What Lessons Can State & Local Leaders Learn from Unique Fiscal Challenges?

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eBlog, 04/25/17

Good Morning! In this a.m.’s eBlog, we consider the unique fiscal challenges in Michigan and how the upswing in the state’s economy is—or, in this case, maybe—is not helping the fiscal recovery of the state’s municipalities. Then we remain in Michigan—but straddle to Virginia, to consider state leadership efforts in each state to rethink state roles in dealing with severe fiscal municipal distress. Finally, we zoom to Chicago to glean what wisdom we can from the Godfather of modern municipal bankruptcy, Jim Spiotto: What lessons might be valuable to the nation’s state and local leaders?  

Fiscal & Physical Municipal Balancing I. Nearly a decade after the upswing in Michigan’s economic recovery, the state’s fiscal outlook appears insufficient to help the state’s municipalities weather the next such recession. Notwithstanding continued job growth and record auto sales, Michigan’s per-capita personal income lags the national average; assessed property values are below peak levels in 85% of the state’s municipalities; and state aid is only 80% of what it was 15 years ago.  Thus, interestingly, state business leaders, represented by the Business Leaders for Michigan, a group composed of executives of Michigan’s largest corporations universities, is pressing the Michigan Legislature to assume greater responsibility to address growing public pension liabilities—an issue which municipal leaders in the state fear extend well beyond legacy costs, but also where fiscal stability has been hampered by cuts in state revenue sharing and tax limitations. Michigan’s $10 billion general fund is roughly comparable to what it was nearly two decades ago—notwithstanding the state’s experience in the Great Recession—much less the nation’s largest ever municipal bankruptcy in Detroit, or the ongoing issues in Flint. Moreover, with personal income growth between 2000 and 2013 growing less than half the national average (in the state, the gain was only 31.1%, compared to 66.1% nationally), and now, with public pension obligations outstripping growth in personal income and property values, Michigan’s taxpayers and corporations—and the state’s municipalities—confront hard choices with regard to “legacy costs” for municipal pensions and post-retirement health care obligations—debts which today are consuming nearly 20 percent of some city, township, and school budgets—even as the state’s revenue sharing program has dropped nearly 25 percent for fiscally-stressed municipalities such as Saginaw, Flint, and Detroit just since 2007—rendering the state the only state to realize negative growth rates (8.5%) in municipal revenue in the 2002-2012 decade, according to numbers compiled by the Michigan Municipal League—a decade in which revenue for the state’s cities and towns from state sources realized the sharpest decline of any state in the nation: 56%, a drop so steep that, as the Michigan Municipal League’s COO Tony Minghine put it: “Our system is just broken…We’re not equipped to deal with another recession. If we were to go into another recession right now, we’d see widespread communities failing.” Unsurprisingly, one of the biggest fears is that another wave of chapter 9 filings could trigger the appointment of the state’s ill-fated emergency manager appointments. From the Michigan Municipal League’s perspective, any fiscal resolution would require the state to address what appears to be a faltering revenue base: Michigan’s taxable property is appreciating too slowly to support the cost of government (between 2007 and 2013, the taxable value of property declined by 8 percent in Grand Rapids, 12% in Detroit, 25% in Livonia, 32% in Warren, 22% in Wayne County values, and 24% in Oakland County.) The fiscal threat, as the former U.S. Comptroller General of the General Accounting Office warned: “Most of these numbers will get worse with the mere passage of time.”

Fiscal & Physical Municipal Balancing II. Mayhap Michigan and Virginia state and local leaders need to talk:  Thinking fiscally about a state’s municipal fiscal challenges—and lessons learned—might be underway in Virginia, where, after the state did not move ahead on such an initiative last year, the new state budget has revived the focus on fiscal stress in Virginia cities and counties, with the revived fiscal focus appearing to have been triggered by the ongoing fiscal collapse of one of the state’s oldest cities, Petersburg. Thus, Sen. Emmett Hanger (R-Augusta County), a former Commissioner of the Revenue and member of the state’s House of Delegates, who, today, serves as Senate Finance Co-Chair, and Chair of the Health and Human Services Finance subcommittee, has filed a bill, SJ 278, to study the fiscal stress of local governments: his proposal would create a joint subcommittee to review local and state tax systems, as well as reforms to promote economic assistance and cooperation between regions. Although the legislation was rejected in the Virginia House Finance Committee, where members deferred consideration of tax reform for next year’s longer session, the state’s adopted budget does include two fiscal stress preventive measures originally incorporated in Senator Hanger’s proposed legislation—or, as co-sponsor Sen. Rosalyn Dance (D-Petersburg), noted: “Currently, there is no statutory authority for the Commission on Local Government to intervene in a fiscally stressed locality, and the state does not currently have any authority to assist a locality financially.” To enhance the state’s authority to intervene fiscally, the budget has set guidelines for state officials to identify and help alleviate signs of financial stress to prevent a more severe crisis. Thus, a workgroup, established by the auditor of public accounts, would determine an appropriate fiscal early warning system to identify fiscal stress: the proposed system would consider such criteria as a local government’s expenditure reports and budget information. Local governments which demonstrate fiscal distress would thence be notified and could request a comprehensive review of their finances by the state. After a fiscal review, the commonwealth would then be charged with drafting an “action plan,” which would provide the purpose, duration, and anticipated resources required for such state intervention. The bill would also give the Governor the option to channel up to $500,000 from the general fund toward relief efforts for the fiscally stressed local government.

Virginia’s new budget also provides for the creation of a Joint Subcommittee on Local Government Fiscal Stress, with members drawn from the Senate Finance Committee, the House Appropriations, and the House Finance committees—with the newly created subcommittee charged to study local and state financial practices, such as: regional cooperation and service consolidation, taxing authority, local responsibilities in state programs, and root causes of fiscal stress. Committee member Del. Lashrecse Aird (D-Petersburg) notes: “It is important to have someone who can speak to first-hand experience dealing with issues of local government fiscal stress…This insight will be essential in forming effective solutions that will be sustainable long-term…Prior to now, Virginia had no mechanism to track, measure, or address fiscal stress in localities…Petersburg’s situation is not unique, and it is encouraging that proactive measures are now being taken to guard against future issues. This is essential to ensuring that Virginia’s economy remains strong and that all communities can share in our Commonwealth’s success.”

Municipal Bankruptcy—or Opportunity? The Chicago Civic Federation last week co-hosted a conference, “Chicago’s Fiscal Future: Growth or Insolvency?” with the Federal Reserve Bank of Chicago, where experts, practitioners, and academics from around the nation met to consider best and worst case scenarios for the Windy City’s fiscal future, including lessons learned from recent chapter 9 municipal bankruptcies. Chicago Fed Vice President William Testa opened up by presenting an alternative method of assessing whether a municipality city is currently insolvent or might become so in the future: he proposed that considering real property in a city might offer both an indicator of the resources available to its governments and how property owners view the prospects of the city, adding that, in addition to traditional financial indicators, property values can be used as a powerful—but not perfect—indicators to reflect a municipality’s current situation and the likelihood for insolvency in the future. He noted that there is considerable evidence that fiscal liabilities of a municipality are capitalized into the value of its properties, and that, if a municipality has high liabilities, those are reflected in an adjustment down in the value of its real estate. Based upon examination, he noted using the examples of Chicago, Milwaukee, and Detroit; Detroit’s property market collapse coincided with its political and economic crises: between 2006 and 2009-2010, the selling price of single family homes in Detroit fell by four-fold; during those years and up to the present, the majority of transactions were done with cash, rather than traditional mortgages, indicating, he said, that the property market is severely distressed. In contrast, he noted, property values in Chicago have seen rebounds in both residential and commercial properties; in Milwaukee, he noted there is less property value, but higher municipal bond ratings, due, he noted, to the state’s reputation for fiscal conservatism and very low unfunded public pension liabilities—on a per capita basis, Chicago’s real estate value compares favorably to other big cities: it lags Los Angeles and New York City, but is ahead of Houston (unsurprisingly given that oil city’s severe pension fiscal crisis) and Phoenix. Nevertheless, he concluded, he believes comparisons between Chicago and Detroit are overblown; the property value indicator shows that property owners in Chicago see value despite the city’s fiscal instability. Therefore, adding the property value indicator could provide additional context to otherwise misleading rankings and ratings that underestimate Chicago’s economic strength.

Lessons Learned from Recent Municipal Bankruptcies. The Chicago Fed conference than convened a session featuring our former State & Local Leader of the Week, Jim Spiotto, a veteran of our more than decade-long efforts to gain former President Ronald Reagan’s signature on PL 100-597 to reform the nation’s municipal bankruptcy laws, who discussed finding from his new, prodigious primer on chapter 9 municipal bankruptcy. Mr. Spiotto advised that chapter 9 municipal bankruptcy is expensive, uncertain, and exceptionally rare—adding it is restrictive in that only debt can be adjusted in the process, because U.S. bankruptcy courts do not have the jurisdiction to alter services. Noting that only a minority of states even authorize local governments to file for federal bankruptcy protection, he noted there is no involuntary process whereby a municipality can be pushed into bankruptcy by its creditors—making it profoundly distinct from Chapter 11 corporate bankruptcy, adding that municipal bankruptcy is solely voluntary on the part of the government. Moreover, he said that, in his prodigious labor over decades, he has found that the large municipal governments which have filed for chapter 9 bankruptcy, each has its own fiscal tale, but, as a rule, these filings have generally involved service level insolvency, revenue insolvency, or economic insolvency—adding that if a school system, county, or city does not have these extraordinary fiscal challenges, municipal bankruptcy is probably not the right option. In contrast, he noted, however, if a municipality elects to file for bankruptcy, it would be wise to develop a comprehensive, long-term recovery plan as part of its plan of debt adjustment.

He was followed by Professor Eric Scorsone, Senior Deputy State Treasurer in the Michigan Department of Treasury, who spoke of the fall and rise of Detroit, focusing on the Motor City’s recovery—who noted that by the time Gov. Rick Snyder appointed Emergency Manager Kevyn Orr, Detroit was arguably insolvent by all of the measures Mr. Spiotto had described, noting that it took the chapter 9 bankruptcy process and mediation to bring all of the city’s communities together to develop the “Grand Bargain” involving a federal judge, U.S. Bankruptcy Judge Steven Rhodes, the Kellogg Foundation, and the Detroit Institute of Arts (a bargain outlined on the napkin of a U.S. District Court Judge, no less) which allowed Detroit to complete and approved plan of debt adjustment and exit municipal bankruptcy. He added that said plan, thus, mandated the philanthropic community, the State of Michigan, and the City of Detroit to put up funding to offset significant proposed public pension cuts. The outcome of this plan of adjustment and its requisite flexibility and comprehensive nature, have proven durable: Prof. Scorsone said the City of Detroit’s finances have significantly improved, and the city is on track to have its oversight board, the Financial Review Commission (FRC) become dormant in 2018—adding that Detroit’s economic recovery since chapter 9 bankruptcy has been extraordinary: much better than could have been imagined five years ago. The city sports a budget surplus, basic services are being provided again, and people and businesses are returning to Detroit.

Harrison J. Goldin, the founder of Goldin Associates, focused his remarks on the near-bankruptcy of New York City in the 1970s, which he said is a unique case, but one with good lessons for other municipal and state leaders (Mr. Goldin was CFO of New York City when it teetered on the edge of bankruptcy). He described Gotham’s disarray in managing and tracking its finances and expenditures prior to his appointment as CFO, noting that the fiscal and financial crisis forced New York City to live within its means and become more transparent in its budgeting. At the same time, he noted, the fiscal crisis also forced difficult cuts to services: the city had to close municipal hospitals, reduce pensions, and close firehouses—even as it increased fees, such as requiring tuition at the previously free City University of New York system and raising bus and subway fares. Nevertheless, he noted: there was an upside: a stable financial environment paved the way for the city to prosper. Thus, he advised, the lesson of all of the municipal bankruptcies and near-bankruptcies he has consulted on is that a coalition of public officials, unions, and civic leaders must come together to implement the four steps necessary for financial recovery: “first, documenting definitively the magnitude of the problem; second, developing a credible multi-year remediation plan; third, formulating credible independent mechanisms for monitoring compliance; and finally, establishing service priorities around which consensus can coalesce.”

Fighting for Cities’ Futures

eBlog, 1/23/17

Good Morning! In this a.m.’s eBlog, we consider the ongoing fiscal and governing challenge to Detroit’s future—especially with regard to the quality of education for the city’s future leaders; then we learn from one of the unsung heroes, retired U.S. Judge Gerald Rosen, about his reflections and role in Detroit’s exit from the largest municipal bankruptcy in American history. Then we return to the historic Virginia municipality of Petersburg, where, in its struggle to exit insolvency, a citizen effort is underway to recall its elected leaders. Finally, in the category of ‘when it rains it pours,’ we consider the city hall relocation underway in San Bernardino—one month before it hopes to gain U.S. Bankruptcy Judge Meredith Jury’s approval of the city’s plan of debt adjustment, permitting the city to egress from the longest municipal bankruptcy in American history.

Fighting for Detroit’s Fiscal Future. The City of Detroit is siding with seven Detroit public schoolchildren suing Gov. Rick Snyder and Michigan state education officials over their right to access literacy. (See Jessie v. Snyder, #16-CV-13292, U.S. District Court), having filed an amicus brief in a proposed class action lawsuit against Gov. Snyder and Michigan education officials in a legal challenge seeking to establish that literacy is a U.S. constitutional right. The suit, which was filed last September by a California public interest law firm, claims the state has functionally excluded Detroit children from the state’s educational system; the suit seeks class-action status and several guarantees of equal access to literacy, screening, intervention, a statewide accountability system, as well as other measures. Detroit’s amicus brief urged the court to hold access to literacy as being fundamental, arguing the plaintiffs have alleged sufficient facts to show they are being denied that right: “Denying children access to literacy today inevitably impedes tomorrow’s job seekers and taxpayers; fathers and mothers; citizens and voters…That is why the Supreme Court has stressed the ‘significant social costs borne by our nation’ when children suffer the ‘stigma of illiteracy’—and are thereby denied ‘the basic tools by which (to) lead economically productive lives to the benefit of us all…The City of Detroit (though it does not control Detroit’s schools) is all too familiar with illiteracy’s far-reaching effects.”

A critical fiscal issue for every city and county is the perceived quality of its public schools—a perception critical to encouraging families with children to move into the city—thereby positively affecting assessed property values. The challenge has been greater in Detroit, where the schools’ fiscal and educational insolvencies led to the appointment of former U.S. Bankruptcy Judge Steven Rhodes to serve as DPS’s Emergency Manager. In Detroit, politics at the state level imposing a disproportionate number of charter schools has meant that today Detroit has a greater share of students in charters than any U.S. city except New Orleans; however, half the charters perform only as well, or worse than, Detroit’s traditional public schools—mayhap a challenge of having a state attempt to substitute itself over local control. Perhaps former state representative Thomas F. Stallworth III, who helped navigate the passage of the 2014 legislation that paved Detroit’s way out of bankruptcy, put it more succinctly: “We’ll either invest in our own children and prepare them to fill these jobs, or I suppose maybe people will migrate from other places in the country to fill them…If that’s the case, we are still left with this underbelly of generational poverty with no clear path out.”

But, in Michigan, it appears that it has been for-profit companies that expressed the greatest interest: they now operate about 80 percent of charters in Michigan, far more than in any other state. In the wake of the state action, and even as Michigan and Detroit continued to preside over an exodus of families, the number of charter schools grew: Michigan today has nearly 220,000 fewer students than it did in 2003, but more than 100 new charter schools. The number not only grew, but the legislature made sure accountability did not: the legislature in 2012 repealed in the Revised School Code Act 451 the state’s longstanding requirement that the Michigan Department of Education issue annual reports monitoring charter school performance; and the state even created a state-run school district, with new charters, in an effort to try to turn around Detroit’s lowest performing schools. Indeed, 24 charter schools have opened in Detroit since the legislature removed the cap 2011: eighteen charters whose existing schools were at or below Detroit’s dismal performance expanded or opened new schools—that despite increasing evidence students in one company’s schools grew less academically than students in the neighboring traditional public schools. By 2015, the Education Trust-Midwest Michigan noted that charter school authorizers’ performance overall had improved marginally over the previous year, but remained terribly low compared to leading states’ charter sectors, in its report, Accountability for All: 2016, The Broken Promise of Michigan’s Charter Sector. The report celebrates high-performing authorizers and sheds light on the devastatingly low performance of other authorizers, adding that roughly one-quarter of one group’s eligible schools ranked among the worst performing 10 percent of schools statewide. Similarly, according to the Trust, a federal review of a grant application for Michigan charter schools found an “unreasonably high” number of charters among the worst-performing 5 percent of public schools statewide, even as the number of charters on the list had doubled from 2010 to 2014.

The great press to create charter schools has led to another challenge: today Detroit has roughly 30,000 more seats, charter and traditional public, than students. For a system desperate for investment in quality education, instead it has badly failed in elementary math; and there is great risk of a discriminatory system: Detroit Public Schools today bears the human and fiscal burden of trying to educate most of Detroit’s special education students. In contrast, charter schools are concentrated downtown, with its boom in renovation and wealthier residents. With only 1,894 high school age students, there are 11 high schools. Meanwhile, northwest Detroit — where it seems every other house is boarded up, burned or abandoned — has nearly twice the number of high school age students, 3,742, and just three high schools. The northeastern part of the city is even more of an education desert: 6,018 high school age students and two high schools.

Like others elsewhere, charter schools receive roughly the same per-pupil state dollars as public schools; however, in Detroit, it is about $7,300 a year — roughly half what New York or Boston schools get, and about $3,500 less than charters in Denver or Milwaukee.

With the significant fiscal challenges to the Detroit Public Schools, Mayor Mike Duggan had proposed an appointed Detroit Education Commission to determine which neighborhoods most needed new schools and to set standards to close failing schools and ensure that only high performing or promising ones could replicate. Backed by a coalition of philanthropies and civic leaders, the teachers’ union and some charter school operators, Mayor Duggan has succeeded in restoring local control of majority-black Detroit Public Schools, and supported the proposal. In the waning days of the legislative session, House Republicans offered a deal: $617 million to pay off the debt of the Detroit Public Schools, but no commission. Lawmakers were forced to take it to prevent the city school system from going bankrupt.

An Interview with Gerald Rosen. U.S. District Court Judge Gerald Rosen, who, as we have written, played an invaluable role in the so-called “Grand Bargain,” which paved the way for Detroit to exit the largest chapter 9 municipal bankruptcy in U.S. history—and who will now join retired U.S. Bankruptcy Judge Steven Rhodes, who presided over Detroit’s municipal bankruptcy, in an interview with the Detroit Free Press, said, in response to the query how well Detroit was doing in adhering to its court approved plan of debt adjustment:  “We are hitting the marks, exceeding them in most areas — certainly revenue, I think the last report I saw was about 2 percent above the projected revenue. On budget. Expenditures are below — not much — but slightly below what was projected. Those are two important things…Certainly, investment and growth in the downtown area, certainly Midtown, and with the Ilitch development coming to fruition, the Red Wings, Pistons, some of the entertainment venues becoming a reality now, I expect the area between Midtown and downtown will become very vibrant over the next two-three years.”

Asked what the most difficult part of that case was, aside from the Grand Bargain, Judge Rosen responded: “You have to go back and see what the case was when we found it, which was an assetless bankruptcy. That was the most difficult part, for me. Certainly, there were a lot of first-impression legal issues. Certainly there were issues that could have gone all the way up to the U.S. Supreme Court, whether it was the collision between the federal bankruptcy code and the federal constitutional supremacy clause and the Michigan Constitution’s provisions to protect pensions. But there were also a lot of other really important issues: The tenor of the security instruments, of the finance instruments, the level and tenor of their security, were all major issues in the bankruptcy, whether they could be crammed down all across the rope line on the financial creditors’ side were really first-impression issues.” He added: “Overwhelmingly, the most challenging issue for me was an assetless bankruptcy—other than the art. I’ll never forget when I was reading Kevyn Orr’s proposal for creditors, coming to the asset section and realizing that there really weren’t any assets other than the art…It was devastating. Kevyn, he had just hired Christie’s to appraise the art, so he was clearly serious about it. I remember thinking, ‘What the hell have I gotten myself into?’ My job is to get deals. To get deals, you have to have revenue or assets that can be monetized into revenue, and the cupboard was pretty much bare. There didn’t seem to be much to work with for deals, other than the art.

There were other aspects to the DIA that I was concerned about. This was a time when Detroit was cannibalizing its heritage to mortgage its future, consistently over the decades. In terms of Detroit’s future, it didn’t make sense to me to do that again, but I was realistic.

Time was Detroit’s enemy. The only way to get through the bankruptcy in any sort of expeditious way was through consensual agreements, and the only asset that could be monetized was the art. So that’s basically what led to the idea of the Grand Bargain—trying to figure out a way to monetize the art without liquidating it, and giving the proceeds to the retirees. Neat trick.

I’ll never forget sitting in this little condo (in Florida) thinking, “What the hell have I gotten myself into? Is my legacy going to be that we liquidated one of the great art collections in the world for sheikhs in Dubai and oligarchs in Russia?” I wasn’t very excited about that.

There was another aspect too. One of the few nascently growing areas in Detroit was Midtown. I went on the DIA website and I saw that the DIA attracted over 600,000 people a year to Midtown. I thought, “Gee whiz, liquidating the DIA would be like dropping a hydrogen bomb in Midtown.” It would suck the life out of it. So there was that part of it.”

What would be the theme song for Detroit’s bankruptcy case?

“Don’t Stop Thinking About Tomorrow.”

We might be having some new City Council members a year from now. What would you suggest to the new ones potentially coming on board?

“I’m not in politics. I’m not a political person in the sense of being involved in the political maw, but my observation is that Mayor (Mike) Duggan is working very positively with President (Brenda) Jones and other members of the council in a way that has not been done by any mayor in years and years.

“At the same time, my word of caution is that we have to be careful to continue to provide the fertile ground that Detroit is for investment for people coming in. Part of that is not placing onerous regulation on people coming in, with artificial employment requirements. I understand the social need for that and I applaud it. I think if Detroit is going to continue the comeback that we are on, the neighborhoods have to be part of it and the African-American population has to be part of it. But you can’t disincentivize people coming in.”

You think that’s been done recently?

“I’m a little bit concerned about the community benefits ordinance. The one that was passed was certainly better than the alternative, but I’m still leery of it because it’s creating entry barriers.”

What was the most surprising individual (Kwame Kilpatrick text) message you saw?

“A lot of that is sealed. I would just refer to it generically by saying there was very little public business conducted by the Mayor and his associates. I’m sure they conducted business by communication means other than texts, but these were city-provided pagers. I assume that the city provided the pagers for people to be able to conduct city business on them, and I saw very little. I learned a lot of new text language that I hadn’t known before, and I appreciate urbandictionary.com.”

Twenty-four hours left in the Obama administration. It’s pardon and commutation time. Does the former mayor deserve one?

No. Absolutely not. I have to be a little cautious, but I presided over that grand jury for 2 ½ years.

Political Leadership & Municipal Insolvency. In Virginia, Petersburg residents who blame their elected municipal leaders for their city’s collapse into insolvency have filed dual petitions to oust both the incumbent and former mayor from their City Council seats—after, over months, gathering the legally required number of signatures from registered voters of Wards 3 and 5 to ask for the removal of Mayor Samuel Parham and W. Howard Myers, whose term as mayor ended this month; both are up for re-election next year. According to the petition, Mayor Parham “has conducted himself in the office of City Councilman, Vice Mayor and Mayor in such a way to govern the City of Petersburg chaotically, unpredictably, secretly and wastefully.” The two-page cover sheet to the petition has garnered 276 certified signatures. (Virginia law requires the petitioners to gather signatures equal to 10 percent of the voter turnout in the contest that resulted in an official’s initial election. For Parham, the number is 160.) The petitions were filed on January 20th in Petersburg Circuit Court under a provision in Virginia law which allows the court to remove officials for specific reasons, which includes certain criminal convictions. Here, in this instance, petitioners cited “neglect of duty, misuse of office, or incompetence in the performance of duties,” faulting the current and former mayor with failing to heed warnings of Petersburg’s impending insolvency, but also alleging ethical breaches and violations of open government law. “Nothing has happened in the new year, with the installation of new council officers, to demonstrate that Myers or Parham are any more capable of providing effective oversight of city government than they have over the past two years,” according to Ms. Barb Rudolph, a local activist and organizer of the good government group Clean Sweep Petersburg. The effort came as Petersburg’s mounting legal claims have now exceeded nearly $19 million in past-due invoices and the city’s budget which was $12 million over budget: the municipality has experienced a stretch of structurally imbalanced budgets dating back to 2009. The City Council fired former City Manager William E. Johnson II last March. For his part, Mayor Parham defended his decisions since taking office, reporting he has done the best he could with the guidance he has received, and noting: “I serve at the pleasure of the people of Petersburg and, with God as my witness, I have tried my best.”

The ouster filings came as former Richmond City Manager, now consultant Robert Bobb, has been hired by the City Council to try to put the city back into solvency. Mr. Bobb has issued a request for a forensic audit of spending over the past three fiscal years—notwithstanding reservations expressed by City Attorney Joseph Preston, who noted that the city’s finances are included in a special grand jury investigation which began as a probe of the Petersburg Police Department. Petersburg obtained short-term financing last month to help meet payroll and other ongoing expenses, with Mr. Bobb reporting the cost of Petersburg’s outstanding invoices has been cut from nearly $19 million to about $6 million. Next comes a session to meet with about 400 of the city’s vendors to try to begin to sort out what they are owed, with a city spokesperson Thursday stating the Petersburg has entered into a payment plan to make good on Petersburg’s share of employee and school worker pensions overdue to the Virginia Retirement System: Petersburg and the city school division collectively owed just over $4.2 million to the system as of last week; however, current payments have resumed, and plans are in place to pay down the balance by $100,000 each month, officials said.

The citizen petitions focus largely on events from last year, but reference years of mounting trouble. The issue for the courts is sufficiency, as a judge in Bath County last week demonstrated when the judge dismissed a similar petition to remove three members of the county’s Board of Supervisors, finding the complaints raised by residents there were insufficient to require a judicial reversal of election results. However, Ms. Rudolph said the Petersburg petitions contain more serious charges, noting: “We believe that, on its merits, it’s far more substantive than the Bath County removal action that was recently rejected by the circuit court there.” Included among the two-page list of grievances documenting reasons for Mayor Myers’ removal were allegations he had “flagrantly and repeatedly acted in contravention of the City of Petersburg’s Code of Ethics” by attempting to “intimidate and silence a critic,” who remains unnamed, by “attempting to harm the citizen’s good standing with her employer.” Petitioners also criticized the Myers-led council for possibly violating the Council’s own rules and the city charter in holding a re-do of a vote to bring in the Bobb Group two days after an initial measure to hire the firm failed. City Attorney Preston has said that the Council did nothing wrong.

Quake & Shake. San Bernardino, on track to end the longest chapter 9 municipal bankruptcy in U.S. history next month, now faces a physical and fiscal challenge not listed in its plan of debt adjustment: a substantial earthquake risk. San Bernardino has two independent engineering evaluations — from 2007 and 2016 — saying City Hall would be unsafe in an earthquake. Specifically, the February 2016 study concludes a magnitude 6.0 earthquake would lead to “a likelihood of building failure” for City Hall, which was designed before code updates following the 1971 Sylmar and 1994 Northridge earthquakes. The building sits along two fault lines. That means the City has plans for vacating City Hall by April, as all employees move out of a building determined to be a substantial earthquake risk, with the approximately 200 municipal employees set to relocate to several leased sites set by a unanimous Council vote. A public information counter will direct members of the public to whatever service they’re seeking, as will signs.

Muhnicipal Bankruptcy in the Home Stretch

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eBlog, 11/18/16

Good Morning! In this a.m.’s eBlog, we consider San Bernardino’s home stretch to emerging from the nation’s longest-ever chapter 9 municipal bankruptcy—and guidance by U.S. Bankruptcy Judge Meredith Jury to steps the city might consider to avoid its emergence early next year from being appealed—a la Jefferson County, Alabama. Indeed, we then visit Jefferson County, where it appears the County’s elected leaders appear on the verge of finally getting their day in court with regard to the appeal related to the county’s plan of debt adjustment. From thence, we observe the political waves rolling ashore where Donald Trump’s bankrupt casinos grace Atlantic City’s beaches—and where the New Jersey League of Municipalities featured Gov. Chris Christie in town and some more discussion of the evolving state takeover of Atlantic City by what Mayor Don Guardian deemed the “occupation force.” We consider the role of the state and mechanisms for a state takeover—as well as the options for the municipality. Finally, we journey back to Detroit where a federal investigation is underway with regard to the city’s unique and innovative demolition program: The challenge for a city in which in 1950, there were 1,849,568 people, but, by 2010, only 713,777, ergo, at the time of its chapter 9 filing, a city home to an estimated 40,000 abandoned lots and structures: Between 1978 and 2007, Detroit lost 67 percent of its business establishments and 80 percent of its manufacturing base. In its efforts to address the issue, Detroit undertook extraordinary measures to address vast tracts of abandoned homes—nests of crime—but maybe triggering a federal investigation.

The Last Hurdle? U.S. Bankruptcy Judge Meredith Jury this week has ordered San Bernardino officials into mediation with one of the municipality’s few creditors still challenging the city’s chapter 9 plan of debt adjustment, writing that she is weeks away from the “final confirmation hearing” of what has been the longest chapter 9 municipal bankruptcy in history. Judge Jury added she had been prepared to make a ruling on some of the issues still blocking her ability to confirm San Bernardino’s plan, more than fifty-one months after the city filed with the U.S. Bankruptcy Court. Judge Jury made clear she now intends to rule on December 6th on both issues raised by one creditor, the Big Independent Cities Excess Pool (BICEP), as well as on other remaining issues, noting, efficiently, that that ought to prevent the mediations from prolonging what is already the record holder for the longest municipal bankruptcy in the nation’s history. Moreover, Judge Jury noted, the mediation could save time, in no small part by preventing an appeal—an outcome with which Jefferson County, Alabama leaders would surely agree. As Judge Jury noted: “This really doesn’t slow down the process, and it might, over the years, if you reach a mediated solution, speed things up.” Judge Jury added that the confirmation hearing would be labeled on the calendar as final, which, while not a 100 percent guarantee it would be the final, does offer hope it shall, writing: “I’m not requesting anything from the city, except to come prepared to potentially put a bow on this case on the 6th – but potentially not.” The mediation in question commences today in Reno, Nevada with retired U.S. Bankruptcy Judge Gregg Zive. (San Bernardino and creditors have noted with respect Judge Zive’s previous mediation sessions as having been key to brokering major settlements as part of the city’s chapter 9 case, including the resolution with the city’s largest creditor, CalPERS. Nonetheless, the proposed mediation has both sides publicly discounting its chances of success: San Bernardino’s attorney, Paul Glassman, noted: “BICEP could have sought mediation six months ago, but instead placed the legal dispute before the court and pressed to block confirmation of the plan unless it got its way…Caving in to BICEP’s intransigence and efforts at delay is not in the best interests of the City’s creditors. It’s too late for mediation.” (BICEP is a risk-sharing pool of large Southern California cities for claims against any of the member cities, and its disputes with San Bernardino involve whether the city or BICEP is responsible for claims of more than $1 million.) Providing an idea of how complex the challenge of extricating one’s municipality from chapter 9 municipal bankruptcy can be, the BICEP issue is related to another outstanding issue in this record-length, complicated chapter 9 case: objections from the group referred to in court as the civil rights creditors. Juries previously awarded those creditors compensation for their claims, such as the $7.7 million awarded to Paul Triplett after a jury found San Bernardino police in 2006 broke Mr. Triplett’s jaw, arm, ribs, leg, ankle, and foot, leaving him comatose for three days. Under the city’s proposed plan of debt adjustment, because these creditors are in the unsecured class, the pending plan of debt adjustment would pay 1 percent or $77,000, in Mr. Triplett’s case. Nevertheless, Judge Jury, in a previous hearing, noted that while she sympathized with Mr. Triplett, she saw no legal reason to argue he did not belong in the unsecured class of creditors, 95 percent of whom voted in favor of the city’s plan of debt adjustment. That would mean any avenue of relief would be for the challenge to demonstrate that experts the city hired were wrong when they argued, with extensive documentation, that San Bernardino could not afford to pay more than 1 percent to its unsecured creditors. However, Judge Jury this week noted that those creditors’ interest now aligned with the city in its battle with BICEP, and that they could attend the mediation in Reno. On a high note, from the city’s perspective, Judge Jury also rejected the proposal by another of the challenging civil rights attorneys, Richard Herman, that the plan be modified in light of the possible “financial bonanza” recently legalized marijuana would bring: Judge Jury said the amount of those revenues would not be known for years, and she was unwilling to delay the case that long, especially when city services were underfunded in many other ways.

An Appealing Route to Full Recovery? Jefferson County Commission President Jimmie Stephens yesterday noted: “I am delighted that our case is now set and that we will have our day in court,” referring to yesterday’s announcement that the 11th U.S. Circuit Court of Appeals has scheduled oral arguments on the appeal of Jefferson County’s chapter municipal bankruptcy plan. The court set December 16th as the date—albeit, this marks the eighth time the court has set a date, so that whether this will finally prove to be the date which could offer the final exit from the county’s municipal bankruptcy remains incompletely certain. It has now been nearly three years since Jefferson County filed with the court an adjustment to its post-chapter 9 filing to adjust debt primarily related to it sewer system obligations (the county had exited its chapter 9 bankruptcy in the wake of issuing some $1.8 billion in sewer refunding warrants to write down $1.4 billion of the sewer system’s debt.) As structured, the agreement incorporates a security provision for the county’s municipal bondholders to allow investors to return to federal bankruptcy court should County Commissioners fail to comply with their promise to enact sewer system rates that will support the 40-year warrants. It was that commitment which provoked a group of sewer ratepayers—a group which includes local elected officials and residents—to challenge the constitutionality of the provision. Ergo, they filed their appeal to Jefferson County’s plan of debt adjustment in January of 2014 with the U.S. District Court in the Northern District of Alabama. Jefferson County has argued that the U.S. Bankruptcy court oversight has been a key security feature to give investors in its bonds reason to purchase its 2013 warrants, and that the ratepayers’ appeal became moot when the chapter 9 plan of adjustment was implemented with the sale of new debt; however, U.S. District Court Judge Sharon Blackburn two years ago opined in the opposite, writing that she could consider whether portions of the County’s plan are constitutional, including the element allowing the federal bankruptcy court to retain oversight. It is Judge Blackburn’s decision that the County has appealed; and it is Jefferson County President Stephens who notes: “I am very confident that the facts and prevailing law support Jefferson County’s position.”

What Does a State Takeover of a City Mean? Atlantic City convened its first City Council meeting since the state officially took the municipality over earlier this week—and since it appeared to be clear that Gov. Chris Christie will not become a member of President-elect Donald Trump’s cabinet—so that the state’s unpopular Governor was himself in Atlantic City for the annual meeting of the New Jersey State League of Municipalities—indeed, where six mayors representing urban areas gathered at the conference to discuss what they would like to see in a new governor and how he or she can help people who are living and struggling in cities across the state—but where, as one writer noted, the elephant in the room, and throughout the entire conference, has been the state’s decision to take over Atlantic City’s government. Indeed, Mayor Don Guardian addressed that and other issues during a speech at The Governor’s Race and the Urban Agenda seminar, noting: “We need a governor that won’t take over Atlantic City, but rather one that will lend us a helping hand,” adding: “I talk to 10 business leaders and developers every single week, and all they tell me is they can’t afford to do business in New Jersey.” Mayor Albert Kelly, of Bridgeton, said he’s frustrated because he feels towns like his get forgotten with the current administration. He said Bridgeton has lost state funding for various programs: “Because we’re a smaller town in New Jersey, we often get overlooked.”

As for the city itself, Mayor Guardian, speaking to his colleagues from around the state, noted, referring to the state takeover: “They can use all of the power, they can use some of the power, and in a very shocking instance, they can use none of the power…This is uncharted territory in our city.” He noted this unrestricted power means any of the items named in the so-called state takeover act enacted earlier this year, including breaking union contracts, vetoing any public-body agenda, and selling city assets. Atlantic City’s state takeover leader, former New Jersey Attorney General and U.S. Senator Jeffrey Chiesa, was in Atlantic City, where he noted he had impressed upon himself the importance of making himself known to the city and the City Council. Earlier in the week, during a radio interview, Governor Christie had lauded Mr. Chiesa as “someone who has provided extraordinary service to the state” and is now determined to revive one of New Jersey’s most iconic cities, adding: “More importantly than that, he’s an outstanding person who cares about getting Atlantic City back on track and working with the people of Atlantic City and the leaders of Atlantic City to get the hard things done. Because if we make the difficult decisions now and do the difficult things, there is no limit to Atlantic City’s future.”

Under the terms of the state takeover, Mr. Chiesa is granted vast power in the city for up to five years, including the ability to break union contracts, hire and fire workers, and sell city assets and more. In his first session with Mayor Don Guardian and members of the city council, Mr. Chiesa noted he had “a chance to listen to (the mayor’s) concerns” and looks forward to gathering more information “so we can make decisions in the city’s best interest,” adding he did not know what his first decisions would be. Atlantic City Councilman Kaleem Shabazz said after the meeting he remains optimistic the city and state can still work together to pull the resort back on its feet: “I’m taking (Chiesa) at his word, what he said he wanted to do, which is work in cooperation with the city.”

With Gov. Christie in Atlantic City yesterday for the League meeting, the Mayor preceded Gov. Christie in speaking to the session, and later sat to the Governor’s right; however, the two avoided any takeover talk at the annual conference luncheon at Sheraton Atlantic City Convention Hotel: that is, the elephant in the room of greatest interest to every elected municipal leader in the room went unaddressed. Or, as Mayor Guardian put it: “Obviously, I was surprised he did not.” Instead of Atlantic City, Gov. Christie discussed his possible future in a Donald Trump White House and defended raising the gas tax to fund road and bridge projects. For his part, the Mayor, in what was described as a fiery speech at an urban mayors’ roundtable discussion, said he needed a new governor with heart, brains and courage—and one who “won’t take over Atlantic City, but rather one that will lend us a helping hand.” New Jersey Senate President Steve Sweeney, who introduced the so-called takeover law, was also a guest at the conference: he noted that, in retrospect, Atlantic City officials would have been better advised to have provided a draft recovery plan to the state much sooner, rather than wait until just before the deadline, adding: “You hope that we can move forward and find a way to put this city back together in a place where the taxpayers can afford it.”

Fiscal Demolition Threat? The U.S. Attorney’s Office yesterday ordered FBI agents to acquire documents yesterday from the Detroit Land Bank Authority, an authority which is under federal criminal investigation relating to Detroit’s demolition program, albeit the office clarified it was a “scheduled visit to provide records, not a raid.” Ironically, the raid occurred in a building owned by Wayne County, which had received a courtesy call from building security that the FBI was present inside the building. The FBI actions relate to a federal investigation related to the city’s federally funded demolition program, which has been under review since last year when questions were raised about its costs and bidding practices. The raid comes just a month after Mayor Mike Duggan revealed that U.S. Treasury had prohibited the use of federal Hardest Hit Funds for demolitions for two months beginning last August in the wake of an investigation conducted by the Michigan Homeowner Assistance Nonprofit Housing Corp., in conjunction with Michigan State Housing Development Authority, which turned up questions with regard to “certain prior transactions” and indicated specific controls needed to be strengthened. In addition, a separate independent audit commissioned last summer by the land bank revealed excessive demolition costs were hidden by spreading them over hundreds of properties so it appeared no demolition exceeded cost limits set by the state—turning up mistakes over a nine month period between June 2015 and February, including inadequate record keeping, bid mistakes, and about $1 million improperly billed to the state. Mayor Duggan has admitted the program has had “mistakes” and “errors.” That admission came after the Office of the Special Inspector General for the Troubled Asset Relief Program, or SIGTARP, sent the city a federal subpoena for records.

Auditor General Mark Lockridge acknowledged his office received the federal subpoena after it released preliminary findings from a months-long audit into the city’s demolition activities. The federal subpoena was seeking documents supporting the preliminary audit; now a Wayne County Circuit judge next month is expected to revisit a battle over the release of the subpoena the land bank received from SIGTARP, after Judge David Allen had, last August, ruled the subpoena could stay secret for the time, albeit he believed it ultimately was “the public’s business.” Judge Allen has scheduled an update on the stage of the investigation during a hearing slated for Pearl Harbor Day. In addition, Detroit’s Office of Inspector General is also conducting a review of an aspect of the program.

The city has taken down more than 10,600 blighted homes since 2014.

The Governing Challenge in Averting Insolvency

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eBlog, 6/10/16
In this morning’s eBlog, we consider the bipartisan legislation overwhelming passed by the U.S. House of Representatives last night to address Puerto Rico’s looming insolvency—and a related U.S. Supreme Court decision; then we look at the almost Detroit Public Schools filing for chapter 9 municipal bankruptcy. It almost seems as if these events and actions were staged just for my fine graduate class on public policy process.

 

Oye! The House last evening passed and forwarded to the Senate legislation to address Puerto Rico’s looming insolvency on a bipartisan 297-127 vote: Speaker Paul Ryan (R-Wi.) and Minority Leader Nancy Pelosi (D-Ca.) took to the House floor to urge support for the legislation, with Speaker Ryan noting: “The Puerto Rican people are our fellow Americans. They pay our taxes. They fight in our wars…We cannot allow this to happen.” The bill now heads to the Senate, where there is little evidence Senators are eager to remake the bill wholesale, particularly as conditions on the island continue to worsen. The only amendment to fail was one offered by Democrats that would have struck a provision of the bill permitting Puerto Rican employers to pay workers under 25 years old less than the minimum wage. The legislation is critical as Puerto Rico—being neither a municipality, nor a state, falls into a Twilight Zone in terms of authority to address an insolvency. Puerto Rico has defaulted on three classes of municipal bonds, including last month when it missed most of a $422 million payment, and faces $2 billion in payments on July 1 that the island’s governor said cannot be paid. That final vote on the amendment was 196 in favor to 225 against. Puerto Rico’s government has begun defaulting on $70 billion in debts, and has warned it could run out of cash this summer.

In pressing for the vote, the Speaker warned that pressure would mount on Congress to spend money rescuing the territory if it could not arrest its economic decline, telling his colleagues: “This bill prevents a bailout. That’s the entire point…if we do not pass this bill…there will be no other choice.” Anne Krueger, a former IMF economist who led a detailed review of Puerto Rico’s economy, has warned: “Come July 1, if nothing is done, Puerto Rico will technically be bankrupt…Assets will be tied up in courts. It is very likely that essential services will have to be suspended.”

As drafted, the House-passed legislation does not commit a single federal dollar to Puerto Rico. The legislation creates a federal oversight board—whose members will be appointed by Congress and President Obama, and not the governor—to determine whether and when to initiate court-supervised debt restructuring: it charges the board with the responsibility to determine the hierarchy of municipal debt obligations and encourages it to respect the existing legal framework, which places constitutionally backed general obligation debt above pension liabilities. The board terminates after Puerto Rico regains the ability to borrow at reasonable interest rates and balances its budget for four consecutive years. Congressional leaders and the Treasury hope the bill will avert a long, expensive courtroom battle between hedge funds and the federal government—a battle that could harm investment in the U.S. territory’s economic future and undercut its ability to provide essential public services (servicing Puerto Rico’s current debt burden today absorbs approximately 30 percent of the Commonwealth’s revenues)—especially as Puerto Rico is now at the forefront of the Zika virus. While critics have falsely warned the bill could set a precedent for distressed states to seek similar relief, the dual sovereignty created by the founding fathers—or statesmen—in the U.S. Constitution clearly undercuts such claims: Congress granted U.S. citizenship in 1917 under the Jones-Shafroth Act to residents of Puerto Rico, which was seized in the Spanish-American War of 1898. The U.S. gave the territory the right to elect its own governor in 1947.

 Republicans have been concerned that the language would allow the to-be appointed oversight board to elevate pensions above the island’s full faith and credit general obligation municipal bond debt: Rep. John Fleming (R-La.) submitted an unsuccessful amendment to require compliance with the legal hierarchy, calling the statutory use of the word “respect” a “weasel word.”

Hear Ye! By coincidence, the U.S. Supreme Court chimed in almost simultaneously in a 6-2 decision (Commonwealth of Puerto Rico v. Sanchez Valle et al., (2016), No. 15-108, involving a simple criminal prosecution for firearms sales, but also the related governance issue of the Commonwealth’s autonomy—a case in which attorneys for Puerto Rico argued that it should be able to try two men who already had pleaded guilty in federal court. Justice Elena Kagan, writing for the majority, said that would amount to double jeopardy, writing: “There is no getting away from the past…Because the ultimate source of Puerto Rico’s prosecutorial power is the federal government…the Commonwealth and the United States are not separate sovereigns.” Reasoning that even though Congress, in 1950, gave Puerto Rico the authority to establish its own government under its own constitution, that did not, in and of itself, break the chain of command that originates with Congress. As a result, the majority determined, the Commonwealth should be treated the same as other U.S. territories. While the 50 states and even Indian tribes enjoy sovereign powers that preceded the union or were enshrined in the U.S. Constitution, Justice Kagan wrote, Puerto Rico in 1952 “became a new kind of political entity, still closely associated with the United States, but governed in accordance with, and exercising self-rule through, a popularly ratified constitution,” adding that Puerto Rico’s Constitution, significant though it is, does not break the chain.” Justice Ruth Bader Ginsburg went further in her concurrence, suggesting that the high court should hear a case that tests whether states and the federal government should remain able to try defendants for the same crime.

During oral argument last January, a majority of Justices appeared to side with the Obama administration, which argued that, as a territory of the United States, Puerto Rico cannot try the gun dealers after federal courts have acted, with Asst. Solicitor General Nicole Saharsky arguing: “Congress is the one who makes the rules.” The majority appeared to agree: Justice Kagan, writing for the majority, noted: “If you go back, the ultimate source of authority is Congress.” Nevertheless, in their dissent, Justices Stephen Breyer and Sonia Sotomayor stood by Puerto Rico — with Justice Breyer writing that if the court ruled against it, “that has enormous implications” for setting back the U.S. territory’s legal status: “Longstanding customs, actions and attitudes, both in Puerto Rico and on the mainland, uniformly favor Puerto Rico’s position — that it is sovereign, and has been since 1952, for purposes of the double jeopardy clause.” Justice Sotomayor, whose parents were born in Puerto Rico, said during oral argument that the island is an “estado libre asociado” Ironically the case was the first of two involving Puerto Rico to come before the high court this term. The Court is also re weighing the Commonwealth’s effort to restructure part of its $70 billion public debt, an issue addressed last evening by the House: a federal appeals court blocked the restructuring because of conflicts with U.S. bankruptcy laws.

Schooling for What If & Municipal Bankruptcy. With uncertainty whether the Michigan legislature would be able to pass and send legislation to him before the Detroit Public Schools exhausted all its cash—and before the legislature completed its session, Gov. Rick Snyder’s administration had commenced discussion with regard to drafting a chapter 9 municipal bankruptcy filing for DPS—in some apprehension of a wave of vendors’ and employees’ suits against DPS—the city’s public school system foundering in more than $515 million in outstanding operating debt: key staff worked with attorneys on a possible DPS chapter 9 bankruptcy, and Gov. Snyder had exchanged text messages with his former law school colleague and appointee as Detroit’s Emergency Manager, Kevyn Orr, who had, as we have catalogued, served as Emergency Manager in charge of both taking Detroit into municipal bankruptcy, and then piloting it through its successful emergence and approval of its plan of debt adjustment. Michigan State Treasurer Nick Khouri recently estimated the DPS would need $65 million for capital costs, including deferred maintenance and upgraded security equipment; $125 million for cash flow needs due to the timing of school aid payments and other startup expenses; and $10 million for academic programming. Now, in the wake of partisan action on which we reported yesterday, DPS will be able to make payroll, pay vendors, and purchase supplies this summer to prepare for school this fall. Logistically, the new school district will be created by July 1: retired U.S. Judge Steven Rhodes, DPS’s emergency manager appointed by Gov. Snyder and now serving as DPS’ transition manager, is working with state administrators to implement the new agreement.

Balancing a Municipality’s Past Versus Its Future

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eBlog, 4/21/16

In this morning’s eBlog, we continue to follow Atlantic City’s blues—and the racing deadline the city faces in the midst of uneven state leadership—but remarkable state power and authority over the city—all without, however, any obligation to provide fiscal assistance. We continue to follow the unprecedented leadership efforts of House Speaker Paul Ryan and House Natural Resources Committee Chair Rob Bishop in their efforts to coordinate with U.S. Treasury officials to address the nearing insolvency in Puerto Rico—mayhap with insolvency looming at the same time as in Puerto Rico. We look back at the test of time since former President Reagan signed the 1988 municipal bankruptcy amendments into law: how has it worked? How has it balanced municipal public pension obligations versus a municipality’s bondholder obligations—and with what potential consequences for a city’s future? As we head down this morning to the Southern Municipal Conference in Norfolk, this seems like a lot to ponder upon.

Atlantic City Blues. New Jersey’s key state legislative leaders met privately yesterday to discuss their competing options for helping Atlantic City avoid insolvency and municipal bankruptcy, but were unable to reach any agreement: the city is beset by the closure of four casinos in recent years; it has about a $100 million budget deficit; and it is more than $550 million in debt. The closure of the casinos and drop in the assessed values of the remaining properties have combined to reduce the city’s property tax base by more than 50 percent in the past five years—forcing it under State supervision pursuant to the Local Government Supervision Act. However, notwithstanding State supervision and imposition of Emergency Manager Kevin Lavin, Atlantic City currently faces a revenue shortfall that could render the municipality insolvent in the near future. Added to the governance challenge, according to an analysis last week by the state’s Office of Legislative Services, there is no New Jersey statute which obligates the State to financially assist Atlantic City in case of an imminent default on its municipal debts—an opinion confirmed by the fact that the State is not listed on the bond covenants as a guarantor; rather the state law pledges the taxing authority of the municipality alone to “pay the interest on bonds issued.” The opinion notes, however, that under the state law: “Once a municipality is under State supervision, the Local Finance Board may impose certain restrictions on the city, including limitation on debt and limitations on expenditures.” The epistle adds that the state has “broad authority to order the city to liquidate or refinance its current debts, and, if the city does not comply with those orders, the Local Finance Board may perform those actions itself or through its agents.” Finally, the letter notes that while the state statute directs the state to “extend all possible consultation and assistance to municipalities,” the state is “not aware of any interpretation of that statute that requires the assistance to be in the nature of state aid or the assumption of the city’s debts.” The letter confirms that not only does the state regard itself under no obligation to help, but that any such help is unlikely.

Similarly, in the wake yesterday of an hour-long discussion between New Jersey Assembly Speaker Vincent Prieto and Senate President Stephen Sweeney, the two reported no progress had been made and stressed that there is now increasing apprehension the city is headed toward insolvency, with President Sweeney noting: “I think we’re going to face bankruptcy…I’m very concerned what’s going to happen to other communities because of this.” It appears the Speaker recognizes the potential for contagion: Atlantic City defaults on its debt or filing for chapter 9 municipal bankruptcy could trigger downgrades to the credit ratings of other municipalities across New Jersey.

For its part, in the wake of Tuesday’s rejection by a New Jersey Superior Court judge of a state request to freeze Atlantic City’s spending until the city makes all the payments it owes to its school district over the next three months, the city turned the tables by filing a counter lawsuit demanding the state pay the city with $33.5 million in aid — funds which local leaders say they were promised, but which Gov. Chris Christie vetoed in January. In addition, the city is requesting the court to designate a special master to be appointed to oversee the state monitor the Christie administration placed in city hall six years ago to oversee the city’s finances—or, as Atlantic City Council President described it: “We have to fight back…We believe to balance this thing out, we have to go in front of a judge. The facts will play themselves out in our favor.” In addition, the suit calls for the state to hand over key documents related to the quasi-state takeover, including the report filed by the Governor’s appointed emergency manager—and that the court bar the state from taking any “punitive, retributive, or adverse action against the city of Atlantic City.”

Meanwhile in Trenton, State Senate President Sweeney has been pushing a plan backed by the Governor which includes an aid package for the city and a bill that would allow a five-year takeover of many city functions—even as in the House, House Speaker Vincent Prieto has announced his own rescue bill—noting, with its introduction yesterday—“Atlantic City needs help…but they need to be treated fairly.” The action came as Sen. Sweeney said he had offered a second compromise in private yesterday, although a spokesperson for Speaker Prieto said no such offer was made. Gov. Christie added in what might herald the commencement of a “blame game” that Speaker Prieto “is going to be responsible for the bankruptcy of Atlantic City.” Sen. Sweeney noted that the Speaker “doesn’t feel Atlantic City can go bankrupt,” because he believes the state is required under law to step in. Senate President Sweeney, however, noted that “Nowhere does it say the state has to write a check,” a position seemingly supported by a different analysis from the state’s Office of Legislative Services—albeit that opinion does note that under New Jersey law, when a municipality defaults for more than 60 days on outstanding notes or bonds, the court “shall require the state to exercise its powers and duties to stave off bankruptcy.”

Maybe A Little Good Gnus. Meanwhile, Atlantic County Superior Court Judge Julio Mendez has ruled that Atlantic City is in compliance with payments owed to its school district, a judge has ruled, denying the state’s request that Atlantic City be forced to freeze spending until outstanding property tax payments owed to its school district through June 30 are paid. The city made an $8.4 million payment to the public schools on Tuesday and needs to pay an additional $25 million over the next two months. In the wake of Judge Mendez’s ruling, Atlantic City announced a counterclaim against New Jersey demanding it provide $33.5 million in aid that had been approved by a state monitor for the FY2015 budget—funds to be derived from a bill in the state legislature vetoed by Gov. Chris Christie that would have enabled the city’s eight casinos to make payments-in-lieu-of-taxes for 10 years—legislation the Governor has said he will not sign without an approval of legislation enabling a state takeover that would empower New Jersey’s Local Finance Board to renegotiate outstanding debt and municipal contracts for up to five years.

Puerto Rico. Congress seems increasingly unlikely to take action to help Puerto Rico ahead of a May Day deadline for the Commonwealth to default on a nearly half-billion-dollar debt payment—a failure to act which could push Puerto Rico and its 3.5 million American citizens further into crisis, exacerbating not only a growing fiscal crisis, but also a potential humanitarian disaster—after House Natural Resource Committee Chairman Rob Bishop (R-Utah) was forced to abruptly cancel a vote on a Puerto Rico debt restructuring bill when it was short of votes last week. A revised version is not yet completed, although Chairman Bishop warned that: “I’m not sure that on May 2 Armageddon takes place, but clearly I think it will illustrate that there is a significant problem…There are still some people out there saying there’s not a problem…No, there is a problem, they will default on some portion.” The Chairman’s draft proposal would create a create a financial control board, not unlike comparable boards that were used to avert bankruptcies in New York City and Washington, D.C., to manage the U.S. territory. Now it appears committee action is unlikely before next week at earliest, risking chances of final passage through the House and the Senate before the end of next week.

Can Municipal Bankruptcy Work? Notwithstanding the naysayers on Capitol Hill, not to mention the deep apprehensions we had (and strong opposition from leaders in the National League of Cities) to the municipal bankruptcy amendments President Reagan signed into law in 1988, nor the significant string of municipal bankruptcies in Jefferson County, Central Falls, Stockton, San Bernardino, but, perhaps most of all, Detroit—where I met with Kevyn Orr, the state’s selected emergency manager, on the morning he filed for the historic city of soul to go into municipal bankruptcy—a city which had suffered not only criminal malfeasance from its own elected leaders, but also devastation by the Great Recession of its iconic auto industry—devastation of economic destruction and population loss so deep that it made one apprehensive that it could ever recover. Yet, today, in the wake of extraordinary leadership by a federal bankruptcy judge and his partner from a U.S. District court, and thanks in no small part to a $100 million pledge from JP Morgan Chase—a commitment that has leveraged, according to Mayor Mike Duggan, another $30 million, and dynamic leadership by the Mayor, the city is on the brink of a sparkling new bridge to Canada that could make Detroit a gateway over the years towards a recovery which only four years’ ago seemed almost unthinkable.

Future versus the Past? Notwithstanding phony claims by some Members of Congress that any form of municipal bankruptcy would amount to a federal bailout of Puerto Rico, municipal bankruptcy means on its face that there will be losers. Just think, Judge Steven Rhodes in Detroit had to opine over the city’s plan of debt adjustment with regard to how its assets would be divvied up between more than 100,000 creditors. His decision was further complicated by Michigan’s constitution, which protects contracts—contracts such as Detroit’s pension obligations. Unlike a non-municipal corporation, the importance of chapter 9 is to insure there is no disruption of essential municipal services; there are, however, exceptionally hard choices forced with regard to such cities’ municipal bondholders and retirees. The latter, after all, are taxpayers to the city—and steep cuts in pension obligations might make them wards of the city. In contrast, bondholders are spread all across the country: they are often neither constituents, nor voters. Yet, they are vital to any enduring fiscal and economic recovery. So, as Bloomberg this week wrote: [municipal] bondholders have reason to fear a fight in a federal bankruptcy court if an insolvent municipality or county files, because, as the piece noted: “recent cases show that when municipalities go broke, investors lose when pitted against municipal retirees,” adding, for instance, that San Bernardino’s proposed plan of debt adjustment pending before U.S. Bankruptcy Judge Meredith Jury provides for a 60 percent loss to the city’s municipal bondholders, but retains retirement benefits intact under the settlement which could pave the way for the terror-stricken municipality to exit nearly four years in municipal bankruptcy—the longest of any city in history. According to Black Rock Inc., the outcome in San Bernardino shows why municipal bondholders should be wary of distressed local governments which can petition to have debts reduced in federal bankruptcy courts, because, Peter Hayes, BlackRock’s head of municipal bonds, notes: “Pensions are faring far better than other creditors under Chapter 9…This reinforces the view that bondholders need to be extremely cautious dealing with distressed municipalities.”

How One Remarkably Gifted Leader Can Make a Difference in Averting Municipal Bankruptcy & Ensuring Continuity of Essential Public Services

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In this morning’s eBlog, we applaud, for the umpteenth time, the rhythm guitar lead of the Indubitable Equivalents, the peripatetic, retired (or so he claims…) U.S. bankruptcy Judge Steven Rhodes, who oversaw the rock and roll trial and exit of Detroit from the largest municipal bankruptcy in U.S. history, but who, since then, has made himself indubitably available to create solvency rhythm from Puerto Rico to the small municipality of Hillview, Kentucky. Somehow, his patience and ear for creating fiscal rhythm has proven unique and invaluable.  Judge Rhodes’ intellect, tact, and public commitment would be an invaluable factor to resolution of the nearing insolvency and default of Atlantic City.

A Different Hill Perspective. Hillview, Kentucky, the small municipal suburb of Louisville, has opted not to pursue municipal bankruptcy; instead the city will issue new municipal bonds and raise taxes to settle a legal judgment it owes to its largest creditor, Truck America, according to documents filed in the U.S. Bankruptcy court yesterday. In a joint filing, Hillview and Truck America Hillview’s municipal bankruptcy filing was the first sought by any U.S. municipality since Detroit had filed in 2013. Training LLC stated that in the wake of “exhaustive, arms-length negotiations” with three different mediators, they had reached agreement to permit the City of Hillview to settle Truck America’s $15 million claim at a discount. That agreement, in which the itinerant and electronically, musically retired U.S. Bankruptcy Judge Steven Rhodes served as a mediator, paved the way for U.S. Bankruptcy Judge Alan C. Stout to schedule an expedited hearing this morning to consider a motion which would provide for the dismissal of Hillview’s petition for chapter 9 municipal bankruptcy.

As part of the negotiations, the city intends to raise revenues and issue debt to resolve the claims emanating from a portion of the $15 million judgment owed to Truck America—an award which had been growing by $3,759.54 a day in interest, and which had initially triggered the city’s filing for chapter 9 last August. Under the proposed agreement, Hillview will make an up-front payment of $5 million from the proceeds of issuing new debt, and to channel approximately 8.3% of its general fund revenue to Truck America for the next two decades. The settlement also calls for Hillview to raise its occupational tax to 1.8% from the current rate of 1.5%, increase its insurance premium tax to 7% from 5%, which is collected on insured property and people within the city limits, according to the settlement. Hillview’s debt to Truck America of $15.23 million was based upon a court-ordered judgment it lost over a soured legal dispute involving a contract to purchase city land. The city lost that dispute in court, and has since transferred ownership of the property to the company, but until now had not come to terms over the monetary award—instead, hoping to absolve itself through filing for municipal bankruptcy. After ten years, Hillview can opt to take a discounted buyout option under a formula outlined under the settlement. Any violation of settlement terms constitutes a default, according to court filings. A resolution to the dispute will actually begin in Bullitt County Circuit Court where Truck America had filed a writ of mandamus to enforce the terms of the judgment. The lower court case was automatically stayed when Hillview filed for Chapter 9 bankruptcy on Aug. 20. A decision as to whether Hillview is insolvent, and eligible to continue its case, is still pending. At Thursday’s hearing, Hillview and Truck America will ask Stout to lift the stay so they can file the settlement in the circuit court. After the settlement is filed, Hillview is expected to dismiss the bankruptcy case. The mediators in the case were retired U.S. Bankruptcy Judge Steven Rhodes, who presided in Detroit’s Chapter 9 case; local attorney Walter A. Sholar; and Thomas Fulton, chief judge for the Bankruptcy Court in the Western District of Kentucky.

Unlike in Hillview, the odds of an agreement in Atlantic City as it nears an historic suspension of governmental services appear low: despite calls from any number of New Jersey Assembly members for Gov. Chris Christie to compromise on a state takeover bill and use tools at his disposal to help the East Coast gambling hub avoid default. Gov. Christie, who last week stated he will not support changes to Senate-passed “The Municipal Stabilization and Recovery Act,” which would empower New Jersey’s Local Finance Board to renegotiate outstanding debt and municipal contracts for up to five years, also said he will not sign a companion bill which would enable Atlantic City’s eight remaining casinos to make payments in lieu of taxes for 10 years, including $30 million collectively in 2016 without the state intervention. He noted that Assembly Majority Leader Louis Greenwald (D-Vorhees Township) had canvassed his caucus and determined there were enough votes to pass both bills…leading Assemblywoman Marlene Caride (D-Ridgefield) to observe: “The Speaker has, time and time again, expressed his willingness to sit down and work out a compromise that protects the city and public workers, but his calls for responsible and fair negotiations have fallen on deaf ears…To oppose any dialogue with the Assembly given what’s at stake is irresponsible.” Assemblywoman Valerie Vainieri (D- Englewood), added: “The Governor would have everyone believe that the only way to save Atlantic City from insolvency is to trample public workers, step residents of their right to a representative government and sell off city assets, perhaps irrevocably…I commend Speaker Prieto for taking a measured and thoughtful approach to the situation and standing up against tremendous pressure while the Governor refuses to negotiate in good faith with one half of the state legislature.” Absent some quick resolution, Atlantic City is projected to both cease non-essential governmental services and default on its debt as early as next month. The City has an estimated $102 million deficit for 2016, according to Moody’s. The city budgeted $33.5 million last September in redirected casino taxes from a PILOT bill—but a bill Gov. Christie conditionally vetoed last November.

Fundamental Federalism Challenges

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In this morning’s eBlog, we applaud what could be a signal breakthrough in San Bernardino that might pave the way towards the city’s exit from the longest municipal bankruptcy in U.S. history. The actions are something those at the Treasury and the U.S. House Committee on Natural Resources might be well advised to consider as they struggle to try and come up with a plan to prevent the rapidly onrushing insolvency in Puerto Rico. As much as the Committee, in its initial draft, has chosen to decry chapter 9 municipal bankruptcy, the process has, time and again, with great patience and an extraordinary federal role, proven prescient. We also try to get schooled on the possible municipal bankruptcy by the Chicago Public School system—something which would require state legislation, and something which would re-raise fundamental federalism challenges between state constitutions and federal law. Oh my.

A Significant Step by San Bernardino. The GE slogan made famous by former California Governor and later President Ronald Reagan in the 1950s was “progress is our most important product.” Yesterday, not so far from the former President’s old stomping ground, the City of San Bernardino, the city in municipal bankruptcy longer than any other in U.S. history, achieved its own significant progress when it reached agreement as part of its negotiation with creditors on a plan of debt adjustment to pay bond holders of its pension obligation bonds 40 percent of what they are owed, thereby achieving a reduction in the total payments to one of its largest creditors by about $45 million. While the deep discount is far short of the 1 percent the city had first proposed, whilst the bondholders sued in an effort to gain the entire amount the city agreed to for the California Public Employees’ Retirement System. In a written statement, City Attorney Gary Saenz noted: “The settlement will end the costly legal battles between the City and the settling creditors over confirmation of the City’s Chapter 9 Plan of Adjustment, as well as how much the creditors are to be paid.” Under the nine-page settlement agreement, those creditors — the Luxembourg-based bank EEPK, and Ambac Assurance Corporation — agreed to drop their litigation against San Bernardino and release the municipality from any future liability related to the pension obligation bonds. The two also agree to support the city’s disclosure statement — an amended version of which is due to U.S. Bankruptcy Judge Meredith Jury today. Under that agreement, San Bernardino agrees to pay its debt over a 30-year period beginning one year after Judge Jury approves its plan of debt adjustment and exit from chapter 9 municipal bankruptcy. The crucial step means the city funds will be freed up for additional investment in public safety of about $2 million per year, according to the city. As we experienced from the invaluable role of U.S. District Judge Gerald Rosen as an intermediary for now-retired U.S. Bankruptcy Judge Steven Rhodes in Detroit, in San Bernardino, U.S. Judge Gregg Zive—serving in a similar capacity—served as the key to the resolution—a resolution the San Bernardino City Council last week approved in closed session.

Getting Schooled on Municipal Bankruptcy. After receipt last month of a signed, sealed, and certified letter to the Chicago Public Schools (CPS) and the city’s board of education, Illinois’ State Board of Education last month commenced a formal investigation “of the financial integrity of Chicago Public Schools,” raising increasing apprehension the city’s massive public school system could become insolvent and bankrupt. Because Illinois does not currently authorize municipalities, including school systems, to file for chapter 9 municipal bankruptcy, the epistle raises the stakes in the Illinois legislature, where Illinois Governor Bruce Rauner has asked the legislature to authorize municipal bankruptcy. Should the state so act on an issue eerily comparable to Congress’s deliberations over the fast-approaching default in Puerto Rico, the impact on the nearly $6 billion in outstanding CPS debt would be at stake. CPS, in its most recent municipal bond sale, warned that one of its pledged repayment streams under the state’s alternate revenue bond structure would meet the bankruptcy code’s designation of “special revenues,” that is revenues that would be affected by a municipal bankruptcy. CPS currently has a failing fiscal grade with some $10 billion in unfunded pension obligations, a looming $1 billion deficit, and a rising annual teacher pension payment of about $700 million. With the issuance just last month of some $725 million in municipal debt—bonds which triggered an 8.5 percent tax-exempt rate in order to sell—and with an accompanying disclosure statement which incorporated language from a special opinion which provides the legal reasoning behind CPS’ position that the municipal bonds’ structure provides a security which preserves the statutory lien on pledged revenues and offers relief from the automatic stay provisions of chapter 9 municipal bankruptcy. The accompanying tax levy for debt service on the bonds is not subject to the property tax caps that non-home-rule units such as the school system operate under. Repayment would rely on a combination of pledged state aid, block grants, and tax-increment financing and personal property replacement tax revenues. Some credit rating agencies have assigned the new debt as junk because of CPS’ severely distressed overall credit profile. The uneasiness about the possibility of a municipal bankruptcy has triggered, unsurprisingly, questions with regard to the so-called “automatic stay” provisions arising from a chapter 9 filing: how would such a filing apply to the application of so-called “special revenues,” e.g. to the payment on the bonds secured by those special revenues? This is, at the moment, further roiled by the absence of any chapter 9 authority under Illinois law and further complicated by the exemption of CPS from some state oversight rules—where CPS is authorized to direct the county to deposit pledged property taxes with the bond trustee, albeit where said direction can may be revoked. All of this would, of course, be confounding to any math student in any Chicago public school, contributing even more to the cost to the system in higher interest rates.

All of this is contributing to the schooling of state legislators on the intricacies of chapter 9 municipal bankruptcy, state authorization of which the Governor had proposed as a key part of what he termed his “turnaround agenda” as a means to provide Illinois’ municipalities leverage in addressing pension negotiations, having, earlier this year, endorsed state legislation which would subject CPS to state statutes allowing for oversight and grading the way for municipal bankruptcy. Were the state legislature to agree, it would raise the kinds of federal-state legal confrontations raised in Detroit’s and Stockton’s chapter 9 municipal bankruptcies with irreconcilable issues because the respective pension programs, defined as contract, are protected by the respective state constitutions; however, those pensions, as reduced under Detroit’s federally approved plan of debt adjustment, reduced the city’s pension obligations—and the initial proposals to pursue appeals to the 6th and 9th U.S. Circuit Courts of Appeals never materialized. Thus, in the wake of the 2014 Illinois Supreme Court ruling two years ago that benefit cuts under Chicago’s 2014 pension reforms violated state law giving contractual status to membership in governmental pension funds, the same federal-state municipal bankruptcy challenge could well re-emerge. The scholarly professor of municipal bankruptcy, Jim Spiotto, yesterday noted to the Bond Buyer that only four school districts have filed for municipal bankruptcy in the last sixty years—in large part because most states hold oversight powers that can be critical to averting insolvency: he said that “Two of the four never got to a plan of adjustment. They realized once they got in there was a better way.” One, the San Jose Unified School District, filed for municipal bankruptcy in 1983 in the face of steep demands under a proposed salary increase plan; however, the parties reached an agreement on a new wage plan and the bankruptcy petition was dismissed. Subsequently, just up the highway, the Richmond Unified School District filed for municipal bankruptcy in 1991 due to fiscal and operational woes. In that instance, school parents sued the state—effectively scoring A’s when the state responded by loaning the district $29 million.