Addressing Municipal Fiscal Disparities

eBlog, 03/01/17

Good Morning! In this a.m.’s eBlog, we consider the dire stakes for Chicago’s kids if the State of Illinois continues to be unable to get its fiscal act together; then we admire the recent wisdom on fiscal disparities among municipalities in Massachusetts and Connecticut by the ever remarkable Bo Zhao of the Federal Reserve Bank of Boston.

Bad Fiscal Math.  Chicago Public School CEO Forrest Claypool Monday warned the public schools in the city could be forced to close nearly three weeks early and that summer school programs could be cut if the district does not receive a fast-tracked, favorable preliminary ruling from a Cook County judge in the near future, stating: “These possibilities are deeply painful to every school community.” Mr. Claypool, a former Chief of Staff to Mayor Daley, in an epistle to families with children in the city’s school system, warned the school year could end June 1st instead of June 20th without action; moreover, he noted that CPS’s summer school could be eliminated for all elementary and middle-school students, except those in special education programs, as he sought to increase pressure on Gov. Bruce Rauner and the Illinois legislature to help, warning success would depend on the courts or what has been billed as a “grand bargain” in the state capitol of Springfield to resolve Illinois’ record budget impasse. The CEO’s actions were not coordinated with Mayor Rahm Emanuel, who campaigned hard in his first term to extend the year for CPS students—a campaign in which the Mayor sought to reverse what we had termed as a “time bomb,” how to reverse the tide of an exodus of 200,000 citizens and make the city a key demographic destination for the 25-29 age group—i.e., meaning a critical commitment to public schools and safety. Now the state’s inability to act on a budget threatens both: the city’s School Board earlier this month accused the state of employing “separate and unequal systems of funding for public education in Illinois” in its lawsuit filed against both Gov. Rauner and the Illinois State Board of Education, describing its suit as the “last stand” for a cash-strapped district which is “on the brink,” seeking to have Judge Franklin Ulyses Valderrama of the Cook County Chancery Division issue a preliminary injunction which would prevent the state from “continuing to fund two separate but massively unequal systems of education,” noting it intends to present its case for an injunction to the court on Friday. In addition to seeking judicial relief, the System, in its judicial filing, noted that reductions in summer school programs and the academic year could save about $96 million; however, a shortened school year could violate Illinois state requirements with regard to the length of the public school year.

Without any doubt, the threatened disruption is undermining the trust of teachers, students, taxpayers, and parents with regard to the system’s future—brought on here by the awkward math of Gov. Rauner’s veto last December of a measure which would have provided CPS with $215 million in state aid—a measure the Governor argued was contingent on Democratic leaders agreeing to broader state public pension reforms. The ante was upped further at the beginning of the week, when Illinois Secretary of Education Beth Purvis said that instead of threatening cuts to the school year, CPS should focus on pushing legislation to overhaul the state’s education funding formula, stating: “I hope that they would really look seriously at not cutting days from the school year…I think people need to understand that the CPS board adopted a budget with a $215 million hole in it. Why is the governor being held responsible for that instead of the CPS board?” Even as the city sought to pressure the state, however, the Chicago Teachers Union this week issued a statement accusing Mayor Emanuel and the school board of playing politics instead of turning to solutions to help schools such as raising taxes, with union President Karen Lewis stating: “The Mayor is behaving as if he has zero solutions is incredibly irresponsible…Rahm wants us to let him off the hook for under-funding our schools and instead wait for the Bad Bargain to pass the Senate or [Gov.] Rauner’s cold, cold heart to melt and provide fair funds.” For those kids imagining an earlier summer break, CEO Claypool would not say when the district would make a final decision to shorten the school year, noting: “We think it would be wrong to prematurely set a final date for a decision when we still have the opportunity to prevent a shorter school year.”

Revenue Sharing. Bo Zhao, the extraordinary writer for the Boston Federal Reserve who authored the very fine piece: “Walking a Tightrope: Are U.S. State and Local Governments on A Fiscally Sustainable Path?” has now completed another piercing study regarding municipal fiscal disparities: “From Urban Core to Wealthy Towns,” looking at fiscal disparities amongst municipalities in Connecticut, and comparing state policies and practices there with Massachusetts, noting: “Fiscal disparities occur when economic resources and public service needs are not evenly distributed across localities. There are equity concerns associated with fiscal disparities. Using a cost-capacity gap framework and a newly assembled data set, this article is the first study to quantify non-school fiscal disparities across Connecticut municipalities. It finds significant non-school fiscal disparities, driven primarily by the uneven distribution of the property tax base while cost differentials also play an important role. State non-school grants are found to have a relatively small effect in offsetting municipal fiscal disparities.

Unlike previous research focused on a single state, this article also conducts a cross-state comparison. It finds that non-school fiscal disparities in Connecticut are more severe than those in Massachusetts, and non-school grants in Connecticut are less equalizing than those in Massachusetts. This article’s conceptual framework and empirical approach are generalizable to other states and other countries.” Writing that his is the first article to quantify non-school fiscal disparities across the Nutmeg State, he notes they are “driven primarily by the uneven distribution of the property tax base, while cost differentials also play an important role,” as he assesses fiscal disparities amongst the state’s 169 municipalities, writing: “There is recent evidence that this longtime state neglect may have exacerbated non-school fiscal disparities…If state aid formulae are based only on local revenue raising-capacity and ignore cost disparities, they would not fully offset fiscal disparities.” This leads him to note: “Urban core municipalities exhibit the highest average per capita cost, mainly because they have the highest unemployment rate and population density, and the most jobs per capita…This means that nearly one-fifth of Connecticut residents live in the highest cost environments.” In contrast, he notes that “wealthier-property rural towns have the lowest average per capita municipal cost—more than 25 percent lower than the urban core municipal cost.” A key part of the fiscal challenge, he writes, is that in the state, the property tax is the only “tax vehicle authorized for municipal governments and virtually the only own-source revenue available to support the local general fund,” adding that the property tax makes up some 94 percent of own source general fund revenue. All of which led Mr. Zhao to assess or measure what he defines as the “Municipal Gap,” or the difference between municipal cost versus municipal capacity: a measure which he finds demonstrates that “a significant share of Connecticut municipalities and populations face municipal gaps”…with urban core municipalities confronting a gap of as much as $1,000 per capita.

Turning to the state role in addressing fiscal disparities, he notes that non-school grants in the state “do not have an explicit equalization goal.” Such grants are broadly spread, and not “well targeted to fiscally disadvantaged municipalities,” indeed, describing the gap as “very wide,” and noting that a comparison with neighboring Massachusetts would better enable Connecticut law and policy makers to better understand the “relative severity of Connecticut municipal fiscal disparities.” While noting that unlike many other states, neither of these two New England states have active county governments, so that municipalities bear much greater responsibilities for a wide range of public services—and property taxes are almost their sole source of municipal revenues, he distinguishes Connecticut’s greater municipal fiscal disparities in that it has a larger share of its population living in what he terms “smallest-gap” municipalities. Finally, he distinguishes the respective state roles by noting that Massachusetts has a “more explicit equalization goal and its main distribution formula directly considers the differences across municipalities in revenue-raising capacity.”

The Fiscal, Balancing Challenges of Federalism

eBlog, 2/16/17

Good Morning! In this a.m.’s eBlog, we consider the fiscal, balancing challenges of federalism, as Connecticut Governor Daniel Malloy’s proposed budget goes to the state legislature; then we return to the small municipality of Petersburg, Virginia—the insolvent city which now confronts not just fiscal issues, but, increasingly, trust issues—including how an insolvent city should bear the costs of litigation against its current and former mayor—including their respective ethical governing responsibilities. Finally, we seek the warming waters of the Caribbean to witness a fiscal electrical storm—all while wishing readers to think about the President who would never tell a lie…

The Challenge of Revenue Sharing—or Passing the Buck? S&P Global Ratings yesterday warned that Connecticut Governor Daniel Malloy’s proposed budget could negatively affect smaller towns while benefiting the cities, noting that from a municipal credit perspective, “S&P Global Ratings believes that communities lacking the reserves or budgetary flexibility to cushion outsized budget gaps will feel the greatest effects of the proposed budget.” S&P, as an example, cited Groton, a town of under 30,000, which has an AA+ credit rating, which could find its $12.1 million reserve balance depleted by a proposed $8.2 million reduction in state aid and a $3.9 million increase to its public pension obligations. Meanwhile, state capitol Hartford, once the richest city in the United States, today is one of the poorest cities in the nation with 3 out of every 10 families living below the poverty line—which is to write that 83% of Hartford’s jobs are filled by commuters from neighboring towns who earn over $80,000, while 75% of Hartford residents who commute to work in other towns earn just $40,000. Thus, under Gov. Rowland’s proposed budget, Hartford would receive sufficient state aid under the Governor’s proposal to likely erase its projected FY2018 nearly $41 million fiscal year 2018 budget gap, according to S&P, leading the rating agency to find that shifting of costs from the state to municipal governments would be a credit positive for Connecticut, but credit negative for many of the affected towns: “Those [municipal] governments lacking the budgetary flexibility to make revenue and expenditure adjustments will be the most vulnerable to immediate downgrades.” With the Connecticut legislature expected to act by the end of April, S&P noted that the state itself—caught between fixed costs and declining revenues, will confront both Gov. Malloy and the legislature with hard choices, or, as S&P analyst David Hitchcock put it: “Bringing the [budget] into balance will involve painful adjustments,” especially as the state is seeking to close a projected $1.7 billion annual deficit. Thus, S&P calculated that general fund debt service, pension, and other OPEB payments will amount to just under 30 percent of revised forecast revenues plus proposed revenue enhancements for FY2018, assuming the legislature agrees to Gov. Malloy’s plan to “share” some one-third, or about $408 million of annual employer teacher pension contributions with cities and towns, effectively reducing state contributions.

As Mr. Hitchcock penned: “Rising state pension and other post-employment benefit payments are colliding with weak revenue growth because of poor economic performance in the state’s financial sector…Although other states are also reporting weak revenue growth and rising pension costs, Connecticut remains especially vulnerable to an unexpected economic downturn due to its particularly volatile revenue structure.” Unsurprisingly, especially given the perfect party split in the state Senate and near balance in the House, acting on the budget promises a heavy lift to confront accumulated debt: Deputy Senate Republican Majority Leader Scott Frantz (R-Greenwich) said the state’s—whose state motto is Qui transtulit sustinet (He who transplanted sustains)—financial struggles have been predictable for more than a decade, “with a completely unsustainable rate of growth in spending on structural costs and far too much borrowing that further adds to the state’s fixed costs, especially as interest rates rise….” adding: “The proposed budget is an admission that the state can no longer afford to pay for many of its obligations and will rely on the municipalities to pick up the slack, which means that local property tax rates will rise.” The Governor’s proposals to modify the state’s school-aid formula could, according to Mr. Hitchcock, be a means by which Connecticut could comply with state Superior Court Judge Thomas Moukawsher’s order for the state to revise its revenue sharing formula to better assist its poorest municipalities: “It could benefit poor cities at the expense of the rich and lower overall local aid;” however, he added that “[c]ombined with other local aid cuts, municipalities’ credit quality could be subject to greater uncertainty.” With regard to Governor Malloy’s proposed pension obligation “sharing,” our esteemed colleagues at Municipal Market Analytics described the shift in teacher pension costs to be “a more positive credit development for the state,” notwithstanding what MMA described as “quite high” challenges. Under the proposal, the municipalities of Hartford and Waterbury would receive about $40 million apiece in incremental aid, while 145 municipalities would lose aid after the netting of pension costs. Several middle-class towns, according to MMA’s analysis, could realize reductions in pension aid of more than $10 million—some of which might be offset by the Governor’s proposal to permit towns to begin assessing property taxes on hospitals, which in turn would be eligible for some state reimbursement.

Hear Ye—or Hear Ye Not. Petersburg residents who say their elected leaders are to blame for the historic city’s fiscal challenges and insolvency yesterday withdrew their efforts to oust Mayor Samuel Parham and Councilman W. Howard Myers (and former mayor) from office in court over procedural issues, notwithstanding that good-government advocates had collected the requisite number of signatures to lodge their complaints against the duo. An attorney representing the pair testified before Petersburg Circuit Court Judge Joseph Teefey that the cover letters accompanying those petitions were drafted after the signatures were gathered. Thus, according to the attorney, even if the petition signers knew why they were endorsing efforts to unseat the elected officials, they were not aware of the specific reasoning later presented to the court.

Not unsurprisingly, Barb Rudolph, a citizen activist who had helped spearhead the attempt, said she felt discouraged but not defeated, noting: “We began collecting these signatures last March, and in all that time we’ve been trying to learn about this process…We will take the information we have learned today and use that to increase our chances of success moving forward.” The petition cited “neglect of duty, misuse of office, or incompetence in the performance of duties,” charging the two elected officials for failing to heed warnings of Petersburg’s impending fiscal insolvency; they alleged ethical breaches and violations of open government law.

But now a different fiscal and ethical challenge for the insolvent municipality ensues: who will foot the tab? Last week the Council had voted to suspend its own rules, so that members could consider whether Petersburg’s taxpayers should pick up the cost of the litigation, with the Council voting 5-2 to have the city’s taxpayers foot the tab for Sands Anderson lawyer James E. Cornwell Jr., who had previously, successfully defended elected officials against similar suits. Unsurprisingly, the current and former Mayor—with neither offering to recuse himself—voted in favor of the measure. Even that vote, it appears, was only taken in the wake of a residents’ questions about whether Council had voted to approve hiring a lawyer for the case.

A Day Late & a Dollar Short? Mayor Parham and Councilmember Myers signed a written statement acknowledging their interest in the vote with the city clerk’s office the following day. The Mayor in a subsequent interview, claimed that the attorney hired by the city told him after that vote that the action was legal and supported by an opinion issued by the Virginia Attorney General’s Office, noting: “Who would want to run for elected office if they knew they could bear the full cost of going to court over actions they took?” To date, the two elected officials have not disclosed the contract or specific terms within it detailing what the pair’s litigation has cost the city budget and the city’s taxpayers. Nor has there been a full disclosure in response to Petersburg Commonwealth’s Attorney Cassandra Conover’s determination last week with regard to whether the Mayor and former Mayor’s votes to have Petersburg’s taxpayers cover their legal fees presented a conflict of interest.

Electric Storm in Puerto Rico. Yesterday, Puerto Rico Governor Ricardo Rosselló stated that the reorganization of the Puerto Rico Electric Power Authority (PREPA) Governing Board’s composition and member benefits will not affect the fiscal recovery process that is currently underway, noting: “I remind you that we announced a week or week and a half ago that we had reached an agreement with the bondholders to extend and reevaluate the Restructuring Support Agreement (RSA) terms. Everything is on the table,” referring to the extension for which he had secured municipal bondholders’ approval—until March 31. His statement came in the wake of the Puerto Rican House of Representatives Monday voting to approve a bill altering the Board’s composition and member benefits—despite PREPA Executive Director Javier Quintana’s warning that the governance model should remain unaltered, since its structure was designed to comply with their creditors’ demands. However, Gov. Rosselló argued that, according to PROMESA, the Governor of Puerto Rico and his administration are the ones responsible for executing plans and public policies: “Therefore, the Governor and the Executive branch should feel confident that the Board and the executive directors will in fact execute our administration’s strategies and public policies. We believe we should have the power to appoint people who will carry out the changes proposed by this administration.” The Governor emphasized: “We have taken steps to have a Board that responds not to the Governor or partisan interests, but to the strategy outlined by this administration, which was validated by the Puerto Rican people.”

Indeed, at the beginning of the week, the Puerto Rican government had approved what will be the Board’s new composition, which would include the executive director of the Fiscal Agency and Financial Advisory Authority (FAFAA), the Secretary of the Department of Economic Development and Commerce, and the executive director of the Public-Private Partnerships Authority among its members: “We campaigned with a platform, the people of Puerto Rico validated it, and the Oversight Board expects all of these entities to respond to what will be a larger plan,” he insisted. Gov. Rosselló added that adjustments are essential, due to the Government’s current fiscal situation, specifically referring to the compensation paid to the members of the Board, which can reach $60,000. If this measure becomes law, the compensation would be limited to an allowance of no more than $200 per day for regular or special sessions. (The measure, pending the Senate’s approval, would establish that no member may receive more than $30,000 per year in diet allowances.) Currently, the Governing Board’s annual expenses—including salaries and other benefits—are approximately $995,000 per year. Meanwhile, PREPA has a debt of almost $9 billion, including a $700-million credit line to purchase fuel and no access to the capital markets.

States & Municipal Accountality

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eBlog, 2/06/17

Good Morning! In this a.m.’s eBlog, we consider the new municipal accountability system proposed by Connecticut Gov. Daniel Malloy to create a new governance mechanism which could trigger early state intervention, then we head west to consider whether Detroit voters will re-elect Mayor Mike Duggan to a second term.  

Municipal Accountability, or “Preventing a Train Wreck.” Connecticut Governor Daniel P. Malloy, noting that “Our towns and cities are the foundation of a strong and prosperous state,” said: “Healthy, vibrant communities—and thriving urban centers in particular—are essential for our success in this global economy…In order to have vibrant downtowns, retain and grow jobs, and attract new businesses, we need to make sure all of our municipalities are on solid fiscal ground or on the path to fiscal health.” Ergo, the Governor has proposed a new municipal accountability system intended and designed to provide early intervention for the Nutmeg State’s cities and towns before they slip into severe fiscal trouble—a signal contrast to, for instance, New Jersey—where, as we have noted, such intervention is after the fact; Alabama, where the state not just refused to act, but actually facilitated Jefferson County’s chapter 9 municipal bankruptcy by barring the city from raising its own revenues; California, where the state has absented itself from playing any role in responding to municipal bankruptcy or fiscal distress—and Michigan, where the state acts early to intervene through the appointment of Emergency Managers—albeit such intervention has, as we have observed in the instances of the City of Flint and the Detroit Public Schools contributed to not just worsening the fiscal crises, but also endangered human lives—especially of young children and their futures.

Gov. Malloy’s proposal would create:

  • a four-tier ranking for municipalities in fiscal or budgetary distress,
  • an enhanced state evaluation of local fiscal issues, and
  • a limit on annual property tax increases for cities and towns deemed at greatest risk of fiscal insolvency.

Currently, Connecticut’s chief budget and policy planning agency, the Office of Policy and Management, routinely reviews annual audits for all municipalities. Under Gov. Malloy’s new proposal, which will be outlined in greater detail the day after tomorrow in Gov. Malloy’s new state biennial budget plan, OPM and a new state review board will have added responsibilities to review local bond ratings, budget fund balances, mill rates, and state aid levels—all with a goal of creating a new, four-tiered municipal fiscal early warning system focused on the identification of municipalities confronting fiscal issues well before their problems approach the level of insolvency. Under his proposal, Connecticut cities and towns with the most severe challenges and risks would be assigned to a higher tier—a tier in which there would be increased state focus and, if the system works, greater state-local collaboration. As proposed, a municipality might be assigned to one of the first three tiers if it has a poor fund balance or credit rating, or if it relies on state aid for more than 30 percent of its revenue needs. In such tiers, the state’s cities and towns would face additional reporting requirements. Moreover, cities and towns in Tiers 2 and 3 would be barred from increasing local property tax rates by more than 3 percent per year. For cities and towns in the lowest fiscal category, the fourth tier, the state would also impose a property tax cap. For these municipalities, the state review board could:

  • Intervene to refinance and otherwise restructure local debt;
  • Serve as an arbitration board in labor matters;
  • Approve local budgets;
  • And appoint a manager to oversee municipal government operations.

The system proposes some flexibility: for instance, a municipality would be assigned to a lowest tier, Tier 4, only if it so requested from the state, or if two-thirds of the new state review board deemed such a ranking necessary, according to Governor Malloy—who estimated that about 20 to 25 of the state’s 188 municipalities might be assigned any tier ranking under his proposal, who described those municipalities which might act to seek to work more closely with the state as ones confronted by “pockets of poverty.”

In response, Connecticut Conference of Municipalities Executive Director Joe DeLong said the Connecticut municipal association appreciated the Governor’s efforts to foster dialogue and had “no issue” with his proposals, but said they should be accompanied by other changes, noting: “The overreliance on property taxes, especially in urban areas where most of the property is tax exempt continues to be a recipe for disaster…Oversight without the necessary structural changes, only insures that we will recognize an impending train wreck more quickly. It does not prevent the wreck.”

This Is His City. Detroit Mayor Mike Duggan this weekend vowed to “fight the irrational closing” of a number of public schools in the city, as he initiated his re-election campaign—and, mayhap, cast a swipe at President Trump’s Education Secretary cabinet choice. Making clear that he would not be running what he termed a “victory lap campaign,” he vowed he would seek to change the recovering city’s focus towards “creating a city where people want to raise their families,” vowing to work hand-in-hand with the Detroit Public Schools Community District School Board in the wake of the Michigan School Reform Office’s recent decision to close low-performing public schools in Detroit and another elsewhere in the state—a state action which could shutter as many as 24 of 119 city schools at the end of this academic year, and another 25 next year if they remain among the state’s lowest performers for another year, based on state rankings released this month which mark consistently failing schools for closure. Mayor Duggan added that he had called Gov. Rick Snyder at the end of last week to tell him the closure is “wrong” and that the school reform office efforts are “immoral, reckless…you have to step in.” Mayor Duggan noted that “[R]eform means first you work with the teachers in the school to raise that performance at that school; second you don’t close the school until you’ve created a quality alternative…Neither one of those has happened here.” The Mayor met yesterday with the school board leadership, and has noted that Gov. Snyder had originally taken the position that closure of the city’s schools would create a legal issue, adding: “You do not have a legal right to have no schools when the children have no reasonable alternative nearby…I’m going to be working with the Detroit public schools…We want to start by sitting down together with the Governor and coming up with a solution. That’s going to be the first order of business.”

Detroit Public Schools Community District School Interim Superintendent Alycia Meriweather thanked Mayor Duggan over the weekend, saying: “As stated multiple times, we do not agree with the methodology, or the approach the (state school reform office) is using to determine school closures, and we are cognizant of the fact that all of the data collected is entirely from the years the district was under emergency management…Closing schools creates a hardship for students in numerous areas including transportation, safety, and the provision of wrap around services…As a new district, we are virtually debt free, with a locally elected board; we deserve the right to build on this foundation and work with our parents, educators, administrators, and the entire community to improve outcomes for all of our children.”

Ms. Ivy Bailey, the President of the Detroit Federation of Teachers, which represents about 3,000 city educators, noted: “The bottom line is this is his city…We don’t want the schools to close.” Ms. Bailey said the newly elected school board had just taken office and needs to be given an opportunity “to turn things around.” A representative for Gov. Snyder could not be immediately reached Saturday, nor could Detroit School Board President Iris Taylor.

Last week, Mayor Duggan picked up petitions to run for re-election, joining 14 others, according to records provided by the city’s Department of Elections. None of the prospective candidates have turned in signatures yet for certification. The filing deadline is April 25. The primary is August 8. The Mayor, when asked who his biggest competition is in the race, said only: “[T]his is Detroit, there’s always an opponent.” “There will be a campaign,” he said. “This is Detroit.”

Mayor Duggan comes at his re-election campaign to be the city’s first post chapter 9 leader after being schooled himself in hard knocks: in his first campaign, he had been knocked off the ballot when it was determined he had failed to meet the city’s one year residency requirement; ergo, he had run as a write-in candidate, and, clearly, run effectively: he received 45 percent of the vote in the primary, and had then earned 55 percent of the vote to become the Motor City’s first post-municipal bankruptcy Mayor. Thus, in his re-election effort, he has been able to point to milestones from his first term, including:

  • the installation of 65,000 new LED street lights,
  • improved police and EMS response times,
  • new city buses as well as added and expanded routes,
  • the launch of the Detroit Promise, a program to provide two years of free college to graduates of any city high school,
  • several major automotive manufacturing centers and suppliers,
  • and a new Little Caesars Arena which will be the future home of the Detroit Red Wings and Detroit Pistons,
  • The relocation by Microsoft (announced Friday) to downtown Detroit in the One Campus Martius building early next year,
  • The results, to date, of the city’s massive blight demolition program—a program which has led to the razing of nearly 11,000 houses, primarily with federal funding, since 2014 (albeit a program which has been the subject of a federal criminal investigation and other state, federal and local reviews after concerns were raised in the fall of 2015 over soaring costs and bidding practices.) Officials with the city and Detroit Land Bank Authority, which oversees the program, have defended the effort, and, last week, Mayor Duggan said an ongoing state review of the program’s billing practices turned up $7.3 million in what the state contends are improper costs. Ergo, Detroit will pay back $1.3 million of that total, but the remaining $6 million—mainly tied to a controversial set-price pilot in 2014—will go to arbitration.

Governing Challenges of Federalism & Severe Fiscal Distress

eBlog, 1/20/17

Good Morning! In this a.m.’s eBlog, we consider the deteriorating municipal fiscal conditions in Connecticut’s central cities, a new twist in New Jersey’s usurpation of municipal governance in Atlantic City, and the ongoing challenges in Puerto Rico where the PROMESA Board has provided new Governor Ricardo Rosselló Nevares additional time to submit a new fiscal plan—albeit a plan potentially complicated by a court ruling, as well as uncertainty with regard to potential changes in direction from Washington where, later this morning, a new Trump Administration takes the reins of power in Washington, D.C.  

Can Connecticut Help to Avert Municipal Bankruptcies? Gov. Daniel Malloy, in his State of the State address this month, stated he wanted to “ensure that no Connecticut city or town will need to explore the avoidable path of [municipal] bankruptcy,” indicating he would be working on an initiative involving statewide restructuring of local aid, especially for schools. His remarks seemed to parallel a new report, “Connecticut’s Broken Cities,” by Stephen Eide of the Manhattan Institute, in which he wrote: “State government is almost certainly going to have to get involved in the case of Hartford…Hartford may need a bailout to restore solvency.” However, the new report also examined the fiscal challenge of three other of the state’s central cities: Bridgeport, New Haven, and Waterbury—cities confronted by nearly $5 billion in OPEB and public pension obligations, estimating their combined annual OPEB liabilities at $120 million, and their unfunded pension liability to be $2.7 billion. The report paints a fiscal picture of municipalities which have the highest property taxes in the state—and the highest per capita municipal debt. Indeed, the rating agencies awarded Hartford two four-notch downgrades last year: Moody’s reduced the city’s rating to junk-level, putting it in the lowest one percent credit rating of all municipalities—even as it cited the city as at risk of further downgrades “over the medium term,” with its analysts noting that: “For the time being, Waterbury, and Bridgeport, and most likely also New Haven, can continue to muddle through without the need for extraordinary support from the state…[but] the same cannot be said for Hartford.” Hartford faces a $48 million gap on a $270 million budget, notwithstanding the steep budget cuts and layoffs the city undertook last year. The city appears to be on the wrong fiscal end of a teeter-totter: its reserves sagged 34% from FY2006 to FY2015; while its debt per capita escalated 78% over the same period, according to the report. Or, as Mayor Luke Bronin describes it: “The city used every trick up its sleeve to try to keep the lights on…I think all of those were mistakes, but in a big sense they’re a symptom of the problem, not the problem itself.” Gov. Malloy attributes the city’s property tax as the key fiscal contributor, whilst Mayor Bronin, the Governor’s former Chief Counsel, has pressed, as we have previously noted, for a regional solution—one that might, for instance, mirror some of the innovative fiscal, regional efforts in the St. Paul-Minneapolis and Denver metro areas. Mayor Bronin believes that a municipal fiscal partnership could include shared services or revising state formulas for education and health funding—a proposal that in some ways fits Connecticut Superior Court Judge Thomas Moukawsher’s order last fall directing the state to revise its state aid to education formula to better serve students in low-income municipalities—an order which Connecticut Attorney General George Jepsen is currently appealing. For his part, Gov. Malloy said a fairer distribution of Connecticut’s state aid to local governments could provide an important lifeline to avert chapter 9 bankruptcies—but that any such aid would mean the state would “play a more active role in helping less-affluent communities – in helping higher-taxed communities – part of that role will be holding local political leadership and stakeholders to substantially higher standards and greater accountability than they’ve been held to in the past: We should do it so that increased aid doesn’t simply mean more spending on local government.”

A Bridge to Local Experience. The New Jersey Department of Community Affairs has hired Atlantic City business administrator Jason Holt to assist in its state takeover of the distressed city, in this case adding a key individual who has worked under Mayor Donald Guardian for the last two years: Mr. Holt is charged with assisting the Department’s Division of Local Government Services in taking on the virtually insolvent city’s fiscal. He seems very well equipped, having served previously as Mayor Guardian’s solicitor, before serving as the city’s business administrator. Indeed, Mayor Guardian yesterday noted: “Over the past three years, Jason Holt has been an integral part of my team…When I originally selected him as my solicitor and then as my business administrator, I did so because of his extreme intellect and professionalism. Obviously, the State sees the same thing in Mr. Holt.” The transition is likely enhanced, because Mr. Holt has worked closely over the last two months with Local Government Services Director Tim Cunningham and Jeffrey Chiesa, the state’s designee in charge of Atlantic City financial matters. Department of Community Affairs spokesperson Lisa Ryan noted: “Mr. Holt’s hire by DLGS formalizes the work he has been doing in practice for the last two months…Mr. Holt will leave the City’s business administrator position, although the work he will do for DLGS will largely be the same as what he is doing now.” She added that Mr. Holt will continue working out of City Hall with his official first day with the DLGS set for next Monday. The state decision, however, has not been met with uniform approval: Assemblyman Chris Brown (R-Atlantic), who has been critical of the state for not producing its own fiscal recovery plan after rejecting the city’s, noted the lack of state transparency: “Without a transparent plan, even if they laid all the state’s experts end to end, they’d still never reach a solution.” In contrast, Mayor Don Guardian, who, in a statement said Mr. Holt has been an integral part of his team, added: “When I originally selected him as my solicitor, and then again as my business administrator, I did so because of his extreme intellect and professionalism. Obviously, the state sees the same thing in Mr. Holt…I look forward to working with him in his new capacity.” Indeed, Mr. Holt brings considerable experience, having previously served as corporation counsel for East Orange, Essex County, where, he provided legal counsel to both the Mayor and City Council, oversaw the complete spectrum of that city’s legal affairs, and played a key role in revamping its public-safety initiatives.

Is There Promise in PROMESA? Just as Puerto Rico enters its 12th year of economic depression, the PROMESA Oversight Board has informed new Governor Ricardo Rosselló Nevares that the Board is willing to grant additional time for the submission of a new fiscal plan—provided the Governor is willing to lay off public employees, reduce the pensions of thousands of retirees, make budget cuts for the University of Puerto Rico and Mi Salud, and extract an additional $1.5 billion from the pockets of corporations and individuals. In addition, the Board indicated it would be willing to extend the stay on litigation provided by PROMESA until May 1st, if Gov. Rosselló Nevares’s administration presents a plan to renegotiate Puerto Rico’ public debt. According to the calculations provided by the Board, this could mean an adjustment of $3 billion to the debt service, with the proposals gleaned from a 14-page letter, which appeared to be a warning to the new Governor that he must balance the budget in the next two fiscal years, and that the proposals for adjustments in public expenditures are “prerequisites” for the Board to certify any plan submitted. In response, Puerto Rico’s representative to the Board, Elías Sánchez Sifonte, immediately stated that Gov. Rosselló Nevares’s administration will seek to meet the Board’s conditions. He also assured that there are other mechanisms to balance the budget and close the fiscal gap—a gap the Oversight Board estimates at nearly $7.6 billion. In its letter, the Board advised the new Governor that his team could submit a new fiscal plan by the end of February, and that the document should be approved by March 15th—all subject to the Governor agreeing to balance the budget with a “one and done” approach, with “no discussion or consideration of short-term liquidity loans or near-term financings,” despite the contention by Gov. Rosselló Nevares and his team that such financing are a prerequisite in order to avoid a government shutdown. The stiff challenges, which the new Governor’s administration agreed were not so different from its own preliminary forecasts, were, nevertheless, perceived as “dramatic,” albeit key to avoid “the total collapse” of the government, blaming the previous Gov. Alejandro García Padilla’s administration’s “unwillingness to cooperate, [and] wasting time in presenting a fiscal plan that did not meet the requirements.”

The Board’s orders will affect not only Puerto Rico’s public employees, government pensioners, and foreign corporations and their tax liabilities, but also holders of Puerto Rican municipal bonds: those bondholders, in every state, could realize a reduction of as much as 80% of the annual payments that Puerto Rico must make—through different issuers—over the next two years. Sacrifices, it appears, will be widespread: the Board also proposed that Gov. Rosselló cut 23% in payroll expenses (about $900 million), which would imply a reduction in the number of public sector employees, an indicator that is already at a historical low; reduced public pensions by 10 percent—in a “progressive manner,” eliminated 100 percent of the subsidies to municipalities (about $400 million), which would be offset by a revision to property taxes, and higher payments by beneficiaries of Puerto Rico’s healthcare plan, all as part of Board recommendations that could, if implemented, save the U.S. territory as much as $1 billion. The Board added it believed the University of Puerto Rico could cut $300 million (27%) from its budget if it hiked tuitions. if it increased the amount of services among students and faculty members, raised the tuition to those who could afford it, and promoted the arrival of international and continental students to take courses in the institution.

The Board noted that to close Puerto Rico’s budget gap, Gov. Rosselló Nevares’s administration would have to meet with Puerto Rico’s municipal bondholders to make voluntary debt renegotiations through Title VI of PROMESA; albeit negotiations with the creditors would not necessarily take place in good terms: according to the numbers the Board released yesterday, the series of cutbacks and changes in the government would, on their own, be insufficient; ergo bondholders—including thousands of Puerto Rican individuals—will have to accept a cut in the debt service, which could amount to $3 billion.

But Here Come da Judge. Yet even as the PROMESA Board and the new Governor were seeking to come to terms with steps critical to fiscal recovery, the third branch of government stepped into the fiscal fray when U.S. District Judge Francisco Besosa handed a victory to holders of Puerto Rico Employment Retirement System (ERS) bonds, marking one of municipal bondholders’ first legal victories since Puerto Rico began defaulting on municipal bond interest payments about a year ago. Judge Besosa has ordered ERS to shift incoming employers’ contributions from its operating account to a segregated account at Banco Popular de Puerto Rico, directing that such funds remain in the segregated account until all parties agree on a different approach or the court orders the money to be moved out of the account. ERS had $3.1 billion in municipal bond debt outstanding as of July 2, 2016, according to the Puerto Rico government—none of it insured; all of it taxable. Normally, Puerto Rico government employers make employer contributions to support the payment of senior pension funding bonds; last year, as part of Puerto Rico’s emergency order 2016-31 in which it declared the ERS was in an emergency, the obligation of the ERS to transfer employer contributions to the bond trustee was suspended. Last November, Judge Besosa ruled against the plaintiffs in the case concerning the ERS bonds. Simultaneously, he had ruled against several other bondholder plaintiffs in other cases—leading some of the municipal bondholders to appeal to the United States Court of Appeals for the First Circuit—which, last week, generally concurred with Judge Besosa’s opinion (see Peaje Investments, LLC v. Alejandro Garcia-Padilla et al, 4th U.S. Court of Appeals, #16-2431, January 11, 2017), affirming the continued stay on bondholder litigation stemming from the Puerto Rico Oversight, Management, and Economic Stability Act in several cases, albeit ordering Judge Besosa to hold a hearing for the arguments of the lead plaintiff, Altair Global Credit Opportunities Fund, and its co-plaintiffs, with the court writing: “We note that the Altair movants’ request for adequate protection here appears to be quite modest. They ask only that the employer contributions collected during the PROMESA stay be placed ‘in an account established for the benefit of movants.’ In light of ERS’s representation that it is not currently spending the funds, but instead simply holding them in an operating account, this solution seems to be a sensible one.” Thus, this week, Judge Besosa ordered such a segregated account to be set up and that all funds not transferred since the start of the PROMESA litigation stay be deposited in the account within five business days; Judge Besosa also ordered that in the future the ERS should transfer the employer contributions to the segregated account no later than the end of each month, noting that the segregated account will be “for the benefit of the holders of the ERS bonds,” adding, moreover, that said funds will simply sit in the account until a court orders otherwise, although he noted it would not preclude the ERS from transferring the employer contributions to the bond trustee for payment of the bonds, as would normally be the case.

TheExceptional Governing Challenges on Roads to Fiscal Recovery

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eBlog, 12/02/16

Good Morning! In this a.m.’s eBlog, we consider the hard role to recovery not just from San Bernardino’s longest-ever municipal bankruptcy, but also the savage terrorist attack a year ago. Then we venture East to observe the evolving state role in New Jersey’s takeover of Atlantic City, where the new designee named by Gov. Chris Christie, Jeffrey Chiesa, yesterday introduced himself to residents and taxpayers, but offered little guidance about exactly how he will usurp the roles of the Mayor and City Council in governing and trying to get the famed boardwalk city out of insolvency and back to fiscal stability. Finally, we look north to the metropolitan Hartford, Connecticut region, where the municipalities in the region are seeking to work out fiscal mechanisms to address Hartford’s potential municipal bankruptcy in order to ensure no disruption of metropolitan water and sewer services—a different, but in this case critical element of a “sharing economy.”  

The Jagged Road to Chapter 9 Recovery. It was one year ago today that terrorists struck in San Bernardino—the city in chapter 9 municipal bankruptcy longer than any other city in U.S. history, marking, then, a day of 14 deaths—with victims caught in the crossfire of gun shots and carnage in the wake of the wanton attack by Syed Rizwan Farook and Tashfeen Malik—and a horror still not over, as it will be another nine months before the trial against Enrique Marquez Jr., who has been charged with buying some of the weapons which were used in the attack, commences in September—months after the beleaguered city anticipates exiting from bankruptcy. Because the shootings took place at a San Bernardino County facility in San Bernardino, the long-term recovery has been further complicated from a governance perspective: many of the shooting survivors are accusing San Bernardino County of cutting off much-needed support for the survivors of the attack, including refusing to approve counseling or antidepressant medication. Others, who were physically wounded are seeking, so far unsuccessfully, to get surgeries and physical therapy covered. The San Bernardino County Board of Supervisors earlier this week convened a closed-door session at which survivors said they felt betrayed and abandoned, left to deal with California’s complicated workers’ compensation program without guidance or help. Their health insurers will not cover their injuries because they occurred in a workplace attack. Congressman Pete Aguilar (D-Ca.), whose district includes San Bernardino, reports that his hometown had been added to a list of cities with which people are familiar for a terrible reason, such as Littleton, Colo., or Newtown, Conn. Nevertheless, he is defiant, insisting “We will not be defined by this tragedy.”

However, murder rates in the city have been climbing: the city of just over 200,000 is grappling with a spike in violent crime, homicides especially: to date, this year, the city has reported 49 killings, already more than last year’s total, which included the terrorist victims—its homicide rate tops that of Chicago, which has become the poster child for big-city violent crime and is on pace for more than 600 killings this year. San Bernardino Police Chief Jarrod Burguan, however, said the crime wave is not unique to the chapter 9 municipality—a currently bankrupt city where empty storefronts and pawn shops have long lined downtown streets. Nevertheless, Brian Levin, a criminal justice professor at California State University, San Bernardino, who studies hate crimes, yesterday noted: “we’re a better community now, even though we’re hurt.” Professor Levin is one who, in the days and weeks which ensued after the mass tragedy, met with faith leaders, law enforcement, and families of the victims—where he discovered a unity of shock and shared pain. Today, he notes: “The attack will always be a part of our history…But here’s the thing: so will the heroics of those police officers and first responders and medical staff, and so will the grace of the families. We’re writing the rest of the history. The bastards lost.” Now the city awaits early next year for emerging not just from the physical tragedy, but also the longest chapter 9 municipal bankruptcy ever.  

Atlantic City Blues.  Jeffrey Chiesa, a former New Jersey Attorney General, U.S. Senator, and, now, Governor Chris Christie’s designee to run the state takeover of Atlantic City, yesterday introduced himself at a City Council meeting and took questions from city taxpayers and residents. He provided, however, in this first public meeting no details on plans to address either the city’s fiscal plight—or its interim governance. He reported the State of New Jersey does not yet have a plan to address the city’s $100 million budget hole, much less to pay down the Atlantic City’s $500 million debt, noting: “It has been two weeks…My plan is to do what I think is necessary to create a structural financial situation that works not for six months, not for a year, but indefinitely so that this place can flourish in a way that it deserves to flourish.” He noted he and his law firm will be paid hourly for their work, albeit he did not report what that hourly rate will be—especially as the state retention agreement remains incomplete, albeit promising: “We’ll make sure that’s available once it’s been finalized.” Related to governance, he noted that—related to his state-granted authority to sell city assets, hire or fire workers or break union contracts, among other powers—he would listen to residents and stakeholders before making major decisions: “What this designation has done is consolidate authority, per the legislation, in the designee to make those decisions…That does not mean that I’m not listening. That does not mean I’m pretending I have all the answers without consulting with other people.” Describing the seaside city as a “jewel” and “truly unique,” he added that he understood concerns about an outsider overseeing the city: “I know that most of you don’t know who I am…All I can do is be judged by my actions and the decision that I make, and I hope you give me time to do that.” He did say that he would have to move swiftly to address immediate issues, likely referring to reaching agreements with casinos to make payments in lieu of property taxes, and then focusing on the city’s expenses—noting: “That timeframe is pretty compressed…So we will take the steps we need to take.”

Fiscally Hard for Hartford. As we have recounted in the fiscally strapped municipality of Petersburg, Virginia, municipal fiscal insolvency cannot occur in a geographic vacuum: whether in Detroit—or as we note above today, in San Bernardino, fiscal insolvency has repercussions for adjacent municipalities. So too in Hartford, the Metropolitan District Commission (MDC) completed its planned $173 million municipal bond sale late last week, temporarily ending the controversy over a $5.5 million reserve fund. Under the provisions, that fund would be paid by seven of the eight MDC municipalities to cover the sewage fee for the second half of 2017 if the City of Hartford is unable to contribute its share, as it has indicated it will be unable to do. Ergo, it means that adjacent Windsor, the first English settlement in the state which abuts Hartford on its northern border, with a population of under 30,000 would contribute over $700,000, with East Hartford contributing about $900,000. The other group members in the metro region, Bloomfield, Newington, Rocky Hill, West Hartford, and Wethersfield, would pay the remaining $900,000, proportionately. One outcome of this watery alliance and experience is that the MDC will, when the state legislature convenes next February, propose two laws to avoid the necessity for a reserve fund in the future, with MDC Chairman William DiBella suggesting that the eight member municipalities be required to set aside as untouchable the percentage of their property taxes the cities and towns already know they will owe to the MDC for sewage services. (Currently, property taxes go into the municipalities’ general funds, and the cities extract the sewage fee when it is due, provided the funds are, in fact, available; however, like water at the tap, that has not always been the experience.) In effect, the consortium is recommending a selves-imposed budgeting municipal mandate, with Chairman DiBella noting: “Every town would have to do it. That way, one town can’t stiff us. You wouldn’t have to go out and borrow money or take charity and hope you get it back.” As the Chairman noted: “We never had a problem like this…Who thought a town would go bankrupt? With the proposed law, if a town were to go bankrupt, the sewage fund would be in a dedicated account and can’t be reached,” or touched in a bankruptcy proceeding. Another potential resolution would be to allow the MDC to borrow money over a long-term for operating expenses. The MDC would then be able to pay Hartford’s $5.5 million bill and look for a city reimbursement in other ways.

There has been increased pressure for a resolution—especially in the wake of municipal bond holders of the MDC, holders who, last week, made clear to the authority they would not buy its municipal bonds if a reserve fund was not put into place. That appeared to be a key incentive for the board’s action earlier this week for the MDC board, including representatives of all eight municipal members, to vote unanimously to adopt the water and sewer service provider’s 2017 budget, which contains the unwelcome “bail-out” fund for Hartford—albeit Chair DiBella said there would be no guarantee the agency could cover a Hartford default or continue operating or pay the bondholders. A key part of the incentive to try to work together relates to potential fiscal contagion: because of concerns over Hartford’s finances and fiscal condition, credit rating agencies have recently downgraded MDC’s bond rating from AA+ to AA, a downgrade expected to cost the agency and its member towns an estimated $500,000 in a higher interest rate for the bonds. The towns, unsurprisingly, are apprehensive the credit rating agencies will now consider changing their credit ratings. In contrast, creating the reserve fund would keep MDC’s credit rating where it is: thus, MDC officials hope that passing the two proposed laws would prompt the credit rating agencies to return its rating to AA+.

 

Municipal Governance: The Challenges of Severe Fiscal Distress

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eBlog, 11/30/16

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

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

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

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

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

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

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

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

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

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

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

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

Who’s in Charge of a Municipality’s Future?

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eBlog, 9/29/16

Good Morning! In this a.m.’s eBlog, we consider, the always difficult state-local governance challenges for cities in fiscal stress: first, we look at yesterday’s editorial from the Detroit Free Press raising serious concerns with regard to Michigan’s emergency manager law—a state law which authorizes the state to appoint an emergency law with dictatorial type authority and without accountability to citizens, voters, or taxpayers in a city, county, or public school district. The issue relates to the kinds of challenges we have been following in New Jersey, Connecticut, Virginia, and other states where the hard questions relate to what the role of a state might be for a municipality in severe fiscal distress—especially where such distress might risk municipal fiscal contagion. Then, mayhap appropriately, we journey back to Atlantic City, which is nearing its own state-imposed deadline to avert a state takeover. Finally, we examine the ongoing plight of East Cleveland —a small, poor municipality in some state of negotiation with the adjacent City of Cleveland with regard to the possibility of a merger—while awaiting a response from the State of Ohio with regard to its specific request for authority to file for chapter 9 bankruptcy. It remains unclear if the State of Ohio will ever even notify the city it has received said request, much less act. Thus, in a week, we have watched the States of Virginia, Connecticut, Michigan, and New Jersey struggle with what the role of a state might be—and how the fiscal ills of a city might adversely impact the credit ratings of said state.

Who’s in Charge of a Municipality’s Future? The Detroit Free Press in an editorial this a.m. wrote that, “[F]our years on, it’s hard to argue that Gov. Rick Snyder’s retooled emergency manager law, [Gov.] Snyder’s second revision of Michigan’s long-standing law, is working,” referring to Michigan’s Emergency Manager Law (Act 436), a state law unique to the state of Michigan: one which authorizes authority to the governor to appoint emergency managers with near-absolute power in cash-strapped cities, towns, and school districts; it authorizes such emergency managers to supersede local ordinances, sell city assets, and break union contracts; it leaves local elected officials without real authority. It provides that an Emergency Manager may be appointed by the Local Emergency Financial Assistance Loan Board. In the case of Detroit, it served as the mechanism by which Governor Rick Snyder appointed Kevyn Orr as Detroit’s emergency financial manager. The law, the Local Financial Stability and Choice Act reads: “The financial and operating plan shall provide for all of the following: The payment in full of the scheduled debt service requirement on all bonds and notes, and municipal securities of the local government, contract obligations in anticipation of which bonds, notes, and municipal securities are issued, and all other uncontested legal obligations (See §141.155§11(1)(B)). The editorial went on: “The crux of the problem lies in the limited impact accounting can have on the myriad factors that affect quality of life or efficient service delivery within a city:

“Sure, an emergency manager (in theory) can balance a city or school district’s books. But no amount of budget slashing or service cuts can make a city somewhere people want to live, or a school district the kind of place that offers quality education. In fact, it’s often the reverse: When residents leave, the tax base slims, meaning cities or school districts stretch to provide the requisite level of service with significantly less money. Cuts exacerbate the population decline, which depletes revenue more, which means more service cuts. And so on and so on and so on.

Nowhere is this object lesson in sharper contrast than Flint, where the city — under a success {I suspect the editors meant “excess’} of emergency managers — started pumping drinking water from the Flint River in 2014, pending the start-up of a new regional water system, a cost-saving switch prompted by the city’s ongoing budget woes. Almost immediately, botched water treatment caused bacterial contamination that altered the color, taste and odor of the city’s drinking water, and 18 months later, the state would acknowledge that improper treatment of which had caused lead to leach from aging service lines, contaminating the city’s drinking supply, and exposing nearly 9,000 children under age 6 to the neurotoxin, which can cause behavioral and developmental problems.

Why play games with something as important as drinking water? When the mandate is to cut, cut, cut, everything is on the table.

But it shouldn’t be.

A task force appointed by [Gov.] Snyder to review the Flint water crisis recommended a slate of changes to the state’s emergency manager law, like a mechanism for local appeal of emergency manager decisions, outside review, and other controls that Flint residents, alarmed by the smell, taste and color of their drinking water, could have employed to halt Flint’s water disaster before it reached crisis proportions.

Snyder says he’s waiting for the completion of a legislative report into the task force’s recommendation.

Why?

Snyder took office in 2011 knowing the bill was about to come due for a wave of municipal crises that threatened to cascade across the state.

There was the City of Detroit, where systemic budget troubles had been building for decades; Pontiac, Flint, and Benton Harbor, Allen Park, Ecorse, and Highland Park, where emergency managers were already waging uphill battles with incremental results, or whose substantial financial challenges put them firmly in emergency management’s crosshairs. And Detroit Public Schools, under state control for most of the last decade, with no fix in sight.

Inexplicably, in this climate, [Gov.] Snyder chose to cut state revenue sharing, continuing a trend of bolstering the state’s fiscal health at the expense of its cities to the tune of about $6 billion in cuts to cities over a decade.

Snyder and then-Treasurer Andy Dillon believed that the state’s long-standing emergency manager act was insufficient to truly remedy cities’ and school districts’ fiscal woes. An emergency manager, Snyder and Dillon believed, should have clear authority over operations, not just finances, and have greater power to impact labor agreements. Through two revisions (the first emergency manager law passed in Snyder’s tenure was repealed by voters; its replacement carries a budget appropriation and is thus repeal-proof), Snyder crafted a law that granted his emergency managers the authority to make the broad fixes he believed necessary.

There’s no question that a temporary usurpation of local elected control, as happens during an emergency manager’s appointment, is a serious matter. But Snyder seemed to understand that ensuring the health and well-being of Michigan residents — by ensuring that Michigan cities and school districts could provide the services necessary to create those conditions — was properly a governor’s job. It still is.

In the meantime, there’s promising news out of Lansing: Michigan State University professor Eric Scorsone, long a champion of funding cities properly and sustainably, has been appointed state deputy treasurer for finance. Scorsone has been a strong advocate for municipal governments and school districts, and we hope, deeply, that his appointment indicates that Snyder has come around to a point of view we’ve advanced for years: Fund cities properly, and whether or not to appoint an emergency manager may become a question that never needs answering.

Tempus Fugit? In ancient Rome, the query was ‘Is time running out,’ now an increasingly anxious question for Atlantic City’s leaders, where, having already missed one state-imposed deadline to initiate dissolution of its authority, the state has given the city until Monday to cure the violation. New Jersey Senate President Steve Sweeney (D-Salem) said Atlantic City must make a “realistic plan” to dig out of its fiscal hole; however, he declined to weigh in on the city’s most recent proposal. Noting that “Atlantic City has roughly 30-something days” left, Sen. Sweeney noted: “It’s incumbent upon them to put a realistic plan forward. You know, we’ve been at this for a while, and they really need to put a plan forward that’s going to make sense and work.” With the state-imposed deadline just six days before election day, Sen. Sweeney said he would “reserve judgment” on the city’s proposal to avail itself of its public water utility to purchase its airport, Bader Field, for at least $100 million. His comments came in the wake of the city’s unveiling earlier this week the first of seven parts to its plan in which city officials announced the Municipal Utilities Authority has agreed to purchase as part of an effort to raise revenues for the city, yet retain the water system in public hands, with the proceeds to go toward paying down the city’s roughly $500 million debt. The deadline comes as Moody’s has warned that the city not only risks defaulting on terms of a $73 million state loan agreement, but could also miss a $9.4 million municipal bond interest payment due on November 1. Analyst Douglas Goldmacher noted Atlantic City “does not have sufficient funds to immediately repay the $62 million already received from the state…Furthermore, unless the state continues to disburse additional funds from the bridge loan, or releases the Atlantic City Alliance and investment alternative tax funds owed to the city, it is highly improbable that the city will be able to make its (Nov. 1) $9.4 million balloon payment.” Mr. Goldmacher wrote, however, that the city’s repayment challenges would be addressed if the proposed Bader Field sale goes through—even as he again said the plan raises questions, such as whether the authority can afford to borrow $100 million and whether the state would even approve the plan—a plan to which the New Jersey Department of Community Affairs has yet to comment—perhaps confirming Mr. Goldmacher’s apprehension that: “Atlantic City’s impending technical default is credit negative for it, and indicates a disconnect between the city council, mayor, and state: “The impending default was caused by political gridlock.”

What Kind of City Do the Voters Want? The Cuyahoga County, Ohio Board of Elections and the East Cleveland City Council Clerk’s office this week certified more than 600 petition signatures to force a recall vote of East Cleveland Mayor Gary Norton and City Council President Tom Wheeler, so that the two highest ranking elected officials in this virtually insolvent municipality will face a recall election this fall, albeit not on the November ballot: the election likely will occur on December 6th—appropriately one day before Pearl Harbor Day. The election, however, will not be without cost to the virtually insolvent city: it could cost the city between $25,000 and $30,000—and will be a run-up just 10 months before the next mayoral primary election, even as the city is locked in so far seemingly non-existent merger negotiations with the City of Cleveland and awaiting a non-existent response from the Ohio State Treasurer with regard to its request for authorization to file for chapter 9 municipal bankruptcy. Nevertheless, the citizens of East Cleveland gathered more than twice the requisite number of signatures necessary to force a special recall election, triggering the City Clerk to send a letter to Mayor Norton informing him of the election. Under the East Cleveland charter, if he does not resign, he will face a recall election within 60-90 days. Unsurprisingly, Mayor Norton does not plan to resign. In a phone interview last Saturday, he characterized the election a waste of money in a city that cannot afford it: “East Cleveland will select it’s next mayor 10 months after this needless recall election…This is a horrible expenditure of funds given the city’s current financial provision, and beyond that, switching a single mayor or single councilman will have no impact on the city’s financial situation and the city’s economy.” Mayor Norton said the money the election will cost will have to be cut from other city services, noting that would include possible cuts in police and fire, because, he added: “There’s little to nothing left to cut in the city.” In East Cleveland, violent crime, on a scale from 1 (low crime) to 100, is 91. Violent crime is composed of four offenses: murder and non-negligent manslaughter, forcible rape, robbery, and aggravated assault. The US average is 41.4. In the city, property crime, on a scale from 1 (low) to 100, is 75. The U.S. average is 43.5. A recall election, if it happens, would be the third for the Mayor.

Mayor Norton’s success rate in overcoming recall votes could change, however, as voters in November—before the next scheduled recall election, will consider an amendment to the city’s charter intended to curtail the ease with which residents can trigger a recall, although it is currently being reviewed by the Board of Elections and has not been finalized for the November ballot. For his part, the beleaguered Mayor Norton has so far refused to say whether he was going to run for re-election next year, and declined to answer why voters should vote to keep him as mayor in December.