Can Municipal Insolvency Affect Neighboring Municipalities?

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eBlog, 9/23/16

In this morning’s eBlog, we consider the chances of getting high in San Bernardino—the city in municipal bankruptcy longer than any other in U.S. history—but now on the verge not only of elections, but also ballot questions, including the legalization of marijuana—something which could, presumably not only make citizens high, but mayhap municipal revenues higher. Then we veer East to Michigan, where the complex issues imposed by the legislature on the virtually insolvent Detroit Public Schools, via the creation of a state-imposed charter and public school system has created threatening credit problems—as well as governance problems for the Detroit Public Schools. Finally, we head further East to the small Virginia municipality of Petersburg, famous as a site during the Civil War where, in nine months of trench war in which vastly outnumbered confederate forces warded off Gen. Ulysses S. Grant, the city was the essential supply line to Confederate Commander Robert E. Lee. Today, the historic city faces a fiscal rather than armed challenge—it is virtually insolvent—and, as we note—because now, as then, the small city is connected to other cities in the state, its insolvency could have ever widening fiscal ramifications–or fiscal contagion– for other municipalities…We wonder what the tipping point into insolvency might be–or when the Commonwealth of Virginia might feel compelled to act.  

Electing a Higher Future for Post-Chapter 9 San Bernardino? San Bernardino City Manager Mark Scott has informed the City Council he will not allow any of the traditional election forums or local election broadcasts unless a majority of the council members vote to undo his decision—even as Councilman Henry Nickel responded he considered that to be a decision which ought to be determined by the city’s elected leaders, calling it a “suppression of the First Amendment rights of the public to hear items that are relevant to our government: It is not up to the unilateral decision of the city manager to deviate substantially from prior practice and policy until and unless it has been presented by the City Council, which has the policy-making power both under the current charter and the (proposed) new city charter.” In his email to his colleagues on the Council, he emphasized, however, that even though the Council could reinstate election events and broadcasts, there might be a conflict of interest: “Just so you know, UNLESS directed otherwise by Council action, we have told those who have asked that we will NOT allow use of the Council Chamber for any election events or taping between now and the November election, nor will we be doing any local election broadcasts on Channel 3,” acknowledging that even though this “has been done in the past,” it just seemed “smart to stay completely arms’ length” this election year. The discussion came as city officials worked on and endorsed a measure that would replace San Bernardino’s city charter and another that would allow marijuana in the city—with the first measure, Measure L, to allow voters to replace the existing city charter with a new one created by a charter review committee—which, by a 6-1 vote, Council adopted. The manager’s announcement would also—unless reversed—mean there would be no public discussion about getting high on the three pending marijuana legalization measures—where all three have been authored by advocates of legalization and none representing the view that dispensaries should remain illegal—in part because only one counter-argument is printed against each measure for the November ballot, and — by random chance — City Clerk Gigi Hanna had selected arguments against each measure that had been filed by proponents of competing measures. (If more than one measure receives more than 50 percent of the vote, whichever measure gets the most “yes” votes will become law…) The city has had a medical marijuana ban on its books since 2007, but enforcement was ineffective, with dispensaries dotting the city in open defiance. City officials had attempted on several occasions to replace the ban with what they hoped would be a more effective regulatory framework; however, they were preempted last July when the City Council determined resident Vincent Guzman had secured sufficient signatures that legally his measure had to be put November’s ballot—Measure O—with Mr. Guzman having written: “Measure O is the only one to generate significant tax revenue for San Bernardino: It funds both enforcement and general city services. It reduces the number of dispensaries and eliminates them near our schools and homes.” In his advocacy, Mr. Guzman cited a study by economist Beau Whitney estimating that Measure O [“The San Bernardino Regulate Marijuana Act of 2016”] would allow an outside special interest group to establish a marijuana monopoly in the city,” the argument against contends: “Measure O circumvents local control and does not comply with our local general plan and land use policies.” Nevertheless, proponents claim the measure, if adopted, would generate between $19.5 million and $24.8 million in revenue for San Bernardino in addition to 2,750 jobs. Opening the doors to getting municipally high stimulated a second group to secure sufficient signatures to place its own, alternative regulation plan on the ballot—all of which led the City Council to draft its own version, which would require separate licenses for marijuana cultivation, marketing, testing, distribution, and dispensaries; application fees and enforcement fees would be set yearly to match the cost of providing the service. Under the city’s version, dispensaries could only be within industrial zones, and could not be within 600 feet of a school, park, library or recreation center, nor within 100 feet of a residential zone or religious center; and no two dispensaries could be within 1,000 feet of each other, amounting to a significant limitation on the number of dispensaries, according to Graham, the primary author of the initiative. The city’s proposal is on the ballot as Measure P, and it’s supported by the same group that opposed Measure O: “Measure P is the only medical marijuana ordinance supported and put on the ballot by our local elected officials,” the group’s ballot statement reads:  “Measure P was drafted by the city attorney’s office – and not by marijuana industry special interest groups.” The argument says Measure P is the only one that would retain local control, “including a potential ban.” In the alphabetic voting guide for readers, the other citizen-submitted ballot item, Measure N, an anti-marijuana measure supported by several City Council members, who claim that even though the harmful effects of marijuana are well-documented, the proponents continue to advocate for its legalization: “The legalization experiment in Colorado and Washington is a disaster. The ‘Regulate and Control’ policy attempt has failed, yielding huge increases in underage and adult use, and drugged driving.” That opposition is signed by Mayor Davis and City Council Members Jim Mulvihill, Fred Shorett, and Virginia Marquez.

Under the math, if voters provide more than 50 percent on the city’s drafted measure and more “yes” votes than either of the citizen-submitted initiatives, the municipally-written measure would become law. Moreover, unlike those initiatives, it could be modified as state law regarding marijuana changes, which led the City Council to put the medical marijuana regulation on the ballot in a 5-2 vote—albeit reluctantly, in some cases. The most vocal advocate of the ban has been Mayor Carey Davis, who gave extensive evidence that marijuana legalization has been harmful in Colorado and suggested it would stretch thin an already understaffed police department. But the city had no legal alternative to putting the two citizen initiatives on the ballot — other than immediately adopting the framework they suggest, and Deputy City Attorney Steven Graham said that was not an option, either, for the measure that imposed a tax on marijuana. (California law forbids cities from passing a tax without a vote of the public. It is unclear legally whether a voter-originated tax can pass in an election at which Council Members are not up for a vote, which is the case in November according to Counselor Graham.) The City-drafted measure would require:

  • separate licenses for marijuana cultivation, marketing, testing, distribution, and dispensaries;
  • application fees and enforcement fees would be set yearly to match the cost of providing the service;
  • Dispensaries could only be within industrial zones, and could not be within 600 feet of a school, park, library or recreation center, nor within 100 feet of a residential zone or religious center;
  • And no two dispensaries could be within 1,000 feet of each other, amounting to a significant limitation on the number of dispensaries, said Graham, the primary author of the initiative.

Protecting Tomorrow’s Leaders? The Michigan Finance Authority has approved a plan to issue $235 million of debt to refund some Detroit Public Schools (DPS) municipal bonds before they lose their state aid backing at the end of this month, approving an authorizing resolution for the issuance to be backed solely by an existing 18-mill non-homestead levy—with the fabulous Matt Fabian of Municipal Market Analytics warning the “investor will be at risk if the levy produced by the 18 mills continues to decline or is disrupted by, for example, assessment appeals in the future. Some kind of state backstop or protection would be needed to make this investment grade.” The Michigan Finance Authority has not, however, provided any indication with regard to whether it intends to backstop the bond refunding, albeit the Authority has stated the outstanding bonds will be refunded and defeased at par “plus any applicable redemption premium and accrued interest,” suggesting that those bondholders will be made whole—albeit with the uncertainty remaining that should the state-aid pledge evaporate or shift, there would be likely adverse credit quality implications, because of the shift to entire reliance on a property tax pledge. The outstanding bonds lost their investment grade status amid uncertainty about the state planned to restructure the debt after the state-ordered restructuring of Detroit Public Schools took effect July 1. The state assistance is set to shift to the state-mandated newly formed public school district that operates schools while the former district remains intact only to collect taxes and repay bonds. Under the provisions, the operating levy of roughly $50 million to $60 million per year will go to pay off debt service on the refunding bonds, which will retire 2011 and 2012 DPS state aid bonds with a final maturity of 2023. The state Finance Authority intends to issue the refunding bonds on or before the end of this month—the date when the current, outstanding bonds lose their state aid backing because, without students, the old district will no longer be able to collect state aid. The pending switch could cause fiscal shivers: the existing municipal bonds had initially carried S&P A ratings because of the state aid pledge; they also carried a limited tax general obligation pledge—albeit DPS’s underlying GO credit ratings are junk level—or, in school parlance, D-, with S&P last week having demoted the credit rating from B to BB-minus, warning that with the October deadline looming closer and ushering in the new fiscal year, there is increasing doubt with regard to whether bondholders would receive full and timely payment on their bonds—with the new drop the third such comparable action over the last three months—moodily moving in some syncopation with Moody’s, which recently revised the outlook on DPS’ Caa1 issuer rating to “developing” from “negative.”

What External Event Can Force a Municipality into Chapter 9 Bankruptcy? The City of Petersburg, the small, independent city in Virginia, a municipality on the steep edge of insolvency, and in which there seems little indication the Virginia legislature is poised to step in, a new shoe has dropped that would seem likely to precipitate a defining event: the South Central Wastewater Authority has filed a $1.2 million lawsuit over unpaid sewer bills, noting the has failed to pay for any wastewater services since May: “The City of Petersburg charges its residents for wastewater service. Under the service agreement between South Central and the city, these fees should be used to pay the costs of that service, including the costs of having the wastewater treated by South Central.” The suit seeks the appointment of a receiver to make sure the more than $1 million the authority says it is owed is not spent by the city on other things. According to the suit, filed in Petersburg Circuit Court, the authority is not only seeking to recover past-due amounts, but also requesting that the court appoint a receiver to supervise Petersburg’s billing and collection of wastewater fees from its residents, writing: “South Central seeks this appointment to ensure that the money is used for its intended purposes and that residents continue to receive the wastewater service they pay for…South Central is particularly dependent upon the regular and timely payment by the city of Petersburg, whose share of these costs account for more than half of South Central’s budget for operations and maintenance.” In addition to seeking payment of about $1.5 million in overdue service charges and penalties, South Central said it was filing the lawsuit “to request the court to appoint a receiver to supervise Petersburg’s billing and collection of wastewater fees from its residents. South Central seeks this appointment to ensure that the money is used for its intended purposes and that residents continue to receive the wastewater service they pay for,” adding that while the utility “appreciates the difficult financial circumstances the city of Petersburg is experiencing. Nevertheless, efforts to resolve the arrearages have been unsuccessful and — if left unaddressed — threaten the continued operation of South Central and the finances of the other member localities and their residents.” That is, there is a fiscal interdependence, and insolvency by Petersburg could have consequences for other Virginia public authorities, including the other four Virginia municipalities served by South Central. For its part, the city had billed residents for the service, but has not been remitting the fees to the CVWMA — a situation similar to what prompted South Central’s lawsuit. In response, interim Petersburg City Attorney Mark Flynn unsurprisingly noted the city “is disappointed that the authority has chosen to file a lawsuit,” adding that the “city is and has been working with the authority to resolve the amounts it owes: The lawsuit does not help the city and the authority in achieving resolution for the city’s obligations. As the authority and citizens know, the City Council and management have been working to resolve the city’s financial difficulties.” Moreover, for the municipality, in which a recent state audit of its finances determined the city is facing a $12 million budget gap in the current fiscal year while dealing with nearly $19 million in unpaid bills, including those to South Central, the suit threatens to unravel efforts by city officials to close the budget gap and repay unpaid obligations—efforts including its approval earlier this month of a series of austerity measures aimed at freeing up much-needed cash flow, including tax increases, pay cuts of city staff members, and the closing of the city’s three museums.

When it Rains, it Pours. The suit could hardly have come at a more inopportune time—as Rochelle Small-Toney, a deputy city manager in Fayetteville, North Carolina, has just removed herself out of the competition to be the city’s next city manager, according to Petersburg Mayor W. Howard Myers III—she had been in the city last week as City Council convened to hire a city manager in the midst of an ongoing financial crisis; however, Council Members were unable to agree on a hire and adjourned the meeting without taking action after local media reported that Ms. Small-Toney had resigned in the midst of a financial controversy from a previous position as city manager of Savannah, Georgia; ergo, the Council had voted unanimously to hire an executive search firm to conduct a national search for a new city manager—albeit with what funds unclear. Indeed, when asked by Ward 4 Councilman Brian Moore what funding source could be tapped to pay for the search, he was advised to talk with the city’s Finance Department and negotiate the best possible financial arrangement: Petersburg has been operating without a permanent city manager since early last March, when William E. Johnson III was fired amid the municipality’s emerging fiscal crisis and a furor over the mishandling of a plan to replace water meters throughout the city. Former City Attorney Brian Telfair resigned at the same time for health reasons. Dironna Moore Belton, who was the general manager of Petersburg Area Transit at the time, was named shortly afterward as interim city manager. At the same time, Mark Flynn of the Richmond law firm of Woodley & Flynn was contracted to act as interim city attorney. Ms. Belton is one of the applicants for the permanent city manager position; however, it is unclear whether she and the other candidates will have to re-apply if a search firm is hired.

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