The Daunting Road to Recovery from the Nation’s Longest Ever Municipal Bankruptcy

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eBlog, 12/09/16

Good Morning! In this a.m.’s eBlog, we look back on the long and rocky road from the nation’s longest municipal bankruptcy back to solvency taken by the City of San Bernardino, a city in a Dillon Rule state, which we described in our original study as the former gateway from the East to Midwest of the L.A. basin and former home to Norton Air Force Base, Kaiser Steel, and the Santa Fe Railroad, but which in the 1990’s, with the departure of those industries and employees, fell into hard times. By the advent of the Great Recession, 46% of its residents were on some form of public assistance—and nearly one-third below the poverty line. By FY2012, the city faced a $45 million deficit; its fund balance and reserves were exhausted—leading the city to file for chapter 9 municipal bankruptcy (note California codes §§53760, 53760.1, 53760.3, 53760.5, and 53760.7—and where, effective on the first day of this year, new statutory state language specifically created a first lien priority for general obligation debt issued by cities, counties, schools, and special districts, so long as the debt was secured by a levy of ad valorum taxes pursuant to California’s Constitution.) As we have noted, in the 18 states which authorize chapter 9 filings, states have proscribed strikingly different legal mechanisms relating to the state role—varying from a state takeover, such as we have described in the case of the nation’s largest municipal bankruptcy in Detroit, but to a very different regime in Jefferson County and San Bernardino—where the elected municipal officials not only remained in office, but here the respective states—if anything—contributed to the severity of the fiscal challenges. Then we turn to what might be Congress’ last day in town this year—and whether funding to help the City of Flint might be enacted: Will Congress pass and send to the President a bill to provide emergency assistance to Flint?

Back to a City’s Viable Future. San Bernardino leaders this week issued a detailed statement on the arduous road to recovery they have travelled and what they intend for the road ahead, albeit noting the city is already well along its own blueprint for its recovery, as it awaits formal approval from U.S. Bankruptcy Judge Meredith Jury from its chapter 9 municipal bankruptcy early next year. In its statement, San Bernardino reported it had implemented about 70 percent of its recovery plan. That’s turned once-dire projections for the future upside down—a virtual u-turn from when the city’s fiscal analysts three years ago projected that in FY2023, the city would have a deficit of $360 million if dramatic changes were not achieved. But today, the city instead projects an unallocated cash balance for FY2023 of $9.5 million, or, as the statement reads: “Now, the city is on the cusp of emerging from bankruptcy as a changed city with a brighter future.” The municipal statement is primarily focused on the governance and fiscal changes made to create a virtual u-turn in the city’s fiscal ship of state since entering what became the nation’s longest municipal bankruptcy—a change in fiscal course without either state aid or state imposition of an emergency manager or a state takeover. The statement notes: “Given the emergency nature of its filing, it took the city several months to assess its financial condition—until April 2013, at which time the city adopted a final budget for fiscal years 2012-13 and 2013-14…The city’s initial financial assessment, however, only reflected further concern over its financial future. In September 2013, Mayor [Pat] Morris announced that absent fundamental modernization and change the city faced a 10-year deficit of a staggering $360 million. The future of San Bernardino looked bleak.”

The statement itemized what appeared to be the key steps to recovery, including achieving labor agreements—agreements which resulted in savings in excess of $100 million, and involved the termination of virtually all health insurance subsidies coverage for employees and retirees, writing that the city calculated the resulting savings to amount to about $44 million for retirees and $51 million for current employees. The statement notes some $56 million in other OPEB changes. A key—and hard-fought change—was achieved by contracting out for essential public services, with one of the most hard fought such changes coming from the annexation agreement with the San Bernardino County Fire Protection District: an agreement under which the county assumed responsibility for fire and emergency medical response—a change projected to save San Bernardino’s budget nearly $66 million over the next two decades just in public pension savings, but also as much as $5 to $6 million in its annual operating budget—and that is before adding in the parcel tax revenues which were incorporated in that agreement. San Bernardino also switched to contracting out for its trash and recycling—an action with a one-time franchise payment of $5 million, but increased estimated annual revenues of approximately $5 million to $7.6 million. The switch led to significant alterations or contracting out for an increasing number of municipal services. Or, as the paper the city released notes: “Modern cities deliver many services via contracts with third-party providers, using competition to get the best terms and price for services…The city has entered into a number of such contracts under the Recovery Plan.”

Governance. The city paper writes that the voters’ approval of a new city charter will allow San Bernardino to eliminate ambiguous lines of authority which had created a lack of authority, or, as U.S. Bankruptcy Judge Meredith Jury put it earlier this week: “(City officials) successfully amended their charter, which will give them modern-day, real-life flexibility in making decisions that need to be made…There was too much political power and not enough management under their charter, to be frank, compared to most cities in California.”

Rechartering San Bernardino’s Public Security. San Bernardino’s Plan of Debt Adjustment calls for increasing investment into the Police Department through a five-year Police Plan—a key step, as a study commissioned to consider the city’s public safety found the city to be California’s most dangerous municipality based on crime, police presence, and other “community factors.” The study used FBI data and looked at crime rates, police presence, and investment in police departments as well as community factors including poverty, education, unemployment, and climate: The report found a high correlation between crime rates and poverty—with San Bernardino’s poverty rate topping 30.6 percent. Thus, in the city’s Police Plan portion of its plan of adjustment, the report notes:  “The Mayor, Common Council, and San Bernardino’s residents agree that crime is the most important issue the city faces,” the city says in the Police Plan, submitted to the federal bankruptcy court as part of its plan. The plan calls for $56 million over five years to add more police, update technology, and replace many of the Police Department’s aging vehicles.

The Cost of Fiscal Inattention. Unsurprisingly, the fiscal costs of bankruptcy for a city or county are staggering. The city estimates that the services of attorneys and consultants will cost at least $25 million by the time of the city’s projected formal emergence from chapter 9 next March—albeit those daunting costs are a fraction of the $350 million in savings achieved under the city’s pending plan of debt adjustment—savings created by the court’s approval of its plan to pay its creditors far less than they would have otherwise been entitled: as little as 1 cent on the dollar owed, in many instances. Or, as the city’s statement wryly notes: “In addition, the city’s bankruptcy has allowed the city a reprieve during which it was able to shore up its finances, find greater cost and organizational efficiencies and improve its governance functions…Thus, all told, while the city’s exit from bankruptcy will have been a hard-fought victory, it was one that was critical and necessary to the city’s continued viability for the future.”

Out Like Flint. The House of Representatives on what it hopes to be its penultimate day yesterday approved two bills which, together, would authorize and fund $170 million for emergency aid to Flint and other communities endangered by contaminated drinking water. The emergency assistance came by way of a stopgap spending bill to keep the federal government operating next April in a bipartisan 326-96 vote and, separately, a water infrastructure bill which directs how the $170 million package should be spent by a 360-61 vote. Nevertheless, the aid for the city is not certain in the U.S. Senate: some have vowed to stop it, at least in part because the bill includes a controversial drought provision which would boost water deliveries to the San Joaquin Valley and Southern California.

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