How Do State-Local Relationships Affect Fiscal Futures?

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eBlog, 8/05/16

In this morning’s eBlog, we consider the uncertain fiscal future of Detroit’s public schools (DPS), a future vital to Detroit’s ongoing recovery from the nation’s largest ever municipal bankruptcy; and we look at a long-term legal challenge in the state with regard to state authority to impose emergency managers to displace city and county elected leaders. Finally, we consider the harsh fiscal terms imposed by Gov. Chris Christie on the nearly insolvent Atlantic City and wonder how it is that a state which once had such a strong reputation for addressing fiscal disparities appears now to have turned its back.

D-? Standard and Poor’s yesterday downgraded two sets of Detroit Public Schools’ $212 million of Michigan state aid-backed municipal bonds: S&P cited uncertainty with regard to the bonds’ security after a restructuring of the school district. S&P also expressed doubt about a new arrangement that splits the school district in two. The situation, unsurprisingly, is complicated by the new state law under which the state approved, on a partisan vote, a $600 million package to stave off a potential DPS municipal bankruptcy filing as the district grappled with insolvency. That new state statute, which went into effect on Friday, divided the Detroit Public Schools into “old” and “new” districts: the old one exists solely to pay off debt with tax revenues, while the new one receives state aid payments to educate students. That odd arrangement has raised doubts at S&P, which, ergo, announced that it would downgrade bonds DPS issued in 2011 and 2012, noting it is no longer confident DPS’ bondholders will be fully repaid, because the bonds are no longer backed by state aid payments, which go to the new district—and which, as it happens, are the same municipal bonds the newly state-created school district is looking to refinance for that very reason: DPS transition manager, retired U.S. Bankruptcy Judge Steven Rhodes, had requested the DPS school board to approve up to $235 million in loans to help with that refinancing—a request the school board rejected over concerns about a possible spike in interest rates on the loan. Judge Rhodes is now expected to take his request to the state emergency loan board. Even though the bonds are still investment-grade at this point, S&P hinted that further downgrades are likely, writing: “The CreditWatch on the bonds reflects our view that the complexity of the situation, the looming requirement to redeem, defease, or refund the bonds, and the numerous parties involved—including the split district and Michigan—result in a more than 50% chance we will lower the rating over the next three months, and could take more than one rating action during that time if warranted.” [DPS was formally divided into two separate entities: the new Detroit Public Schools Community District operates schools and will receive the future state aid payments that had secured the 2011 and 2012 bonds—municipal bonds which also carry a limited tax general obligation backing.] S&P lowered the 2011 first lien bonds three notches to BB from BBB and the 2012 second lien bonds to BB-minus from BBB-minus. The action yesterday followed another recent three-notch downgrade after S&P raised concerns over the status of the bonds after the new district formally opened its doors July 1, or, as S&P analyst Jane Ridley wrote: “The downgrade is based on the lack of a formal plan regarding bondholder repayment terms following the recent restructuring of the district, and the resultant elimination of a pledged revenue stream at the end of the state’s fiscal year…Although the intent is to take out the existing debt at full value, in our view, as October approaches and ushers in the new fiscal year, it creates greater uncertainty as to whether bondholders will receive full and timely payment on their bonds.” S&P reports the ratings will remain on CreditWatch with negative implications reflecting the possibility that further hits could result if a redemption, refunding, or defeasance is not undertaken in a timely manner, or, as Ms. Ridley put it: “If the actions taken through this process provide bondholders with anything less than the full promise of the original bonds, it is likely to be considered a distressed exchange and therefore a default under our criteria.” The situation, already complicated with the state’s partisan action to create two school districts in Detroit, is designed so that state aid can only flow to school districts with students, so the only remaining fundable pledge backing the bonds when the state starts its next fiscal year will be DPS’ limited tax full faith and credit pledge, which is not rated by S&P—or, as Ms. Ridley added: “Because state aid will no longer support the bonds effective Oct. 1, 2016, in our view the situation must be resolved by then or bondholders will lose a critical revenue stream, which would result in a significant reduction in value.” Our colleagues at Municipal Market Analytics demonstrated their own scholarly perspective last month, noting: “The complexity surrounding the split and the allocation of debt and revenue sources raises concerns regarding the execution of the plan to repay bondholders in the short-term,” adding: “This debt would likely be considered unsecured in the context of a Chapter 9 bankruptcy.” DPS’existing, non-state aid backed-debt is repaid with an 18 mill levy that expires in 2022 and would require voters to reauthorize it. The state has estimated that repaying the district’s existing debts would take 10 years. The three-member Local Emergency Financial Assistance Loan Board last month approved a $150 million loan to help fund the new DPS address its start-up costs and authorized $235 million in school financing stability bonding to restructure the state-aid backed bonds.

What Grade for this Governance? On a related DPS issue, Michigan Court of Claims Chief Judge Michael Talbot is being asked whether Gov. Rick Snyder can be sued over the new law with regard to the provisions which allow uncertified teachers to be hired in Detroit Public Schools. The query arose in his courtroom along with several related issues in a suit filed in early July against Gov. Snyder which seeks to block the law that restructures the district. The suit raises two claims: that it is unconstitutional to allow uncertified persons to teach DPS children and that the law itself is invalid because it violates state law. The suit was filed by former members of the Detroit Board of Education and activists. Judge Talbot indicated the latter claim likely belongs before the Michigan Court of Appeals and said he would issue an opinion today. Thomas Bleakley, the attorney representing the plaintiffs, said Michigan state law bars the legislature from passing a law that is specific to any locality without a two-thirds vote of both the state House and Senate and the majority of voters in the district. (The DPS bills passed with razor-thin margins and no support from Detroit lawmakers.) With regard to the issue of uncertified teachers, Judge Talbot noted he was uncertain Gov. Snyder would be the proper person to sue, asking: “Have you sued the right party? What would I enjoin the governor from doing at this point?” Judge Talbot also noted he is uncertain the plaintiffs have a case until someone actually makes the decision to hire uncertified teachers. That person, he said, likely would be the proper person to sue. The plaintiffs have argued that by allowing uncertified teachers, the legislation treats Detroit students differently than students in other districts in the state, which violates the equal protection clauses of both the U.S. and Michigan constitutions.

SOS. The long simmering state-local conflict in Michigan over the state’s emergency manager law—the law which permits the Governor to appoint an individual to preempt all local governance authority—is now before a federal appeals court. The new challenge comes in the wake, two years ago, of most such claims, but permitted to go forward on the issue with regard to whether the law violates the U.S. Constitution by having a disproportionate impact on communities with large black populations. U.S. District Judge George Steeh had refused to put a stay on a court challenge to the emergency manager law, but dismissed most of the case except for a claim that it is disproportionately applied to governing African-Americans, echoing then U.S. Bankruptcy Judge Steven Rhodes’ prior statement that the lawsuit against Public Act 436 of 2012 would not necessarily invalidate Detroit’s bankruptcy or debt shedding plans, and calling that assertion from state officials “speculative at best.” He also dismissed eight claims in a 2013 lawsuit brought by various local elected officials and members of the governing boards of religious and civil rights groups, challenging the 2012 law; however, he allowed a ninth claim, alleging racial discrimination because the state has placed 52 percent of the state’s African-American population under EM appointments in various communities, but less than 2 percent of its white residents, ruling the case can go forward after Judge Steeh found the plaintiffs had stated a plausible claim: “(S)ix out of seven communities…with a majority population of racial and ethnic minorities received EMs when they had (fiscal stress indicator) scores of 7. At the same time, none of the 12 communities…with a majority white population received an EM despite having scores of 7 or higher…(State officials) argue that these statistics (from fiscal year 2009) are old and of no application to PA 436, but the history of state intervention makes it reasonable to assume that similar statistics are available in discovery to support plaintiffs’ claims regarding the pattern of decision-making.”

In Michigan, emergency managers have exceptional power to run local governments and school districts, while elected officials typically are displaced. In his ruling, Judge George Steeh echoed U.S. Bankruptcy Judge Steven Rhodes’ prior statement that the lawsuit against Public Act 436 of 2012 would not necessarily invalidate Detroit’s bankruptcy or debt shedding plans, and called that assertion from state officials “speculative at best.” He added that the lawsuit claims are not directly related to Detroit; he also dismissed eight claims in a 2013 lawsuit brought by various local elected officials and members of the governing boards of religious and civil rights groups, challenging the 2012 law; however, he ruled that a ninth claim, alleging racial discrimination because the state has placed 52 percent of the state’s African-American population under EM appointments in various communities, but less than 2 percent of its white residents, can go forward. The state has made emergency manager appointments in Detroit, Flint, Hamtramck, and Lincoln Park, and is in post-emergency management transition advisory board governance for Benton Harbor, Allen Park, Ecorse and Pontiac.

Lifeboat Needed. As we noted yesterday, the exceptionally harsh terms of the agreement imposed upon Atlantic City by Gov. Chris Christie appear to signal a significant change in the Garden State’s relationship with local governments. Professor Henry Coleman of the Edward J. Bloustein School of Planning and Public Policy in New Jersey seven years ago wrote that “(in the absence of court-ordered school funding assistance from the state), one can question how much of a state funding priority local jurisdictions have been over recent decades. New Jersey localities may well be firmly entrenched in what John Shannon has called the era of fend-for-yourself federalism.” But now it would appear something more fundamental might be underway, or as a colleague noted yesterday: “this is interesting, because it may signal a sea change in NJ local oversight…[Gov.] Christie really wants to control Atlantic City, which is a huge source of cash for the state budget. In return for the emergency loan, the state has basically put a lien on everything important that can be sold to raise cash. Newark also has a vast and scandal plagued water authority. East Orange’s water utility owns a swathe of another town adjacent to a private water company serving other parts of the area… Lots of assets to collateralize or offset state aid…”  That is, for a state which long had a reputation for addressing disparate fiscal crises and in which no city has filed for chapter 9 municipal bankruptcy, these latest actions appear to undercut Atlantic City’s fiscal future. The virtually insolvent municipality owes the Atlantic County Utilities Authority nearly a half-million dollars, and has not, according to the Press of Atlantic City paid anything since June; Atlantic City has an outstanding balance of $469,433 for services dating to January 2015, according to letters sent to city officials from ACUA Chief Financial Officer Linda Bazemore: most of the bill is for tipping fees, which are based on the waste received by the authority. (To which Mayor Guardian notes: “They’re going to get paid…We owe it to them.”) The epistles, however, demonstrate repeated efforts by the ACUA to recoup its money. In May, CFO Bazemore told city officials “It is imperative that a payment is received in the very near future.” The balance then was $418,529. The city made three payments in June totaling $200,720, but paid nothing in July, according to the letters. The skipped July payment increased the balance, according to Ms. Bazemore, who this week wrote: “Since our communications began, we have not recognized a decline in the balance due…The authority would like to again request that at a minimum, the authority receive monthly payments for billing associated with two months of services performed.”

The letters were sent even as Atlantic City waited for a state loan promised in a rescue package passed in May—a wait so prolonged it has been forced to raid its capital and terminal-leave funds to pay bills and expenses—a wait until the state-imposed agreement for a still unreceived $73 million loan. Mayor Don Guardian yesterday, referring to the utility debt, noted: “We’re going to try to pay them…We’re asking the state for the funding through the loan. We’re going to be paying a whole lot of people this month.” The city also owes the ACUA money for recycling services from January and February 2015, according to the letters. All this comes in the wake of ACUA’s halt in picking up recycling in Atlantic City a year ago last March after the City Council declined to extend the contract due to a 2 percent cost increase.

Now, under the harsh terms of this week’s loan agreement imposed by the state, an agreement which mandates that if redirected casino funds or state aid are insufficient to pay back the loan, the state can collect money from a Bader Field sale, take the assets of a dissolved Municipal Utilities Authority, seize state aid or casino payments in lieu of property taxes, or withhold state payments due to the city. Moreover, under the harsh terms of the state-imposed agreement, the loan must be paid in full when the state decides whether to approve the city’s five-year fiscal plan to avoid a state takeover: a repayment due on November 3rd, or sooner in an “event of default,” which is defined as a failure to meet loan obligations, a bankruptcy or insolvency proceeding by or against the city, or a prohibited use of loan money. The city can prepay the loan in part or full at any time.

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One thought on “How Do State-Local Relationships Affect Fiscal Futures?

  1. Pingback: What Is the State Role in Municipal Fiscal Distress? | The GMU Municipal Sustainability Project

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