Are Municipal Bankruptcies at the End of the Longest Stretch in U.S. History?

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eBlog, 1/29/17

Good Morning! In this a.m.’s eBlog, we consider an extraordinary ending to mayhap the most significant string of chapter 9 municipal bankruptcies in American history, with U.S. Bankruptcy Judge Meredith Jury’ milestone decision that she will issue a written confirmation order to confirm San Bernardino’s plan of debt adjustment. When San Bernardino emerges from the longest municipal bankruptcy in U.S. history, it will mean that for the first time since the Great Recession, no municipality is in bankruptcy—albeit, in the case of East Cleveland, Ohio, the absence appears to be more a matter of incompetency than governance.   

The End of the Longest Road. Nearly four and a half years after filing for what has become the longest municipal bankruptcy in U.S. history, the California municipality of San Bernardino is ready to celebrate its likely last appearance before U.S. Bankruptcy Judge Meredith Jury, after Judge Jury on Friday agreed to issue a written confirmation order consistent with the fifty page proposal the city’s attorneys had submitted, noting: “The last words I will say is congratulations to the city…I look forward to the order and I look forward to the city having a prosperous future.” Expectations are that San Bernardino will remain in its current bankruptcy status for about two more months, as Judge Jury deals with a smattering of creditors who have said they intend to appeal her decision. One such creditor, as we have previously noted, is a citizen of the city who alleged he had been beaten by San Bernardino police officers six years ago—a beating in which he testified he had incurred brain damage; ergo he is appealing that he should be entitled to more than the one percent of the amount a jury had awarded—and should also be allowed to be to sue the officers individually, with his attorney having testified before the court that, notwithstanding San Bernardino’s municipal bankruptcy, an appellate court, in the City of Vallejo’s chapter 9 bankruptcy, had ruled that individual police officers should be held liable for excessive force. However, Judge Jury had ruled that, unlike Vallejo, San Bernardino’s plan of debt adjustment did include an injunction against claims against city employees, holding that San Bernardino “has demonstrated, with unrefuted evidence, that the city does not have the financial resources to pay the holders of litigation claims except pursuant to the terms of the plan…There certainly are no legal bases or equitable grounds for treating the four objectors any differently than all of the other holders of litigation claims.” Judge Jury did not advise the city when she would sign the confirmation order—a date which will start the two-week clock for any appeals—but not interfere with the projected official exit from the nation’s longest ever municipal bankruptcy projected for April.

In the wake of the momentous day, Mayor Carey Davis said: “The bankruptcy has been a major focus, and now we can work more on our other goals.” That is, the city’s plan of debt adjustment could best be likened to a municipal fiscal blueprint demonstrating both for the federal bankruptcy court, but also for the city’s citizens as well as credit rating agencies: a detailed 20-year recipe and guidance with regard to the city’s blueprint for reinvesting in police and infrastructure in a future of constrained fiscal options—a blueprint that emerged from a strategic plan developed via a series of meetings two years ago, where, Mayor Davis noted, leaders “had to make one of the first goals fiscal stability, although we have begun to turn that corner already, with three years of balanced budgets, two years of surpluses.”

Nevertheless, as the records demonstrate, filing for chapter 9 municipal bankruptcy is a politically and fiscally expensive undertaking: San Bernardino will end up expending at least $25 million for attorneys and consultants—albeit that will likely turn out to be a pretty smart investment: the city estimates the final, court-approved plan of debt adjustment will provide for some $350 million in savings—savings reflected in substantial concessions by retirees, unions, and payment obligations to the city’s municipal bondholders—or, as San Bernardino City Attorney Gary Saenz said outside the courtroom: “I’m very proud that all of our creditors recognize that, while the deals are tough, they’re best for all involved…Each of those decisions, we made with the people of San Bernardino in mind. They are the most important reason we did anything. This was all done so they can get the service levels they deserve.”

What Could Be the State Role in Averting Municipal Fiscal Distress & Bamkruptcy?

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eBlog, 1/27/17

Good Morning! In this a.m.’s eBlog, we consider the ongoing challenge in Petersburg, Virginia—and the role of the Commonwealth of Virginia. Because, in our federal system, each state has a different blueprint with regard to whether a municipality is even allowed to file for chapter 9 municipal bankruptcy (only 18), and because there is not necessarily rhyme nor reason with regard to fiscal oversight and response mechanisms—as we have observed so wrenchingly in the forlorn case of East Cleveland—the role of states appears to be constantly evolving. So it is this a.m. that we look to Virginia, where the now insolvent municipality of Petersburg had routinely filed financial information with the Virginia auditor of public accounts—but somehow the accumulating fiscal descent into insolvency never triggered alarm bells.   

Virginia Auditor Martha Mavredes this week, testifying before the House Appropriations Committee, told Chairman S. Chris Jones (R-Suffolk) it was “just hard for us to really get our minds around how that was missed,” telling the committee the state currently has no requirement for municipalities to furnish the kind of comprehensive information that would trigger awareness of insolvency; there appears to be no mechanism for the Commonwealth to step in and help. Indeed, that was the very purpose of Chairman Jones to call for the hearing: he wants to better understand options Virginia might consider to not just create some kind of trip wire, but, mayhap more importantly, to act on provisions which could avert future such municipal insolvencies. Auditor Mavredes indicated to the Committee she is scrambling to scrabble together some kind of tripwire or early warning system that would flag financial problems in Virginia’s municipalities at an earlier stage, telling the committee she is using a system devised by the state of Louisiana to help Virginia identify cities and counties in dire fiscal straits. Thus she plans to create a database of all localities in the commonwealth to rate or score their relative fiscal health. Under what she is proposing, her office will approach cities that show warning signs in order to assess more information. Her real issue, she told the committee, is what fiscal assistance tools might be available—or as she put it: the “piece I can’t solve right now is what kind of assistance might be there” once such problems come to light.” Virginia, like a majority of states, has no provision for the state to step in if a locality goes into default. Indeed, it was the thoughtful step of Virginia’s Finance Secretary Ric Brown, who took the unusual step last year to investigate Petersburg’s finances, which led him to discover the city had some $18 million in unpaid bills, an unbalanced budget, and a fiscal practice of papering over deficits with short-term borrowing—a practice that not only jeopardized the city’s bond rating, but also affected the cost of borrowing for the regional public utility. Secretary Brown stressed the need for training local elected officials about budgeting and best practices, and he suggested a program to allow outside management firms to help get cities on a better fiscal foundation. Interestingly, the Committee might want to avail itself of the pioneering work underway by the irrepressibly insightful Don Boyd of the Rockefeller Institute of Government to assess state responses to municipal fiscal distress, seeking to answer the kinds of thoughtful queries Secretary Brown is asking. In a chart for Rockefeller, we tried our own answer:

Understanding Municipal Fiscal Stress

Assessing State Responses to Growing Municipal Fiscal Distress and Insolvency:

  • The Ostriches (head in the sand): Do Nothings/modified harm: e.g. Illinois
  • Denigrators (Alabama is a prime example: when Jefferson County requested authority to raise its own taxes, the Legislature refused, forcing the county into chapter 9 bankruptcy);
  • Learners (Rhode Island is a very good candidate here—in the wake of Central Falls, the state evolved into a much more constructive partnership;
  • Thinkers (I put Colo. & Minn. here—especially because both seem to recognize potential benefits of tax sharing & innovation in intergovernmental fiscal policy);
  • Preemptors (Michigan, because it provides for the usurpation of any local authority through the appointment of an Emergency Manager); New Jersey seems to be fitting in with that category re: Atlantic City;
  • Substitutors: Pa.: Act 47
  • Maybe Do-Nothings: Ohio, even though it authorizes municipal bankruptcy, appears to have been totally non-responsive the petition by East Cleveland to file—and has appeared to play no role in the so-far dysfunctional discussions between Cleveland and East Cleveland).

Balancing New Taxes & Public Safety in an Insolvent City

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eBlog, 1/26/17

Good Morning! In this a.m.’s eBlog, we consider the ongoing challenge in Atlantic City—the city taken over by the State of New Jersey—but where the path back to solvency remains blurry. Yesterday New Jersey General Assembly Speaker Vincent Prieto proposed a bill to set a $2 dollar per room hotel surtax as one option to help address the city’s fiscal dilemma.

Helping Out. New Jersey Assembly Speaker Vincent Prieto (D-Secaucus) has proposed state legislation under which Atlantic City would receive temporary authority to impose a $2 surcharge on hotel rooms in the city—a move the Speakers says would be important to avert any police or firefighters layoffs—layoffs which he is apprehensive Governor Chris Christie’s administration is seeking as a step in the state’s takeover of the city. Under his proposed bill, A4556, the authority to impose the tax would be for a two year period—revenues raised would only be available for public safety expenditures. In introducing the bill, the Speaker noted: I was adamant that any state takeover of Atlantic City not involve, among other things, police and firefighter layoffs that would threaten public safety and the city’s effort to market itself as a safe and family-friendly destination, but not everyone agreed…the harsh reality is now setting in, sadly, but I will not stand idle and allow police and firefighter layoffs to harm public safety for residents while also hurting the public’s ability to feel confident about visiting the city…Atlantic City must remain successful for the betterment of the entire state.” The proposal creates its own potential dilemma: because the city’s hotels currently remit state, luxury, casino, occupancy, and promotion taxes and fees—would still another increase create the potential to overprice rooms and discourage tourists? According to Atlantic City’s convention bureau, the city’s hotels already remit some of the highest room taxes in the country—so, for a city where tourism is the key driver for the city and its recovery, the fiscal question might be: would this be a tax too far?

The Different Roads out of Municipal Bankruptcy

eBlog, 1/25/17

Good Morning! In this a.m.’s eBlog, we consider yesterday’s guilty plea from the former Mayor of Pennsylvania’s capitol, Harrisburg, for actions he had taken as Mayor which plunged the city to the brink of chapter 9 bankruptcy; then we consider Detroit Mayor Mike Duggan’s announcement that a majority of Detroiters will see a reduction in their property tax obligations—a sign of the signal fiscal turnaround. Then we head into the icy blast of Winter in Pennsylvania, where the former Mayor of Harrisburg has pleaded guilty to stealing city-purchased artifacts, before veering south to note Puerto Rico Gov. Ricardo Rosselló has signed into law an extension of Act 154’s tax on foreign corporations.  

Public Mistrust. Former Harrisburg, Pa., Mayor Stephen Reed pleaded guilty Monday to 20 counts of theft  for stealing artifacts purchased by the city in Dauphin County court Monday, with the outcome coming in the wake of negotiations with the state Attorney General’s office. The 20 counts reflects a dramatic reduction of criminal counts from the original more than 470, including many tied to fiscal decisions during his service as Mayor, a period which had propelled the city to the verge of chapter 9 municipal bankruptcy—and a leftover severe set of fiscal challenges still bedeviling the state capitol. The former mayor, in his comments to the press after the proceeding, described it as “gut-wrenchingly humiliating.” The Patriot-News of Harrisburg reported that Mr. Reed, who served as mayor from 1982 to 2009, admitted to taking 20 historic artifacts, but said he had no criminal intent. Judge Kevin Hess scheduled a sentencing hearing for Friday in the Dauphin County Court of Common Pleas in Harrisburg. The trial commenced in the wake of then Pennsylvania Attorney General Kathleen Kane in July of 2015 announcing the indictment of the former Mayor: prosecutors asserted he had diverted municipal bond proceeds, notably related to an incinerator retrofit project, to a special projects fund he allegedly used to purchase as many as 10,000 Wild West artifacts and other “curiosities” for himself—including a $6,500 vampire hunting kit—a series of disclosures which contributed to the city’s descent into receivership due to municipal bond financing overruns related to an incinerator retrofit project; the Harrisburg City Council filed for chapter 9 municipal bankruptcy in October of 2011, notwithstanding the objection of then-Mayor Linda Thompson; however, a federal judge two months later negated the filing, and a state-appointed receivership team pulled together a recovery plan approved by the Commonwealth Court of Pennsylvania in September of 2013. Yesterday, Christopher Papst, author of the book Capital Murder an Investigative Reporter’s Hunt for Answers in a Collapsing City, noted: “Stephen Reed’s guilty plea concerning his stealing of city artifacts is a good start for the people of Harrisburg who deserve answers and justice. But far more needs to be done and more people need to be held accountable for the city’s financial collapse…A strong message must be sent that any impropriety concerning municipal financial dealings will not be tolerated.”

Rebalancing Motor City’s Tax Wheel Alignments. Detroit Mayor Mike Duggan has announced that about 55% of residential property owners in the city will see a reduction in their property tax obligations later this year. His announcement came in the wake of the city’s completion of a three-year reappraisal project, as required under Detroit’s plan of debt adjustment approved by the U.S. Bankruptcy Court. According to Mayor Duggan, about 140,000 residents will realize an average reduction of $263 on their tax bills, while 112,000 will see an average increase of $80. The reappraisal process, unlike past years, assessed each property individually. Tax assessments were mailed Monday. The city, despite boasting one of the broadest tax bases of any city in the U.S., (its municipal income taxes constitute the city’s largest single source of revenues), nevertheless have been constrained by the state: only Chrysler and DTE Energy pay business taxes; moreover, state law bars cities from increasing revenues by adding a sales tax or raising residential property tax rates more than inflation. Moreover, in the years leading up to the city’s fiscal collapse into chapter 9 bankruptcy, homeowners had complained that their property taxes did not compare to the market value of their homes. Ergo, now Mayor Duggan is hopeful that the new assessment will improve property tax collections—or as he put it yesterday: “It turns out, when people feel they’re being assessed fairly, they pay their taxes….For years, we basically have taken entire neighborhoods or sections of the city and taken averages, which is the best that could be done with the data available.” But the new assessments are based upon house-by-house reassessments using aerial and street-level photography as well as field visits. In addition, the city digitized field cards for every single residential property, allowing employees to inspect the condition of homes based on the historical information and new ground and aerial photos, according to City Assessor Alvin Horhn—or, as Mr. Horn notes: “Where everything matched up, fine. Whenever there was a difference, we sent people out to look…For the most part, this was done at a desktop (computer) review.” Next up: a citywide reassessment of all commercial and industrial properties will be completed for the winter 2018 tax bills. According to city data, collections have increased steadily from about 68% in 2012-14 during the city’s municipal bankruptcy to 79% in 2015 and a projected 82% last year: from 2015 to 2016, the city reported that property tax collections increased approximately $8 million.

Act 54 Where Are You? Puerto Rico Gov. Ricardo Rosselló has signed into law an extension of Act 154’s tax on foreign corporations (mainly corporations manufacturing pharmaceuticals and other high-tech products), a key action to preserve revenues which provide a quarter of the U.S. Territory’s general fund revenues; the action came as Public Affairs Secretary Ramon Rosario Cortés submitted a measure to replace Puerto Rico’s Moratorium Law, an action which he said could mean Puerto Rico could dedicate some of the savings from which to provide “payment of interest or some part of the principal” in negotiations with the island’s creditors: “The obligations of the government of Puerto Rico will be fulfilled in an orderly process. The government is going to commit itself to the policy that what it is directed is to pay the obligations of the government of Puerto Rico. The first thing is essential services.” The discussion occurs at a pivotal point, as, since before the administration of newly elected Governor Ricardo Rosselló Nevares taking office, Senate President Thomas Rivera Schatz had announced that they were in tune to extend the expiration of the moratorium scheduled for the end of this month. If the government does not extend the litigation deadlock, it will face $1.3 billion in February, leaving it with no cash for operations, according to a liquidity report by Conway Mackenzie. Secretary Cortés, in response to a query yesterday with regard to interest payments, did note that would be possible “with the savings that are achieved, guaranteeing priority, which are essential services…The government of Puerto Rico will be making savings with this measure and the savings that will be made will be part of the renegotiation process, which could include the payment of interest or some part of principal, but in negotiation with creditors.” The revenues, as reported over the most recent half fiscal year, accounted for 25% of all General Fund revenues—more even than the $713 million in individual income taxes. The Act, adopted in 2010 to help address the dire fiscal imbalance, was set to impose a continually declining levy rate on foreign corporations until it would phase out this year, based on Treasury regulations promulgated six years ago which allow corporations to take tax credits against temporary excise taxes. Now a tricky shoal to navigate in the midst of the major transition in power in Washington, D.C. The issue involves whether the IRS will grant an extension of Act 154 past its current scheduled expiration at the end of this calendar year. According to Puerto Rico, 10 corporations and partnerships paid some 90 percent of all Act 154 taxes in FY2016. The law mainly affects corporations manufacturing pharmaceuticals and other high-tech products on the island.

How Does a Leader Balance Fiscal Versus Human Health & Safety?

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eBlog, 1/24/17

Good Morning! In this a.m.’s eBlog, we consider the ongoing fiscal and human health and safety challenges—and fiscal implications—in the City of Flint, as city residents have sued the State of Michigan; then we look east to Ohio, where the question with regard to a similar human and fiscal health related to East Cleveland appears to be worsening with regard to health, fiscal health, and governance. Finally, we peer south to the warm Caribbean, but where the warmth in weather is exceeded by the increasing political heat between the PROMESA oversight board and the new Governor—a challenge with parallels to the fiscal struggle Washington, D.C. underwent nearly two decades ago.

Fighting for Flint’s Fiscal Future. U.S. District Judge David Lawson has described an attempt by Michigan Attorney General Bill Schuette to side with Flint residents in a lawsuit against the state as “superficial posturing,” stating that the AG has created a “troubling ethical issue” that could delay the case that seeks to provide the city with bottled water delivery. In his opinion, Judge Lawson denied Mr. Schuette’s request to file an amicus brief in the case on behalf of “the people of the State of Michigan,” saying the motion is problematic for several reasons, including that assistant attorneys general have already appeared in the case on behalf of state defendants, including Gov. Rick Snyder, writing: “The proposed amicus brief has not introduced any new arguments or offered a perspective that has not been presented by the parties already. Instead, the attorney general has taken a position aligned with the plaintiffs and at odds with other attorneys in his own office…In doing so, he has managed to inject a troubling ethical issue into this lawsuit, potentially complicating adjudication of the serious legal questions before the court, without adding anything of substance.” A spokesperson for the Michigan Attorney General said he would not appeal this ruling, noting that while the attorney general respectfully disagreed with the ruling, “We originally obtained concurrence from all parties prior to filing, and because it failed to include mention of the conflict wall in this case…Attorney General Schuette will continue to fight aggressively for Flint families and remains thankful to the many Flint residents and elected officials who expressed their support of his actions.” The denial came the day before Judge Lawson is to take up an emergency motion in the case: today, Judge Lawson must decide whether and how the State of Michigan and both state and Flint officials should—or must—comply with a largely ignored federal court order requiring door-to-door delivery of bottled water to Flint homes lacking a working water filter.

The legal challenge dates back to last November, when Judge Lawson ordered the state and City of Flint to provide and finance the provision of four cases of bottled water per resident per week if officials cannot prove faucet filters are working to remove harmful lead. That was an order Gov. Snyder’s administration opposed, arguing it is “overbroad,” and one which the city is fiscally unable to meet; indeed, Michigan has filed an emergency motion with the U.S. Sixth Circuit Court of Appeals to block the order, arguing before the court that while the state was not “reluctant “to comply with the order, rather it was confronted by “financial, logistical, and practical difficulties” in doing so. According to state officials, the order would be a five-fold increase over current efforts and require another 137 trucks, hiring at least 150 additional people and “a warehouse so large it is not clear if one even exists in the Flint area” at a cost of more than $11 million per month. In his order at the beginning of last month, Judge Lawson wrote: “The main thrust of the ordered relief is the proper installation and maintenance of tap water filters. For those homes that have properly installed and maintained water filters in place—which is the vast majority of residences, if the state defendants’ witnesses are to be believed—bottled water delivery is not necessary and was not ordered.” While testing shows lead levels in Flint water are on the decline, Flint residents have been instructed to use only filtered or bottled water for consumption, and researchers have encouraged those practices until further notice from state or federal officials: no amount of lead is considered safe.

Does East Cleveland Have a Future? Ohio’s Environmental Protection agency has shut down a waste site in East Cleveland which currently holds an estimated 2 million yards of waste and construction debris, piled up over the past few years by Arco Recycling, declaring it an unpermitted landfill. In the nonce, former East Cleveland Mayor Eric Brewer worked with Auburn Environmental to understand the harm which might already have occurred at a site which features a combination of toxic gas and toxic particles both on the outside and inside of the property—and which appears to have been operating without any legal authority granted by the municipality. The EPA has given Arco Recycling two weeks to clean up or face further actions. Given the small city’s fiscal depletion and insolvency—and the lack of any state response, it would almost appear to be another Flint-like situation, with grave implications for public health and safety, and a fiscal inability by the small city to address on its own—either fiscally or governmentally.

Is there Unpromise in PROMESA? According to Governor Ricardo Rosselló Nevares, it is time for the PROMESA Oversight Board created by the U.S. Congress and former Obama Administration to turn into Puerto Rico’s representative in Washington, D.C., because, otherwise, the various efforts coordinated to strike a fiscal balance and attain socioeconomic development in the U.S. territory will be in vain. The Governor was responding to a lengthy letter from the Board demanding austerity—a demand which appeared to reflect little flexibility with regard to demanding $4.5 billion in spending cuts and/or tax increases per year. While the PROMESA board said it was open with regard to how the Governor achieves that bottom line, the epistle noted: “To be clear, presenting a plan that can achieve at least this level of savings is a pre-requisite to certifying a fiscal plan.”

According to Governor Rosselló Nevares, the delicate state of the island’s public finances, as well as the grave risk of disruption to Puerto Rico’s healthcare services creates what he described as an “unambiguous need” to obtain the federal government’s support in overcoming the crisis, a message that pertains to his administration, but also the Oversight Board—or, as the Governor put it: “The Board has, I believe, that role to fulfill. They need to be the voice for Puerto Rico’s credibility, as did other fiscal boards, like the board in Washington, D.C…For two and a half years, the members of the board in Washington, D.C., using all available financial tools, but were unable to, failed, or attained only marginal improvements. Which is why they had to return to the Capitol to explain two huge faults they had found.” According to Governor Rosselló Nevares, the PROMESA legislation that ordained the oversight board lacked economic development tools critical to the island’s economy and future revenues, and, he added, as with the District of Columbia, where a comparable oversight body was created—that body went back to Congress to ask for fiscal support. But, in addition, the Governor noted, the second element the legislation for D.C. lacked was “equal treatment as a state.”

The Governor was referring to the period nearly three decades ago when the nation’s capitol, Washington, D.C., succumbed to a comparable fiscal crisis which resulted in credit downgrades and the city’s inability to pay its required pension contributions, all while experiencing disruption in public services. In response, Congress intervened by creating an entity similar to the Oversight Board, in 1997, via the National Capital Revitalization Act, a statute which allowed for the transfer of hundreds of programs funded by DC’s administration to the federal government. The act, among other things, had the federal government take over the criminal justice programs and the actuarial deficiencies in the pensions for teachers, police officers, firemen, and judges. In addition, the federal government also increased its contribution to the District’s Medicaid program, from 50% to 70%—changes which, Governor Rosselló Nevares noted, when made, provided for a nation’s capital city that “was able to thrive.” According to the Governor, under PROMESA, “We have a report from that group, which could presumably help our economic development, but it’s not binding and we don’t know what we’re going to do…The Board, like us, should be a spokesperson to our credibility, and they should tell those who put them there (Congress) that Puerto Rico is taking action, and we’re making good progress.” Although the Governor urged the board members to take up a position in favor of the U.S. territory, while PROMESA regulates the pension and public debt payments, the federal entity’s mandate is explicit: restoring fiscal discipline and achieving Puerto Rico’s return to the capital markets under reasonable conditions.

Consequently, Gov. Rosselló Nevares has focused on providing tools for the private sector, enabling the development of infrastructure projects, and ensuring the continuity of certain collections by approving the extension of Act 154 (which created the 4% tax on foreign companies); but he still counsels “there needs to be action from the federal government,” noting: “You may take fiscal measures to check them off the list, but without economic development, it would have a noxious effect, possibly on emigration, on the quality of life for citizens, and the social environment,” as he rejected the Financial Oversight and Management Board for Puerto Rico’s demands for quick and deep austerity measures, deriding the letter from the oversight board as one demanding an “average 79% haircut,” insisting, instead, “We will reflect a fundamental willingness to pay based upon available resources, while satisfying the need for essential services, adequate funding for public pensions and providing a platform for economic growth, all as required by [the Puerto Rico Oversight, Management and Economic Stability Act].”

Fighting for Cities’ Futures

eBlog, 1/23/17

Good Morning! In this a.m.’s eBlog, we consider the ongoing fiscal and governing challenge to Detroit’s future—especially with regard to the quality of education for the city’s future leaders; then we learn from one of the unsung heroes, retired U.S. Judge Gerald Rosen, about his reflections and role in Detroit’s exit from the largest municipal bankruptcy in American history. Then we return to the historic Virginia municipality of Petersburg, where, in its struggle to exit insolvency, a citizen effort is underway to recall its elected leaders. Finally, in the category of ‘when it rains it pours,’ we consider the city hall relocation underway in San Bernardino—one month before it hopes to gain U.S. Bankruptcy Judge Meredith Jury’s approval of the city’s plan of debt adjustment, permitting the city to egress from the longest municipal bankruptcy in American history.

Fighting for Detroit’s Fiscal Future. The City of Detroit is siding with seven Detroit public schoolchildren suing Gov. Rick Snyder and Michigan state education officials over their right to access literacy. (See Jessie v. Snyder, #16-CV-13292, U.S. District Court), having filed an amicus brief in a proposed class action lawsuit against Gov. Snyder and Michigan education officials in a legal challenge seeking to establish that literacy is a U.S. constitutional right. The suit, which was filed last September by a California public interest law firm, claims the state has functionally excluded Detroit children from the state’s educational system; the suit seeks class-action status and several guarantees of equal access to literacy, screening, intervention, a statewide accountability system, as well as other measures. Detroit’s amicus brief urged the court to hold access to literacy as being fundamental, arguing the plaintiffs have alleged sufficient facts to show they are being denied that right: “Denying children access to literacy today inevitably impedes tomorrow’s job seekers and taxpayers; fathers and mothers; citizens and voters…That is why the Supreme Court has stressed the ‘significant social costs borne by our nation’ when children suffer the ‘stigma of illiteracy’—and are thereby denied ‘the basic tools by which (to) lead economically productive lives to the benefit of us all…The City of Detroit (though it does not control Detroit’s schools) is all too familiar with illiteracy’s far-reaching effects.”

A critical fiscal issue for every city and county is the perceived quality of its public schools—a perception critical to encouraging families with children to move into the city—thereby positively affecting assessed property values. The challenge has been greater in Detroit, where the schools’ fiscal and educational insolvencies led to the appointment of former U.S. Bankruptcy Judge Steven Rhodes to serve as DPS’s Emergency Manager. In Detroit, politics at the state level imposing a disproportionate number of charter schools has meant that today Detroit has a greater share of students in charters than any U.S. city except New Orleans; however, half the charters perform only as well, or worse than, Detroit’s traditional public schools—mayhap a challenge of having a state attempt to substitute itself over local control. Perhaps former state representative Thomas F. Stallworth III, who helped navigate the passage of the 2014 legislation that paved Detroit’s way out of bankruptcy, put it more succinctly: “We’ll either invest in our own children and prepare them to fill these jobs, or I suppose maybe people will migrate from other places in the country to fill them…If that’s the case, we are still left with this underbelly of generational poverty with no clear path out.”

But, in Michigan, it appears that it has been for-profit companies that expressed the greatest interest: they now operate about 80 percent of charters in Michigan, far more than in any other state. In the wake of the state action, and even as Michigan and Detroit continued to preside over an exodus of families, the number of charter schools grew: Michigan today has nearly 220,000 fewer students than it did in 2003, but more than 100 new charter schools. The number not only grew, but the legislature made sure accountability did not: the legislature in 2012 repealed in the Revised School Code Act 451 the state’s longstanding requirement that the Michigan Department of Education issue annual reports monitoring charter school performance; and the state even created a state-run school district, with new charters, in an effort to try to turn around Detroit’s lowest performing schools. Indeed, 24 charter schools have opened in Detroit since the legislature removed the cap 2011: eighteen charters whose existing schools were at or below Detroit’s dismal performance expanded or opened new schools—that despite increasing evidence students in one company’s schools grew less academically than students in the neighboring traditional public schools. By 2015, the Education Trust-Midwest Michigan noted that charter school authorizers’ performance overall had improved marginally over the previous year, but remained terribly low compared to leading states’ charter sectors, in its report, Accountability for All: 2016, The Broken Promise of Michigan’s Charter Sector. The report celebrates high-performing authorizers and sheds light on the devastatingly low performance of other authorizers, adding that roughly one-quarter of one group’s eligible schools ranked among the worst performing 10 percent of schools statewide. Similarly, according to the Trust, a federal review of a grant application for Michigan charter schools found an “unreasonably high” number of charters among the worst-performing 5 percent of public schools statewide, even as the number of charters on the list had doubled from 2010 to 2014.

The great press to create charter schools has led to another challenge: today Detroit has roughly 30,000 more seats, charter and traditional public, than students. For a system desperate for investment in quality education, instead it has badly failed in elementary math; and there is great risk of a discriminatory system: Detroit Public Schools today bears the human and fiscal burden of trying to educate most of Detroit’s special education students. In contrast, charter schools are concentrated downtown, with its boom in renovation and wealthier residents. With only 1,894 high school age students, there are 11 high schools. Meanwhile, northwest Detroit — where it seems every other house is boarded up, burned or abandoned — has nearly twice the number of high school age students, 3,742, and just three high schools. The northeastern part of the city is even more of an education desert: 6,018 high school age students and two high schools.

Like others elsewhere, charter schools receive roughly the same per-pupil state dollars as public schools; however, in Detroit, it is about $7,300 a year — roughly half what New York or Boston schools get, and about $3,500 less than charters in Denver or Milwaukee.

With the significant fiscal challenges to the Detroit Public Schools, Mayor Mike Duggan had proposed an appointed Detroit Education Commission to determine which neighborhoods most needed new schools and to set standards to close failing schools and ensure that only high performing or promising ones could replicate. Backed by a coalition of philanthropies and civic leaders, the teachers’ union and some charter school operators, Mayor Duggan has succeeded in restoring local control of majority-black Detroit Public Schools, and supported the proposal. In the waning days of the legislative session, House Republicans offered a deal: $617 million to pay off the debt of the Detroit Public Schools, but no commission. Lawmakers were forced to take it to prevent the city school system from going bankrupt.

An Interview with Gerald Rosen. U.S. District Court Judge Gerald Rosen, who, as we have written, played an invaluable role in the so-called “Grand Bargain,” which paved the way for Detroit to exit the largest chapter 9 municipal bankruptcy in U.S. history—and who will now join retired U.S. Bankruptcy Judge Steven Rhodes, who presided over Detroit’s municipal bankruptcy, in an interview with the Detroit Free Press, said, in response to the query how well Detroit was doing in adhering to its court approved plan of debt adjustment:  “We are hitting the marks, exceeding them in most areas — certainly revenue, I think the last report I saw was about 2 percent above the projected revenue. On budget. Expenditures are below — not much — but slightly below what was projected. Those are two important things…Certainly, investment and growth in the downtown area, certainly Midtown, and with the Ilitch development coming to fruition, the Red Wings, Pistons, some of the entertainment venues becoming a reality now, I expect the area between Midtown and downtown will become very vibrant over the next two-three years.”

Asked what the most difficult part of that case was, aside from the Grand Bargain, Judge Rosen responded: “You have to go back and see what the case was when we found it, which was an assetless bankruptcy. That was the most difficult part, for me. Certainly, there were a lot of first-impression legal issues. Certainly there were issues that could have gone all the way up to the U.S. Supreme Court, whether it was the collision between the federal bankruptcy code and the federal constitutional supremacy clause and the Michigan Constitution’s provisions to protect pensions. But there were also a lot of other really important issues: The tenor of the security instruments, of the finance instruments, the level and tenor of their security, were all major issues in the bankruptcy, whether they could be crammed down all across the rope line on the financial creditors’ side were really first-impression issues.” He added: “Overwhelmingly, the most challenging issue for me was an assetless bankruptcy—other than the art. I’ll never forget when I was reading Kevyn Orr’s proposal for creditors, coming to the asset section and realizing that there really weren’t any assets other than the art…It was devastating. Kevyn, he had just hired Christie’s to appraise the art, so he was clearly serious about it. I remember thinking, ‘What the hell have I gotten myself into?’ My job is to get deals. To get deals, you have to have revenue or assets that can be monetized into revenue, and the cupboard was pretty much bare. There didn’t seem to be much to work with for deals, other than the art.

There were other aspects to the DIA that I was concerned about. This was a time when Detroit was cannibalizing its heritage to mortgage its future, consistently over the decades. In terms of Detroit’s future, it didn’t make sense to me to do that again, but I was realistic.

Time was Detroit’s enemy. The only way to get through the bankruptcy in any sort of expeditious way was through consensual agreements, and the only asset that could be monetized was the art. So that’s basically what led to the idea of the Grand Bargain—trying to figure out a way to monetize the art without liquidating it, and giving the proceeds to the retirees. Neat trick.

I’ll never forget sitting in this little condo (in Florida) thinking, “What the hell have I gotten myself into? Is my legacy going to be that we liquidated one of the great art collections in the world for sheikhs in Dubai and oligarchs in Russia?” I wasn’t very excited about that.

There was another aspect too. One of the few nascently growing areas in Detroit was Midtown. I went on the DIA website and I saw that the DIA attracted over 600,000 people a year to Midtown. I thought, “Gee whiz, liquidating the DIA would be like dropping a hydrogen bomb in Midtown.” It would suck the life out of it. So there was that part of it.”

What would be the theme song for Detroit’s bankruptcy case?

“Don’t Stop Thinking About Tomorrow.”

We might be having some new City Council members a year from now. What would you suggest to the new ones potentially coming on board?

“I’m not in politics. I’m not a political person in the sense of being involved in the political maw, but my observation is that Mayor (Mike) Duggan is working very positively with President (Brenda) Jones and other members of the council in a way that has not been done by any mayor in years and years.

“At the same time, my word of caution is that we have to be careful to continue to provide the fertile ground that Detroit is for investment for people coming in. Part of that is not placing onerous regulation on people coming in, with artificial employment requirements. I understand the social need for that and I applaud it. I think if Detroit is going to continue the comeback that we are on, the neighborhoods have to be part of it and the African-American population has to be part of it. But you can’t disincentivize people coming in.”

You think that’s been done recently?

“I’m a little bit concerned about the community benefits ordinance. The one that was passed was certainly better than the alternative, but I’m still leery of it because it’s creating entry barriers.”

What was the most surprising individual (Kwame Kilpatrick text) message you saw?

“A lot of that is sealed. I would just refer to it generically by saying there was very little public business conducted by the Mayor and his associates. I’m sure they conducted business by communication means other than texts, but these were city-provided pagers. I assume that the city provided the pagers for people to be able to conduct city business on them, and I saw very little. I learned a lot of new text language that I hadn’t known before, and I appreciate urbandictionary.com.”

Twenty-four hours left in the Obama administration. It’s pardon and commutation time. Does the former mayor deserve one?

No. Absolutely not. I have to be a little cautious, but I presided over that grand jury for 2 ½ years.

Political Leadership & Municipal Insolvency. In Virginia, Petersburg residents who blame their elected municipal leaders for their city’s collapse into insolvency have filed dual petitions to oust both the incumbent and former mayor from their City Council seats—after, over months, gathering the legally required number of signatures from registered voters of Wards 3 and 5 to ask for the removal of Mayor Samuel Parham and W. Howard Myers, whose term as mayor ended this month; both are up for re-election next year. According to the petition, Mayor Parham “has conducted himself in the office of City Councilman, Vice Mayor and Mayor in such a way to govern the City of Petersburg chaotically, unpredictably, secretly and wastefully.” The two-page cover sheet to the petition has garnered 276 certified signatures. (Virginia law requires the petitioners to gather signatures equal to 10 percent of the voter turnout in the contest that resulted in an official’s initial election. For Parham, the number is 160.) The petitions were filed on January 20th in Petersburg Circuit Court under a provision in Virginia law which allows the court to remove officials for specific reasons, which includes certain criminal convictions. Here, in this instance, petitioners cited “neglect of duty, misuse of office, or incompetence in the performance of duties,” faulting the current and former mayor with failing to heed warnings of Petersburg’s impending insolvency, but also alleging ethical breaches and violations of open government law. “Nothing has happened in the new year, with the installation of new council officers, to demonstrate that Myers or Parham are any more capable of providing effective oversight of city government than they have over the past two years,” according to Ms. Barb Rudolph, a local activist and organizer of the good government group Clean Sweep Petersburg. The effort came as Petersburg’s mounting legal claims have now exceeded nearly $19 million in past-due invoices and the city’s budget which was $12 million over budget: the municipality has experienced a stretch of structurally imbalanced budgets dating back to 2009. The City Council fired former City Manager William E. Johnson II last March. For his part, Mayor Parham defended his decisions since taking office, reporting he has done the best he could with the guidance he has received, and noting: “I serve at the pleasure of the people of Petersburg and, with God as my witness, I have tried my best.”

The ouster filings came as former Richmond City Manager, now consultant Robert Bobb, has been hired by the City Council to try to put the city back into solvency. Mr. Bobb has issued a request for a forensic audit of spending over the past three fiscal years—notwithstanding reservations expressed by City Attorney Joseph Preston, who noted that the city’s finances are included in a special grand jury investigation which began as a probe of the Petersburg Police Department. Petersburg obtained short-term financing last month to help meet payroll and other ongoing expenses, with Mr. Bobb reporting the cost of Petersburg’s outstanding invoices has been cut from nearly $19 million to about $6 million. Next comes a session to meet with about 400 of the city’s vendors to try to begin to sort out what they are owed, with a city spokesperson Thursday stating the Petersburg has entered into a payment plan to make good on Petersburg’s share of employee and school worker pensions overdue to the Virginia Retirement System: Petersburg and the city school division collectively owed just over $4.2 million to the system as of last week; however, current payments have resumed, and plans are in place to pay down the balance by $100,000 each month, officials said.

The citizen petitions focus largely on events from last year, but reference years of mounting trouble. The issue for the courts is sufficiency, as a judge in Bath County last week demonstrated when the judge dismissed a similar petition to remove three members of the county’s Board of Supervisors, finding the complaints raised by residents there were insufficient to require a judicial reversal of election results. However, Ms. Rudolph said the Petersburg petitions contain more serious charges, noting: “We believe that, on its merits, it’s far more substantive than the Bath County removal action that was recently rejected by the circuit court there.” Included among the two-page list of grievances documenting reasons for Mayor Myers’ removal were allegations he had “flagrantly and repeatedly acted in contravention of the City of Petersburg’s Code of Ethics” by attempting to “intimidate and silence a critic,” who remains unnamed, by “attempting to harm the citizen’s good standing with her employer.” Petitioners also criticized the Myers-led council for possibly violating the Council’s own rules and the city charter in holding a re-do of a vote to bring in the Bobb Group two days after an initial measure to hire the firm failed. City Attorney Preston has said that the Council did nothing wrong.

Quake & Shake. San Bernardino, on track to end the longest chapter 9 municipal bankruptcy in U.S. history next month, now faces a physical and fiscal challenge not listed in its plan of debt adjustment: a substantial earthquake risk. San Bernardino has two independent engineering evaluations — from 2007 and 2016 — saying City Hall would be unsafe in an earthquake. Specifically, the February 2016 study concludes a magnitude 6.0 earthquake would lead to “a likelihood of building failure” for City Hall, which was designed before code updates following the 1971 Sylmar and 1994 Northridge earthquakes. The building sits along two fault lines. That means the City has plans for vacating City Hall by April, as all employees move out of a building determined to be a substantial earthquake risk, with the approximately 200 municipal employees set to relocate to several leased sites set by a unanimous Council vote. A public information counter will direct members of the public to whatever service they’re seeking, as will signs.

Governing Challenges of Federalism & Severe Fiscal Distress

eBlog, 1/20/17

Good Morning! In this a.m.’s eBlog, we consider the deteriorating municipal fiscal conditions in Connecticut’s central cities, a new twist in New Jersey’s usurpation of municipal governance in Atlantic City, and the ongoing challenges in Puerto Rico where the PROMESA Board has provided new Governor Ricardo Rosselló Nevares additional time to submit a new fiscal plan—albeit a plan potentially complicated by a court ruling, as well as uncertainty with regard to potential changes in direction from Washington where, later this morning, a new Trump Administration takes the reins of power in Washington, D.C.  

Can Connecticut Help to Avert Municipal Bankruptcies? Gov. Daniel Malloy, in his State of the State address this month, stated he wanted to “ensure that no Connecticut city or town will need to explore the avoidable path of [municipal] bankruptcy,” indicating he would be working on an initiative involving statewide restructuring of local aid, especially for schools. His remarks seemed to parallel a new report, “Connecticut’s Broken Cities,” by Stephen Eide of the Manhattan Institute, in which he wrote: “State government is almost certainly going to have to get involved in the case of Hartford…Hartford may need a bailout to restore solvency.” However, the new report also examined the fiscal challenge of three other of the state’s central cities: Bridgeport, New Haven, and Waterbury—cities confronted by nearly $5 billion in OPEB and public pension obligations, estimating their combined annual OPEB liabilities at $120 million, and their unfunded pension liability to be $2.7 billion. The report paints a fiscal picture of municipalities which have the highest property taxes in the state—and the highest per capita municipal debt. Indeed, the rating agencies awarded Hartford two four-notch downgrades last year: Moody’s reduced the city’s rating to junk-level, putting it in the lowest one percent credit rating of all municipalities—even as it cited the city as at risk of further downgrades “over the medium term,” with its analysts noting that: “For the time being, Waterbury, and Bridgeport, and most likely also New Haven, can continue to muddle through without the need for extraordinary support from the state…[but] the same cannot be said for Hartford.” Hartford faces a $48 million gap on a $270 million budget, notwithstanding the steep budget cuts and layoffs the city undertook last year. The city appears to be on the wrong fiscal end of a teeter-totter: its reserves sagged 34% from FY2006 to FY2015; while its debt per capita escalated 78% over the same period, according to the report. Or, as Mayor Luke Bronin describes it: “The city used every trick up its sleeve to try to keep the lights on…I think all of those were mistakes, but in a big sense they’re a symptom of the problem, not the problem itself.” Gov. Malloy attributes the city’s property tax as the key fiscal contributor, whilst Mayor Bronin, the Governor’s former Chief Counsel, has pressed, as we have previously noted, for a regional solution—one that might, for instance, mirror some of the innovative fiscal, regional efforts in the St. Paul-Minneapolis and Denver metro areas. Mayor Bronin believes that a municipal fiscal partnership could include shared services or revising state formulas for education and health funding—a proposal that in some ways fits Connecticut Superior Court Judge Thomas Moukawsher’s order last fall directing the state to revise its state aid to education formula to better serve students in low-income municipalities—an order which Connecticut Attorney General George Jepsen is currently appealing. For his part, Gov. Malloy said a fairer distribution of Connecticut’s state aid to local governments could provide an important lifeline to avert chapter 9 bankruptcies—but that any such aid would mean the state would “play a more active role in helping less-affluent communities – in helping higher-taxed communities – part of that role will be holding local political leadership and stakeholders to substantially higher standards and greater accountability than they’ve been held to in the past: We should do it so that increased aid doesn’t simply mean more spending on local government.”

A Bridge to Local Experience. The New Jersey Department of Community Affairs has hired Atlantic City business administrator Jason Holt to assist in its state takeover of the distressed city, in this case adding a key individual who has worked under Mayor Donald Guardian for the last two years: Mr. Holt is charged with assisting the Department’s Division of Local Government Services in taking on the virtually insolvent city’s fiscal. He seems very well equipped, having served previously as Mayor Guardian’s solicitor, before serving as the city’s business administrator. Indeed, Mayor Guardian yesterday noted: “Over the past three years, Jason Holt has been an integral part of my team…When I originally selected him as my solicitor and then as my business administrator, I did so because of his extreme intellect and professionalism. Obviously, the State sees the same thing in Mr. Holt.” The transition is likely enhanced, because Mr. Holt has worked closely over the last two months with Local Government Services Director Tim Cunningham and Jeffrey Chiesa, the state’s designee in charge of Atlantic City financial matters. Department of Community Affairs spokesperson Lisa Ryan noted: “Mr. Holt’s hire by DLGS formalizes the work he has been doing in practice for the last two months…Mr. Holt will leave the City’s business administrator position, although the work he will do for DLGS will largely be the same as what he is doing now.” She added that Mr. Holt will continue working out of City Hall with his official first day with the DLGS set for next Monday. The state decision, however, has not been met with uniform approval: Assemblyman Chris Brown (R-Atlantic), who has been critical of the state for not producing its own fiscal recovery plan after rejecting the city’s, noted the lack of state transparency: “Without a transparent plan, even if they laid all the state’s experts end to end, they’d still never reach a solution.” In contrast, Mayor Don Guardian, who, in a statement said Mr. Holt has been an integral part of his team, added: “When I originally selected him as my solicitor, and then again as my business administrator, I did so because of his extreme intellect and professionalism. Obviously, the state sees the same thing in Mr. Holt…I look forward to working with him in his new capacity.” Indeed, Mr. Holt brings considerable experience, having previously served as corporation counsel for East Orange, Essex County, where, he provided legal counsel to both the Mayor and City Council, oversaw the complete spectrum of that city’s legal affairs, and played a key role in revamping its public-safety initiatives.

Is There Promise in PROMESA? Just as Puerto Rico enters its 12th year of economic depression, the PROMESA Oversight Board has informed new Governor Ricardo Rosselló Nevares that the Board is willing to grant additional time for the submission of a new fiscal plan—provided the Governor is willing to lay off public employees, reduce the pensions of thousands of retirees, make budget cuts for the University of Puerto Rico and Mi Salud, and extract an additional $1.5 billion from the pockets of corporations and individuals. In addition, the Board indicated it would be willing to extend the stay on litigation provided by PROMESA until May 1st, if Gov. Rosselló Nevares’s administration presents a plan to renegotiate Puerto Rico’ public debt. According to the calculations provided by the Board, this could mean an adjustment of $3 billion to the debt service, with the proposals gleaned from a 14-page letter, which appeared to be a warning to the new Governor that he must balance the budget in the next two fiscal years, and that the proposals for adjustments in public expenditures are “prerequisites” for the Board to certify any plan submitted. In response, Puerto Rico’s representative to the Board, Elías Sánchez Sifonte, immediately stated that Gov. Rosselló Nevares’s administration will seek to meet the Board’s conditions. He also assured that there are other mechanisms to balance the budget and close the fiscal gap—a gap the Oversight Board estimates at nearly $7.6 billion. In its letter, the Board advised the new Governor that his team could submit a new fiscal plan by the end of February, and that the document should be approved by March 15th—all subject to the Governor agreeing to balance the budget with a “one and done” approach, with “no discussion or consideration of short-term liquidity loans or near-term financings,” despite the contention by Gov. Rosselló Nevares and his team that such financing are a prerequisite in order to avoid a government shutdown. The stiff challenges, which the new Governor’s administration agreed were not so different from its own preliminary forecasts, were, nevertheless, perceived as “dramatic,” albeit key to avoid “the total collapse” of the government, blaming the previous Gov. Alejandro García Padilla’s administration’s “unwillingness to cooperate, [and] wasting time in presenting a fiscal plan that did not meet the requirements.”

The Board’s orders will affect not only Puerto Rico’s public employees, government pensioners, and foreign corporations and their tax liabilities, but also holders of Puerto Rican municipal bonds: those bondholders, in every state, could realize a reduction of as much as 80% of the annual payments that Puerto Rico must make—through different issuers—over the next two years. Sacrifices, it appears, will be widespread: the Board also proposed that Gov. Rosselló cut 23% in payroll expenses (about $900 million), which would imply a reduction in the number of public sector employees, an indicator that is already at a historical low; reduced public pensions by 10 percent—in a “progressive manner,” eliminated 100 percent of the subsidies to municipalities (about $400 million), which would be offset by a revision to property taxes, and higher payments by beneficiaries of Puerto Rico’s healthcare plan, all as part of Board recommendations that could, if implemented, save the U.S. territory as much as $1 billion. The Board added it believed the University of Puerto Rico could cut $300 million (27%) from its budget if it hiked tuitions. if it increased the amount of services among students and faculty members, raised the tuition to those who could afford it, and promoted the arrival of international and continental students to take courses in the institution.

The Board noted that to close Puerto Rico’s budget gap, Gov. Rosselló Nevares’s administration would have to meet with Puerto Rico’s municipal bondholders to make voluntary debt renegotiations through Title VI of PROMESA; albeit negotiations with the creditors would not necessarily take place in good terms: according to the numbers the Board released yesterday, the series of cutbacks and changes in the government would, on their own, be insufficient; ergo bondholders—including thousands of Puerto Rican individuals—will have to accept a cut in the debt service, which could amount to $3 billion.

But Here Come da Judge. Yet even as the PROMESA Board and the new Governor were seeking to come to terms with steps critical to fiscal recovery, the third branch of government stepped into the fiscal fray when U.S. District Judge Francisco Besosa handed a victory to holders of Puerto Rico Employment Retirement System (ERS) bonds, marking one of municipal bondholders’ first legal victories since Puerto Rico began defaulting on municipal bond interest payments about a year ago. Judge Besosa has ordered ERS to shift incoming employers’ contributions from its operating account to a segregated account at Banco Popular de Puerto Rico, directing that such funds remain in the segregated account until all parties agree on a different approach or the court orders the money to be moved out of the account. ERS had $3.1 billion in municipal bond debt outstanding as of July 2, 2016, according to the Puerto Rico government—none of it insured; all of it taxable. Normally, Puerto Rico government employers make employer contributions to support the payment of senior pension funding bonds; last year, as part of Puerto Rico’s emergency order 2016-31 in which it declared the ERS was in an emergency, the obligation of the ERS to transfer employer contributions to the bond trustee was suspended. Last November, Judge Besosa ruled against the plaintiffs in the case concerning the ERS bonds. Simultaneously, he had ruled against several other bondholder plaintiffs in other cases—leading some of the municipal bondholders to appeal to the United States Court of Appeals for the First Circuit—which, last week, generally concurred with Judge Besosa’s opinion (see Peaje Investments, LLC v. Alejandro Garcia-Padilla et al, 4th U.S. Court of Appeals, #16-2431, January 11, 2017), affirming the continued stay on bondholder litigation stemming from the Puerto Rico Oversight, Management, and Economic Stability Act in several cases, albeit ordering Judge Besosa to hold a hearing for the arguments of the lead plaintiff, Altair Global Credit Opportunities Fund, and its co-plaintiffs, with the court writing: “We note that the Altair movants’ request for adequate protection here appears to be quite modest. They ask only that the employer contributions collected during the PROMESA stay be placed ‘in an account established for the benefit of movants.’ In light of ERS’s representation that it is not currently spending the funds, but instead simply holding them in an operating account, this solution seems to be a sensible one.” Thus, this week, Judge Besosa ordered such a segregated account to be set up and that all funds not transferred since the start of the PROMESA litigation stay be deposited in the account within five business days; Judge Besosa also ordered that in the future the ERS should transfer the employer contributions to the segregated account no later than the end of each month, noting that the segregated account will be “for the benefit of the holders of the ERS bonds,” adding, moreover, that said funds will simply sit in the account until a court orders otherwise, although he noted it would not preclude the ERS from transferring the employer contributions to the bond trustee for payment of the bonds, as would normally be the case.

Fiscal & Physical Health & Safety: What Are the Options?

eBlog, 1/18/17

Good Morning! In this a.m.’s eBlog, we consider the deteriorating fiscal situation in East Cleveland, as epitomized by a seeming breakdown in essential municipal services—combined with an absence of any effective state response to its fiscal insolvency. Then we turn to a seemingly forgotten aspect of the change of administrations in Washington, D.C.: what might that mean to Puerto Rico, where a new study delineates the physical and fiscal impacts on mental health from the disparate treatment the U.S. territory receives—and raises the issue—largely unexplored in the campaign: what will the change in Administrations this Friday mean with regard to the fiscal—and health—situation in Puerto Rico?

Hold Your Nose. As if insolvent East Cleveland did not have enough problems affecting its fiscal dilemmas, Ohio—which in the Urban Institute’s new, incredible, handy-dandy fiscal guide to the states, ranks 45th out of the 50 states with regard to expenditures per capita on corrections and has a high share of its population in state prisons, local jails, or under probation or parole supervision (take-up); EPA Director Craig Butler yesterday ordered mountains of construction and demolition debris removed from an open dump located in a residential neighborhood in East Cleveland, issuing a notice of violation and orders to Arco Recycling to stop accepting construction and demolition debris, and to remove the acres of waste from the site, action taking place in the wake of inspection of the site last week in response to citizen complaints, as well as a determination that the site was an open dump, not a recycling facility as claimed by the company’s owner. The dump was supposed to contain only construction and demolition debris, with the bulk coming from hundreds of abandoned nuisance homes demolished by the Cuyahoga Land Bank. Ohio EPA last June had, in response to citizen complaints, ordered Arco officials to draw down the piles of rubble; however, when the EPA inspectors revisited the site last week, they found four-story piles of rubble and debris which had grown over the past year, not shrunk, triggering the notice of violation and the unilateral EPA order. The mountain of garbage no doubt is part of what appears to have contributed to the 36% population decline in the municipality since 2000. The estimated median income in the city is $20,435—lower than it was in the year 2000, and less than half the statewide median household income.

Is there a Trump Promise for PROMESA? In an epistle to Congressional leaders yesterday, U.S. Treasury Secretary Jack Lew and Health and Human Services Secretary Sylvia Burwell urged Congress to pass legislation to help Puerto Rico before the commonwealth is forced to confront more serious health care and economic challenges—where a new set of findings from the first epidemiological study on the state of mental health in Puerto Ricans since 1985 by the Behavioral Sciences Research Institute for the Puerto Rico Administration of Mental Health and Anti-Addiction Services (PRHIA) found that—as part of an effort to justify the allocation of federal funds—7.3% of Puerto Ricans have serious mental conditions—albeit the level is likely considerably greater, but the study does not include homeless persons, which is a vast population thought to also have a large amount of people with mental illnesses or substance dependence. Of these 165,497 people with serious mental health conditions, 36.1% had not received specialized services in the past year, which would sappear to indicate that there are thousands of undiagnosed or untreated mentally ill people in the streets of the country. The study warns of the danger that the critical fiscal situation Puerto Rico faces could end up affecting the services of mental health patients. The Health Insurance Administration (PRHIA)—which administers the Puerto Rico Government Health Plan, upon which almost two million Puerto Ricans rely—faces a fiscal and physical insufficiency crisis that has forced it to incur millions of dollars of debt with their providers—and which, according to PRHIA, has set off a chain reaction, with longer wait times for clinical and therapeutic procedures, overcrowded emergency rooms, attempts to directly charge patients for services, and an increasing exodus of physicians from Puerto Rico. According to the Puerto Rico College of Physicians and Surgeons, “364 physicians left Puerto Rico in 2014, and 500 in 2015,” so that the “PRHIA debt represents a significant threat to maintaining an operational healthcare system.” The study further cautions that the uncertainty and deterioration of the quality of life in Puerto Rico, due to the fiscal crisis, have the potential of increasing the prevalence of mental health conditions in the years to come: “Since 2008, the Island has been affected by an economic recession. As a consequence, Puerto Rico has been facing greater chronic stressors that might have a negative impact on mental health: high levels of unemployment or underemployment, poverty, a drastic reduction of population, and higher levels of crime.”

Puerto Rico has an unemployment rate of over 10%, and a poverty level of 46%. So it was unsurprising that Secretaries Lew and Burwell had sought to “underscore the need for additional legislation early in this [Congressional] session to address the economic and fiscal crisis in Puerto Rico.” The authors noted that the PROMESA legislation enacted last summer was an example of “important progress achieved to date with bipartisan support.” They wrote, however, that the “the work is not done,” focusing on the critical need to pass legislation to avert what they deemed a “Medicaid Cliff” for Puerto Rico and implement an Earned Income Tax Credit (EITC) to incentivize employment—actions made even more critical because the President-elect’s vows to work with Congress to eliminate the Affordable Care Act will put at early risk significant amounts of Puerto Rico’s Medicaid—putting, according to the two outgoing Cabinet Secretaries, up to 900,000 Americans on the island currently receiving health care under the Affordable Care Act at risk. The two added that while the Congressional Task Force on Economic Growth in Puerto Rico, created under PROMESA to analyze challenges in Puerto Rico and propose federal solutions, had only recommended studying the possibility of an EITC for the territory, they wrote that an EITC would be a “powerful driver to bolster Puerto Rico’s future,” describing it as a “most effective and powerful tool” to address structural challenges like the high unemployment and lesser participation in the formal economy, adding that it will be important for Congress to consider solutions such as an expanded Child Tax Credit, continued authorization for Treasury to provide the Commonwealth with technical assistance, reliance on data in benchmarking economic growth, and initiatives to incentivize small business development.

Assessing a City’s Fiscal Future

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eBlog, 1/17/17

Good Morning! In this a.m.’s eBlog, we consider—again—the ongoing fiscal and physical challenges to the City of Flint, Michigan in the wake of the disastrous state appointment of an Emergency Manager with the subsequent devastating health and fiscal subsequent crises, before turning to political stirrings in Atlantic City, New Jersey—where, notwithstanding the city’s state takeover, there appears to be rising aspirations with regard to the City Council’s next election.

Out Like Flint. When Michigan Gov. Rick Snyder delivered his State of the State speech a year ago, he addressed Flint’s water crisis by directly speaking to the city’s residents to say: “I am sorry, and I will fix it.” Today, one year later, as Gov. Snyder preps for his seventh annual address to state legislators, filtered and bottled remain the only safe way for its residents—any resolution of the health care crisis and threat caused by the state’s then-appointed Emergency Manager’s actions that led to such life-endangering contamination problems could be more than two years away from reaching every home. The city’s elected officials contend that Gov. Snyder has not secured sufficient funding to address the city’s problems, while the Governor’s office points to the state’s allocation of $234 million in aid and Congressional approval of $170 million in Flint-inspired funding from which the city may be able to tap tens of millions of dollars. In addition, a year-long Michigan Attorney General’s Office investigation into the Flint crisis has resulted in the filing of charges against 13 city and state workers and officials, including former state-imposed Emergency Managers Darnell Earley and Gerald Ambrose. (From April 2014 until the fall of 2015, while Flint was under state control via Gov. Snyder-appointed emergency managers, the city drew its water from the Flint River, but failed to treat it properly to prevent pipe corrosion, thus allowing lead to not only leach into the drinking water, but also damage the pipes themselves, creating a need for replacement.) It was just a year ago, in his annual address to the Michigan Legislature that Gov. Snyder devoted the first 20 minutes of address to outline the mistakes made in Flint—and his battle plan to overcome them, telling legislators: “There can be no excuse—when Michiganders turn on the tap, they expect and deserve clean, safe water…It’s that simple. It’s that straightforward. So that’s what we will deliver. To the families in Flint, it is my responsibility, my commitment, to deliver…I give you my commitment that Michigan will not let you down.”

Indeed, in that year, crews have replaced service lines in 780 homes so far, according to retired Brig. Gen. McDaniel, who heads the replacement program, who yesterday noted: “If we can do 6,000 homes per year, for the next three years, we should address the problem we have.” Under Gen. McDaniel’s timeline, however, completion and restoration of trust in governance will not be complete until late 2019 or early 2020—and, mayhap more worrisome, funding to pay for the work has not yet been secured.

For her part, Flint Mayor Karen Weaver has constantly lobbied the state for more funding, but reports that the response from Gov. Snyder’s office has been disappointing: one of the reasons for the slow movement of her Fast Start replacement program, which was designed to target neighborhoods with seniors, homes with high lead readings, and high concentrations of children age 6 and under who are most vulnerable to lead exposure. Or, as she put it yesterday: “We should have had money right then…We had $500,000 to start…We’re in our third year of not being able to drink our water. Now where does that make sense in the United States of America? No place that I know of.”

Sen. Jim Ananich (D-Flint) reported he would, as a former teacher, give Gov. Snyder an “incomplete.” While crediting the state’s efforts to provide health services and monitoring, he said funding in general is lacking—and the provision of state aid has, at times, been bungled, noting an original state appropriation of $2 million intended to support families facing water shut-off for non-payment: “That plan included a stipulation that in order to get the money, 70 percent of customers, commercial and residential, have to be up to date on payments,” even though customers were being asked to pay for water they could not use safely, so that, as he put it: “To rectify a problem of undrinkable water, the fix is to make people pay or cut them off.” Sen. Ananich and Genesee County health officer Mark Valacak have praised the state’s immediate health efforts targeting Flint’s most vulnerable populations, its youngest children and pregnant women, but have stressed the need to create a database to track the impacts of residents’ exposure to contaminated water, so that there is a critical understanding of potential long-term human impacts—a request, in response to which, the Michigan Department of Health and Human Services last Friday announced there would be a one-year $500,000 grant to Michigan State University for “long-term tracking of residents exposed to Flint water” between April 2014 and now. It would seem the state ought to–at the same time–undertake an effort to examine the impact on Flint’s assessed property values.

Nevertheless, Mayor Weaver and Flint City Councilman Eric Mays are concerned that the state’s efforts have not closely involved local residents, or, as Councilman Mays put it: “We know (Snyder) has another State of the State address coming up…and we’ll see if he spends as much time on this one talking about Flint as he did on that one…But I don’t believe he’s pushed the Legislature to do what they could do.”

Succession? Even in a city taken over by its garden state, there appears strong interest in who might be the next Mayor. Thus, in Atlantic City, Fareed Abdullah, a substitute teacher and former City Council candidate, has thrown his hat into the ring: he will face Council President Marty Small and Councilman Frank Gilliam in the June Democratic primary, where the winner will take on Republican Mayor Don Guardian. Mr. Abdullah reports: “I want to re-do Atlantic City…People feel left out. And we have to make sure that Atlantic City residents’ voices are heard, and that’s what I’m focused on.” He adds that his priorities include reducing taxes, creating jobs, making re-entry programs for those convicted of crimes and youth programs tied to science and technology, and improving police-community relations: “I want to work with private-sector companies throughout the country, and throughout the world really, to bring more businesses to Atlantic City, which in return would reduce our taxes because we will have more ratables…Building up small businesses and absolutely trying to realize that this is what has made Atlantic City great. The barber shops. The corner stores,” he said. “We don’t want people to forget there’s a whole culture in the barber shop.” (Mr. Abdullah has twice run unsuccessfully for City Council (in 2009 and 2013, just missing election by 72 votes in the most recent), after losing the first effort in no small part because of a 1997 cocaine possession conviction.

Are American Cities at a Financial Brink?

eBlog, 1/13/17

Good Morning! In this a.m.’s eBlog, we consider the ongoing fiscal and physical challenges to the City of Flint, Michigan in the wake of the disastrous state appointment of an Emergency Manager with the subsequent devastating health and fiscal subsequent crises, before turning to a new report, When Cities Are at the Financial Brink” which would have us understand that the risk of insolvency for large cities is now higher than at any point since the federal government first passed a municipal bankruptcy law in the 1930’s,” before briefly considering the potential impact on every state, local government, and public school system in the country were Congress to adopt the President-elect’s proposed infrastructure plan; then we consider the challenge of aging: what do longer lifespans of city, county, and state employees augur for state and local public pension obligations and credit ratings?

Not In Like Flint. Residents of the City of Flint received less than a vote of confidence Wednesday about the state of and safety of their long-contaminated drinking water, precipitated in significant part by the appointment of an Emergency Manager by Governor Rick Snyder. Nevertheless, at this week’s town hall, citizens heard from state officials that city water reaching homes continues to improve in terms of proper lead, copper, alkaline, and bacteria levels—seeking to describe Flint as very much like other American cities. The statements, however, appeared to fall far short of bridging the trust gap between Flint residents and the ability to trust their water and those in charge of it appears wide—or, as one Flint resident described it: “I’m hoping for a lot…But I’ve been hoping for three years.” Indeed, residents received less than encouraging words. They were informed that they should, more than 30 months into Flint’s water crisis, continue to use filters at home; that it will take roughly three years for Flint to replace lead water service lines throughout the city; that the funds to finance that replacement have not been secured, and that Flint’s municipal treatment plants needs well over $100 million in upgrades: it appears unlikely the city will be ready to handle water from the new Karegnondi Water Authority until late-2019-early 2020. The state-federal presentation led to a searing statement from one citizen: “I’ve got kids that are sick…My teeth are falling out…You have no solution to this problem.”

Nevertheless, progress is happening: in the last six months of water sampling in Flint, lead readings averaged 12 parts per billion, below the federal action level of 15 ppb, and down from 20 ppb in the first six months of last year. Marc Edwards, a Virginia Tech researcher who helped identify the city’s contamination problems, said: “Levels of bacteria we’re seeing are at dramatically lower levels than we saw a year ago.” However, the physical, fiscal, public trust, and health damage to the citizens of Flint during the year-and-a-half of using the Flint River as prescribed by the state-appointed Emergency Manager has had a two-fold impact: the recovery has been slow and residents have little faith in the safety of the water. Mayor Karen Weaver has sought to spearhead a program of quick pipeline replacement, but that process has been hindered by a lack of funding.

State Intervention in Municipal Bankruptcy. In a new report yesterday, “When Cities Are at the Financial Brink,” Manhattan Institute authors Daniel DiSalvo and Stephen Eide wrote the “risk of insolvency for large cities in now higher than at any point since the federal government first passed a municipal bankruptcy law in the 1930’s,” adding that “states…should intervene at the outset and appoint a receiver before allowing a city or other local government entity to petition for bankruptcy in federal court—and writing, contrary to recent history: “Recent experiences with municipal bankruptcies indicates that when local officials manage the process, they often fail to propose the changes necessary to stabilize their city’s future finances.” Instead, they opine in writing about connections between chapter 9, and the role of the states, there should be what they term “intervention bankruptcy,” which could be an ‘attractive alternative’ to the current Chapter 9. They noted, however, that Congress is unlikely to amend the current municipal bankruptcy chapter 9, adding, moreover, that further empowering federal judges in municipal affairs “is sure to raise federalism concerns.” It might be that they overlook that chapter 9, reflecting the dual sovereignty created by the founding fathers, incorporates that same federalism, so that a municipality may only file for chapter 9 federal bankruptcy if authorized by state law—something only 18 states do—and that in doing so, each state has the prerogative to determine, as we have often noted, the process—so that, as we have also written, there are states which:

  • Precipitate municipal bankruptcy (Alabama);
  • Contribute to municipal insolvency (California);
  • Opt, through enactment of enabling legislation, significant state roles—including the power and authority to appoint emergency managers (Michigan and Rhode Island, for instance);
  • Have authority to preempt local authority and take over a municipality (New Jersey and Atlantic City.).

The authors added: “The recent experience of some bankrupt cities, as well as much legal scholarship casts doubt on the effectiveness of municipal bankruptcy.” It is doubtful the citizens in Stockton, Central Falls, Detroit, Jefferson County, or San Bernardino would agree—albeit, of course, all would have preferred the federal bailouts received in the wake of the Great Recession by Detroit’s automobile manufacturers, and Fannie Mae and Freddie Mac. Similarly, it sees increasingly clear that the State of Michigan was a significant contributor to the near insolvency of Flint—by the very same appointment of an Emergency Manager by the Governor to preempt any local control.

Despite the current chapter 9 waning of cases as San Bernardino awaits U.S. Bankruptcy Judge Meredith Jury’s approval of its exit from the nation’s longest municipal bankruptcy, the two authors noted: “Cities’ debt-levels are near all-time highs. And the risk of municipal insolvency is greater than at any time since the Great Depression.” While municipal debt levels are far better off than the federal government’s, and the post-Great Recession collapse of the housing market has improved significantly, they also wrote that pension debt is increasingly a problem. The two authors cited a 2014 report by Moody’s Investors Service which wrote that rising public pension obligations would challenge post-bankruptcy recoveries in Vallejo and Stockton—perhaps not fully understanding the fine distinctions between state constitutions and laws and how they vary from state to state, thereby—as we noted in the near challenges in the Detroit case between Michigan’s constitution with regard to contracts versus chapter 9. Thus, they claim that “A more promising approach would be for state-appointed receivers to manage municipal bankruptcy plans – subject, of course, to federal court approval.” Congress, of course, as would seem appropriate under our Constitutional system of dual sovereignty, specifically left it to each of the states to determine whether such a state wanted to allow a municipality to even file for municipal bankruptcy (18 do), and, if so, to specifically set out the legal process and authority to do so. The authors, however, wrote that anything was preferable to leaving local officials in charge—mayhap conveniently overlooking the role of the State of Alabama in precipitating Jefferson County’s insolvency.  

American Infrastructure FirstIn his campaign, the President-elect vowed he would transform “America’s crumbling infrastructure into a golden opportunity for accelerated economic growth and more rapid productivity gains with a deficit-neutral plan targeting substantial new infrastructure investments,” a plan the campaign said which would provide maximum flexibility to the states—a plan, “American Infrastructure First” plan composed of $137 billion in federal tax credits which would, however, only be available investors in revenue-producing projects—such as toll roads and airports—meaning the proposed infrastructure plan would not address capital investment in the nation’s public schools, libraries, etc. Left unclear is how such a plan would impact the nation’s public infrastructure, the financing of which is, currently, primarily financed by state and local governments through the use of tax-exempt municipal bonds—where the financing is accomplished by means of local or state property, sales, and/or income taxes—and some user fees. According to the Boston Federal Reserve, annual capital spending by state and local governments over the last decade represented about 2.3% of GDP and about 12% of state and local spending: in FY2012 alone, these governments provided more than $331 billion in capital spending. Of that, local governments accounted for nearly two-thirds of those capital investments—accounting for 14.4 percent of all outstanding state and local tax-exempt debt. Indeed, the average real per capita capital expenditure by local governments, over the 2000-2012 time period, according to the Boston Federal Reserve was $724—nearly double state capital spending. Similarly, according to Census data, state governments are responsible for about one-third of state and local capital financing. Under the President-elect’s proposed “American Infrastructure First” plan composed of $137 billion in federal tax credits—such credit would only be available to investors in revenue-producing projects—such as toll roads and airports—meaning the proposed infrastructure plan would not address capital investment in the nation’s public schools, libraries, etc. Similarly, because less than 2 percent of the nation’s 70,000 bridges in need of rebuilding or repairs are tolled, the proposed plan would be of no value to those respective states, local governments, or users. Perhaps, to state and local leaders, more worrisome is that according to a Congressional Budget Office 2015 report, of public infrastructure projects which have relied upon some form of private financing, more than half of the eight which have been open for more than five years have either filed for bankruptcy or been taken over by state or local governments.

Moody Southern Pension Blues. S&P Global Ratings Wednesday lowered Dallas’s credit rating one notch to AA-minus while keeping its outlook negative, with the action following in the wake of Moody’s downgrade last month—with, in each case, the agencies citing increased fiscal risk related to Dallas’ struggling Police and Fire Pension Fund, currently seeking to stem and address from a recent run on the bank from retirees amid efforts to keep the fund from failing, or, as S&P put it: “The downgrade reflects our view that despite the city’s broad and diverse economy, which continues to grow, stable financial performance, and very strong management practices, expected continued deterioration in the funded status of the city’s police and fire pension system coupled with growing carrying costs for debt, pension, and other post-employment benefit obligations is significant and negatively affects Dallas’ creditworthiness.” S&P lowered its rating on Dallas’ moral obligation bonds to A-minus from A, retaining a negative outlook, with its analysis noting: “Deterioration over the next two years in the city’s budget flexibility, performance, or liquidity could result in a downgrade…Similarly, uncertainty regarding future fixed cost expenditures could make budgeting and forecasting more difficult…If the city’s debt service, pension, and OPEB carrying charge elevate to a level we view as very high and the city is not successful in implementing an affordable plan to address the large pension liabilities, we could lower the rating multiple notches.” For its part, Fitch Ratings this week reported that a downgrade is likely if the Texas Legislature fails to provide a structural solution to the city’s pension fund problem. The twin ratings calls come in the wake of Dallas Mayor Mike Rawlings report to the Texas Pension Review Board last November that the combined impact of the pension fund and a court case involving back pay for Dallas Police officers could come to $8 billion—mayhap such an obligation that it could force the municipality into chapter 9 municipal bankruptcy, albeit stating that Dallas is not legally responsible for the $4 billion pension liability, even though he said that the city wants to help. The fund has an estimated $6 billion in future liabilities under its current structure. In testimony to the Texas State Pension Review Board, Mayor Rawlings said the pension crisis has made recruitment of police officers more difficult just as the city faces a flood of retirements.