution. The higher savings estimate includes resumption of payments for facilities maintenance, equipment replacement and overhead support eliminated from City budget.
Contract business license administration $650,000 to $900,000 Pending – Organizational analysis recommending moving function to Finance completed. RFP in development. Will be complete in 2016.
Contract fleet maintenance $400,000 Pending – 2016
Contract soccer complex management and maintenance  $240,000 to $320,000 Completed. The City has contracted for the operation of the complex by a private vendor effective October 1, 2015. Annual savings are estimated at $300,000. Private vendor has begun a $1M renovation and established a new National Premiere Soccer League team.
Contract custodial maintenance $150,000 Pending – 2016
Contract graffiti abatement $132,600 Pending – 2016
Implement other efficiency improvements $1,000,000 or more Completed. Right of way maintenance and street-sweeping are being implemented with solid waste contracting.
Health care savings (retirees) Up to $60 million in total savings Completed. Actuarial report is being finalized.
Debt Restructuring    
General Secured Bond Obligations $487,450 Implementing – Agreement has been reached. Documentation is underway.
General Unsecured Bond Obligations – Pension Obligation Bonds Up to all but 1% of obligation or approximately $95 million Implementing – City has reached agreement with creditor. Obligation reduced from $95.8 million to $50.7 million. Annual payments reduced from $3.3 to $4.7M per year to $1.0 to $2.5M per year
Restructuring of other creditor obligations Up to $4,300,000 in total savings Pending – Tentative agreement reached with holder of $527,490 lease purchase obligation
New Fee Revenue and Tax Adjustments  
Seek reauthorization of the Measure Z sales tax in 2021 (requires voter approval) $8,300,000 Pending – 2021. Police resources plan for rebuilding police capacity and improving public safety adopted by City Council
Perform a transient occupancy tax (TOT) audit $200,000 Pending – 2016
Collect new waste management franchise fee (once service has been contracted) $5,000,000 Completed. Council approved a contract with Burrtec. Service began April 1, 2016. Paid a $5M one-time fee plus will increase annual franchise payment to $5M from $2.2M. Sale of equipment nets City $12M.
Increase waste management franchise fee  $2,800,000 Completed. Will increase annual franchise payment to $5M from $2.2M.
Implement water/sewer utilities franchise fee  $1,050,000 Completed. New agreement adopted by City and Water Department.
Update master fees and charges schedule $200,000 Pending – 2016
Implement program for collecting street sweeping parking violations $200,000 Pending. Will be done in conjunction with move to private vendor – 2016
Implement compensation adjustments for all City employees $400,000 and growing (2% adjustment for non-safety employees) Completed. Agreements have been reached with all employee bargaining groups.
Provide resources to Charter Task Force and schedule election to consider revised Charter $150,000 (one time cost) Pending. A new draft charter is under development and has been reviewed at public meetings. Charter Committee to provide recommendations to Council in May and anticipate November 2016 election. Costs have been less than estimated
Organizational Improvements Ongoing Costs Implementation Schedule
Implement strategic planning initiatives $1,000,000 to $3,000,000 depending on timing and ability to fund Pending. Have completed Police Five Year Resources Plan which calls for additional investment of from $6.7M to $13.3M in annual funding over next five years starting in July 2016. Current model can only fund a portion of total needed
Rebuild corporate support functions $100,000 with a one-time cost of $500,000 Pending. Organizational reviews in process and have preliminary observations and recommendations for Finance, Human Resources and Information Technology

The third amended Disclosure Statement, Plan for the Adjustment of Debts and revised/new exhibits were filed with the bankruptcy court on May 27, 2016.

 

Movong toward Municipal Bankruptcy’s Endgame

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eBlog, 6/17/16

In this morning’s eBlog, we consider the final stages of the process for exiting the longest chapter 9 municipal bankruptcy in U.S. history in San Bernardino, California; and we briefly review action relating to Puerto Rico yesterday by the House Financial Services Committee.

The Last Full Measure? The City of San Bernardino yesterday began the last full measure down the road towards a confirmation hearing to exit the longest municipal bankruptcy in history by October: the first of what could be multiple hearings on whether to confirm the city’s proposed plan of debt adjustment, approval of which by the federal court is the prerequisite for the city. That hearing has been scheduled for October 14th; albeit that process is unlikely to be smooth, as could be seen in a hearing before U.S. Bankruptcy Judge Meredith Jury yesterday involving the final objecting creditor, the Big Independent Cities Excess Pool, or BICEP, which raised objections in the federal courtroom to San Bernardino’s disclosure statement—which, in addition to the all-important Plan of Debt Adjustment, are the prerequisites for Judge Jury’s confirmation. The Pool is a group of six mid-sized cities which provide liability claim pool coverage, including for an unspecified number of civil rights creditor claims against San Bernardino, claims that total more than $1 million. San Bernardino’s plan of debt adjustment filing with the federal court includes a section which the city told Judge Jury was word-for-word the position of BICEP—eliciting unhappiness from the Judge, who yesterday said: “This is extraordinary, and I had never seen anything like it…where an objecting creditor is given the full opportunity to say whatever they wanted. The opponent adopted their language verbatim. And yet they’re still crying.” In response, an attorney representing the pool responded there was a simple explanation for that: The city was not testifying the truth with regard to the language being verbatim: “We gave them language. They did not put it in…They have misled the court today to our detriment. That’s not the only place.” These are not soothing words to a federal bankruptcy judge. San Bernardino’s bankruptcy attorney told the court that most of BICEP’s statement was included in the city’s filing; however, he added: “It is true we changed some of the language where we thought either was not true or did not make sense, but then we sent it back to BICEP and said, ‘Here’s what we’re proposing to put in.’” Then he told Judge Jury: “We did not receive a response back, nor did BICEP raise in any objection (in their filing);” in response to which Judge Jury suggested San Bernardino file the disclosure statement with the original language from BICEP, add a section explaining their disagreement, and work together with BICEP to include a summary paragraph saying that there is a disagreement, noting: “What they (the people with the claims against the city) need to know is that there is a dispute about how this is going to work, and they can’t count on it, if they happen to be in that class of more than a million, other than the city will pay what it promises for the unsecured class,” adding she would decide whether to favor the city or BICEP on that point before confirming the city’s proposed plan of debt adjustment. In San Bernardino’s proposed plan of debt adjustment, unsecured claims would receive 1 cent for every dollar owed, under the city’s bankruptcy plan. The next step for San Bernardino will begin next month when it will mail ballots to creditors seeking their approval of the proposed plan. Creditors will have until Sept. 2 to return those ballots.

Protecting Puerto Rico. The House Financial Services Committee yesterday unanimously approved the U.S. Territories Investor Protection Act of 2016 (H.R. 5322), which would amend the Investment Company Act of 1940 to terminate an exemption for companies located in Puerto Rico, the Virgin Islands, and any other possession of the United States—that is, that key sponsor Rep. Nydia M. Velázquez (D-N.Y.) believes would close a legal loophole that allowed broker-dealers to defraud Puerto Rico investors and extend to the U.S. territory of Puerto Rico the same protections under the Investment Company Act of 1940 as those afforded to investors residing on the U.S. mainland. Rep. Velázquez contends that, under a loophole in the Investment Company Act of 1940, some broker-dealers underwrote Puerto Rico municipal bonds and then repackaged them into mutual funds and sold them to Puerto Rican investors without disclosing the risks in some cases—an arrangement permitted under Puerto Rico law due to an exemption in the 1940 act, but barred in the U.S. mainland. Rep. Velázquez told her colleagues the situation has been compounded by Puerto Rico’s debt crisis, noting: “Retirees and other vulnerable citizens are being fleeced because of this outdated exemption in federal investment law: this bill would ensure statutory parity by ending this practice,” noting further that when the exemption was codified in 1940, Puerto Rico and other U.S. territories were considered to be physically located too far away for the Investment Act protections to be enforced. Since then, however, Hawaii and Alaska—U.S. states farther away from the mainland than Puerto Rico, have been granted statehood and, ergo, been beneficiaries of the protections granted in the 1940 Act, leading Rep. Velasquez to note: “It is absurd to suggest that we are unable to have a robust financial regulatory presence in Puerto Rico for geographical reasons,” she said. “All this exemption does today is enrich large financial companies at the expense of vulnerable retirees and working families.”

The Challenge of Tax Subsidies in Municipal Fiscal Recovery

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eBlog, 6/16/16

In this morning’s eBlog, we consider the fiscal balancing challenges in Detroit as it emerges from the largest municipal bankruptcy in the nation’s history: how does it deal with the expiration of a key state tax break that has been successful in drawing higher income families and investment to its downtown? How does it balance equity in dealing with a state program that has been effective in revitalizing the city’s heart, but has provided benefits to those least in need—but not to those in greatest need?

Taxing Challenges to Detroit’s Future. At a time when Mayor Mike Duggan and the Detroit City Council have so far led a stirring physical and fiscal revival out of the largest municipal bankruptcy in American history—two issues challenge the ongoing recovery: 1) will the state bailout of the Detroit Public Schools inspire sufficient confidence in the city’s public schools (and charter schools) so that families not only do not leave, but also that there are incentives for other young families to move in, and, 2) how to deal with the expiring Neighborhood Enterprise Zone (NEZ) tax incentives program, which appears to have played a key role in drawing professionals to downtown and Midtown Detroit. Mike Wilkinson, writing for Bridge Magazine, noted that this state tax incentive, which appears to have been strikingly effective in filling high-rise downtown condos, is not permanent—raising two difficult questions: equity and the downtown’s future. The stakes are significant: yesterday, Realcomp Ltd reported that Metro Detroit experienced record median home sale prices in May: the number of sales reached a 10-year high, in the latest year-over-year figures; median home and condominium sales jumped 8 percent and sale prices increased 3.8 percent in Wayne, Oakland, Macomb, and Livingston counties. At the time Detroit filed for chapter 9 municipal bankruptcy, the city today was home to an estimated 40,000 abandoned lots and structures. Indeed, between 1978 and 2007, Detroit lost 67 percent of its business establishments and 80 percent of its manufacturing base.

Detroit, which had been hemorrhaging population for decades, but which has one of the broadest tax bases of any city in the U.S., has been using the NEZ program aggressively—and with impressive results: a renaissance of development and reinvestment downtown and other neighborhoods near the city’s core. Now, however, with hundreds of NEZ units set to expire this year and next, there is increased apprehension with regard to whether the lapse might reverse this tide of human and capital investment in the city core. That is: when condo tax bills that have been artificially reduced to as little as $500 annually revert to their assessed level of $12,000: what will happen? Mr. Wilkinson, writing about an interview he did with the author of a Michigan State graduate doctoral study on the issue, wrote said author told him: “If you start taxing them on what their (properties are) worth, they’re not going to stay,” leading him to wonder, however, if the city opts to further extend generous tax subsidies to new(er) Detroiters living in some of the city’s most expensive homes, “what message does that send to ordinary residents of more modest means, people taxed on the full value of their properties for decades? After all, the city’s high assessments, combined with the city’s high tax rate, are why so many longtime residents have been unable to pay their tax bills.”

Michigan’s NEZ program has been around for more than two decades. When it began, it targeted new construction and building rehabilitation. For new construction, the owner would receive up to 15 years of tax relief, paying half the statewide average millage rate. This year, that amounts to less than 17 mills, a startling 75 percent discount from the 69 mills that most Detroit homeowners without an abatement would pay.

The program is not unique to Detroit: more than 14,600 residential properties in 26 municipalities have been the beneficiaries of state-sanctioned NEZ tax subsidies since 1993, designed to encourage residential development in financially distressed communities; however, the vast bulk, close to 90 percent, have been issued in Detroit to incentivize new construction throughout the city and the rehabilitation of older buildings. Moreover, the City of Detroit and some other communities have also been innovative in finding ways to extend the program to existing homeowners, so that if a homeowner invests as little as $500 in improvements, she or he is eligible.

That raises taxing issues of equity, however: he notes that some 5,000-square-foot mansions in gated communities with personal boat docks along the Detroit River assessed at values in excess of $800,000 year pay less than $5,000 in taxes, even as less than a mile away Detroit homeowners with properties assessed at only $30,000 are paying more than $1,500 a year in taxes.

Gary Evanko, the Motor City’s chief assessor concurs that too many properties are assessed too low, even as many more are assessed too high, deeming the question about the future of the NEZ program as something which merits special attention. The challenge of expiring tax incentives is not unique to Detroit—as Mark Skidmore, an economics professor at Michigan State University put it: when a business which has been the beneficiary of tax subsidies watches the end nearing, it seeks to renegotiate, obtain an extension, or threaten to depart. So, as Mr. Wilkinson writes: “That same dynamic could play out with residential properties in struggling cities: The question is: what will the city of Detroit do? Will they…extend the abatements for fear of losing the people, or will it make them pay the full rate?”

In Detroit, as in every metropolitan area, the challenge of setting property tax rates is competitive: each jurisdiction watching its neighbors for bragging rights with regard to which has the lowest—even as there is recognition that families with children sometimes find the assessment of such a jurisdiction’s public schools a greater determinant in where the family would like to live. So it is in Detroit that, at 69 mills for owner-occupied homes and condos, the city’s tax rate can generate a bill of as much as $7,000 for homes worth $200,000—in contrast, in the Detroit suburb of Troy, a home assessed at the same $200,000 would mean a property tax bill of just over half: $3,700.

For owners of rehabilitated buildings, the NEZ program works differently: owners pay the full property tax rate; however the assessment is frozen at the share of the building’s value before renovations. So that, for instance, in downtown Motown at the Book Cadillac, which underwent extensive renovation and emerged as a mix of hotel rooms, condos and restaurants, that meant valuing refurbished condo units at their assessed value pre-chapter 9—meaning that today’s posh condo owners are the beneficiaries of assessments frozen for 15 years at $3,026, or roughly 1 percent of the $290,000 cost of purchase in 2008—or an annual property tax of less than $500—that is unless you are a lucky reader who happens to own one of Book Cadillac’s three-story penthouse units, then your assessment is frozen at $3,000—one of more than 3,000 municipal tax subsidies for rehabbed buildings and some nearly 3,900 for new construction. Because these tax breaks are time limited; however, and many of the NEZ tax subsidies offered to new and current homeowners are maturing, there are two issues: what will happen as these subsidies phase out: will higher income owners move out of the downtown? And, second, what is the equity in a city with such a disproportionate number of low-income families?