The Absences of Fiscal Balances

May 4, 2018

Good Morning! In this morning’s eBlog, we note the deepening road towards insolvency of the Harvey, Illinois; then we turn south to consider the potential adverse municipal fiscal impacts were the State of Georgia to enable the de-annexation of the small city of Stockbridge. Finally, we journey back to Puerto Rico, where House Natural Resources Committee Chair Rob Bishop is headed for a first-hand assessment of the ongoing fiscal and physical challenges and federal emergency assistance still needed. 

An Absence of Fiscal Balance? In the Land of Lincoln, Illinois, where the state’s courts have heard requests for municipal bankruptcy relief; but where chapter 9 municipal bankruptcy is not authorized; relief appears only to have been granted when not challenged. Under 65 Illinois Comp. Statute 5/8-5-1, smaller municipalities may, if not home rule jurisdictions, seek judicial relief. Under the state’s Local Government Financial Planning and Supervision Act (50 Ill. Comp. Stat. 3200) a municipality with a population under 25,000 suffering a “fiscal emergency” may, after securing a two-thirds vote of the governing body, petition the state to establish a financial planning and supervision commission to address such “fiscal emergency.” Ironically, Harvey, with a population of 25,282, just exceeds that level—some 1,052 Illinois municipalities have less than 25,000 residents. Now, with the municipality unable to meet its police and fire pensions, Illinois Comptroller Susana Mendoza is holding up more than $1 million in state funds the town is owed—under Illinois statutes which authorize the state to withhold tax revenues a municipality is slated to receive if it does not make the required payments into its police and firefighter pensions: the funds withheld go right into the pension fund instead of town services—which, in the case of Harvey, amount to about $1.4 million, leading to, as we have previously noted, the town’s announcement that it will lay off nearly half of its police and fire department. Making the fiscal situation more dire, the city’s Mayor, Eric Kellogg, has been banned for life from the municipal bond market for misleading investors; the municipality appears to be in a chronic pattern of underfunding its public safety pension funds, even as its operating budget chronically spends more than the revenues it brings in. Ergo, as we have written, under Illinois’ Public Act 96-1495, the Comptroller may be compelled to withhold state tax revenues, which would traditionally be in order to ensure pension payments are made to a municipality which has failed to make full pension payments for years.

In a situation which risks compromising public health and safety, Harvey has laid off nearly half its police and fire force—even as it has warned it might not be able to make payroll—especially with inadequate municipal fiscal resources now being rerouted to oppose the state actions in court.

It being Illinois—and an election year—Gov. Bruce Rauner has been uncharacteristically silent about the brewing fiscal catastrophe. The godfather of chapter 9 municipal bankruptcy, Jim Spiotto, has joined with the exceptional Chicago Civic Federation in drafting legislation, the Local Government Protection Authority, which includes a provision to:

  • establish an oversight board,
  • set up a clear procedure for dealing with a stressed city, and
  • allow filing for Chapter 9 municipal bankruptcy. (Legislation which has, to date, gained no traction in the legislature.)

Harvey Town Attorney Bob Fioretti reports: “We are going to find some solution, if possible,” signaling that the municipality was still negotiating with its police and fire pension funds, but warning that, if those discussions falter:  “Layoffs will occur. But the safety of the population is key, and that will continue.”

Mayhap ironically, Illinois adopted its pension law eight years ago as a way to ensure smaller municipalities would stop shorting their pension fund contributions—provisions upheld the week when a judge affirmed that the Illinois comptroller was within the state law to withhold the revenue. Thus, while the Comptroller’s Office issued a statement that it “does not want to see any Harvey employees harmed or any Harvey residents put at risk…the law does not give the Comptroller discretion in this case: The Comptroller’s Office is obligated to follow the law. This dispute is between the retired Harvey police officers’ pension fund and the city of Harvey.”

Nor does Harvey appear to be an isolated case: According to an analysis by Amanda Kass, a researcher at the University of Chicago, there are 74 police or fire pension funds in Illinois municipalities with similar unfunded pension liabilities—leading Chicago Civic Federation President Laurence Msall to note: “If they ignore the law and don’t make the contribution as Harvey has, then yes, those municipalities all around the state have ability to seek an intercept of state revenues that would otherwise come to the municipality.”

The complicating factor for Harvey is, however, not just that it has had years of decline and corruption in government, but also with declining assessed property values and very high property taxes, the municipality has a shrinking set of fiscal options—or, as Mr. Fioretti puts it: “We have an aging population, a declining population, a fixed-income population, and our revenues aren’t even being collected from the real estate taxes. We’re below 50 percent for the year on those collections,” noting that the delinquent real estate tax money is costing the town $12 million this year.”

Uneasy Fiscal Options. While Mr. Msall notes that the State of Illinois helped create the fiscal mess by setting up the pension funds and setting all of the pension levels; now, he notes, Illinois must either dissolve Harvey’s pension into the state fund, or put together an emergency financial team to sort through the wreckage of this and other distressed towns—adding: “Let’s create a board that could be independent with real financial expertise to guide these local governments, not to push them into [municipal] bankruptcy: The best path forward for Harvey is independent oversight that could sort out why they’re not making their financial reports on a regular basis.”

The Cost of Municipal Annexation. Municipalities across Georgia could face higher borrowing costs if the state government enables the “de-annexation” of about half of one small city, that city being Stockbridge, one settled in 1829 when the Concord Methodist Church was organized near present-day Old Stagecoach Road—and, especially, when Stockbridge was granted a post office on April 5, 1847, named for a traveling professor, Levi Stockbridge, who had passed through the area many times before the post office was built. Albeit that heritage remains a matter of some dispute: others contend that the city was named after Thomas Stock, who was State Surveyor and the Georgia State President in the 1820s. The small municipality was incorporated as a town in 1895 and, subsequently, as a city on August 6, 1920. Now, however, more change might be on the way, especially if Georgia Governor Nathan Deal signs into law Senate bills 262 and 263—bills which, if enacted, would de-annex just over half of Stockbridge’s assessable residential and commercial property. Why? Because proposed SB 263, an Act to incorporate the City of Eagles Landing, provide a charter for the City of Eagles Landing; provide for a referendum; provide for transition of powers and duties; provide for community improvement districts; and repeal conflicting laws would effectively have disconcerting fiscal impacts on City Hall in Stockbridge, which was financed with municipal revenue bonds. Neither of the two bills apportions the revenues involved between the to-be two entities—a requirement which, according to some legal experts, is based upon precedent-setting court cases before the U.S. Supreme Court and Georgia when the boundaries of a governmental entity are changed.

Thus, unsurprisingly, during the Georgia Municipal Association’s Georgia Cities Week last week, Stockbridge officials and representatives of the Eagle’s Landing effort held separate meetings with Gov. Deal.  Stockbridge City Attorney Michael Williams described their session as “very productive: The Governor said he would consider the series of points we made…I’m certainly taking him at his word that he will.” Nevertheless, the municipality is hedging its fiscal bets: it has hired three outside law firms to challenge the laws if Gov. Deal approves them.

Should that happen, however, the much reduced City if Stockbridge would still would be obligated to pay off about $13.02 million of privately placed Urban Redevelopment Agency lease-revenue bonds, and $1.5 million of water and sewer notes issued through the Georgia Environmental Facilities Authority—municipal bonds owned by Capitol One Public Funding LLC. Unsurprisingly, the Romulus and Remus of Eagles Landing have expressed no eagerness to help make those payments: sharing only goes so far. The lease-revenue bonds, issued in 2005 and 2006 for projects including funding to purchase land and build city hall, backed by general fund revenues and the city’s taxing power, if needed, even though the city does not currently impose a property tax.

Also unsurprisingly, Jim Spiotto’s firm, Chapman and Cutler LLP, which represents Capital One, wrote to the city a day after the General Assembly ended its session last month, warning it could face potential litigation: “SB 262 and SB 263 infringe Capital One’s constitutional rights under the contracts clause of the U.S. Constitution and the Georgia Constitution by taking away a significant source of the security and source of repayment for the bonds that was contractually bargained for by the bondholders,” Chapman and Cutler partner Laura Appleby wrote to the City Attorney. Unless the bonds are properly apportioned between Stockbridge and Eagle’s Landing, and the [municipal] bondholders have the benefit of the full security that they were originally promised, Ms. Appleby wrote, “We have serious concerns regarding the ability of [Stockbridge] to continue to pay debt service on the bonds because it will have lost a large portion of its ad valorem tax base.”

Jonathan Lewis, Capital One Public Funding’s president, has written to Gov. Deal also requesting a meeting, writing: “The failure of SB 262 and SB 263 to provide for the apportionment of the [municipal] bonds between the City of Stockbridge and, if formed, the City of Eagle’s Landing, is not only an inequitable result for the City of Stockbridge, it is an infringement on Capital One’s constitutional rights under the contracts clause of the U.S. Constitution and the Georgia Constitution, as it removes a significant portion of the security and source of repayment for the bonds…Capital One has come to trust that the State of Georgia will take those actions required to maintain, preserve, and protect the pledges made by its municipalities to their bondholders…Permitting SB 262 and SB 263 to become law would no longer allow us to rely in the State of Georgia [based] on the bedrock public finance principle of non-impairment,” adding that such a “de-annexation” would impair Capital One’s municipal bonds and “create new, unprecedented risks for existing holders and prospective purchasers of State of Georgia local debt.” Mr. Lewis last week also communicated to Georgia Municipal Association Executive Director Larry Hanson, whose organization is made up of 521 municipalities, that if enacted, the de-annexation would require all lenders to Georgia municipalities to “consider, and price in, the potential loss of security from future de-annexations,” because the legislation does not apportion Stockbridge’s outstanding debt: “GMA’s members would bear the burden of this new, Georgia-specific risk in the form of higher interest costs: “The uncertainty created by such a shift sets a dangerous precedent and could produce additional negative unintended consequences as lenders consider municipal financing opportunities within the state.”

Who’s on First? Chairman Rob Bishop (R-Utah) of the House Natural Resources Committee, the committee of jurisdiction for U.S. territories, yesterday confirmed he would got to Puerto Rico to meet with island leaders to assess the recovery in the wake of Hurricane Maria’s devastation, noting: “This trip will allow me to better understand the ongoing challenges and the emergency assistance that is still needed.” He is scheduled to meet with Puerto Rico’s non-voting Member of Congress, Jenniffer Gonzalez, as well as Chairman Jose Carrion of the PROMESA Board as part of an effort the Chairman described as a “first hand look at recovery efforts,” pointing out that, in his view, it would be irresponsible for Governor Rosselló, who apparently the Chairman had not advised of his visit, not to implement the government reforms ordered by the PROMESA oversight board—making clear the fiscal gulf between the two leaders, with the Governor observing that Chairman Bishop, with his demands in favor of a dialogue with creditors, seems to be supporting the causes of the territory’s municipal bondholders over the U.S. citizens of Puerto Rico.

Unlike chapter 9 municipal bankruptcy, wherein state laws create a process—where permitted—for a municipality; there are many fiscal chefs in the kitchen in Puerto Rico, with growing questions with regard to the limits of their respective legal authority under the PROMESA law. A key issue, the final decision with regard to the implementation of cuts to the pension system and the labor reform may yet take a few months. The fiscal stakes, however, especially on an island where there has been a steady stream of college graduates and young professionals moving to the mainland—leaving behind  disproportionate number of older, retired Puerto Ricans, increasingly creates a greater and greater fiscal imbalance. That is now front and center in the wake of the Board’s proposed 10 percent average reduction in pensions—a proposal Gov. Rosselló has rejected, but, as one commentator noted, it is the Board which holds all the cards. The challenge is in interpreting the PROMESA Board’s authority to use its fiscal plans to provide “adequate funding” to Puerto Rico’s public pension systems: under the proposed fiscal plan, the Board cut in pensions would not begin until FY2020—giving time for the PROMESA Board to submit to U.S. Judge Laura Taylor Swain a quasi-plan of chapter 9 debt plan of debt adjustment by the end of this year.

It is not that the Governor believes pension should be off the table—after all, he had recommended a 6% reduction last year; thus, there remains some chance that the government and the Board could reach an agreement and avoid the heavy costs of fighting the fiscal issues out before Judge Swain. Indeed, as we saw in San Bernardino, those back door negotiations between the government and creditors can save an awful lot in lawyers’ fees—or, as former U.S. Bankruptcy Judge Gerardo Carlo-Altier put it: “The ideal thing would be for the Board, the government, and the groups of creditors to reach an agreement in advance and go together to court.”

A key sticking point appears to be the Board’s insistence of labor reforms: under its proposed plan, the Puerto Rico Legislature should approve the labor reform by the end of this month, so that the seven-day reduction for vacation and sick leave would take effect immediately. The elimination of the protections against unjustified dismissal, the mandatory Christmas bonus, and work requirements for the Nutrition Assistance Program (NAP) are proposed for next January—with the PROMESA Board estimating that, absent the enactment of such labor reforms, including: such as employment at will, reductions in sick and vacation leaves, and non-mandatory Christmas bonus; the government of Puerto Rico would stop receiving $330 million within the next five years. They estimate another $ 185 million to cuts in pensions—all of which has led the PROMESA Board to project that, absent the adoption of the reforms proposed in the five-year fiscal plan, Puerto Rico’s economic growth and capacity to finance its public debt service would fail.

Who Will Govern? Are there too many fiscal cooks in the kitchen? In Central Falls, Rhode Island: there was one individual in charge of steering the small city, aka Chocolateville, out of bankruptcy. Similarly, in Detroit, Governor Snyder named Kevyn Orr as Emergency Manager—effectively suspending the governance authority of the Mayor and Council during the pendency of the city’s chapter 9 proceedings until U.S. Bankruptcy Judge Steven Rhodes approved Detroit’s plan of debt adjustment. Yet, in Puerto Rico—a territory which is neither a state, nor a municipality; there are a multiplicity of actors—including, now, Chairman Bishop, the Governor, the Legislature, and the PROMESA Board—a Board which Constitutionalist Professor Carlos Ramos González of the Inter-American University Law School believes, even given the power conferred upon it by Congress over Puerto Rico’s elected government, is uncertain with regard to its own authority to implement the structural reforms it favors—or, as he has noted: “Nobody wants to be blamed for cutting pensions: in all the chapter 9 municipal bankruptcy cases, there were pension reductions,” adding that, as we saw especially in the case of Detroit, the issue of equity is challenging: how to make those cuts without plunging many retirees into poverty—a problem of even greater resonance on an island experiencing an outflow of its young professionals, so that the demography already risks insufficient revenues to meet a clearly growing demand.  

Then there is a second challenge: while PROMESA appears clear in its grant of authority to the Board to certify the fiscal plan, it appears to lack any authority to implement it on its own. Unlike Central Falls, Detroit, San Bernardino, or other chapter 9 plans of debt adjustment approved by U.S. Bankruptcy Courts; the current PROMESA statute does not authorize a federal court to control Puerto Rico’s legislative process: there is a separation of powers issue.  Nevertheless, in the wake of the approval of the fiscal plan, the PROMESA Board is trying: it has submitted a preliminary labor reform draft to the Puerto Rico Legislature, where Senate President Thomas Rivera Schatz has invited PROMESA President José Carrión III to defend the proposed changes and cuts—an invitation, however, which has not been accepted.  

Former Governor Aníbal Acevedo Vilá, who lectures for a Separation of Powers class at the Law School of the University of Puerto Rico, finds it self-evident that the Legislature will not give way to the Boards proposed labor reforms, noting: “I think the Board has a very weak case in terms of imposing the labor reform. It has a better case in other measures, because they are directly tied to Puerto Rico’s fiscal crisis.” Similarly, Governor Rosselló usually quotes §205 of the PROMESA Act, which refers to the fact that the Board can make “recommendations to the Governor or the Legislature on actions the territorial government may take to ensure compliance with the Fiscal Plan, or to otherwise promote the financial stability, economic growth, management responsibility, and service delivery efficiency of the territorial government.” While Carlo Altieri adds to the debate §108, which, regarding the general powers of the Board, warns that: “Neither the Governor nor the Legislature may— (1) exercise any control, supervision, oversight, or review over the Oversight Board or its activities; or (2) enact, implement, or enforce any statute, resolution, policy, or rule that would impair or defeat the purposes of this Act, as determined by the Oversight Board.”

Indeed, an attorney for the Governor, Richard Cooper of Cleary Gottlieb, noted: “Congress did not grant the Board the power to pass laws or appoint or replace government officials…it left the government of Puerto Rico the capacity and responsibility to make the law (as long as it is consistent with the adopted fiscal plan and adjustment fiscal plan) and manage the government, with all that it entails.” Indeed, in an earlier ‘who’s in charge dispute,’ when the PROMESA Board tried to appoint a trustee to monitor the Puerto Rico Electric Power Authority (PREPA), alleging that PROMESA recognizes it as representative of the “debtor,” Judge Swain stated that no section of the PROMESA law granted the Board power with regard to the “the implementation of those (fiscal) plans and budgets,” instead comparing the statute Congress adopted in the 1990’s creating a fiscal control board over Washington, D.C. with PROMESA. She concluded that the Board has the task of establishing the “rails” for the “territorial government” to move “towards credibility and fiscal responsibility.” Indeed, the Congressional Record appears to make no reference to the power of the Board to impose structural governmental reforms—just as Congress lacks any authority to impose such on a state—especially in a nation where it was the states which created the nation, rather than vice versa. Rather, the Congressional debate on Puerto Rico reflected an emphasis on the power of the PROMESA Board to restructure the debt, which is the main burden of Puerto Rico—and, in Congress, Republicans and Democrats have expressed no interest in amending the act, either to strengthen or soften the powers of the Board.

For his part, Chairman Bishop believes that the act allows the Board to implement structural reforms and that it would be an irresponsible attitude of the Puerto Rican government to block them. That indicates there could well be intriguing fiscal and governmental discussions this weekend—albeit it seems most certain that, as Gov. Rosselló has made clear: “We are not going to allow an imposed Board to dictate the public policy of Puerto Rico.”

Notwithstanding their differences over the extent of the powers of the PROMESA Board, Gov. Rosselló and the Board are not at complete odds: they appear to have made common cause before regarding the case of Aurelius investment group and the Electrical Industry and Irrigation Workers Union, the main union of PREPA, to defend the constitutionality of the appointment of the Board members, because six of the seven were proposed by the Congressional leadership; rather, Gov. Rosselló’s administration has limited itself to challenging actions of the Board, not its existence—even as one of his predecessors, former Governor Acevedo Vilá, noting that, even under the colonial situation and the doctrine of Insular Cases decided a century ago by the U.S. Supreme Court, which has repeatedly validated the so-called “plenary powers” of Congress in Puerto Rico, the government of Puerto Rico must challenge the existence of the Board as a violation of the U.S. Constitution under the theory that “to the extent that Board has executive and legislative powers, even under the Insular Cases, it is unconstitutional,” adding that: “Even when organizing the territories, Congress has to guarantee a minimum system of separation of powers.”

The Puerto Rico Debt Tango. While the PROMESA Oversight Board and Gov. Rosselló are engaged in a complicated dance over future debt payments and policy, their complicated dance steps are not dissimilar: In successive versions of a fiscal plan that the Governor submitted to the Board in January, February, March, and last month; the Governor said the amount of debt Puerto Rico should carry should be determined through a comparison with debt medians in the 50 mainland states—quite similar to the Board’s certified plan.  Like the Governor’s proposed fiscal plans, the board certified plan has a comparison to the medians for the 50 states and to the 10 states with the highest levels of four measures of debt. The Board certified plan stated: “The implied debt capacity and expected growth in debt capacity in debt capacity must be sufficient to cover both the payments due on the restructured debt, and all payments due on future new money borrowings.” Accordingly, the aggregate debt service due on all fixed payment debt issued in the restructuring of the government’s existing tax-supported debt should be capped at a maximum annual debt service level: “The cap would be derived from the U.S. state rating metrics, and specifically what Moody’s [Investors Service] calls the ‘Debt Service Ratio.’” (The debt service ratio is defined as ratio of total debt payments due in a year divided by a state-government’s own source revenues.)

Under such a construct, it would appear that Puerto Rico could pay about $19 billion of the roughly $45 billion that the central government and its closely related lending entities owe, according to the plan’s exhibit 26. In the same exhibit, the PROMESA Board alternately suggests that one should use an average of a set of four measures of debt capacity and not just own-source revenues. Using this composite measure would mean that Puerto Rico should pay back about $10.7 billion in outstanding debt. But the Board plan notes this would be optimistic for a promised level of payments, rather, it reports, the fixed amount committed to should be cut by 10% to 30% to allow for “implementation risk.” It suggest that 20% should be used and the coupon be adjusted to 5%. These would lead to Puerto Rico committing to pay 19% of its debt—adding: “Any additional cash flow above the maximum annual debt service cap applied to the restructured fixed payment debt that is generated over the long-term from successful implementation of the new fiscal plan could be dedicated to a combination of contingent ‘growth bond’ payments to legacy bond creditors, debt service due on future new money borrowings needed to fund Puerto Rico’s infrastructure investments, and additional ‘PayGo’ capital investment to reduce the government’s historically out-size reliance on borrowing to fund its needs, among other purposes.”

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Phoenix Rises in Detroit!

April 30, 2018

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

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

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

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

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

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

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

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

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

Human, Fiscal, & Physical Challenges

April 20, 2018

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

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

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

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

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

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

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

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

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

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

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

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

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

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

 

The Once & Future Puerto Rico?

April 17, 2018

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Plans of Debt Adjustment

April 16, 2018

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

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

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

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

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

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

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

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

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

Fiscal Recovery & Home Rule

April 6, 2018

Good Morning! In this morning’s eBlog, we can safely write: free, free at last, as Michigan Governor Rick Snyder has signed an order releasing Flint from receivership and state oversight—making it the final  municipality to be under such state fiscal control. Then we turn East to the Empire State to assess whether New York will grant the same fiscal liberty to Nassau County, before dipping into the warm Caribbean to assess the ongoing fiscal and political tug of fiscal war so critical to the fiscal future of Puerto Rico. Finally, before your second cup of java, we jet back to King George, Virginia, as the rural county struggles to reduce its more than $100 million in indebtedness.

Setting the Path for a Strategic Recovery & a Return to Home Rule. Gov. Rick Snyder announced he has signed an order to release the City of Flint from receivership and state oversight—making Flint the final city in the state to exit such oversight and preemption of local authority. His decision came as the lame duck Governor, who has been under fire for his selection of emergency managers to the Genesee County city and handling of the Flint water crisis, came at the behest of the Flint Receivership Transition Advisory Board. The decision marks the end of an era of state usurpation of municipal authority—especially in the wake of the role of state imposed emergency managers in the state’s lead contamination crisis for their decisions to switch to the Flint River—decisions which led to the drinking water health crisis, as well as to the devastation of the city’s assessed property values, as well as contributed to the poisoning of thousands of citizens and the deaths of 12. The Governor stated: “City management and elected leadership have worked hard to put Flint on a stronger path…With continuing cooperation between the city and state, Flint has an opportunity to take advantage of the momentum being felt around the city in terms of economic development, which can lead to stronger budgets and improved services for residents.”

The announcement cleared the path for Michigan state Treasurer Nick Khouri’s expected signature on a “Flint RTAB resolution that repeals all remaining emergency manager orders,” with the repeal effectively securing the municipality from seven years of state emergency management, restoring full authority to the city’s Mayor and Council—or, as Mayor Karen Weaver put it: “We’ve just got our divorce…I feel real good about it…I remember when I was campaigning (in 2015) — it was one of the things I talked about, was I wanted to work on getting home rule back to the City of Flint. I know it’s how we got into this mess (the water crisis), was having an emergency manager and our voice being taken from the city and taking the power away from the local elected officials. We’ve shown that we’ve been responsible, and we’re moving this city forward.” That state preemption had come in the wake of a state financial review team opining that a “financial emergency existed” in Flint, and that the city had no “satisfactory plan in place to address the city’s fiscal problems,” leading to the preemption of local control and state imposition of an emergency manager from that time until shortly after Mayor Weaver was elected in November 2015.

Will Nassau County Be Free at Last? In a comparable governing and federalism issue in New York State, Nassau County Executive Laura Curran, who took office at the beginning of this year, has submitted a revised spending plan which relies upon new revenue initiatives, after, at the end of last year, the Nassau Interim Finance Authority had rejected a $2.99 billion budget and ordered $18 million in cuts due to revenue uncertainty. The new, proposed budget, which was submitted to the Authority on March 15th, contains $54.7 million in projected savings and revenues; however, the Authority’s Executive Director, Evan Cohen, Wednesday expressed apprehensions with regard to required legislative approvals needed for some of the revenue initiatives, even as he praised the new County Executive, who attended the Authority’s session Wednesday evening in an effort to secure support for proposed new revenues and avoiding a reliance on borrowing sought by previous administrations. Director Cohen, in a letter, wrote: “Our analysis indicates that the projected risks confronting the County will impede its chances for ending FY 2018 in [generally accepted accounting principles] balance…Strong management and legislative cooperation will be essential to any chance of success on that fiscal front,” stressing in her epistle that the County is confronted by political challenges to get the Republican-controlled Nassau County Legislature to agree to and implement some of her revenue plans: the County is seeking approval of some $9.7 million of $29 million in additional projected revenues, even as it is already confronting resistance on a proposal to change fees for Little Leagues and other non-profit groups to use county-operated athletic fields. A County spokesperson noted: “It is a viable operating budget except for the risks associated with the overwhelming cost of commercial and residential claims for tax overpayment…Once again, it is clear that the county’s poor fiscal health is intertwined with the broken assessment system and the failed the tax policies of the previous administration.” Nevertheless, the Authority identified $104.7 million of projected risks in the modified budget. County Executive Curran noted that this figure, which is up from $101.4 million of projected risks cited in the December review of the budget, reflects her administration’s decision to fund $43.8 million for to honor a court judgment mandating the payment to two men who were exonerated in the wake of a 1985 murder conviction. The Authority praised the County Executive her fiscal plan to pay off the judgment through operating revenue rather than through the issuance of municipal debt. The gold star from the Authority could begin to clear the path for exit from state oversight.

Modern Day Colonialism? The Puerto Rico Senate Wednesday voted unanimously to terminate its appropriations to fund the PROMESA Oversight Board, which, under the law, is defined as an integral part of the U.S. territory’s government; the federal act specifies that Puerto Rico’s government revenues are to be used for its funding. Puerto Rico Sen. President Thomas Rivera Schatz, an attorney and former prosecutor, who was born in New York City, as well as Gov. Ricardo Rosselló both conveyed messages of defiance to the Oversight Board, with the messages coming in the wake of Gov. Rosselló’s epistle to Chairman Rob Bishop (R-Utah) of the House Natural Resources Committee defending his independent power relative to that of the Oversight Board and denouncing the quasi-imperialist effort to preempt the authority as the elected leader of the territory—an effort unimaginable for a Member of the U.S. Congress to take against any Governor of any of the 50 mainland states. Senate President Schatz noted: “The key message we want to send here is that we do not bend, we respond to the people who chose us, and we defend the Puerto Rico citizens and the American citizens who live on the island.” He added: “If there is anyone who defends the board, I urge you to tell us if the American dream and the principles of freedom and democracy that inspired the creation of the American nation accept as good that the Board’s executive director [Natalie Jaresko] earns $650,000 with all possible luxury benefits…” adding that Ms. Jaresko “lives at the expense of the people of Puerto Rico while trying to eliminate the Christmas bonus to workers of private companies and the government…and is also trying to reduce your working hours or eliminate your vacation. And who is attacking the medical services, education, and housing of the Puerto Rican people.”

Nevertheless, by submitting a revised fiscal plan—a plan which includes only 20 of the 48 recommendations made by the PROMESA Board, regarding financial and technical matters, Governor Ricardo Rosselló yesterday ruled out any alternative, as he, during a round table at La Fortaleza, insisted that the PROMESA Board may not establish a plan in which it enters into public policy issues, a prerogative that only holds for the Puerto Rico government—as would be the case with any of the nation’s other 50 states. Nevertheless, he added that it is not about having to go to court to assert Puerto Rico’s democratic rights against the PROMESA Board. Simultaneously, the Governor ruled out giving way to a measure such as that approved by the Puerto Rico Senate to stop the disbursement of public funds for the operation of the body of Congressional creation. The projected allocation of funds for the six-year PROMESA Board term is projected to cost the taxpayers of Puerto Rico up to $1.4 billion—a figure which includes operational budget, expenses of advisors, and everything related to the representation for the process of Title III of PROMESA. Thus, the Governor added: “We do not have to go to court. That is what I would like everyone to understand. We are doing what is in law that we must do. Our preference would be that all matters that we can agree, that can be executed. That we can work in that direction, but our action if they (the PROMESA Board) certify something that is the work and the right of the elected government of Puerto Rico, which does not match the public policy of our government, that part is simply not going to take. Our warning is for what to do if what they are going to do is weaken a fiscal plan before measures that obviously are not going to be executed.”

In response to the measure approved by the Puerto Rico Senate, the Governor noted: “[H]here we must show that we are a jurisdiction of law and order, and I am following the steps of our strategy…What I have said is that in the face of the future, I will always seek to defend the people of Puerto Rico. Although I understand the feeling of the Legislative Assembly, the frustration, which is a prevalent feeling, the fact is that everyone’s approach, and we discussed it yesterday in the legislative conference…must be within the subject in law, demonstrate that the fiscal oversight board cannot implement public policy issues.” He stressed that responsible, prudent actions “are aimed at achieving a fiscal plan that is enforceable.”

Referring to the 202-page document, provided to the PROMESA Board before 5:00 pm yesterday, Gov. Rossello said that once the numbers are analyzed “We are basically about [at a] $100 million difference from where they wanted to be and where we are,” highlighting that the document, through structural reforms and adjusted fiscal measures, proposes the government will achieve a surplus of $1,400 million by FY2023—that is, a document which places Puerto Rico on the path “of structural balance and restoration of growth,” insisting it is important to approve the plan Puerto Rico submitted, because it will allow for a better position toward the judicial process for debt readjustment or Title III, comparable to a chapter 9 plan of debt adjustment. Stressing that “after implementing all government transformation initiatives and structural reforms, and incorporating the federal support received for health assistance and disasters, Puerto Rico will accumulate a surplus of $6,300 million by FY2023.”

With regard to other PROMESA proposed changes, the Governor stated that Puerto Rico had agreed to a number of the PROMESA recommendations, mentioning that more than a dozen corresponded to economic aspects, noting, for example, that Puerto Rico had requested $94.4 million in federal disaster assistance because of Hurricane Maria, but on the recommendation of the Board had reduced that by nearly half to $49.7 million. With regard to differences on estimated GNP for FY2018, he noted that it had been readjusted from a fall of negative 3.9% to negative 12%, because of the resulting economic slowdown of Puerto Rico—adding, that by next year, he anticipates a rebound of 6.9%, in part because of the flow of federal aid for post-hurricane reconstruction and disbursements from insurers, which will decrease considerably in subsequent years to 0.6% positive growth in GNP by FY2023. He noted that the revision for the population decline due to migration varied significantly from a fall to negative 0.2% in the previous plan to a decrease of negative 6.4% this year.

For his part, House Natural Resources Committee Chairman Bishop has written to the PROMESA Board to criticize it for its lack of dialogue with the creditor community, lack of sufficiently aggressive action to make structural and fiscal changes in Puerto Rico, and suggesting the Board take steps to end the local government’s separate legal representation in the Title III bankruptcy cases—an epistle which, unsurprisingly, Gov. Rosselló described as anti-democratic and colonialist. Earlier, the Governor made public his own letter to Chairman Bishop in which he had written: “Your letter is truly disturbing in its reckless disregard for collaboration and cooperation in favor of an anti-democratic process akin to a dictatorial regime imposing its will by imperial fiat and decree…I cannot and will not permit you to elevate concerns of bondholders on the mainland above concern for the well-being of my constituents.” In his epistle, the Governor made clear his view that, contrary to its claims, the PROMESA Board does not have the legal authority to “take over the role of the elected government of Puerto Rico.” He added that while the Puerto Rico government “recognizes that structural reforms are key to Puerto Rico’s future success; it does not need the Board to substitute its judgment for our own in that regard.” With regard to reducing the Title III litigation costs to Puerto Rico’s government, the Governor expressed apprehension at any effort to preempt or take away the “government’s own voice and own representation in its own restructuring process,” adding that he believes Chairman Bishop’s committee “faces a fork in the road:” It can support the process found in the Puerto Rico Oversight, Management, and Economic Stability Act, or the “other path lies obstructionist behavior that would undermine the duly elected government’s authority and legitimacy…If the committee, led by you, Mr. Chairman, persists on this ruinous path, the people of Puerto Rico and their brothers and sisters on the mainland will know who to hold accountable,” adding: “Your letter embodies everything that is wrong with this process and only serves to reinforce the dismissive and second-class colonial treatment Puerto Rico has suffered throughout its history as a territory of the United States, which undermines our efforts to address the island’s fiscal, economic, and humanitarian crises.”

Colonial Eras? Meanwhile, in the former British colonies, the aptly named King George County, Virginia, where indigenous peoples of varying cultures lived along the waterways for thousands of years before Europeans came to America, Algonquian Indians some three hundred fourteen years ago first came into conflict, when early colonists retaliated for the tribe’s attacking the farm of John Rowley, capturing and shipping 40 people, including children older than 12, to Antigua, where they were sold into slavery—paving the way for the county to be formally established in 1720, when land was split off from Richmond County, Virginia—before it was substantially reorganized in the critical year of 1776, with land swapped with both Stafford and Westmoreland Counties to form today’s political boundaries—some twenty-five years after its native son, James Madison, the nation’s fourth President, was born there. Today, the county of about 26,000, with a median family income of $49,882, is looking to pay down its debt; however, one of its primary sources of revenue is no longer available: therefore, the Board of Supervisors is working on an ambitious fiscal plan to try to reduce about 30 percent of the county’s debt over the next five years, meaning it will seek to shift some of its reserve funds in order to allocate more new funds each year to pay down its debt—an effort which one consulting firm in the state described as unique: Kyle Laux, a senior vice president of Davenport & Co., a financial counseling firm for King George, Caroline, and Spotsylvania counties, noted: “What the county administrator and board are doing is unique…and it’s unique in a really good way: It’s thinking long-term about the county.”

The effort comes after the most recent campaign, when several Board of Supervisors members campaigned on the need for King George to reduce its $113 million in accumulated debt—debt which, when current County Administrator Neiman Young came on board a little over a year ago, he described as shocking—especially that no actions had been taken to address the accumulating debt. Indeed, at a work session two months ago, Mr. Young laid out numbers that caused those listening to gasp aloud. While the county has a proverbial golden goose with the King George Landfill, it turns out that the bulk of the non-odoriferous revenues generated from the landfill is already accounted for‒for the next two decades. Indeed, even the its expansion, the landfill is expected to reach capacity in 29 years—which, in turn, means that, for the next two decades, $6.2 million of the $7.5 million the county currently receives annually from the landfill is already consumed to finance capital debt. Thus, County officials wanted to change those numbers; ergo, they asked Davenport to rustle up a fiscal plan—and, subsequently, at a recent work session, County Supervisors supported the application of some $3 million from general and capital improvement reserves to pay down capital debt, with the fiscal plan adjusted to mesh with the County’s which provide that King George must have a certain amount set aside. Thus the County is proposing to add about $1 million each year for four years from revenues. Some of that would come from additional revenues King George would receive in the wake of upcoming reassessments, with the remainder from an annual surplus. The idea is to pay down the debt in three different payments between 2019 and 2023—recognizing that because every dollar paid on the debt principal saves about 41 cents in interest, the plan would free up about $11.1 million in cash flow and pay off $6.57 million in principal, according to Mr. Laux.

However, in the world of municipal finance, little is easy. Indeed, as the Supervisors learned during the work session, the amount pulled annually from revenue sources would likely fluctuate in order to address operational needs. Thus, the Board opted to place school resource officers in two of the county’s three elementary schools; it already has officers at its middle and high schools, and is applying for a grant to place a deputy for the third elementary school. Along with other operational expenses, ergo, the county is considering the set aside of some $200,000 from FY2019 revenues, far below the $750,000 proposed—or, as Board of Supervisors Chair Richard Granger put it: “It doesn’t necessarily blow up our plan, but it’s doing something rather than nothing.” He added government debt is like a home mortgage, not a credit card.

The County’s existing debt is based on a fixed rate, and the principal is repaid annually. If supervisors opt not to go forward with plans to pay down the debt sooner, the County is scheduled to repay about half of its debt within 10 years, according to a Davenport report. However, because paying down the principal faster would free up fiscal resources, the County’s new debt reduction and mitigation plan should reduce about 30% of the county’s debt over the next five years, which equates to roughly $22 million, an amount which Administrator Young understandably described as “huge.” But Supervisor Ruby Brabo had the last word: “The landfill is going to go away, folks. We either raise your taxes 30 cents or we make sure the debt is paid off before it does.”

April 3, 2018

Good Morning! In this morning’s eBlog, we consider the challenges of governance in insolvency. Who is in charge of steering a municipality, county, or U.S. territory out of insolvency? How? How do we understand and assess the status of the ongoing quasi chapter 9 municipal bankruptcy PROMESA deliberations in the U.S. territory of Puerto Rico. Then we head north to assess the difficult fiscal balancing challenges in Connecticut.

Governance in Insolvency.  Because, in our country, it was the states which created the federal government, making the U.S. unique in the world; chapter 9 municipal bankruptcy is only, in this country, an option in states which have enacted state legislation to authorize municipal bankruptcy. Thus, unsurprisingly, the process is quite different in the minority of states which have authorized municipal bankruptcy. In some states, such as Rhode Island and Michigan, for instance, the Governor has a vital role in which she or he is granted authority to name an emergency manager–a quasi-dictator to assume governmental and fiscal authority, usurping that of the respective city or county’s elected officials. That is what happened in the cases of Detroit and Central Falls, Rhode Island, where, in each instance, all authority was stripped from the respective Mayors and Councils pending a U.S. Bankruptcy Court’s approval of respective plans of debt adjustment, allowing the respective jurisdictions to emerge from municipal bankruptcy. Thus, in the case of those two municipalities, the state law preempted the governing authority of the respective Mayors and Councils.

That was not the case, however, in Jefferson County, Alabama–a municipal bankruptcy precipitated by the state’s refusal to allow the County to raise its own taxes. Nor was it the case in the instances of Stockton or San Bernardino, California: two chapter 9 cases where the State of California played virtually no role. 

Thus, the question with regard to governance in the event of a default or municipal bankruptcy is a product of our country’s unique form of federalism.

In the case of Puerto Rico, the U.S. territory created under the Jones-Shafroth Act, however, the issue falls under Rod Sterling’s Twilight Zone–as Puerto Rico is neither a municipality, nor a state: a legal status which has perplexed Congress, and now appears to plague the author of the PROMESA law, House Natural Resources Committee Chair Rob Bishop (R-Utah) with regard to who, exactly, has governing or governance authority in Puerto Rico during its quasi-chapter 9 bankruptcy process: is it Puerto Rico’s elected Governor and legislature? Is it the PROMESA Board imposed by the U.S. Congress? Is it U.S. Judge Laura Swain, presiding over the quasi-chapter 9 bankruptcy trial in New York City? 

Chairman Bishop has defended the PROMESA’s Board’s authority to preempt the Governor and Legislature’s ruling and governance authority, stressing that the federal statute gave the Board the power to promote “structural reforms” and fiscal authority, writing to Board Chair Jose Carrion: “It has been delegated a statutory duty to order any reforms–fiscal or structural–to the government of Puerto Rico to ensure compliance with the purpose of PROMESA, as he demanded the federally named Board use its power to make a transparent assessment of the economic impact of Hurricanes Irma and Maria on Puerto Rico’s fiscal conditions–and to ensure that the relative legal priorities and liens of Puerto Rico’s public debt are respected–leaving murky whether he intended that to mean municipal bonholders and other lien holders living far away from Puerto Rico ought to have a priority over U.S. citizens of Puerto Rico still trying to recover from violent hurricanes which received far less in federal response aid than the City of Houston–even appearing to link his demands for reforms to the continuity of that more limited federal storm recovery assistance to compliance with his insistence that there be greater “accountability, goodwill, and cooperation from the government of Puerto Rico…” Indeed, it seems ironic that a key Chairman of the U.S. Congress, which has voted to create the greatest national debt in the history of the United States, would insist upon a quite different standard of accountability for Puerto Rico than for his own colleagues.

It seems that the federal appeals court, which may soon consider an appeal of Judge Swain’s opinion with regard to Puerto Rico’s Highway and Transportation Authority not to be mandated to make payments on its special revenue debt during said authority’s own insolvency, could help Puerto Rico: a positive decision would give Puerto Rico access to special revenues during the pendency of its proceedings in the quasi-chapter 9 case before Judge Swain.

Stabilizing the Ship of State. Farther north in Connecticut, progressive Democrats at the end of last week pressed in the General Assembly against Connecticut’s new fiscal stability panel, charging its recommendations shortchange key priorities, such as poorer municipalities, education and social services—even as the leaders of the Commission on Fiscal Stability and Economic Growth conceded they were limited by severe time constraints. Nevertheless, Co-Chairs Robert Patricelli and Jim Smith asserted the best way to invest in all of these priorities would be to end the cycle of state budget deficits and jump-start a lagging state economy. The co-chairs aired their perspectives at a marathon public hearing in the Hall of the House, answering questions from members of four legislative committees: Appropriations; Commerce; Finance, Revenue and Bonding; and Planning and Development—where Rep. Robyn Porter (D-New Haven) charged: “I’m only seeing sacrifice from the same people over and over again,” stating she was increasingly concerned about growing income inequality, asking: “When do we strike a balance?” Indeed, New York and Connecticut, with the wealthiest 1 percent of households in those states earning more than 40 times the average annual income of the bottom 99 percent, demonstrate the governance and fiscal challenge of that trend. In its report, the 14-member Commission made a wide array of recommendations centered on a major redistribution of state taxes—primarily reducing income tax rates across the board, while boosting the sales and corporation levies. Ironically, however, because the wealthy pay the majority of state income taxes, the proposed changes would disproportionately accrue to the benefit of the state’s highest income residents—in effect mirroring the federal tax reform, leading Rep. Porter to question why the Commission made such recommendations, including another to do away immediately with the estate tax on estates valued at more than $2 million, but gradually phase in an increase to the minimum wage over the next four years.  From a municipal perspective, Rep. James Albis (D-East Haven), cited a 2014 state tax incidence report showing that Connecticut’s heavy reliance on property taxes to fund municipal government “is incredibly regressive,” noting it has the effect of shifting a huge burden onto lower-middle- and low-income households—even as the report found that households earning less than $48,000 per year effectively pay nearly one-quarter of their annual income to cover state and local taxes. Rep. Brandon McGee (D-Hartford), the Vice Chair of the legislature’s Black and Puerto Rican Caucus, said the Committee’s recommendations lack bold ideas on how to revitalize Connecticut’s poor urban centers—with his concerns mirrored by Rep. Toni E. Walker (D-New Haven), Chair of the House Appropriations Committee, who warned she fears a commission proposal to cut $1 billion from the state’s nearly $20 billion annual operating budget would inevitably reduce municipal aid, especially to the state’s cities. Co-Chair Patricelli appeared to concur, noting: “Candidly, I would agree we came up a little short on the cities,” adding that the high property tax rates in Hartford and other urban centers hinder economic growth: “They really are fighting with one or more hands tied behind their backs.”

The ongoing discussion comes amidst the state’s fiscal commitment to assume responsibility to pay for Hartford’s general obligation debt service payments, more than $50 million annually—a fiscal commitment which understandably is creating equity questions for other municipalities in the state confronted by fiscal challenges. Like a teeter-totter, balancing fiscal needs in a state where the state itself has a ways to go to balance its own budget creates a test of fiscal and moral courage.