State and Local Insolvency & Governance Challenges

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eBlog, 03/29/17

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

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

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

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

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

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

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

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

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

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

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

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

The Roads out of Municipal Bankruptcy

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eBlog, 2/24/17

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

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

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

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

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

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

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

Are American Cities at a Financial Brink?

eBlog, 1/13/17

Good Morning! In this a.m.’s eBlog, we consider the ongoing fiscal and physical challenges to the City of Flint, Michigan in the wake of the disastrous state appointment of an Emergency Manager with the subsequent devastating health and fiscal subsequent crises, before turning to a new report, When Cities Are at the Financial Brink” which would have us understand that the risk of insolvency for large cities is now higher than at any point since the federal government first passed a municipal bankruptcy law in the 1930’s,” before briefly considering the potential impact on every state, local government, and public school system in the country were Congress to adopt the President-elect’s proposed infrastructure plan; then we consider the challenge of aging: what do longer lifespans of city, county, and state employees augur for state and local public pension obligations and credit ratings?

Not In Like Flint. Residents of the City of Flint received less than a vote of confidence Wednesday about the state of and safety of their long-contaminated drinking water, precipitated in significant part by the appointment of an Emergency Manager by Governor Rick Snyder. Nevertheless, at this week’s town hall, citizens heard from state officials that city water reaching homes continues to improve in terms of proper lead, copper, alkaline, and bacteria levels—seeking to describe Flint as very much like other American cities. The statements, however, appeared to fall far short of bridging the trust gap between Flint residents and the ability to trust their water and those in charge of it appears wide—or, as one Flint resident described it: “I’m hoping for a lot…But I’ve been hoping for three years.” Indeed, residents received less than encouraging words. They were informed that they should, more than 30 months into Flint’s water crisis, continue to use filters at home; that it will take roughly three years for Flint to replace lead water service lines throughout the city; that the funds to finance that replacement have not been secured, and that Flint’s municipal treatment plants needs well over $100 million in upgrades: it appears unlikely the city will be ready to handle water from the new Karegnondi Water Authority until late-2019-early 2020. The state-federal presentation led to a searing statement from one citizen: “I’ve got kids that are sick…My teeth are falling out…You have no solution to this problem.”

Nevertheless, progress is happening: in the last six months of water sampling in Flint, lead readings averaged 12 parts per billion, below the federal action level of 15 ppb, and down from 20 ppb in the first six months of last year. Marc Edwards, a Virginia Tech researcher who helped identify the city’s contamination problems, said: “Levels of bacteria we’re seeing are at dramatically lower levels than we saw a year ago.” However, the physical, fiscal, public trust, and health damage to the citizens of Flint during the year-and-a-half of using the Flint River as prescribed by the state-appointed Emergency Manager has had a two-fold impact: the recovery has been slow and residents have little faith in the safety of the water. Mayor Karen Weaver has sought to spearhead a program of quick pipeline replacement, but that process has been hindered by a lack of funding.

State Intervention in Municipal Bankruptcy. In a new report yesterday, “When Cities Are at the Financial Brink,” Manhattan Institute authors Daniel DiSalvo and Stephen Eide wrote the “risk of insolvency for large cities in now higher than at any point since the federal government first passed a municipal bankruptcy law in the 1930’s,” adding that “states…should intervene at the outset and appoint a receiver before allowing a city or other local government entity to petition for bankruptcy in federal court—and writing, contrary to recent history: “Recent experiences with municipal bankruptcies indicates that when local officials manage the process, they often fail to propose the changes necessary to stabilize their city’s future finances.” Instead, they opine in writing about connections between chapter 9, and the role of the states, there should be what they term “intervention bankruptcy,” which could be an ‘attractive alternative’ to the current Chapter 9. They noted, however, that Congress is unlikely to amend the current municipal bankruptcy chapter 9, adding, moreover, that further empowering federal judges in municipal affairs “is sure to raise federalism concerns.” It might be that they overlook that chapter 9, reflecting the dual sovereignty created by the founding fathers, incorporates that same federalism, so that a municipality may only file for chapter 9 federal bankruptcy if authorized by state law—something only 18 states do—and that in doing so, each state has the prerogative to determine, as we have often noted, the process—so that, as we have also written, there are states which:

  • Precipitate municipal bankruptcy (Alabama);
  • Contribute to municipal insolvency (California);
  • Opt, through enactment of enabling legislation, significant state roles—including the power and authority to appoint emergency managers (Michigan and Rhode Island, for instance);
  • Have authority to preempt local authority and take over a municipality (New Jersey and Atlantic City.).

The authors added: “The recent experience of some bankrupt cities, as well as much legal scholarship casts doubt on the effectiveness of municipal bankruptcy.” It is doubtful the citizens in Stockton, Central Falls, Detroit, Jefferson County, or San Bernardino would agree—albeit, of course, all would have preferred the federal bailouts received in the wake of the Great Recession by Detroit’s automobile manufacturers, and Fannie Mae and Freddie Mac. Similarly, it sees increasingly clear that the State of Michigan was a significant contributor to the near insolvency of Flint—by the very same appointment of an Emergency Manager by the Governor to preempt any local control.

Despite the current chapter 9 waning of cases as San Bernardino awaits U.S. Bankruptcy Judge Meredith Jury’s approval of its exit from the nation’s longest municipal bankruptcy, the two authors noted: “Cities’ debt-levels are near all-time highs. And the risk of municipal insolvency is greater than at any time since the Great Depression.” While municipal debt levels are far better off than the federal government’s, and the post-Great Recession collapse of the housing market has improved significantly, they also wrote that pension debt is increasingly a problem. The two authors cited a 2014 report by Moody’s Investors Service which wrote that rising public pension obligations would challenge post-bankruptcy recoveries in Vallejo and Stockton—perhaps not fully understanding the fine distinctions between state constitutions and laws and how they vary from state to state, thereby—as we noted in the near challenges in the Detroit case between Michigan’s constitution with regard to contracts versus chapter 9. Thus, they claim that “A more promising approach would be for state-appointed receivers to manage municipal bankruptcy plans – subject, of course, to federal court approval.” Congress, of course, as would seem appropriate under our Constitutional system of dual sovereignty, specifically left it to each of the states to determine whether such a state wanted to allow a municipality to even file for municipal bankruptcy (18 do), and, if so, to specifically set out the legal process and authority to do so. The authors, however, wrote that anything was preferable to leaving local officials in charge—mayhap conveniently overlooking the role of the State of Alabama in precipitating Jefferson County’s insolvency.  

American Infrastructure FirstIn his campaign, the President-elect vowed he would transform “America’s crumbling infrastructure into a golden opportunity for accelerated economic growth and more rapid productivity gains with a deficit-neutral plan targeting substantial new infrastructure investments,” a plan the campaign said which would provide maximum flexibility to the states—a plan, “American Infrastructure First” plan composed of $137 billion in federal tax credits which would, however, only be available investors in revenue-producing projects—such as toll roads and airports—meaning the proposed infrastructure plan would not address capital investment in the nation’s public schools, libraries, etc. Left unclear is how such a plan would impact the nation’s public infrastructure, the financing of which is, currently, primarily financed by state and local governments through the use of tax-exempt municipal bonds—where the financing is accomplished by means of local or state property, sales, and/or income taxes—and some user fees. According to the Boston Federal Reserve, annual capital spending by state and local governments over the last decade represented about 2.3% of GDP and about 12% of state and local spending: in FY2012 alone, these governments provided more than $331 billion in capital spending. Of that, local governments accounted for nearly two-thirds of those capital investments—accounting for 14.4 percent of all outstanding state and local tax-exempt debt. Indeed, the average real per capita capital expenditure by local governments, over the 2000-2012 time period, according to the Boston Federal Reserve was $724—nearly double state capital spending. Similarly, according to Census data, state governments are responsible for about one-third of state and local capital financing. Under the President-elect’s proposed “American Infrastructure First” plan composed of $137 billion in federal tax credits—such credit would only be available to investors in revenue-producing projects—such as toll roads and airports—meaning the proposed infrastructure plan would not address capital investment in the nation’s public schools, libraries, etc. Similarly, because less than 2 percent of the nation’s 70,000 bridges in need of rebuilding or repairs are tolled, the proposed plan would be of no value to those respective states, local governments, or users. Perhaps, to state and local leaders, more worrisome is that according to a Congressional Budget Office 2015 report, of public infrastructure projects which have relied upon some form of private financing, more than half of the eight which have been open for more than five years have either filed for bankruptcy or been taken over by state or local governments.

Moody Southern Pension Blues. S&P Global Ratings Wednesday lowered Dallas’s credit rating one notch to AA-minus while keeping its outlook negative, with the action following in the wake of Moody’s downgrade last month—with, in each case, the agencies citing increased fiscal risk related to Dallas’ struggling Police and Fire Pension Fund, currently seeking to stem and address from a recent run on the bank from retirees amid efforts to keep the fund from failing, or, as S&P put it: “The downgrade reflects our view that despite the city’s broad and diverse economy, which continues to grow, stable financial performance, and very strong management practices, expected continued deterioration in the funded status of the city’s police and fire pension system coupled with growing carrying costs for debt, pension, and other post-employment benefit obligations is significant and negatively affects Dallas’ creditworthiness.” S&P lowered its rating on Dallas’ moral obligation bonds to A-minus from A, retaining a negative outlook, with its analysis noting: “Deterioration over the next two years in the city’s budget flexibility, performance, or liquidity could result in a downgrade…Similarly, uncertainty regarding future fixed cost expenditures could make budgeting and forecasting more difficult…If the city’s debt service, pension, and OPEB carrying charge elevate to a level we view as very high and the city is not successful in implementing an affordable plan to address the large pension liabilities, we could lower the rating multiple notches.” For its part, Fitch Ratings this week reported that a downgrade is likely if the Texas Legislature fails to provide a structural solution to the city’s pension fund problem. The twin ratings calls come in the wake of Dallas Mayor Mike Rawlings report to the Texas Pension Review Board last November that the combined impact of the pension fund and a court case involving back pay for Dallas Police officers could come to $8 billion—mayhap such an obligation that it could force the municipality into chapter 9 municipal bankruptcy, albeit stating that Dallas is not legally responsible for the $4 billion pension liability, even though he said that the city wants to help. The fund has an estimated $6 billion in future liabilities under its current structure. In testimony to the Texas State Pension Review Board, Mayor Rawlings said the pension crisis has made recruitment of police officers more difficult just as the city faces a flood of retirements.

 

Preempting Local Governance?

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eBlog, 11/07/16

Good Morning! In this a.m.’s eBlog, we observe the ongoing efforts by Atlantic City to respond to and avert a state takeover of the city—with a key hearing now scheduled one day after the Presidential election; then we look south to the small city of Petersburg, Virginia, where a wholly distinct takeover of a municipal government is underway in the virtually insolvent city, even as, tomorrow, its citizens will have a chance to vote for candidates who will at some indeterminate point in the future be able to resume responsibility and authority to reshape the beleaguered city’s fiscal future.   

State Preemption of a Municipality? In response to Atlantic City’s information and efforts to avert a state takeover, as well as Mayor Don Guardian’s epistle late last week to the New Jersey Department of Community Affairs, the Department, created to provide administrative guidance, financial support, and technical assistance to local governments, community development organizations, businesses and individuals, has scheduled the following agenda items for its meeting Wednesday:

11:15 AM City of Atlantic City
Atlantic – NJSA 52:27BB-87 0 Proposed Adoption of Municipal Budget

11:20 AM City of Atlantic City
Atlantic – NJSA 52:27BBBB-1 et seq. – Confirmation of Powers under Municipal Stabilization and Recovery Act. 

Under said Act, the Commissioner of the Department of Community Affairs has 150 days in which to approve or reject the city’s five-year plan. Should the Department find that the proposed plan failed to achieve fiscal stability, a state takeover would take effect. Moreover, the statute also provides authority for a state takeover if Atlantic City, at any point, fails to follow the five-year plan—although it permits Atlantic City the right to appeal the Commissioner’s decisions to a Superior Court judge.

In its 25-page document, as we previously noted, the city sought to respond to the criticisms of the state to its report and urge that the city’s proposed plan is the best way to address its fiscal future. The timing, one day after the Presidential election, is mayhap ironic, coming after last week’s closure of candidate Donald Trump’s Taj Mahal casino—one he once called “the eighth wonder of the world,” despite, ironically, taking his Atlantic City casinos through bankruptcy four times. Nevertheless, he last week said: “There’s no reason for this,” in a recent interview as his friend and fellow billionaire Carl Icahn prepared to close the casino. Thus, in another blow to the city’s tax base and employment and other sales and hotel tax revenues, the Taj Mahal closed its doors amid a strike by union members that had lasted more than 100 days, making it the fifth Atlantic City casino to close since 2014. Mr. Trump claimed both sides should have been able to work out an agreement to keep the casino open. Local 54 of the Unite-HERE union had gone on strike July 1st, after the Local was unable to agree with Mr. Icahn on a new contract to restore health insurance and pension benefits—benefits which were terminated two years ago in a federal bankruptcy court. So last August, Mr. Icahn decided to close the casino, stating it lacked a “path to profitability.” That path, according to candidate Trump, is now forever closed: “Once it closes, it’s too expensive to ever reopen it.” The casino’s closure of course impacted Atlantic City’s fiscal challenges: its impact in lost jobs (nearly 3,000 workers—bringing the total jobs lost by Atlantic City casino closings to 11,000 since 2014), reduced assessed property values.

An Affordable Cost for an Insolvent City? The Petersburg City Council and the small municipality’s residents have finally been able to get a sense at what services or responsibilities they will receive in return for the insolvent municipality’s very expensive payments to a consulting firm over the next five months after Robert C. Bobb, the founder and president of the Robert Bobb Group, provided a detailed presentation at last week’s City Council meeting with regard to how his firm plans to help Petersburg solve its financial problems and what the company had completed in its first week on the job. In the wake of meeting with Councilmembers and city officials, and reviewing scores of reports and other documents, the Bobb Group’s experts concluded that “by not addressing growing structural deficits since 2009, the city faces great risk in funding essential and critical public services. The fiscal crisis deepens.” (Among the reviewed documents was the August 3rd report by auditors from the Virginia Department of Finance alerting the small city’s officials to a backlog of nearly $19 million in unpaid bills from FY2016, as well as a looming $12 million deficit in the current fiscal year.) In addition, the group noted additional problems with regard to how the city government manages its money, adding that it had determined that some of the steps taken to deal with the fiscal crisis may not have done enough—indeed, may have done more harm than good: “The fiscal year 17 budget is unrealistic, lacks transparency, and has not been appropriated or made available to the public…Even with the $12.5 million reduction from the original budget to the amended budget, there is a lack of accountability and information…to ensure that the city can meet what is planned.”

Indeed, the report noted that some of the fiscal steps taken by the city may well have been counter-productive, noting that the early action imposing an across-the-board 10 percent pay cut for city employees—an imposition which, according to the Bobb Group, triggered a “mass exodus” of city workers, “was taken over-dramatically, eliminating services:” The pay cut, the group reported, led to the resignations of 146 city employees.

The city had already issued a solicitation for a $6.5 million loan against its expected tax revenue before the Bobb Group arrived on scene. Nelsie L. Birch, the Bobb Group staffer currently acting as Petersburg’s interim budget and finance director, reported that negotiations with potential lenders are about to get underway. Already, however, it appears the proceedings might be delayed: Petersburg officials had expected the loan proceeds to be available this month; however, according to the Bobb Group, “the proceeds may not be available until December (at the earliest). This leaves November vulnerable to ensuring payroll obligations are able to be met.”

Governance by Contract? The terms of the firm’s effective preemption of municipal governance which the Bobb Group provided to the city—a plan which included a so-called “plan of entry” featuring an “immediate ‘All Hands’ discussion with the Mayor and City Council on the city’s goals, service levels, and future direction; immediate one-on-one meetings with the individual members of the City Council…[and] a documents review, including but not limited to budgets, audits, special studies on the city’s current financial operations, organizational structure [and] city charter.” Among the key services the contract calls for the consulting firm to provide:

  • “Perform a financial review of the city, including but not limited to a review and assessment of financial information that has been, and that will be, provided by the city to its creditors, including without limitation its short- and long-term projected cash flows and operating performance.”
  • “Assist in the identification and implementation of cost-reduction and operations-improvement opportunities.”
  • “Assist the mayor and City Council and other city-authorized professionals in developing for the City Council’s review possible restructuring plans or strategic alternatives for maximizing the enterprise value of the city’s various economic development opportunities.”

For these and other services, the Bobb Company is to be paid $350,000 plus expenses up to $25,000 to cover the company’s employees’ travel, lodging and meals. The contract requires that “All hotel and apartment rental for the period of the engagement will be within the City of Petersburg.”

Can Municipal Insolvency Be Contagious?

eBlog, 10/24/16

Good Morning! In this a.m.’s eBlog, we consider the risks of fiscal contagion emanating from the historic city of Petersburg, Virginia, where the city’s virtual insolvency risks the solvency of the regional wastewater authority—and, therefore, the other participating municipalities. Next, with Election Day approaching, we travel to post-chapter 9 Stockton where the ballot issue of a sales tax increase on next month’s municipal ballot has divided the city’s candidates for Mayor and Council. Finally, we consider the exceptional challenges for the U.S. territory of Puerto Rico in the wake of the first PROMESA board meeting.

Can Municipal Insolvency Be Contagious? The South Central Wastewater Authority (SCWA), which provides wastewater treatment services to protect and enhance the environment for the City of Petersburg, the City of Colonial Heights, Chesterfield County, Dinwiddie County, and Prince George County, Virginia, may have to dip into its cash reserves and raise rates for its four other member municipalities if Petersburg fails to resume making its monthly payments very soon: to make up for the gap, each of the other four member jurisdictions would have to increase its monthly payments by approximately 61 percent. At a special meeting at the end of last week, the boards of the SCWA and the Appomattox River Water Authority were briefed on the outlook for SCWA’s finances due to Petersburg’s looming insolvency—with SCWA accounting manager Melissa B. Wilkins warning that unless the authority can tap some of its cash reserves, without Petersburg’s monthly payments, the Authority will be insolvent by the middle of next month—or, as she put it: “Right now, mid-October, we’re broke.” Indeed, forecasts provided to the directors, all municipal government officials from Petersburg, Chesterfield County, Colonial Heights, Dinwiddie County, and Prince George County, make clear that if SCWA does not begin to receive payments consistently by Petersburg and does not tap into its reserves, its operating cash will go into the red as early as next month: by the end of the fiscal year next June, the figures show the authority’s cash balance will be nearly $3 million in arrears. Ms. Wilkens advised that if Petersburg were to start making regular monthly payments beginning with the amount due for this month, and if SCWA were to shift about $996,000 in unused construction funds from a reserve account to the authority’s operating account, the authority would end the fiscal year with a positive cash balance of $35. Ms. Wilkin’s forecast assumes that SCWA will continue to operate under a “bare bones” budget—one which would not include any deposits into the authority’s reserves and puts a hold on any non-mandated construction projects. The key issue is that Petersburg imposes a disproportionate burden on the joint authority: the city accounts for approximately 55 percent of SCWA’s treatment load; ergo its share is of SCWA’s operating and maintenance costs. Its failure to do so means that to make up for the non-payment, each of the other four member municipalities would have to increase its monthly payments by about 61 percent.

The urgency and briefing come in the wake of the suit the authority filed against Petersburg last month, seeking the appointment of a receiver to oversee the city’s utility revenue and make sure the money collected from residents is used to pay SCWA and not for other purposes: the authority claims Petersburg owed it more than $1.5 million in overdue payments. Two weeks ago, Petersburg Circuit Court Judge Joseph M. Teefey Jr. opined that the suit contained “sufficient information that an emergency exists, and it is necessary that this court appoint a special receiver” to make sure residents’ wastewater payments are not used for other purposes, naming attorney Bruce Matson of the Richmond-based law firm LeClairRyan as the receiver. In addition, Judge Teefey, on his own initiative, ordered the city and the wastewater authority to meet with a mediator, McCammon Group of Richmond, because of “the special relationship of the parties to this action and the potential conflicts that are a consequence of these relationships.” In response, the City of Petersburg’s attorneys have filed a motion asking Judge Teefey to issue a stay of his order or to vacate it, because the appointment of a receiver automatically puts the city in technical default on more than $12 million in debt. The court has scheduled a hearing in the case for next Monday.)

For her part, Petersburg Interim City Manager Dironna Moore Belton, who represents the city on the SCWWA’s board, indicated she was hopeful the city would be able to resume making its monthly payments in the very near future, stating that the city is currently seeking a short-term loan to help that effort, advising the board Petersburg has identified a list of “key obligations” to be paid each month, which includes payments to regional authorities such as SCWWA, the Appomattox River Water Authority, and Riverside Regional Jail—albeit acknowledging that to keep current on those payments, that would “still not address some past-due payments.” Ms. Belton stated that city officials and their financial advisers “have a long-term package we are working on to address fiscal year 2016 past-due payments.”

Financing Post Municipal Bankruptcy City Services. Stockton residents in two weeks will have a say on whether to approve a quarter-cent restricted sales tax increase where the new revenues would be dedicated toward funding libraries, a recreation program, and other services in the city. The vote on Measure M is projected to generate $9 million a year and $144 million overall for library and recreation services, including after-school programs, homework centers, and children’s story times. It will be a heavy lift: Measure M requires approval of two-thirds of voters to pass. Since 1980, proponents argue, the city has underfunded its library and recreation services; they add that the city’s municipal bankruptcy and the recession “only compounded previously existing problems;” moreover, they argue that since 1980, the city’s population has doubled, but not a single new library has been built. The main goal for proponents of the tax is to get Stockton to go from an average spending per resident of $15 on public libraries and recreation to California’s median of $35 per capita. Last June, the City Council voted 5-2, with councilmen Michael Tubbs and Dan Wright opposing, to reopen the Fair Oaks Library; however, the facility is not expected to open for several months. The City’s Community Service Director John Alita, speaking as a private citizen, told the Stockton Record the city has had to close pools, has under maintained playing fields, and has reduced the average time libraries are open to less than 30 hours per week, noting: “The more that those things continue, then the less and less there is opportunity for our community members to actually benefit from these amenities that we made and created to provide for them…(The) combined benefit of restoring what would be a normal schedule to residents and then being able to enhance that in areas where there’s nothing right now, I think we see that as Measure M’s greatest benefit.” (Last year, the Stockton Unified School District had the lowest third-grade literacy rate in San Joaquin County at 16 percent, according to University of the Pacific’s annual San Joaquin Literacy Report Card.) All six of the city’s Council Members have endorsed Measure M, as have civil rights leader Dolores Huerta, San Joaquin County Superintendent of Schools James Mousalimas, the League of Women Voters, and the Greater Stockton Chamber of Commerce. As proposed, Measure M would essentially leave the sales tax unchanged, as a state sales tax increase approved by the passage of Proposition 30 in 2012 will expire this year.

Nonetheless, incumbent Mayor and candidate for re-election Anthony Silva, City Council candidate Steve Colangelo, and former Councilman Ralph Lee White have expressed apprehensions, testifying before the City Council last May they opposed approving a new tax when Measure A funds are not being used to fund library services. (Measure A, a three-quarter cent tax, was a tax increase approved by voters in 2014 with no restrictions, but with the city’s promise funds would be used to hire more police officers—a promise as yet unmet.) Mayor Silva, at a candidate’s forum last week, said: “I’m kind of caught in the middle on this one: All that money that we promised has not been spent exactly on what it was promised to you. So here comes another tax,” adding that Measure A had also promised to fund essential services, including opening libraries and pools; however, but none of those things were done…I love libraries…I love books, but the schools already have libraries.” Another opponent. Ned Leiba, a CPA, who closely monitors the Stockton’s finances, noting what he termed was poor management of Measure A funds and the city’s overall “problem with accounting and auditing,” stated: “You don’t want to give money to an entity that can’t be responsible.” Mr. Leiba, a member of the Measure A oversight committee, said that instead, Measure M proponents should pressure the city into using budgeted but unspent funds and not a new tax to open libraries. Stockton wants to “hold on to every shekel,” but there’s no basis for management’s claim that there’s no money, he added: “You want to exhaust all other remedies before you turn to taxes.” Were voters to adopt Measure M, a seven-member oversight committee would be appointed to do an annual review of how much money is generated and how funds are used. It appears that were the measure to pass, all dollars collected by the restricted sales tax would be placed in a separate city fund to be used for libraries and recreation services in Stockton.  

Wherefore the Promise of PROMESA? The process of unravelling insolvency is slow and frustrating: it can be even more trying where it involves a quasi-state and there are issues of sovereignty. Ergo, despite two meetings, the federal control board has, to date, evidenced scant progress—likely awaiting the outcome of both U.S. and Puerto Rico elections. Moreover, despite the ongoing recovery from the Great Recession, our respected colleagues at Municipal Market Analytics note that the fifty-two year-to-date first time payment defaulters so far this year has broken above last year’s trend (forty-eight between January and October), noting that in order for this year to finish with fewer defaults than last year (a trend that has held every year since MMA began collecting this data in 2009), “there can be no more than six additional defaults in November and December. Those two months have together averaged 14 defaults since 2013, strongly suggesting that 2016 will see a break in the downtrend.” For its part, the representatives of the U.S. territory advised the PROMESA Board it lacked any fiscal ability to finance any of its debt service over the next decade absent changes in federal laws to address both the island’s economy—and those provisions which harm its ability to compete against other Caribbean nations, noting that Puerto Rico’s GDP has contracted for nine of the last ten years in real terms, driven by the expiration of incentives provided under §936 of the U.S. tax code and the U.S. financial crisis, both of which were exacerbated by out-migration and extraordinary austerity measures taken by the Commonwealth, measures including reducing government consumption by 12% in real terms from 2006 through 2015, cutting the public administration headcount by approximately a quarter; reducing or deferring critical capital expenditures; delaying tax refunds and vendor payments; implementing significant new revenue measures, including recent sales and petroleum products tax increases generating approximately $1.4 billion annually; depleting liquidity and undertaking extraordinary short-term borrowings from pension and insurance systems; reforming pensions, converting defined benefit plans to defined contribution plans—austerity measures which they said had been insufficient to eliminate deficits, thereby incurring significant deficit financing, a ballooning debt load, and persistent economic decline, as evidenced by driving emigration to the U.S. mainland: a loss of not just some 9% of the island’s population—but disproportionately a loss for the best-educated.

The statistics, part of a 100-page fiscal plan submitted to the PROMESA Board, sought to identify the resources available to support basic governmental services and promote growth; it promised to put together a specific debt restructuring proposal in the wake of receipt of input from the Oversight Board. The plan warns that if the U.S. territory were to take various steps to improve revenues, reduce spending, and improve economic growth, it would still face a $6 billion gap over the decade—leaving no resources to meet commonwealth-supported debt. The plan addressed neither the financial outlook for Puerto Rico’s public corporations or municipalities (which also owe roughly $17 billion of debt). The plan treats $50.2 billion of debt as being addressed by the fiscal plan and the remainder of Puerto Rico’s debt as independent of it, because it is supported by the public corporations, municipalities, and other public entities. For priorities, Puerto Rico’s first is for Congress to continue Affordable Care Act funding to the Commonwealth beyond its planned end in FY2018—a continuation which the territory projects this could mean an additional $16.1 billion in direct Puerto Rico government revenues and an additional $8.4 billion in indirect revenues due to improved economic performance. Gov. Padilla also asked for an indefinite extension of the Affordable Care Act and that Congress treat Puerto Rico similarly to the 50 states with regard to Medicaid spending—and the extension of the earned income tax credit program to Puerto Rico, noting that such changes would lead to an $18.9 billion surplus, which could be used for the payments. This would be out of a total scheduled debt service of $34.2 billion. In its plan, the Governor recommended seven principals critical to reducing the government financing gap and restoring economic growth: any austerity must be minimal; the government must introduce improved budgetary controls and financial transparency; Puerto Rico needs to improve tax enforcement, consolidate agencies, reduce workforce, and reform its tax policy to eliminate the revenue impact of the planned end of the Act 154 tax in fiscal 2018; change local labor regulations, simplify permitting in order to promote economic growth, and invest in strategic growth-promoting projects. Fifth, Puerto Rico’s government must continue to protect vulnerable members of the population, such as the elderly, young, disabled, and poor through government services. The territory must reduce its debt to a “sustainable” level. And, seventh, the federal government must be involved to help generate economic growth.

He identified other concerns, as well, including caution in balancing amongst the island’s creditors, noting a “contingent value right or growth bond that pays creditors in the event growth targets set in the plan are exceeded should therefore be considered as part of any debt restructuring,” and that, because local municipal bondholders are believed to hold $8 billion to $12 billion of Puerto Rico’s debt, according to an official with the Puerto Rico Fiscal Agency and Financial Authority, the plan says there must be consideration of the impact of debt restructuring on the local economy. Finally, Puerto Rico Secretary of the Treasury Juan Zaragoza advised the board that Puerto Rico currently owes $1.3 billion to $1.35 billion to suppliers.

 

What Is a State’s Role When a Municipality Can No Longer Provide Essential Public Services?

eBlog, 9/27/16

Good Morning! In this a.m.’s eBlog, we consider the risk of municipal fiscal contagion—and what the critical role of a state might be as the small municipality of Petersburg, Virginia’s fiscal plight appears to be spreading to neighboring municipalities and utilities: Virginia currently lacks a clearly defined legal or legislated route to address not just insolvency, but also to avoid the spread of fiscal contagion. Then we journey to Atlantic City, where a comparable fiscal challenge—but in a state with a much longer history of state-local consideration—appears on the verge of a total state takeover: we ask whether the city’s end is nigh: will the state, in fact, take it over? Then we turn to the school yards in Chicago, where a threatened teacher strike augurs fiscal downgrades and worse fiscal math for Chicago Public Schools—a city beleaguered by this year’s terrible increase in murders and now unsettling math.

When It Rains, It Pours. The small Virginia municipality of Petersburg, near insolvency–or its tipping point, uncertain of what role the Commonwealth of Virginia will take in a state where, were the city to file a chapter 9 municipal bankruptcy petition, its municipal bondholders holding bonds to which statutory liens have attached would continue to receive payments on those bonds, [§15.2-5358], now is confronted by the filing of two similar lawsuits, accusing the city of repeated failures to meet payment due dates. The fiscal crisis is finally forcing the State of Virginia to contemplate what role it might have to take—a role which would set a precedent in a state which does not specifically authorize its municipal entities to file for municipal bankruptcy—and where the only such petition filed—by an economic development authority—was dismissed. The likely mechanism that will leave the state little alternative but to act is likely to be the filing of two lawsuits against the city over past-due payments—suits alleging similar accusations of repeated failures to meet payment due dates even before Petersburg’s fiscal problems evolved into a crisis: the South Central Wastewater Authority last week filed a lawsuit against the city, seeking more than $1 million and the appointment of a receiver to make sure the money the authority says it is owed is not spent by the city on other things, with the suit alleging: “Since 2011, city officials have failed to regularly and timely bill and collect monies for wastewater services and have failed to make payments due and owing to South Central.”

The second suit, filed last month by a road paving company, alleges that Petersburg failed to make payments on time for the company’s work repaving U.S. Route 460 East—a contract which specified that the company would receive payment within 30 days of the work being billed. In its filing, however, the company noted that its bills were paid late and that many times “those checks bore dates that made it appear they had been issued on time pursuant to the contract terms, even though delivery did not occur until weeks or months later.” The company’s corporate credit manager and chief financial officer met in July 2015 with Petersburg’s then Finance Director to discuss the problems—in the wake of which the city proposed a very delayed schedule—late enough that the company halted work on the project. The suit charges it has been left with an unpaid balance of about $214,000, so that it is seeking payment of that balance plus interest of 1 percent per month. For its part, the South Central Wastewater Authority alleges a similar pattern of late payments stretching back to mid-2011: “Since 2011, city officials have failed to regularly and timely bill and collect monies for wastewater services and have failed to make payments due and owing to South Central…This failure by Petersburg became sustained and serious beginning in the middle of 2012 and has become chronic and severe since…Despite continuous communication and extraordinary forbearance by [South Central] regarding Petersburg’s payment practices, which only resulted in repeated assurances of payment followed by more broken commitments, Petersburg has now altogether ceased making payments.” The suit charges the city is delinquent by $1.2 million, excluding penalty fees. Another $410,000 came due on the first of this month, according to the lawsuit. Because the Authority, moreover, provides wastewater treatment for the municipalities of Petersburg and Colonial Heights, and the counties of Chesterfield, Dinwiddie, and Prince George; and because Petersburg uses about half of the wastewater plant’s capacity, South Central’s complaint notes that  if Petersburg continues to fail to make payments, the authority will have to ask the other municipalities to pay higher rates, or it may be forced to shut down the treatment plant—a shutdown which, the utility notes, “would endanger public health and require an alternate means of treatment to prevent the flow of untreated wastewater directly into the Appomattox River…Planning, permitting, financing and construction of new facilities would take years. The scale and seriousness of this crisis cannot be overstated.” Indeed, the scale and complexity of the growing list of creditors of the municipality unearthed by auditors last summer determined Petersburg owed a total of about $3.4 million to six regional organizations: South Central, the Appomattox River Water Authority, the Central Virginia Waste Management Authority and Riverside Regional Jail, Crater Youth Care and the District 19 Community Services Board. It has become increasingly apparent that Petersburg’s fiscal problems have become contagious to adjacent municipalities and essential public services, so that, increasingly, the Commonwealth of Virginia will be forced to act.

Indeed, Virginia Secretary of Finance Richard D. Brown last week briefed members of the General Assembly’s Finance Committees on his department’s effort to help Petersburg figure out how to close its $12 million budget gap and generate enough cash flow to both keep the city government operating and to begin to pay down a debt that has ballooned to nearly $19 million. But, as it has become apparent the city likely will simply be unable to get out by itself, its fiscal collapse risks spreading—as can be noted from the impact of its non-payment to a regional facility—adjacent municipalities, it would appear the Governor and Virginia legislature will have little choice but to both act on measures to protect the state’s AAA credit rating, but also to prevent the fiscal distress from spreading. The Virginian Commission on Local Government, which has measured local fiscal distress in the state for three decades: notes in its stress index measures cities’ and counties’ revenue capacity, revenue effort, and median household income: it ranks Petersburg as the third-most fiscally stressed locality in Virginia—behind Emporia and Buena Vista.

The increasing apprehension in Richmond has led the Chairman of the House Appropriations Committee, Del. S. Chris Jones (R-Suffolk) to ask: “How did this get this bad without anyone knowing about it?” It also triggered his appointment last week of Del. R. Steven Landes (R-Augusta) to head a subcommittee to study states dealing with fiscally stressed localities and come up with solutions if a situation similar to that in Petersburg were to occur elsewhere in Virginia—or, as the Chairman put it: “We want to do our due diligence to see if there is legislation we might have to put in place to give authority to the state in certain circumstances to potentially take action…Right now, we don’t have the authority to do this, which is why I thought it is important to have this subcommittee between now and January and then begin the process to come up with some legislation.” In doing so, the Chairman emphasized that the state legislature will look primarily for proposals aimed at protecting the state’s interests—not those of the troubled localities, stating: “We are elected to represent our citizens at the state level, and we have our AAA bond rating to consider.” For his part, Chairman Landes said his committee will also examine the state’s options with regard to steps it could take to shorten its response time when a locality is heading toward the fiscal cliff, noting: “We want to make sure that audit information is getting to the money committees and the administration, because we would much rather be kept abreast sooner rather than later,” even as he vowed that a “bailout” for Petersburg is out of the question, noting: “I’m not aware where the state has ever stepped in to provide a locality a bailout…I don’t see that happening.”

Balancing on the Prick of the NeedleWhile it seems clear that neither the Governor nor the Legislature have much willingness to either grant municipal bankruptcy or provide significant fiscal assistance; nevertheless, there appears to be recognition that should Petersburg default, it would have implications for other municipalities in the state, especially if there were a default—such a default—increasingly possible in Petersburg’s case, because it is unclear how Petersburg, by Saturday, will come up with a $1.4 million principal-and-interest payment owed to the Virginia Resources Authority, a premier funding source for local government infrastructure financing through bond and loan programs. Under Virginia’s intercept provision, the Commonwealth is authorized to seize dollars it directs to localities for services, such as for schools, police and welfare, and use them, instead, to make scheduled payments on bonds to avoid default.

Interim City Manager Dironna Moore Belton acknowledged in an email last week that in order to secure short-term financing and bring long-term stability to the city, it cannot default on its loan payments. But Ms. Belton did not provide any specifics about from where she would take these dollars: “The city regularly collects revenues which go toward paying obligations…(and) has set aside dollars from incoming revenue to make the VRA payment;” however, in light of the $1.2 million lawsuit filed last week by the South Central Wastewater Authority, calls for the city to file for chapter 9 municipal bankruptcy have grown louder at public meetings and on internet message boards. However, as one expert commentator warns: “The state’s position is that Petersburg has dug themselves into a very unusual hole, and that they are going to have to take some very stringent and even draconian steps to get their house in order.” It is no longer certain, however, that the municipality has the capacity to get out by itself—indeed, it seems that, more likely than not, its fiscal tribulations will, increasingly, adversely affect neighboring public utilities and jurisdictions. According to Secretary Brown, the possibility of the city defaulting on bond payments is very real—a default which would leave the municipality with few alternatives—to which the Secretary remarked: “Some say that if it’s gotten to the point where they can’t operate, they should look at their charter and un-incorporate.” Such incorporation, however, would be a version of passing the buck—after all: which government would then be responsible for not only providing essential public services, but also paying off the growing mountain of municipal debts?

Thirsty City. Just as the provision of drinking water was a difficult issue in Detroit’s chapter 9 municipal bankruptcy, and has become so in Petersburg, so too the issue has arisen in San Bernardino, where the city’s municipal water department has announced water bills will increase by an average of $3.50 starting in October—with some of the increased  costs triggered by a state mandated water reduction goal of 28% this past summer—even as the utility notes the importance of conserving water during winter months: the Board of Water Commissioners, which is responsible for water rates in the city, voted unanimously to impose the higher rates, the first increase in four years; the city has approved further increases to go into effect next July 1st and in the subsequent July 1st of 2018. Again, just as in Detroit, virtually all who attended the session and vote came away angry—as the city water department’s General Manager put it: “For all of us, the last thing we want to do is cause economic distress to people…But we need to take care of what we’ve got, or we’re going to end up spending more in the future.” Since the city’s last rate increase, the water department has had to deal with California’s historic drought; the rising cost of imported water; new water quality regulations; and other expenses. Cost-cutting efforts include operating with fewer employees than in 2007, requiring employees to pay for a larger portion of their benefits, and securing as much as $350,000 in rebates from Southern California Edison, according to the water department. According to the water department website, the average water bill in San Bernardino, will be just under $50 per month, higher than average in adjacent Riverside and Redlands, but less than in Colton, Rialto, the East Valley Water District, the Cucamonga Valley Water District, the West Valley Water District and Fontana. Unlike Detroit, where one of the most difficult issues for then U.S. Bankruptcy Judge Steven Rhodes was how to balance the critical public health and safety issues related to water versus affordability; that question appears not to have arisen in San Bernardino.

Can a City Maintain its Sovereignty? Just as the question of sovereignty for a municipality in Virginia has become an issue, so too the question of whether the State of New Jersey will take over Atlantic  City and dissolve its sovereignty, after the New Jersey Division of Local Government Services notified Atlantic City that it has until Monday to comply with the terms of a $73 million state loan or face the possibility of default, warning that, because the city is in violation of its loan terms, it must act swiftly to “cure the breach.” As part of its effortsd to cure that “breach,” Atlantic City has reached an agreement with its water utility to purchase its old municipal airport property in a deal that officials of the city hope will help it avoid a state takeover. The Municipal Utilities Authority, which provides Atlantic City’s drinking water and is financially independent from the city, plans to purchase the 143-acres of the former Bader Field airport for at least $100 million through bonding, officials announced at a press conference yesterday, with Mayor Donald Guardian touting the partnership as a way of maintaining both the city and utility’s “sovereignty” while also helping the city dig its way out of more than $500 million of total debt. Mayor Guardian said he hopes the agreement, one which still needs city council and state approval, prevents New Jersey’s Local Finance Board from taking action after it violated the terms of a $73 million bridge loan that called for dissolving the MUA. Nevertheless, the New Jersey Department of Community Affairs declined to comment on whether the Local Finance Board would accept the Atlantic City MUA plan—a key apprehension after that Board last Thursday had imposed a deadline of next Monday to fix a breach of a condition on its $73 million bridge loan or face a possible default where the state could seek full repayment and withhold state aid—indeed, under the terms of last July’s loan agreement mandating the city needed to dissolve the MUA by September 15th, the state could demand full repayment of the $73 million loan and withhold state aid if the city were unable to avert a default by the October 3 deadline. For his part, MUA Executive Director Bruce Ward said the authority will get an agreement with the city before deciding how to proceed with the property. Mr. Ward added that floating a bond for the Bader Field purchase is attainable and that the MUA has advisors who will help strategize the borrowing. The MUA has $15.7 million in annual revenues with $16.6 million of net water revenue debt outstanding, according to Moody’s Investors Service.

Learning about Debt—or Failing Grades? Moody’s yesterday awarded a failing credit grade to Chicago Public Schools, downgrading CPS’ bond rating further into junk status, lowering its view of the school system’s debt one notch to a B3 rating, citing a variety of factors, including CPS’ reliance on short-term borrowing, a “deepening structural deficit,” and a budget “built on unrealistic expectations” of help from a state government with money woes of its own. If there could be fiscal insult to financial injury, it arrived yesterday when CPS announced budgets at about 300 schools would lose a total of $45 million because of enrollment declines, and the Chicago Teachers Union said its members authorized a strike if contract talks break down. Unsurprisingly, that led the ever so moody Moody’s to warn that its debt rating could decline even further—a downgrade that would make the school district’s borrowing more expensive, even as CPS’ Board is set to vote Wednesday on the system’s $338 million capital budget—a budget projected to swell amid plans to borrow up to $945 million in long-term debt for a variety of other school infrastructure projects. For its part, the union yesterday announced that more than 95% of members who submitted a ballot last week voted in favor of authorizing a strike, easily crossing the requisite 75% threshold: CTU’s House of Delegates will meet Wednesday to discuss a possible strike date which could come as soon as October 11th—a strike, were it to occur, which added to Moody’s fiscal moodiness, as it noted CPS’ “increasingly precarious liquidity position and acute need for cash flow borrowing to support ongoing operations…The downgrade is also based on CPS’s deepening structural deficit, with budgets that are built on unrealistic expectations of assistance from the State of Illinois, which faces its own financial challenges. The rating also incorporates escalating pension contribution requirements, strong employee bargaining groups that impede cost cutting efforts, and elevated debt service expenses.” (CPS is offering raises in a new multi-year contract offer but it wants to phase out the $130 million annual tab for covering 7% of teachers’ 9% pension contribution. The union argues that the contract offer results in a pay cut and is strike-worthy.)

Constructing Post Municipal Bankruptcy City Futures

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eBlog, 6/29/16

In this morning’s eBlog, we welcome Sen. Majority Leader Mitch McConnell’s leadership in taking up the House-passed PROMESA legislation today in the full Senate; Detroit gets a green light to refinance debt, enabling it to issue its first post-municipal bankruptcy general obligation debt; San Bernardino adopts its annual operating budget, marking its first steps towards a post-municipal bankruptcy fiscal sustainability; and Atlantic City hosts a public meeting to explain the steps it is taking to avoid a state takeover.

Puerto Rico: Ensuring Essential Public Services. The Senate will begin debate this morning on the House-passed PROMESA—with a final vote possible by this afternoon. Majority Leader Mitch McConnell (R-Ky.) started the process for consideration by filing for cloture late yesterday, so he will need 60 votes to bar any filibuster. U.S. Treasury Secretary Jack Lew is warning the Senate that any delay in acting on the House-passed PROMESA legislation to avert insolvency could carry severe repercussions for the U.S. territory, advising Senators that if Congress fails to pass a bill by July 1, a torrent of litigation from creditors could put the territory’s public services at risk. Puerto Rico has $2 billion in debt payments due, and government officials have warned they have insufficient funds, leading the Secretary to warn: “In the event of default, and if creditor lawsuits are successful, a judge could immediately order Puerto Rico to pay creditors over essential services such as health, education, and public safety…This could force Puerto Rico to lay off police officers, shut down public transit, or close a hospital.” Sec. Lew added that were Congress to miss the July 1 deadline and pass something retroactively, it would be unable to halt such a judge’s order, meaning the island’s essential public services would be at risk: “Doing nothing now to end the debt crisis will result in a chaotic, disorderly unwinding with widespread consequences…Some well-funded creditors are working hard to delay legislative action this week, even if it comes at the expense of the Puerto Rican people.”

A Motor City Thumbs Up! The Detroit Financial Review Commission, the nine-member Financial Review Commission, created nearly two years ago to ensure the City of Detroit is meeting statutory requirements, and to review and approve the city’s four-year financial plan created as part of its plan of debt adjustment, and to establish programs and requirements for prudent fiscal management, yesterday provided an all clear to proceed with a refunding of $660 million of general obligation debt—a key step which Detroit Finance Director John Naglick described as the last step in the process for the city to return to the municipal bond market: he anticipates a late July, early August issuance date. Yesterday’s approval clears the deck for Detroit to issue its first full faith and credit debt since exiting the largest municipal bankruptcy in U.S. history a little over a year and a half ago—with the projected savings estimated by Director Naglick to be as much as $40 million—savings which he said the city would use to provide budget and property tax relief. Detroit will refund up to $275 million of unlimited tax GO bonds the city sold in 2014, and as much as $385 million of limited tax GO bonds sold in 2010 and 2012. The bonds were issued through the Michigan Finance Authority and carry a backing of the city’s state distributable aid—in Michigan, a municipality can only pledge such distributable state aid on municipal bonds issued by the Michigan Finance Agency. Mr. Naglick added that the projected interest rate savings on the limited tax general obligation bonds will benefit Detroit’s general fund budget by as much as $15 million, while savings on the backed by the pledge of the issuer (generally a city or municipality) to raise taxes, without limit, to service the debt until it is repaid. Because of this feature, unlimited tax bonds may have higher credit ratings and offer lower yields than other comparable municipal bonds of the same maturity. The unlimited tax or UTGO bonds of $24 million, according to Mr. Naglick, will be used to lower the debt millage on the city’s property owners.

Roadmap to Sustainability. The Mayor and Council of San Bernardino have unanimously adopted a balanced budget for FY2016-17—a budget which, in stark contrast to recent years, includes no layoffs, or, as Councilwoman Virginia Marquez said after the vote: “Tonight really marks the first step in the right direction…Since the bankruptcy, we’ve lost a lot of great people. I’m glad to see that this year there are no layoffs needed.” As adopted, the operating budget (the capital budget is to be adopted later this summer) provides 752 employees—some 67 fewer than last fiscal year, but the difference is attributed to the city’s outsourcing of fire and refuse services—steps taken as part of the city’s plan of debt adjustment. In another sign of the city’s fiscal turnaround and steps towards sustainability, the budget includes $400,000 to finance step increases. City Manager Mark Scott presented the budget alongside an extensive list of items not included in the budget that could be wanted, including master plans for street lights and street paving, additional Code Enforcement Staffing and an expansion of the Quality of Life Team. He’ll bring groups of those suggestions to the City Council for possible addition later. Also coming up for discussion later are several items included in the budget that some council members indicated they might not approve. That includes $150,000 for “education” related to a proposed ballot measure to replace the city charter. The cost might be less than that, Mr. Scott said, once a potential expert in ballot item education — which is closely limited by law to prohibit advocacy in favor of the item — and Council members have the chance to approve or not approve the specifics once they are selected: “You’re not locking yourself into anything with your vote today,” Mr. Scott said. The budget projects $112.76 million in general fund revenue and $112.52 million in expenditures, a small surplus.

Betting on one’s City’s Future. Atlantic City Mayor Don Guardian yesterday reported that the city has hired public finance attorneys to restructure some of its $240 million of outstanding bond debt: the attorneys have been brought on to work on reducing the city’s debt load, much of which it took on to pay back casinos which had prevailed over the city on property tax appeals. The attorneys will be a key part of the city’s last gulp effort to put together a fiscal recovery/sustainability plan prior to October 1—where failure would doom the city to a state takeover. The Mayor and Council, at a public meeting last night, made clear the city will be seeking some assistance from surrounding Atlantic County. At the session, Councilman Kaleem Shabazz noted: “Bankruptcy scares investors away. It chills financial markets. Bankruptcy doesn’t solve our problems,” adding as a reminder, moreover, that whether or not the city can even seek municipal bankruptcy is a state rather than the city’s final decision. Thus, he noted: “Atlantic City is a functional, contributing part of the economic engine of the state, so we have to work together.”

For his part, Mayor Guardian spoke about steps the city has taken or is planning, including that the city will ask private companies for bids to see if they could save money on certain services, including trash and recycling, payroll, and towing. He said the city had also asked Atlantic County about sharing senior citizen transportation and some other services.

In describing actions the city has taken to ensure it can control its own destiny, he added the city has increased a number of fees, including for parking meters, which are expected to bring in nearly $800,000 this year, and double that amount next year. (The city’s fiscal year follows the calendar year.) Mayor Guardian said that since he took office in January of 2014, the city had reduced its workforce by 28 percent to 904 as of the end of April, with more employees leaving at the end of this week. The city will also receive $1.7 million for properties it auctioned off on June 23rd and, potentially, another $5 million combined for two other properties.