Structures for Restructuring Fiscal Futures

eBlog, 9/01/16

In this morning’s eBlog, we consider yesterday’s appointments by President Obama of the PROMESA oversight board—a step which, as in Washington, D.C. and New York City a generation ago—challenge traditional concepts of democracy, but offer a fiscal chance for the U.S. Territory’s fiscal future—albeit it in a far more complex way than in the two mainland cities. Then we turn, once again, to the grim fiscal, ethical, and legal challenges confronting the Detroit Public Schools—the public system critical to a city hoping to begin to regrow—and, ergo, so dependent on attracting young families with children back into the city.

Is There Promise in Promesa? President Obama yesterday, describing the White House/Congressional PROMESA financial control board to oversee the restructuring of Puerto Rico’s $70 billion debt burden, noted the panel came“[W]ith a broad range of skills and experiences: these officials have the breadth and depth of knowledge that is needed to tackle this complex challenge and put the future of the Puerto Rican people first.” The newly named panel is mandated to, in effect, will manage the U.S. territory’s finances for at least five years. House Speaker Paul Ryan (R-Wis.), who steered the bipartisan legislation through Congress, said: “Drawing from a wide variety of practical experiences and policy prowess, the members have what it takes to serve Puerto Rico and help get the territory on a path to fiscal health.”

As announced, the board is comprised of four Republicans and three Democrats, was drawn by the White House were made from a list provided by Congressional leaders of both parties. Under the new law, the board is expected to serve similarly to previous such boards in Washington, D.C. and New York City—with the PROMESA legislation shielding Puerto Rico from bondholder litigation: the Democrats on the panel are: Arthur Gonzalez, a senior fellow at New York University’s School of Law and former Chief Judge of the U.S. Bankruptcy Court for the Southern District of New York; Jose Ramon Gonzalez, president and chief executive officer of the Federal Home Loan Bank of New York; and Ana Matosantos, who served as California’s budget director from 2009 to 2013. The Republicans are: Carlos Garcia, former president of Puerto Rico’s Government Development Bank and founder and chief executive officer of BayBoston Managers LLC, a minority-owned private equity firm; Andrew Biggs, a resident scholar at the American Enterprise Institute; David Skeel, a University of Pennsylvania law professor; and Jose Carrion III, co-founder of Carrion, Laffitte & Casellas Inc. Kin addition to political balance, the board also appears to mitigate apprehensions from Puerto Rico with regard to its own citizens by the inclusion of four of the new appointees being Puerto Rican.

The federally appointed control board will oversee Puerto Rico’s budget and any debt reduction, which can now be enforced by a court, similar to a municipal bankruptcy. The board will designate a chair within 30 days of the panel’s formation, according to PROMESA. For the newly named board, the first challenge will be governance: how can the board coordinate with Puerto Rico Governor Garcia Padilla on a quasi-plan of debt adjustment or fiscal plan that will enable it to—as in a municipal bankruptcy negotiation with creditors—work out a plan of debt adjustment. However, the federal legislation does not specify how to prioritize Puerto Rico’s many classes of municipal bonds—bonds which are backed by various revenues and legal protections, but the new federal law requires that any fiscal plan “provide adequate funding for public pension systems.”

Gov. Padilla is expected to submit a blueprint as early as the second week of September, according to one Puerto Rican official. The challenge—as in Detroit, San Bernardino, Stockton, etc.—will be double: what will the new board’s relationship be with the island’s elected leaders, and how will the board balance the financing of essential public services and public pension obligations versus obligations to creditors—especially given the ravaging explosion of Zika cases. Moreover, the amounts at stake are significant: the U.S. territory has been defaulting on a growing share of its debt: in July, Puerto Rico missed nearly $1 billion of principal and interest, the first time a state-level borrower skipped payments on its direct debt since the 1930’s. Puerto Rico and its agencies owe municipal bondholders in all fifty states $70 billion; Puerto Rico’s three retirement systems have an unfunded liability of about $43 billion. If that were not enough of a challenge, the courts will be involved in a separate lane: hedge funds holding Puerto Rico full faith and credit debt filed suit last July against the government, claiming Gov. Garcia Padilla is re-directing cash in violation of Puerto Rico’s constitution.

Unsurprisingly, David Bernier, the gubernatorial nominee for Puerto Rico’s Popular Democratic Party, was less enthusiastic about yesterday’s announcement: “We oppose the board, because we understand that it lacerates our own government and is anti-democratic…Given the reality of PROMESA, we will defend the interests of our people always before the board or any forum necessary so that what prevails is the welfare of Puerto Rican families.”

New Math? Detroit Inspector General Bernadette Kakooza yesterday issued a report detailing a new wave of alleged theft and fraud cases in the Detroit Public Schools Community District—a district already at the center of a federal probe of a kickback scandal involving more than a dozen employees and a vendor. The new report, coming as schools ready to open in what will be a quasi-divided city between charter and Detroit Public Schools, outlines an unreported payroll error that overpaid an employee more than $50,000, fraudulent teaching credentials, and missing equipment and money. Inspector General Kakooza notes that a June 2014 tip over fraudulent procurement practices ultimately led to a federal kickback scandal investigation in which 12 former DPS employees were convicted, along with district vendor Norman Shy.

The report comes in the wake of retired U.S. Bankruptcy Judge Steven Rhodes, DPS’s Emergency Manager, reinstatement last of the Office of Inspector General—reinstated to include two primary functions: investigations and internal audits—or, as Judge Rhodes described it: “The Office of the Inspector General (OIG) is a critical element for the new District and our commitment to zero tolerance for wrongdoing and misconduct by any individual or organization affiliated with this District…The OIG will serve an active role as the District’s watchdog to protect our resources, employees, children and families.” The office had originally been established in March 2009, but eliminated at the end of June 2015 by then-Emergency Manager Darnell Earley—the Gubernatorially-appointed Emergency Manager who served to the human health and fiscal detriment of Flint, before being transferred by Gov. Rick Snyder to the Detroit Public Schools—where he presided over DPS’ near municipal bankruptcy—before being ousted.

Among the investigative highlights: The removal of a district principal following claims in 2014 that the administrator had approved the operation of a food store in a district building that violated DPS’ fundraising guidelines and cash management policies. There was no evidence provided for accountability of sales proceeds; nor was there any evidence the proceeds were used to benefit the students, as required; an investigation last year revealed a district employee had claimed and received about $14,000 in unemployment compensation while partially on an approved Family and Medical Leave of absence. The employee also received $49,000 in earnings from the district during the same period.

Former DPS school supply vendor Norman Shy and 12 DPS officials are to be sentenced next month after taking plea deals in connection with the FBI investigation into public corruption at the district this spring. Federal prosecutors allege the scheme, which started in 2002 and ran through January 2015, was hatched by Shy, 74, of Franklin, who billed DPS for $5 million in school supplies but delivered less than what was promised. Mr. Shy, in return for the business, allegedly paid bribes and gave kickbacks to 12 former DPS principals and one assistant superintendent in the form of cash and gift cards totaling $908,518. The report comes in the wake of a two-year investigation of DPS in the wake of a tip from state auditors.  

The deep fiscal and trust chasm created and fostered by Mr. Earley has signal implications for Detroit’s kids’ future. It makes the task for Judge Rhodes all the more critical.

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