The Importance of Property Taxes in Municipal Bankrupcy Recovery

November 11, 2015. Share on Twitter

Does the Motor City Have to Change its Property Tax? Detroit has one of the broadest tax bases of any city in the U.S.: municipal income taxes constitute the city’s largest single source, contributing about 21 percent of total revenue in 2012, or $323.5 million, the last year in which the city realized a general fund surplus. Thereafter, receipts declined each year through 2010, reflecting both a rate reduction mandated by the state and the Great Recession. But the path to municipal bankruptcy also reflected not just the significant population decline, but also the make-up of the decline: the census reported that one-third of current residents are under the poverty line and that the composition of businesses—unlike any other major city in the nation—are primarily made up of public organizations. The reduction also reflected state mandates. Only Chrysler and DTE Energy pay business taxes. Detroit’s revenues had been declining year-over-year. And, even while spending has declined, spending had exceeded revenues, on average, by more than $100 million every year since 2008. Moreover, state law prohibits cities from increasing revenues by adding a sales tax or raising residential property tax rates more than inflation. Now, having emerged from the largest municipal bankruptcy in U.S. history, Detroit is still hindered in its recovery by structural flaws in its property tax system, according to a new report published by the prestigious Lincoln Institute of Land Policy, which has reported that Detroit’s high property tax rates, delinquency problem, inaccurate assessments, and overuse of tax breaks—together with limitations imposed by the Michigan constitution and state statutes, continue to expose the post-bankruptcy city to fiscal stress, with authors Gary Sands, a professor emeritus of urban planning at Wayne State University and co-author Mark Skidmore, a visiting fellow at the Lincoln Institute and a professor of economics at Michigan State University, writing: “Property tax reform is just one of several challenges facing Detroit and its residents, but tackling it could have a real impact on the city’s economy and quality of life, and could serve as an example for other cities struggling with population and job losses and a shrinking tax base….Detroit has an opportunity to restore the basic covenant that should exist between every city and its residents — fair and efficient taxes in exchange for good public services and reliable infrastructure.” In the post-bankrupt city, where Mayor Mike Duggan has secured Council approval to lower assessments 5 percent to 20 percent in some neighborhoods, the report recommends Detroit cut its tax rate, which is the highest of any major U.S. city and more than double the average rate for neighboring cities (The rate for homeowners is 69 mills, $69 for every $1,000 of assessed value).The report, Detroit and the Property Tax: Strategies to Improve Equity and Enhance Revenue, suggests key, post-bankruptcy reforms which could help, including: improving the city’s assessment system—a pre-bankruptcy system under which significantly over-assessed properties was a key contributor to the Motor City’s exceptional property tax delinquency rate—a rate which, the report notes, has improved, yet remains still about 30 percent, or ten times the median rate for major U.S. cities—adding the city also should reconsider its property abatement practices: Detroit has granted property tax breaks to over three percent of its 11,400 private properties; yet the report notes that research shows that the fiscal benefits of abatements are often outweighed by the costs. Significantly, the authors recommended the city should implement a land-based tax, a municipal tax based purely on the value or size of a piece of land, but with no additional tax for new development or improvements—an approach favored over the traditional property tax by many economists because it discourages holding property vacant or underutilizing land, and encourages development. The report also recommends eliminate Michigan’s “taxable-value cap,” a mechanism adopted by the state’s voters in 1994 which restricts the growth of the city’s tax base as the real estate market recovers, and which, the authors warn, also provides preferential treatment to longtime homeowners, locking in low effective tax rates at the expense of new buyers. The authors finally recommend reducing the city’s statutory tax rates, noting Detroit has the highest tax rate of any major U.S. city, more than double the average rate for neighboring cities. Lowering the rate could reduce delinquency and help increase property values, and could help offset increased tax burdens that may otherwise result from reducing abatements or eliminating the taxable-value cap.

Unschooled in Pensionary Math? While fixing Detroit’s revenue and tax systems is an ongoing issue, addressing its bankrupt public school system is key to the city’s fiscal future. Yet, now that the Detroit Public Schools (DPS) has to count its pension obligations, DPS’ balance sheet, in the first set of annual financial statements since Detroit emerged from municipal bankruptcy, the system has reported a $1.66 billion net deficit—or more than double that of a year ago—a change in significant part attributed to a new line on the balance sheet: $858 million of unfunded pension liabilities—a change reported in the wake of the implementation of a new accounting law which requires shortfalls to be counted against an entity’s assets on its annual balance sheet: DPS’s pension funded ratio as of last June 30th was 66.2%, according to the document. In contrast, other parts of DPS’s finances appear to be improving: its operating deficit was $42 million, a significant drop from the previous $70 million, and DPS appears to be modestly reducing its expenditures, where figures released demonstrated a modest reduction from $887 last year to $863 million. DPS state-appointed Emergency Manager stated: “Our team is working diligently every day to become a solvent school system which will allow local control to be restored.” Nevertheless, under strong pressure from Michigan Governor Rick Snyder, the state continues to seek a fiscal sustainable solution through a potential restructuring plan which would split DPS into two divisions: one responsible for the math: financial management, and other for the arithmetic: education. Indeed, DPS remedial math is an issue: In the first set of annual financial statements since Detroit emerged from bankruptcy, the system reported a $1.66 billion net deficit—equivalent to a 118 percent increase over last year, with the increase most adversely impacted by some $858 million of unfunded pension liabilities—liabilities which the system reports issued yesterday show DPS’s pension funded ratio as of June 30, 2015, was 66.2 percent.

Betting on the Garden State? In the wake of his conditional vetoes of the New Jersey legislature’s Atlantic City relief package, Gov. and Republican Presidential contender Chris Christie yesterday vowed he would meet with state Senate President Steve Sweeney (D-Gloucester) in an effort to agree on an alternate relief package for Atlantic City—a relief package the legislature sent to him last June—with the pair rolling the dice in issuing a joint statement that they intend to “construct a final and fast (sic) resolution path for Atlantic City.” Given that his veto was not issued until the very last possible moment, it is unclear what the Governor’s concept of “fast” means, but the clock began yesterday, with the legislature’s session scheduled to end in early January. In their joint statement, they said: “We remain jointly committed to Atlantic City’s long term viability as a great resort destination for entertainment, gaming and sports…Additionally, we both now understand more clearly how challenging this revitalization will be as a result of all the hard work that ensued this past year.” The timing with regard to Gov. Christie’s commitment is further complicated by the looming $11 million debt service payment due in December—a payment which Atlantic City Revenue Director Michael Stinson said would be made even if the redirected casino funds from the conditionally vetoed bills is not approved. Atlantic City Mayor Donald Guardian, who apparently was not consulted about the Governor’s last minute vetoes, is seeking better explanations and understanding from the New Jersey Office of Community Affairs with regard to the state’s concerns—especially as the clock is ticking. Or, as Garden State Assemblyman Vince Mazzeo (D-Northfield) put it: “Since June, we’ve been hopeful that Gov. Christie would do the right thing and sign these bills without delay…These bills were designed to bring real long term sustainable reforms to Atlantic City, help stabilize the tax base and generate new investments and business opportunities in the region.”

Windy City Pension Instability. Credit rating agency Moody reports, gloomily, in a special credit report, that Chicago’s unfunded pension obligations could continue to grow for at least the next decade, notwithstanding the record property tax that Mayor Rahm Emanuel secured from the City Council for the city’s public safety pension funds—and even assuming Chicago is successful in its pending legal challenges. The city’s general obligation bond ratings have steadily dropped in large part due to its accumulation of some $20 billion in unfunded liabilities, with the steep path down accelerating last spring when the rating agency dropped Chicago’s investment grade rating and issued a negative outlook. Moody analyst Matthew Butler noted: “The analysis indicates that, despite significantly increasing its contributions to its pension plans, Chicago’s unfunded pension liabilities could grow, at a minimum, for another ten years…Chicago’s statutory pension contributions will remain insufficient to arrest growth in unfunded pension liabilities for many years under each scenario,” adding that growth in the city’s unfunded liabilities and pension costs will continue “for some time regardless of the outcomes of the state’s and court’s decisions.” The credit report setback comes despite the record tax hike—a hike committed to the city’s proposed re-amortization of the schedule to implement increases in public safety pension contributions under a 2010 Illinois state mandate to fund them on an actuarial basis. Moreover, while the state legislature has passed and sent that re-amortization proposal to the Governor—a proposal which would delay the Chicago’s shift to an actuarially required contribution payment, that bill has become part of the accumulating morass caught up in Illinois’ dysfunctional ability to adopt its FY2016 budget—an inaction which is only driving up Chicago’s liabilities more, even as it prepares for a showdown before the Illinois Supreme Court next week over pension reforms approved for its municipal and laborers’ funds in Public Act 98-0641 to preserve and protect the funds’ solvency—a showdown which is an effort to overturn the lower court’s decision that the reforms violated Illinois’ constitution. A lower court judge in July voided the reforms, finding benefit cuts violated the state constitution. Yet even a win with the Supremes, Moody testily noted, despite being a “credit positive,” would still fail to address what the rating agency termed its “expectation of future growth in unfunded liabilities and the associated credit risk.” In response to the report, the city said: “Mayor Emanuel is committed to ensuring that city employees and retirees have a pension to turn to. Both SB777 and SB1922 were passed after successful discussions with the impacted unions, securing the retirements of our employees and retirees without burdening taxpayers with unsustainable pension contributions…These pension reform plans are sensible and represent a shared path forward in addressing the pension challenges that threaten Chicago’s future, while reducing the impact on taxpayers, and as Moody’s accurately states, the passage of SB777 and upholding of SB1922 are credit positives for the city.”

Should Municipal Bankruptcy Be a Last Resort?

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November 3, 2015. Share on Twitter

Complexities of Democracy & Municipal Bankruptcy. On the eve of an election, San Bernardino’s voters, tomorrow, could help determine or reshape the city’s chances of getting out of municipal bankruptcy—especially with regard to how any plan of debt adjustment addresses public safety and taxes. There are three Council seats at stake, as well as the city’s Treasurer. In a city where key votes related to its efforts to exit bankruptcy have been decided by one vote margins, this election could well reshape the city’s future—indeed, determine whether it will have a future. In the Council races, Councilman John Valdivia is running unopposed, while 5th Ward incumbent Henry Nickel is being challenged. Next door, with current Councilmember Rikke Van Johnson retiring, there is a heated four-way race. In the 7th Ward, incumbent Jim Mulvihill, who was elected two years ago in a recall election, is facing four challengers.

Polee, Polee. In Liberia, the elders in the village, Konweaken, where I lived and worked, used to caution us with those words—which, literally, translate to “slowly, slowly; but surely.” So too credit rating company Standard and Poor’s seems to be cautioning Chicago Mayor Rahm Emanuel in the wake of his success in gaining passage a record $548 million increase in the Windy City’s property tax—warning the adoption of the city’s budget and record tax increase represent notable progress, but, nevertheless, adding: “While the actions taken in this budget to raise property taxes are intended to address the cost pressures in 2016, they may not be sufficient to mitigate the city’s financial stress…In our view, the extent of the city’s structural imbalance, when factoring in required pension contributions, will take multiple years to rectify,” noting that Chicago confronts some $20 billion in unfunded public pension obligations—and that the pace with which the city plans to stabilize its pension obligations will continue to “place pressure on the city’s budget—one of the primary drivers of our rating.” S&P rates Chicago’s general obligation debt BBB-plus with a negative outlook. In its new analysis, S&P analysts Helen Samuelson, John Kenward, and Jane Ridley noted the property tax increase was an “important first step” toward dealing with skyrocketing public safety contributions under a 2010 state mandate; nevertheless, the trio expressed apprehension over the plan’s reliance on approval by the seemingly dysfunctional state of a re-amortization of the police and firefighter fund contribution schedule. Chicago’s proposal would reduce by $220 million the amount due next year to $328 million: if the proposed changes are not approved by the state, the city will owe, instead, $550 million. Under the city-adopted plan, Chicago would phase in the changes over five years to an actuarially required contribution (ARC) level which, under Illinois’ 2010 mandate, is supposed to take effect in 2016—with the first year’s payment finalized by the end of this year—a problematic deadline given the stalemate in Springfield—and failure, as the S&P trio noted, would put “even more stress on the city’s budget.” Chicago’s contributions to its four pension funds now run to $978 million, a 78% increase from the $550 million the city budgeted in 2015, and the deteriorated fiscal condition of its pension funds appear to be falling far short. S&P also expressed concerns over the long -term impact of a looming Illinois Supreme Court ruling deciding the fate of Chicago’s 2014 pension reforms to its laborers and municipal funds—changes on appeal to the Illinois Supreme Court in the wake of rejection by the lower court, with oral arguments looming this month. If successful in its appeal, Chicago would see public pension payments due next year fall by about $100 million. Nevertheless, the city would still need to come up with a plan to keep the funds solvent that does not rely on benefit cuts.

Won’t You Be My Neighbor? Wayne County has filed a class action suit against Wyandotte, a small city of about 25,000 inside of Wayne County, over tax revenues which were supposed to be collected as part of a judgment levy earlier this year. Wayne County is alleging Wyandotte and its Downtown Development Authority and Tax Increment Finance Authority instead collected taxes intended for the judgment levy for their own use. The levy in question derives from a ruling last June which requires Wayne County to replenish funds it pulled from a retirement fund. In its filing, Wayne County charged: “The (city of Wyandotte, its Downtown Development Authorities, and Tax Increment Finance Authorities) have stated that they…intend to capture revenue raised from a special purpose millage levied by Wayne County…(They) have misconstrued applicable law to conclude that they are required to capture revenue from the judgment levy…If (the city of Wyandotte, its DDA and TIFA) divert a portion of the judgment levy to their own use, the county will be unable to satisfy the judgment levy, because the revenue collected will be insufficient.” A key reasoning behind the filing by Wayne County—which is in a state of fiscal emergency, is to protect against any intergovernmental precedent whereby other municipalities, development districts, or tax increment financing authorities would not capture and use revenues from the judgment levy. While it is unclear how much Wyandotte’s tax increment finance systems have collected, Wayne County’s lawsuit does state “the amount in controversy exceeds $25,000, exclusive of interest and costs,” as it seeks a speedy hearing. Wayne County Commissioners are scheduled to meet Thursday to hear further updates on the matter, which relates to a one-time tax on property owners Wayne County adopted last June in order to raise sufficient revenue to pay a $49 million judgment in favor of a Wayne County retiree fund, stemming a lawsuit retirees filed against the county for pulling $32 million from its “Inflation Equity Fund—” the fund which provided retirees what is referred to as the “13th check.” The $49 million made up for the amount taken from the fund, plus lost earnings. In the wake of the ruling, Wayne County Commissioners adopted a resolution to use the delinquent revolving tax fund to pay for the judgment, but County Executive Warren Evans vetoed it. The result was the average Wayne County homeowner had to pay an extra $35 on her or his summer tax bill.

Will the View Be Downhill? The question before U.S. Bankruptcy Judge Alan Stout is with regard to what makes a municipality eligible for chapter 9 bankruptcy. Now the question appears to be coming to a head in the small municipality of Hillview, Kentucky, which became, last August, the first municipality to file for municipal bankruptcy since Detroit did in July of 2013, with Hillview Mayor Jim Eadens stating to the U.S. Bankruptcy court: “I believe that we did everything humanly possible to try to work this out, but we will not commit to something that is too much and that we believe will impair the city too much as far as our obligations to provide care and services to our citizens.” The filing came in the wake of the small city’s unsuccessful appeal of a court ruling ordering it to pay $11.4 million in damages to Truck America Training. Now attorneys for Truck America have challenged Hillview’s request to utilize municipal bankruptcy, citing federal rules which require a municipality to negotiate with all its creditors—not just one—before turning to chapter 9 municipal bankruptcy, noting that the municipality neither tried to make deals, nor did it try to raise taxes on the small city’s growing population. Hillview’s occupational tax, the city’s key source of revenue, is much lower than the region’s average rate: indeed, according to Truck America, raising the rate to 2% from 1.5% would give the small municipality an additional $500,000 in annual reveues. The trucking company attorneys added: “We don’t think they ever seriously tried to raise taxes or negotiate other debts,” and the city had rejected an offer to repay the Truck America debt at a 40% discount the day before the bankruptcy. The company is seeking to convince Judge Stout that Hillview should be ruled ineligible for municipal bankruptcy. In fact, the city appears to have sought to negotiate a repayment deal, including in talks which were led by retired U.S. Bankruptcy Judge and lead rhythm guitar player for the Indubitable Equivalents Steven Rhodes—but those talks led to naught—a breakdown which created apprehension on the part of Mayor Eadens that Truck America would gain the requisite authority to freeze the city’s bank account a second time—with the Mayor noting that when that happened the first time, it “was extremely disruptive, scary, and a real crisis in city operations,” in the city’s court filings. Hillview, a municipality of about 8,000 people had about $13.8 million in debt, compared with revenue of $2.5 million in the 2014 fiscal year. That is, the municipality, at least according to Moody’s analyst Nathan Phelps, is in sufficient fiscal shape to issue municipal bonds to cover losses in legal judgments and pay off the resolution over the course of a decade or, it could increase taxes on wages, business profits and property. That is, there might well be less expensive ways for the city to avoid being towed into federal bankruptcy court—and, with Truck America petitioning the federal bankruptcy court by filing an objection to the city’s petition, claiming “Hillview cannot sustain its burden of establishing eligibility under 11 U.S.C. § 109(c) and has not filed its petition in good faith,” it might well be that the federal court will concur.

Municipal Information. The Center for Integrity and Public Policy in Puerto Rico has started a web site and municipal financial index to provide statistics on Puerto Rico’s 78 cities, http://fiscal.cipp-pr.org: the site will provide comparative rankings of the cities, and will provide information in both English and Spanish, including the financial rank of each of the municipalities overall and on different measures In its press release, the Center found that Puerto Rico’s cities or muncipios were generally in a difficult financial position:
• 70 municipalities have negative net assets (unrestricted);
• 50 municipalities have a general fund deficit;
• 43 municipalities have an accumulated general fund deficit (that is, a negative general fund balance);
• 24 municipalities spend more than 15% of their budget on debt service;
• 40 municipalities receive over 40% of their revenues from the central government;
• Total long-term debt of the municipalities exceeds $5 billion.

OPEN Puerto Rico [http://abrepr.org/], which is not in English, (lo siento!) has, simultaneously announced the launch of a Municipal Financial Health Index for all 78 municipalities, noting: “With this index we are providing a new measurement tool that will allow residents to compare their municipality to the others on the island utilizing a series of standardized financial indicators…Mayors can often arrive at their own conclusions about the financial health of their municipality, but now they can do it using the index and its underlying indicators and data that is information that can be independently verified,” with the financial information on the site current to FY2013. Over time as new data becomes available, OPEN Puerto Rico will update the financial information and the index values. The index values are based on a statistical analysis of 13 financial indicators and how municipalities compare to the current Puerto Rico municipal averages. The indicators of short-term financial health have a greater weight than the long-term measures, Cruz said. The index can take positive and negative values with no particular maximum or minimum value. It indicates how far each city or town is from the mean financial condition of the Puerto Rico municipalities. Positive values indicate the municipalities are better than average and negative values show the reverse. The index values are currently not on the web site proper but in a Spanish language paper which is linked on the web site.

Ethics & Their Role in Municipal Fiscal Distress

October 15, 2015. Share on Twitter

Unravelling SWAPs & Paying the Windy City’s Pipers. In a new report, the Chicago Civic Federation rendered its support for Mayor Rahm Emanuel’s City of Chicago proposed FY2016 budget of $7.8 billion—applauding the Mayor’s proposals to take on the Windy City’s public safety pension funding crisis, but expressing apprehension that perhaps the largest municipal property tax increase in U.S. history, by itself, might be insufficient to stabilize Chicago finances, especially given continued legal uncertainty with regard to the city’s public pension and retiree health care reforms. The big kahuna in the Mayor’s proposed FY2016 budget is a $1.26 billion property tax levy, an increase of more than 33% from the originally adopted FY2015 budget, rising in subsequent years to $544.2 million between FY2015 (payable in 2016) and FY2018 (payable in 2019) with those proceeds dedicated entirely to fund the city’s Police and Fire pension funds, with the always insightful federation leader Laurence Msall noting: “Mayor Emanuel and his team deserve credit for transparently outlining a plan to address one of the City’s most urgent financial crises,” adding, however, that “[G]reater sacrifice will be needed to address the pension funding crises for non-public safety funds, the liquidity crises at Chicago Public Schools (please see below for the criminal, ethical, and fiscal challenges to CPS), and Chicago’s ongoing structural deficit, urging the city to consider greater cost savings and efficiencies, “especially in public safety operations that have largely avoided budgetary scrutiny in recent years.” Mr. Msall noted that the Mayor’s FY’2016 budget reduces Chicago’s reliance on what the Federation terms “scoop and toss,” or what he notes is “an expensive practice which extends the life of existing [municipal] bonds and dramatically increases the cost of providing government services—” a practice Mayor Emanuel pledged to the Association he would phase out by FY2019, beginning with a $100 million reduction in FY2016. {Please note next item, “Gambling,” with regard to this prohibitive municipal finance process.] Nevertheless, Mr. Msall expressed apprehension with regard to the as yet unreleased portion of the city’s proposed budget on its plans for how to fund two significant potential expenses in its upcoming fiscal year: an additional $220 million pension contribution and an increase in retiree health care costs. In its proposal, the city’s budget assumes the state will act to adopt the Mayor’s proposed changes to the City’s pension funding schedule. Indeed, such legislation has passed both houses of the Illinois legislature; however, the bill has not been released for Governor Rauner’s signature, nor has Gov. Rauner indicated that he will sign it: without such a signature Chicago will be required to contribute an additional $220 million to its pension funds in the new fiscal year. Moreover, the city still faces uncertainty with regard to the ongoing litigation over its proposed phase-out of its retiree health care benefits—where an adverse court ruling could significantly increase retiree health care costs.

Gambling on a City’s Future. At the exceptional conference, Bankruptcy and Beyond, hosted by Professor Juliet Moringiello of the Widener Law School in Harrisburg, Pennsylvania last year, there was substantive focus on the dangers of municipal involvement with so-called swaps—or municipal instruments packaged by Wall Street to make bets on interest rates—bets which Bloomberg this week insightfully noted are “costing [Chicago] taxpayers at least $270 million since Moody’s Investors Service cut its rating to junk in May,” noting that while traditionally, the exchange of one kind of municipal security for another to change the maturity (bonds), quality of issues (stocks or bonds), or because investment objectives have changed has been a more or less regular practice—one which has left all too many municipalities susceptible to significant fees and risk; more recently, so-called swaps have expanded to include currency and interest rate swaps—all leading to increased payouts to Wall Street banks, but coming, as noted above, as the Windy City considers a record tax increase to cover its public pension liabilities—swap costs in this case that are more than the city spends annually for the collection of garbage at 613,000 homes, or the equivalent of hiring more than 2,000 police officers. And that is before the city is forced to pay the piper to unwind municipal derivatives as it considers still another round of municipal debt restructuring—a round which could cost the debt-stressed city $110 million to unwind derivatives on its water debt—or, as the ever prescient Richard Ciccarone, the CEO of Merritt Research Services: “I don’t think the public should be gambling with its funds…Save the speculation for people who risk their own money, not for taxpayers.” Indeed, as can be seen from Bloomberg’s chart, Chicago confronts enormous debts to banks—not to teach in its troubled schools or to protect it citizens, but almost as a penalty for failing for too many years to address its rising pensions and borrowings to cover debt service. Instead of such critical investments, the city—and other cities and counties, as Bloomberg noted, “and other municipal borrowers in the past decade made bets on the future direction of interest rates through agreements with banks to swap interest payments. But when rates fell under the Federal Reserve’s attempt to stimulate the economy after the financial crisis, many issuers ended up on the wrong side of the bets. Since then [municipal] issuers have paid at least $5 billion to unwind the agreements.” Indeed, the city was scheduled to sell $439 million worth of municipal of bonds yesterday—with nearly 20 percent set aside to cover some $70.2 million to end an interest-rate swap tied to variable-rate debt for the city’s sewer system—and that, as Bloomberg adds, is “on top of $185 million paid to unwind swaps on general-obligation and sales tax debt since May.”The estimated $270 million total also includes the cost to banks and other professionals to restructure, according to data Bloomberg compiled from city documents. Chicago owed as much as $396 million to banks in March, before the city started terminating the swap agreements, according to market values at the time. Saqib Bhatti, a Chicago-based fellow at the Roosevelt Institute, told Bloomberg: “We’re paying these fees at the same time the city is looking at the biggest tax increase in its history,” adding that he has been recommending that governments with swaps should push to cut the fees rather than pay Wall Street banks: “Working residents of the city are going to have to sacrifice for the city to pay these fees to the banks.”

Aiding & Abetting Municipal Fiscal Distress. While they might teach math in Michigan’s schools, it might be that ethics ought also to be mandatory there and in Chicago—both places of exceptional fiscal challenges, but with, seemingly, one common denominator: unethical behavior from the top with abhorrent fiscal consequences. Thus it was Tuesday that former Chicago Public Schools (CPS) head Barbara Byrd-Bennett pled guilty to her role in a scheme to steer $23 million in no-bid contracts to education firms for $2.3 million in bribes and kickbacks. As part of her agreement, prosecutors recommended that Ms. Byrd-Bennett serve 7.5 years in prison for one count of fraud—an agreement under which prosecutors said in return they would drop the 19 other fraud counts, each of which carried a maximum 20-year term. The disservice by which Ms. Byrd-Bennett harmed Chicago’s fiscal sustainability and its children’s future came from her own past disservice to Detroit, where, as the former Detroit Public Schools chief academic officer, she had stepped down in the wake of a federal investigation into a contract between the district and SUPES Academy, a training academy where she once worked.—an investigation in which prosecutors allege the scheme started in 2012 — the year Mayor Rahm Emanuel hired her to become Chicago’s school district CEO. The indictment alleged that the owners of the two education service and training firms offered her a job and a hefty one-time payment, a payment purported to be a lucrative signing bonus — once she left CPS. The indictment alleges Ms. Byrd-Bennett expected to receive kickbacks worth 10 percent of the value of the contracts, or close to $2.3 million—or enough as Ms. Byrd-Bennett emailed to executives more than three years’ ago so that she could make money, writing: “I have tuition to pay and casinos to visit.” Her untimely departure comes in the wake of leaving the Detroit Public Schools system with what, today, is $327 million in debt with no visible means of repayment, and contemplating municipal bankruptcy, even as its debt insurer, Assured Guaranty Ltd., is pressing the Michigan legislature to bar the system from such a filing. Without the agreement, the insurer has threatened to accelerate long-term debt payments, raising the annual payment amount from $21 million to $45 million. In some sense, Ms. Byrd-Bennett brought her unethical and criminal fiscal legacy with her: SUPES Academy and Synesi Associates LLC owners Gary Soloman and Thomas Vranas have been accused of offering Ms. Byrd-Bennett money, along with sporting-event tickets and other kickbacks, in exchange for the contracts. Synesi Associates, which trains principals and school administrators—one shudders to imagine what kind of training they offer, was awarded contracts with Detroit Public Schools under Ms. Byrd-Bennett’s tenure, according to records posted on DPS’ website.

The ABC’s of Municipal Fiscal Challenges. The Holland, Michigan, School District, more than 100 years old—as may be observed from one of its oldest photos—is, like many Michigan school districts, confronting sharp and unexpected enrollment declines—declines adversely affecting their bottom lines; or, as Moody’s yesterday moodily opined, Holland illustrates not the place to skate all Winter, but rather the kinds of severe fiscal challenges of too many Michigan school districts—districts facing declining enrollments, stagnant state aid, and limited ability to raise additional revenues. Holland, a city of about 33,000 in the southwestern part of the lower peninsula, not unlike Detroit, is confronting a severe fiscal, as opposed to scholastic challenge in its K-12 system—or, as Moody’s this week reported, the A-1 credit-rated school district, has experienced a 174-student drop in enrollment—a drop nearly double what the district had anticipated and budgeted for in its current fiscal year—an enrollment drop which translates into a revenue loss of $591,000 in state aid, or, as Moody’s moodily explains: “The enrollment decline is not only credit negative for the district, but reflects the widespread credit challenges that continue to face Michigan school districts.” Moody analyst David Levett wrote: “Such pressures have led us to downgrade 44 Michigan school districts this year.” Holland’s six consecutive general fund operating deficits have been driven primarily by declining enrollment and the ensuing reduction in state aid under Michigan’s per-pupil funding system. As Mr. Levett notes: “Although officials are still analyzing this year’s enrollment figures, the district’s long-term trend of enrollment declines is attributable to significant competition from charter schools and an aging population,” effectively a fiscal one-two punch—two trends, however, which appear to be schooling Michigan’s elementary and secondary school fiscal sustainability, albeit with a potential steepening of the downward curve—or, as Mr. Levett added: “Even [school] districts that plan for declines may miss the mark on the magnitude of those declines.” Demographics are contributing to the fiscal python squeeze; the Census Bureau reports Michigan’s under-18 population is projected to decline an estimated 13% from 2000 to 2012, so that, as Mr. Levett further writes, “The state’s funding structure, demographic trends and liberal enrollment policies create an unpredictable and competitive environment for districts.” Indeed, close to 80 percent of Michigan’s school districts with more than $25 million in outstanding municipal debt experienced enrollment declines between 2009 and 2013—creating not just arithmetic opportunities for the system’s students, but math problems for the state’s school fiscal officers.

Restructuring Municipal Debt & Supermunis. Treasury Department and Puerto Rico officials are negotiating options for restructuring the U.S. commonwealth’s $72 billion in debts, especially with it becoming increasingly clear that the absentee U.S. Congress is unlikely to take any action to ensure Puerto Rico can avoid insolvency and be unable to provide essential public services. Under the evolving plan, the Treasury, or an agreed upon third party, would be in charge of an account which held a significant portion of Puerto Rico’s tax revenues—which would, effectively, be designated to pay holders of so -called super municipal bonds—municipal bonds, in this instance, held by bond owners in Puerto Rico and every state in the country who agreed to trade in their existing bonds for the new hybrid—albeit, a post “haircut” hybrid which, as in the case of a municipal bankruptcy, would be worth less than before the exchange, but which would be backed by employment and other taxes that the U.S. Treasury would collect for the territory, as well as possibly some of Puerto Rico’s own Treasury revenues. Under the evolving proposal, Treasury would act as a kind of intermediary; it would not be providing the territory with any kind of direct financial assistance or any guarantee; rather its role would be to serve as a quasi-trusted third party in a financial arrangement under which the new super municipal bonds would not only be backed by a much broader range of taxes than those that back the individual bonds of the territory and its authorities currently, but also indirectly through the unprecedented role of the U.S. Treasury—protecting and providing greater assurance to Puerto Rico’s bondholders of repayment. The discussions have not resolved whether any Congressional legislation would be needed, albeit, it is clear that the U.S. territory’s elected leaders would have to agree to potential debt exchange.

The Steep Road to Recovery from Municipal Bankruptcy

October 7, 2015

The Hard, but Critical Road to Recovery & Fiscal Sustainability. Few municipalities, especially compared to other corporations, go into bankruptcy. But for those that do, they do not disappear, as is the outcome in many corporate bankruptcies; rather they do not miss a beat with regard to providing essential services, even as they began the long and expensive process of putting Humpty Dumpty back together again by means of assembling a plan of debt adjustment in negotiations with their thousands upon thousands of creditors. While each of those plans must receive approval from a federal bankruptcy court—and the respected and respective judges do look to see that such proposed plans incorporate long-term fiscal sustainability provisions; nevertheless, those municipalities are not starting on a level playing field. So the question with regard to their ability to fully recover remains a story to be learned—because never before in American history has there been such a spate of major municipal bankruptcies. Ergo, unsurprisingly, Detroit—with its plan approved and the Mayor and Council restored to governance authority—in effect starts at a disadvantage compared to other municipalities: its road to climb is steep.

There is good news, however: a new report, “Estimating Home Equity Impacts from Rapid, Targeted Residential Demolition in Detroit, Michigan: Application of a Spatially-Dynamic Data System for Decision Support,” from the Skillman Foundation, Rock Ventures LLC, and Dynamo Metrics has found that the valuations of homes within 500 feet of a demolition funded by the U.S. Department of Treasury’s $100 million in Hardest Hit Funds have increased by an estimated 2.4 percent between December 2014 and May 2015. Indeed, blight removal has been a core element of any route to Motor City recovery: in May of 2014, the Detroit Blight Removal Task Force — which includes representatives from Detroit Public Schools, U-SNAP-BAC Inc. and Rock Ventures — identified more than 78,000 properties in need of sales, repair, or demolition. That is, federal help seems to have sparked a critical revival of affected assessed property values and, ergo, the Motor City’s revenues: the report found demolitions have increased the value of surrounding homes within 500 feet by 4.2 percent, or an average of $1,106. Citywide, that amounts to an increase in home values of more than $209 million. The bad news is that even as this innovative federal program is beginning to demonstrate its ability to contribute to Detroit’s comeback, the assistance in financing the demolition is drying up.

The report also suggests that combined with other efforts by the city—efforts which include code enforcement and sales of public assets such as side lots—have also begun to make telling fiscal differences: the value of homes nearby increased by 13.8 percent, or an average of $3,634. Citywide, that amounts to an increased assessed property value of about $410 million—or as Mayor Mike Duggan describes it: “The numbers are extraordinary,” noting that eliminating blight has allowed “good homes and good vacant homes” to increase in value: from January of last year until last, 5,812 blighted structures in the city were demolished thanks to funding from the federal “Hardest Hit” fund—a now drying up fund focusing nearly $8 billion in post Great Recession assistance foreclosure prevention in 18 states, including Michigan, with where Michigan’s share was over $498 million, of which Detroit received just over one fifth. Because those funds will be depleted this year, Mayor Duggan is planning to travel to Washington soon to meet with White House officials and others to lobby for the next round of money—especially since the demolitions to date have only addressed some 10 percent of the city’s blight.

Good Gnus. In its review of Chicago’s proposed FY2016 Budget, Kroll Bond Rating Agency (KBRA) reports it believes Mayor Rahm Emanuel’s budget includes “reasonable actions for closing the projected fiscal 2016 operating shortfall, and represents clear progress in confronting the challenges of unfunded pension liabilities.” The Budget closes the city’s FY2016 gap via proposed savings and reforms, efficiencies, and significantly increased property taxes from a four-year phased-in $543 million increase in the property tax levy, earmarked to specifically address rising police and fire pension liabilities. The rating agency wrote it believes the choice of a property tax levy increase demonstrates the Chicago’s political will to craft an effective and sustainable solution. Nevertheless, the agency noted there still remain numerous unresolved issues, which could potentially undermine budgetary goals: first, will the City Council, in an election year, approve the Mayor’s proposed budget? Second, the big shoulder city is relying on State action to increase the size of the home-owners property tax exemption, which would exempt homes valued at less than $250,000 from the increase—this a state legislature which is locked in a stalemate with the Governor. The phased-in property levy increases assume that Senate Bill 777, which reforms police and fire pension funding, will be enacted into law—and not be rejected by the Illinois Supreme Court. If not enacted, Chicago’s police and fire pension funding obligation would immediately rise from approximately $328 million to $550 million, and the city would have to identify and act on additional funding sources.

Not the Odor of Verbena. The Securities and Exchange Commission (SEC) has settled its almost six-year-old pay-to-pay case against two ex-JPMorgan bankers involved in hold-your-nose, soured sewer deals that thrust Jefferson County, Ala., into municipal bankruptcy. The SEC, according to a notice filed in federal court this week, reported it had reached agreement with Charles LeCroy and Douglas MacFaddin via mediation which resolves securities fraud charges against the two, albeit the actual terms of the settlement will not be made public until it is presented to the full commission for approval, with the independent federal securities agency advising the federal district court that, if the Commission approves the report, that would end litigation on the case. The long, simmering case dates back just about six years to when the SEC filed a civil suit alleging that Messieurs LeCroy and MacFaddin had improperly arranged payments to local broker-dealers in Alabama to assure that certain Jefferson County commissioners would award $5 billion in county sewer bond and swap deals to JPMorgan. The SEC suit, which charged that the two men “privately agreed with certain county commissioners to pay more than $8.2 million in 2002 and 2003 to close friends of the commissioners who either owned or worked at local broker-dealers,” sought declaratory and permanent injunctions against the two for federal securities law violations, as well as disgorgement of all profits they received as a result of their legal misbehavior, plus interest. The SEC had brought the suit simultaneously with its settlement of municipal securities fraud charges with the investment bank. Without admitting or denying the SEC’s charges, JPMorgan agreed to pay $75 million in penalties eventually turned over to Jefferson County, and to forfeit more than $647 million of claimed swap termination fees. In January, the SEC sought summary judgment in the case, leading U.S. District Court Judge Abdul Kallon to determine the five-year-old case was appropriate for mediation—this all in a case involving some nearly two dozen municipal elected officials, contractors, and county employees involved in Jefferson County’s sewer bond sales or construction of the sewer system who were jailed for bribery and fraud—and which led to what was, at the time, a filing for the largest municipal bankruptcy in U.S. history.

Wither Its Future—and Who Decides? Facing decades of structural budget gaps and unsustainable legacy costs, the City of Pittsburgh entered two forms of state oversight in 2004. In the subsequent decade, that engagement appeared to have been key to a turnaround in the city’s structural deficits, leading to annual positive fund balances, as the then-partnership helped restructure its crushing debt load, streamline an outsized government, and earn a triple-notch bond rating upgrade. Nevertheless, the Steel City still carried a $380 million pension liability, leaving questions with regard to whether the city was ready to graduate from state oversight – especially given the extra relief from restrictive state laws that the state’s Act 47 provides to city officials. Now that state-local tension seems to be back, with the Pennsylvania Intergovernmental Cooperation Authority (ICA), the city’s overseer, an authority state lawmakers formed in 2004 to oversee Pittsburgh’s finances, at a time the city was on the precipice of municipal bankruptcy, claiming it is justified by state law in withholding Pennsylvania gambling revenue from the city (ICA is invoking Act 71 of 2004, a state statute which grants, according to ICA, has “exclusive control” of the gaming revenues dedicated for Pittsburgh, the only second-class city under the commonwealth’s system of categorizing cities.), because, as the Intergovernmental Cooperation Authority’s Henry Sciortino, reports: “They haven’t met certain benchmarks.” Indeed, the former amity is now gone: Pittsburgh is suing the state agency in the Allegheny County Court of Common Pleas, accusing it of illegally withholding $10 million in annual gambling host city revenue funds the past two years related to the Rivers Casino—a costly dispute triggered by state agency claims that Pittsburgh Mayor Bill Peduto is backing off his commitment of $86.4 million to fully fund current payments to retirees – separate from the city’s overall unfunded pension liability estimated in the hundreds of millions. In addition, Mayor Peduto requested that Pennsylvania Auditor General Eugene DePasquale conduct an audit of the ICA—a request putting Mr. DePasquale now in a most awkward position in the wake of the city’s decision to file suit. Moreover, the city-state dispute—itself now becoming a costly court battle—arises even as the city faces daunting pension challenges: returns on the city’s employee pension funds have, according to the State Auditor, deteriorated from 16.3% in fiscal 2013 to 5.5% this year, reflecting the slowdown in financial markets, who estimates the city’s funds’ assets to be $675 million versus liabilities of almost $1.2 billion. Indeed, the Public Employee Retirement Commission considers Pittsburgh’s pension fund “moderately distressed.” In a letter to Gov. Tom Wolf and top legislative leaders a week ago, ICA Chairman Nicholas Varischetti called pension underfunding “one of the most serious barriers to Pittsburgh’s fiscal stability.” That statement comes in the wake of Pittsburgh’s efforts just five years ago to avoid a state takeover of its pension funds by earmarking nearly $750 million in parking revenues over three decades to prop its funding level above a state-mandated 50%. Keeping this growing state-local dispute constructive could matter: over the last decade, Pittsburgh has received 11 upgrades, most recently in early 2014 when S&P elevated its general obligation rating to A-plus, and Moody’s, just a year ago, revised its outlook to positive on the steel city’s general obligation bonds. The city’s suit alleges the ICA has been illegally withholding $10 million in annual gambling host city revenue funds the past two years, whilst, for its part, ICA officials claim Mayor Peduto is backing off his commitment of $86.4 million to fully fund current payments to retirees. Indeed, in an epistle to Gov. Tom Wolf, ICA Chairman Nicholas Varischetti wrote that pension underfunding was “one of the most serious barriers to Pittsburgh’s fiscal stability.” The state-local tension over the city’s pension liabilities is hardly new–five years ago Pittsburgh avoided a state takeover of its pension funds by earmarking nearly $750 million in parking revenues over 30 years to prop its funding level above a state-mandated 50%; however, once again, state apprehension is on the uptick that the city is, as one expert, David Fiorenza, a Villanova School of Business professor and a former chief financial officer of Radnor Township, said: Pa., said “[O]nce again the municipality is only fixing the leak and not curing the flooding problem of pension debt and other unfunded liabilities looming around like an albatross,” adding that he believes the state ICA can be a force to persuade cities to devote gambling revenues to other areas of the budget, such as pensions.

“Our city would become unlivable.”

A Most Serious Fiscal Challenge. Chicago Mayor Rahm Emanuel yesterday called on the Windy City’s 50 aldermen to summon the courage to pass the largest property tax increase in modern Chicago history: he told them they could justify such a hard vote by ensuring their voters understood the alternative: the dismissal of one out of five police officers, the closure of half the city’s fire stations, the elimination of the city’s rodent (read rats) control program, and the reduction of trash services to only twice a month—or, as he put it: “Our city would become unlivable…That would be totally unacceptable.” His proposed budget will total $9.3 billion when corporate, enterprise, and grant funds are added up, including a $3.6 billion general fund formally known as the corporate fund—up from $9.2 billion and $3.5 billion, respectively, for FY2015. In his budget address, Mayor Emanuel, in his second-term, laid out a grim assessment should the Council fail to act: “Our greatest financial challenge today is the exploding cost of our unpaid pensions. It is a big dark cloud that hangs over the rest of our city’s finances…Now the bill has come due,” referring to a mandate which will take effect next year to stabilize police and fire funds across Illinois: Chicago must pay the two public pension funds $550 million more as it moves to an actuarially required contribution—and, that is assuming positive action on state legislation to trim next year’s increase to $328 million. Even though his proposed budget includes some cuts and reform measures, the Mayor told his colleagues yesterday that the debt burden is so ponderous that the city cannot cut its way out of the crisis—cuts, he warned, which would require the loss of 2,500 police officers, the closure of 48 fire stations, and laying off 2,000 firefighters: “Our city would become unlivable.”

Chicago, after a significant effort to remake itself into a global city today confronts unprecedented challenges. Challenges facing the city’s fiscal future include: schools, which one commentator cited as “almost insoluble;” police—crime—gangs (also “almost insoluble”); infrastructure (on which Mayor Emanuel has earned very high marks); pensions, where Chicagoans’ long-term debt and pension obligations per capita have risen nearly 200% since 2002—and which are inextricably linked to the state; and bringing jobs back to Chicago—fiscal sustainability challenges exacerbated by the state dysfunction, by the Illinois constitution’s and Supreme Court’s rejection of efforts to modify public pension obligations, and as state and federal aid have been reduced. The Windy City, the third most populous city in the U.S. with 2.7 million residents, was a time bomb waiting to happen from the very moment Mayor Emanuel took office—an office in which he immediately confronted not only a $635 million operating deficit, but also a city which had experienced an exodus of 200,000 in the previous decade—and some 7.1% of its jobs. Now, revenues are coming back, but the city faces an exceptional challenge in trying to shape its future. By FY2014, Chicago had a debt level of $63,525 per capita, leading one expert to note that if one included the debt per capita with the unfunded liability per capita, the city would be a prime “candidate for fiscal distress.” Nevertheless, since his election, unemployment has been coming down, and census data demonstrated the city is returning as a destination for the key demographic group, the 25-29 age group, which grew from 227,000 in 2006 to 274,000 by end of 2011. Nevertheless, the city’s unrelenting pension liabilities and what Moody’s has termed it “unrelenting public safety demands” have left the city, increasingly, between a rock and hard place. Now Chicago, which has one of the largest city councils in the U.S., faces a momentous challenge to its future—a fiscal challenge, and, with his announcement, now a political challenge, or, as the Mayor put it yesterday: “I know this budget’s tough, and therefore I know it carries political risk. I get it…But there’s a choice to be made, make no mistake about it. Either we muster the political courage to deal with the mounting challenges we inherited, or we repeat the same practices and allow the financial challenges to grow.”

Now, in a vote unlike in other U.S. city, the mayor is asking the aldermen on the city council to put their own jobs on the line. Mayhap more daunting, should even modest public pension legislation pending in the stalemated Illinois legislature not be enacted, the Mayor’s proposed, record property tax increase would be more than $200 million short of the requisite level to meet Chicago’s public pension obligations. Under the Mayor’s proposed budget, property taxes would be increased $543 million over the next four years, beginning with a jolting $318 million next year; a separate $45 million property tax hike would go toward construction projects at Chicago Public Schools to alleviate overcrowding in some neighborhoods. In his proposal to the Council, Mayor Emanuel makes clear he has asked for an expanded homeowners’ exemption from Gov. Bruce Rauner and the legislature for Chicago homeowners who own and live in a home worth $250,000 or less. But the massive property tax increase alone comes at a time when Gov. Rauner is seeking a statewide property tax freeze. In his proposed budget, Mayor Emanuel also proposed new fees on taxi and ride-sharing services, such as Uber and Lyft, which would generate $48.6 million per year and a tax on electronic cigarettes which would reap another $1 million. Mayor Emanuel told the Council his budget includes $170 million in cuts and efficiencies; however, he has yet to release the fine print on what those reductions are. In asking for the unaskable, Mayor Emanuel, speaking from the City Council dais to his fellow elected leaders, said: “With this budget, we can be remembered for stepping up to the challenge rather than stepping aside. With this budget, we will be counted among the doers rather than among those who dithered…With this budget, when we look back at our public service, our individual names will be in the history book rather than the guest book. We owe it to our city and to the generations who come after us to do what is right — even when it is hard.”

The Civic Federation of Chicago defined the city’s problem concisely: “There’s no question that the mayor will need to ask taxpayers to pay more while they receive fewer services. Decades of ignoring fiscal reality have led us to this crisis: a pension system on the brink of disaster, an enormous debt burden, below-investment-grade credit. Most critically, Chicago Public Schools may not have the money to stay open for the entire school year….the question… will be whether the mayor’s budget provides enough certainty to residents and businesses that their investments will lead us beyond the morale-killing status quo to a more stable and vibrant city. A possible $500 million increase to the city’s property tax levy would be the largest tax increase in Chicago history, yet it would be only a first step. Chicago and its school system will need to make more difficult choices to close structural deficits and pay down nearly $30 billion in unfunded pension liabilities…We have to start to spend within our means — no more “scoop and toss” or borrowing for operating expenses. It would be irresponsible to raise taxes unless the city commits to significant cost reductions and efficiencies. Areas that have been considered untouchable should be reviewed, such as staffing for police and fire, the size of the City Council and the aldermanic menu program. Even with a tax increase, many services will have to be reduced or eliminated.

“Taxpayers will need answers to longer-range questions. How will the choices in this year’s budget impact future debt and taxation levels? How long before the city’s debt burden is reduced to a more manageable level? How does this budget take into account what will be asked of taxpayers to stabilize Chicago Public Schools, Cook County and the state of Illinois?

“Many of Chicago’s fiscal problems are embedded in state law. Any comprehensive solutions will require action from Springfield. State lawmakers should extend the sales tax to certain services, increase revenue sharing with local governments, merge the Chicago Teachers’ Pension Fund with the Illinois Teachers’ Retirement System and consolidate police and fire pension funds throughout the state.

“We cannot change the poor financial decisions that brought us to this crisis. With all that Chicago has to offer, however, we should make the sacrifices necessary to set the city on a more stable fiscal path. Leaders in Chicago and Springfield just need to give taxpayers the confidence that their sacrifice will pay off.”

Municipal Bankruptcy Is Large, Complicated, & Seemingly Unending

September 10, 2015

Fiscal Gales in the Windy City. As the City of Chicago grapples with its growing unfunded pension liabilities, the city’s fiscal sustainability has become increasingly at risk—putting Mayor Rahm Emanuel nearer to a fiscal cliff for the Windy City. Increasingly the unfunded pension liabilities are threatening the city’s fiscal future, and the options on the table—such as a potential huge property tax hike to fund the city’s pension liabilities portray how risky the city’s fiscal future and options are: would a huge property tax increase discourage businesses and families from moving into Chicago? Or, as the ever insightful Laurence Msall, president of the Chicago Civic Federation, puts it: “How is Mayor Emanuel going to convince the City Council and the citizens of Chicago that with this very painful and, we believe, necessary increase?” The question arises as Mayor Emanuel may seek a record half billion property tax increase to address the city’s rising pension costs—and avoid bankruptcy. The city is also considering the imposition of a new levy for garbage collection, as well as other revenue sources to respond to a $328 million to $550 million scheduled annual spike in police and fire pension contributions under a prior state unfunded mandate requiring the city to make such contributions on an actuarial basis. The window for the Mayor is winnowing down: he is scheduled to release his proposed budget a week from Tuesday—a budget in which, in addition to tax and revenue proposals, Mayor Emanuel is also expected to propose a long-term fiscal plan which will also include changes in both spending habits and debt practices in what Mr. Msall denotes as a day of reckoning for Chicago. Chicago’s fiscal dilemma is further complicated by the ongoing stalemate in Springfield, where Gov. Bruce Rauner and the legislature remain deadlocked, so that there is still no FY2016 budge—where the stalemate shows little sign of abatement. For Mayor Emanuel, no matter the stalemate in the state capitol, he has just over 10 days to put together a proposed $754 million budget—one likely to incorporate a $233 million operating deficit, $93 million in increased city contributions owed to the municipal and laborers’ pension funds, and about $100 million in debt repayment the city previously intended to defer in its amortization schedule. The budget is almost certain to propose a $328 million hike in contributions for Chicago’s police and firefighters’ pension funds—but mayhap larger if the legislature and Gov. in Springfield are unable to reach consensus on pending state legislation which would re-amortize payments.

Fiscal Teetering in Pa.’s Capitol City. In his State of the City address this week, Harrisburg Mayor Eric Papenfuse warned that the city’s plan it adopted two years ago when the city narrowly averted filing for municipal bankruptcy must be amended—noting that the revenues assumed under that plan are falling short and will be insufficient by next year—and making clear that the deficiencies could not be offset by cost-cutting alone, especially since, he noted: “While the City is starving for capacity, we have already cut discretionary funding to the bone.” Indeed, Mayor Papenfuse noted the city has reduced its work force by nearly half over the last decade and that this fiscal year “will mark the second year in a row that we have significantly underspent our adopted budget.” Nevertheless, he warned, this city is simply not on a “sustainable course.” Therefore, he has proposed three key fiscal changes: 1) Tripling the municipality’s $1-per-week tax on employees working within the city limits to $3 per week; 2) Expanding the city’s sanitation operations, and 3) Transitioning to home rule authority.

Planning Debt Adjustment. The nation’s last large municipality in municipal bankruptcy, San Bernardino, has reached a tentative contract agreement with its largest employee group, its so-called general unit. The announcement, Tuesday, reached after last month’s agreement with the city’s Police Officers Association, means that San Bernardino now has plan of debt adjustment agreements with nearly all its employees—except its firefighters—where multiple legal complaints by the fire union against the city continue. Indeed, in the wake of the city’s rejection of its bargaining agreement with the fire union and implementing changes, including closing fire stations—in an election year—the city hopes to reach agreement on the fire front within a week, even as the city is proceeding in its process of having its fire department annexed into the San Bernardino County fire protection district—a key step anticipated to add more than $12 million to the bankrupt municipality’s treasury: $4.7 million in savings and $7.8 million in revenue from a parcel tax, according to San Bernardino’s bankruptcy attorney, Paul Glassman—or more than the $7 million to $10 million in savings the city incorporated into its proposed plan of debt adjustment it submitted to U.S. Bankruptcy Judge Meredith Jury—proposing that the funds should go toward pension obligation bondholders whom San Bernardino proposes to pay 1 cent for every dollar they are owed, according to the bondholders’ attorney—a proposal certain to be bitterly challenged in the federal courtroom. Complicating the process—and quite unlike any other major municipal bankruptcy—is that it remains unclear what might occur were the proposed annexation process to break down between now and July — especially were a sufficient number of San Bernardino voters to protest the tax and trigger an election. Although missing the deadlines required to complete the annexation process by July 2016 would be costly (because it would trigger a full fiscal year delay), an interim agreement with the San Bernardino County Fire Department would continue to provide services. Next up: Judge Jury has scheduled a hearing in her federal courtroom next month on the adequacy of San Bernardino’s financial statements and its modified plan of debt adjustment for October 8th.

Debt Restructuring Outside of Bankruptcy. The U.S. territory of Puerto Rico yesterday proposed a five-year plan Document: Puerto Rico’s Debt Plan under which the island would broadly restructure its unpayable debts, restructuring more than half its $72 billion in outstanding municipal bond debt, and seeking to implement major economic overhauls—and act under the direction of a financial control board—somewhat akin to the actions taken in New York City and Washington, D.C. to avert municipal bankruptcy. The proposed plan also proposed changes, such as welfare reform, changes to labor laws, and elimination of corporate-tax loopholes. Under the proposal, the governor would select a five-member control board from nominees submitted by creditors, outside stakeholders, and, possibly, the federal government—a panel which would have the power to enforce budgetary cuts. The document explains that Puerto Rico confronts a $13 billion funding shortfall for debt payments over the next five years—even after taking into account proposed spending cuts and revenue enhancement measures outlined in a long-awaited fiscal and economic growth plan. The report from Puerto Rico Governor Alejandro Garcia Padilla’s administration notes that Puerto Rico will seek to restructure its debt in negotiations with creditors as an alternative to avoid a legal morass which could further weaken the territory’s economy: it offered no estimates of what kind or level of potential losses would be anticipated from the owners spread across each of the nation’s 50 states of Puerto Rico’s $72 billion in outstanding municipal debt. The plan details the grim situation of Puerto Rico’s fiscal challenges—and of the dire consequences to the island’s 3.5 million residents: Puerto Rico will have less than a third of the fiscal resources to meet its obligations: it has only about $5 billion available to pay $18 billion of principal and interest payments to its municipal bondholders spread all across the U.S. and coming due between 2016 to 2020—and that only if the plan’s proposed savings from the consolidation of 135 public schools, reductions in health-care spending, additional subsidy cuts, and reductions in payroll expenses were realized. Mayhap the greatest obstacle under the proposed plan will be its proposal to restructure Puerto Rico’s general obligation bond debts, municipal bonds which were sold to investors with an explicit territorial constitutional promise that Puerto Rico would commit to timely repayments—repayments which would take priority over all other governmental expenditures. Nevertheless, the plan proposes to renege on the so-called ‘full faith and credit’ pledge attached to municipal bonds issued by state and local governments on so-called general obligation or ‘full faith and credit’ bonds—a proposal which is unconstitutional under the territory’s constitution—but which the island’s leaders contend is critical lest Puerto Rico were to run out of cash by next summer—as its current fiscal projections indicate is certain absent access to municipal bankruptcy protection or triggering a proposal such as has been now proposed. The plan leaves unclear how it squares with Puerto Rico’s constitution; yet island officials made clear that were Puerto Rico to continue to make such required payments, Puerto Rico’s treasury would be depleted by next summer—with such payments, were they not cut back, leaving the government short of cash for vital public services as early as November. Under the proposed fiscal blueprint, Puerto Rico will provide its creditors with more detailed cash flow projections so that negotiations could begin on repayment alternatives and options—negotiations not only pitting the island’s essential services against bondholders in every state in the U.S., but also between classes of municipal bondholders—with general obligation bondholders anticipated to seek the most favorable treatment. One of the exceptional challenges will be that—unlike in Jefferson County, Detroit, Stockton, or San Bernardino—there will be no referee, no federal bankruptcy judge—to oversee the process. In addition to the debt restructuring, the new five-year plan calls for an ambitious series of steps to deliver public services and collect taxes more efficiently, stimulate business investment and job creation and carry out long-overdue maintenance on roads, ports and bridges. Many of the measures will require legislative approval.

Financial Control Board. The plan proposes a five-member board of independent fiscal experts who would be selected from a list of candidates nominated by different parties, including classes of creditors, the federal government, and others. Such a board would be charged with: how to deal with disproportionate and inequitably imbalanced creditors—creditors imbalanced not just fiscally, but also in terms of capacity to represent themselves. How do the island’s poorest U.S. citizens (an estimated 48 percent of Puerto Ricans are Medicaid recipients) fare against some of the wealthiest U.S. citizens who live in Alaska, California, New York, etc., and who own Puerto Rican G.O. bonds? That is, as members of Governor Padilla’s working group have noted, the inability to have access to a neutral federal court and legal process could put the island—and especially its poorest Americans—at the greatest disadvantage.

Fiscal Challenges. Gov. Padilla’s working group plan projected that, if the plan were adopted and implemented, it would be key to bringing Puerto Rico’s five-year total fiscal deficit down to about $13 billion. To close it, however, they made clear, Puerto Rico could not meet its full municipal bond payment obligations. The working plan estimated that over the next five years, Puerto Rico would have to make $18 billion in principal and interest payments to municipal bondholders on some $47 billion in outstanding municipal bond debt—but that they would propose diverting $13 billion to finish paying for essential public services over the coming five years, leaving for a Solomon’s choice about how to apportion deep cuts in Puerto’s Rico’s constitutionally obligated payments to bondholders scattered all across America—and no road map or federal bankruptcy judge to opine what might be the most equitable means in which to opt to make such payments—much less what legal ramifications might trigger. Put in context, the plan proposes a fiscal restructuring significantly larger than Detroit’s record municipal bankruptcy filing—a filing with U.S. Bankruptcy Judge Steven Rhodes which involved some $8 billion of municipal bond debt. Puerto Rico entities are unable to access Chapter 9.

Muni Bankruptcy Is Large, Complicated, & Seemingly Unending. Jefferson County, which emerged from what was—at the time—the largest municipal bankruptcy in U.S. history nearly two years ago now can better appreciate that it “ain’t over until it’s over,” finding itself before the 11th U.S. Circuit Court of Appeals this week where a group of the County’s residents claimed they were denied constitutional protections under the decision of the U.S. bankruptcy court’s approval of Jefferson County’s plan of debt adjustment, with their attorney testifying: “The essence of our client’s position to the 11th Circuit Court of Appeals is that our clients are entitled to their day in court on the merits of the legal issues presented by the Jefferson County plan of adjustment,” adding that while it was “understandable that the U.S. bankruptcy court wanted to bring the case to closure…fundamental constitutional issues simply cannot be trumped by such concerns.” The issue is whether the court should accept or reject Jefferson County’s appeal of a September 2014 ruling by U.S. District Judge Sharon Blackburn, in which Judge Blackburn rejected the county’s arguments that the ratepayers’ municipal bankruptcy appeal was moot, in part because the plan had been significantly consummated, but also because Judge Blackburn claimed she could consider the constitutionality of Jefferson County’s plan of debt adjustment, which ceded Jefferson County’s future authority to oversee sewer rates to the federal bankruptcy court. The odoriferous legal issue relates to Jefferson County’s issuance—as part of its approved plan of debt adjustment—to issue $1.8 billion in sewer refunding warrants—an issuance which not only paved the way for Jefferson County to write down some $1.4 billion in related sewer debt, but also to exit municipal bankruptcy and the overwhelming costs of the litigation. Thus, with the sale of the new warrants consummated, Jefferson County exited (or at least believed it had…) municipal bankruptcy. The county’s sewer ratepayers, however, are claiming Jefferson County’s plan contains an “offensive” provision which would enable the federal bankruptcy court to retain jurisdiction over the plan for the 40 years that the sewer refunding warrants remain outstanding—a federal oversight which Jefferson County has argued has provided a critical security feature that has been key to attracting investors to purchase the warrants it issued in 2013—a transaction which the County alleges cannot be unwound—and added that the appeal by the residents is constitutionally, equitably, and statutorily moot, because the plan has already been implemented. The ratepayers have countered that even if the federal oversight provision were to be deleted from the County’s approved plan of adjustment, the indenture for the 2013 sewer warrants provides greater latitude to resolve a default: noting that were a subsequent fiscal default to occur, “the trustee shall be entitled to petition the bankruptcy court or any other court of competent jurisdiction for an order enforcing the requirements of the confirmed plan of adjustment.” (Such requirements include increasing rates charged for services, so that the sewer system generates sufficient revenue to cure any default.) But it is the provision allowing the federal bankruptcy court to maintain oversight which is central to Jefferson County’s position—in no small part because it offers an extra layer of security for bondholders and prospective bondholders of a municipality which opts to avail itself of a provision in the U.S. bankruptcy code which allows the judicial branch of the U.S. to retain oversight of a city or county’s plan of fiscal adjustment—or, as the perennial godfather of municipal bankruptcy Jim Spiotto puts it, the question in Jefferson County’s case involves an interpretation over what the U.S. bankruptcy code permits and whether the federal court’s supervision is actually the act of setting rates or insuring that the county complies with the covenants that it promised.

In Jefferson County, as in most cities and counties, sewer system rates have been set by resolutions approved by the Jefferson County Commission to fix rates and charges sufficient to cover the cost of providing sewer service, including funds for operations and maintenance, capital expenditures, and debt service on the 2013 warrants. Jefferson County’s attorneys have added that neither the plan of adjustment or U.S. Bankruptcy Judge Thomas Bennett’s confirmation order “changes the substantive law of the state of Alabama with regard to the enforcement of rates established pursuant to contract or legislation….Rather, the plan merely retains the bankruptcy court as an available forum in which such substantive law may be enforced, using the same remedies available in Alabama state court…In no event will the bankruptcy court ever set sewer rates; it is simply a forum to enforce the plan and related contracts – just as an Alabama state court could.” Ergo, part of the federalism issue and challenge relates to the Johnson Act, which essentially prohibits federal courts from taking actions that directly and indirectly affect the rates of utilities organized under state laws. In this instance, the ratepayers have claimed that the removal of the “retention of jurisdiction provision” from Jefferson County’s bankruptcy confirmation order would not unlawfully impose a new, involuntary plan on the county and its residents because “the indenture explicitly contemplates that the purchasers of the new sewer warrants may seek relief from courts other than the bankruptcy court.” Moreover, they claim the transaction would not have to be unwound were the U.S. district court to strike the jurisdictional retention provision from the plan, because the sewer bondholders could seek relief from other courts were Jefferson County to fail to increase sewer rates. The court directed Jefferson County to respond to its challenging sewer ratepayers by Monday, September 28th. Stay tuned.

Schooling in Municipal Bankruptcy

eBlog

August 27, 2015

Schooling in Muni Bankruptcy. Paul Vallas, CEO of the Chicago Public Schools (CPS) from 1995 to 2001, this week warned that were CPS to file for municipal bankruptcy—should the legislature authorize municipal bankruptcy in Illinois as proposed by Governor Bruce Rauner—that could devolve CPS, whose credit rating has been reduced to junk status by Fitch, into a financial “death spiral.” Mr. Vallas warned that such a filing would lead to an exodus of students from the system, which, in turn, would trigger a decline in state aid—in effect triggering a vicious fiscal cycle. Gov. Rauner, in proposing authorization of chapter 9 for Illinois municipalities has said CPS would be a good candidate for such a filing. The warning came as Mayor Rahm Emanuel’s CPS school board yesterday unanimously approved CPS’s budget, relying heavily on borrowed money and the hope of a nearly $500 million bailout from the legislature—a legislature which appears to be in a semi-permanent stalemate. Absent the assumed state aid, CPS will have few options but to make searing cuts in January. The $5.7 billion spending plan contains another property tax hike — an estimated $19-a-year increase for the owner of a $250,000 home — as well as teacher and staff layoffs. The CPS budget action came as the Chicago Board of Education also prepared to issue $1 billion in municipal bonds and agreed to spend $475,000 so an accounting firm can monitor a cash flow problem so acute that CPS considered skipping a massive teacher pension payment at the end of June. Mayor Emanuel’s new choice for board president, former ComEd executive Frank Clark, summed up the financial peril: “This is much like, in your personal lives, if you begin to have revenue shortfalls…you start living off your credit cards…And you can do it short-term, but sooner or later, those credit cards max out and you’ve got yourself in a very serious situation. That’s where CPS finds itself today: It is a budget that keeps us going today. It is not a sustainable approach long-term.” Indeed, the more than 8 percent hole in the adopted budget leaves little option but for Mayor Emanuel and new CPS Chief Forrest Claypool to try to get Gov. Rauner and the legislature to enact changes to CPS’ teacher pension obligations. On the reality front, CEO Vallas asked: “Who wants to send their kids to a bankrupt school district?” He warned that litigation and potential teacher strikes could “totally destabilize the system which means people would flock away from the system which means you would put the system in a financial death spiral,” adding: “At the end of the day bankruptcy is literally the kiss of death…that would decimate the finances so it’s simply not an option.” Chicago Civic Federation President Laurence Msall described the proposed CPS budget as “[Y]et another financially risky, short-sighted proposal and [one which] fails to provide any reassurance that Chicago Public Schools has a plan for emerging from its perpetual financial crisis…If stakeholders do not come together now to develop a multi-year plan, the Federation is deeply concerned that CPS could fail, with devastating consequences for the future of Chicago and Illinois.”

To Be or Not to Be. With Gov. Alejandro García Padilla theoretically set to release a fiscal stability and economic development plan for Puerto Rico’s future next Monday, there has been increased discussion of the cancellation of the Puerto Rico Aqueduct and Sewer Authority’s (PRASA) bond offering, apparently out of apprehension with regard to global market conditions and an apparent lack of investor appetite for the municipal bonds—but without any official statement released on a change to the status of the sale, either from PRASA officials or from the Commonwealth. In addition, the U.S. territory has asked the U.S. Supreme Court for a ruling to overturn a ban which prevents Puerto Rico public agencies from restructuring, seeking permission for the right to restructure its debt — which has reached $72 billion — under its own quasi-bankruptcy law. The uncertainty came as Nuveen yesterday noted: “The Government Development Bank reports liquidity sufficient to operate until November…In addition, the Department of Justice has designated Puerto Rico a ‘high risk grantee,’ requiring Puerto Rico to account for how it spends federal funds going forward.” Yesterday, in addition, Moody’s added: The PRASA postponement of a $750 million bond offering after repeated delays “shows the difficult obstacles blocking Puerto Rico’s capital market access…Investor sentiment has deteriorated sharply since the commonwealth’s last public offering almost a year and a half ago. If underwriters can eventually complete the PRASA sale, it may signal a return to some degree of market access that would help maintain liquidity.” If anything, with Puerto Rico impinging on its self-set August 31st deadline to reveal its plan to restructure its staggering $72 billion debt, the island likely is opting not to move ahead with its controversial proposal to borrow an additional $750 million to pay for PRASA improvements—likely out of at least some apprehension it could not borrow the money — by issuing bonds — at an affordable interest rate. Adding to the messy situation, a working group, appointed by Gov. Garcia Padilla, has been trying to put a proposal together for several months; however, Puerto Rico’s main opposition party has dropped out of the group—raising grave doubts about any consensus. The PRASA debt issuance cancellation is more worrisome—as the utility provides essential services and is authorized to increase rates, within reason. Moreover, the utility’s bondholders have a first claim on its revenues: they are authorized to bring in a receiver to enforce collections.

A Post Muni Bankruptcy High? Recovering from municipal bankruptcy is like recovering from surgery. There are scars, but lessons learned. Thus, as post-bankrupt Stockton continues its comeback, City Attorney John Luebberke notes: “The City Council’s goal is to pursue the betterment of the community…Now that we’re out of bankruptcy, we can pursue some of these opportunities. Even in an era of constrained resources, we’re going to do what we can to improve the community.” One action, in which Mr. Luebberke is taking a lead role, is to enforce the city’s medical marijuana ordinance. Thus, post municipal bankruptcy Stockton last week filed two lawsuits last week aimed at preventing a pair of medical-marijuana dispensaries from operating in Stockton in violation of a city ordinance. While one has closed, the other—Collective 1950—will remain open while the city’s lawsuit is being adjudicated, with court dates not scheduled until mid-January. Mr. Luebberke said it is uncertain whether Stockton initially will seek a temporary injunction to immediately close Collective 1950 or choose to gain permanent injunctions from the court against Collective 1950 and Elevate Wellness. For Stockton, the issue of municipal enforcement of Stockton’s medical-marijuana ordinance is complicated by California’s “Compassionate Use Act,” which allows for marijuana use and possession for medical reasons—whilst Stockton’s ordinance is focused on preventing unregulated dispensaries from selling to minors and seeks to reduce the potential for “nuisances” and crimes associated with the presence of the facilities, according to Mr. Luebberke. According to Stockton’s lawsuits, the city can enforce its municipal code by “public nuisance abatement,” “civil injunction,” and “civil penalties of up to $1,000 per day of violation.”

First Chapter 9 since Detroit. Some of the first transatlantic passengers to come to America on the Arbella—passengers who left England in 1630 with their new charter–had a great vision. They were to be an example for the rest of the world in rightful living, or as then Gov. John Winthrop put it: “We shall be as a city upon a hill, the eyes of all people are upon us.” But there is a different perspective from Hillview, the small Kentucky municipality which last week filed for chapter 9 municipal bankruptcy in the first municipal bankruptcy since Detroit, with Rick Cohen noting: “With its Chapter 9 filing, Hillview may have liabilities of around $100 million, against assets potentially only as much as $10 million…There may be a reason that Hillview found bankruptcy preferable to paying out, even at a lower rate than the court ordered, to the trucking company.” His thesis, referring to Moody’s report this month: “Municipal Bankruptcy Still Rare, but No Longer Taboo,” notes that Moody’s Senior VP Al Medioli appears to find that recent chapter 9 decisions have treated public pensioners “as a group above other creditors, and that further places pensions on a higher plane above all other liabilities, regardless of bond security or legal revenue pledge.” He notes that Kentucky confronts an unfunded pension liability of over $9 billion, making it the nation’s least well-funded state pension system, albeit he confesses there is insufficient information with regard to Hillview’s pension obligations that might have been affected by the municipality’s bankruptcy filing and potential proposed plan of debt adjustment.

Stately Oversight. In a brief released yesterday by Pew, the organization determined that New Jersey’s long track record of “strong state oversight” has, at least to date, been a key factor in fiscally protecting Atlantic City from being forced into municipal bankruptcy. Noting that the Garden State established its first fiscal oversight program in 1931, the report finds that the state has taken an active role to prevent municipal defaults and bankruptcies: Camden, before the state intervened with additional funds to help the city meet its obligations, came close in 1999 to becoming the first New Jersey municipality to file for Chapter 9 since Fort Lee in 1938, noting that New Jersey’s “tradition of intervention” is a stark contrast to other states such as California and Alabama which leave it up to local governments to resolve their own fiscal challenges, noting: “Most states tend to react to distress when it’s too late and not be proactive and that is not the case with New Jersey.” The report adds that Atlantic City also has benefited this year from New Jersey’s Municipal Qualified Bond Act, which allowed it to issue $43 million in general obligation bonds to cover repayment of a state loan for refinancing $12.8 million in bond anticipation notes. Atlantic City also received a $10 million increase in state funds this year under the state’s transitional aid program designed to assist distressed local governments. Pew cautioned, however, that while New Jersey has a strong record of avoiding municipal bankruptcies, no municipality in modern times has experienced close to the city’s 64 percent tax base decline, driven largely by casino closures from increased regional gambling competition, noting that the state still might be forced to “bail the city out” if it is to avoid filing for municipal bankruptcy—adding that such a rescue could be manageable given Atlantic City’s relatively small size.

Municipal Bankruptcy & The Role of Intergovernmental Relations

August 18, 2015

Municipal Bankruptcy, Intergovernmental Relations, & Democracy. The San Bernardino City Council voted 4-2 late Monday to appropriate over half a million dollars to fund a new community center on the bankrupt city’s Westside—notwithstanding apprehensions the city might not be allowed to use the modular that will now be used for that purpose, much less concerns about how it might affect the city’s already difficult relations with the state. The center, once constructed, is intended to provide classes on aerobics, Zumba, nutrition, mental health, and English as a second language, in addition to partnering on other services. The financing is not to come from the bankrupt city’s general fund, but rather from the city’s CDBG grants. But it was only after a citizen at the session raised a question—after the first of the two votes needed to approve the center—that there appeared to be some recognition of a problem. The citizen asked how it was that that since the state had taken control of redevelopment how it was the Council could “wonder why the state is mad at you, you wonder why the state doesn’t want to help you? Maybe listen to yourselves, and wonder, ‘What am I doing?’” Indeed, City Manager Allen Parker responded to a follow-up question to staff that last year, when the city had requested the California Department of Finance to transfer redevelopment assets — items such as desks, computers, and this $158,000 modular, which the city-controlled agency had used until the statewide shut-down — to San Bernardino so the city could control them: the request had been rejected. The response triggered two Councilmembers to change their votes from aye to nay, with Councilmember Henry Nickel noting: “We have some very delicate negotiations going on with the state right now…The last thing I want to do is upset them. I want to be very clear on the legal ramifications of taking a $150,000-plus asset and using that for city use.” Notwithstanding, the rest kept their votes unchanged, demonstrating one of the many intergovernmental challenges that confront the city as it seeks to put together a plan of debt adjustment for the U.S. bankruptcy court’s approval, even as—in an election year—it must continue to govern the municipality. Indeed, community members have been asking for the community center since the city promised it before the state’s dissolution of the redevelopment agency.

As we have previously noted, the uneasy relationship between California cities and the state has played an important role in San Bernardino’s municipal bankruptcy, whether it be the suit filed by the state’s California retirement agency (CalPERS) for non-payment of the city’s prescribed contribution to the state’s public retirement system for its employees, or the—to this point—takeover and dissolution of local redevelopment agencies in 2012, a takeover at least in some part triggered by disagreement as to whether cities were consistently using the revenues from these redevelopment agencies as originally intended. More broadly, of course, the withdrawal of most California state direct financial aid to cities, which commenced some three decades ago in the wake of Proposition 13, has not only negatively impacted most cities in the state, but especially poorer cities such as San Bernardino—with fiscal insult added to injury via California’s redirection of some non-state revenues to specific programs including education and public safety, thereby shifting the expenditure burden from the state to its cities. State aid constitutes a very small percentage of revenue for cities in California—2% in the case of San Bernardino. This minute amount does little to even out disparities in fiscal capacity and need for cities such as San Bernardino. State actions in recent years—including changes in the motor vehicle license taxes and redevelopment agencies— have only served to exacerbate, rather than ameliorate San Bernardino’s fiscal problems.

The Painful Cost of Recovery. Notwithstanding some of the unique and fiscally creative partnerships engineered as part of the resolution of the Motor City’s record municipal bankruptcy recovery, Detroit will find that getting back on its four wheels will come at a high price: the city is expected to have to pay interest rates close to 5 percent in its maiden return to the municipal bond market on its sale set for tomorrow of some $245 million in bonds—the city’s first sale since emerging from municipal bankruptcy. The sale, which will be done through the Michigan Finance Authority, will provide that bondholders will have the first claim on Detroit’s income tax revenues, so as to ensure investors in the recovering city are repaid. Ergo, the 14-year bonds are being marketed at an initial yield of 4.75 percent, according to persons familiar with the sale, some 2.1 percentage points more than top-rated municipal securities. The high cost to Detroit’s taxpayers and the city’s budget is a reflection of the significant cuts the city’s g.o. bondholders received as part of the court-approved plan of debt adjustment, nearly a 60 percent reduction. Nevertheless, for the city—in stark contrast to virtual bankruptcy in state-local fiscal relations in California (please see above)—this is a key factor in the likely successful sale tomorrow: Michigan Gov. Rick Snyder, together the bipartisan leadership of the state leadership, enacted legislation to provide prospective Detroit municipal bondholders first claim to the Motor City’s income taxes—an innovative step to help in the city’s recovery—and one which earned an A rating for tomorrow’s sale from S&P–nine levels higher than its grade on Detroit’s general obligations. Moody’s, in mayhap a surprisingly upbeat mode, noted that Detroit’s employment has risen 3 percent over the past four years; more generously, the rating agency wrote that the Motor City’s income tax revenue rose 18 percent from 2010 to 2015. The proceeds from this week’s sale are intended to be devoted to repayment of a loan from Barclays plc that was a key to the city’s emergence from bankruptcy, as well as to help finance city projects, including upgrades for the fire department’s fleet. S&P wrote that Detroit’s income tax collections are strong enough to cover the bonds.

Arriba! The Puerto Rico Treasury Department reports that last month’s General Fund tax revenues for the U.S. territory of Puerto Rico came in 3.5% higher than budgeted, with sales and use tax collections coming in at a rate more than ten times (35.7%) greater than those for a year ago. The increased revenues included $21.1 million more than projected for the island’s General Fund. But the most significant increase came from individual income taxes: some $7.2 million more than projected, as well as foreign corporation excise taxes ($4.6 million ahead), and alcoholic beverage taxes ($4.5 million above projections). The biggest shortfall was for motor vehicle taxes, at $2.7 million. No doubt, the increase in the territory’s sales and use tax revenues was due in no small part to the rate rise from 7 to 11.5% which went into effect last July 1^st; nevertheless, the Treasury reported the increased rate only contributed about $8 million directly to the sales and use tax revenue increase of $40.6 million in July compared to one year earlier—moreover, as Puerto Rico Treasury Secretary Juan Zaragoza Gómez noted, the sales and use tax realized revenue increases might have been spurred by a rush-to-beat-the rate increase which went into effect July 1^st. But Sec. Zaragoza Gómez also noted that Puerto Rico’s completion last May of the last phase of an Integrated Merchant Portal collection of sales and use taxes at ports also likely contributed to the improvement in these tax collections. Finally, the Secretary also noted the government had reached settlements for back sales and use taxes owed with several large retailers last month—adding: “These collection efforts will continue during the coming months.” The rising revenues from traditional tax sources came as a Puerto Rican study group has recommended going ahead with converting Puerto Rico’s sales and use tax to a value added tax effective April Fools’ Day next year.

Failing Grade. S&P downgraded the Windy City’s Chicago Public Schools three notches, finding that its proposed budget would do little to address either its structural or liquidity woes. The rating agency also removed the credit from CreditWatch with negative implications and assigned a negative outlook, with analyst Jennifer Boyd scholastically writing: “The rating action reflects our view of the proposed fiscal 2016 budget, which includes what we view as the [school] Board’s continued structural imbalance and low liquidity with a reliance on external borrowing for cash flow needs.” The poor grades appear to reflect the system’s increased reliance in its proposed $6.4 billion FY2016 budget on more than $300 million from one-time revenues, not to mention an almost mythical assumption that the stalemated Governor and state legislature will provide CPS with $480 million in public pension funding assistance this year to close a $1.1 billion deficit—or, as CEO Forrest Claypool put it: “This budget reflects the reality of where we are today — facing a squeeze from both ends — in which CPS is receiving less state funding to pay our bills even as our pension obligations swell to nearly $700 million this year.” The hopes from CPS come as the stalemate in Springfield over passage of the state’s FY2016 budget has shown little to no progress—even as Chicago’s kids are already, no doubt, dreading the September 2^nd return to the classrooms. CPS’s proposed budget assumes Illinois will help assume almost $200 million in CPS pension contributions—not unreasonable, as that would be in line with what the state contributes on behalf of other districts. The package could also be made up by shifting $170 million of the teachers’ contribution now paid by the district over to teachers, extending a payment amortization period, and possibly higher property taxes. Further, CPS last month announced some $200 million in cuts in the wake, last month, of its failed efforts to delay its FY2015 pension payment. The budget also relies on $250 million of debt relief primarily from $200 million in so-called scoop and toss refunding in which principal payments coming due are pushed off. CPS is proposing to draw down $75 million from reserves. Unsurprisingly, S&P does its math differently than CPS: the rating agency questions the school system’s arithmetic, wondering how it all adds up, especially because of CPS’ reliance on $480 million in, to date, unsecured state assistance for debt restructuring and reserves, both non-recurring revenue sources, adding: “The rating is also based on our view of the challenges the board faces in attempting to secure a sustainable long-term solution to its financial pressures, given the state’s own financial problems reflected in the current budget stalemate, and the board’s fiscal 2016 budget proposal that shows the continuation of a structural imbalance even if the board gets the assistance from the state.” The challenged fiscal math has already exacted a cost: CPS is paying a premium to borrow: its most recent issuance came at a yield of 5.63 percent on 25-year bonds—and that even with not only the system’s full faith and credit pledge, but also security via an alternate revenue pledge of state aid. The convoluted math, S&P totes up, is further jeopardized by next year’s expiration of the district’s teachers’ contract.

August 13, 2015

Municipal Bankruptcy & Public Safety. In California alone, 16 wildfires are burning 229,713 acres. So it is unsurprising that citizens and their elected leaders in San Bernardino have a significant stake in ensuring that any plan of debt adjustment approved by U.S. Bankruptcy Judge Meredith Jury ensures confidence, thereby guaranteeing there will be significant interest in the 28-page report (www.tinyurl.com/oraatpk) by fire consultant Citygate Associated the city released last night—a report recommending that the city’s fire department be annexed into the San Bernardino County Fire District. The report is consistent with the proposal recommended by San Bernardino City Manager Allen Parker; it is contrary to the position of the San Bernardino Fire Management Association. For both the city’s residents—and Judge Jury—the issue in bankruptcy is how to ensure the continuity of essential public services.  In its report to the city, Citygate evaluated the ability of three bidders — county fire, city fire, and Florida-based private firm Centerra — to meet certain key staffing standards. The report recommends San Bernardino County take over, under a plan which would include keeping 10 current city fire stations open, closing two, and adding the use of one additional county fire station, noting: “The best cost-to-services choice is County Fire’s Option C for 14 units and 41 firefighters (per shift) at $26,307,731 which includes sharing the use of a nearby County Fire station and Battalion Chief that can assist with covering part of the western City.” While the mere suggestion of privatizing or turning over control of a municipality’s fire department to another jurisdiction has traditionally been a sure fire road to unelection, it has actually become more prevalent in other parts of San Bernardino County and other areas in California. Indeed, San Bernardino Councilman Henry Nickel compared the modest opposition by constituents to the proposal to the outpouring of opposition when a community sent a robocall asking citizens to oppose privatizing the Fire Department, noting to the San Bernardino Sun yesterday: “My phone was literally on fire for two days…My voice mail filled up within about an hour of that robo call going out, and it took me two or three days to catch up. But since this article came out (outlining the report), I’ve received one phone call today regarding the county versus city debate…I think it’s very clear that Centerra is not something the public by and large supports, but — I hate to use the word resignation, but I think much of the public understands that the county medicine is probably the one we’ll have to take…It’s not something we want to do, but it’s something we might have to do.” City spokeswoman Monica Lagos posted a summary of the report and the city’s next steps here (www.tinyurl.com/pbogaxr). A special meeting, including a presentation of the report and a chance for resident comment, is scheduled for a week from Monday.

The uncontrollable nature of wildfires adds a combustible to the already complex challenge of elected leaders of a municipality in bankruptcy—with elections pending in November—creating a difficult balancing set of public as compared to campaign responsibilities. Unlike Donald Trump, the decision to file for bankruptcy for the city’s elected leaders is something no elected leader ever wants to do. And then the responsibility to approve a plan of debt adjustment to the federal bankruptcy court—even while contemplating a re-election campaign amidst the combustion of wildfires and politics is evidence of the extraordinary challenges and decisions ahead which will affect so many citizens—and their safety—not to mention the future of a city.

Jailhouse Rock. Wayne County’s elected leaders are scheduled to consider the proposed fiscal consent agreement between Michigan and the County today—an agreement intended to offer ways to improve Wayne County’s cash position, reduce underfunding in its pension system, and eliminate the county’s$52 million structural deficit—and be a governing alternative starkly different than in neighboring Detroit where the state preempted local authority through the appointment of an emergency manager. The consent agreement allows for the commission and Chairman Evans to “retain their respective authority.” The document has a number of highlighted sections on issues such as employee relations and changes that can be made to expired contracts, state financial management and technical assistance, and a prohibition against new debt unless approved by the State Treasurer. It also specifically mentions pension obligations and other employee contract commitments as at least a factor in the county’s financial troubles. But the major point of the agreement that will likely gain close scrutiny by many who work for the county is the authority it grants Chairman Evans to act as the sole agent of the county in collective bargaining with employees or representatives and approve any contract or agreement. The agreement will also address—and affect—the county’s jails, whose conditions have already been the subject of a court order this year, as Wayne County—and jail host Detroit—consider the future of the unfinished facility. In its review of Wayne County’s finances, the state noted the county’s unfinished jail and its $4.5 billion in long-term obligations as problems that need to be addressed, and mandated Wayne County to put together a plan to “adequately meet the county’s needs for adult detention facilities…” The County’s elected leaders, who are scheduled to discuss the agreement tomorrow, have just over three weeks in which to approve the document—an agreement which Wayne County Chairman Warren Evans very much hopes will be the key to resolving the county’s structural debt and unsustainable fiscal future: the proposed recovery plan lays out $230 million in cuts over four years.

Whether and how the plan will get the County and Detroit out from behind the fiscal bars will be a subset—but one with critical implications for the future relationship of the two jurisdictions, as well as for the county’s fiscal sustainability. The jail—in downtown Detroit on which Wayne County broke ground for construction four years ago—is an exceptional fiscal millstone: some two years after construction was halted because of ballooning expenses, the failed Wayne County jail project is still costing taxpayers more than $1 million a month. The plan was to build a $300-million state-of-the-art jail in downtown Motown four years ago—a plan which today features a costly pile of steel and concrete — fenced and guarded — with construction costs of $151 million, and an ever growing fiscal tab for county taxpayers of an average of $1.2 million every month. Thus, not only is the jail a sticking point between the two jurisdictions, but also a severe fiscal drain—or as the County described the situation last May: “Due to the county’s financial state, anything done on the Gratiot jail will just add to the deficit. Once the deficit has been solved, the county can move forward with options on whether to finish the Gratiot site or renovate the three existing jails. As the county makes progress on its recovery plan, it will better be able to solve the jail issue.” Worse, it appears that much of the debt issued by Wayne County for the jail’s construction has been diverted for other purposes—meaning Wayne County is spending as much as $1.2 million each month from its general fund. According to County officials, only $49 million remains from the $200 million in bonds Wayne County sold to finance the unfinished jail—a borrowing forcing the county to make interest payments on of $1.1 million monthly—even as it is spending nearly $55,000 each month on unfinished jail-related costs, including: security ($10,849), sump pump maintenance ($12,852), and electricity to the site ($4,000).

The Hard Road to Fiscal Recovery

July 7, 2015

The Steep Road to Recovery. Because almost every state which authorizes municipalities to file for municipal bankruptcy imposes different requirements/mandates—including, in the case of Michigan, suspension or preemption of authority of a municipality’s elected leaders, the process of reverting to municipal authority for Detroit came with strings attached—there was no stomach in Lansing to see a substantial state investment in Detroit’s recovery fail; nor, as retired U.S. Bankruptcy Judge Steven Rhodes noted, did he ever want to be known as the first U.S. Bankruptcy Judge to have to preside over a second or repeat municipal bankruptcy. Therefore, when Judge Rhodes approved Detroit’s plan of debt adjustment, clearing the way for the state-appointed emergency manager Kevyn Orr to leave and Mayor Mike Duggan and the City Council to resume governance authority, that authority became subject to nearly a decade of state oversight by means of a nine-member Financial Review Commission, created as a key provision in Detroit’s plan of debt adjustment last November as part of the “Grand Bargain,” that is the agreement which involved both state fiscal assistance and a significant contribution from non-profits to ensure the Detroit Institute of Art remained in the city. The agreement created a mechanism to ensure the City of Detroit is meeting statutory requirements. Statutorily required members of the body include Michigan Treasurer Nick A. Khouri, who serves as chairman; State Budget Director John Roberts serves as the designee of the director of the state Department of Technology, Management and Budget. The oversight board also includes, by statute, Detroit Mayor Mike Duggan and City Council President Brenda Jones, or their designees, as well as five gubernatorial appointees. The Commission is charged with reviewing and approving Detroit’s four-year financial plan, and establishing programs and requirements for prudent fiscal management, among other roles and responsibilities. Detroit is operating under the oversight of a Financial Review Commission and must maintain a balanced budget for three consecutive years, among other requirements, to emerge from oversight in 2018. The commission is scheduled to meet on July 27th, when it will likely review the City Council’s decision to reject a hike in water rates–unless, in the nonce, the Mayor and Council reverse their position.

Under the new law, one of strict requirements is that the Mayor and Council may not enact a budget with a deficit. Thus, in a letter last Thursday to the Mayor and Council, State Treasurer Khouri raised apprehensions over the Council’s vote not to increase water rates, writing that if the vote is not reversed, the Detroit Water and Sewer District’s Enterprise Fund will be in deficit—ergo requesting that Detroit’s elected leaders either provide the Commission with information to demonstrate the city’s plan to comply with the approved budget for the current fiscal year, or the basis upon which it will seek a budget amendment. In addition, Treasurer Khouri wrote that he was seeking details with regard to whether Detroit could — without the rate increase — meet its obligation to provide quarterly certifications to the commission that it can meet debt service requirements though the end of the fiscal year. Unsurprisingly, the City Council is expected to reconsider its decision to reject proposed water and sewer rate increases for city residents as early as today, with President Pro Tem George Cushingberry, Jr. expected to offer a motion asking the Council to revisit its June 30th vote on the rates recommended for the new fiscal year, which began July 1st. In its earlier vote, the Council voted 6-2 against the hikes proposed by the Detroit Water and Sewerage Department, with some members expressing apprehension with regard to how residents already having trouble paying their bills would be affected. Under the rejected and to be reconsidered proposal, DWSD’s average Detroit customer would pay about $64 more a year for service—in contrast, under the Council’s rejection of the proposed increase last week, an estimated $27 million leak was created in the city’s budget, triggering the state apprehension and response—with Detroit’s Chief Operating Officer Gary Brown noting last week that he has been educating Council members on the “unintended consequences” of the decision, reminding them that the no vote went against the Council’s unanimous support in March of the city’s fiscal year budget—a budget which, he noted, included revenue for the water department.

As the very fine editorial writer Daniel Howes of the Detroit News this morning notes: “Detroit’s bankruptcy would be an enormous waste of time, money and unparalleled cooperation between the public and private sectors, foundations and state legislators, unions, retirees and pension funds, if the city’s leaders choose grandstanding over financial discipline…Detroit collapsed into the largest municipal bankruptcy in American history in large part because its elected officials refused to do what they agreed to do. If their successors repeat the mistake, the result is likely to be less forgiving.”

Is Puerto Rico Being Held Up? Puerto Rico Gov. Alejandro García Padilla yesterday reported he had created a Working Group for the Economic Recovery of Puerto Rico. The effort, to be led by Chief of Staff Victor Suárez, Government Development Bank President Melba Acosta, Secretary of Justice César Miranda, and the Presidents of the Senate and House, Eduardo Bhatia and Jaime Perelló, is to focus on how to achieve a consensus on the restructuring of Puerto Rico’s public debt, or, as Gov. Padilla described it: “The ultimate goal is a negotiated moratorium with bondholders to postpone debt payments a number of years, so that the money can be invested here in Puerto Rico.” In a response, Senate Pres. Eduardo Bhatia said, “I have long anticipated this moment. Restructuring the debt has always been the right way, but it is not an easy road. I constantly referred to the 3 Rs: reducing costs, increasing revenues, and restructuring the debt.” Absent access to a federal bankruptcy court, where a timeout could be called by a federal judge and Puerto Rico could provide critical public services, even as it worked to put together a plan of adjustment in negotiation with all its creditors; the U.S. territory instead confronts an expensive challenge from one of its biggest bondholders as it seeks to reduce debt service payments for several years. OppenheimerFunds has announced it intends to defend the municipal bond promises to its clients—in effect following up on its successful legal challenge last summer to the Territory’s proposed bankruptcy measure for its public corporations. Puerto Rico has appealed this case to a higher court, where it is still being considered. The profound challenge for Puerto Rico is how it can adjust its debts in a manner to ensure the ongoing ability to provide essential public services, as well as to ensure economic growth: clearly, it has long since passed the time when it has the fiscal resources to pay each and every one of its creditors 100 cents on the dollar. Consequently, GDB President Acosta will be meeting with representatives of the island’s municipal bondholders and representatives of the muni bond industry in New York City and Washington, D.C. to discuss restructuring of the bonds: the stiff challenge: how to juggle about $72 billion of total outstanding Puerto Rico public sector debt outside of a public process or federal court supervision. Because it is appears clear that Puerto Rico cannot pay all of its debt–even if it took strong measures to cut spending and increase revenues—the issue is how, or is it even possible, to create a process outside of bankruptcy—to restructure? The ever effervescent Natalie Cohen, a managing guru at Wells Fargo Securities, yesterday put it—as she invariably does, succinctly: “I agree that Puerto Rico’s current trajectory is unsustainable and lack of immediate action will only make their situation more painful to resolve. I thought the [Puerto Rico — A Way Forward] report was balanced and shows that without action, there is a financing gap of $3.7 billion in 2016, growing substantially in future years as Affordable Care Act reductions and loss of Act 154 benefits disappear (about 20% of General Fund revenues).”

According to Gov. Padilla, a Working Group formed this week will create a long-term fiscal agenda by the end of next month focused on:
• “Establishing the parameters for a five-year fiscal plan; proposing additional cuts in spending — including cuts in some services — to avoid an increase in taxes;
• “restructuring the Department of Treasury to increase the efficiency of income gathering; promoting alliances with the private sector to provide some of the services which are today provided by the public sector, such as successful projects like the Moscoso Bridge, the airport, and the highway to Arecibo;
• “radically changing the way in which we work with government finances and economic statistics, to establish greater transparency and credibility; guaranteeing our citizens’ essential services and our pensioners a just income;
• “[and] creating a fiscal board which, outside political considerations, will guarantee the continuity and honor of the commitments agreed upon by us during the restructuring process.”
• Finally, Gov. Padilla said he would seek passage in Washington for Chapter 9 eligibility for Puerto Rico’s public corporations, a more equitable distribution of Medicare payments, and the end of the Jones Act, which increases costs of shipping to and from the island.

The ABC’s of a Sustainable Fiscal Future. Chicago Mayor Rahm Emanuel reports that the Chicago School District, the third largest of the country, will be eliminating 1,400 jobs, while at the same time increasing borrowing in response to the growing fiscal crisis facing both the State of Illinois and the Windy City, noting that the job cuts at the Chicago Public Schools, which largely shield teachers and include positions that are vacant, are part of a plan to cut annual spending by $200 million, or roughly 3.5%. The announcement came in the wake of a decision by Chicago officials to make a $634 million payment due to the teachers’ retirement system before a Tuesday night deadline, with Mayor Emanuel noting: “These payments do not come without a cost…There is a series of political compromises and patchwork over the years that can no longer continue.” The announcement comes in the wake of inaction by the Illinois legislature—in a state where state lawmakers have considerable control over education spending and the pension systems—but where, at least to date, no steps to assist the city school system—or, as Mayor Emanuel put it: “Your stalemate is having consequences.” In the immediate term—to ensure the city’s schools open on time and keep class sizes from rising, the district drew down on two credit lines to make the pension system payment due this week. Now it is seeking to put off for a year $500 million in pension payments due in the new fiscal year. For his part, Mayor Emanuel has proposed that teachers’ pension contributions and local property taxes would be increased if the state would make increased payments into Chicago’s teacher retirement system. But the prospects are most uncertain: the state government remains entrapped in its own budget Armageddon—at an impasse over this fiscal year’s state budget, which had yet to be approved nearly a week into the new fiscal year and now faced with a partial state government shutdown.

Protecting the Ability to Provide Essential Public Services

eBlog

July 1, 2015

Is Puerto Rico at the Tipping Point? As Puerto Rico nears insolvency, the White House and key members of Congress, perhaps observing events in Greece, appear to recognize that any reorganization of the U.S. territory’s debt outside of the U.S. judicial system would be chaotic and prohibitively expensive. Nevertheless, with Congress in recess, some of the island’s creditors are threatening they will continue to oppose any effort by Puerto Rico to have access to federal bankruptcy courts. Oppenheimer Funds, the largest holder of Puerto Rico debt among U.S. municipal bond funds, yesterday warned Puerto Rico it stands ready to defend the terms of the municipal bonds it holds, challenging Gov. Alejandro Padilla’s proposal to begin restructuring Puerto Rico’s debt and to postpone interest payments on outstanding Puerto Rican municipal bonds. Oppenheimer’s fierce denunciation came in the wake of Gov. Padilla’s proposal Monday to create a Working Group for the Economic Recovery of Puerto Rico, led by Chief of Staff Victor Suárez, Government Development Bank President Melba Acosta, Secretary of Justice César Miranda, and the Presidents of the Senate and House, Eduardo Bhatia and Jaime Perelló: with the group charged to develop a consensus on the restructuring of Puerto Rico’s public debt—or, as Gov. Padilla put it: “The ultimate goal is a negotiated moratorium with bondholders to postpone debt payments a number of years, so that the money can be invested here in Puerto Rico.” .That is, absent the kind of neutral referee created under the U.S. bankruptcy laws and courts, chaos could reign as Gov. Padilla seeks to restructure the island’s $73 billion debt to relieve its fiscal problems. Retired U.S. Bankruptcy Judge Steven Rhodes, who presided over Detroit’s 18 month municipal bankruptcy trial before approving its unprecedented plan of debt adjustment—a plan under which Detroit’s municipal bondholders took significant reductions—and who has been retained to assist Puerto Rico as it seeks to restructure its debts in a way that preserves the island’s abilities to provide essential public services, such as 9-1-1, water, street lights, etc. yesterday told Reuters it would be impractical to expect Puerto Rico to restructure its $72 billion of obligations outside the court system: “I just don’t think that an out-of-court negotiation process is feasible here…There are too many creditors, too many different kinds of creditors. They’re all over the place,” adding Puerto Rico will need access to federal bankruptcy courts for more than just its public agencies, which would be allowed under H.R. 870, a bill introduced by Rep. Pedro Pierluisi, Puerto Rico’s non-voting member of Congress: “The commonwealth itself needs access to Chapter 9 relief as well…Puerto Rico is not a state. It’s not a sovereign in the same sense that Michigan or Pennsylvania or Illinois is. Congress has complete and plenary authority over it. Without violating any of our constitutional principles, it could grant the commonwealth that relief, if it chose.”

The U.S. House Judiciary Committee has, to date, refused to take the bill up for consideration—especially in the face of a well-financed campaign by hedge funds lobbying against any Congressional action. Support from Congressional leaders for providing Puerto Rico access to U.S. bankruptcy began to build this week, however. Sen. Charles Schumer (D-NY), the third-highest ranking Democrat will sponsor a companion of H.R. 870. In addition, Josh Earnest, a spokesman for the White House, said that Congress should “take a look” at the bill. In addition, a spokeswoman for House Minority Leader Nancy Pelosi (D-Ca.) said the legislation should be voted on when the House of Representatives returns to work later this month.

The inaction in Congress follows rejection last year by a U.S. District Court of proposed Puerto Rican legislation which would have enabled Puerto Rico’s public corporations to file for federal bankruptcy protection: U.S. District Judge Francisco A. Besosa last February held that the proposed legislation, the Public Corporation Debt Enforcement and Recovery Act, violated the U.S. Constitution in a suit brought in federal court by municipal bond funds affiliated with Franklin Resources Inc., Oppenheimer Rochester Funds, and Blue Mountain Capital Management—firms which had sued Puerto Rico, arguing the law was unconstitutional and that, if enacted, would have depressed the value of the $2 billion in Puerto Rico power utility municipal bonds they held. Puerto Rico has appealed.

Oppenheimer Funds, which has an estimated $4.5 billion exposure on municipal bonds on behalf of its clients according to Morningstar, claims it believes Puerto Rico could repay municipal bondholders even while providing essential services to its citizens and taking steps to revitalize the island’s economy, adding that it stands ready “to defend the previously agreed to terms in each and every bond indenture,”—and that it is “disheartened that Governor Padilla, in a public forum, has called for negotiations with other creditors, representing and including the millions of individual Americans that hold Puerto Rico municipal bonds.” Oppenheimer’s statement came in the wake of Gov. Padilla’s statement Monday that his goal was to come up with a negotiated moratorium with the territory’s municipal bondholders to postpone debt payments for a number of years. No doubt, the fierceness of Oppenheimer and other of the island’s municipal bondholder servicers is related to recognition that in the resolutions of plan of adjustment approvals granted by the U.S. Bankruptcy courts in the Stockton and Detroit cases, the respective cities’ municipal bondholders took very steep haircuts—an outcome that clearly affected Puerto Rican bonds yesterday, which fell sharply for the second consecutive day, with general obligation 8 percent bonds maturing in 2035 as low as $64.50 versus a low of $68.75 on Monday. A Moody’s chart reflects the significant cuts bondholders took in the Vallejo, Detroit, and Stockton chapter 9 municipal bankruptcies—as well as the reductions proposed in San Bernardino’s proposed plan of debt adjustment pending before U.S. Bankruptcy Judge Meredith Jury. Almost 10 percent of municipal bonds that traded Monday were Puerto Rico-related, according to Janney Capital Markets. A key part of the drop, no doubt, came from downgrades by S&P and Fitch, with S&P warning that a default, distressed exchange, or redemption of Puerto Rico’s debt within the next six months seemed inevitable. Nevertheless, S&P reported it expects Puerto Rico to make its scheduled payment today of $655 million on general obligation debt; while Puerto Rico’s public utility corporation, PREPA, which has a current estimated debt in the range of $9 billion, is in discussions with creditors with regard to its own $400 million payment due today. One gets an appreciation of how fiercely municipal bond funds have been opposing giving access to the federal courts by Puerto Rico or any of its 147 municipalities: U.S. open-ended municipal bond funds have $11 billion of Puerto Rico bonds and nearly 53 percent of such funds have exposure to the commonwealth—with the biggest exposure including Franklin Templeton, which already was thoroughly bloodied in the Stockton federally approved resolution to its emergence from municipal bankruptcy.

Gov. Padilla, earlier this week, in the wake of the release of the Puerto Rico “Way Forward” report, made clear the U.S. territory could not pay all of its debt, even if it took strong measures to cut spending and increase revenues: “All the measures we have taken in the last two years reflect our willingness to pay and, had we not taken them, we would not be in a position today to request restructuring…We have done all that was within our power, but, as the report makes clear, the next step must be to ensure more favorable terms for the repayment of our debt.” That same day, the redoubtable Natalie Cohen of Wells Fargo Securities noted: “I agree that Puerto Rico’s current trajectory is unsustainable and lack of immediate action will only make its situation more painful to resolve. I thought the report was balanced and shows that without action, there is a financing gap of $3.7 billion in 2016, growing substantially in future years as Affordable Care Act reductions and loss of Act 154 benefits disappear (about 20% of General Fund revenues).”

• According to Gov. Padilla, the Working Group formed this week will create a long-term fiscal agenda by Aug. 30 aimed at:
  • Establishing the parameters for a five-year fiscal plan; proposing additional cuts in spending — including cuts in some services — to avoid an increase in taxes; * *Restructuring the Department of Treasury to increase the efficiency of income gathering;
• promoting alliances with the private sector to provide some of the services that are today provided by the public sector, such as the successful projects like the Moscoso Bridge, the airport, and the highway to Arecibo;
• radically changing the way in which we work with government finances and economic statistics, to establish greater transparency and credibility;
• guaranteeing our citizens’ essential services and our pensioners a just income; [and] creating a fiscal board which, outside political considerations, will guarantee the continuity and honor of the commitments agreed upon by us during the restructuring process.
• Seeking passage in Washington of Chapter 9 eligibility for Puerto Rico’s public corporations, a more equitable distribution of Medicare payments, and the end of the Jones Act, which increases costs of shipping to and from the island.

Retirees v. Municipal Bondholders. The incredible Boston Federal Reserve report, “Walking a Tightrope: Are U.S. State & Local Governments on a Fiscally Sustainable Path?” by Bo Shao and David Coyne came as increasing data makes clear that municipalities have never recovered in terms of employees from pre-recession levels—so there are fewer employees paying into municipal pensions—even as retirees appear to have the gall to live much longer than any previous generations: the teeter-totter is fiscally teetering. Thus, when Chicago Public School system, last week, announced it intended to issue some $1 billion in new debt to finance its $600 million-plus pension payment due yesterday; it created still another battlefront between firms like Oppenheimer and states and municipalities. It also appears to have been a key factor in Moody’s sharp downgrade of the Windy City’s credit rating—a downgrade Moody’s attributed almost entirely to Chicago’s pension issues—adding to apprehensions that should the Illinois legislature grant Chicago and other Illinois municipalities access to municipal bankruptcy, the municipalities’ constitutional and political inabilities to reign in pension liabilities could trigger future U.S. Bankruptcy court decisions that, as in Puerto Rico, would have signal repercussions for municipal bondholders. . In the bankruptcies of Detroit, Vallejo, Stockton and San Bernardino, bondholders have faced losses of up to 99% of their holdings, according to a Moody’s report dated May 18. Meanwhile all three California cities chose to preserve full pensions for their employees, while Detroit only cut pensions by approximately 18%.