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.

 

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