Municipal Governance in the Wake of Bankruptcy

eBlog, 9/08/16

In this morning’s eBlog, we consider the ongoing challenge in Detroit and Wayne County related to tax foreclosures. Then we turn to the looming election in San Bernardino to determine the city’s post-municipal bankruptcy governance. Then we head east to the small municipality of Petersburg, Virginia, which has been left on its own with hard choices in its efforts to stave off municipal insolvency and bankruptcy.  Finally, we turn to the awkward transition in governance in Puerto Rico under the recently enacted PROMESA, quasi-chapter 9 legislation signed last month by President Obama to steer the U.S. territory of Puerto Rico out of insolvency.

The Imbalance of Taxes & Affordability. Wayne County and Detroit officials have reduced the number of tax foreclosures by half as they began yesterday’s annual auction—one in which they put a record 23,000 occupied properties on repayment plans; nevertheless, after decades of population decline (In 1950, there were 1,849,568 people in Detroit. In 2010, there were 713,777), the city still confronts a significant backlog. At the inception of its chapter 9 bankruptcy, Detroit was home to an estimated 40,000 abandoned lots and structures: between 1978 and 2007, Detroit lost 67 percent of its business establishments and 80 percent of its manufacturing base. It was, as my esteemed colleague and fine writer Billy Hamilton noted “either the ghost of a lost time and place in America, or a resource of enormous potential.” Ironically, as we have noted, Detroit has one of the broadest tax bases of any city in the U.S.: municipal income taxes constitute the city’s largest single source, contributing about 21 percent of total revenue in 2012, or $323.5 million in 2002, the last year in which the city realized a general fund surplus. Thereafter, receipts declined each year through 2010, reflecting both a rate reduction mandated by the state and the Great Recession. The declining revenues also reflect not just the significant population decline, but also the make-up of the decline: the census reported that one-third of the city’s residents were under the poverty line and that the composition of businesses—unlike any other major city in the nation—was primarily made up of public organizations. The reduction also reflects state mandates. Worse, we had noted, state law prohibits cities from increasing revenues by adding a sales tax or raising residential property tax rates more than inflation. But even in the wake of its emergence from the largest municipal bankruptcy in U.S. history, the Detroit News notes tax debt on some 6,000 homes “may have just delayed a crisis.” The News notes that owners of these occupied properties owe tax debt that is a quarter or more of what the houses are worth, according to the analysis that compared county payment plan data and city assessments as of last month. The problem comes amid growing recognition that the level of debt is unsustainable—likely meaning many owners will default (The average debt for homeowners on payment plans is nearly $6,000.) Or, as the ACLU’s legal director Michael Steinberg put it: the city is “simply kicking the can down the road.” (The ACLU filed suit this summer to halt homeowner foreclosures until city assessments can be corrected, arguing the city’s residents have been hit with unfair tax bills for years because of inflated city assessments—assessments which, the organization asserts, have further fueled Detroit’s foreclosure crisis. (The Wayne County Treasurer has processed more than 140,000 foreclosures countywide since 2002.) Moreover, even though the legislature acted last year to impose a cap on high property tax assessments at no more than a quarter of a home’s value, the News reports Wayne County “has barely used the option even though officials, including Mayor Mike Duggan and Gov. Rick Snyder, touted it last year when it was signed into law.” While Wayne County has modified its enforcement actions by reducing the interest rates it is imposing on such delinquent debt from 18 percent to 6 percent using another new law change designed to help homeowners; the County is understandably apprehensive that too much tax relief could reduce revenues for other vital public services, such as schools, city government and libraries.

This year only 14,300 properties will be offered up at the tax auction, compared with 28,000 the previous year. Wayne County Treasurer Eric Sabree said 85 percent of the 31,000 occupied and vacant properties on payment plans are making payments; nevertheless, he is uncertain whether such onerous debt for some families could presage greater numbers being forced into foreclosure next year. It is one of the hardest balancing tasks of governing. Indeed, Margaret Dewar, a University of Michigan professor of urban and regional planning, warns that debt could be too much for many—especially some 6,000 owners who owe at least a quarter of what their houses are worth: “I don’t think a lot of them can sustain that…Why would you pay that? It’s way too much.”

Elections, Leaving Municipal Bankruptcy, & A City’s Future. San Bernardino has commenced what it hopes will be the final step on its path to exit the nation’s longest municipal bankruptcy; U.S. bankruptcy Judge Meredith Jury has scheduled a hearing to consider confirmation of the city’s “Third Amended Plan for the Adjustment of Debts of the City of San Bernardino” for 10 a.m. on Friday, October 14th. Now, as the city can begin to anticipate that exit, weeks before November’s elections, a key issue before the city and its voters revolve around big campaigns for and against the ballot measure to replace the city’s charter — essentially a municipal constitution which, if changed, could either finally free city leaders to fix the city and increase voter participation or could throw away the city’s heritage and citizen protections. In our report on San Bernardino, indeed, we had written: “In the estimation of most individuals, a key challenge for the city is in its charter. Decision-making authority over budgets, personnel, development and other matters is fragmented between and among the mayor, city manager, city council and city attorney—as well as several boards and commissions. Elected officials do not have the power to alter the salary calculations resulting from these provisions (except through voluntary negotiations with the representatives of that set of employees). These provisions greatly reduce the ability and flexibility of the city to adapt to economic and fiscal conditions as they change over time.” Unsurprisingly, however, most voters—in any jurisdiction—are unfamiliar with the mechanics of municipal governance: in San Bernardino, some two-thirds of likely voters have neither seen, heard, nor read anything about efforts to replace the city’s charter, according to a poll of 400 people. But with election day not so far off, a citizen committee has undertaken such efforts—especially in the wake of voters, earlier this year, rejecting one of their two suggested charter amendments, Measure Q, the proposed change to how police and firefighters are paid. Betsy Starbuck, Chairwoman of the campaign to replace San Bernardino’s charter, notes: “Most voters don’t know the charter is 111 years old, written when there were fewer than 10,000 people in San Bernardino, and now as a city of over 200,000, we need a charter that is comparable to all the other cities around us, that brings us into modern, efficient and transparent government.” Nevertheless, opponents to any changes charge: “They don’t want to give up their right to vote…They don’t trust placing the city’s business in the hands of appointed officials.”

As we have previously noted, San Bernardino has operated under its own city charter since 1905: the charter serves as the governing framework with regard to which positions are elected and which are appointed, the responsibilities of those officials, and certain other restrictions. The proposed new charter is more similar to the model of other charter cities: its intent is to increase clarity, flexibility, and efficiency. One of those changes would increase the power of the city manager, the position appointed by the mayor and council to run day-to-day operations: the change would shift responsibility away from the elected officials directly, converting San Bernardino to a council-manager form of government, or what ICMA notes is the structure for 58 percent of cities with a population over 100,000—a change advocated by the current mayor, who supports that change and the charter as a whole, even if it means less power for him: “This is how modern governments work, with the mayor and council setting the policy and professionals implementing it.” In contrast, former San Bernardino Mayor Judith Valles believes such a change would weaken the city: “There’s a pecking order among cities, and the cities where the mayor is a strong mayor are able to take leadership,” she said, noting that can be especially the case in affecting decisions in regional bodies.

The proposed charter change, if adopted by voters, would eliminate elections for the city attorney, city clerk, and Finance Director: the mayor and council would appoint the city attorney (as is done in 16 of 17 peer agencies) and city clerk (as 14 of those cities do), while the decision and appointment of a treasurer would be at the discretion of the Finance Director. San Bernardino’s incumbent elected attorney, clerk and treasurer have all said they support being appointed; however, the former city attorney, James F. Penman, believes the city’s voters will not and should not give up their power to vote: “When he was a Congressman in the House of Representatives, on July 27, 1848, Abraham Lincoln gave a speech in which he said, quote, ‘In leaving the people’s business in their hands, we cannot be wrong,’ ” Mr. Penman said: “It’s such a fundamental part of American democracy,” who notes that: “The mayor and council are free to ignore the city attorney’s advice…The difference is an elected city attorney is not afraid to call it to the attention of the public. The mayor and city council can’t kick the city attorney out — the elected city attorney.”

Elections: San Bernardino’s current charter sets elections for the mayor and council members in November of odd-numbered years, with a “run-off” in February of the following year if no candidate gets more than 50 percent of the vote; the new charter would move elections to match the state’s — November of even-numbered years—when there tends to be a much higher voter turnout.

Personnel Rules. San Bernardino’s current charter has some bedeviling personnel rules, such as the one mandating that police and firefighter pay be set as the average of 10 like-sized California cities, rather than by collective bargaining like nearly all other municipalities—nevertheless, a charter requirement voters in the city two years ago retained by a ten point margin. In the vote this time, if the charter were changed, employee pay would be set by collective bargaining. Likewise, whereas the current charter sets City Council salary at $600 per year, if changed, the new salary would be determined by the mayor and council after a public hearing, after hearing from an advisory commission. Any raises would go into effect following the next election after the increase.

Budgetary Stipulations: The ballot statement in favor of replacing the charter says the new one will require a balanced budget, strict financial controls, and an annual independent audit that must be shared publicly. (These include the two most popular components, according to the charter reform group’s poll: 91 percent favor the balanced budget requirement and 84 percent favor independent audits.) Ironically, these stipulations already exist: the current charter provides: “The Mayor shall have the books and records of all public departments, pertaining to the finances of the City, experted by a competent person at least once in every year.” (I hope readers appreciate that word “experted.”)

Staving Off Municipal Bankruptcy. Petersburg, the small, independent city in Virginia perched on the very edge of insolvency, where the median income for a household in the city is under $29,000, drew a crowd of some 500 mostly unhappy citizens as the City Council Tuesday evening adopted most of a package of tax increases and budget cuts, but rejected a proposal to close one of the city’s four fire stations; the City Council had previously voted two weeks ago to adopt a package of recommendations from financial consulting firm PFM Group in hopes the fiscal surgery would provide the municipality access to the market to enable it to borrow sufficiently to rescue itself from its severe cash crunch; it has been clear throughout the state is most unlikely to offer any fiscal relief. At heart, the session was about whether the municipality has a future; indeed, as one young citizen addressed the elected leaders, she stated: “I am 18 years old, and I have watched all of my friends move to Richmond because they feel they have no future here…You have a chance to try and fix things, but you need to care, and you need to listen.”

This week’s sessions came as the municipality is mandated by Virginia law to hold public hearings on changes to tax rates and amendments to the current year’s budget. The citizen concern about the dire fiscal straits meant that the Council agreed to convene at Petersburg High School, because of its 800-seat auditorium. Nevertheless, and unsurprisingly, residents appeared to be confused about the municipality’s budget process, with many stepping up to make comments about the proposed budget cuts during the public hearings on the tax rates. On the agenda: five public hearings on the proposed increases in tax rates: the Council voted to adopt most of the proposed increases:

  • The tax rate on hotel room rentals (lodging tax) was raised, as recommended, to 10 percent from 6 percent.
  • The tax on restaurant meals was raised from the current 6 percent to 7 percent, less than the 7.5% rate recommended by its advisor PFM Group. (The 0.5% difference will mean about $150,000 less revenue to the city, according to Interim City Manager Dironna Moore Belton.)
  • The tax on cigarettes was raised, as recommended, to 90 cents per pack from the current 10 cents.
  • The personal property tax rate was increased to $4.90 per $100 per $100 of value from $4.40. (Initially, council members voted to table the proposed increase until their next regular meeting, but after a short break, they voted to rescind the motion to table and adopt a motion to raise the rate.)
  • The monthly charge for solid waste removal was raised to $20 from $14.

On the other side of the teeter-totter, recommended budget cuts, the Council voted to reject a proposal to close one fire station—a closing projected to reduce the city’s deficit by $675,000, and voted to continue funding of the nonprofit Southside Virginia Emergency Crew.

Unsurprisingly, numerous speakers during the public hearings raised alarms about what they said was a potential safety threats to homes and residents, to reducing funding for the school system by $4.1 million, and to cutting funding for museums and visitor centers, estimated to save the city $300,000. The proposed and recommended budget cuts and tax increases were drawn from a report by state auditors and other financial experts—a report which found the municipality facing a backlog of nearly $19 million in unpaid bills from FY2016, and a looming $12 million deficit in the current fiscal year. This week’s difficult session came as the municipality’s access to short-term loans has evaporated: no lender is currently willing to extend a loan; thus the difficult budget decisions, as well as reforms to the city’s accounting and cash-control processes, are aimed at persuading lenders that the municipality is serious about stabilizing its finances.

Puerto Rico’s Fiscal Future. A federal judge in Puerto Rico has refused to temporarily halt a lawsuit in which holders of Puerto Rico municipal bonds are claiming Puerto Rico Gov. Alejandro García Padilla violated the newly enacted federal PROMESA law by declaring a moratorium on constitutional debt payments after the law was signed by President Obama, but before the establishment of the new control board. The suit, filed by Delaware-based Lex Claims LLC and other companies which hold the U.S. territory’s constitutionally backed debt, focuses on three actions the territory took which, the bondholders charge violated the new federal law, seeking an injunction to halt the claimed violations. U.S. District Court Judge Francisco Besosa has ruled out Puerto Rico’s request for a stay. In their claim, the plaintiffs have charged that Gov. Pasdilla’s June 30th Executive Order 2016-30 violated a provision of the new law which bars Puerto Rico from enacting new laws that either permit the transfer of any funds or assets outside the ordinary course of business or that are inconsistent with the constitution or laws of the territory between the date of PROMESA’s enactment and the time the oversight board and its chair have been appointed. In addition, the suit claims that Puerto Rico’s FY2017 budget violates the law because it “makes huge transfers outside the ordinary course of business and diverts vast resources to purposes that apparently enjoy political favor but are indisputably junior to constitutional debt.” The companies cite a roughly $800 million contribution to the pension system in the budget as well as about $250 million from Puerto Rico’s general fund to “prop up its insolvent Government Development Bank,” adding “All of this is well outside the ‘ordinary course of business’ and flouts the Puerto Rico constitution, which expressly requires appropriations for full payment of constitutional debt.” The suit alleges Puerto Rico, without approval of the PROMESA oversight board, took on responsibility for debts owed to the GDB by other, independent entities in violation of §207 of the newly enacted federal law which bars Puerto Rico from issuing “debt or guarantee, exchange, modify, repurchase, redeem, or enter into similar transactions with respect to its debt” absent approval of the new oversight board. In its response, the island argued it had acted to trigger a provision of PROMESA which puts an automatic stay on debt litigation against the Commonwealth, noting: “This is, in short, precisely the sort of bondholder litigation against Puerto Rico that PROMESA sought to halt for a temporary period to allow the commonwealth to stabilize its financial situation and to give the oversight board time to set up and review.” Judge Besosa’s ruling that the stay did not apply noted that it was primarily based on considerations with regard to the timing of the suit and whether the plaintiffs’ requested relief could be considered monetary relief. In his decision, Judge Besosa wrote that a suit could be subject to the stay if it were a judicial action to recover a “liability claim” against the government of Puerto Rico which arose before the enactment of PROMESA, noting that the new federal the judge associates “liability claim” with monetary relief, defining it as a claim that relates to liability, right to payment, or right to an equitable remedy for breach of performance if such breech gives rise to a right to payment”—or, as Judge Besosa wrote: “In their amended complaint, plaintiffs expressly state that their lawsuit ‘does not seek to compel payment on plaintiffs’ bonds.’ Rather, plaintiffs seek only declaratory and injunctive relief…Thus, plaintiffs do not seek to recover a right to payment that arose before PROMESA’s enactment.” Ergo, he noted, the suit does not meet that requirement for a stay.


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