State and Local Insolvency & Governance Challenges

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eBlog, 03/29/17

Good Morning! In this a.m.’s eBlog, we consider the efforts to recover from the brink of insolvency in the small municipality of Petersburg, Virginia, before considering the legal settlement between the State of Michigan and City of Flint to resolve the city’s state-contaminated water which nearly forced it into municipal insolvency.

On the Precipice of Governing & Municipal Insolvency. Consultants hired to pull the historic Virginia municipality of Petersburg from the brink of municipal bankruptcy this week unveiled an FY2018 fiscal plan they claim would put the city on the path to fiscal stability—addressing what interim City Manager Tom Tyrrell described as: “It’s bad, it’s bad, it’s bad.” With the city’s credit ratings at risk, and uncertainty with regard to whether to sell the city’s utility infrastructure for a cash infusion, former Richmond city manager Robert Bobb’s organization presented the Petersburg City Council with the city’s first structurally balanced spending plan in nearly a decade: the proposed $77 million operating budget would increase spending on public safety and restore 10 percent cuts to municipal employees’ pay, even as it proposes cutting the city’s workforce, deeming it to be bloated and structurally inefficient. The recommendations also propose: restructuring municipal departments, the outsourcing of services that could eliminate up to 12 positions, and the reduction through attrition of more than 70 vacancies.

As offered, the plan also recommends about a 13 percent increase in the city’s current operating budget of $68.4 million, which was amended twice this fiscal year: the $77 million total assumes a $6 million cash infusion labeled on a public presentation as a “revenue event,” referring to a controversial issue dividing the elected leaders versus the consultants: Council members and the Washington, D.C. based firm have been at loggerheads over unsolicited proposals from private companies offering to purchase Petersburg’s public city’s utility system—a challenge, especially because of citizen/taxpayer apprehension about private companies increasing rates for consumers at a time when double-digit rate increases already are on the horizon. That, in turn, has raised governance challenges: Mr. Bobb, for instance, has expressed frustration with the city’s elected leaders’ decision to stall negotiations and study the prospect by committee, noting: “The city is out of time…They’re out of time with what’s needed with respect to the long-term financial health of the city. Time’s up.” Mr. Bobb believes the city cannot cut its way to financial health, or raise tax rates for city residents who themselves are struggling to get by, noting that at $1.35 per $100 of assessed value, the city’s real estate tax rate is currently the highest in the region—and at a potential tipping point, as, according to Census data, nearly half the city’s children live below the poverty line, which is set at $24,600 for a family of four. Moreover, Petersburg’s assessed property values have stagnated for the past five years, according to the credit rating agency Standard & Poor’s, which rated the city with a negative outlook at the end of last year: the lowest of any municipality in the state. (The city ended FY2016 with $18.8 million in unpaid bills and began the new fiscal year $12.5 million over budget. The budget since has been balanced, but debts remain.)

Under Mr. Bobb’s proposed plan, in a city where public safety is already the largest expense in the operating budget, he has proposed increasing police pay, addressing salary compression in the department, and providing for a force of 111 full-time and seven part-time employees. He suggests that should Petersburg not reap a $6 million “revenue event” in FY2018, the operating budget would be about 5 percent above this year’s, and a few million below revenues for fiscal years 2016 and 2015. Mr. Bobb’s consultant, Nelsie Birch, who is serving as Petersburg’s CFO, reports the city’s budget process and the development of the upcoming year’s budget have been thwarted by a lack of administrative infrastructure, noting that in the wake of starting work last October, he walked into a city finance department that had two part-time workers out of seven allocated positions—and a municipality with only $75,000 in its checking account. (Last week, there was approximately $700,000.) Today, Mr. Birch holds one of more than a half-dozen high-profile positions now filled by interim workers and consultants; Petersburg is paying about $80,000 for a Florida-based head hunter to help fill some of the city’s key vacancies, including those for city manager, deputy city manager, police chief, and finance director—with the City Council having voted last week to extend the Bobb Group’s contract through the end of September—at a cost to Petersburg’s city taxpayers of about $520,000.

Nevertheless, the eventual governance decisions remain with the Petersburg City Council, which secured its first opportunity to study the plan this week—a plan which will be explored during more than a half-dozen public meetings planned for the coming weeks: explorations which will define the city’s fiscal future—or address the challenge with regard to whether the city continues on its road to chapter 9 municipal bankruptcy.

The fiscal and governance challenges in this pivotal Civil War city, however, extend beyond its borders—or, as the ever so insightful Neal Menkes, the Director of Fiscal Policy for the Virginia Municipal League notes:  

“Perhaps the unstated theme is that the push for ‘regionalism’ is related not just to changing economic realities but to the state’s outmoded governance and taxation models. Local finances are driven primarily by growth in real estate and local sales, revenues that are not sensitive to a service economy. Sharing service costs with the Commonwealth is another downer. K-12 funding formulae are more focused on limiting the state’s liability than meeting the true costs of education.  That’s why locals overmatch by over $3.0 billion a year the amounts required by the state to access state basic aid funding.”

State Preemption of Municipal Authority & Ensuing Physical, Governing, and Fiscal Distress. U.S. District Judge David Lawson yesterday approved a settlement under which Michigan and the City of Flint have agreed to replace water lines at 18,000 homes under a sweeping agreement to settle a lawsuit over lead-contaminated water in the troubled city—where the lead contamination ensued under the aegis of a state-appointed emergency manager. The agreement sets a 2020 deadline to replace lead or galvanized-steel lines serving Flint homes, and provides that the state and the federal government are mandated to finance the resolution, which could cost nearly $100 million; in addition, it provides for the state to spend another $47 million to replace lead pipes and provide free bottled water—with those funds in addition to $40 million budgeted to address the lead-contamination crisis; Michigan will also set aside $10 million to cover unexpected costs, bringing the total to $97 million.

The lawsuit, filed last year by a coalition of religious, environmental, and civil rights activists, alleged state and city officials were violating the Safe Drinking Water Act—with Flint’s water tainted with lead for at least 18 months, as the city, at the time under a state-imposed emergency manager, tapped the Flint River, but did not treat the water to reduce corrosion. Consequently, lead leached from old pipes and fixtures. Judge Lawson, in approving the settlement, called it “fair and reasonable” and “in the best interests of the citizens of Flint and the state,” adding the federal court would maintain jurisdiction over the case and enforce any disputes with residents. Under the agreement, Michigan will spend an additional $47 million to help ensure safe drinking water in Flint by replacing lead pipes and providing free bottled water, with the state aid in addition to $40 million previously budgeted to address Flint’s widespread lead-contamination crisis and another $10 million to cover unexpected costs, bringing the total to $97 million. The suit, brought last year by a coalition of religious, environmental, and civil rights activists, alleged Flint water was unsafe to drink because state and city officials were violating the Safe Drinking Water Act; the settlement covers a litany of work in Flint, including replacing 18,000 lead and other pipes as well as providing continued bottled water distribution and funding of health care programs for affected residents in the city of nearly 100,000 residents. It targets spending $87 million, with the remaining $10 million saved in reserve. Ergo, if more pipes need to be replaced, the state will make “reasonable efforts” to “secure more money in the legislature,” Judge Lawson wrote, adding that the final resolution would not have been possible but for the involvement of Michigan Governor Rick Snyder. Judge Lawson also wrote that the agreement addresses short and long-term concerns over water issues in Flint.

The settlement comes in the wake of last December’s announcement by Michigan Attorney General Bill Scheutte of charges against two former state-appointed emergency managers of Flint, Mich., and two other former city officials, with the charges linked to the disastrous decision by a former state-appointed emergency manager to switch water sources, ultimately resulting in widespread and dangerous lead contamination. Indeed, the events in Flint played a key role in the revocation of state authority to preempt local control—or Public Act 72, known as the Local Government Fiscal Responsibility Act, which was enacted in 1990, but revised to become the Emergency Manager law under current Gov. Rick Snyder. Michigan State University economist Eric Scorsone described the origin of this state preemption law as one based on the legal precedent that local government is a branch of Michigan’s state government; he noted that Public Act 72 was rarely used in the approximately two decades it was in effect through the administrations of Gov. John Engler and Gov. Jennifer Granholm; however, when current Gov. Rick Snyder took office, one of the first bills that he signed in 2011 was Public Act 4, which Mr. Scorsone described as a “beefed-up” emergency manager law—one which Michigan voters rejected by referendum in 2012, only to see a new bill enacted one month later (PA 436), with the revised version providing that the state, rather than the affected local government paying the salary of the emergency manager. The new law also authorized the local government the authority to vote out the state appointed emergency manager after 18 months; albeit the most controversial change made to PA 436 was that it stipulated that the public could not repeal it. The new version also provided that local Michigan governments be provided four choices with regard to how to proceed once the Governor has declared an “emergency” situation: a municipality can choose between a consent agreement, which keeps local officials in charge–but with constraints, neutral evaluation (somewhat akin to a pre-bankruptcy process), filing for chapter 9 municipal bankruptcy, or suffering the state appointment of an emergency manager. As Mr. Scorsone noted, however, the replacement version did not provide Michigan municipalities with a “true” choice; rather “what you actually find is that a local government can choose a consent agreement, for example, but actually the state Treasurer has to agree that that is the right approach. If they don’t agree, they can force them to go back to one of the other options. So it is a choice, but perhaps a bit of a constrained choice.”

Thus, the liability of the emergency managers and the decisions they made became a major issue in the Flint water crisis—and it undercut the claim that the state could do better than elected local leaders—or, as Mr. Scorsone put it: “The state can take over the local government and run it better and provide the expertise, and that clearly didn’t work in the Flint case. The situation is epically wrong, perhaps, but this is clearly a case of where we have to ask the question: why did it go wrong, and I think it’s a complex answer, but one of the things that needs to be done…we need a better relationship between state and local government.” That has proven to be especially the case in the wake felony charges levied against former state appointed Emergency Managers in Flint of Darnell Earley and Gerald Ambrose, who were each charged with two felonies that carry penalties of up to 20 years—false pretenses and conspiracy to commit false pretenses, in addition to misconduct in office (also a felony) and willful neglect of duty in office, a misdemeanor.

Today, Michigan local governments have four choices in the wake of a gubernatorial declaration of an “emergency” situation: a municipality or county  can choose between a consent agreement, which keeps local officials in charge but with constraints; neutral evaluation, which is like a pre-municipal bankruptcy process;  filing for chapter 9 municipal bankruptcy directly; or suffering the appointment of an emergency manager—albeit, as Mr. Scorsone writes: “The choice is a little constrained, to be truthful about it…If you really carefully read PA 436, what you actually find is that a local government can choose consent agreement, for example, but actually the state Treasurer has to agree that that is the right approach. If they don’t agree, they can force them to go back to one of the other options. So it is a choice, but perhaps a bit of a constrained choice…The law is pretty clear that the emergency manager is acting in a way that does provide some governmental immunity…The emergency manager, if there’s a claim against her or him, has to be defended by the Attorney General. That was fairly new to these new emergency manager laws. The city actually has to pay the legal bills of what the Attorney General incurs, and it’s certainly true that there is a degree of immunity provided to that emergency manager, and I suppose the rationale would be that they want some kind of protection because they are making these difficult decisions. But I think this issue is going to be tested in the Flint case to see how that really plays out.” Then, he noted: “The theory is that the state can do it better…The state can take over the local government and run it better and provide the expertise, and that clearly didn’t work in the Flint case. The situation is especially wrong, perhaps, but this is clearly a case of where we have to ask the question why did it go wrong, and I think it’s a complex answer, but one of the things that needs to be done…we need a better relationship between state and local government.”

Breaking Up Is Hard to Do.

eBlog, 03/06/17

Good Morning! In this a.m.’s eBlog, we consider the trials and tribulations of really emerging from the largest chapter 9 municipal bankruptcy in American history; then we turn to an alternative to municipal bankruptcy: dissolution.

The Hard Road of Exiting Municipal Bankruptcy: A Time of Fragility. Christopher Ilitch, the Chief Executive Officer of Ilitch Holdings Inc., companies in Detroit which represent leading brands in the food, sports, and entertainment industries (including Little Caesars, the Detroit Red Wings, the Detroit Tigers, Olympia Entertainment, Uptown Entertainment, Blue Line Foodservice Distribution, Champion Foods, Little Caesars Pizza Kit Fundraising Program, and Olympia Development), notes that “We are at a critical time in Detroit’s history,” speaking at the Detroit Regional Chamber’s Detroit Policy Conference: “There’s been no community that’s been through what Detroit has been through. Through the depths, there’s been a lot of choices.” Indeed, as the very fine editor of the Detroit News, Daniel Howeswrote: “There still is, and how they’re made could meaningfully impact Detroit’s arc of reinvention: despite a booming development scene spearheaded now by the Ilitch family’s $1.2 billion District Detroit, Quicken Loans Inc. Chairman Dan Gilbert’s empire-building, more effective policing and a burgeoning downtown scene, four words loom: “We’re not there yet.” Mr. Howes notes that the cost of new construction projects still cannot be fully recouped through commercial and residential rents, adding: “The business climate, including taxes and regulation, still is not as attractive as it could be. And longstanding residents in the city’s neighborhoods worry that the reinvention of downtown and Midtown risks leaving them behind.” Or, as Detroit City Council President Brenda Jones puts it: “We have been talking about downtown and Midtown so much, and we know downtown and Midtown are important…If we are going to subsidize development, we would like to see something in it for us as well.” That is, exiting chapter 9 bankruptcy is not a panacea: one’s city still confronts a steep hill to execute its plan of debt adjustment—and a hill the scaling of which comes at higher borrowing costs than other cities of the same size. That is to say, long-term recovery has to involve the entire community—not just the municipal government. Or, as Mr. Howes notes: “Business leaders stepped in to acquire new police cruisers and EMT trucks, even as some of them finance ‘secondary patrols’ of downtown districts. The moves by General Motors Co. and Gilbert’s Rock Ventures LLC, to name two, to employ off-duty Detroit police officers are supported by Detroit Police Chief James Craig…The partnership has been bipartisan and regional. It’s been public and private, city and suburb. It’s required Republicans to act less Republican and Democrats to act less Democratic. That’s not because either side is suddenly non-partisan, but because the long history of confrontation and suspicion chronically under-delivers.” But he adds the critical point: “[A]s the city moves into an election year, as the memories of recessionary hardship dim, as the construction and investment boom continues. None of it is guaranteed, including collaboration forged by leaders under difficult circumstances…If there’s any town in America that can make its virtuous circle become a vicious cycle, Detroit is it. Remembering what’s worked, what hasn’t, and how inclusion can improve the chances for success remains critical…It’s a tricky balance that depends most on leadership and transparency so long as the macro-economic environment remains positive. If there are two themes connecting the reinvention of Detroit with its present, they are that a) experts expect the building and redevelopment boom to continue and b) neighborhood concerns are real and should not be dismissed.” In Detroit, it turned out going into chapter 9 municipal bankruptcy—a slide enabled by criminal behavior of its Mayor, and the profound failure to make it a city on a hill—a city which would draw families and businesses—was easy. That means getting out—and staying out—is the opposite in this fragile time of recovery, or, as Moddie Turay, executive vice president of real estate and financial services at the Detroit Economic Growth Corp., notes: “There’s a ton that’s happening here. We’re just not there yet…We have another five or so years to go. We are at a fragile time — a great time in the city, but still a fragile time.”

Disappearville? Breaking Up Is Hard to Do. Mayor Margaret J. Nelms and her Council Members in Centerville, North Carolina have voted to dissolve the town’s charter and become unincorporated in the wake of voters’ rejection, in January, of an effort to raise property taxes. The municipality (town), founded in 1882, in the rural northeastern corner of Franklin County had a population of 89 as of the 2010 census, a ten percent decline from the previous census: this is a municipality without a post office or a zip code—or, now, a future. It was incorporated during the same time period as the dissolution of the nearby town of Wood in 1961, roughly 80 years after first settlement. Unlike elected officials of other Franklin County municipalities (as well as the county itself) which have four-year terms, in Centerville, the Mayor and its three-member Town Council are elected every two years. The city’s downtown consists of two small old-fashioned country stores—Arnold’s and The Country Store, with one also the local gas station. The City has its own volunteer fire department: there is no police department, so Centerville—like the surrounding unincorporated area—is patrolled by the Franklin County sheriff.

Sen. Chad Barefoot (R), whose district includes Centerville, the sponsor of the state legislation [Senate Bill DRS45094-LM-35 (02/16)] to dissolve the municipality, noted: “There are a lot of towns like Centerville in North Carolina…What they’re doing is pretty courageous. They’re acting like adults. It’s something very hard to do, but it’s very responsible.” His proposed bill, the Repeal Centerville Charter, will allow the dissolution of the town, except that the governing board of the Town of Centerville would be continued in office for days thereafter for the sole purpose of liquidating the assets and liabilities of the Town and filing any financial reports which may be required by law, with any remaining net assets to be paid over to the Centerville Fire Department, which would be directed to use those funds for some public purpose. (In Centerville, the main municipal services provided to residents are: streetlights in the town center; Centerville also pays for an annual audit and holds municipal elections, although only a dozen citizens voted in the most recent municipal election, in 2015.) Centerville will continue to exist as a community, but any local-government services will be provided by the county: any remaining municipal funds left over after the town is unincorporated will be donated to the local volunteer fire department, according to the legislation. Dissolution is a painful choice: Frank Albano, the owner of an antique store in Centerville, rued the city did not consider other fiscal options, such as charging businesses like his an $100 annual operating fee, or asked $5 per float in the New Year’s Day parade. He notes: “The more local the government is, the better.”

The decision to dissolve is, however, not new: it was nearly a century ago that Farrington Carpenter, a Harvard-educated rancher in Colorado, noted that—at the time—there were 20 counties in the Mile High state with populations under 5,000. Municipalities—and their voters—rarely agree to give up their identities, leading him to query: “How can such small counties afford the cost of a complete county government?”  On the other end of the country, in Pennsylvania, home to more municipalities than any state in the union, running the gamut from metropolitan cities to first, second, and third class townships, it has long been a vexing governance conundrum how such a governing model is sustainable. Indeed, James Brooks, my former colleague from when I workd at the National League of Cities, where he serves as Director of City Solutions, reports that according to NLC’s 2015 report examining the economic vitality of cities, the smallest cities have generally been slower to recover—or, as one commentator describes it: “They can’t solve their problems themselves…Wealth has left these little cities to such a degree that they’re basically bankrupt.”

The Roads out of Municipal Bankruptcy

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eBlog, 2/24/17

Good Morning! In this a.m.’s eBlog, we consider the post-chapter 9 municipal bankruptcy trajectories of the nation’s longest (San Bernardino) and largest (Detroit) municipal bankruptcies.

Exit I. So Long, Farewell…San Bernardino City Manager Mark Scott was given a two-week extension to his expired contract this week—on the very same day the Reno, Nevada City Council selected him as one of two finalists to be Reno’s City Manager—with the extension granted just a little over the turbulent year Mr. Scott had devoted to working with the Mayor, Council, and attorneys to complete and submit to U.S. Bankruptcy Judge Meredith Jury San Bernardino’s proposed plan of debt adjustment—with the city, at the end of January, in the wake of San Bernardino’s “final, final” confirmation hearing, where the city gained authority to issue water and sewer revenue bonds prior to this month’s final bankruptcy confirmation hearing—or, as Urban Futures Chief Executive Officer Michael Busch, whose firm provided the city with financial guidance throughout the four-plus years of bankruptcy, put it: “It has been a lot of work, and the city has made a lot of tough decisions, but I think some of the things the city has done will become best practices for cities in distress.” Judge Jury is expected to make few changes from the redline suggestions made to her preliminary ruling by San Bernardino in its filing at the end of January—marking, as Mayor Carey Davis noted: a “milestone…After today, we have approval of the bankruptcy exit confirmation order.” Indeed, San Bernardino has already acted on much of its plan—and now, Mayor Davis notes the city exiting from the longest municipal bankruptcy in U.S. history is poised for growth in the wake of outsourcing fire services to the county and waste removal services to a private contractor, and reaching agreements with city employees, including police officers and retirees, to substantially reduce healthcare OPEB benefits to lessen pension reductions. Indeed, the city’s plan agreement on its $56 million in pension obligation bonds—and in significant part with CalPERS—meant its retirees fared better than the city’s municipal bondholders to whom San Bernardino committed to pay 40 percent of what they are owed—far more than its early offer of one percent. San Bernardino’s pension bondholders succeeded in wrangling a richer recovery than the city’s opening offer of one percent, but far less than CalPERS, which received a nearly 100 percent recovery. (San Bernardino did not make some $13 million in payments to CalPERS early in the chapter 9 process, but did set up payments to make the public employee pension fund whole; the city was aided in those efforts as we have previously noted after Judge Jury ruled against the argument made by pension bond attorneys two years ago. After the city’s pension bondholders entered into mediation again prior to exit confirmation, substantial agreement was achieved for th0se bondholders, no doubt beneficial at the end of last year to the city’s water department’s issuance of $68 million in water and sewer bonds at competitive interest rates in November and December—with the payments to come from the city’s water and sewer revenues, which were not included in the bankruptcy. The proceeds from these municipal bonds will meet critical needs to facilitate seismic upgrades to San Bernardino’s water reservoirs and funding for the first phase of the Clean Water Factor–Recycled Water Program.

Now, with some eager anticipation of Judge Jury’s final verdict, Assistant San Bernardino City Attorney Jolena Grider advised the Mayor and Council with regard to the requested contract extension: “If you don’t approve this, we have no city manager…We’re in the midst of getting out of bankruptcy. That just sends the wrong message to the bankruptcy court, to our creditors.” Ergo, the City Council voted 8-0, marking the first vote taken under the new city charter, which requires the Mayor to vote, to extend the departing Manager’s contract until March 7th, the day after the Council’s next meeting—and, likely the very same day Mr. Scott will return to Reno for a second interview, after beating out two others to reach the final round of interviews. Reno city officials assert they will make their selection on March 8th—and Mr. Scott will be one of four candidates.

For their part, San Bernardino Councilmembers Henry Nickel, Virginia Marquez, and John Valdivia reported they would not vote to extend Mr. Scott’s contract on a month-to-month basis, although they joined other Councilmembers in praising the city manager who commenced his service almost immediately after the December 2nd terrorist attack, and, of course, played a key role in steering the city through the maze to exit the nation’s longest ever municipal bankruptcy. Nevertheless, Councilmember Nickel noted: “Month-to-month may be more destabilizing than the alternative…Uncertainty is not a friend of investment and the business community, which is what our city needs now.” From his perspective, as hard and stressful as his time in San Bernardino had to be, Mr. Scott, in a radio interview while he was across the border in Reno, noted: “I’ve worked for 74 council members—I counted them one time on a plane…And I’ve liked 72 of them.”

Exit II. Detroit Mayor Mike Duggan says the Motor City is on track to exit Michigan state fiscal oversight by next year , in the wake of a third straight year of balancing its books, during his State of the City address: noting, “When Kevyn Orr (Gov. Rick Snyder’s appointed Emergency Manager who shepherded Detroit through the largest chapter 9 municipal bankruptcy in U.S. history) departed, and we left bankruptcy in December 2014, a lot of people predicted Detroit would be right back in the same financial problems, that we couldn’t manage our own affairs, but instead we finished 2015 with the first balanced budget in 12 years, and we finished 2016 with the second, and this year we are going to finish with the third….I fully expect that by early 2018 we will be out from financial review commission oversight, because we would have made budget and paid our bills three years in a row.”

Nonetheless, the fiscal challenge remains steep: Detroit confronts stiff fiscal challenges, including an unexpected gap in public pensions, and the absence of a long-term economic plan. It faces disproportionate long-term borrowing costs because of its lingering low credit ratings—ratings of B2 and B from Moody’s Investors Service and S&P Global Ratings, respectively, albeit each assigns the city stable outlooks. Nevertheless, the Mayor is eyes forward: “If we want to fulfill the vision of a building a Detroit that includes everybody, we have to do a whole lot more.” By more, he went on, the city has work to do to bring back jobs, referencing his focus on a new job training program which will match citizens to training programs and then to jobs. (Detroit’s unemployment rate has dropped by nearly 50 percent from three years ago, but still is the highest of any Michigan city at just under 10 percent.) The Mayor expressed hope that the potential move of the NBA’s Detroit Pistons to the new Little Caesars Arena in downtown Detroit would create job opportunities for the city: “After the action of the Detroit city council in support of the first step of our next project very shortly, the Pistons will be hiring people from the city of Detroit.” The new arena, to be financed with municipal bonds, is set to open in September as home to the Detroit Red Wings hockey team, which will abandon the Joe Louis Arena on the Detroit riverfront, after the Detroit City Council this week voted to support plans for the Pistons’ move, albeit claiming the vote was not an endorsement of the complex deal involving millions in tax subsidies. Indeed, moving the NBA team will carry a price tag of $34 million to adapt the design of the nearly finished arena: the city has agreed to contribute toward the cost for the redesign which Mayor Duggan said will be funded through savings generated by the refinancing of $250 million of 2014 bonds issued by the Detroit Development Authority.

Mayor Duggan reiterated his commitment to stand with Detroit Public Schools Community District and its new school board President Iris Taylor against the threat of school closures. His statements came in the face of threats by the Michigan School Reform Office, which has identified 38 underperforming schools, the vast bulk of which (25) are in the city, stating: “We aren’t saying schools are where they need to be now…They need to be turned around, but we need 110,000 seats in quality schools and closing schools doesn’t add a single quality seat, all it does is bounce children around.” Mayor Duggan noted that Detroit also remains committed to its demolition program—a program which has, to date, razed some 11,000 abandoned homes, more than half the goal the city has set, in some part assisted by some $42 million in funds from the U.S Department of Treasury’s Hardest Hit Funds program for its blight removal program last October, the first installment of a new $130 million blight allocation for the city which was part of an appropriations bill Congress passed in December of 2015—but where a portion of that amount had been suspended by the Treasury for two months after a review found that internal controls needed improvement. Now, Major Duggan reports: “We have a team of state employees and land bank employees and a new process in place to get the program up and running and this time our goal isn’t only to be fast but to be in federal compliance too.” Of course, with a new Administration in office in Washington, D.C., James Thurber—were he still alive—might be warning the Mayor not to count any chickens before they’re hatched.

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

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eBlog, 1/29/17

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

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

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

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

The Daunting Road to Recovery from the Nation’s Longest Ever Municipal Bankruptcy

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eBlog, 12/09/16

Good Morning! In this a.m.’s eBlog, we look back on the long and rocky road from the nation’s longest municipal bankruptcy back to solvency taken by the City of San Bernardino, a city in a Dillon Rule state, which we described in our original study as the former gateway from the East to Midwest of the L.A. basin and former home to Norton Air Force Base, Kaiser Steel, and the Santa Fe Railroad, but which in the 1990’s, with the departure of those industries and employees, fell into hard times. By the advent of the Great Recession, 46% of its residents were on some form of public assistance—and nearly one-third below the poverty line. By FY2012, the city faced a $45 million deficit; its fund balance and reserves were exhausted—leading the city to file for chapter 9 municipal bankruptcy (note California codes §§53760, 53760.1, 53760.3, 53760.5, and 53760.7—and where, effective on the first day of this year, new statutory state language specifically created a first lien priority for general obligation debt issued by cities, counties, schools, and special districts, so long as the debt was secured by a levy of ad valorum taxes pursuant to California’s Constitution.) As we have noted, in the 18 states which authorize chapter 9 filings, states have proscribed strikingly different legal mechanisms relating to the state role—varying from a state takeover, such as we have described in the case of the nation’s largest municipal bankruptcy in Detroit, but to a very different regime in Jefferson County and San Bernardino—where the elected municipal officials not only remained in office, but here the respective states—if anything—contributed to the severity of the fiscal challenges. Then we turn to what might be Congress’ last day in town this year—and whether funding to help the City of Flint might be enacted: Will Congress pass and send to the President a bill to provide emergency assistance to Flint?

Back to a City’s Viable Future. San Bernardino leaders this week issued a detailed statement on the arduous road to recovery they have travelled and what they intend for the road ahead, albeit noting the city is already well along its own blueprint for its recovery, as it awaits formal approval from U.S. Bankruptcy Judge Meredith Jury from its chapter 9 municipal bankruptcy early next year. In its statement, San Bernardino reported it had implemented about 70 percent of its recovery plan. That’s turned once-dire projections for the future upside down—a virtual u-turn from when the city’s fiscal analysts three years ago projected that in FY2023, the city would have a deficit of $360 million if dramatic changes were not achieved. But today, the city instead projects an unallocated cash balance for FY2023 of $9.5 million, or, as the statement reads: “Now, the city is on the cusp of emerging from bankruptcy as a changed city with a brighter future.” The municipal statement is primarily focused on the governance and fiscal changes made to create a virtual u-turn in the city’s fiscal ship of state since entering what became the nation’s longest municipal bankruptcy—a change in fiscal course without either state aid or state imposition of an emergency manager or a state takeover. The statement notes: “Given the emergency nature of its filing, it took the city several months to assess its financial condition—until April 2013, at which time the city adopted a final budget for fiscal years 2012-13 and 2013-14…The city’s initial financial assessment, however, only reflected further concern over its financial future. In September 2013, Mayor [Pat] Morris announced that absent fundamental modernization and change the city faced a 10-year deficit of a staggering $360 million. The future of San Bernardino looked bleak.”

The statement itemized what appeared to be the key steps to recovery, including achieving labor agreements—agreements which resulted in savings in excess of $100 million, and involved the termination of virtually all health insurance subsidies coverage for employees and retirees, writing that the city calculated the resulting savings to amount to about $44 million for retirees and $51 million for current employees. The statement notes some $56 million in other OPEB changes. A key—and hard-fought change—was achieved by contracting out for essential public services, with one of the most hard fought such changes coming from the annexation agreement with the San Bernardino County Fire Protection District: an agreement under which the county assumed responsibility for fire and emergency medical response—a change projected to save San Bernardino’s budget nearly $66 million over the next two decades just in public pension savings, but also as much as $5 to $6 million in its annual operating budget—and that is before adding in the parcel tax revenues which were incorporated in that agreement. San Bernardino also switched to contracting out for its trash and recycling—an action with a one-time franchise payment of $5 million, but increased estimated annual revenues of approximately $5 million to $7.6 million. The switch led to significant alterations or contracting out for an increasing number of municipal services. Or, as the paper the city released notes: “Modern cities deliver many services via contracts with third-party providers, using competition to get the best terms and price for services…The city has entered into a number of such contracts under the Recovery Plan.”

Governance. The city paper writes that the voters’ approval of a new city charter will allow San Bernardino to eliminate ambiguous lines of authority which had created a lack of authority, or, as U.S. Bankruptcy Judge Meredith Jury put it earlier this week: “(City officials) successfully amended their charter, which will give them modern-day, real-life flexibility in making decisions that need to be made…There was too much political power and not enough management under their charter, to be frank, compared to most cities in California.”

Rechartering San Bernardino’s Public Security. San Bernardino’s Plan of Debt Adjustment calls for increasing investment into the Police Department through a five-year Police Plan—a key step, as a study commissioned to consider the city’s public safety found the city to be California’s most dangerous municipality based on crime, police presence, and other “community factors.” The study used FBI data and looked at crime rates, police presence, and investment in police departments as well as community factors including poverty, education, unemployment, and climate: The report found a high correlation between crime rates and poverty—with San Bernardino’s poverty rate topping 30.6 percent. Thus, in the city’s Police Plan portion of its plan of adjustment, the report notes:  “The Mayor, Common Council, and San Bernardino’s residents agree that crime is the most important issue the city faces,” the city says in the Police Plan, submitted to the federal bankruptcy court as part of its plan. The plan calls for $56 million over five years to add more police, update technology, and replace many of the Police Department’s aging vehicles.

The Cost of Fiscal Inattention. Unsurprisingly, the fiscal costs of bankruptcy for a city or county are staggering. The city estimates that the services of attorneys and consultants will cost at least $25 million by the time of the city’s projected formal emergence from chapter 9 next March—albeit those daunting costs are a fraction of the $350 million in savings achieved under the city’s pending plan of debt adjustment—savings created by the court’s approval of its plan to pay its creditors far less than they would have otherwise been entitled: as little as 1 cent on the dollar owed, in many instances. Or, as the city’s statement wryly notes: “In addition, the city’s bankruptcy has allowed the city a reprieve during which it was able to shore up its finances, find greater cost and organizational efficiencies and improve its governance functions…Thus, all told, while the city’s exit from bankruptcy will have been a hard-fought victory, it was one that was critical and necessary to the city’s continued viability for the future.”

Out Like Flint. The House of Representatives on what it hopes to be its penultimate day yesterday approved two bills which, together, would authorize and fund $170 million for emergency aid to Flint and other communities endangered by contaminated drinking water. The emergency assistance came by way of a stopgap spending bill to keep the federal government operating next April in a bipartisan 326-96 vote and, separately, a water infrastructure bill which directs how the $170 million package should be spent by a 360-61 vote. Nevertheless, the aid for the city is not certain in the U.S. Senate: some have vowed to stop it, at least in part because the bill includes a controversial drought provision which would boost water deliveries to the San Joaquin Valley and Southern California.

Municipal Governance: The Challenges of Severe Fiscal Distress

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eBlog, 11/30/16

Good Morning! In this a.m.’s eBlog, we consider the difficult trials and tribulations of governance in a municipality confronting severe fiscal distress—in this case in the historic municipality of Petersburg, Virginia, before heading West to San Bernardino where the old expression “When it rains, it pours,” might be an apt description as a physical rather than fiscal earthquake appears to be adding to the city’s fiscal challenges as it seeks to emerge early next year from the nation’s longest ever chapter 9 municipal bankruptcy. Then we journey back to Ohio, where a municipal election next week in the virtually insolvent municipality of East Cleveland appears to offer little optimism of any resolution of its insolvency. Then we continue east to Connecticut, a state now confronting serious fiscal pressures. Finally, we head south, not to escape winter, but rather to observe the difficulty of governance created by a federal oversight board and an incoming new Governor.    

Is It a Municipal Government of the People? The ACLU of Virginia released a letter Monday criticizing the Petersburg City Council for meeting practices it said violate “the spirit of open government laws.” The organization claimed the City Council over-relied on special meetings, sometimes called at the last-minute, during the work day, or held in cramped quarters, to vote on matters of governance and financial management even as the city veered into insolvency. In the letter, ACLU executive director Claire Guthrie Gastañaga warned: “Holding meetings at inconvenient times and in small spaces that cannot accommodate the public violates the spirit of open government laws that serve to promote an increased awareness by all persons of government activities and afford every opportunity to citizens to witness the operations of government.” Part of the reaction reflects the growing anger of city residents and taxpayers with regard to the ways in which the Mayor and Council allowed the fiscal crisis to grow unattended—and then to hire at steep prices turnaround specialists from Washington, D.C. Indeed, some believe that the Council’s decision to hire the Robert Bobb Group—especially the way it did so—to try to avert insolvency and potential chapter 9 bankruptcy violated the municipality’s own rules and possibly the city charter, because of the procedure of forcing the matter to a second vote days after an initial vote for the partnership failed to pass, with two council members absent. The Petersburg City Council’s rules require a month delay; the city’s charter provides that a reconsideration vote must have as many members present as were there for the initial vote. The city attorney has defended the vote, asserting that nothing illegal or untoward transpired during the second consideration of the Bobb Group contract, which sealed the $350,000, five-month fee from the nearly bankrupt municipality with the firm. The aftertaste led citizens to publicly lambaste Mayor W. Howard Myers at a council meeting following the vote: now those citizens are actively circulating a recall petition to force the Mayor to step down. As Barb Rudolph, an organizer of the community group Clean Sweep Petersburg, put it: “For the many citizens of Petersburg who want to better understand what our elected leaders are deciding and why, this letter is most welcome…It puts City Council on notice that they can’t hide behind their misinterpretation of FOIA laws and inadequate commitment to open government.”

The vote last month on hiring the Bobb Group took place at one of 13 special meetings called by the City Council between March and October, according to the ACLU’s review. The Council publicized some in advance as being called solely for closed-session discussions, which “has the result of suppressing interest in attending and participating,” according to Ms. Gastañaga, who is pressing for the Council to be more open and resort less to executive sessions, or, as she puts it: “Even if legally permitted, the Council should hold all meetings in public unless there is a specific and important policy reason for the Council to meet outside of the hearing of the residents and public the Council was elected to serve.”

A Physical, not a Fiscal Quake. San Bernardino municipal employees are one step closer to completely moving out of City Hall, not because of the city’s chapter 9 bankruptcy—from which the city expects to emerge next March, but rather in response to a substantial earthquake risk: the City Council voted 7-0 Monday night to authorize City Manager Mark Scott to lease office space in two adjacent buildings in the wake of seismic experts’ warnings that the 43-year-old City Hall building is likely to collapse during a strong earthquake. The plan is to seek a grant to retrofit City Hall so that it could comply with modern earthquake standards and employees can return; however, for the municipality hoping to emerge from the nation’s longest chapter 9 municipal bankruptcy early next year, the physical disruption will be costly: it will take more than $14 million and an extended period of time, according to the city’s engineering study. Moreover, because the city was unable to obtain a lease for less than two years, the city will pay a total of $42,688 and $21,566—per month for the first year of the two-year lease, and a bit more for the second year. Additional costs associated with the move, including Information Technology costs and a moving company, approach $500,000, according to the staff report. Mayhap unsurprisingly, the plan was blasted at a Council session Monday by all of the members of the public who spoke—with one member of the public telling the Mayor and Council: “Anybody that votes yes on (the lease proposal) at this time, with as little studying as has been done, deserves to be removed from their office.”

The city, now addressing its fiscal earthquake, has received two independent engineering evaluations, in 2007 and 2016, which warn that City Hall sits atop two large faults, making it unsafe in an earthquake. The February study concluded that a magnitude 6.0 earthquake would lead to “a likelihood of building failure” for City Hall, which was designed before code updates following the 1971 Sylmar and 1994 Northridge earthquakes. With a greater than 90 percent chance of an earthquake of 6.0 or greater striking the region within 50 years, it would appear that steps not anticipated in the city’s chapter 9 plan of debt adjustment will require spending not included in that plan—spending not well received by the city’s taxpayers, who fear such spending will likely come at the expense of what they already complain is inadequate spending to combat crime, homelessness, and other issues. Moreover, the time contemplated—nine years—has added to citizen frustrations. Or as one citizen testified before the Council referring to the seismic information provided to the city nearly a decade ago: “Nine years?…I’ve heard of slow bureaucracy, but what kind of an emergency is it, if it’s nine years down the road?”

Municipal Integrity. The old expression that “when it rains, it pours,” might be apt for East Cleveland Mayor Gary Norton, who is seemingly waiting for Godot—that is, the State of Ohio to respond to the City’s request for authorization to file for chapter 9 municipal bankruptcy, but, instead, is confronted by an Ohio state board’s large fines for filing incomplete and late campaign finance reports related to next week’s municipal elections—in this case a recall election. Last month, the Ohio Elections Commission fined the Mayor $114,000—nearly sextuple the levy imposed by Ohio’s Attorney General last year. The most recent fines were levied in response to complaints from the Cuyahoga County Board of Elections that Mayor Norton did not file an annual report for 2015, turned in his 2014 report late, and did not resolve issues with his 2013 reports. In a series of letters, the Board of Elections asked Mayor Norton to fix a number of discrepancies in his 2013 reports—including incorrect fundraising totals and missing addresses. The board also requested proof of mileage, bank fees, phone expenses, and other spending for that year. Mayor and candidate Norton also is confronted by complaints over several missing finance reports from years prior to 2013, according to elections commission case summary records. Many of those reports have since been submitted and posted on the county board of elections website: a year ago last August, the elections commission imposed a $20,000 fine in connection with many of those cases. Mayor Norton’s last reported fundraising was in 2013, when he won a second term. He reported raising no money in 2014. Election commission fines balloon quickly. Mayor Norton’s grew by $100 for every day the problems remained unaddressed.

State Fiscal Sustainability? In Connecticut, where the state motto is Qui transtulit sustinet, or he who is transplanted still sustains, fiscal sustainability appears to be uncertain. Indeed, downgrades and related underperformance of the state’s debt are anticipated in the near-term, in no small measure due to weaker than expected revenue performance and rising fixed costs. The state confronts an expected expenditure reduction of more than 12 percent in FY2018, or $1.2 billion in non-fixed costs in FY18—a fiscal gap made more stressful because this year’s state budget relied on nearly $200 million in non-recurring revenues. The state’s Office of Fiscal Accountability recently revised state income and sales and use tax estimates down for FY17 by an aggregate of -$115.4 million; general fund revenues for FY18 are expected to post a decline of approximately $190 million from FY17 and aggregate revenue growth assumptions for FY19 and FY20 have also been downgraded. A significant factor has been fixed costs, especially from public pension obligations and other post-employment or OPEB benefits—in addition to municipal debt service and entitlements—which, together—like a Pac-Man are projected to account for 53% of expenditures in FY18. The state projects that pensions, OPEB, and debt service costs will rise by nearly 15%, while entitlements grow by nearly 5% in FY18. Worse, anticipated higher interest rates will add to future fixed costs in the form of debt service costs, while at the same time reducing bond premiums which the state has used over the past several years to reduce debt service appropriations. If there is any upside, it is that Connecticut has fully funded its pensions since 2012, albeit it has computed the liability using a relatively aggressive discount rate of 8 percent. Should the funds return less than this rate, pension costs will rise more than projected as the higher liability is amortized.

The Promise of PROMESA. Our insightful colleagues at Municipal Market Analytics note that the federally created PROMESA board has demanded that any fiscal reform plan adopted by the U.S. territory of Puerto Rico be:

  • honest with regard to any incremental federal aid Congress and the new Trump administration might provide,
  • that recurring revenues must actually be set to afford recurring expenses and vice-versa, and
  • that traditional capital market access cannot be assumed, but rather must be cultivated through balanced settlements.

MMA noted this to be “an unexpectedly earnest expression by the board and a very positive development for Puerto Rico in the long-term, although it also exacerbates short-term volatility by making standard extend-and-pretend restructuring strategies more difficult to pull off.” In response (or really non-response), outgoing Alejandro Javier García Padilla noted that although his own plan assumes massive injections of new federal aid, leaves current commonwealth spending levels unchanged, and disregards the market access issue entirely; he would not be submitting an amended version—a response that makes more difficult the PROMESA Board’s ambitious December 15th deadline for submitting its plan. MMA perspicaciously notes that the federal oversight board’s perspective could also pose a threat to the recent price appreciation in Puerto Rico’s municipal bonds, noting that to the extent to which the Commonwealth, nearing next month’s change of administrations, is forced to meaningfully address its massive structural budget deficit, there will be little room to project payment of debt service in the near– or medium-terms, with MMA noting: “In theory, more sustainable projections will reduce the size of any bondholder recovery, but will allow for higher bond ratings once a restructuring has been completed. Adding to medium-term issues, an acceptable plan’s likely need for sweeping layoffs, service austerity, and, potentially, pension payout reductions increases the potential for social unrest on the island: a development that will aid no parties besides partisans for independence.”  

Is There Promise in PROMESA? The Puerto Rico PROMESA Financial Oversight and Management Board has appealed a U.S. District Court ruling that stopped it from intervening in several consolidated suits filed against the government, having filed a motion in October to intervene in four consolidated lawsuits in order to make known its views on the plaintiffs’ pending motions to lift the automatic stay imposed under §405 of the Puerto Rico Oversight, Management and Economic Stability Act (PROMESA). Thus, two weeks ago, U.S. District Court Judge Francisco Besosa denied the oversight board’s request to intervene in the suits filed by U.S. Bank Trust, Brigade Leveraged Capital Structures Fund Ltd, National Public Finance Guarantee Corp. and the Dionisio Trigo group of bondholders—a suit in which the plaintiffs were challenging the constitutionality of the Moratorium Act, which stopped payments to bondholders. Judge Besosa, early this month, had upheld a block on creditors’ ability to file lawsuits against the government of Puerto Rico in an attempt to extract repayment on defaulted municipal bonds to give time to the territory to restructure its $69 billion debt load—with the stay order part of the PROMESA Act: Judge Besosa consolidated the lawsuit filed by Altair with the suits by three other claimants and imposed a stay on them, writing: “The Court hastens to add that the Commonwealth defendants must not abuse or squander the ‘breathing room’ that the Court’s decision fosters. The purpose of the PROMESA stay is to allow the Commonwealth to engage in meaningful, voluntary negotiations with its creditors without the distraction and burden of defending numerous lawsuits.” (Besides Altair, the lawsuit was brought by Peaje Investments LLC and Assured Guaranty Corp against the government and outgoing Governor Alejandro Garcia Padilla.)

Unpromising? Puerto Rico Governor-Elect Ricardo Rosselló has opted to select his campaign manager, Elías Sánchez Sifonte, to replace public finance veteran Richard Ravitch as Puerto Rico’s non-voting representative to the PROMESA Oversight Board. Commencing next year, Senor Sánchez Sifonte will replace Mr. Ravitch, and losing the experience and expertise of a public finance veteran of the Detroit oversight board, as well as someone who played a key oversight role in the cases of both New York City and Washington, D.C. Mr. Sánchez Sifonte has held a variety of positions in recent years. Most recently he was campaign manager for Gov.-elect Rosselló’s bid for governorship. Prior to that he was human resources director for the city of Toa Baja, which according to the El Nuevo Día news web site had a payroll from $16 million to $23 million per year in the last 10 years. Senor Sifonte, a Republican, is a licensed attorney and provided legal advice to the Puerto Rico Senate from 2009 to 2011. He has run Veritas Consulting since 2011. According to El Nuevo Día he worked as a lobbyist to the Puerto Rico legislature without properly being registered as a lobbyist.

State-Local Governance in the Balance or Imbalance: Uncharted New Territory

eBlog, 11/11/16

Good Morning! In this a.m.’s eBlog, we consider the uncertain governance situation in New Jersey in the wake of Wednesday’s yesterday’s granting of authority for a state takeover of the City of Atlantic City—a state takeover which could be further impacted by the potential selection by President-elect Trump, because New Jersey Governor Chris Christie appears to be a potential Cabinet or other senior advisor to the President-elect. As we noted yesterday, actual governance will shift from local accountability to the state’s Division of Local Government Services—but with the state already having imposed a state emergency manager in the city, what the new state takeover means continues to be uncertain.  Then we turn to a very different change of governance—in bankrupt San Bernardino, where the state has played absolutely no role, but where voters Tuesday, by a wide margin, voted to change the city’s charter and move to a city manager form of government, even as the city nears, early next year, emerging from the longest chapter 9 municipal bankruptcy ever. Then we venture to post-chapter 9 Detroit, where voters pored through an exceptionally long list of candidates to elect a new school board—a board confronted with a state-imposed double school system of charter and public schools—and in a city whose school system has been under a state imposed manager, the ever so rhythmic retired U.S. Bankruptcy Judge Steven Rhodes, who oversaw the long judicial process from which Detroit emerged from the largest municipal bankruptcy in U.S. history. Given the critical import of restoring a school system that would bring families back into Detroit—and thereby enhancing assessed property values, the new DPS school board members will have to learn very fast. Finally, we venture to Flint, where, yesterday, a U.S. District court decision could have difficult and costly consequences for the fiscally challenged city.

State Preemption of a Municipality? In the wake of this week’s 5-0 vote by the New Jersey Local Finance Board, Gov. Chris Christie’s administration has been granted the authority to immediately seize control of financially distressed Atlantic City, with the unanimous vote paving the way for a five-year state takeover—a takeover Governor Christie referred to as the best way to keep the city from becoming the first New Jersey municipality since 1938 to go into chapter 9 municipal bankruptcy. The vote came, of course, just prior to the Presidential election of Donald Trump—an election which has many guessing that Governor Christie might abruptly be named as a senior adviser or even member of a new Presidential cabinet—he has been discussed as a potential Attorney General. Thus, even as the state of New Jersey has moved to usurp the authority to assume key functions usually controlled by local elected leaders: renegotiating union contracts, hiring and firing employees, and selling municipal assets, the question is how. The right to wrest governance authority was power included under the Municipal Stabilization and Recovery Act, but exactly how that state takeover will work remains fuzzy. Under the terms of the state preemption, Timothy Cunningham, the Director of the Division of Local Government Services, will assume responsibility during the takeover—in effect not unlike the authority granted under Michigan’s Emergency manager law—except that in Michigan, said emergency manager can—and did in the case of Detroit—assume absolute power. Within the first twenty-four hours, the then Mayor and Council were barred from meeting and preempted from any governance authority.

In New Jersey, however, the State of New Jersey, with only one previous takeover as experience, means, as Mr. Cunningham appears to be the first to admit: he is uncertain what duties or responsibilities would remain with the city’s elected local leaders—describing the decision as moving into “unchartered territory,” as well as an “unbelievable responsibility.” Thus the state takeover, comes at this time of uncertainty in the statehouse, and with the state emergency manager already having been in place in Atlantic City for over a year: what happens next? The ever so insightful Marc Pfeiffer, the Assistant Director of the Bloustein Local Government Research Center at Rutgers University, puts it succinctly: “This is a new process…We’ve never done a process like this before.” While New Jersey has previous experience, as we have written, with a state takeover of Camden, in this instance, as Mr. Pfeiffer notes, the state has granted itself more authority to take direct control in Atlantic City, adding that while more than a decade ago in Camden, the state assigned a chief operating officer to help sort out Camden’s financial problems—a change which resulted in the dissolution of the city’s police department and the transfer of authority to patrol Camden to the county police—and which, today, he notes,means: “Camden is effectively not on the critical list anymore,” adding it is, fiscally, in better shape than either Trenton or Paterson—even as he cautions: “Atlantic City’s fiscal problems are far more critical that those of Trenton or Paterson: The city’s not dead: They haven’t been able to get their expenses under control to live within their circumstances.” Mr. Pfeiffer opines that the state might opt to dissolve Atlantic City’s Municipal Utilities Authority and sell it or enter into a long-term contract with an outside entity for its operation—even as the city’s leadership has countered they would sue to stop such a move.

Who’s in Charge? Again, unlike in Michigan, the state preemption authority is not spelled out with regard to who will be in charge, what will happen to the state’s existing quasi emergency manager who has been in Atlantic City for well over a year, much less what actions it will take and which powers, if any, will remain with city officials. And, as Mr. Pfeiffer notes, there are also legal questions about how the state can execute the major decision-making powers it usurped from the city and gave to Local Government Services Director Timothy Cunningham.

Presumably, Director Cunningham, or his designee, can now sell city assets, hire or fire workers and break union contracts, among other powers, for up to five years as the state tries to fix the city’s finances—all part of a brave new world of distressed municipal finance the state is still trying to work out—even down to questions not just with regard to who will be in charge of the city, but also whether that supervising state official will be based in Trenton or in Atlantic City. Mr. Cunningham has so far declined to comment on whether he would run the city himself or appoint a designee, but said he would consider looking “outside and inside” the division. He noted yesterday: “I do have a very competent staff that has the majority of the municipalities under control while my attention has been on Atlantic City…If a designee was brought on, I don’t know if I have the resources in-house.”

From the city’s perspective, as it seeks to keep its legal options to sue the state open, it remains unclear what authority remains: the New Jersey preemption authority does, however, include a long list of powers the state could use, from suing on behalf of the city to purchasing goods and services. Thus, Council President Marty Small noted: “We have to sit down with the Commissioner and see what powers we still have to continue to represent the people who elected us,” adding that the Commissioner has “all the powers to do everything that was in the (takeover law), and we’re just hoping it isn’t as draconian.” But, as Mr. Cunningham noted, there will remain a role for the Mayor and Council, as he committed to meet with city officials to discuss the powers granted to him under the takeover law, noting: “I think there are still some authorities and actions that will be retained by the executive and legislative branches.”

 “If there was such a plan for the state, we could say ‘They’re planning to implement this power,’” as Michael Darcy, Executive Director of the New Jersey League of Municipalities put it: “It creates a lot of questions.” Mr. Darcy said the League would await to see how the state intervenes in Atlantic City and what the possible statewide implications might mean to the future of state-local relations before deciding to get involved, adding: “We’re not the league of one municipality, we’re the league of all municipalities…We are going to keep a close look at it.” In this unclear and unsettled set of complex governance choices, as Mr. Pfeiffer makes clear, New Jersey’s third branch of government, the courts, could play a role, as the state’s actions may trigger a lawsuit, citing, for example, that if the State of New Jersey were to break city union contracts, such an action could be grounds for litigation.

Bracing for a New Beginning. San Bernardino voters Tuesday voted overwhelmingly to adopt a new city charter to move to a city manager form of governance, reversing rejections of that direction in 2014 and 2010. With more than a 60% margin, they voted for Measure L, which replaces the city’s governing document. The new charter replaces the 111 year old charter—a charter adopted when the city was a small municipality of less than 10,000, with a charter for the 21st century which provides the framework with regard to which positions are elected and which are appointed, the responsibilities of those officials and certain other restrictions. A key change will increase the power of the city manager and shift that day-to-day responsibility away from the elected officials directly—that is, move to a council-manager form of government, the structure for 58 percent of cities with a population over 100,000, or, as Mayor Davis described it during the campaign: “This is how modern governments work, with the mayor and council setting the policy and professionals implementing it,” even as his predecessor, former Mayor Judith Valles had warned that such a change would weaken San Bernardino: “There’s a pecking order among cities, and the cities where the mayor is a strong mayor are able to take leadership.” The new charter eliminates elections for three positions, so that, in future, the Mayor and Council will appoint the city attorney.

Interestingly, during the campaign, former city attorney, James F. Penman, in opposing the measure, had argued that the people will not and should not give up their power to vote, stating: “When he was a Congressman in the House of Representatives, on July 27, 1848, Abraham Lincoln gave a speech in which he said, quote, ‘In leaving the people’s business in their hands, we cannot be wrong’…It’s such a fundamental part of American democracy.” Under the newly adopted charter, San Bernardino will move its election cycle to even-numbered years, the years when state legislators, the governor, and President are up for election, a change with regard to which former San Bernardino Councilwoman Susan Lien Longville had said: “Combining elections will even save San Bernardino taxpayer dollars—money the city can spend on reducing crime, improving parks and libraries, and fixing our roads.” Also, interestingly, the new charter will replace the old charter’s personnel rules—rules which mandated that police and firefighter pay be set as the average of 10 like-sized California cities, rather than by collective bargaining like nearly all other cities. Under the new charter, employee pay will be set through collective bargaining. Similarly, pay for the City Councilmembers, previously set at $600 per year, now will be set by the Mayor and Council after a public hearing, and after hearing from an advisory commission. Any raises will go into effect following the next election after the increase. The new charter also imposes a balanced budget requirement, strict financial controls, and an annual independent audit which must be shared publicly. The now discarded charter read: “The Mayor shall have the books and records of all public departments, pertaining to the finances of the City, experted by a competent person at least once in every year.” Clearly that “experted” part proved out-of-order as the city collapsed in 2012 into what has stretched to the longest municipal bankruptcy in American history with the city’s books crushed in 2012 under a $45.8 million deficit and its books unaudited for years. The newly adopted charter provides that the city’s Water Department and Library Board will remain independent. In the wake of the vote, Mayor Davis said he looked forward to seeing the reaction of U.S. Bankruptcy Judge Meredith Jury, who has been presiding over the city’s chapter petition, noting: “It sends a good message…I think she’ll be overjoyed.”

Learning for a City’s Future. Detroit voters, facing record numbers of candidates (sixty-three!) for its re-constituted public school system, elected newcomers to a majority of the seven public school board seats that were open: among the winners were one former school board member and his wife. Those vying included ten persons who sat on the previous school board, as well as newcomers hailing from backgrounds in business, education, and the ministry. (All seats were at-large.) Of those elected, the top two vote-getters will serve for six years, the next three will serve four-year terms, and the final two will serve for two years. Their unenviable task will be to steer the 45,000-student district following years of severe financial turmoil, poor academic performance, a series of widely criticized state-appointed emergency managers, and the signal disruption by the Michigan Legislature’s creation of a dual school system in Detroit made up of charter and public schools—as part of the controversial and historic $617-million financial restructuring package which divided the  Detroit Public Schools (DPS) in two, creating the new DPSCD: the old of former DPS district now exists only to collect tax revenue to pay down debt. That new legislation also restored power to an elected board, albeit authority subject to the prerogatives of the Detroit Financial Review Commission, which monitors the city’s finances, and now will add oversight of the newly created district to its report card.

The new DPS school board will be able to hire a new superintendent and have policy-making authority; however, it cannot fire the superintendent on its own. How the new schooling system works as the Motor City is emerging from the largest municipal bankruptcy in U.S. history, will, perhaps, be the single most critical determinant pf the city’s long-term post-bankruptcy future. And it will require heavy lifting: the city’s public schools have suffered enrollment losses over 66 percent over the last sixteen years: enrollment has dropped by more than two-thirds since 2000—a combination of the city’s sharp population decline, but also the flood of departures to charter schools and suburban districts: more than 100 schools have closed since 2005. During this period, state-appointed emergency managers have run the district since 2009—and that followed the period from 1999 to 2005, when the system was also under state control. Now, with the board facing a severely impeded school system of charter and public schools mandated by the state, the question is whether this seemingly jerry-rigged patchwork of charter and public schools can recover their reputation sufficiently to lure young families in from the suburbs to create an enhanced municipal tax base for the future.

Out Like Flint? U.S. District Judge David Lawson yesterday ruled that the State of Michigan and the City of Flint must provide home-delivered bottled water to residents if they cannot prove faucet filters are working to remove harmful lead from the drinking water, ordering home delivery of four cases of water per resident each week unless state and city officials can verify each resident has a properly installed and maintained faucet water filter, writing: “The defendants need not deliver water to homes that have properly installed and maintained faucet water filters, as long as the defendants can monitor and verify the effectiveness of the filters,” in his 37-page opinion. Judge Lawson’s preliminary injunction had been pressed for by the Natural Resources Defense Council, the American Civil Liberties Union of Michigan, and Flint residents who had sued Michigan and Flint officials in an effort to try to speed up the slow process of removing lead service lines blamed for contaminating the city’s water. ACLU’s Michigan Legal Director Michael J. Steinberg, in the wake of the decision, noted: “It is an important, but rare, victory for the people of Flint, who have suffered one set back after the next since poison started flowing out their faucets more than two years ago.” Both Flint and Michigan officials had opposed door-to-door water service: they testified that the costly and time-consuming weekly distribution would delay efforts to remove and replace lead and galvanized metal pipes that are leaching toxic metal into the drinking water supply. In his opinion, however, Judge Lawson wrote: “It is in the best interest of everyone to move people out of harm’s way before addressing the source of the harm.” Indeed, it will be costly: the Michigan State Police’s emergency operations division estimated it would cost $9.4 million for weekly delivery of bottled water to the 30,000 to 34,000 occupied homes in Flint. Judge Lawson also ordered state and city officials to file a report by December 16th detailing how they are complying with his order. In his decision, Judge Lawson wrote that the city and state’s water resource sites were insufficient for the daily needs of Flint residents, while the water remains unsafe to drink without lead filters: “The fact that such items are available does not mean that they are reliably accessible or effective in furnishing safe drinking water to every household…Indeed, the endeavor of hunting for water has become a dominant activity in some Flint residents’ daily lives.” The judge also wrote that a safe and reliable water supply “has always been critical to civilization,” as he blamed the city’s water pipe leaching of lead directly on the shoulders of the City of Flint while under control by a state-appointed emergency manager: “It appears beyond dispute that the city of Flint failed to meet its responsibilities under the corrosion control regulations of the Lead and Copper Rule,” adding it “appears that Flint is continuing to violate” rules for monitoring lead levels in Flint’s drinking water system based water sampling protocols not being followed.