Have We Learned Any Lessons from Flint?

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eBlog, 8/11/16

In this morning’s eBlog, we consider the fiscally bleak Detroit public school system—a system critical to the Motor City’s fiscal and human future—but where the state intervention appears to be unravelling; we then consider the related governance challenge with regard to municipalities and school systems at fiscal risk—specifically, in the wake of the state-imposed emergency manager in Flint, Michigan (a manager who was then, for still inexplicable reasons named by Michigan’s Governor to be the emergency manager for Detroit’s public school system)—an imposition that led to severe threats not just to the city’s own authority and fiscal future—but also to grave threats to human lives. We ask: is the state’s emergency manager law a state law which ought to be reconsidered? What lessons have been learned from Flint? Then we return to Puerto Rico with a brief look at this a.m.’s marvelous blog from the New York Federal Reserve—albeit, the report is hardly optimistic about the human capital so critical to Puerto Rico’s long-term economy.

Getting School on Debt. Michigan’s plan to bail out Detroit Public Schools (DPS) is putting debt backed by state aid at risk of falling into default if the bonds are not refinanced by mid-October, with S&P Global Ratings having, in the wake of two downgrades since June, reduced DPS’s debt to below a passing grade. In response, a DPS spokeswoman reports: “Detroit Public Schools and the Michigan Department of Treasury are in the process of refinancing the bonds with a goal to have this completed prior to Oct. 1, 2016.” The state restructuring of DPS’ finances diverts state payments on about $370 million of bonds sold in 2011 and 2012 to the new, debt-free Detroit school district—a district which bears no responsibility for the old debt; however, according to S&P, Michigan still lacks a plan to refinance the bonds. Absent such a plan, S&P warns, it would likely consider the DPS debt a distressed exchange that would merit being labeled as a default. The emerging, failing grade comes in the wake of the state legislature’s partisan decision to adopt a $617 million rescue plan under which, as we have previously noted, the Detroit district was split in two: a new, debt-free Detroit Public Schools Community District is set to open next month with about 46,000 students in 97 schools, while the debt of the former DPS is to be paid off with a combination of state aid and collections from the district’s 18-mill non-homestead levy, which is collected on businesses and second homes.

The new statute means the existing public school district is responsible to continue to pay off the district’s old debt, including about $2.2 billion of municipal bonds and pension liabilities from property taxes—with the state providing approximately $467 million to help repay the old debt: the Michigan Finance Authority, which issued the debt cut by S&P for DPS, is putting together a plan to refinance the debt by October 20th. However, since Michigan Governor Rick Snyder signed the bill, S&P has downgraded the bonds—which Moody’s has moodily graded Caa1 with a negative outlook. S&P notes its assessment is based “on the lack of a formal plan regarding bondholder repayment terms” and the elimination of one of the pledged revenue streams in the fiscal year that begins next October. The restructuring needs to be in place before October 20th when state aid moves to the new district, leaving the bonds rated with S&P with just the property-tax pledge—changes which S&P notes have created uncertainty for bondholders, raising the risk of default, with analyst Jane Ridley noting: “If they don’t get it refinanced, the loss of the revenue stream is going to seriously erode bondholder value,” adding last week that separating the state-aid payments from the bonds creates a more than 50 percent chance the debt could be cut again in the next two months, warning that it could use its D, or default category, if repayment is less than originally promised: “As October approaches and ushers in the new fiscal year, it creates greater uncertainty as to whether bondholders will receive full and timely payment…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.” Note, as we have previously written, the partisan vote in the legislature to create two school districts in the city—one a public school district, the other charter schools—had already raised apprehensions about a recipe for failure. The new fiscal warning from S&P hardly heralds academic or fiscal high grades. The harder academic question is whether the bleak fiscal warnings could serve to deter young families with children from wanting to move to Detroit.

Not in Like Flint. Detroit’s fiscally devastated public schools and Flint’s life-threatening drinking water crisis were connected by two critical factors: the state’s Emergency Manager law—here specifically by one such manager who, after desperately failing in Flint, somehow was inexplicably appointed by Gov. Snyder to be the DPS emergency manager—and deep state cuts in revenue sharing. Coming out of the Great Recession, which disproportionately hammered assessed property values—values still deeply distressed in many Michigan municipalities—state tax limitations and reduced revenue sharing have left a legacy of municipal bankruptcy and fiscal instability at the local level. Reductions in aid to Michigan municipalities (cities, villages, and townships) totaled $5.5 billion between 1998 and 2016, according to a May report from Great Lakes Economic Consultants. It means that despite a nationwide recovery, Michigan municipalities are still struggling with depressed assessed housing values, tax limitations, and cuts in state revenue-sharing. It means the state still has the authority to preempt local democracy through the imposition of an Emergency Manager—an imposition which, unlike in Detroit, in the cases of Flint and the Detroit Public Schools have caused fiscal and severe physical harm.

The state actions have also left a residue of governmental distrust: indeed, despite deep cuts in spending, Wayne voters last week rejected a tax proposal to support police and fire protection. (Wayne is a small city of under 18,000 in Wayne County west of Detroit.) Wayne’s Mayor, Susan Rowe, after watching the extraordinary damage to human health and safety as well as fiscal distress caused by Flint’s state-appointed Emergency Manager vowed she would never put her residents at the mercy of the state. However, in the wake of last February’s Moody’s downgrade, Mayor Rowe not unreasonably fears her city will become the first municipality since Flint to be placed in state emergency financial management. She notes: “I think it will happen, and I think it would be devastating…People tell us to live within our means, but we can’t shut the doors. We can’t say we’re not going to have police or fire or trash collection…We just have no way of bringing in any more money.” For Mayor Rowe, a retiree whose munificent mayoral salary is $3,000 annually, the squeeze is almost unimaginable: assessed housing values cratered during the recession and revenue has plunged more than 40 percent since 2010. The city lost a property-tax appeal with Ford Motor Co., its largest employer. State limitations prevent local property taxes from increasing at a rate higher than annual inflation. If anything, the tipping point came last week when the city’s voters resoundingly rejected a tax increase that would have enabled the city to share public-safety expenses with two other municipalities. Mayor Rowe said people are frustrated, and she does not hold the vote against them.

Have There Been Lessons Learned from Flint? The terrible harm to human life and fiscal stability in Flint caused by the former state appointed emergency manager has increased political pressure to repeal the state’s law—one of the most preemptive of municipal authority in the nation, under which the state is authorized to intervene in fiscally struggling municipalities and school districts, and preempt all municipal or county authority, as well as to break union contracts if negotiations fail—or, as Michigan Municipal League COO Tony Minghine describes it: “They go in, they come out, and the cities become a less desirable place to live: The only tool they’re given is to cut.” (When first enacted in 1990, the state’s emergency manager law was designed as an early warning system to ward off defaults and bankruptcies. Under Gov. Rick Snyder, who was first elected in 2010, the pace of state intervention increased as the recession eroded local tax revenue, especially from property taxes. Unsurprisingly, voters repealed the measure in 2012 after forcing a statewide ballot question. Less than two months later, however, the legislature approved a similar law with a provision that preempted state democracy by barring it from being overturned by a referendum.)

Indeed, the experience under the state law, to date, is less than inspiring: most of the dozen Michigan towns and cities which have been under the direction of an emergency manager continue to lose population; their poverty rates remain between 20 percent and nearly 50 percent, according to U.S. Census data. In Flint, garbage collection stopped at the beginning of this month after a contract dispute. Or, as former State Treasurer Robert Kleine puts it: “The law’s pretty much a Band-Aid, because it never really addresses the fundamental issue; it’s mostly a lack of tax base.” My colleague and mentor in the field of municipal bankruptcy Jim Spiotto notes Michigan might be better served changing its law to allow local officials input into decision-making and reducing the “heavy hand” of an emergency manager: “Local government is representative of the people, and you don’t want to lose sight of that.”

What state voters also do not appear losing sight of is the exceptional damage the state oversight has wrought in Flint: Six state employees were criminally charged last month, accused of trying to cover up the poisoning of Flint’s drinking water. Three other government workers were charged earlier. Gov. Snyder publicly apologized last March for the contamination, but claimed the law has been a success. He said he would be open to improving the law, but not repealing it; state Sen. Jim Ananich (D-Flint) has a different perspective: “It’s a failure-driven model…They leave you with a city that’s impossible to run.” Indeed, as Eric Scorsone, who directs the Center for Local Government Finance and Policy at Michigan State University, puts it, there is no clear path forward, short of increasing state revenue-sharing and other assistance.

What to Do about a Declining Economy? Moody’s warns that the surge in Zika cases in Puerto Rico may harm the U.S. territory’s already declining economy—one already projected to decline by 2 percent in FY2017, with the warning coming as the crack New York Federal Reserve squad of Rajashri Chakrabarti, Giacomo De Giorgi, and Rachel Schuh, writing for the Fed’s Blog Liberty Street Economics, this morning noted, with regard to human capital, that: “The test results for both PISA and NAEP are alarming, and even more so given the migration trajectories out of Puerto Rico. The very slow growth of Puerto Rico seemed puzzling given previous estimates of the quantity of human capital—as proxied by the number of years of schooling—and its contribution to growth. However, this slow economic growth is in fact consistent with the evidence on the quality of human capital highlighted in this blog. As a caveat, the test scores cited here reflect the human capital of students who have not yet entered the labor force, so this analysis relies on the assumption that these poor educational outcomes persist. It seems clear, nonetheless, that boosting educational performance can help Puerto Rico substantially in establishing future economic growth.”

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