The Fiscal Straits of Federalism: constitutional, fiscal, and human challenges for state and local leaders.

08/11/17

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Good Morning! In this a.m.’s blog, we consider the dire state of Hartford, Connecticut and the ongoing constitutional and fiscal challenges to the U.S. territory of Puerto Rico.

Fiscal Heart for Hartford? With no state budget in sight, the first day of school looming, Moody’s this week gloomily wondered whether the capitol city can avoid chapter 9 municipal bankruptcy via a path of debt restructuring and labor concessions as it contemplates looming debt payments of $3.8 million next month, and then $26.9 million in tax anticipation note payments in October. Moreover, given the grim state of Connecticut’s own fisc—upon which Hartford relies for half its municipal budget, Halloween could bring more than fiscal ghouls. Its options, moreover, as we have previously noted, are slim: with one fifth of its municipal budget composed of fixed costs, the option of increasing taxes—in a city with the highest tax rates in the state—would risk the loss of key businesses, potentially reducing, rather than increasing vital revenues. Thus, the challenge of meeting increased debt service costs and rising OPEB and pension obligations seem to more and more point to municipal debt restructuring.

If anything, the fiscal challenge is further complicated by the uncertainty on the state front: Connecticut has yet to adopt the budget for the fiscal year that began on July 1st: legislators have been unable to achieve consensus on a new two-year plan the governor will sign to address the state’s own projected $3.5 billion deficit. Indeed, Gov. Daniel P. Malloy’s budget, which proposes shifts of state education aid from wealthier communities to poorer communities, promises difficult negotiations with an uncertain outcome. Patrice McCarthy, the deputy director and general counsel at the Connecticut Association of Boards of Education, warned that while there were previous state budget impasses in 1991 and 2009, this year could be much worse for public school officials: “In those years, while we didn’t have a finalized budget, people had a better idea in each community about how much they’d be receiving: This year, everything is up in the air.”

Fundido. In Latin America, the word fundido can be translated to “dead beat;” while in English, the old expression that one cannot beat a dead horse might seem apt for the challenge confronting U.S. District Judge Laura Taylor Swain, who is presiding over the PROMESA version of a chapter 9 municipal bankruptcy process—a process created under the statute adopted by Congress which Theodore Olson, the former Solicitor General of the United States, this week described in an op-ed to the Wall Street Journal as a law which blatantly violates the Appointments Clause of the U.S Constitution.

Judge Swain this week approved an agreement intended to address creditors’ competing claims with regard to Puerto Rico’s sales tax revenue by the end of this year as part of an effort to resolve an agreement between the island’s two biggest creditor classes, General Obligation bondholders and COFINA bondholders, in part through appointing an agent for each side—agents charged with pursuing the best resolution for their debtor’s estate as a whole, as opposed to advocating for particular creditors of that debtor. (COFINA’s bonds are backed by Puerto Rico’s sales and use tax revenue, unlike Puerto Rico’s General Obligation debt, which carries a constitutional guarantee providing a claim on all of Puerto Rico’s revenues.) Thus, unsurprisingly, Judge Swain had been placed in the position of Solomon: she could threaten to cut the baby in half if the two sides do not reach an agreement by December 15th.  Here, the judicial combatants, who, together, claim to hold approximately half the U.S. territory’s $72 billion in debt, are fighting over which side has the primary claim on sales and use tax revenues.

Separately, Judge Swain this week has held off on responding to a request by creditors of Puerto Rico’s bankrupt power utility, PREPA, to appoint a receiver at the agency, denying a motion by a group of cities and towns to form an official committee in the case, whose attorneys’ fees would be paid by the island’s bankruptcy estate. Judge Swain informed the parties it was unclear whether the municipalities had valid claims against Puerto Rico’s government, a claim which, as we have previously noted, is critical, as Michael Rochelle, an attorney for the muncipios, told the judge his clients are confronted with budget cuts of as much as 50 percent; he plead: “This place will become Greece…We will have municipalities needing to be bankrupted.” Increasingly, too, there are fears that exorbitant legal fees, fees which some experts believe could run to in excess of $1 billion, are coming at the expense of Puerto Rico’s future. In so informing the muncipios, Judge Swain rejected a motion by several municipalities to have a committee representing their interests in Puerto Rico’s Title III case: she said that §1102 of the bankruptcy code allowed committees for creditors or equity security holders, but the municipalities are not the latter, and the municipalities’ principal concerns are not those of being creditors, adding that the municipalities are adequately represented without having their own committee.

The president of the Association of Puerto Rico Mayors, Rolando Ortiz, yesterday made clear the gravity of the fiscal situation, warning that 45 municipalities will be inoperative as early as the close of the fiscal year, under the fiscal plan submitted by Gov. Ricardo Rosselló and certified by the Federal Fiscal Control Board. He noted that the proposal would eliminate a loan of some $350 million, which was granted to municipalities in exchange for exempting public corporations from paying the tax on real property—or, as he stated: “From the fiscal point of view, it leaves us without protection of the judicial apparatus of the country and limits our capacity to serve to the citizens to the extent that they take away resources that we have always used to help the people that we attend in the different cities.”

Indeed, it appears the fiscal impact has already begun to have an effect on the pockets of municipal employees, who have experienced reductions in working hours in 22 municipalities: Arroyo, Toa Alta, Cabo Rojo, Yauco, Las Piedras, Juana Diaz, Comerío, Vieques, Aguadilla, Mayagüez, Toa Baja, Salinas, Adjuntas, Vega Baja, Sabana Grande, Villalba, and Trujillo Alt; five other municipalities had applied the reduction of working hours in previous years. (Ponce, Ciales, Luquillo, Maunabo, and Camuy.) The likely next step, he warned, would be that more municipalities will join the lawsuits filed by the municipalities of San Juan and Caguas—litigation in response to which they said: “The decision of (Judge Swain) what she is going to bring is more cases on the part of the municipalities.” The Mayor of Caguas, a municipality  founded in 1775 of about 150,000 located in the Central Mountain Range, William Miranda Torres, regretted the closure of the judicial door to the municipalities, describing it as a “scenario where they have made decisions, by blow and blow, to make use of our monies without allowing us fair participation,” describing it as “clear discrimination against the municipalities,” noting that the municipalities offer direct services to the citizenry, including  maintenance to infrastructure, health, safety, emergency management, programs to the elderly, garbage collection, cultural programs, fine arts programs and sports programs—adding: “The central government has been stripping municipalities of important resources to provide essential services that will now be very difficult to cover. The humanitarian crisis has come and closing doors give us very few possibilities to fight it from where we can best do it.”

For her part, San Juan Mayor Carmen Yulin Cruz recalled that her municipality continues along the route to sue under PROMESA’s Title VI, even as she praised the management of mayors who filed their appeal by way of Title III: “If the judge (Judge Swain) said it was not for Title III, at least those comrades dared to challenge PROMESA.”

Rising from Municipal Bankruptcies’ Ashes

07/24/17

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Good Morning! You might describe this a.m.’s e or iBlog as The Turnaround Story, as we consider the remarkable fiscal recovery in Atlantic City and observe some of the reflections from Detroit’s riot of half a century ago—a riot which presaged its nation’s largest chapter 9 bankruptcy, before we assess the ongoing fiscal turmoil in the U.S. territory look at Puerto Rico.

New Jersey & You. Governor Chris Christie on Friday announced his administration is delivering an 11.4% decrease in the overall Atlantic City property tax rate for 2017—a tax cut which will provide an annual savings of $621 for the City’s average homeowner, but which, mayhap more importantly, appears to affirm that the city’s fiscal fortunes have gone from the red to the black, after, earlier this month, the City Council accepted its $206 million budget with a proposed 5% reduction in the municipal purpose tax rate, bringing it to about $1.80 per $100 of assessed valuation. Atlantic City’s new budget, after all, marks the first to be accepted since the state took over the city’s finances last November; indeed, as Mayor Don Guardian noted, the fiscal swing was regional: the county and school tax rates also dropped—producing a reduction of more than 11%—and an FY2018 budget $35 million lower than last year—and $56 million below the FY2016 budget: “We had considerably reduced our budget this year and over the last couple of years…I’m just glad that we’re finally able to bring taxes down.” Mayor Guardian added the city would still like to give taxpayers even greater reductions; nevertheless, the tax and budget actions reflect the restoration of the city’s budget authority in the wake of last year’s state takeover: the budget is the first accepted since the state took over the city’s finances in November after the appointment last year of a state fiscal overseer, Jeff Chiesa—whom the Governor thanked, noting:

“Property taxes can be lowered in New Jersey, when localities have the will and leaders step in to make difficult decisions, as the Department of Community Affairs and Senator Jeff Chiesa have done…Our hard work to stop city officials’ irresponsible spending habits is bearing tangible fruit for Atlantic City residents. Annual savings of more than $600 for the average household is substantial money that families can use in their everyday lives. This 11.4% decrease is further proof that what we are doing is working.”

Contributing to the property tax rate decrease is a $35-million reduction in the City’s FY2017 budget, which, at $206.3 million, is about 25% lower than its FY2015 budget, reflecting reduced salaries, benefits, and work schedules of Atlantic City’s firefighters and police officers, as well as the outsourcing of municipal services, such as trash pickup and vehicle towing to private vendors. On the revenue side, the new fiscal budget also reflects a jackpot in the wake of the significant Borgata settlement agreement on property tax appeals—all reflected in the city’s most recent credit upgrade and by Hard Rock’s and Stockton University’s decisions to make capital investments in Atlantic City, as well as developers’ plans to transform other properties, such as the Showboat, into attractions intended to attract a wider variety of age groups to the City for activities beyond gambling—or, as the state-appointed fiscal overseer, Mr. Chiesa noted: “The City is on the road to living within its means…We’re not done yet, but we’ve made tremendous progress that working families can appreciate. We’ll continue to work hard to make even more gains for the City’s residents and businesses.

The Red & the Black. Unsurprisingly, there seems to be little agreement with regard to which level of government merits fiscal congratulations. Atlantic City Mayor Guardian Friday noted: “We had considerably reduced our budget this year and over the last couple of years…“I’m just glad that we’re finally able to bring taxes down.” Unsurprisingly, lame duck Gov. Christie credited the New Jersey Department of Community Affairs and Mr. Chiesa, stating: “Our hard work to stop city officials’ irresponsible spending habits is bearing tangible fruit for Atlantic City residents.” However, Tim Cunningham, the state director of local government services, earlier this month told the Mayor and Council the city and its budget were moving in the “right direction,” adding hopes for the city’s fiscal future, citing Hard Rock and Stockton University’s investment in the city; while Mr. Chiesa, in a statement, added: “The city is on the road to living within its means…We’re not done yet, but we’ve made tremendous progress that working families can appreciate. We’ll continue to work hard to make even more gains for the city’s residents and businesses.”

Do You Recall or Remember at All? Detroit Mayor Mike Duggan, the white mayor of the largest African-American city in America, last month spoke at a business conference in Michigan about the racially divisive public policies of the first half of 20th century which helped contribute to Detroit’s long, painful decline in the second half of the last century—a decline which ended in five torrid nights and days of riots which contributed to the burning and looting of some 2,509 businesses—and to the exodus of nearly 1.2 million citizens. The Mayor, campaigning for re-election, noted: “If we fail again, I don’t know if the city can come back.” His remarks appropriately come at the outset of this summer’s 50th anniversary of the summer the City Detroit burned.

Boston University economics Professor Robert Margo, a Detroit native who has studied the economic effects of the 1960’s U.S. riots, noting how a way of life evaporated in 120 hours for the most black residents in the riot’s epicenter, said: “It wasn’t just that people lived in that neighborhood; they shopped and conducted business in that neighborhood. Overnight all your institutions were gone,” noting that calculating the economic devastation from that week in 1967 was more than a numbers exercise: there was an unquantifiable human cost. That economic devastation, he noted, exacerbated civic and problems already well underway: job losses, white flight, middle-income black flight, and the decay and virtual wholesale abandonment of neighborhoods, where, subsequently, once-vibrant neighborhoods were bulldozed, so that, even today, if we were to tour along main artery of the riot, Rosa Parks Boulevard (which was 12th Street at the time of the riots), you would see overgrown vacant lots, lone empty commercial and light industrial buildings, boarded-up old homes—that is, sites which impose extra security costs and fire hazards for the city’s budget, but continue to undercut municipal revenues. Yet, you would also be able to find evidence of the city’s turnaround: townhouses, apartments, and the Virginia Park Community Plaza strip mall built from a grassroots community effort. But the once teeming avenue of stores, pharmacies, bars, lounges, gas stations, pawn shops, laundromats, and myriad of other businesses today have long since disappeared.

In the wake of the terrible violence, former President Lyndon Johnson created the Kerner Commission, formally titled the National Advisory Commission on Civil Disorders, to analyze the causes and effects of the nationwide wave of 1967 riots. That 426-page report concluded that Detroit’s “city assessor’s office placed the loss—excluding building stock, private furnishings, and the buildings of churches and charitable institutions—at approximately $22 million. Insurance payouts, according to the State Insurance Bureau, will come to about $32 million, representing an estimated 65 to 75 percent of the total loss,” while concluding the nation was “moving toward two societies, one black, one white—separate and unequal.” Absent federal action, the Commission warned, the country faced a “system of ’apartheid’” in its major cities: two Americas: delivering an indictment of a “white society” for isolating and neglecting African-Americans and urging federal legislation to promote racial integration and to enrich slums—primarily through the creation of jobs, job training programs, and decent housing. In April of 1968, one month after the release of the Kerner Commission report, rioting broke out in more than 100 cities across the country in the wake of the assassination of civil rights leader Martin Luther King, Jr.

In excerpts from the Kerner Report summary, the Commission analyzed patterns in the riots and offered explanations for the disturbances. Reports determined that, in Detroit, adjusted for inflation, there were losses in the city in excess of $315 million—with those numbers not even reflecting untabulated losses from businesses which either under-insured or had no insurance at all—and simply not covering at all other economic losses, such as missed wages, lost sales and future business, and personal taxes lost by the city because the stores had simply disappeared. Academic analysis determined that riot areas in Detroit showed a loss of 237,000 residents between 1960 and 1980, while the rest of the entire city lost 252,000 people in that same time span. Data shows that 64 percent of Detroit’s black population in 1967 lived in the riot tracts. U. of Michigan Professor June Thomas, of the Alfred Taubman College of Architecture and Urban Planning, wrote: “The loss of the commercial strips in several areas preceded the loss of housing in the nearby residential areas. That means that some of the residential areas were still intact but negatively affected by nearby loss of commercial strips.” The riots devastated assessed property values—creating signal incentives to leave the city for its suburbs—if one could afford to.

On the small business side, the loss of families and households, contributed to the exodus—an exodus from a city of 140 square miles that left it like a post WWII Berlin—but with lasting fiscal impacts, or, as Professor Bill Volz of the WSU Mike Ilitch School of Business notes: the price to reconstitute a business was too high for many, and others simply chose to follow the population migration elsewhere: “Most didn’t get rebuilt. They were gone, those mom-and-pop stores…Those small business, they were a critical part of the glue that made a neighborhood. Those small businesses anchored people there. Not rebuilding those small businesses, it just hurt the neighborhood feel that it critical in a city that is 140 square miles. This is a city of neighborhoods.” Or, maybe, he might have said: “was.” Professor Thomas adds that the Motor City’s rules and the realities of post-war suburbanization also made it nearly impossible to replace neighborhood businesses: “It’s important to point out that, as set in place by zoning and confirmed by the (city’s) 1951 master plan, Detroit’s main corridors had a lot of strip commercial space that was not easily converted or economically viable given the wave of suburban malls that had already been built and continued to draw shoppers and commerce…This, of course, all came on top of loss of many businesses, especially black-owned, because of urban renewal and I-75 construction.”

Left en Atras? (Left Behind?As of last week, two-thirds of Puerto Rico’s muncipios, or municipalities, had reported system breakdowns, according to Ramón Luis Cruz Burgos, the deputy spokesman of the delegation of the Popular Democratic Party (PPD) in the Puerto Rico House Of Representatives: he added that in Puerto Rico, a great blackout occurs every day due to the susceptibility of the electric power system, noting, for instance, that last month, for six consecutive days, nearly 70 percent of Puerto Rico’s municipalities had problems with electricity service, or, as he stated: “In Puerto Rico we have a big blackout every day. We have investigated the complaints that have been filed at the Autoridad de Energía Eléctrica (AEE) for blackouts in different sectors, and we conclude that daily, two-thirds of the island are left without light. This means that sectors of some 51 municipalities are left in the dark and face problems with the daily electricity service.”

It seems an odd juxtaposition/comparison with the events that triggered the nation’s largest ever chapter 9 municipal bankruptcy in Detroit—even as it reminds us that in Puerto Rico, not only is the Commonwealth ineligible for chapter 9 municipal bankruptcy, but also its municipalities. Mr. Cruz Burgos noted that reliability in the electric power system is one of the most important issues in the economic development of a country, expressing exasperation and apprehension that interruptions in service have become the order of the day: “Over the last two months, we have seen how more than half of the island’s villages are left dark for hours and even for several days, because the utility takes too long to repair breakdowns,” warning this problem will be further aggravated during the month of August, when energy consumption in schools and public facilities increases: “In the last two months, there are not many schools operating and the use of university facilities is also reduced for the summer vacation period. In addition, many employees go on vacation so operations in public facilities reduce their operation and, therefore, energy consumption.”

Jose Aponte Hernandez, Chair of the International and House Relations Committee, blamed the interruptions on the previous administration of Gov. Luis Fortuno, claiming: it had “abandoned the aggressive program of maintenance of the electrical structure implemented by former Gov. Luis Fortuna, claiming: “In the past four years the administration of the PPD did not lift a finger to rehabilitate the ESA structure. On the contrary, they went out of their way to destroy it in order to justify millionaire-consulting contracts. That is why today we are confronting these blackouts.”

The struggle for basic public services—just as there was a generation ago in Detroit, reflect the fiscal and governing challenge for Puerto Rico and its 88 municipalities at a time when non-Puerto Rican municipal bondholders have launched litigation in the U.S. Court of Federal Claims to demand payment of $3.1 billion in principal and interest in Puerto Rico Employment Retirement System bonds (In Altair Global Credit Opportunities Fund (A), LLC et al. v. The United States of America)—the first suit against the U.S. government proper, in contrast to prior litigation already filed against the Puerto Rico Oversight Board, with the suit relying on just compensation claims and that PROMESA is a federal entity. Here, as the Wizard of chapter 9 municipal bankruptcy, Jim Spiotto, notes, the key is whether the PROMESA board was acting on behalf of the federal government or on behalf of Puerto Rico—adding that he believes it was acting for Puerto Rico and, ergo, should not be considered part of the federal government, and that the U.S. Court of Federal Claims may find that the federal government’s actions were illegal. Nevertheless, the issue remains with regard to whether the bonds should be paid from the pledged collateral—in this case being Puerto Rico employer contributions. (The Altair complaint alleges that the PROMESA Board is a federal entity which has encouraged, directed, and even forced Puerto Rico to default on its ERS bonds—a board created by Congress which has directed the stream of employer contributions away from the bondholders and into the General Fund, according to these bondholders’ allegations.

Trying to Recover on all Pistons

07/19/17

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Good Morning! In this a.m.’s eBlog, we look back at the steep road out of the nation’s largest ever municipal bankruptcy—in Detroit, where the Chicago Federal Reserve and former U.S. Chief Bankruptcy Judge Thomas Bennett, who presided over Jefferson County’s chapter 9 municipal bankruptcy case, has noted: “[S]tates can have precipitating roles as well as preventative roles” in work he did for the Chicago Federal Reserve. Indeed, it seems the Great Recession demarcated the nation’s states into distinct fiscal categories: those with state oversight programs which either protected against or offered fiscal support to assist troubled municipalities, versus those, such as Alabama or California—with the former appearing to aid and abet Jefferson County’s descent into chapter 9 bankruptcy, and California, home to the largest number of chapter 9 bankruptcies over the last two decades, contributing to fiscal distress, but avoiding any acceptance of risk. Therefore, we try to provide our own fiscal autopsy of Detroit’s journey into and out of the nation’s largest municipal bankruptcy.

I met in the Governor’s Detroit offices with Kevyn Orr, whom Governor Rick Snyder had asked to come out from Washington, D.C. to serve as the city’s Emergency Manager to take the city into—and out of chapter 9 municipal bankruptcy: the largest in American history. Having been told by the hotel staff that it was unsafe to walk the few blocks from my hotel to the Governor’s Detroit offices on the city’s very first day in insolvency—a day in which the city was spending 38 cents on every dollar of taxes collected from residents and businesses on legacy costs and operating debt payments totaling $18 billion; it was clear from the get go, as he told me that early morning, there was no choice other than chapter 9: it was an essential, urgent step in order to ensure the provision of essential services, including street and traffic lights, emergency first responders, and basic maintenance of the Motor City’s crumbling infrastructure—especially given the grim statistics, with police response times averaging 58 minutes across the city, fewer than a third of the city’s ambulances in service, 40% of the city’s 88,000 traffic lights not working, “primarily due to disrepair and neglect.” It was, as my walk made clear, a city aptly described as: “[I]nfested with urban blight, which depresses property values, provides a fertile breeding ground for crime and tinder for fires…and compels the city to devote precious resources to demolition.” Of course, not just physical blight and distress, but also fiscal distress: the Motor City’s unbalanced fiscal condition was foundering under its failure to make some $108 million in pension payments—payments which, under the Michigan constitution, because they are contracts, were constitutionally binding. Nevertheless, in one of his early steps to staunch the fiscal bleeding, Mr. Orr halted a $39.7 million payment on $1.4 billion in pension debt issued by former Detroit Mayor Kwame Kilpatrick’s administration to make the city pension funds appear better funded than they really were; thus, Mr. Orr’s stop payment was essential to avoid immediate cash insolvency at a moment in time when Detroit’s cash position was in deepening debt. Thus, in his filing, Mr. Orr aptly described the city’s dire position and the urgency of swift action thusly: “Without this, the city’s death spiral I describe herein will continue.”

Today, the equivalent of a Presidential term later, the city has installed 65,000 new streetlights; it has cut police and emergency responder response times to 25% of what they were; it has razed 11,847 blighted buildings. Indeed, ambulance response times in Detroit today are half of what they were—and close to the national average—even as the city’s unrestricted general fund finished FY2016 fiscal year with a $143 million surplus, 200% of the prior fiscal year: as of March 31st, Detroit sported a general fund surplus of $51 million, with $52.8 million more cash on hand than March of last year, according to the Detroit Financial Review Commission—with the surplus now dedicated to setting aside an additional $20 million into a trust fund for a pension “funding cliff” the city has anticipated in its plan of debt adjustment by 2024.  

Trying to Run on all Pistons. The Detroit City Council has voted 7-1 to approve a resolution to allow the Motor City to realize millions of dollars in income tax revenues from its National Basketball Association Pistons players, employees, and visiting NBA players—with such revenues dedicated to finance neighborhood improvements across the Motor City, under a Neighborhood Improvement Fund—a fund proposed in June by Councilwoman (and ordained Minister) Mary Sheffield, with the proposal coming a week after the City Council agreed to issue some $34.5 million in municipal bonds to finance modifications to the Little Caesars Arena—where the Pistons are scheduled to play next season. Councilwoman Sheffield advised her colleagues the fund would also enable the city to focus on blight removal, home repairs for seniors, educational opportunities for young people, and affordable housing development in neighborhoods outside of downtown and Midtown—or, as she put it: “This sets the framework; it expresses what the fund should be used for; and it ultimately gives Council the ability to propose projects.” She further noted the Council could, subsequently, impose additional limitations with regard to the use of the funds—noting she had come up with the proposal in response to complaints from Detroit constituents who had complained the city’s recovery efforts had left them out—stating: “It’s not going to solve all of the problems, and it’s not going to please everyone, but I do believe it’s a step in the right direction to make sure these catalyst projects have some type of tangible benefits for residents.”

Detroit officials estimate the new ordinance will help generate a projected $1.3 million annually. In addition, city leaders hope to find other sources to add to the fund—sources the Councilmember reports, which will be both public and private: “We as a council are going to look at other development projects and sources that could go into the fund too.” As adopted, the resolution provides: “[I]t is imperative that the neighborhoods, and all other areas of the City, benefit from the Detroit Pistons’ return downtown …In turn, the City will receive income tax revenue, from the multimillion dollar salaries of the NBA players as well as other Pistons employees and Palace Sports & Entertainment employees.” The Council has forwarded the adopted proposals to Mayor Duggan’s office for final consideration and action. The proposed new revenues—unless the tax is modified or rejected by the Mayor—would be dedicated for use in the city’s Neighborhood Improvement Fund in FY2018—with decisions with regard to how to allocate the funds—by Council District or citywide—to be determined at a later date. The funds, however, could also be used to address one of the lingering challenges from the city’s adopted plan of debt adjustment from its chapter 9 bankruptcy: meeting its public pension obligations when general fund revenues are insufficient, “should there be any unforeseen shortfall,” as the resolution provides.

This fiscal recovery, however, remains an ongoing challenge: Detroit CFO John Hill laid up the proverbial hook shot up by advising the Council that the reason the city reserved the right to use the Pistons tax revenue to cover pension or debt obligation shortfalls was because of the large pension obligation payment the city will confront in 2024: “We knew that in meeting our pensions and debt obligation in 2024 and 2025 that those funds get very tight: If this kind of valve wasn’t there, I would have a lot of concerns that in those years its tighter and we don’t get revenues we expect we don’t get any of those funds to meet those obligations.”

But, as in basketball, there is another side: at the beginning of the week, the NBA, Palace Sports & Entertainment, and Olympia Entertainment were added to a federal lawsuit—a suit filed in late June by community activist Robert Davis and Detroit city clerk candidate D. Etta Wilcox against the Detroit Public Schools Community District. The suit seeks to force a vote on the $34.5 million public funding portion of the Pistons’ deal, under which Detroit, as noted above, is seeking to capture the school operating tax, the proceeds of which are currently used to service $250 million of bonds DDA bonds previously issued for the arena project in addition to the $34.5 million of additional bonds the city planned to issue for the Pistons relocation.

Emerging from Chapter 9–and the conflict between fiscal and physical safety.

07/07/17

Good Morning! In this a.m.’s eBlog, we consider the final emergence of Orange County, California from chapter 9 municipal bankruptcy; then we consider the ongoing fiscal and fiscal challenges for Flint’s leaders from its fiscal & physical challenges.

Free at Last? Twenty-three years ago, when the former Orange County, California Treasurer, Robert Citron, then managing an investment pool for southern California municipalities, speculated unwisely, the municipal pool he managed lost $1.64 billion—plunging the county into the first chapter 9 municipal bankruptcy of the modern era (California §53760)—a chapter 9 bankruptcy from which the County emerged this week in the wake of its final payment on the $1 billion worth of municipal bonds it had issued. Orange County, however, still owes approximately $20 million to various cities and agencies that have a separate repayment agreement—debt Orange County expects to resolve by late next year. (A subsequent grand jury investigation later found that Mr. Citron, who had earned praise for his investment skills, relied on a mail order astrologer and a psychic for interest rate predictions as Orange County’s Treasurer.)

For this writer, the emergence evokes memories of how controversial the concept of municipal bankruptcy had been—at the time—for the National League of Cities to advocate for the changes in chapter 9: the then Executive Director and the then President of NLC (former New York City Council Chair Carol Bellamy) decried the notion that an association of municipal elected leaders would support facilitating filing for municipal bankruptcy; yet the Orange County case illuminated its importance by demonstrating how important it was to have a mechanism in federal law to ensure continuity in the provision of essential municipal public services.  

In the case of Orange County, the insolvency of an investment pool it ran on behalf of itself and other municipalities in the region would have, absent the kinds of protections provided under chapter 9, risked plunging municipalities in the region into insolvency without a mechanism to ensure vital public services and operations. The County’s insolvency and threat to the other municipalities in the region was its own kind of tremor: a fiscal, rather than physical tremor. In the end, the access to chapter 9 meant the county was able to issue $1 billion in municipal bonds to avoid a critical default and ensure avoidance of any disruption in essential municipal services—bonds the payments on which ($1.5 billion including interest) were finally completed at the beginning of this month when the County made its final payment on that bankruptcy bond debt. While the price to its taxpayers was steep–repayments averaged $68 million a year, and the loss of vital public improvements and services great; the shock it sent to the nation’s cities was key in helping Congress better understand that while an Eastern Airlines could file for federal bankruptcy protection and simply walk away from its services and debts; that could never be the case for a city or county: there had to be a mechanism in federal law to ensure that a city, county, or public school system could continue to operate during insolvency.  

In managing these municipalities’ investment pool, Mr. Citron made unlucky/unwise wagers on interest rates—so unwise that the multi-jurisdiction investment pool suffered a crippling $1.64 billion loss. Now California State Senator John Moorlach, who prior to his Senate service was twice re-elected Orange County Treasurer-Tax Collector after running against Mr. Citron in 1994, has noted: “The bankruptcy dramatically changed my life…I sort of feel like I lived in a movie. I was an officer of the county when those recovery bonds were issued, and I wondered if I’d live long enough to see them paid off. It was a great turn-around opportunity. A lot has changed since then, and the county is better for it. It’s been nearly 23 years, and no one has been able to pull a stunt like this again. It’s a good day.”

While the “day” is not quite over: there are still another $19.7 million which must be settled before all municipal bankruptcy-related bills are resolved; the fiscal lesson appears to have been learned—or as current Supervisor William Steiner put it: “Despite the checks and balances now, and a commitment to strategic planning, there is always the chance that institutional memory will fade as time goes by and as leadership changes…The county has essentially fared well over the years despite the bankruptcy. Still, millions of dollars have been diverted from other important county departments and priorities.” The godfather of modern-day chapter 9 municipal bankruptcy, the incomparable Jim Spiotto, with whom I had the great fortune to work for so many years to achieve enactment of today’s municipal bankruptcy laws, appropriately notes: “Chapter 9 is the most extreme remedy, the last resort, if you can even call it a last resort.” Nevertheless, as he puts it, it creates a powerful tool for a municipality to avoid a potentially devastating “run on the bank.”

Out Like Flint? The State of Michigan, whose former Emergency Manager law played the critical role precipitating the grave physical and fiscal crisis affecting Flint, is now pressing the Flint City Council to vote on a long-term water contract under which Flint would lose rights to a municipal bond financed water pipeline—after the City Council two weeks ago voted to extend the city’s water delivery contract with the Great Lakes Water Authority (GLWA) until September, but delayed a vote on a longer term proposal by Mayor Karen Weaver to extend the contract for 30-years. Unsurprisingly, the state is now ramping up the pressure: in the wake of this week’s City Council vote, the state Department of Environmental Quality (MDEQ) filed suit against the city over the delay on a long-term arrangement, with the state alleging that the City Council’s refusal to approve a long-term water contract is endangering public health in the wake of the city’s lead contamination crisis. The complaint seeks a declaration that the Council’s failure to act is a violation of the federal Safe Drinking Water Act and a mandate that the city must enter into the long-term agreement with the GLWA negotiated by Mayor Weaver. The MDEQ charges that the city would be wasting its resources if it refuses to quit its current Karegnondi water pipeline plan: “The MDEQ has determined that the City Council’s failure to approve the agreement with GLWA and continued consideration of other options that may require operation of the water treatment plant places public health at risk.”

Under the proposed long-term contract, Flint would lose water rights to the Karegnondi Water Authority (KWA) (a new pipeline to Lake Huron, which is currently under construction). Thus, as Flint has awaited completion of the Karegnondi pipeline, it has been drawing its water from the Flint River—withdrawals which contributed to corroding pipes and lead contamination. Flint has been preparing to shift to KWA supplied, un-treated water in two years—with plans to construct vital upgrades to its treatment plant to meet EPA-mandated standards. In April, Mayor Weaver dropped the plan to make the switch to the bond-financed pipeline and recommended the city continue to purchase water from GLWA, believing that the GLWA supplied and treated water is more affordable—and apprehensive about the risk of another supply shift. With the city’s fiscal and physical health scarred by the water contamination crisis which came in the wake of the state-appointed emergency manager’s fateful decision to allow the city’s contract with Detroit for Lake Huron-treated water to expire—Mayor Weaver advised: “The recommendation I put forward months ago is the best option to protect public health and is supported by the public health community…[It] would also allow the City to avoid a projected 40 percent water rate increase and ensure the City of Flint gets millions of dollars to continue replacing lead tainted pipes and make much-needed repairs to our damaged infrastructure so we are able to deliver quality water to residents. The people of Flint have waited long enough for a reliable, permanent water source. Implementing my recommendation will provide that, and will allow us to move forward as a community and focus more on rebuilding our City.” Under her plan, Flint would recoup the roughly $7 million in annual debt service by transferring its KWA water rights to the GLWA.

Nevertheless, as Flint Councilmember Eric Mays described his apprehensions with regard to Flint losing its rights to the KWA pipeline, he recommended the city retain the asset: “My position is that the since the Governor won’t apologize, and the state has the money they can pay the bond; and whether we ever use the KWA asset, I don’t want, at this juncture, to turn over that asset and lose those rights under the deal with GLWA…I would be almost ready to vote for the GLWA deal if we could tweak it and get that bond off to the state and still retain the asset.” He added that he is the only Councilmember to propose an alternative to Mayor Weaver’s plan—a plan, he added, on which the Council “has done nothing.” Rather, he believes the State of Michigan, the precursor of the fiscal and physical crisis, should bear the burden for the municipal bond payments: “Since the MDEQ issued a suspicious administrative consent order for minor repairs and put it into the bond prospectus at the initial bond sale, my position is that Governor has the money and can pay the bond.”

Disparate Fiscal Solvency Challenges

06/23/17

Good Morning! In this a.m.’s eBlog, we consider the serious municipal fiscal challenges in Ohio, where the decline in coal-fired power has led Adams County auditor David Gifford to warn that if its existing power plants close, the county could be forced to raise its property tax rates at least 500% in order to make its requisite school district bond interest payments. Then we turn to the steep fiscal trials and tribulations of implementing San Bernardino’s post-chapter 9 exit, before finally considering the governing challenges affecting the City of Flint’s physical and fiscal future, and then to the criminal charges related to Flint’s fiscal and moral insolvency. Finally, we turn to the potential for a new fiscal chapter for the nearly insolvent Virginia municipality of Petersburg.

Fiscal Municipal Distress in Coal Country. While President Trump has stressed his commitment to try to protect the U.S. coal industry, less attention has been focused on the municipal fiscal challenges for local elected leaders. For instance, in Adams County, Ohio, where the median income for a household is about $33,000, and where approximately 20% of families fall below the federal poverty line, the county, with a population near 22,000, has been in fiscal emergency for more than two years—making it one of 23 such jurisdictions in the state.  But now its auditor, David Gifford, warns that if its coal-fired power plants close, the county could be forced to raise the property tax by at least 500% in order to make the bond payments on its public school districts debt. (In Ohio, when so designated, the average time a municipality spends in fiscal emergency averages about five years.) Since 1980, when the state auditor was empowered to place municipalities in fiscal emergency, Ohio has declared and released 54 communities—with time spent in fiscal emergency averaging five years, albeit the Village of Manchester in Adams County (approximately 2,000 residents) holds the record for time spent in fiscal emergency — nearly 20 years and still counting. Over the past five years, some 350 coal-fired generating units have closed across the country, according to the Energy Information Administration: closures, which have cost not just jobs, but key tax revenues vital to municipal solvency. It is uncertain whether any actions by the White House could make coal viable as a source of energy generation; it is clear that neither the Trump Administration, nor the State of Ohio appear to have put together fiscal options to address the resulting fiscal challenges. Ohio Municipal League Director Kent Scarrett, in testimony before the Ohio Legislature last February, on behalf of the League’s 733 municipal members, in which close to 90% of Ohio’s citizens live, reminded legislators that “a lack of opportunity to invest in critical infrastructure projects” and “the myriad of challenges that present themselves as a result of the escalating opioid epidemic,” would require “reigniting the relationship between the state and municipalities.” 

Post Municipal Bankruptcy Challenges. San Bernardino Mayor Carey Davis this Wednesday declared the city’s municipal bankruptcy process officially over, noting San Bernardino had come “to the momentous exit from that process,” a five-year process which resulted in the outsourcing of its fire department to San Bernardino County, contracting out waste removal services, and reductions in healthcare benefits for retirees and current employees to lessen the impact on pensions. Mayor Davis noted: “The proceedings guided us through a process of rebuilding and restructuring, and we will continue to rebuild and create systems for successful municipal operations,” as the City Council confronted by what City Manager Mark Scott warned was “without a doubt among the lowest in per capita revenues per capita and in city employees per capita,” yet still confronted by what he described as:  “Among California’s largest cities, San Bernardino is without a doubt among the lowest in government revenues per capita and in city employees per capita…Furthermore, our average household income is low and our poverty rate is high.” Nevertheless, the Council adopted its first post-chapter 9 budget—a budget which is projected to achieve a surplus of $108,000, sufficient to achieve a 15% reserve. To give a perspective on the fiscal challenge, Mr. Scott warned the Mayor and City Council: “Among California’s largest cities, San Bernardino is without a doubt among the lowest in government revenues per capita and in city employees per capita…Furthermore, our average household income is low and our poverty rate is high.” Adding that San Bernardino’s property values and business spending are lower than other cities, contributing to its low revenue, he added: “At the same time, it costs roughly the same to repair a street in Rancho Cucamonga as in San Bernardino: California’s tax system rewards wealth.”

Nevertheless, even though San Bernardino’s plan of debt adjustment calls for minimal revenue growth over the next two decades, he advised that the plan is focused on making the city more attractive. Ergo, he proposed three criteria: 1) urgent safety concerns, including the relocation of City Hall to address unreinforced masonry concerns; 2) restoration of public safety, 30 new police officers, vehicle and safety equipment replacement, radio maintenance, and a violence intervention initiative; 3) greater efficiencies, via information technology upgrades, and economic development and revenue growth—to be met by hiring a transportation planner, associate planner, grant-writing, and consulting. In addition to the operating budget, the manager also focused on the city’s capital budget, proposing significant investment for the next two to three years. Some of these increased costs would be offset by reducing the city’s full-time city employees by about 4%. Nevertheless, the Manager noted: “The community’s momentum is clearly increasing, and we are building internal capacity to address our management challenges…We look forward to the next year and to our collective role in returning this city to a more prosperous condition.”

Under its plan of debt adjustment, San Bernardino began making distributions to creditors this month: Mayor Carey Davis noted: “From the beginning, we understood the time, hard work, sacrifice and commitment it would take for the city to emerge from the bankruptcy process,” in asking the Council to adopt the proposed $160 million operating budget and a $22.6 million capital budget.

Moody Blues. The fiscal challenge of recovering from municipal bankruptcy for the city was highlighted last April when Moody’s Investors Service analysts had warned that the city’s plan of debt adjustment approved by U.S. Bankruptcy Judge Meredith Jury would “lead to a general fund unallocated cash balance of approximately $9.5 million by fiscal 2023, down from a $360 million deficit the city projected in 2013 for the fiscal years 2013-23,” adding, however, that the city still faces hurdles with pensions, public safety, and infrastructure. Noting that San Bernardino’s plan of debt adjustment provided more generous treatment of its pension obligations than its municipal bondholders—some of its unsecured creditors will receive as little as 1% of what they are owed—and the city’s pension obligation bondholders will take the most severe cuts—about 60%–or, as Moody’s moodily noted: “The [court-approved] plan calls for San Bernardino to leave bankruptcy with increased revenues and an improved balance sheet, but the city will retain significant unfunded and rapidly rising pension obligations…Additionally, it will face operational challenges associated with deferred maintenance and potential service shortfalls…which, added to the pension difficulties, increase the probability of continued financial distress and possibly even a return to bankruptcy.”

The glum report added that San Bernardino’s finances put its aging infrastructure at risk, noting the deferral of some $180 million in street repairs and $130 million in deferred facility repairs and improvements, and that the city had failed to inspect 80 percent of its sewer system, adding: “Cities typically rely on financing large capital needs with debt, but this option may no longer exist for San Bernardino…Even if San Bernardino is able to stabilize its finances, the city will still face a material infrastructure challenge.”  Moody’s report added: “Adjusted net pension liability will remain unchanged at $904 million, a figure that dwarfs the projected bankruptcy savings of approximately $350 million.”

Justice for Flint? Michigan Attorney General Bill Schuette has charged Michigan Health and Human Services Director Nick Lyon with involuntary manslaughter and misconduct in office, making the Director the fifth state official, including a former Flint emergency manager and a member of Gov. Rick Snyder’s administration, to be confronted with involuntary manslaughter charges for their alleged roles in the Flint water contamination crisis and ensuing Legionnaire’s disease outbreak which has, to date, claimed 12 lives, noting: “This is about people’s lives and families and kids, and it’s about demonstrating to people across the state—it doesn’t matter who you are, young, old, rich, poor, black, white, north, south, east, west. There is one system of justice, and the rules apply to everybody, whether you’re a big shot or no shot at all.” To date, 12 people have died in the wake of the switch by a state-appointed Emergency Manager of the city’s drinking water supply to the Flint River—a switch which led to an outbreak of Legionnaires’ disease that resulted in those deaths. Flint Mayor Karen Weaver, in response, noted: “We wanted to know who knew what and when they knew it, and we wanted someone to be held accountable. It’s another step toward justice for the people Flint,” adding that: “What happened in Flint was serious: Not only did we have people impacted by lead poisoning, but we had people who died.”

In making his charges, Attorney General Schuette declined to say whether he had subpoenaed Governor Rick Snyder—with the charges coming some 622 days after Gov. Snyder had acknowledged that Flint’s drinking water was tainted with lead—and that the state was liable for the worst water tragedy in Michigan’s history—a tragedy due, in no small part, from the state appointment of an emergency manager to displace the city’s own elected leaders.

The state Attorney General has charged HHS Director Lyon in relation to the individual death of Robert Skidmore, who died Dec. 13, 2015, “as a result of [Mr.] Lyon’s failure to warn the public of the Legionnaires’ outbreak; the court has also received testimony that the Director “participated in obstructing” an independent research team from Wayne State University which was investigating the presence of Legionella bacteria in Flint’s water. In addition, four defendants who have been previously charged, former Flint Emergency Manager Darnell Earley, former Michigan Department of Environmental Quality drinking water Director Liane Shekter-Smith, DEQ drinking water official Stephen Busch, and former City of Flint Water Department manager Howard Croft, each now face additional charges of involuntary manslaughter in Mr. Skidmore’s death—bringing, to date, 15 current or former Michigan or Flint city officials to have been charged.

Attorney General Scheutte, at a press conference, noted: “Involuntary manslaughter is a very serious crime and a very serious charge and holds significant gravity and weight for all involved.” He was joined by Genesee County Prosecutor David Leyton, Flint Water Investigation Special Prosecutor Todd Flood, and Chief Investigator Andrew Arena. (In Michigan, involuntary manslaughter is punishable by up to 15 years in prison and/or a $7,500 fine.) The announcement brings to 51 the number of charges leveled against 15 current and former local and state leaders as a result of the probe during which 180 witnesses have been interviewed—and in the wake of the release this week of an 18-page interim investigation report, which notes: “The Flint Water Crisis caused children to be exposed to lead poisoning, witnessed an outbreak of Legionnaires’ disease resulting in multiple deaths, and created a lack of trust and confidence in the effectiveness of government to solve problems.”

A New City Leader to Take on Near Insolvency. Petersburg, Virginia has hired a new City Manager, Aretha Ferrell-Benavides, just days after consultants charged with the fiscal challenge of extricating the city from the brink of municipal bankruptcy advised the Mayor and Council the municipality needed a $20 million cash infusion to make up a deficit and comply with its own reserve policies: increased taxes, they warned, would not do the trick; rather, in the wake of a decade of imbalanced budgets that drained the city’s rainy day funds, triggered pay cuts, disrupted the regional public utility, and forced steep cuts in public school funding, the city needed a new manager. Indeed, on her first day, Ms. Ferrell-Benavides said: “To have the opportunity to come in and make a difference in a community like this, it’s worth its weight in gold.” The gold might be heavy: her predecessor, William E. Johnson III, was fired last year as the city fiscally foundered—leading Mayor Sam Parham to note: “We’re looking forward to a new beginning, better times for the city of Petersburg.”

Manager Ferrell-Benavides won out in a field of four aspirants, with Mayor Parham noting: “She was definitely head and shoulders above the other candidates…She had clear, precise answers and a 90-day plan of action,” albeit that plan has yet to be shared until after she meets with department heads and residents in order to get a better understanding of the city’s needs. Nevertheless, City Councilman Charles Cuthbert noted: “Her energy and her warm personality and her expressions of commitment to help Petersburg solve its problems stood out…My sense is that she truly views these problems as an opportunity.” In what will mark a fiscal clean slate, Manager Ferrell-Benavides will officially begin on July 10th, alongside a new city Finance Director Blake Rane, and Police Chief Kenneth Miller, who is coming to Petersburg from the Virginia Beach Police Department. She brings considerable governmental experience, including more than 25 years of work in government for the State of Maryland, the Chicago Public Housing Authority, the City of Sunnyvale, Calif.; and Los Alamos, New Mexico—in addition to multiple jobs with the District of Columbia.

 

Solomon’s Choices: Who Will Define Puerto Rico’s Fiscal Future–and How?

eBlog

Good Morning! In this a.m.’s eBlog, we consider the growing physical and fiscal breakdown in the U.S. Territory of Puerto Rico as it seeks, along with the oversight PROMESA Board, an alternative to municipal bankruptcy. 

Tropical Fiscal Typhoon. U.S. Supreme Court Chief Justice John Roberts has selected Southern District of New York Judge Laura Taylor Swain, who previously served as a federal bankruptcy Judge for the Eastern District of New York from 1996 until 2000 to preside over Puerto Rico’s PROMESA Title III bankruptcy proceedings—presiding, thus, over a municipal bankruptcy nearly 500% larger than that of Detroit’s–one which will grapple with creating a human and fiscal blueprint for the future of some 3.5 million Americans—and force Judge Swain to grapple with the battle between the citizens of the country and the holders of its debt spread throughout the U.S. (Title III of PROMESA, which is modeled after Chapter 9 of the Municipal Bankruptcy Code and nearly a century of legal precedent, provides a framework for protecting Puerto Rico’s citizens while also respecting the legitimate rights and priorities of creditors.) For example, the recent Chapter 9 restructuring in Detroit sought reasonable accommodations for vulnerable pensioners and respected secured creditors’ rights.

The action came in the wake of Puerto Rico’s announcement last week that it was restructuring a portion of its nearly $73 billion in debt—an action which it was clear almost from the get-go that the requisite two-thirds majority of Puerto Rico’s municipal bondholders would not have supported. (Puerto Rico’s constitution provides that payments to holders of so-called “general obligation” bonds have priority over all other expenditures—even as another group of creditors has first access to revenues from the territory’s sales tax.) More critically, Judge Swain will be presiding over a process affecting the lives and futures of some 3.5 million Americans—nearly 500% greater than the population of Detroit. And while the poverty rate in Detroit was 40%, the surrounding region, especially after the federal bailout of the auto industry, differs signally from Puerto Rico, where the poverty rate is 46.1%–and where there is no surrounding state to address or help finance schools, health care, etc. Indeed, Puerto Rico, in its efforts to address its debt, has cut its health care and public transportation fiscal support; closed schools; and increased sales taxes. With the Bureau of Labor Statistics reporting an unemployment rate of at 12.2%, and, in the wake of last year’s Zika virus, when thousands of workers who were fighting the epidemic were let go from their jobs; the U.S. territory’s fiscal conditions have been exacerbated by the emigration of some of its most able talent—or, as the Pew Research Center has noted:  “More recent Puerto Rican arrivals from the island are also less well off than earlier migrants, with lower household incomes and a greater likelihood of living in poverty.”

For Judge Swain—as was the case in Detroit, Central Falls, San Bernardino, Stockton, etc., a grave challenge in seeking to fashion a plan of debt adjustment will resolve around public pensions. While the state constitutional issues, which complicated—and nearly led to a U.S. Supreme Court federalism challenge—do not appear to be at issue here; nevertheless the human aspect is. Just as former Rhode Island Supreme Court Judge Robert G. Flanders, Jr., who served as Central Falls’ Receiver during that city’s chapter 9 bankruptcy—and told us, with his voice breaking—of the deep pension cuts which he had summarily imposed of as much as 50%—so too Puerto Rico’s public pension funds have been depleted. Thus, it will fall to Judge Swain to seek to balance the desperate human needs on one side versus the demands of municipal bondholders on the other. Finally, the trial over which Judge Swain will preside has an element somewhat distinct from the others we have traced: can she press, as part of this process to fashion a plan of debt adjustment, for measures—likely ones which would have to emanate from Congress—to address the current drain of some of Puerto Rico’s most valuable human resources: taxpayers fleeing to the mainland. Today, Puerto Rico’s population is more than 8% smaller than seven years ago; the territory has been in recession almost continuously for a decade—and Puerto Rico is in the midst of political turmoil: should it change its form of governance: a poll two months’ ago found that 57% support statehood. Indeed, even were Puerto Rico’s voters to vote that way, and even though the 2016 GOP platform backed statehood; it seems most unlikely that in the nation’s increasingly polarized status the majority in the U.S. Congress would agree to any provision which would change the balance of political power in the U.S. Senate.

Is There a PROMESA of Recovery?

eBlog

Good Morning! In this a.m.’s eBlog, we consider the growing physical and fiscal breakdown in the U.S. Territory of Puerto Rico as it seeks, along with the oversight PROMESA Board, an alternative to municipal bankruptcy, after which we journey north to review the remarkable fiscal recovery from chapter 9 municipal bankruptcy of one of the nation’s smallest municipalities.

Tropical Fiscal Typhoon. Puerto Rico is trapped in a vicious fiscal whirlpool where the austerity measures it has taken to meet short-term obligations to its creditors all across the U.S., including laying off some 30,000 public sector employees and increasing its sales tax by nearly 75% have seemingly backfired—doing more fiscal harm than good: it has devastated its economy, depleted revenue sources, and put the government on a vicious cycle of increasingly drastic fiscal steps in an effort to make payments—enough so that nearly 33% of the territory’s revenue is currently going to creditors and bondholders, even as its economy has shrunk 10% since 2006, while its poverty rate has grown to 45%. At the same time, a demographic imbalance has continued to accelerate with the exit of some 300,000 Puerto Ricans—mostly the young and better educated—leaving for Miami and New York. Puerto Rico and its public agencies owe $73 billion to its creditors, nearly 500% greater than the nearly $18 billion in debts accumulated by Detroit when it filed for chapter 9 municipal bankruptcy four years ago in what was then the largest municipal bankruptcy in U.S. history. Thus, with the island’s hedge-fund creditors holding defaulted municipal general obligation bonds on the verge of completing a consensual agreement earlier this week, the PROMESA oversight board intervened to halt negotiations and place Puerto Rico under the Title III quasi municipal bankruptcy protection. That will set up courtroom confrontations between an impoverished population, wealthy municipal bondholders in every state in the domestic U.S., and hedge funds—pitted against some of the poorest U.S. citizens and their future. Nevertheless, as Congress contemplated, the quasi-municipal bankruptcy process enacted as part of the PROMESA statute provides the best hope for Puerto Rico’s future.

Thus the PROMESA Board has invoked these provisions of the PROMESA statute before a federal judge in San Juan, in what promises to be a long process—as we have seen in Detroit, San Bernardino, and other cities, but with one critical distinction: each of the previous municipal bankruptcies has involved a city or county—the quasi municipal bankruptcy here is more akin to a filing by a state. (Because of the dual federalism of our founding fathers, Congress may not enact legislation to permit states to file for bankruptcy protection.) Unsurprisingly, when Puerto Rico was made a U.S. territory under the Jones-Shafroth Act, no one contemplated the possibility of bankruptcy. Moreover, as chapter 9, as authorized by Congress, only provides that a city or county may file for chapter 9 bankruptcy if authorized by its respective state; Puerto Rico inconveniently falls into a Twilight Zone—to write nothing with regard to access to such protections for Puerto Rico’s 87 municipalities or muncipios.

Moreover, while from Central Falls, Rhode Island to Detroit, the role of public pension obligations has played a critical role in those chapter 9 resolutions; the challenge could be far greater here: in Puerto Rico, retired teachers and police officers do not participate in Social Security. Adopting deep cuts to their pensions would be a virtual impossibility. So now it is that Puerto Rico will be in a courtroom to confront hedge funds, mutual funds, and bond insurers, after the negotiations between Puerto Rico and its creditors over a PROMESA Board-approved fiscal plan that allocates about $787 million a year to creditors for the next decade, less than a quarter of what they are owed, was deemed by said creditors to be a slap in the face—with the Board having pressed for a combination of debt restructuring spending cuts in its efforts to revive an economy trapped by a 45% poverty rate—and where the Board had proposed upping water rates on consumers, liquidating its decades-old industrial development bank, and seeking concessions from creditors of other government agencies. Moreover, amid all this, Gov. Ricardo Rosselló, who has recently renegotiated to mitigate politically unpopular fee increases on residents, now finds himself nearly transfixed between desperate efforts to sort out governance, meet demands of his constituents and taxpayers, and negotiate with a federally imposed oversight board, even as he is in the midst of a campaign for U.S. statehood ahead of a plebiscite on Puerto Rico’s political status—and in the wake of being named a defendant in a lawsuit by hedge funds after the expiration of a stay on such suits expired this week. Hedge funds holding general obligation and sales-tax bonds filed the suit on Tuesday, naming Gov. Rosselló as a defendant—albeit, the suit, and others, are nearly certain to be frozen, as the main judicial arena now will fall into a quasi-chapter 9 courtroom epic battle. And that battle will not necessarily be able to fully look to prior chapter 9 judicial precedents: while Title III incorporates features of chapter 9, the section of the U.S. bankruptcy code covering insolvent municipal entities, courts have never interpreted key provisions of Title III—a title, moreover, which protections for creditors which chapter 9 does not.

The Rich Chocolatey Road to Recovery! Moody’s has awarded one of the nation’s smallest municipalities, Central Falls, aka Chocolate City, Rhode Island, its second general obligation bond upgrade in two months, a sign of the former mill city’s ongoing recovery from municipal bankruptcy—an upgrade which Mayor James Diossa unsurprisingly noted to be “very important.” Moody’s noted that its upgrade “reflects a multi-year trend of stable operating results and continued positive performance relative to the post-bankruptcy plan since the city’s emergence from Chapter 9 bankruptcy in 2012,” adding that it expects the city will enhance its flexibility when its plan of debt adjustment period ends at the end of next month—at which time one of the nation’s smallest cities (one square mile and 19,000 citizens) will implement a policy of requiring maintenance of unassigned general fund reserves of at least 10% of prior year expenditures. In its upgrade, Moody’s reported the upgrade reflected Central Falls’ high fixed costs, referring to its public pension obligations, OPEB, and debt service–costs which add up to nearly 30% of its budget—and what it termed a high sensitivity to adverse economic trends compared with other municipalities, with the rating agency noting that a sustained increase in fund balance and maintenance of structural balance could lead to a further upgrade, as could a reduction in long-term liabilities and fixed costs and material tax-base and growth.