The Human & Fiscal Prices of Insolvency

October 20, 2017

Good Morning! In today’s Blog, we consider the spread of Connecticut’s fiscal blues to its municipalities; then we consider the health and fiscal health challenge to Flint; before, finally, observing the seemingly worsening fiscal and human plight of Puerto Rico.

Visit the project blog: The Municipal Sustainability Project 

The Price of Solvency. It appears that the City of Hartford would have to restructure its debt to receive the requisite state assistance to keep it out of chapter 9 municipal bankruptcy under the emerging state budget compromise between the Governor and Legislature. Under the terms of the discussions, the State of Connecticut would also guarantee a major refunding of the city’s debt, as well as cover a major share of the city’s debt payments, at least for this fiscal year and next, with House Majority Leader Matt Ritter (D-Hartford) indicating this was part of a bipartisan compromise the legislature recognizes is needed to avert municipal bankruptcy: “This budget gives the city all of the tools it needs to be on a structural path to sustainability…This solution truly is a bipartisan one.” According to the city’s Mayor Luke Bronin, Hartford needs about $40 million annually in new state assistance to avert bankruptcy. The emerging agreement also includes $28 million per year for a new Municipal Accountability Review Board, likely similar to what the Commonwealth of Virginia has used so effectively, to focus on municipalities at risk of fiscal insolvency and to intervene beforehand: approximately $20 million of that $28 million would be earmarked for Hartford. The new state budget would require Hartford to restructure a significant portion of its capital debt, but the state would guarantee this refinancing, an action which—as was the case in Detroit—will help Hartford have access to lower borrowing costs: the agreement also calls for the state to pay $20 million of the city’s annual debt service—at least for this fiscal year and next.

The state actions came as Moody’s Investor Service this week placed ratings of 26 of the state’s municipalities, as well as three of the state’s regional school districts under review for downgrade, citing state aid cuts in the absence of a budget, warning those municipalities and districts face cuts in state funding equal to 100% or more of available fund balance or cash—with those cities most at risk: Hartford (which currently receives 50 percent of its revenues from the state), New Haven, New Britain, West Haven, and Bridgeport. Moody’s was even fiscally moodier, dropping the credit ratings of an additional 25 Connecticut cities and towns, and three other regional school districts, while maintaining the existing negative outlook on the rating of one town. Moody’s list did not, however, include Hartford. The down-gradings come as the state has continued to operate under Executive order in the absence of an approved fiscal budget, now more than a fiscal quarter overdue. Gov. Dannel Malloy, at the beginning of the week, had submitted his fourth FY2018-19 budget to lawmakers, a $41.3 billion spending plan in the wake of his veto last month of the version approved by the legislature, reporting that his most recent fiscal plan would eliminate some revenue proposals, including new taxes on second homes, cell phone surcharges, ridesharing fees, and daily fantasy sports fees—instead, he has proposed an additional $150 million in spending over the biennium, while simplifying the implementor language. According to Moody’s, under the Governor’s new executive order, state aid to local governments will be nearly $1 billion below last year’s level—or, as Moody’s put it: “The current budget impasse highlights the ongoing vulnerability of funding that Connecticut provides to its local governments.” Connecticut traditionally has provided significant funding to its local governments, largely through education cost sharing grants, but also through payments in lieu of taxes and other smaller governmental grants. Connecticut’s GO bond prices have deteriorated with 10-year credit spreads around 80 basis points, well above historical levels, according to Janney Capital Markets Managing Director Alan Schankel: “A state’s fiscal stress tends to flow downstream to local governments, and Connecticut is no exception.” The fiscal irony is that despite the state’s high per capita wealth, the state’s debt, at 9.2% of gross state product, is highest among the states, lagging only behind Illinois.

Not in Like Flint. U.S. District Court Judge David Lawson has ordered Flint’s City Council to choose a long-term water source for the city by Monday after it spent more than three months refusing to make a decision. In his 29-page opinion, he took Flint’s City Council to task for sitting on an April agreement backed by Mayor Karen Weaver, the state and the federal Environmental Protection Agencies that would see the city stay on the Detroit area water system through a new 30-year contract with the Great Lakes Water Authority, writing:. “The failure of leadership, in light of the past crises and manifold warnings related to the Flint water system, is breathtaking.” Judge Lawson’s decision came in response to a suit filed by the Michigan Department of Environmental Quality last June in the wake of the Flint City Council ignoring the state’s deadline for a water supply decision, arguing the delay would “cause an imminent and substantial endangerment to public health in Flint.” The Council, in hearing and filings, had requested more time from the court; however, Judge Lawson wrote that the state had demonstrated potential for “irreparable injury” in Flint and that there was an urgency to act, because the city’s short-term water agreements have expired and the long-term agreement is time sensitive, concluding: “The City Council has not voted on the negotiated agreement, it has not proposed an alternative, and the future of Flint’s fragile water system—its safety, reliability, and financial stability— is in peril…Because of the city’s indecision, the court must issue its ruling.” Judge Lawson’s order likely ensures the City Council will approve the proposed contract with the Great Lakes Authority that it had been resisting though it was negotiated with Mayor Karen Weaver’s approval. The city could choose to risk defying the court order; however, the State of Michigan has warned that tens of millions of dollars in extensive repairs and updates need to be made to the inactive Flint water plant—repairs which would take three and a half years to complete.

The warnings of Wayne State University Professor Nicholas Schroeck with regard to the risk to public health and the financial stability of the water supply system appeared key to persuading Judge Lawson to side with the state and issue a pre-emptive order. The Judge, in early August, had appointed a mediator in an effort to try gain an agreement between the city and the state Dept. of Environmental Quality; however, when the sides were unable to settle, he warned that  extending Flint’s contract with the Detroit area water system beyond 30 days could result in funding problems: “It seems to me that inaction is inviting intervention.” The Weaver administration analyzed various long-term water options for Flint, and the Mayor said Tuesday the Great Lakes agreement “proved to be in the best interest of public health by avoiding another water source switch, which could result in unforeseen issues.” The Michigan DEQ praised Judge Lawson for “recognizing there is no need to wait…and remains committed to working with the City of Flint to implement a plan once a source water determination has been finalized to ensure compliance with the Safe Drinking Water Act.” In its arguments before Judge Lawson, the State of Michigan had warned: “The City Council’s failure to act will result in at least a 55-63% increase in the water rate being charged to Flint residents, create an immediate risk of bankrupting the Flint water fund, will preclude required investment in Flint’s water distribution system, and create another imminent and substantial endangerment to public health in Flint.” That was similar to a statement from a key aide to Gov. Rick Snyder who had warned that stalling the water contract decision was costing the City of Flint an extra $600,000 a month, because it was paying for two sources—Great Lakes, from which it currently gets its treated water, and Karegnondi, from which it contractually would receive water by 2019 to 2020. Under the 30-year agreement with Great Lakes, Flint would no longer have to make payments to Karegnondi.

Unresponsiveness. President Trump last week awarded himself a perfect rating for his response to the hurricane that devastated Puerto Rico: “I would give myself a 10,” he responded when asked by reporters how he would score his efforts, on a one to 10 scale. He told Fox News correspondent Geraldo Rivera that Puerto Rican governments “owe a lot of money to your friends on Wall Street, and we’re going to have to wipe that out. You can say goodbye to that.” A comment to which OMB Director Mick Mulvaney noted: “I wouldn’t take it word for word.” Indeed, a week later, Congressional Republicans unveiled a relief plan that would only add to Puerto Rico’s unsustainable debt load. In his meeting this week with Puerto Rico Governor Ricardo Rosselló, who was in Washington to press for federal disaster relief, the President claimed: “We have provided so much, so fast.” Yet, today nearly 80 percent of the island remains without electricity, and almost 30 of the island still does not have access to clean water, according to Puerto Rican government figures.

In contrast with Texas after Hurricane Harvey and Florida after Irma, where thousands of repair workers rushed in to restring power lines, only a few hundred electrical workers from outside Puerto Rico have arrived to help: it was not until last Saturday that the Puerto Rican government said it had the federal funding needed to bring in more workers. That compares to some 5,300 workers from outside the region who converged on coastal Texas in the days after Hurricane Harvey to restore a power loss about a tenth of the size that struck Puerto Rico. Similarly, in Florida, 18,000 outside workers went in after Hurricane Irma knocked out electricity to most of the state last month, according to Florida Power and Light; whereas, in Puerto Rico, the challenge of restoration has fallen on the shoulders of about 900 members of local crews—an outcome industry experts report to be a result of poor planning, a slow response by power officials, and Puerto Rico’s dire fiscal situation—a sharp contrast to the President’s claim that his administration deserved a 10 for its response to the hurricanes which struck Puerto Rico and other parts of the United States.

The U.S. Army Corps of Engineers, charged by FEMA with restoring Puerto Rico’s power, estimated that it needed at least 2,000 additional workers. So far, the Corps has brought only about 200 workers, and most of them were dedicated not to restoring power, but to installing generators at crucial locations. In the wake of major storms, such as Katrina, power companies typically rely on mutual aid agreements to get electricity restored: such outside companies send thousands of workers, and electric companies pay for the service with funds from FEMA. However, providing such assistance to Puerto Rico is not just logistically a greater challenge—but also a discriminatorily greater challenge: the Jones Act—which the President only suspended for ten days—means that the time and cost of shipping comes at a 20% premium.  

The Human Storm. Maria risks accelerating the trend of the last decade of economic decline and depopulation, described as “a slower-moving catastrophe,” which is wreaking a devastating toll: The number of residents had plunged by 11 percent, the economy had shrunk by 15 percent, and the government has become fiscally insolvent. Already ranked among the worst cycles of economic decline and depopulation in postwar American history, the aftermath of Maria threatens an acceleration of residents fleeing en masse: accelerating economic decline and potentially accelerating a vicious cycle. Lyman Stone, an independent migration researcher and economist at the Agriculture Department notes: “We are watching a real live demographic and population collapse on a monumental scale.” At a news conference last week, Gov. Rosselló warned that without significant help, “millions” could leave for the U.S. mainland: You’re not going to get hundreds of thousands of Puerto Ricans moving to the States—you’re going to get millions…You’re going to get millions, creating a devastating demographic shift for us here in Puerto Rico.” Puerto Rico Treasury Secretary Raúl Maldonado has warned, meanwhile, that without more aid, the government could suffer a shutdown by the end of the month.

Today, only about 40 percent of Puerto Ricans in the territory are employed or seeking work—more than 33% below levels on the mainland. The danger, now, is of increased flight—but flight by the young and those with college degrees. After all, with the PROMESA Board charged with fashioning a fiscal plan to pay off more than $70 billion in Puerto Rico’s municipal debt calling for efforts to raise taxes and significant cuts to the government, the Board has predicted continuing shrinkage of the Puerto Rican economy. Thus, there is a real apprehension

As a result, for Washington and Puerto Rican officials planning a recovery, the ongoing exodus poses a multifaceted dilemma. “They’ve got to start from the ground up,” a former U.S. Treasury official said of any new plan for the island. In the short-term, at least, the island is likely to see an economic boost; rebuilding after a hurricane often injects a jolt of spending into local economies. But, according to recent research of 90 years of natural disasters in the United States, published as a National Bureau of Economic Research working paper, major natural disasters also have unfavorable effects: They increase out-migration, lower home prices, and raise poverty rates. Like many on the island, Sergio M. Marxuach, policy director for the Center for a New Economy, a San Juan-based think tank, said a massive federal investment is necessary. “We’re going to need some significant government intervention — essentially a big rescue package, not only to rebuild the economy but get it growing…People are saying, ‘I don’t want my children to grow up in a place where the economy is going to be devastated for the next 10 years.’ If enough people think that way, it’s going to be a self-reinforcing downward spiral.”

In addressing complaints about ongoing struggles on the island, President Trump noted this week that the disaster in Puerto Rico in many ways had begun years ago. Puerto Rico “was in very poor shape before the hurricanes ever hit. Their electrical grid was destroyed before the hurricanes got there. It was in very bad shape, was not working, was in bankruptcy.”

At the Level of a Muncipio. While many have considered the fiscal and physical impact on the U.S. territory of Puerto Rico, fewer have considered the fiscal challenge to Puerto Rico’s municipalities. Consider, for instance, Juncos, one of Puerto Rico’s 78 municipalities: it is located in the eastern central region of the island; it is spread over 9 wards and Juncos Pueblo (the downtown area and the administrative center of the city). The city, one of the oldest in the United States,was founded on the request of Tomas Pizarro on August 2, 1797, having previously been a village which evolved from a small ranch, the Hatillo de los Juncos. Hurricane Maria has changed this municipality forever: more than 1,000 families in Juncos lost it all that unforgettable September 20th, when Hurricane Maria struck. Yet, in a remarkable effort, residents of the La Hormiga sector of Las Piñas neighborhood, in the immediate aftermath of the hurricane, organized to help recover the humble community that is often highlighted by criminal incidents in the area: one of the community leaders of the sector, Wanda Bonilla, highlighted the deed of the trash rescuers: “Thanks to them, they have also relieved the pick up of the rubble.” The city’s community board worked immediately to install a shelter in the neighborhood community center given the circumstances that some 17 families, with between five and seven members each, where the storm tore the roofs off their homes—and most of those homes have single mothers. She noted: “Our president, Ivelisse Esquilín, who also lost everything, is helping us through the Municipality and with other donations.” Juncos Mayor Alfredo Alejandro noted that, in the wake of the storm, crossing arms was not an option for anyone “in the neighborhood” even though many of the 60 families living in the sector experienced the grief of having lost their home: “You have to do it because imagine …right now, look here, I have these pieces of a car to see if I invent a type of small generator to, even be, to turn on a fan.” The Mayor described Maria’s devastation to be of “great proportions:” Out of population of 42,000 people, more than 1,000 lost their homes and a comparable number suffered major damage to their structures; 85% of the city’s residents are still without potable water, while there are few expectations that electricity will soon be restored.

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