What Is the State Role in Municipal Fiscal Distress?

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eBlog, 8/18/16

 In this morning’s eBlog, we consider the risk of, for the first time in American history, a city reverting back into municipal bankruptcy. Here the fall could come from any combination of governance failures—as well as deeply falling returns on public pension investments. Then we look at an almost comparable inability of governance in Atlantic City—a failure here which risks the city’s own autonomy. Finally, we revisit the historic city of Petersburg, Virginia, a small city in significant fiscal distress—but which appears most unlikely to receive any state aid—meaning it could become the first municipality in the Commonwealth’s history to be forced to seek municipal bankruptcy protection.

The Risk of Re-entry into Municipal Bankruptcy. In an open letter to the citizens and taxpayers of Stockton, the City, on February 25th, last year, wrote: “Over time, the City was facing over $2 billion in labor agreements, long-term debt, and other obligations that would not have been possible to address outside of [municipal] bankruptcy. However, unlike personal bankruptcy, municipal bankruptcy does not erase or ‘wipe out’ debt. Finding solutions required hard work and heavy lifting by everyone involved. Focused by our guiding principles, we have achieved significant, sustainable change. Our employees worked with us to accomplish equitable labor agreements that brought pay and benefits more in line with the average of the labor market. City retirees, represented by a Retirees Committee, recognized that lifetime City-paid healthcare benefits were not sustainable and agreed to a settlement which helped to address the biggest obligation facing the City’s General Fund—a $544 million unfunded liability for retiree medical.” But now, in the midst of a heated election—one which is almost certain to be interrupted and affected by the pending trial of the incumbent mayor who presided during the city’s entry into and exit from chapter 9 municipal bankruptcy—the California Public Employees’ Retirement System (CalPERS) has reported that its rate of return for the year ended June 30 was just 0.61%. What’s more, Ted Eliopoulos, the pension fund’s chief investment officer, said the poor year has pushed CalPERS’ long-term returns below expected levels.

In approving Stockton’s exit from bankruptcy, U.S. Bankruptcy Judge Christopher Klein had opined that public pension obligations can be impaired in California, even though Stockton had not, in its proposed plan of debt adjustment, proposed to impair pensions; nonetheless, Judge Klein made clear that public pensions could be restructured should there be a next time around. In his analysis, Judge Klein said under chapter 9 federal bankruptcy law Stockton could reject its contract with CalPERS, and, he added, the $1.6 billion termination fee that CalPERS said it would charge to break the contract would be voidable in bankruptcy. Now, however, the issue of pensions could be re-opened in the wake of CalPERS’ projections that its pension management system, which had projected a 7.5% return on its investments, investments it uses to defray the cost of public employee pensions to cities such as Stockton, instead gained a return of only 0.61%—an outcome which could force CalPERS to increase its charges to Stockton—an increase for which the current city budget appears ill-equipped to meet—a budget, after all, which is based upon a 7.25% investment return from CalPERS. That is, such a reduction could put Stockton back into chapter 9—making it the first municipality ever to go into chapter 9 a second time. Indeed, the harsh fiscal discipline of the city’s plan of debt adjustment appears to be slipping: the Council gave police an 11% raise; it voted to re-open the Fair Oaks library branch, overruling objections from city staff—a vote which, for the first time, breached the city’s plan of debt adjustment.

Risking Autonomy. The Atlantic City Council this week, in a 4-4-1 vote, failed to adopt an ordinance to dissolve the Municipal Utilities Authority, a failure which puts the city at risk of defaulting on a state loan. (The terms of the $73 million state loan made the Authority collateral and required the city to adopt an ordinance dissolving it by September 15th.) Under the Council’s rules, it may not reconsider a failed ordinance for six months—meaning the city is in breach of the state’s loan terms. Failure to meet the deadline would make loan repayment due immediately and could require the city “to deliver each item of collateral” to the Department of Community Affairs, according to the loan terms. City Council President Marty Small blasted those who voted against the ordinance, saying they just “gift-wrapped the city to the state….So when the city shuts down and people lose their jobs and we owe the state $73 million because we defaulted on a loan, they can look the people in the eye who voted against it and they can thank them.” Council President Frank Gilliam described a lack of transparency leading up to the vote. A statement from Mayor Don Guardian this month said the ordinance’s first reading was needed by Sept. 15, not yesterday; he pointed to the July 28 emergency council meeting, which was announced just earlier that day and only had four members approving the loan terms, adding: “When decisions like these are basically put on the table, I think it’s very important for the public to have an opportunity to chime in.”

SOS! Virginia Delegate Riley Ingram reports he is seeking an appropriation to help Petersburg, a small city of just over 30,000, get through its current financial crisis, after residents of the city spoke with him about the possibility of getting state money for Petersburg, which is facing a cash crunch that state auditors say could hit as early as this month. Del. Ingram made clear he would not support any bailout of the city, which he said would set a bad precedent, adding: “In my opinion it would be a big mistake for the state to get involved: You’ve got to live within your budget and live within your means.” Earlier this month, at a meeting between state auditors and Petersburg city officials, an audit group sent in by the state to review the city’s books, the group informed city leaders that they owe $18.8 million in unpaid bills, making clear the municipality was in a worse financial crisis than they initially thought—by at least $1 million, with debt which includes $14.7 million to external entities, such as contractors and $4.1 million for internal loans, with the auditors making clear the “historic overspending” started in 2012. The growing debt has now reached a point where the city payroll is at risk—a risk made clear last month when the Petersburg City Council agreed to a 10 percent pay cut for its full-time employees, as a method to help balance the budget deficit—a reduction intended to last just six months and projected to save the city about $1.5 million dollars over the six-month period. The deficit was thought to be $17 million at the time of the cuts. Virginia House Majority Leader Kirk Cox (R-66th), a member of the Appropriations Committee, said getting the General Assembly to appropriate funds to help the city shore up its finances “would be a very, very heavy lift” in the legislature, in part because “it would be a very dangerous precedent to set;” moreover, the Majority Leader added that no action could be taken before next year’s General Assembly meets next January—and even then, any such funds would not be available until the start of the next fiscal year on July 1, 2017. State Secretary of Finance Richard D. Brown, who presented the team’s findings, said a high priority for the city is to get control over its finances as quickly as possible so as to be able to assure potential lenders that Petersburg is a safe lending risk. Virginia does not specifically authorize its municipalities to file for chapter 9 municipal bankruptcy; the state does, in certain situations, allow for the appointment of a receiver with respect to municipal revenue bonds.

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