Phoenix Rises in Detroit!

April 30, 2018

Good Morning! In this morning’s eBlog, we recognize and celebrate Detroit’s emergence from the largest chapter 9 municipal bankruptcy in U.S. history.

More than three years since the Motor City emerged from the largest chapter 9 municipal bankruptcy in U.S. history, the Michigan Financial Review Commission is widely expected to act early this afternoon to vote on a waiver, after its Executive Director, Kevin Kubacki, had, last December, notified Gov. Rick Snyder of the city’s fiscal successes in holding open vacancies and reporting “revenues trending above the city’s adopted budget.” The city’s exit, if approved as expected, would restore local control and end state oversight of the City of Detroit. The expected outcome arrives in the wake of three consecutive municipal budget surpluses—something unanticipated for the federal government any year in the forseeable future. In the case of the Commission, Detroit’s fiscal accomplishment met a crucial threshold required to exit oversight: the Motor City completed FY2017 with a $53.8 million general fund operating surplus and revenues exceeding expenditures by $108.6 million—after recording an FY2016 $63 million surplus, and $71 million for FY2015. Michigan’s statute still requires the Review Commission to meet each year to grant Detroit a waiver to continue local control until the completion of 10 consecutive years.

In acknowledging the historic fiscal recovery, Mayor Mike Duggan noted that the restoration is akin to a suspension, as the oversight commission will not be active—but will remain in a so-called “dormancy period” under which, he said, referring to the Commission: “They do continue to review our finances, and, if we, in the future, run a deficit, they come back to life; and it takes another three years before we can move them out.”

On the morning Detroit went into chapter 9 bankruptcy—a morning I was warned it was too dangerous to walk the less than a mile from my downtown hotel to the Governor’s Detroit offices to meet with Kevyn Orr as he accepted Gov. Snyder’s request that he serve as Emergency Manager; Mr. Orr told me he had ordered every employee to report to work on time—and that the highest priority would be to ensure that all traffic and street lights were operating—and no 9-1-1 call was ignored. We sometimes forget—to our peril—that while the federal government can shut down, that is not an option for a city or county.  From the critical—to the vital everyday services, crews in Detroit have started cleaning 2,000 miles of residential streets, with Mayor Duggan’s office reporting that the first of three city-wide street sweeping operations is underway: each will take 10 weeks to complete.

The state oversight has, unsurprisingly, been prickly, at times: it has added levels of frustration to governance. For example, under the state oversight, all major city and labor contracts are delayed 30 days in order to await approval from the state. Nevertheless, with Detroit a vital component of Michigan’s economy, Detroit Chief Financial Officer John Hill had likened this oversight as a “real constructive process where the city has excelled.” Indeed, under the city’s plan of chapter 9 debt adjustment, Detroit had committed to shed some $7 billion in debt, while at the same time investing some $1.7 billion into restructuring and municipal city service improvements over a decade. In addition, the city had accepted the state fiscal oversight of its municipal finances, including budgets, contracts, and collective bargaining agreements with municipal employees. In return, the carrot, as it were, was that the state would assist by defraying cuts to Detroit retiree pensions and shield the Detroit Institute of Arts collection from bankruptcy creditors. The plan of debt adjustment also provided for relief of most public pension obligations to Detroit’s two pension funds through FY2023—after which Detroit will have to start funding a substantial portion of the pension obligations from its general fund for the General Retirement System and Police and Fire Retirement System.

Follow the Yellow Brick Road? While the Review Commission’s vote of fiscal and governing confidence for Detroit is a recognition of fiscal responsibility and accountability…and pride, the road of bankruptcy is steeper than for other municipalities—and the road is not unencumbered. Detroit is, in many ways, fiscally unique: more than 20 percent of its revenues are derived from a municipal income tax versus 17 percent from property taxes. That means the Motor City cannot fiscally rest: as in Chicago, city leaders need to continue to work with the state and the city’s School Board to improve the city’s public schools in order to attract families to move back into the city—a challenge made more difficult at a time when the current Congress and Administration have demonstrated little interest in addressing fiscal disparities: so Detroit is not competing on a level playing field.

In Michigan, however, the federal disinterest is partially offset by Michigan’s Revenue Sharing program, which, for the current fiscal year, provides that each eligible local unit is eligible to receive 100% of its eligible payment, according to Section 952 of 2016 PA 268. Therefore, if a city’s, village’s, or township’s FY 2010 statutory payment was greater than $4,500, the local unit will be eligible to receive a “Percent Payment” equal to 78.51044% of the local unit’s FY 2010 statutory payment. If a city’s, village’s, or township’s population is greater than 7,500, the local unit will be eligible to receive a “Population Payment” equal to the local unit’s population multiplied by $2.64659. Cities, villages, or townships that had a FY 2010 statutory payment greater than $4,500 and have a population greater than 7,500 will receive the greater of the “Percent Payment” or “Population Payment.

Unfortunately, since the Great Recession, local units of government have been hit with three major blows, all of which involve the state government. The first is the major decline in revenue sharing as the state struggled to balance its budget during the recession of 2007-2009. (Statutory revenue sharing declined from a peak of $684 million in FY 2001 to $210 million in FY 2012 and only recovered to $249 million by FY 2016. Total revenue sharing which fell from a peak of $1.326 billion in FY 2001 had only recovered to $998 million in FY 2016.)

Nevertheless, and, against seemingly all odds, it appears the civic pride created in this extraordinary challenge to recover from the largest chapter 9 in American history has given the Governor, legislature, and Detroit’s leaders—and citizens—a resolute determination to succeed.

Upsetting State & Local Fiscal Balances

April 27, 2018

Good Morning! In this morning’s eBlog, we seek to understand the fiscal imbalances in Connecticut and its capitol city of Hartford, before venturing west to assess the uneasy fiscal dilemmas in Illinois.

Biting the Fiscal Hand that Feeds the City? In a letter to Connecticut Treasurer Denise Nappier, House Minority Leader Themis Klarides (R-Derby) this week warned that the state’s fiscal bailout out the City of Hartford will exhaust the state’s ability to issue debt, — at least temporarily, noting that the legislature’s non nonpartisan Office of Fiscal Analysis projects “the state would exceed the statutory bond cap by $522 million” effective next July 1st, because of the Hartford fiscal agreement. That arrangement, implemented earlier this spring by Gov. Dannel P. Malloy’s administration and by Treasurer Nappier’s office, commits the State of Connecticut to finance Hartford’s $534 million in outstanding municipal bond debt, in addition to an undetermined about of interest. While state Legislators had ordered fiscal assistance for Hartford last October as part of a final consensus on adopting the budget, now a number are claiming the agreement went beyond what legislators had authorized. At stake is Connecticut’s expectation of retiring this debt over 20 to 30 years—something which could now depend upon how Hartford city leaders renegotiate their obligations with the city’s municipal bondholders—and, especially, at what interest rates—in one of the nation’s oldest states, and one which has long had in statute a debt limit—one which applies not only to bond debt already issued by the state, but also bonded debt it has committed to undertake in the future. Leader Klarides noted that he had been informed by the state’s Office of Fiscal Analysis that the full amount of Hartford which the state is expected to assume, $534 million, would be counted against the state’s bond cap: he has, indeed, requested clarification from the Treasurer with regard to when Hartford’s debt was included in calculations of the state’s debt burden. Unless legislators abandon the cap, the only alternatives to exceeding the limit this summer would be to delay or cancel planned municipal bonding for various projects, such as municipal school construction or capital programs at public colleges and universities; increase taxes or adopt other revenue raising measures, or vote to modify the Connecticut debt limit statute and grant an exemption for the emergency aid for the City of Hartford.

With Republicans currently holding nearly half the seats in the House (71 of 151) and exactly half the seats in the Senate, any traction for the city will confront, ergo, steep political divides—especially in an election year where Republicans have already indicated they plan to campaign on their efforts to stabilize state finances; thus, any effort to curtail other projects is likely to draw objections from both sides of the aisle. Treasurer Nappier’s office did not comment immediately after Leader Klarides issued her letter. Wednesday, Gov. Dannell Malloy’s office, noted that legislators should have known the assistance would count against the state’s debt limit, with a spokesperson for his office noting: “The contract assistance agreement is perfectly in keeping with the legislation passed last year by the bipartisan coalition,” adding that that was language the Legislature had both drafted and passed with support from Leader Klarides—language which stated that contract assistance agreements would constitute a full faith and credit obligation of the state: “This was not ambiguous then, and it is not now. The only question that continues to arise regarding the contract assistance agreement is did Representative Klarides have any idea what she was voting for?”

While there is consensus on both sides of the aisle that the two-year state budget enacted last October appropriated about $80 million in assistance for Hartford over the biennium, legislators had also agreed that Hartford would seek to refinance its debt over the long-term—debt the state would guarantee, committing to make annual debt assistance payments close to $40 million for 20 to 30 years, until the city’s entire $534 million general obligation debt is retired; however, last week, House and Senate Republicans recommended budget adjustments which would reduce traditional state grants to Hartford each year, beginning in the new fiscal year, by an amount equal to the debt assistance—effectively undercutting the fiscal commitment—or, as  effectively neutralizing the deal. Or, as Rep. Klarides put it, legislators were very clear in what they ordered, and that the Governor and Treasurer negotiated last-minute changes with the city and its bondholders that overstepped their authority, noting: “We only agreed to a two-year lifeline: This was a deal that was done in the dark of night.” Leader Klarides declined to speculate what the Legislature will do, but warned that if lawmakers are forced to begin canceling planned borrowing: “Let’s de-authorize Hartford projects.” In response, House Majority Leader Matt Ritter (D-Hartford), unsurprisingly, said exempting the aid for his home community from the statutory debt limit might be the best solution, especially, as he noted, because legislators on both sides of the aisle still want to make adjustments to the state budget for the next fiscal year before the session’s scheduled close on May 9th, noting that the single-largest amount of state borrowing is used to support municipal school construction, and canceling more than $500 million in planned borrowing by July 1 likely would impact many communities across Connecticut. Thus, he added: “If we all agree we want safe schools for our kids, we should come together and talk.”

The difficult negotiations in the Legislature come as Wall Street is warning Connecticut that its municipalities could be in fiscal peril. Last week, Moody’s moodily released an analysis that the recently enacted federal tax law changes may wreak fiscal havoc to the state’s local governments—especially the cap on the deductibility of state and local taxes. There is fiscal apprehension that the federal changes could lead to stagnant assessed property values—changes which would augur bad news for municipal property tax receipts in a state which relies more on property taxes than any other—or., as the exception UConn Law Professor Richard Pomp noted: “Because fewer people are going to be able to deduct the property tax, there is the concern that this will lower the demand for housing: That will lower a municipality’s property tax base at the next reassessment.” The federal tax changes which have led to record federal deficits and debt for the one level of government which does not try to balance its budget means, as Kevin Maloney of the Connecticut Conference of Municipalities put it: “There is no way to sugarcoat the fact that the recently passed sweeping federal tax reform will adversely impact a majority of property taxpayers and towns and city governments across Connecticut: Limiting the ability of Connecticut towns and cities to write off property tax paid annually will only place more pressure on the property tax in Connecticut, making Connecticut local economies and tax environment more uncompetitive and depressing the value of homeownership.”

In 2014, more than 41% of returns in Connecticut included a state and local tax deduction (the last year available): the average amount for this deduction was $19,000. Thus, as he put it: “Property taxes represent an absolutely vital source of revenue for cities in Connecticut: According to the Lincoln Institute for Land Policy, property taxes account for 60% of local revenues—twice the national average.” That unbalanced reliance is further complicating fiscal stability in the state, because Connecticut is the state with the nation’s greatest income inequality—creating widely disparate impacts on Connecticut municipalities’ fiscal capacity to provide equitable levels of services.  Those fiscal disparities can cause, as Moody’s reported, “significant headwinds,” especially for cities like Bridgeport, where a shrinking tax base and plummeting assessed property values have generated a vicious fiscal cycle of ever-higher tax increases on remaining residents: higher and higher tax burdens, even as services are reduced. Two years; ago, a Bridgeport family making $75,000 a year faced a tax rate of nearly 16%: as higher income families have fled the municipality, the new federal tax bill could contribute to drive still more away.

On a Golden Parachute in Highland Park? In an Illinois County, Highland Park, where more than a century ago in 1867, ten men purchased Highland Park for the gaudy sum of $39,198.70 to become the original stockholders of the Highland Park Building Company—after which, following construction of the Chicago and Milwaukee Railroad, a depot was established at Highland Park and a plat, extending south to Central Avenue, was laid out in 1856, leading to the establishment of the municipality on March 11, 1869, with a population of 500; today, the Chicago suburb has a different distinction: it is a county with some of the state’s highest property taxes, and one where more than one-third of employees at one park district are making more than six figures: out of 51 employees listed in compensation documents provided by the Park District of Highland Park, 18 earn more than $100,000 in total compensation. (In Illinois, park districts receive the bulk of their funding from local property taxes: the Park District of Highland Park is no exception, with more than 57% of its funding coming from local tax dollars.)

Part of the cost appears to stem from lavish severance payouts. Thus, one proposal in the Illinois General Assembly, Senate Bill 3604, would limit government workers’ ability to collect extravagant severance packages, or “golden parachutes.” The bill, the Government Severance Pay Act, would mandate specific provisions in government employment contracts to limit the capacity for excessive severance pay, imposing a fixed ceiling on severance payouts, capping any severance pay at the equivalent of 20 weeks of compensation, and re-establishing public-worker severance pay as a privilege, rather than an entitlement, mandating that government worker contracts include a provision barring severance packages for employees terminated due to misconduct. Illinois Sen. Bill Cunningham (D-Chicago) would require greater transparency in severance pay negotiations for public university officials, as well as cap their payouts at one year’s compensation. Indeed, it seems leaving municipal employment has been munificent in the state: the Better Government Association illustrated as much in a report released last October, cataloguing a number of big severance payouts. University officials comprised seven of the nine Illinois officials listed in the report. The College of DuPage Board of Trustees issued one of the largest severance packages for a government employee in Illinois history, according to the Chicago Tribune, reporting that during his tenure, President Robert Breuder hid more than $95 million in public expenditures, $243,300 of which was used to purchase liquor—an item listed as “instructional supplies” on ledger lines. Generously, trustees purchased Mr. Breuder’s early retirement for nearly $763,000 in severance pay.

Can the “City of Fog” Take the Fiscal Bulls by its Horns?

April 25, 2018

Good Morning! In this morning’s eBlog, we seek to understand the fiscal perspective in Puerto Rice from the municipal perspective, where a group of Mayors from the Popular Democratic Party are seeking to put together collaborative models in order to both achieve fiscal savings, and ensure the provision of essential services. The we jet West out of the rain to sunny San Bernardino, where voters in the post chapter 9 municipality are weighing candidates to lead the city through its plan of debt adjustment.

Taking the Fiscal Bull by the Horns. Cayey, Puerto Rico, is known as “La Ciudad del Torito” (town of the little bull), but also as “La Ciudad de las Brumas,” or the City of Fog. Founded in August of 1773, it is one of our nation’s oldest municipalities: its founder—and first Mayor, was Juan Mata Vázquez. The city’s name is also said to have been derived from the Taino Indian word for “a place of waters.” Located in Puerto Rico’s Central Mountain range, Cavey is surrounded by the Guavate, Jjome, Maton, La Plata, and Grande de Loiza rivers—and the Carite Forest Reserve, which offers more than 6,000 acres of protected parkland. The city is also home to Cayey University College, a branch of the University of Puerto Rico. The surrounding areas produces sugar, tobacco, and poultry—and cigars. Coca-Cola and Procter & Gamble have manufacturing facilities in Cayey. But Cayez’s Mayor—or Alcalde, Rolando Ortiz, is his own optimistic bull: it was, after all, just one year ago that he, together with the Mayors of Coamo (Juan Carlos García Padilla) Villalba (Luis Javier Hernández), and Salinas (Karilyn Bonilla) created what is now known as the Services and Permits Alliance, an innovative initiative through which they have managed to generate an increase of $105,000, and have reduced the approval period for municipal permits by 60 percent. Now, Mayor Ortiz reports: “The Fiscal Supervision Board (JSF) has just certified the different fiscal plans of the government agencies and those final determinations make the country in a position of starting, where Puerto Rico has to continue to seek solutions to the problems of Puerto Rican families,” with his remarks coming exactly one year after he met with his colleagues, the Mayors Juan Carlos García Padilla, of Villalba, Mayor Luis Javier Hernández; and Salinas Mayor Karilyn Bonilla, to create what is now known as the Services and Permits Alliance, an initiative through which they have managed to generate an increase of $105,000, and have reduced the approval period for municipal permits by a whopping 60%.

Their municipio coalition, in addition to the savings and efficiency of services, allows this unique coalition to have direct control over the development of infrastructure in their municipalities and protect those areas designated for agricultural use or the development of parks and public recreational areas. In addition, the agreement makes it easier for them to redirect the development to the areas of the urban centers—or, as Mayor Ortiz put it: “Development experts postulate that 70% of the world’s population has to move to live in cities in the coming decades, and cities have to temper that reality and have to organize their territories, their public spaces, in such a way that this mobilization to the urban centers can occur…This organization aims to organize the territory and have control of what is being built and what is developed from the point of view of planning and organization in each of our municipalities.” Mayor Bonillo added: “We have been able to comply with several of the goals we established when we established the service consortium, including that the services would be more accessible to citizens.” She added that the sharing of services would benefit efficiency, explaining that the consortium has a regional office in Cayey and satellite spaces in the remaining three towns—with a shared workforce of 15 employees—along with a technical staff of engineers, lawyers, planners, and inspectors to collaborate with the four City Councils. Or, as the Mayor put it: “He has given us a tool to all municipalities in the process of monitoring the construction taxes of all the permits that are located in each of our towns,” with a focus on four key objectives: accessibility, maximization of resources streamline the permit process and achieve new revenues. Indeed, it appears the model has been so effective that these municipal executives are already focused on the possibility of integrating the areas of Human Resources, Finance, and the Center for Municipal Revenue Collection, an integration that they hope to have completed in six months. Or, as Mayor Hernández explained: “What started as an alliance of permits…now takes another direction, an extension…today this success story is celebrated, but it is the beginning of many other alliances…the design of a platform that has been successful and that can serve as a model for other municipalities.”

Is There Mayoral Promise from PROMESA? The ambitions of the troika of Mayors comes in the wake of, last week, the PROMESA Board’s approval of a number of fiscal plans to be imposed upon Puerto Rico in efforts to address growth, revenue, expenditure, debt, and government reform—plans which some describe as mayhap “overly (and maybe recklessly) optimistic.” Our colleagues at Municipal Market Analytics, for instance, write that “while it is possible that, as the plan supposes, Hurricane Maria and subsequent aid-fueled rebuilding will leave the Puerto Rico economy stronger and larger than if there had been no storm, this should not be a baseline assumption. We note the island economy’s contraction despite decades of annual billion-dollar stimulus injections via deficit borrowing by Puerto Rico’s public entities. Further, with Maria highlighting the island’s increasing vulnerability to weather-related damage and climate change, MMA expects a material long-term reduction in corporations’ interest in locating facilities in Puerto Rico and a related drag on employment, all else being equal.” Writing that the PROMESA Board’s plans provide little margin for error, MMA worries of a potential slide back into bankruptcy. MMA also noted, as have we, that with so many fiscal cooks in the kitchen, and the Governor having already announced his dedicated opposition to any cuts in pensions or labor reforms, there appears little evidence of an overall change in Puerto Rico’s hunger for hard fiscal steps, such as would be required in a plan of debt adjustment.

A Taxing Imbalance. Perhaps demonstrative of the fiscal challenges of multiple cooks in the kitchen, Governor Ricardo Rosselló’s promised reduction of Puerto Rico’s Sales and Use Tax (IVU) in restaurants now appears to hang in the balance, because, according to the PROMESA plan, his government will be mandated to submit to the PROMESA Board quarterly reports on its budget to determine if the tax changes will remain or will be revoked: the Board’s conditions for approving any proposed tax reform join the list of demands that the Board had imposed on Puerto Rico last week: according to the plan, the tax reform must be revenue “neutral,” that is, it must be most unlike the federal tax reform passed by Congress and signed into law by President Trump. Moreover, under the plan, Puerto Rico will be mandated to carry out an annual so-called “fiscal responsibility test,” and submit an annual report which will be the reference to determine if any tax reduction may continue. According to the proposed fiscal plan, in the first two years of its implementation, incentives and subsidies granted through 17 laws will be eliminated or modified: for example, incentives to the film industry, reimbursements for the rum tax, credits, and incentives tied to affordable housing, the elderly, and the renewal of urban centers will be modified—with the Board plan claiming such changes would result in net savings of $123 million—or less than half the savings target announced by the government. Puerto Rico’s House plans to commence its public hearing process on tax reform next Wednesday.

A Sunny Post Chapter 9 Municipal Future? In San Bernardino, California, six Mayoral candidates on Tuesday offered their qualifications for the position, their plans to improve transparency and participation at City Hall and their vision for downtown before a number of citizens—but also an online audience: Mayor Carey Davis, Councilman John Valdivia, City Clerk Gigi Hanna, businesswoman Karmel Roe, general engineering contractor Rick Avila, and San Bernardino school board member Danny Tillman spoke about the city’s future, with Ms. Roe describing the post-chapter 9 municipality as “one big fix and flip,” describing the city as one which has the resources, money, and energy to cure its ails. Mr. Avila said he would run the city like a business and leave politics out of City Hall; while school board member Tillman explained his plan to increase outside investment by making San Bernardino safer and more visually appealing. Ms. Hanna, who has been twice elected to her current position, stated: “People know me, and people trust me…I have one of the largest Rolodexes in town, and I’m not afraid to use it.” Interestingly, the two veterans of the city’s long ordeal into and out of chapter 9 municipal bankruptcy, Mayor Davis and Councilmember Valdivia kept their distance while sharing their respective accomplishments as city leaders, with Mayor Davis touting his leadership in guiding the city through chapter 9 municipal bankruptcy, implementing a new city charter, hiring reputable city officials, and reducing crime—or, as he sought to frame his candidacy: “I’m a proven leader who delivers results.” Each candidate endorsed more participation in local government. Ms. Roe, a regular at City Council meetings, said she would be a “servant leader,” adding: “We cannot build this city divided.” Mr. Avila and Clerk Hanna noted San Bernardino’s negative reputation among prospective business owners, while School Board Member Tillman said the $30 million surplus Mayor Davis mentioned was not a surplus, but rather “money we haven’t spent on things we need.” Their presentations come as voters head to the primary election on Tuesday, June 5th, to select leaders for the city’s post plan of debt adjustment future.

 

Fiscal Fire in the Hole

April 24, 2018

Good Morning! In this morning’s eBlog, we return to the Windy City region and the small Chicago suburb of Harvey, as it teeters on the edge of insolvency in a state where municipalities are not authorized to file for chapter 9 municipal bankruptcy, albeit under Illinois’ Local Government Financial Planning and Supervision Act (see 50 Ill. Comp. Stat. 320), a local Illinois government with a population under 25,000 suffering from a “fiscal emergency” may—if it secures a two-thirds vote of its Council, petition the Governor to appoint a financial planning and supervision commission to recommend that the local government be granted the authority to file for chapter 9 via submission to the Illinois Legislature—something which happened twenty-nine years ago in the case of East St. Louis.

Fire in the Hole. Illinois Rep. Jeanne Ives (R-Ill.), whose Chicago suburban district includes all or portions of Wheaton, Warrenville, West Chicago, Winfield, Carol Stream, Lisle, and Naperville—and who served on the Wheaton City Council prior to being elected to the Legislature, yesterday said the embattled, small municipality of Harvey was not alone in its inability to meet Illinois’ pension demand, adding the small city should strongly consider filing for municipal bankruptcy. In the wake, as we have noted, of the state’s withholding of funds to Harvey because of its non-payment into the pension system, firefighters and police officers have been laid off. That is, there is a growing human risk—and, as with fire, it is a risk which could spread to other municipalities in the region—from Burbank to Niles to Maywood, small cities in comparable fiscal straits. With boarded up businesses on the main street, it appears, as Rep. Ives notes, that “Bankruptcy is the only way out.”

In the wake of the State of Illinois’ decision to withhold state assistance because of its failure to make mandatory public pension contributions, the city laid off nearly one-third of its 67 firefighters and 12 of its 81 police officers. Harvey has not kept pace with pension payments for more than 10 years. With boarded up businesses on the municipality’s main street, Rep. Ives, ergo, notes: “Bankruptcy is the only way out.” Adding, in reference to the small city’s layoffs: “Forty-two retired Harvey firefighters have saved a collective $1.42 million, but have already collected nearly $25 million in retirement.” Her comments came in the wake of the Cook County Appellate Court overturning of a prior decision by the Cook County Circuit Court and grant of a temporary restraining order against the Illinois State Comptroller with regard to the hold of $1.4 million from the City of Harvey. The Mayor, Eric Kellogg, has released a statement noting: “We will not entertain any conversation concerning the filing of bankruptcy;” however, the municipality’s fiscal options are limited. Even though the Appellate Court of Cook County has overturned the prior decision of the Cook County Circuity Court and granted a temporary restraining order against the Illinois State Comptroller regarding the hold of $1.4 million from Harvey, the option of raising local taxes appears most unlikely—or, as one local taxpayer who used to own a restaurant there put it: “My property taxes were $80,000 a year: How many hot dogs can you sell?”

As our insightful colleagues at the Municipal Market Journal observe, Illinois’ statute, P.A. 96-1495, “potentially transforms pension funding problems into service funding issues and may accelerate fiscal deterioration of some municipalities. The law, which recently became effective, requires that the Illinois Comptroller to withhold and divert state revenues targeted for a municipality to police and fire pension plans when requested to do so by the funds, because of the failure of the sponsor to make required contributions. The Journal goes on to observe: “The City of North Chicago is the second, but according to a recently published paper by the University of Chicago’s Amanda Kass, there are over 600 individual police and fire pension funds in the state and 29% were less than 50% funded in 2016 (Chicago excluded). This suggests that, if the court upholds that the state must divert money away from municipalities that short their police and fire pensions, more governments may be thrust into fiscal distress.” Their note adds: “Because of a lack of readily available information, the paper uses the Illinois Department of Insurance’s calculations regarding what should have been contributed to the pensions during the period from 2003-2010 to determine the municipalities that are more likely to be at risk of a diversion. Fifty-four municipalities responsible for 71 funds contributed 50% or less of what the Illinois Department of Insurance said should be paid, and, as a result, the funds are worse off with a 47% funded ratio in 2016 compared with a state average (again, excluding Chicago) of 60%. Notably, over 50% are in Cook County. The Department of Insurance (DOI) is one of three sources that can determine the contribution (an actuary hired by the fund or by the municipality can also make the determination).

The Fiscal Challenges of Exiting from Fiscal Oversight

April 23, 2018

Good Morning! In this morning’s eBlog, we return to Michigan to assess the unbalanced state of its municipal public pension and post-retirement health care obligations, before turning to the state’s largest city, Detroit, which appears to be on the brink of earning freedom from state oversight—marking the remarkable fiscal exodus from the largest chapter 9 municipal bankruptcy in American history. Then we return to Puerto Rico, a territory plunged once again into darkness and an exorbitant and costly set of fiscal overseers. 

Imbalanced Fiscal Stress. In the Michigan Treasury Department’s first round of assessments under a new state law, the Treasury reported that 110 of 490 local units of government across the state are underfunded for retiree health care benefits, pension obligations‒or both. That number is expected to increase. Nineteen municipalities in Wayne County, including Allen Park, Dearborn and two of the five Grosse Pointes (Farms and Woods), are behind on their retiree health care funding, the state says, as well as six Wayne County jurisdictions, including Redford Township, Trenton, Wayne and Westland are underfunded on both, as are Hazel Park, Oak Park, and Madison Heights in Oakland County. The state fiscal oversight effort to highlight the expanding obligations competing for scarce taxpayer dollars in the state which is home to the largest chapter 9 municipal bankruptcy in American history, the result of the state’s “Protecting Local Government Retirement and Benefits Act,” Act 202, which was enacted last December, marks a pioneering effort to put tighter local data to detect and assess the likelihood of severe fiscal distress—kind of a municipal fiscal radar—or, as Michigan Deputy Treasurer Eric Scorsone, who is the designated head of the State and Local Finance Group,  describes it: “By working together, we can help ensure the benefits promised by communities are delivered to their retirees and help ensure that the fiscal health of communities allows them to be vibrant now and into the future,” Eric Scorsone, deputy state treasurer and head of Treasury’s State and Local Finance Group, put it: “This is just a start. One of the common denominators of the financial crisis has been legacy costs. We know this is a big liability out there”—and it continues to grow for current and retired public employees, as well as their counterparts in public schools, whose districts are not covered by the new state law. In an era featuring longer lifespans, the unfunded liability of the Michigan Public School Employees Retirement System totaled $29.1 billion, or 40.3 percent, at the end of FY2015-16—an aggregate number, the likes of which have not been previously available at the municipal level. Now, under the new statute, a municipality’s post-retirement health care plan is deemed underfunded if its assets are “less than 40 percent” of its obligations, or require annual contributions “greater than 12 percent” of a jurisdiction’s annual operating revenues. A pension plan is deemed underfunded if it is “less than 60 percent funded,” or its annual contributions are “greater than 10 percent” of annual operating revenues. The new state mandates require the state’s panoply of cities, villages, townships, counties, and county commissions to report pension and retiree health care finances by the end of January. (Municipalities whose books close later could be included in future lists.) The aim is to underline the fiscal need to local elected leaders to do something the federal government simply does not do: reconcile reconciling long-term obligations with current contributions and recurring revenue—that is, not only adopt annual balanced budgets, but also longer term. The new state law, an outgrowth of the Responsible Retiree Reform for Local Government Task Force, is intended to enhance transparency and community awareness of local government finance, as well as to emphasize that failure to account for such obligations could negatively impact municipal bond ratings—effectively raising the costs of capital infrastructure. Indeed, as East Lansing City Manager George Lahanas stated last week, “The city’s pension plan was 80 percent funded in 2003 and is 50 percent funded today…The city has implemented numerous cost-controlling measures over the years to address the legacy cost challenges…City officials have identified that more aggressive payments need to be made moving forward to further address the challenges.”

Nevertheless, in one of the very few states which still try to address municipal fiscal disparities, the Michigan Senate General Government subcommittee met last week and reported (Senate Bill 855) its budget recommendations, including for revenue sharing, the subcommittee matched the Governor’s recommendation, which eliminate the 2.5% increase cities, villages, and townships received this year—a cut, ergo, of some $6.2 million for FY2019; the Senate version retained the counties current year 1% increase (which the Governor had also recommended removing) and added another 1% to the county revenue sharing line item—with the accompanying report language noting the increase was intended to ensure “fairness and stability” across local unit types, since counties do not receive Constitutional revenue sharing payments.  Estimates for sales tax growth related to Constitutional payments anticipate an additional 3.1% next year for cities, villages, and townships, distributed on a per capita basis. 

Moving into the Passing Lane? The Legislature’s actions came as the Detroit Financial Review Commission has approved the Motor City’s Four-Year Financial Plan, setting the stage for the city’s exit from direct state supervision as early as this month, enabling the city with the largest chapter 9 municipal bankruptcy in U.S. history to glimpse the possibility of exiting state oversight—or, as Detroit CFO John Hill put it:  “Today’s FRC approval of the City’s 2019 budget and plan for fiscal years 2020-2022, is another key milestone in the city’s financial recovery: It demonstrates the continued commitment of city leaders to prepare and enact budgets that are realistic and balanced now and into the future. It also demonstrates continued progress toward the waiver of active State oversight, which we expect will occur later this month.” The Commission is scheduled to meet at the end of this month for a vote to end state fiscal oversight, albeit the Commission would remain in existence, so that it could be jump started in the event of any reversal in the city’s fiscal comeback. Thus, Mr. Hill said there would likely be a memorandum of understanding between Detroit and the Commission to lay out the kinds of information the city would need to provide to the Commission for review, as he noted: “They still can at any time decide to change the waiver, although we hope and will make sure that doesn’t happen.” Mr. Hill noted that the now approved financial plan includes Mayor Mike Duggan’s budget for FY2019, as well as fiscal years 2020-2022—and that the Motor City now projects ending the current fiscal year with an operating surplus of $33 million: that would mark Detroit’s fourth consecutive municipal budget surplus since exiting from the nation’s largest ever chapter 9 municipal bankruptcy. He also noted that, as provided for under the city’s plan of debt adjustment, Detroit continues to put aside funds to address the city’s higher-than-expected pension payments, payments starting in 2024, when annual payments of at least $143 million begin. Payments of $20 million run through 2019 with no payments then due through 2023.

Unbalanced Budgets & Power–& Justice. Although they are still evaluating the impact that a new reduction of their budget would have, Puerto Rico’s Judicial Branch has expressed apprehension with regard to the PROMESA Board’s imposed cuts, with Sigfredo Steidel Figueroa, Puerto Rico’s Director of the Office of Court Administration, expressing apprehension: “At the moment, we are evaluating the impact that the proposals of the Fiscal Oversight Board, contained in the fiscal plan published yesterday, could have on the Judicial Branch,” referring to the Board certified plan of staggered cuts for the Judiciary—cuts of $31.9 million, rising to a cut of $161.9 million by 2023. He noted: “In the light of the measures already taken, any proposal for additional reduction to our budget is a matter of concern. Therefore, we will remain vigilant to ensure that the Judicial Branch has the resources it needs to ensure its efficiency and that any budgetary measures taken do not affect the quality of judicial services and the access to justice that corresponds to all the citizens and residents of Puerto Rico,” as he stressed that, “At present, even with the budgetary limitations of recent years, the Judicial Branch has managed to draw and execute the work plan defined by the presiding judge, Maite D. Oronoz Rodríguez, for an increasingly more judicial administration—one of efficiency, transparency, and accessibility.” He added:An independent and robust judiciary is essential to guarantee the legal security necessary for the stability and economic development of Puerto Rico.”

PROMESA Board Chair Jose Carrion, at the end of last week, issued a warning: “We hope the government and the legislature will comply. We don’t want to sue the government, but we have to fulfill the duties that we understand the law gives us.” That is to write that in this fiscal governance Rod Serling Twilight Zone, somewhere between chapter 9 municipal bankruptcy and hegemony; there is an ongoing question with regard to sovereignty, autonomy, and, as they would say in Puerto Rico, al fin (in the end): who is ultimately responsible for making decisions in Puerto Rico? We have a federal, quasi U.S. bankruptcy judge, a federal oversight board, a Governor, and a legislature—with only the latter two representing the U.S. citizens of Puerto Rico.

And now, in the midst of a 21st century exodus of the young and educated to Florida and New York, it appears that banks are joining this exodus—threating, potentially, to further not only isolate Puerto Rico’s financial system—a system in which the number of consumer banks has dropped by half over the past decade, and in which two of the largest, Bank of Nova Scotia and Bank of Santander SA, have been quietly shrinking—the challenge of governance and fiscal recovery as Puerto Rico seeks to emerge from recession and rebuild after last year’s Hurricane Maria, a small number of financial institutions could end up in charge of deposits and lending for its 3 million citizens. Poplar, Inc., First Bancorp/Puerto Rico, and OFG Bancorp, are cash rich and have many branches, but these financial institutions appear to have limited ability to facilitate trade beyond the Caribbean and Florida—and, as economist Antonio Fernos of the Interamerican University of Puerto Rico notes: “What would really be negative is if we lose access to the network of international banks.” The U.S. territory, once was an attractive place for banks to invest, with pharmaceutical manufacturing driving growth, meant that financial institutions entered and opened what had been scarce financing for everything from homes and cars to consumer electronics. However, as Congress changed the rules which had incentivized pharmaceutical companies to locate there—and as Congress moved to make it more attractive to provide shipping to other Caribbean nations, rather than the U.S. territory, many drug companies departed. Today, in the wake of a decade-long recession, Puerto Rico’s economy is 14% smaller, and the emigration of college graduates to the mainland appears to have accelerated—leaving behind the elderly and those who could not afford to leave—increasing a crushing public pension burden, while imposing greater fiscal burdens to serve an increasingly elderly and poor population left behind—and left with over $120 billion in debt and pension liabilities, and now, in then wake of Maria’s devastation, a spike in mortgage delinquency.

Human, Fiscal, & Physical Challenges

April 20, 2018

Good Morning! In this morning’s eBlog, we return to Flint, Michigan to assess its human and fiscal challenges in the wake of its exit from state receivership; then we return to Puerto Rico, a territory plunged once again into darkness and an exorbitant and costly set of fiscal overseers. 

Out Like Flint. Serious fiscal challenges remain for Flint, Michigan, after its exit from state financial receivership. Those challenges include employee retirement funding and the aging, corroded pipes that caused its drinking water crisis, according to Mary Schulz, associate director for Michigan State University’s Extension Center for Local Government Finance and Policy. In the public pension challenge, Michigan’s statute enacted last year mandates that the state’s municipalities report underfunded retirement benefits. That meant, in the wake of Flint’s reporting that it had only funded its pension at 37%–with nothing set aside for its other OPEB benefits, combined with the estimated $600 million to finance the infrastructure repair of its aging water infrastructure, Director Schulz added the small city is also confronted by a serious problem with its public schools—describing the city’s fiscal ills as “Michigan’s Puerto Rico,” adding it would “remain Michigan’s Puerto Rico until the state decides Flint is part of Michigan.”

Michigan Municipal League Director Dan Gilmartin notes that Flint is making better decisions financially, but still suffers from state funding cuts. He observed that Flint’s leaders are making better decisions fiscally—that they have put together a more realistic budget than before its elected leaders were preempted by state imposed emergency managers, noting: “The biggest problem Flint faces now is what all cities in Michigan face, and that is the state’s system of municipal financing, which simply doesn’t work.”

Perhaps in recognition of that, Michigan State Treasurer Nick Khouri, on April 10th announced the end of state-imposed receivership under Michigan’s Local Financial Stability and Choice Act, and he dissolved the Flint Receivership Transition Advisory Board. Treasurer Khouri also signed a resolution repealing all remaining emergency manager orders, noting: “Removing all emergency manager orders gives the City of Flint a fresh start without any lingering restrictions.” Concurrently, Michigan Governor Rick Snyder, in an email, wrote: “Under the state’s emergency manager law, emergency managers were put in place in a number of cities facing financial emergencies to ensure residents were protected and their local governments’ fiscal problems were addressed: This process has worked well for the state’s struggling cities, helping to restore financial stability and put them on a path toward long-term success. Flint’s recent exit from receivership marks the end of emergency management for cities in Michigan and a new chapter in the state’s continued comeback.” Indeed, the state action means that Detroit is the only Michigan municipality city still under a form of state oversight, albeit Benton Harbor Area Schools, Pontiac Public Schools, Highland Park School District, and the Muskegon Heights school district remain under state oversight.

The nation’s preeminent chapter 9 municipal bankruptcy expert Jim Spiotto notes that a financial emergency manager is supposed to get a struggling municipality back to a balanced budget, to find a means to increase revenue, to cut unnecessary expenses, and to keep essential services at an acceptable level:  “To the degree that they achieve that, then you want to continue with best practices: If they don’t accomplish that, then even if you return the city back to Mayor and City Council, then they have to do it: Someone has to come up with viable sustainable recovery plan, not just treading water.”

From his perspective, Director Gilmartin notes: “Flint has more realistic numbers in place, especially when it comes to revenues. I think that is the most important thing the city has accomplished from a nuts and bolts standpoint…The negative side of it is the system in which they are working under just doesn’t work for them or any communities in the state. In some cases making all the right decisions at the local level still doesn’t get to where you need to get to, and it will require a change in the state law.” Referencing last year’s Michigan Municipal League report which estimated the state’s municipalities had been shortchanged to the tune of $8 billion since 2002, Director Gilmartin noted: “A lot of the fiscal pressures that Flint and other cities in Michigan find themselves in are there by state actions.” No doubt, he was referencing the nearly $55 million in reduced state aid to Flint by 2014—as the state moved to pare revenue sharing—the state’s fiscal assistance program to provide assistance based upon population and fiscal need—funds which, had they been provided, would have sufficed to not only balance the city’s budget, but also cut sharply into its capital debts—enhancing its credit quality. Indeed, it was the state’s Emergency Manager program that voters repealed six years ago after devastating decisions had plunged Flint into not just dire fiscal straits, but also the fateful decision to change its public drinking water source—a decision poisoning children, and the city’s fisc by decimating its assessed property values. During those desperate human and fiscal times, local elected leaders were preempted—even as two of the gubernatorially named Emergency Managers were charged with criminal wrongdoing in relation to the city’s lead contamination crisis and ensuing Legionnaire’s disease outbreak which claimed 12 lives in the wake of the fateful decision to  change Flint’s water source to the Flint River in April of 2014. Now, as Director Schulz notes: “Until we come up with other solutions that aren’t really punitive in nature and leave communities like Flint vulnerable as repeat customer for emergency management law, these communities will remain in financial and service delivery purgatory indefinitely.”

Director Schulz notes a more profound threat to municipal fiscal equity: she has identified at least 93 Michigan municipalities with a taxable value per capita under $20,000, describing that as a “good indicator” for which municipalities in the state are prime candidates for finding themselves under a gubernatorially imposed Emergency Manager, in addition to 32 other municipalities in the state which  are either deemed service insolvent or on the verge of service insolvency. Flint’s taxable value per capita of $7575 comes in as the second lowest behind St. Louis, Michigan, which has a taxable value of $6733. Ms. Schulz defines such insolvency as the level below which a municipality is likely unable to fiscally provide “a basic level of services a city need to provide to its residents.” Indeed, a report released by Treasurer Khouri’s office has identified nearly 25% of the state’s local units of government as having an underfunded pension plan, retirement health care plan, or both—an issue which, as we have noted in the eGnus, comes after the State, last December enacted legislation creating thresholds on pensions and OPEB which all municipalities must meet in order to be considered funded at a viable level, meaning OPEB liabilities must be at least 40% funded, and pensions 60% funded. While the Treasurer may grant waivers, such granting is premised on plans approved to remedy the underfunding—failure to do so could trigger oversight by a three-member Michigan Stability Board appointed by the Governor. As Director Schulz notes: “The winds here are blowing such that the municipality stability board is going to be up and running soon, and there will be an effort to give that board emergency manager powers…That means they can break contacts, they can sell assets…whatever it needs to put money in the OPEB.” But in the face of such preemption—preemption which, after all, had caused such human and fiscal damage to Detroit, Detroit’s public schools, and to the City of Flint; Director Gilmartin notes: “Getting the community back to zero is the easy part and is just a function of budgeting, but having it function and provide services is harder: I would say that a lot of the support for emergency management by the state has dwindled based on the experience over the last several years.”

A Storm of Leaders. If the human health and safety, and fiscal challenges created by state oversight in Michigan give one pause; the multiplicity—and cost—of the many overseers of Puerto Rico and its future by the inequitable storm response by Congress and the Trump Administration—and by the costly “who’s on first…” sets of conflicting fiscal overseers could experience at least some level of greater clarity today, as the PROMESA Board releases its proposed fiscal plans it intends to certify, including the maintenance of its mandate to the federal court for an average public pension cut of 10 percent—after having kept under advisement the concerns of Governor Ricardo Rosselló the inclusion in the revised fiscal, quasi chapter 9 plan of debt adjustment immediate reductions in sick and vacation leave.

Thus, it appears U.S. Judge Laura Taylor Swain will consider a proposed adjustment plan to reduce public pensions later this year which would total savings of as much as nearly $1.45 billion over the next five years—a level below the PROMESA Board’s proposed $1.58 million—but massive when put in the context that the current average public pension on the island is roughly $1,100 a month, but more than 38,000 retired government employees receive only $500, because of the type of job they had and the number of years worked.

Thus, there are fiscal and human dilemmas—and governance challenges: even though the PROMESA law authorizes the restructuring of retirement systems, it is unclear whether the Congressionally-created Board has the authority to impose such a significant, unfunded federal mandate on the government of Puerto Rico, including labor reforms, and restrictions of vacation and sick leaves. Last year, Governor Rosselló agreed to a reduction in pensions for government retirees, but then his aim was to propose cuts of 6 percent.

At the moment, he is against it. A few weeks ago, after negotiations with the Board, Governor Rosselló proposed a labor reform similar to the one he negotiated with members of the Board, with differences on how to balance it with an increase in the minimum wage and when to put it in into effect—a proposal he subsequently withdrew after the PROMESA Board mandated that the labor reform be in full force in January 2019, instead of phasing it in over next three years, and conditioning the increase from $7.25 to $8.25 per hour in the minimum wage to the increase in labor participation rates—proposals which, in any event, made clear the “too many leaders” governance challenges—as these were proposals with little chance of approval by the Puerto Rican House. That is, for the Governor, there is not only a federal judge, and a PROMESA Board, but also his own legislature elected by Puerto Ricans—not appointed by non-Puerto Ricans. (Under the PROMESA Law, which also created the territorial judicial system to restructure the public debt of Puerto Rico, the PROMESA Board also has power over the local government until four consecutive balanced budgets and medium and long-term access to the financial markets are achieved. Thus, as the ever insightful Gregory Makoff of the Center for International Governance Innovation—and former U.S. Treasury Advisor put it: “While the lack of cooperation with the Board may be good in political terms in the short-term, it simply delays the return of confidence and extends the time it will take for the Oversight Board to leave the island.” Thus, he has recommended the Board and Gov. Rosselló propose to Judge Swain a cut from $45 billion to $6 billion of the public debt backed by taxes, with a payment of only 13.6 cents per each dollar owed, with the aim of equating it with the average that the states have. All of this has been complicated this week by the blackout Wednesday, before the Puerto Rico Electric Power Authority, PREPA, yesterday announced it had restored power to some 870,000 customers.

As in  Central Falls, Rhode Island, and in Detroit, in their respective chapter 9 bankruptcies, the issue and debate on pensions appears to be a matter which will be settled or resolved by the court—not the parties or Board. While the Board has the power to propose a reform in the retirement systems, it appears to lack the administrative or legislative mechanisms to implement a labor reform. The marvelous Puerto Rican daily newspaper, El Nuevo Día asked one of the PROMESA Board sources if it were possible for the Board to go to Court and demand the implementation of a labor reform in case the Governor does not propose such legislation—the response to which was such a probability was “low.” Concurrently, an advisor to House Natural Resources Committee Chairman Rob Bishop (R-Utah) with regard to proposing legislation to address the issue receive a doubtful response, albeit an official in the Chairman’s office said recently that if the Rosselló administration does not implement the labor reforms proposed by the PROMESA Board, the option for the Board would be to further reduce the expenses of the government of Puerto Rico. Put another way, Carlos Ramos González, Professor of Constitutional Law at the Interamerican University of Puerto Rico, is of the view that, notwithstanding the impasse, “in one way or another, the Board will end up imposing its criteria. How it will do it remains to be seen.”

Physical, Not Fiscal—But Fiscal Storms.  Amid the governance and fiscal storm, a physical storm in the form of am island-wide blackout hit Puerto Rico Wednesday after an excavator accidentally downed a transmission line, contributing to the ongoing physical and fiscal challenge to repair an increasingly unstable power grid nearly seven months after Hurricane Maria. More than 1.4 million homes and businesses lost power, marking the second major outage in less than a week, with the previous one affecting some 840,000 customers. PREPA estimated it would take 24 to 36 hours to restore power to all customers—it is focusing first on re-establishing service for hospitals, water pumping systems, the main airport in San Juan and other critical facilities. The physical blackout came as the PROMESA Board has placed PREPA, a public monopoly with $9 billion of debt, in the equivalent of its own quasi chapter 9 bankruptcy, in an effort to help advance plans to modernize the utility and transform it into a regulated private utility—after, last January, Gov. Ricardo Rosselló announced plans to put the utility up for sale.

Several large power outages have hit Puerto Rico in recent months, but Wednesday was the first time since Hurricane Maria that the U.S. territory has experienced a full island-wide blackout. Officials said restoring power to hospitals, airports, banking centers and water pumping systems was their priority. Following that would be businesses and then homes. By late that day, power had returned to several hospitals and at least five of the island’s 78 municipalities. Federal officials who testified before Congress last week said they expect to have a plan by June on how to strengthen and stabilize Puerto Rico’s power grid, noting that up to 75% of distribution lines were damaged by high winds and flooding. Meanwhile, the U.S. Army Corps of Engineers, which is overseeing the federal power restoration efforts, said it hopes to have the entire island fully restored by next month: some 40,000 power customers still remain without normal electrical service as a result of the hurricane. The new blackout occurred as Puerto Rico legislators debate a bill that would privatize the island’s power company, which is $14 billion in debt and relies on infrastructure nearly three times older than the industry average.

 

The Undelicate Local-State Fiscal Balance

eBlog

April 18, 2018

Good Morning! In this morning’s eBlog, we try to assess the odds for Atlantic City’s exit from state preemptive control, and then we look west to observe the lingering fiscal and physical damage created by the State of Michigan’s takeover of the City of Flint.

The Difficult Challenge of Ending State Fiscal Preemption. In the Garden State, New Jersey Gov. Phil Murphy has removed and replaced former Gov. Chris Christie’s designee, attorney Jeff Chiesa, who had been tapped to preempt local governance authority and run the famed city in an effort to avert its filing for chapter 9 municipal bankruptcy. The new Governor’s action has the effect of retaining state oversight of the fiscal governance of Atlantic City–effectively leaving the city still under state authority first imposed by former Governor Christie in November of 2016. As we had noted, that state takeover did not remove the Mayor and Council; however, Mr. Chiesa was granted broad powers in the city, such as the ability to break union contracts and sell off city assets. Ironically, it was also a prohibitively costly takeover to state taxpayers: Mr. Chesia’s law firm has filed a claim with the State of New Jersey for at least $4 million in taxpayer dollars for its work. Indeed, unlike the city’s elected leaders, Mr. Chiesa has been compensated at a rate of $400 an hour; his firm colleagues have been paid slightly less. In announcing the replacement, Gov. Murphy left unsaid the status of his earlier vow to end the state takeover of Atlantic City; he did, however, announce that state control of the city would revert to the New Jersey Department of Community Affairs, currently overseen by New Jersey Lt. Governor Sheila Oliver, a long-time opponent of the state takeover. Left unclear are the new Governor’s time frame or commitment with regard to restoring local control—as, under the current statute signed by former Gov. Christie, state control and preemption could persist until 2021.

During his campaign, then candidate Murphy had campaigned for ending the state takeover; however, when pressed to clarify his intentions last February, then candidate Murphy responded that the state would be a “partner” with the city—comments similar to those he made this week, when he said: “The economic revitalization of Atlantic City is critical to advancing our overall state economy…The actions we are taking today will ensure we are working in full partnership with the city to ensure economic growth and empowerment for all Atlantic City residents.”  Indeed, New Jersey Lt. Governor Oliver said the Department will “continue to play an active role in Atlantic City to build upon the significant gains the city and state have made over the last 18 months in stabilizing Atlantic City’s finances: This ongoing partnership between DCA’s knowledgeable local government experts and the City’s governing body and its professionals will keep Atlantic City moving in the right direction for its residents and businesses and the surrounding region.” For his part, Atlantic City Mayor Frank Gilliam notes: “Atlantic City’s rebirth is looking very bright.”

For their part, former Gov. Christie and New Jersey State Senate President Stephen Sweeney (D-Gloucester) had pressed for the state takeover in the wake of the shuttering of five of the famed resort city’s casinos over the last decade, causing a swoon in the seaside city’s tax ratables by $14 million, and its debt to balloon to over $500 million. Unsurprisingly, former Gov. Christie, Sen. Sweeney, and others claim the state takeover has helped restore the city—a saving which, not coincidentally, has meant thousands of jobs in the state, and, mayhap more fiscally valuable, millions of dollars in state tax revenues. Since the takeover commenced, New Jersey has settled tax appeal debt with Borgata casino and worked with the city to adopt a municipal budget providing the first municipal tax decrease in almost a decade. Describing the state preemption and takeover, former Gov. Christie noted: “If you compare the results Sen. Chiesa has gotten from what he billed with what you all have paid to the people who have been running this city into the ground, Sen. Chiesa is the biggest bargain in the world…You all should wish he stays here for the rest of his life.” Unsurprisingly, however, many city leaders, some state lawmakers, and union officials have opposed the takeover, saying it violates civil rights and damages collective bargaining. 

Atlantic City Mayor Frank Gilliam has, unsurprisingly, applauded the new Governor’s action, noting: “Atlantic City’s rebirth is looking very bright.”

Out Like Flint. A visibly irate Mayor Karen Weaver has stated the city is exploring legal options against Gov. Rick Snyder and the state after the Governor told her “to get over” the ending of water distribution in the citya characterization the Governor’s office disputed as inaccurate. In a hastily called news conference in her office, Mayor Weaver said she met with the Governor Monday morning in Lansing in an effort to dissuade him from his announced decision to have the state cease the provision of bottled drinking water to the various “pods” across Flint—in the wake of, more than two years ago, the city’s declaration of a lead contamination state of emergency. However, on April 6th, Gov. Snyder, citing nearly two years of test results showing lead levels in city tap water below federal standards, had ordered the end of such distributions. Thus, in the wake of her meeting with the Governor, Mayor Weaver noted: “We did not get very far in the conversation, because one of the things the Governor basically said was we need to get over it.”

But, from her perspective—and responsibility–Mayor Weaver stated that providing water to the residents of Flint is a “moral issue,” especially since it had been the state’s action—in appointing an Emergency Manager to preempt all local authority—who had been responsible for Flint’s lead-in-water crisis. Noting that, since it was state action which had precipitated the physical and fiscal crisis, she believes the burden is on the state to reestablish trust: “They gave us their word that they would see us through this lead and galvanized service line replacement and that we would have pods stay open until then…And they backed out on what they said.”

However, Anna Heaton, a spokesperson for Gov. Snyder disagreed: she said: “It was a good discussion about the city and state’s continued partnership, and an offer for economic development help, since the Mayor brought the city’s new economic development official with her to the meeting…State taxpayers could ceased funding the pods last September, but, in the wake of the city’s request, the Governor opted to keep them open—and keep them open a full seven months past when the state could have ceased funding them, asserting this action was taken in order to help with the state’s continued partnership with the city, and to “foster trust with residents as the water quality continued to improve.” Her comments came in the wake of an earlier announcement by Gov. Snyder, in which he said the state has “worked diligently to restore the water quality and the scientific data now proves the water system is stable and the need for bottled water has ended.”

Mayor Weaver said the Governor, in the 35-minute meeting, had wanted to discuss economic development, but she told him the bottled water issue was not going away. Flint’s legal counsel, Angela Wheeler, added: “We do have to explore all possibilities” with regard to whether Flint will opt to sue the state—as Mayor Weaver has been clear that the State of Michigan should wait until all of the city’s lead service lines are replaced.

The Once & Future Puerto Rico?

April 17, 2018

Good Morning! In this morning’s eBlog, we try to assess the fiscal and future governance options for Puerto Rico: will it become a second class state? A nation? Or, at long last, an integral part of the nation? And governance: who is in charge of its governance?

Before Hurricane Maria wracked its terrible human, fiscal, and physical toll; more than 50% of Americans knew not that Puerto Ricans were U.S. citizens. Still, today, some six months after the disaster, more than 50,000 have no electricity. The fiscal and physical toll on low-income Americans on the island has been especially harsh: of the nearly 1.2 million applications to FEMA for assistance to help fix damaged homes, nearly 60% have been rejected: FEMA provided no assistance, citing the lack of lack of title deeds or because the edifices in need were constructed on stolen land or in contravention of building codes. That is to write that this exceptionally powerful storm took a grievous toll not just on life and limb, but especially on the local and state economy, destroying an estimated 80% of Puerto Rico’s agricultural crop, including coffee and banana plantations—where regrowing is projected to take years. The super storm devastated 20% of businesses—today an estimated 10,000 firms remain closed. Discouragingly, the government forecasts output will shrink by another 11% in the year to June 2018.

It might be, ojala que si (one hopes) that a burst of growth will ensue, with estimates of as much as 8% next year, in no small part thanks to federal recovery assistance and as much as $20 billion in private-insurance payments—as well as Puerto Ricans dipping into their own savings to make repairs to their own homes and businesses. Yet, even those positive signs can appear to pale against the scope of the physical misery: by one estimate, Puerto Rico and the U.S. Virgin Islands will lose nearly $48 billion in output—and employment equivalent to 332,000 people working for a year. Of perhaps longer term fiscal concern are the estimated thousands of Puerto Ricans who left the island for Florida and other points on the mainland—disproportionately those better educated and with greater fiscal resources—leaving behind older and poorer Americans, and a greater physical and fiscal burden for Puerto Rico’s government.

The massive storm—and disparate treatment by the Trump administration and Congress—have encumbered Puerto Rico with massive debts, both to its central government and municipalities, but also to its businesses. Encumbered with massive debts—including $70 billion to its municipal bondholders and another $50 billion in public pension liabilities; Governor Ricardo Rosselló’s administration is making deep cuts: prior to the massive storm, the government had been committed to slashing funding to its local governments by $175 million, closing 184 schools, and cutting public pensions—pensions which, at just over $1,000 are not especially generous. Now, that task will be eased, provided the PROMESA oversight Board approves, to moderate the proposed cuts in services in order to do less harm the reviving economy.

Assisted by federal tax incentives, Puerto Rico’s economic model was for decades based on manufacturing, especially of pharmaceuticals. However, what Congress can bestow; it can take away. Thus it was that over the last decade, Congress steadily eroded economic incentives—Congressional actions which contributed to the territory’s massive debt crisis, and contributing to the World Bank dropping Puerto Rico 58 places in its ranking compared to the mainland with regard to the ease of doing business.

The havoc wreaked by Maria could be especially creative for the island’s private sector, which represents a chronically missed opportunity. Puerto Rico, for all its problems, is a beautiful tropical island, with white-sanded beaches, rainforest, fascinating history, lovely colonial buildings and a vibrant mix of Latin-American and European culture. Yet, with 3.5 million visitors a year, its tourism industry is less than half the size of Hawaii’s. It has an excellent climate for growing coffee and other highly marketable products, yet its agriculture sector is inefficient and tiny. The island has a well-educated, bilingual middle-class, including a surfeit of engineers, trained at the well-regarded University of Puerto Rico for the manufacturing industry, and cheap to hire. But in the wake of the departing multinationals, they are also leaving. Isabel Rullán, a 20-something former migrant, who has returned to the island from Washington to try to improve linkages to the diaspora, estimates that half her university classmates are on the mainland.

Quien Es Encargado? (Who is in charge?) Unlike a normal chapter 9 municipal bankruptcy proceeding, the process created by Congress under the PROMESA law created a distinct governance model—one which does create a quasi emergency manager, but here in the form of a board, the PROMESA Board, which, today, will submit its proposed fiscal plan, or quasi plan of debt adjustment to U.S. Judge Laura Swain Taylor; it will maintain its requirement to propose the reduction of the public pensions of Puerto Ricans by an average of 10 percent. Until last weekend, the PROMESA Board had kept under review the complaints to Governor Ricardo Rosselló with regard to the inclusion in its revised fiscal plan of the central government the base of a labor reform which, among other proposals, calls for the immediate reduction in vacation and sick leaves from 15 to 7 days for workers of private companies, according to two sources close to the Board. Under the fiscal plan proposed by the Governor Rosselló, the cuts would reach $1.45 billion in five years. The PROMESA Board has requested that they total $1.58 million by June of 2023. The proposal, unsurprisingly, has raised questions with regard to whether the Congress has the authority to impose on the government of Puerto Rico a reform of its labor laws—any more than its inability under our form of federalism to dictate changes in any state’s retirement systems—contracts which are inherent in state constitutions.

Pension reductions in chapter 9 cases, because they involve contracts, are difficult, as contracts are protected under state constitutions—moreover, as we saw in Detroit’s plan of debt adjustment approved by now retired U.S. Bankruptcy Judge Steven Rhodes, the court wanted to ensure that any such reductions would not subject the retiree to income below the federal poverty level—a level which, Puerto Rico Governor Ricardo Rossello told Reuters, in an interview this past week, “many retirees are already under,” as he warned  that any further pension cuts could “cast them out and challenge their livelihood.” That is, in the U.S. territory struggling with a 45 percent poverty rate and unemployment more than double the U.S. national average, the fiscal challenge of how to restructure nearly $70 billion in debt, where public pensions, which owe $45 billion in benefits, are also virtually insolvent, makes the challenges which had confronted Judge Rhodes pale in comparison.  Moreover, with the current pensions already virtually insolvent, paying pension benefits out of Puerto Rico’s general fund, on a pay-as-you-go basis, could cost the virtually bankrupt Puerto Rico $1.5 billion a year. The PROMESA Board has recommended that Gov. Rossello reduce pensions by 10 percent.  

For their part, the island’s pensioners have formed a negotiating committee, advised by Robert Gordon, an attorney who advised retirees in Detroit’s chapter 9 municipal bankruptcy, as well as Hector Mayol, the former administrator of Puerto Rico’s public pensions. The fiscal challenge in Puerto Rico, however, promises to be more stiff than Detroit—or, as Moody’s put it: Puerto Rico’s “unusual circumstances mean that it will not conform exactly” to recent public bankruptcies, in which “judges reduced creditor claims far more than amounts owed to pensioners.” Moreover, the scope or size of Puerto Rico’s public pension chasm is exacerbated by the ongoing emigration of young professionals from Puerto Rico to the mainland—making it almost like an increasingly unbalanced teeter totter.  The U.S. territory’s largest public pension, the Employee Retirement System (ERS), which covers nearly 100,000 retirees, is projected to run out of cash this year: it is confronted by a double fiscal whammy: in addition to paying retiree benefits, ERS owes some $3.1 billion to repay debts on municipal bonds it issued in 2008—bonds issued to finance Puerto Rico’s public pension obligations. Last year, Governor Rosselló had agreed to a reduction in pensions for government retirees, indicating a willingness to seek as much as a 6% reduction. That appears not, however, to be something he currently supports.

A few weeks ago, in the wake of negotiations with the PROMESA Board, Governor Rosselló proposed a labor reform similar to the one he negotiated with members of the Board, with differences with regard to how to balance it with an increase in the minimum wage and when to implement such changes. The Governor, however, withdrew the proposal when the Board required that the labor reform be in full force by next January, instead of applying it gradually over the next three years, and conditioned the increase from $ 7.25 to $ 8.25 per hour in the minimum wage to the increase in labor participation rates. It seems the PROMESA Board is intent upon labor reform as an essential element for future economic growth.

The Challenge of “Shared” Governance. Unlike in Central Falls, San Bernardino, Detroit, Jefferson County, or other chapter 9 cases where state enacted chapter 9 statutes prescribed governance through the process, the PROMESA statute created a territorial judicial system to restructure Puerto Rico’s public debt, creating a Board empowered to reign until four consecutive balanced budgets and medium and long-term access to the financial markets are achieved—or, as our colleague and expert, Gregory Makoff, of the Center for International Governance Innovation, who worked for a year as an advisor to the Department of Treasury in the Puerto Rican case, put it: “While the lack of cooperation with the Board may be good in political terms in the short-term, it simply delays the return of confidence and extends the time it will take for the Oversight Board to leave the island.” Mr. Makoff has recommended the Board and Gov. Rosselló propose to Judge Swain a cut of from $45 down to $6 billion of the public debt backed by taxes, with a payment of only 13.6 cents per each dollar owed, with the intent of equating it with the average that the states have. His suggestion comes as the Board aims to disclose its plans as early as this evening in advance of its scheduled sessions at the end of the week at the San Juan Convention Center, where, Thursday, the Board wants to certify Puerto Rico’s and PREPA’s proposed plans, and then, Friday, vote on the plans of the other public corporations: the Aqueducts and Sewers Authority (PRASA), the Highways and Transportation Authority (PRHTA), the Government Development Bank, the University of Puerto Rico (UPR) and the Cooperatives Supervision & Insurance Corporation (COSSEC).

Fiscal Balancing. The PROMESA law authorizes the Board the power to impose a fiscal plan and propose to Judge Swain a quasi plan of debt adjustment, as under chapter 9, on behalf of the government, much as in a chapter 9 plan of debt adjustment‒albeit the PROMESA statute does not grant the Board the power to enact laws or appoint or replace government officials. The Congressional act retained for the government of Puerto Rico the capacity and responsibility to enact laws consistent with the fiscal plan and the fiscal adjustment plan, as well as, obviously, to operate the government.

The Promise & Unpromise of PROMESA: Who Is Encargado II? Unlike in a, dare one write “traditional” chapter 9 municipal bankruptcy, where state enacted legislation defines governing authority in the interim before a municipality receives approval of its plan of debt adjustment to exit municipal bankruptcy, the Congressional PROMESA statute has left blurred the balance—or really imbalance—of authority between the power of the Board to approve a budget and fiscal plans, with its possible lack of authority to implement reforms, such as changes to federal regulations it promotes. An adviser to House Natural Resources Committee Chairman Rob Bishop ((R-Utah) recently noted that if the Rosselló administration does not implement the labor reform proposed by the PROMESA Board, the option for the Board would be to further reduce the expenses of the government of Puerto Rico—or, as Constitutional Law Professor Carlos Ramos González, at the Interamerican University of Puerto Rico, describes it, notwithstanding the impasse, “in one way or another, the Board will end up imposing its criteria. How it will do it remains to be seen.” An adviser to Chair Bishop said recently that if Gov. Rosselló’s administration does not implement the labor reform proposed by the Board, the option for the PROMESA Board would be to further reduce the expenses of the government of Puerto Rico—or, as Professor González put it: “In one way or another, the Board will end up imposing its criteria. How it will do it remains to be seen.”

The Uncertain State of the State. An ongoing challenge to full recovery for Puerto Rico is its uncertain status—a challenge that has marked it from its beginning: in February of 1917, during debate on the Senate floor of HR 9533 to provide for a civil government for Puerto Rico, when Sen. James Wadsworth (R-N.Y) inquired of Senate sponsor John F. Shafroth of Colorado whether it would “provide woman suffrage in Puerto Rico?” Sen. Shafroth made clear his intent that the eligibility of voters in Puerto Rico—as in other states—“may be prescribed by the Legislature of Puerto Rico.” That debate, more than a century ago, lingers as what some have described as “the albatross hanging around the island’s neck: the uncertainty over its status.” Is it a state? A country? Or some lesser form of government?  Even though thousands of Puerto Ricans have fought and died serving their country in World Wars I and II, in Vietnam and Afghanistan, Puerto Rico has never been treated as a state—and its own citizens have been unable to decide themselves whether they wish to support statehood.

Some believe Puerto Rico will become a state eventually. But to get there, especially without risking a violent nationalist repulse, Puerto Rico needs to understand what the federal requirements and barriers will be—and what the promise of PROMESA really will mean. And, as they used to say in Rome: tempus fugit. Time is running out: for, absent economic and fiscal recovery soon, the flood of emigration of young Americans from Puerto Rico will become a brain-drain boding a demographic death-spiral, leaving the island with too few taxpayers to cover its more rapidly growing health care costs for an aged population.

Plans of Debt Adjustment

April 16, 2018

Good Morning! In this morning’s eBlog, we return to the Motor City, Detroit, a city, which, to some extent, was the touchstone of chapter 9 municipal bankruptcy, to observe how the process of debt adjustment, as approved by U.S. Bankruptcy Judge Steven Rhodes fared. Then we journey south to consider an assessment by the Capitol Hill publication, Politico, of the response to Hurricane Maria in Puerto Rico.

A Motor City Perspective from a Battle Veteran. Former CIA Director and U.S. Army General David Petraeus, speaking at the end of last week in Detroit at Wayne State University, likened Detroit’s rebound from the nation’s largest ever chapter 9 municipal bankruptcy to be like a “Phoenix rising from the ashes,” suggesting that the United States should emulate the Motor City’s multifaceted template for success. His speech, titled, “National Security: How safe are we at home and around the world?” was part of Wayne State’s Forum on Contemporary Issues in Society’s 10th anniversary lecture series. The issue, or question, Gen. Petraeus told the audience with regard to: “What in the World is Going On?” related to: “Detroit is a city that hit rock bottom that is bringing you back.” Thus, General Petraeus asked: “The question is: how to do that for the entire country?” Telling the audience: “In Detroit, where do you start when you have a city that’s crumbling at its core? Do you start with policing? Urban renewal? Economic revival? Education? It takes all of the above.” Gen. Petraeus said the biggest threats facing the U.S. are “countries that aren’t satisfied with the status quo and want a change…such as Russia, China, Iran and North Korea; Islamic extremists; cyber threats; and increasing domestic populism.”

Gen. Petraeus added: “We really need to come to grips with the legal pathway of unskilled workers who are hugely important, particularly to the agriculture and hospitality industries; we need to come to grips with those who are already here but not legally, particularly the DACA children.”

But, as the fine editorial writer for the Detroit News, Bankhole Thompson, writing about a forum over the weekend at the Kennedy School’s Institute of Politics, billed as a forum to focus on the Motor City’s recovery, featuring Mayor Mike Duggan, JP Morgan Chase Chair Jamie Dimon, and Peter Scher, the bank’s global head of corporate social responsibility,  the event “appeared more like a carefully orchestrated public relations and ‘job well done’ session for JPMorgan Chase, or at best the case of a bank issuing its own report card about its involvement in the city’s recovery,” adding that, “poverty, the greatest challenge to the city’s revival, was not given the deserving spotlight: They referenced the Mayor’s race speech last year without in-depth analysis about it. Listening to the entire exchange about Detroit, one would think the speakers were talking about a completely different city, not the one which is today the headquarters of poverty in America, as the 2016 Census shows Detroit leads the nation among the largest cities with poverty at 35.7%.” Mr. Thompson added that if one were unfamiliar with the crime index of Detroit, one would have been “hard-pressed to believe that the three-person panel led by Mayor Duggan was talking about a city that is now No. 1 in violent crime in the nation,” asking: “How can a discussion about rebuilding a city like Detroit not first acknowledge the problem of poverty, which is central to achieving even-handed recovery?” Wondering how if the city’s leaders continued to shy away “from the proper diagnosis, how can the problem be solved?” While expressing appreciation for the role that JPMorgan Chase and other entities are playing by investing in certain targeted neighborhoods, he wrote: “But the fact remains that while some neighborhoods are poised to revive and soar, the vast majority of them are nowhere close to experiencing economic salvation…As a result, Detroit has remained a city of different and especially unequal neighborhoods where the future of the city’s kids is determined by ZIP codes…Men and women of all races are born with the same range of abilities. Referencing former President Lyndon Johnson’s Howard University commencement address from 1965, he wrote: “ ‘But ability is not just the product of birth. Ability is stretched or stunted by the family that you live with and the neighborhood you live in, by the school you go to and the poverty or the richness of your surroundings,’” noting that the former President’s comments capture the “current realities of life for many in Detroit, where children wake up frightful and go to sleep hungry in high poverty neighborhoods,” Adding that the panel “failed to delve into the spectacles of destitution and misery that have created the ‘two Detroit’ phenomenon.” He wrote: “Detroit’s leaders must first acknowledge that poverty is real, not a myth, and then work assiduously to address it. An omission like this often leaves some people with this question: who is the city coming back for?”

Beating the Odds: A grim Assessment of FEMA. The Capitol Hill periodical, Politico, in an investigation by writer Danny Vinik “How Trump Favored Texas over Puerto Rico,” noted that the federal government had significantly underestimated the potential damage to Puerto Rico from Hurricane Maria and relied too heavily on local officials and private-sector entities to handle the cleanup, noting that its cleanup plan, which had been developed four years ago by a FEMA contractor in anticipation of a catastrophic storm and utilized by FEMA when Maria hit last September, prepared for a Category 4 hurricane and “projected that the island would shift from response to recovery mode after roughly 30 days. In fact, Hurricane Maria was a ‘high-end’ Category 4 storm with different locations on the island experiencing Category 5 winds. More than six months after Maria made landfall, the island is just beginning to shift to recovery mode,” adding that, according to a half-dozen disaster-recovery experts who reviewed the document at Politico’s request, FEMA did not anticipate having to take on a lead role in the aftermath of the disaster, despite clear signs that Puerto Rico’s government and critical infrastructure would be overwhelmed by the force of such a storm; rather, the document largely relied on local Puerto Rico entities to restore the island’s power and telecommunications systems. Moreover, the FEMA analysis omitted discussion of the U.S. territory’s fiscal instability, as well as the capacity of PREPA—or, as Mr. Vinik wrote: “The plan truly didn’t contemplate the event the size of Maria…They made assumptions that people would be able to do things that they wouldn’t be able to do.” Nevertheless, he added that disaster-recovery experts determined that the 140-page plan, published last month on the open-information site MuckRock through a Freedom of Information Act request, correctly predicted many challenges that FEMA faced with Hurricane Maria, including widespread road closures and difficulties transporting emergency supplies to the island territories, but failed to anticipate the extent of the damage. Mr. Vinik noted that Michael Coen, an appointee of President Barack Obama, who was serving as chief of staff at FEMA when the report was written, said the drafters should have expected that the federal government would need to play a larger role than they envisioned: “They probably should have made the assumption that it was going to require federal support: That should have been flagged,” with experts describing that omission as significant, because such planning documents are most useful in advance of the disaster, in significant part to assist federal, state, and local entities to better understand and coordinate their responsibilities. He found, mayhap ironically, that FEMA’s plan “did accurately predict that the island’s geographic position and aging infrastructure would make the response challenging. It correctly identified that moving assets to nearby locations in advance would be ‘limited’ as a result of the storm’s uncertain path and that ‘hotel space commonly used to house responders may be necessary to house survivors.’” Moreover, he found, FEMA’s plan also found that Puerto Rico’s power is generated in the island’s south, while most of the population lives in the north, requiring transmission lines which transverse Puerto Rico’s steep terrain would render “repair and restoration difficult and lengthy: It is anticipated that infrastructure of essential utilities will be out of service for extended periods of time.” Indeed, he noted that Jeremy Konyndyk, the former key USAID disaster response official during the Obama administration, had described FEMA’s plan as “reasonably good,” that it “presciently anticipate[d] many of the issues that emerged in the Maria response.” However, Mr. Konyndyk and other disaster response experts suggested that the plan contained some critical omissions, especially its heavy reliance on state and local officials to respond to the storm. The FEMA plan had determined that the U.S. Army Corps of Engineers could help with temporary power restoration, but “cannot fix transmission lines,” since such a job “is the responsibility of the owners.” However, after Maria struck, the Corps was tasked with repairing the entire power grid in Puerto Rico, a result of financial and management difficulties at PREPA. Thus, the plan’s over optimistic assumptions that temporary repairs to critical infrastructure, such as the power system, would be complete soon after the storm proved to be gravely off.

The plan also projected that private sector companies would move swiftly to restore telecommunications, or, as the report described it: “There are minimal expectations that federal assistance would be required to restore the infrastructure during the response and recovery of a storm,” adding that, if communication systems were not swiftly fixed, first responders could use satellite phones instead or rely on mobile communication trucks delivered to the island. The reality, as we have previously noted, however, is that Puerto Rico’s communication system was wiped out, leaving telecommunications companies in the midst of such serious infrastructure disruption to slowly repair the infrastructure, unaided by rolls of paper towels tossed by President Trump as Puerto Rico’s leaders and mayors desperately sought to communicate with FEMA and other first responders. Indeed, as Mr. Vinik wrote: “Local officials described limited communications as one of the biggest challenges in the first week after the storm.”

Noting the importance of having a FEMA plan on a Caribbean island subject to violent hurricanes, Mr. Vinik, wrote that in a March interview at FEMA’s joint field office in Puerto Rico, Michael Byrne, FEMA’s top official overseeing the response to Hurricane Maria, had, instead downplayed the importance of the plan—telling him: “A plan is good when you don’t have all the ground truth about what your requirements are going to be. You use that someone thought about this, someone took the time to think it through and said it’s likely that this is what’s going to happen. And then you execute the plan.” In the aftermath of Maria, FEMA is revising its hurricane plan for Puerto Rico, and, a day late and many dollars short, FEMA is creating teams to help Puerto Rico municipios to update their own plans, using new assumptions about the risks and damage from a catastrophic storm. 

Who Is on First? In its revised, quasi plan of debt adjustment, Puerto Rico has increased its projected five-year cash surplus to $7.36 billion; the plan, however, does not include layoffs or pension cuts that have been urged by the federally-appointed PROMESA oversight board—raising, once again, the difficult governance issue with regard to how the elected leaders of Puerto Rico and the federally appointed oversight board will reach any consensus after months of seeking to negotiate a consensual plan, with Governor Rossello vowing to oppose the PROMESA Board’s proposed 10% cut in public pension payments and a number of proposed labor reforms. In addition, the Governor has insisted he can achieve the Board’s requested level of spending cuts without layoffs in the public sector workforce—something with regard to which the Board has remained doubtful. Now, with the Board’s April 20th deadline looming this Friday, the question will be whether there might be still another deferral to continue talks with the Governor, albeit, there appears to be growing speculation that the Board will act to approve or disapprove this week.  

The Fiscal & Physical Challenge. In the real world, for any meaningful fiscal recovery, any plan agreed to—or imposed by the Board, will have to address the trials and tribulations of one of the nation’s oldest municipalities, Cidra, a municipio of about 44,000, which is one of the oldest cities in the U.S. Founded in 1795, the city has, in the wake of Maria, lost hundreds of jobs: chains of adverse events which are outside of local control demonstrate the complexity of assessing what kind of fiscal recovery plan could actually work. In February, PepsiCo announced the closure of its plant in the city—and the dismissal of 200 employees, after operating there for 30 years. Pepsi reported its decision was not related to Hurricane Maria or its location in that town, but with its strategy of optimizing global network and long-term growth. Whatever the reasoning, for Cidra, the bottom line will be the loss of jobs and the reduction of tax revenues for the municipality and for Puerto Rico: it will mark another knock on Puerto Rico’s fiscal base—of which manufacturing constitutes 20% of the island’s fiscal base. The closure will translate into losses of jobs, both private and public, reduced license taxes, corporate taxes, and individual taxes—meaning the loss of 70% of license revenues and 40% of the municipal budget. That, in turn, is forcing municipal layoffs: Cidra intends to dismiss 200 employees from a payroll of 526 representing a potential savings of $10.5 million a year—and a reduction in the city’s municipal budget, from $18 million to $11 million for FY2018-2019.

Beating the Fiscal Odds?

April 10, 2018

Good Morning! In this morning’s eBlog, we return to the fiscal gaming tables of Atlantic City, where the State oversight body for the city appears to appreciate the way the fiscal dice are rolling; then we turn south to assess the depressing future for Puerto Rico’s next generation.

Beating the Odds. The New Jersey Department of Community Affairs, the Department which assumed the key role in steering Atlantic City through its quasi plan of debt adjustment, perceives the city is in the midst of a “major breakthrough” in the wake of the sale of $49.2 million in taxable municipal bonds to help finance deferred pension and health care contributions—contributions which had been deferred when the city teetered on the edge of chapter 9 municipal bankruptcy and the state stepped in to fiscally take over the municipality. In the wake of the successful sale, the Department reported the success had demonstrated that “investors are confident in Atlantic City’s ability to pay its debt and in the State of New Jersey’s oversight of the city’s finances…[and] is proud of the team of city and state professionals who worked very hard to develop a unique solution to pay the city’s deferred contributions without having to resort to tax increases on city residents,” according to New Jersey Lieutenant Gov. and Department of Community Affairs Commissioner Sheila Oliver, who noted: “These deferred contributions from 2015 were the last major debt hurdle facing Atlantic City. With yesterday’s successful bond sale, the city is now positioned to responsibly finance this debt within its budget and have confidence in its future.” The municipal bonds were sold pursuant to New Jersey’s Municipal Qualified Bond Act, which stipulates that the state Treasurer withhold a portion of the city’s state aid in amounts sufficient to pay the principal and interest on the bonds, with the Treasurer directing a portion of the Investment Alternative Taxes paid by licensed casinos to go to the city for funding the debt service on the municipal bonds. Absent such a plan, Atlantic City would have been forced to raise property taxes by more than $700 on the average assessed home of $140,000—a most unwanted option in the wake of last year’s first-in-a-decade property tax reduction, with the Commission’s Director of Local Government Services, Timothy Cunningham, stating the option had been selected to “spare city taxpayers from picking up this expense” and “immediately ends the accrual of interest.” He added that the state fiscal strategy had demonstrated the state’s willingness and ability to find creative solutions to Atlantic City’s difficult financial problems,” noting that: “Conventional thinking would have been to take the deferred contributions the city owes and incorporate them as part of the city’s budget over the next five years. But that would have resulted in significant tax increases for residents and it wouldn’t have stopped interest from accruing on the deferred contributions.”

The bonds were priced via the Garden State’s Qualified Bond Act program to fund $37.7 million in pension and healthcare payments, after, three years ago, Atlantic City had been granted state approval to defer interest payments in the face of $101 million budget shortfall, creating ever-increasing odds to the city’s bookmakers the city might file for municipal bankruptcy. Under the new fiscal arrangements, Atlantic City, by the end of this year, will owe about $47 million for these obligations—or, as New Jersey Lt. Governor Sheila Y. Oliver put it: “These deferred contributions from 2015 were the last major debt hurdle facing Atlantic City…With yesterday’s successful bond sale, the city is now positioned to responsibly finance this debt within its budget and have confidence in its future.” That fiscal confidence is bolstered, no doubt, by being wrapped with the Garden State’s credit enhancement program and backed by Investment Alternative Tax revenue from casinos, which are directed to pay down debt or debt service payments under the authority the state assumed two years ago in November to take over Atlantic City—a fiscal system under which the State Treasurer withholds a portion of the city’s state aid in amounts sufficient to pay the principal and interest on the municipal bonds, or, as Director Cunningham described it: “This strategy, which culminated in yesterday’s bond sale, demonstrates the state’s willingness and ability to find creative solutions to Atlantic City’s difficult financial problems…Conventional thinking would have been to take the deferred contributions the city owes and incorporate them as part of the city’s budget over the next five years. But that would have resulted in significant tax increases for residents, and it wouldn’t have stopped interest from accruing on the deferred contributions.” New Jersey officials said that without the bond sale, Atlantic City would have been forced to raise property taxes on residents by more than $700 on the average assessed home of $140,000.In the wake of this week’s bond sale, Atlantic City has approximately $400 million in outstanding bond debt, according to Moody’s.

But beating the odds is not just a matter of fiscal soundness, but also physical safety. Thus, Atlantic City, in finding a new way to combat crime, has beaten the odds in developing ways to stay ahead of crimes before they are committed—meaning that the number of shootings, homicides, and robberies in the city decreased by more than 33% last year, after Atlantic City began using a risk-based policing model which analyzes data to map out crime risk factors around the city and places where crimes are likely to take place: a new tool which has helped police prevent crimes by tackling factors in the environment identified as risks where crimes take place, and not the people. Indeed, the new strategy not only contributed to the reduction by more than a third in shootings, homicides, and robberies last year, but also that greater security appears likely to enhance assessed property values.

Tempus Fugit. U.S. Director of the Federal Emergency Management Agency Brock Long has warned it will take up to an estimated $50 billion to help rebuild Puerto Rico in the wake of Hurricane Maria—even as he warned the U.S. territory is not ready for another disaster. He told NPR that the agency is focused on making Puerto Rico’s roads, homes, bridges, and electrical grid as strong as possible—but that the time to complete the effort is running out: the new hurricane season is projected to hit as early as June 1st. projected to blow in June 1. A critical issue for Puerto Rico’s fiscal future, then, is a double public infrastructure risk: its physical and human capital. On the latter front, Puerto Rico Education officials have announced the closure of some 283 schools through this summer, nearly seven months after Hurricane Maria struck, reporting that Hurricane Maria exacerbated the demographic teeter totter as increasing numbers of families with children who can afford to have left for the continental U.S., leaving, increasingly, a poorer and older population behind with a depleting tax base, but significantly greater fiscal pressures. Thus, during his visit to Puerto Rico, he warned: “We’re running out of time.” And, observing that much of the territory’s infrastructure had collapsed, he added: “We have a long way to go.” He said FEMA is coordinating a Flag Day planning and training exercise with Puerto Rico’s government in which life-saving supplies will be delivered to the island’s 78 municipalities to ensure better response times for any upcoming storms, adding the muncipios and towns will be allowed to store those supplies for future disasters, but stressing that Puerto Rico’s public and private sectors have to build a strong emergency response network and establish unified plans: “FEMA cannot be directly responsible for all of the response and recovery.” Director Long added that the private sector should ensure that communication systems become more resistant—reflecting that Maria had left nearly all of Puerto Rico without phone service after the Category 4 storm struck last September. At the same time, he defended his agency from ongoing criticism that it did not respond quickly enough to the hurricane or dedicate the same amount of resources compared with other natural disasters in the U.S. mainland, asserting: “(That’s) completely false,” adding that in the first six months since Maria hit, FEMA had invested $10 billion in Puerto Rico, in contrast to the $6 billion invested in the six months after Hurricane Katrina: “Recovery never moves as fast as people want it to be…And in this case, moving faster can be detrimental from the standpoint of putting this money to work in a manner that truly makes Puerto Rico stronger and more resilient.” His staffer, Mike Byrne, who serves as FEMA’s federal coordinating officer in Puerto Rico, said he is working with Puerto Rico’s government to determine how federal funds will be used to identify priorities and rebuild damaged infrastructure: he stated that some of the funds will go toward strengthening Puerto Rico’s power grid—some two-thirds of which Maria destroyed: even hoy dia (today), some two-thirds of its distribution system remains to be fixed; more than 50,000 power customers remain in the dark. Nevertheless, he said 96 percent of all customers now have electricity, noting: “We’ve done the Band-Aid,” adding that the recovery process has been slow in part because supplies ranging from construction equipment to power poles have been scarce in light of the natural disasters that hit the U.S. mainland, Puerto Rico, and the U.S. Virgin Islands last year

La Escuela or School of Debt. In an in-depth session with NPR’s Hari Sreenivasan, who was joined by San Juan by Danica Coto of the Associated Press, Ms. Cotto noted that, over the last three decades, Puerto Rico has experienced school enrollment drop by 42%; since May of last year, that enrollment has dropped by 38,700—in part reflecting the roughly 135,000 Puerto Ricans who, in the wake of Maria, left for the mainland—that ism, those who could afford to. Ms. Cotto added that for the island’s 4,700 affected teachers, the Secretary of Education has promised that no one will lose her or his job—albeit for a quasi-state in quasi chapter 9 municipal bankruptcy, such a commitment seems hard to imagine—the related query is what will happen to the schools themselves—150 of which had been closed in the half decade prior to Maria—and an additional 179 last year. Currently, Ms.Cotto noted, there are about 283 schools in the process of closing.

Mr. Sreenivasan inquired about the demographics of those students, some 319,000 in public schools, staying behind—in response to which Ms. Cotto responded that 30% have special needs, or about twice the average of the U.S. mainland. One can appreciate immediately the disparate fiscal and human implications—for Puerto Rico’s hopes for recovery—and for its fiscal future. And she asked about the equity in the process for determining which schools would close, reminding us of Detroit Emergency Manager Kevin Orr’s recognition that any final plan of debt adjustment for Detroit to exit the largest chapter 9 municipal bankruptcy in the nation’s history would require a perception that the public schools were competitive with surrounding jurisdictions.

Ms. Cotto noted that the bulk of public school closures in Puerto Rico will be in rural areas, noting that along the north coast of the island, some muncipios will experience closures of nearly half their public schools—creating a risk of an increasing number of young Americans losing access to public education—and a risk to local tax bases. Several other municipalities will see 44 to 46% of its schools close.