How Does a Leader Balance Fiscal Versus Human Health & Safety?

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eBlog, 1/24/17

Good Morning! In this a.m.’s eBlog, we consider the ongoing fiscal and human health and safety challenges—and fiscal implications—in the City of Flint, as city residents have sued the State of Michigan; then we look east to Ohio, where the question with regard to a similar human and fiscal health related to East Cleveland appears to be worsening with regard to health, fiscal health, and governance. Finally, we peer south to the warm Caribbean, but where the warmth in weather is exceeded by the increasing political heat between the PROMESA oversight board and the new Governor—a challenge with parallels to the fiscal struggle Washington, D.C. underwent nearly two decades ago.

Fighting for Flint’s Fiscal Future. U.S. District Judge David Lawson has described an attempt by Michigan Attorney General Bill Schuette to side with Flint residents in a lawsuit against the state as “superficial posturing,” stating that the AG has created a “troubling ethical issue” that could delay the case that seeks to provide the city with bottled water delivery. In his opinion, Judge Lawson denied Mr. Schuette’s request to file an amicus brief in the case on behalf of “the people of the State of Michigan,” saying the motion is problematic for several reasons, including that assistant attorneys general have already appeared in the case on behalf of state defendants, including Gov. Rick Snyder, writing: “The proposed amicus brief has not introduced any new arguments or offered a perspective that has not been presented by the parties already. Instead, the attorney general has taken a position aligned with the plaintiffs and at odds with other attorneys in his own office…In doing so, he has managed to inject a troubling ethical issue into this lawsuit, potentially complicating adjudication of the serious legal questions before the court, without adding anything of substance.” A spokesperson for the Michigan Attorney General said he would not appeal this ruling, noting that while the attorney general respectfully disagreed with the ruling, “We originally obtained concurrence from all parties prior to filing, and because it failed to include mention of the conflict wall in this case…Attorney General Schuette will continue to fight aggressively for Flint families and remains thankful to the many Flint residents and elected officials who expressed their support of his actions.” The denial came the day before Judge Lawson is to take up an emergency motion in the case: today, Judge Lawson must decide whether and how the State of Michigan and both state and Flint officials should—or must—comply with a largely ignored federal court order requiring door-to-door delivery of bottled water to Flint homes lacking a working water filter.

The legal challenge dates back to last November, when Judge Lawson ordered the state and City of Flint to provide and finance the provision of four cases of bottled water per resident per week if officials cannot prove faucet filters are working to remove harmful lead. That was an order Gov. Snyder’s administration opposed, arguing it is “overbroad,” and one which the city is fiscally unable to meet; indeed, Michigan has filed an emergency motion with the U.S. Sixth Circuit Court of Appeals to block the order, arguing before the court that while the state was not “reluctant “to comply with the order, rather it was confronted by “financial, logistical, and practical difficulties” in doing so. According to state officials, the order would be a five-fold increase over current efforts and require another 137 trucks, hiring at least 150 additional people and “a warehouse so large it is not clear if one even exists in the Flint area” at a cost of more than $11 million per month. In his order at the beginning of last month, Judge Lawson wrote: “The main thrust of the ordered relief is the proper installation and maintenance of tap water filters. For those homes that have properly installed and maintained water filters in place—which is the vast majority of residences, if the state defendants’ witnesses are to be believed—bottled water delivery is not necessary and was not ordered.” While testing shows lead levels in Flint water are on the decline, Flint residents have been instructed to use only filtered or bottled water for consumption, and researchers have encouraged those practices until further notice from state or federal officials: no amount of lead is considered safe.

Does East Cleveland Have a Future? Ohio’s Environmental Protection agency has shut down a waste site in East Cleveland which currently holds an estimated 2 million yards of waste and construction debris, piled up over the past few years by Arco Recycling, declaring it an unpermitted landfill. In the nonce, former East Cleveland Mayor Eric Brewer worked with Auburn Environmental to understand the harm which might already have occurred at a site which features a combination of toxic gas and toxic particles both on the outside and inside of the property—and which appears to have been operating without any legal authority granted by the municipality. The EPA has given Arco Recycling two weeks to clean up or face further actions. Given the small city’s fiscal depletion and insolvency—and the lack of any state response, it would almost appear to be another Flint-like situation, with grave implications for public health and safety, and a fiscal inability by the small city to address on its own—either fiscally or governmentally.

Is there Unpromise in PROMESA? According to Governor Ricardo Rosselló Nevares, it is time for the PROMESA Oversight Board created by the U.S. Congress and former Obama Administration to turn into Puerto Rico’s representative in Washington, D.C., because, otherwise, the various efforts coordinated to strike a fiscal balance and attain socioeconomic development in the U.S. territory will be in vain. The Governor was responding to a lengthy letter from the Board demanding austerity—a demand which appeared to reflect little flexibility with regard to demanding $4.5 billion in spending cuts and/or tax increases per year. While the PROMESA board said it was open with regard to how the Governor achieves that bottom line, the epistle noted: “To be clear, presenting a plan that can achieve at least this level of savings is a pre-requisite to certifying a fiscal plan.”

According to Governor Rosselló Nevares, the delicate state of the island’s public finances, as well as the grave risk of disruption to Puerto Rico’s healthcare services creates what he described as an “unambiguous need” to obtain the federal government’s support in overcoming the crisis, a message that pertains to his administration, but also the Oversight Board—or, as the Governor put it: “The Board has, I believe, that role to fulfill. They need to be the voice for Puerto Rico’s credibility, as did other fiscal boards, like the board in Washington, D.C…For two and a half years, the members of the board in Washington, D.C., using all available financial tools, but were unable to, failed, or attained only marginal improvements. Which is why they had to return to the Capitol to explain two huge faults they had found.” According to Governor Rosselló Nevares, the PROMESA legislation that ordained the oversight board lacked economic development tools critical to the island’s economy and future revenues, and, he added, as with the District of Columbia, where a comparable oversight body was created—that body went back to Congress to ask for fiscal support. But, in addition, the Governor noted, the second element the legislation for D.C. lacked was “equal treatment as a state.”

The Governor was referring to the period nearly three decades ago when the nation’s capitol, Washington, D.C., succumbed to a comparable fiscal crisis which resulted in credit downgrades and the city’s inability to pay its required pension contributions, all while experiencing disruption in public services. In response, Congress intervened by creating an entity similar to the Oversight Board, in 1997, via the National Capital Revitalization Act, a statute which allowed for the transfer of hundreds of programs funded by DC’s administration to the federal government. The act, among other things, had the federal government take over the criminal justice programs and the actuarial deficiencies in the pensions for teachers, police officers, firemen, and judges. In addition, the federal government also increased its contribution to the District’s Medicaid program, from 50% to 70%—changes which, Governor Rosselló Nevares noted, when made, provided for a nation’s capital city that “was able to thrive.” According to the Governor, under PROMESA, “We have a report from that group, which could presumably help our economic development, but it’s not binding and we don’t know what we’re going to do…The Board, like us, should be a spokesperson to our credibility, and they should tell those who put them there (Congress) that Puerto Rico is taking action, and we’re making good progress.” Although the Governor urged the board members to take up a position in favor of the U.S. territory, while PROMESA regulates the pension and public debt payments, the federal entity’s mandate is explicit: restoring fiscal discipline and achieving Puerto Rico’s return to the capital markets under reasonable conditions.

Consequently, Gov. Rosselló Nevares has focused on providing tools for the private sector, enabling the development of infrastructure projects, and ensuring the continuity of certain collections by approving the extension of Act 154 (which created the 4% tax on foreign companies); but he still counsels “there needs to be action from the federal government,” noting: “You may take fiscal measures to check them off the list, but without economic development, it would have a noxious effect, possibly on emigration, on the quality of life for citizens, and the social environment,” as he rejected the Financial Oversight and Management Board for Puerto Rico’s demands for quick and deep austerity measures, deriding the letter from the oversight board as one demanding an “average 79% haircut,” insisting, instead, “We will reflect a fundamental willingness to pay based upon available resources, while satisfying the need for essential services, adequate funding for public pensions and providing a platform for economic growth, all as required by [the Puerto Rico Oversight, Management and Economic Stability Act].”

Recovery Governing

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eBlog, 7/20/16

In this morning’s eBlog, we consider the ongoing recovery from the nation’s largest ever municipal bankruptcy in Detroit, where the city is demonstrating remarkable success in its effort to downsize: it has just completed its 10,000th demolition!  Then we review steps Mayor Duggan is proposing to adjust public safety pensions—the hard balancing between municipal resources versus benefits key to filling critical public safety slots even as it is struggling to address a pension shortfall.  Then we look south to the extraordinary governance challenge posed by the new PROMESA law: how will an unpaid oversight board working in  a U.S. territory  with its own Governor and legislature—where Spanish is the main language—and where the board members are unpaid—be able to succeed?

Downsizing to Rightsizing. Detroit Mayor Mike Duggan described the 10,000th demolition yesterday of an abandoned house in Detroit as a “remarkable accomplishment,” adding, however: “We’ve still got 30,000 to go: Every time one of these houses goes down, we raise the quality of life for everybody else in the neighborhood…And you look here, the beautiful houses of the families across the street. These are folks who stayed in the city, paid their taxes, kept their houses up and had to watch the blight spread. We’re finally starting to fight it effectively.” While it would seem strange for a municipal leader to celebrate the razing of homes, in Detroit we are discussing a city in which between 1972 and 2007, the city experienced an overall loss of 15,648 business establishments; the bankruptcies of General Motors and Chrysler: jobs left Detroit as auto plants moved to the suburbs and to other countries with globalization. Manufacturing jobs in the city fell to fewer than 27,000 in 2011 from about 296,000 in 1950. By the time the city filed for the largest municipal bankruptcy in U.S. history, the city’s density had declined to eight people per acre, down from 21 per acre in 1950. Thus it was that yesterday, Mayor Duggan marked a milestone in Detroit’s effort to rid itself of blight. City officials said the city is on target to tear down 5,000 blighted houses this year and 6,000 next year.

The razing is not, however, 100 percent smooth: the federal Office of Special Investigator General for the Troubled Asset Relief Program, which monitors the Hardest Hit Fund, is investigating the blight program with assistance from the FBI—an investigation for which Mayor Duggan has promised full cooperation: it appears that the investigation was triggered by last year’s near doubling of the average demolition price to $16,400 from $8,500-$10,000 under former Mayor Dave Bing. Mayor Duggan noted yesterday that the average cost for the 5,000 homes the city will tear down this year will be under $13,000, noting: “It took us a while to really get the hang of this, and I won’t tell you we’re perfect: But we’re moving much more efficiently than anybody else in the country, and for the folks on this block, I don’t think it could come too soon.” The Mayor said the rapid pace of blight removal has done more than improve quality of life in neighborhoods: he noted that structure fires have dropped by 25% in the city over the past two years, and a 2015 report found that in neighborhoods where abandoned homes have been removed, property values have risen citywide by more than $209 million.

Pensionary Recovery? Detroit Mayor Mike Duggan has announced plans to boost public safety pension contributions at the cost of hiring fewer firefighters: the move comes in the wake of the city’s difficulty in filling 100 fire department vacant slots: the city has only been able to fill 60; however, those empty spots have, in turn, freed up resources to help pay finance higher municipal contributions for public safety pensions. The new agreement provides for a 6% wage increase which will be directed to the firefighters’ legacy pensions pending the resolution of some technical issues: under the plan, firefighters licensed as medical first responders will also receive a 4% pay raise effective immediately—a raise in addition to 2.5% raises previously negotiated for 2016, 2017, and 2018, with Mayor Duggan noting: “This is the city and union coming together to help ensure our emergency personnel won’t face another pension shortfall.” Because under Detroit’s approved plan of debt adjustment to exit municipal bankruptcy, the pension changes still must be submitted to and approved by the Financial Review Commission, which must approve any collective bargaining agreements after determining that the city can fund the contracts without running a deficit. Detroit Finance Director John Naglick noted: “The DFD wage package still requires a number of approvals, but if put in place, the wage increases are budgeted as part of wages and benefits in the general fund: The number of filled fire fighter operations positions is below the budgeted amount and will fund these increases.” He also noted that Detroit has already begun to set aside additional funding for the legacy plans and has hired Cheiron as its actuarial consultant to help it develop a formal long-term funding plan: “The legacy plans were frozen as a result of the bankruptcy, and the vast majority of the participants are already in pay status…For that reason, we believe this will be a manageable issue that will not affect the city’s recovery.”

Actually, the pension contribution will matter: Detroit confronts nearly a $500 million pension shortfall that it must begin paying in 2024. Nevertheless, Moody’s was unmoody in upgrading the city’s credit rating to stable from positive, citing the strain of meeting the increase in pension costs related to the legacy plans which limits the prospects for upward rating movement at this time. Mayor Duggan had warned earlier this year, as we had noted, that consultants who advised the city through its municipal bankruptcy had miscalculated the pension deficit by the tidy sum of $490 million. Detroit’s plan of debt adjustment submitted to the U.S. Bankruptcy Judge Steven Rhodes, had proposed freezing Detroit’s legacy pension plans: the plan provided an initial funding infusion from the so-called “grand bargain” funded with help from the state and private entities. Under the plan, the city deferred contributions until payments resume in 2024. Now Mr. Naglick notes the size of the city’s looming payment is unclear, because the value of plan assets will change; however, the additional 6% contribution, which is based on firefighter payroll, will help ease the unfunded liabilities. (When Detroit came out of chapter 9 municipal bankruptcy in December of 2014, actuarial estimates in the city’s Plan of Adjustment projected a payment of $111 million in 2024. Last November, the system’s actuary raised the figure to $194.4 million.) Last month, the Detroit City Council approved the set aside of $30 million from a city budget surplus in order to enable it to address a potential public pension shortfall.

Guiding Puerto Rico’s Fiscal Future. Congressional leaders have named eight members who will serve on a legislative task force with the task of considering options to boost Puerto Rico’s economy: the Congressional Task Force on Economic Growth for Puerto Rico. The board will have the power to require balanced budgets and fiscal plans, as well as to file debt restructuring petitions on behalf of the commonwealth and its entities in a federal district court as a last resort, if voluntary negotiations fail. The task force, created as part of the new PROMESA law, as well as a separate seven-member oversight board, is divided evenly between House and Senate members, as well as Republicans and Democrats: the Senators who will serve on the task force: Sens. Orrin Hatch (R-Utah), Marco Rubio (R-Fla.), Robert Menendez (D-N.J.), and Bob Nelson (D-Fla.); House Members are: Puerto Rico Resident Commissioner Pedro Pierluisi, Reps. Nydia Velazquez (D-N.Y.), Tom MacArthur (R-N.J.), and Sean Duffy (R-Wis.). Senate Majority Leader Mitch McConnell (R-Ky.) said he was confident that Sens. Rubio and Hatch, whom he was responsible for naming to the task force, would “use their commonsense approach and deep policy backgrounds to help Puerto Rico and its citizens achieve long-term prosperity with a thriving economy.” House Speaker Paul Ryan (R-Wisc.) named the two Republicans, while House Minority Leader Nancy Pelosi (D-Ca.) named the two Democrats from the House. Speaker Ryan is also required to choose one of the eight task force members to serve as chair, but noted that Reps. Duffy and MacArthur are the leaders we need to make the right recommendations so Puerto Rico can create jobs and reboot its economy.”

The task force will be responsible for examining current federal law and programs as they relate to Puerto Rico to find if there are any current impediments they could impose on economic growth or healthcare coverage for the territory; the task force will also be responsible to explore possible improvements which could enhance job creation, reduce child poverty, and attract investment. Under the provisions, the task force is required to provide a status update on its work during the first fortnight of September—and a final report by the end of the year. The task force, however, is quite different than the heavy lifting to be imposed on the still unnamed PROMESA board created under the new law to oversee resolving Puerto Rico’s recovery from its virtual municipal bankruptcy—a quasi-volunteer, unpaid board which will confront far more intractable problems than previous oversight boards such as in New York City and Washington, D.C.—boards on which members were required to either live or work in the city. In stark contrast, under PROMESA, only one member must either live or work in Puerto Rico. Not only might there be a cultural and language challenge, but also a quasi-sovereign challenge: Puerto Rico is, after all, something between a municipality and a state: the U.S. territory will be represented by its Governor and legislature—both of which are, theoretically, directed to work with the as yet unnamed board. The new law will allow board members to be reimbursed for their expenses; it provides there will be paid staff members. For its part, Puerto Rico is also concerned with the PROMESA board. Governor Garcia Padilla’s Chief of Staff Grace Santana notes: “[T]he law will only achieve its stated goals if the members of the soon-to-be established Oversight Board are truly committed to the Commonwealth and its people.”

There will also be other questions based on previous federal takeovers: Would Congress, as it did in the case of D.C., assume responsibility to fund Puerto Rico’s underfunded employee pensions? Will Congress agree to increase the federal rate for Medicaid reimbursements? Will it agree to take over Puerto Rico’s courts and prisons?

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.”

February 26, 2016. Share on Twitter

Out Like Flint. The profound threats to human health and safety in Flint created in signal part by a state appointed emergency manager—especially for the city’s children—appear to have been issues brought to the state’s attention long before there was any action: key advisers to Gov. Rick Snyder urged switching Flint back to Detroit’s water system nearly a year and a half ago in October of 2014 in the wake of a General Motors Co. warning that Flint’s heavily chlorinated river water was rusting engine parts, according to governor’s office emails examined by The Detroit News: Valerie Brader, then Gov. Snyder’s environmental policy adviser, requested that the governor’s office ask Flint’s state-appointed emergency manager to return to Detroit’s system on October 14, 2014, three weeks before Gov. Snyder’s re-election. Moreover, Mike Gadola, then Gov. Snyder’s chief legal counsel—today a Judge on the Michigan Court of Appeals, appointed by Gov. Snyder– agreed Flint should be switched back to Detroit water nearly a year before state officials relented to public pressure and independent research demonstrated elevated levels of lead in the water and bloodstreams of Flint residents. Mr. Gadola’s memo reported: “To anyone who grew up in Flint as I did, the notion that I would be getting my drinking water from the Flint River is downright scary…Too bad the (emergency manager) didn’t ask me what I thought, though I’m sure he heard it from plenty of others.” Mr. Gadola added that his mother remains a resident of Flint, making his personal alarm part of his communication to Gov. Snyder’s Chief of Staff Dennis Muchmore, Deputy Chief of Staff Beth Clement, as well as then-Communications Director Jarrod Agen, writing: “Nice to know she’s drinking water with elevated chlorine levels and fecal coliform…I agree with Valerie (Brader). They should try to get back on the Detroit system as a stopgap ASAP before this thing gets too far out of control.”

The telltale emails make clear that that some of the Governor’s closest advisers were privately, but clearly put on notice of the human health threat to Flint—especially its children—long, long before the state began to act. The information comes in the wake of the Governor’s office this week releasing nearly 1,6oo pages of emails to The Detroit News related to Flint’s 2014 switch to river water—a switch which experts believe caused the deadly leaching of lead into Flint’s drinking water. If anything, the News notes, the emails make clear that the Governor’s aides discussed poor water quality in Flint as early as the fall of 2014 after the city issued limited boil-water advisories because of an outbreak of E. coli and total coliform bacteria in the water supply. Moreover, Ms. Brader’s email alluded to festering apprehensions with regard to how the chlorine used to kill the bacteria outbreak was causing the formation of a harmful disinfection byproduct known as trihalomethane, a carcinogen which can increase the risk of cancer, liver, kidney, and central nervous system problems—or, as she tellingly wrote: “Specifically, there has been a boil water order due to bacterial contamination…What is not yet broadly known is that attempts to fix that have led to some levels of chlorine-related chemicals that can cause long-term damage if not remedied (though we believe they will remedy them before any damage would occur in the population).” Two months later, the Michigan Department of Environmental Quality issued a Safe Drinking Water Act violation to Flint for the high levels of trihalomethanes in the water. According to state records, Flint violated the law twice more until coming into compliance on Sept. 2, 2015. Nevertheless, despite her concerns and other staff concerns about the city’s brownish water quality, the Governor’s staff never took a recommendation to him that Flint be switched back to Detroit water until the following October.

Perhaps unsurprisingly, the apprehensions by key members of the Governor’s staff were held in abeyance pending completion of the new Karegnondi Water Authority pipeline could be completed; however, Michigan Treasury Department officials seemed to feel that the cost to reconnect Flint to Detroit water — an extra $1 million per month — was more than the fiscally stressed city of Flint could afford, with, as one aide to the Gov. put it: “The assessment was you couldn’t do it, because it was a cost that should have borne by the system.” Nevertheless, Mr. Muchmore, in a subsequent email, advocated using a $2 million grant the state had given Flint to upgrade its troubled water plant toward reconnecting to the Detroit water system, tellingly writing: “Since we’re in charge, we can hardly ignore the people of Flint,” in an email he sent to communications officials in the Governor’s office, the state Department of Environment Quality, and the Treasury Department, adding: “After all, if GM refuses to use the water in their plant and our own agencies are warning people not to drink it…we look pretty stupid hiding behind some financial statement.” But when asked why the Governor’s office had not sought funding from the Michigan Senate and House appropriations Chairmen last winter for a supplemental appropriations bill to reconnect Flint to Detroit’s system, the former chief of staff told the Detroit News it would have been dead on arrival.

Indeed, the newly released trove of emails demonstrates that Ms. Brader learned of GM’s switch to Detroit water on October 14, 2014 from an aide in the office of Senate Minority Leader Jim Ananich (D-Flint): Ms. Brader sent a note that afternoon to other top gubernatorial aides writing that Flint’s water was “an urgent matter to fix.” By August and September 2014, the city of Flint had issued boil water advisories to residents after water tests revealed an outbreak of E. coli and total coliform in some parts of the city. To treat the outbreak, the city increased the amount of chloride added to the drinking water at the Flint water treatment plant—chlorine levels General Motors had cited when it disconnected from Flint’s water system and turned to nearby Flint Township’s water, which came from Detroit’s Lake Huron pipeline. The message, however, did not seem to impact Flint’s state-appointed emergency manager: On Oct. 16, 2014, the City of Flint reported that General Motors’ exit from Flint’s water system “ensures that Flint residents will continue to have safe quality drinking water but minimizes the impact on GM’s machining work.”

Puerto Rico. In the wake of two Congressional hearings this week, Congress appears to be leaning in support of creating a federal oversight control board for the U.S. territory of Puerto Rico—an oversight board not dissimilar to previous New York City and Washington, D.C. boards—authorized to restructure and oversee Puerto Rico’s debt, pension, and economic crises. The hearings come as House Speaker Paul Ryan (R-Wi.) has set a March 31 deadline for action by the full House—a critical timeline, as Puerto Rico risks insolvency as early as April. Legislators said the two hearings, one on the Treasury Department’s proposal for the commonwealth and the other on possible ramifications of a restructuring on the municipal bond market, were the last scheduled before they prepare to draft a legislative package before a March 31 deadline imposed by House Speaker Rep. Paul Ryan (R-Wisc.).

At one of yesterday’s two hearings, Antonio Weiss, a counselor to U.S. Treasury Secretary Jack Lew, testified the administration believes the best solution is for Congress to allow for territorial restructuring authority using the powers Congress has under the U.S. Constitution’s Territorial Clause: “This would give Puerto Rico the tools it needs to reach a resolution with creditors and adjust its debts to a sustainable level…Importantly, this authority would expressly not apply to states, which have an entirely different relationship with the federal government under the 10th Amendment.” Mr. Weiss’s testimony appeared to signal a shift in the Administration’s position to ask Congress to authorize Puerto Rico authority to restructure all of its debts under Chapter 9 bankruptcy protections—a proposal dubbed “Super Chapter 9,” which never gained support in Congress because of misplaced apprehensions and misunderstandings in Congress about the nation’s dual sovereignty. Mr. Weiss also dispensed with a second misapprehension with regard to Puerto Rico’s public pension liabilities, testifying that while the Treasury is “deeply concerned about the pensions in Puerto Rico,” he said there was no truth to some press reports that the administration is proposing to put the territory’s pension obligations above its debt obligations in a restructuring hierarchy. Instead he said everyone should come to the table in a restructuring. With regard to restructuring, the Administration believes it should be in three parts in addition to a balanced approach to any federal board’s authority: a temporary stay on litigation to allow for voluntary negotiations between creditors and the commonwealth; a voting mechanism to prevent a few hold-out creditors from blocking a reasonable compromise; and a court-supervised structure to assure an orderly resolution if negotiations fail. Mr. Weiss testified there would be room for further Puerto Rico proposals to address economic growth, territorial tax reform, and improving Puerto Rico’s access to federal healthcare programs, noting: “We believe it is for Puerto Rican legislators and the governor to identify the reforms that are needed structurally, but we think it is equally important that the oversight board makes sure that those reforms that are identified are implemented.” He also sought to address apprehensions about potential concerns which have been raised with regard to broader adverse impacts on the state and local municipal bond front, noting that a key focus was to ensure an orderly restructure of the islands debts precisely to avoid the kinds of “cascading defaults and litigation” over the next decade that could risk muni market destabilization, telling lawmakers: “The best thing for municipal bond markets is for this to be brought to an orderly solution.”

Chairman Rob Bishop (R-Ut.) of the Natural Resources Committee, in the wake of the hearing, seemed to concur that any entity given oversight authority in Puerto Rico would also need to have the power to restructure, stating: “Some organization that is going to do a restructuring in this situation has to be the logical solution and there’s no other way around it…But it’s not necessarily going to be a remake of other control boards that have happened in the past. It has to be dictated by the specific situation.”

In the companion, simultaneous hearing chaired by Rep. Sean Duffy (R-Wis.), Chairman of the House Financial Services Committee’s Subcommittee on Oversight & Government Reform, Mark Zandi, Moody Analytics’ Chief economist testified that the Chairman’s proposed legislation was “a very positive step in the right direction;” however, he said he believed it failed to be broad enough, noting that Puerto Rico needs a much broader restructuring of all of its debts—as well as its unfunded pension liabilities. (Chairman Duffy’s proposed legislation (HR 4199) would provide public authorities in Puerto Rico with Chapter 9 municipal bankruptcy authority in return for Puerto Rico’s acceptance of a newly created five-member Financial Stability Council to review and approve its financial plans, budget and borrowing plans.) Mr. Zandi testified that authorizing the territory to file for municipal bankruptcy might only help restructure 30% of Puerto Rico’s debt—and perhaps up to 75% if COFINA bonds were included, but the proposal could trigger expensive and lengthy litigation—consuming time that is running out; ergo, Mr. Zandi recommended a Financial Stability Council be authorized to implement a temporary stay of perhaps 12 to 18 months on all debt payments so that there would be sufficient time to “fashion a sustainable restructuring.”

Anne Krueger, a senior research professor of international economics at Johns Hopkins University who led a study on Puerto Rico’s economic situation and prospects, told lawmakers the Commonwealth needs to reform its financial policies to become sustainable, stressing that Puerto Rico must deal with its unfunded pension liabilities, reform its tax and business policies, and receive Medicaid equal to all other states. William Isaac, senior managing director and global head of financial institutions for FTI Consulting, testified that authorizing municipal bankruptcy authority to the territory, “would be unprecedented and would have far-reaching implications, including raising the costs of borrowers for the fifty states.” Subcommittee members responded that Iowa Gov. Terry Branstad had raised the same apprehensions in a recent letter to House leaders. But Rep. Nydia Velazquez (D-NY) noted: “There’s no evidence of this,” and asked Mr. Zandi for his perspective—in response to which, he replied: “Investors have said quite clearly that Puerto Rico’s situation is Puerto Rico’s situation and it’s no one else’s problem.”

Our respected and admired friends at Municipal Market Analytics this week provided their own key perspective on this tension we have observed in Detroit, Central Falls, Stockton, and San Bernardino, noting that by elevating Puerto Rico’s pension systems to a higher priority that its constitutional debt, the territory would be “abrogating its duty to creditors,” adding that such an elevation would also be picking one set of retirees over another—e.g., in this instance, Puerto Ricans, who own a significant amount of the U.S. territory’s debt: 30 percent of all outstanding Puerto Rico municipal bonds are owned on-island through retirement funds, leading MMA to write: “By choosing to support pensioners from the public employee system instead of debt, the Commonwealth would effectively be choosing public employees over private employees, biasing the system against retirees who saved in private markets in favor of retirees in the government-run program. Pension systems in PR are collectively underfunded by about $44 billion at present, according to the most recent actuarial estimates, and the contributions made by public employees into defined contribution plans have been liquidated alongside the contributions made for defined benefit plans in the past. Meanwhile, about 30 Puerto Rican credit unions (cooperativas) are on the brink of default due to losses incurred on PR bonds.” Thus, MMA worries: “If the stated purpose of a PR restructuring is to protect regular Puerto Ricans through shared sacrifice, proposals of the type advanced by the US Treasury (per Reuters) are not the route forward, as severe damage to the local financial system would ensue under such a plan.”

Seizing Atlantic City. If anything, the time line for insolvency could be direr in Atlantic City than Puerto Rico, potentially triggering a state takeover of the city even if the state fails to enact pending takeover legislation. The issue comes with regard to costs: according to a memo from the nonpartisan Office of Legislative Services (OLS), preventing a “catastrophe” would require significant, long-term state financial support. Such a situation could occur if the city defaulted on its bonds or were unable to transfer property tax payments to the state, local school district, or Atlantic County government. Atlantic City, which is on the edge of insolvency, has little to no ability to borrow: its credit rating is below junk-bond status. Under the Local Government Supervision Act of 1947 — the same law that allowed the state to imposed oversight of some parts of city government in 2010 — New Jersey has significant powers to intervene in the city’s finances, according to OLS. It also has additional authority because the local government receives transitional aid that is subject to a memorandum of understanding with the Division of Local Government Services. The memo notes: “At the point when Atlantic City cannot borrow, short-term, to pay its essential operating expenses and payments due to the county and other taxing districts, it is hard to envision the State refusing to exercise its powers under the Local Government Supervision Act (1947) to take control of the finances of the city.”

The new development comes as local leaders, led by Mayor Don Guardian, are pushing back against the takeover proposal sponsored by Senate President Stephen Sweeney and supported by Gov. Chris Christie, with Mayor Guardian and City Council members holding a press conference at the beginning of the week to oppose the legislation, with the mayor going so far as to describe it as a “fascist dictatorship.” Nevertheless, the Governor and Sen. Sweeney have stood their ground, albeit Assembly Majority Leader Lou Greenwald, the sponsor in the lower chamber, on Monday said he may not move forward with the proposal unless local leaders are on board. Nevertheless, Atlantic City’s leaders are rapidly losing leverage: Gov. Christie last month vetoed a bill that would have protected the city from the impact of court-ordered reassessments on the struggling casinos and injected millions of dollars in revenue in the near term. Now the new takeover proposal comes with similar legislation, which would create payments in lieu of taxes the casinos could pay to the city, the school district and county government.

If state lawmakers were to drop their takeover effort, some form of intervention increasingly seems inevitable, according to the legislative services memo, which asserts the state has “sufficient authority over the city’s finances to prevent a financial catastrophe.” In the short-term, the state could offer a low or no-interest loan. It could also force the city to liquidate debt and require the city’s financial officer to issue special reports and hold hearings, OLS says. While the state would not be able to unilaterally end existing collective bargaining agreements — a power included in the proposed takeover bill — it could negotiate new agreements with unions. But all that would not necessarily fix the city’s deep-rooted problems, according to OLS. The city owes hundreds of millions of dollars to bond holders and casinos that won tax appeals, and it also receives less money than it used to from the casinos. Referring to the pachyderms in the house, the memo notes: “Of course, the ‘elephants in the room,’ being the tax refunds owed by Atlantic City to the casinos and the corresponding loss of casino ratables to the city’s property tax base, will likely render the State’s financial supervision efforts insufficient to fully address Atlantic City’s financial situation without the provision of increased long-term financial aid to the city and school district.”

To make matters worse, federal bankruptcy protection — something that city had been mulling but would need state approval to seek — may not be able to solve the issue either. A judge may not have the authority to erase or “cram-down” the $170 million in debt the city owes the Borgata Hotel Casino & Spa, which had won tax appeals and is owed a refund. Because the casino is exercising its right to skip property tax payments until the city issues the refund, a judge might consider the debt a credit against future taxes, or, as OLS noted: “If the Borgata property tax refund can be characterized as a property tax prepayment for future tax quarters, then it is unlikely that the bankruptcy code’s automatic stay of action would apply.”

Marc Pfeiffer, the superb Assistant Director of the Bloustein Local Government Research Center, Bloustein School of Planning and Public Policy in New Brunswick, New Jersey, notes that generally, while New Jersey clearly has significant authority now, given the magnitude of Atlantic City’s immediate and long term problems, the traditional solutions may not work, pointing to immediate issues such as cash flow, the need for stability of calculating casino property values and the tax revenue they represent, and monetizing their accumulated debt and deficits. He wrote that the long term requires the city to restructure and rationalize the cost of running the city: the current cost structure (with a few exceptions) was effectively established when Atlantic City had 12 casinos of higher value (i.e., market value of $22B in 2007 and $7.4B today), adding that labor costs, staffing levels, and position allocations all need to be rationalized—and there is no adequate legal authority for that to happen. Further, he notes, city officials need to understand that the current and prior generations of elected officials could have done a better job of managing their resources. The city has traditionally been overstaffed with pay scales in excess. Historically the city has been rife with patronage appointments and expectation of privilege (he notes, for instance, that only in the last month did city council members give up their personal vehicles). That means they cannot do business as usual and blame the state; that does not win any arguments, adding that even though Atlantic City officials were aware of the drop in value, they did little to address it.

Similarly, he adds, New Jersey’s plans for the City over the last 6 years have not met expectations: political decisions along the way resulted in the today’s crisis: Instead of waiting until 2015 to engage via an emergency manager who only recommended actions, if stronger state action had been taken several years ago, the immediate crisis could have been avoided—adding that, nevertheless, the situation being as grave as it is, the parties need to quickly align and understand that dramatic action is needed now to avoid a municipal bankruptcy filing which would only prolong the problem and add more costs. He notes that while the state clearly has significant authority now, given the magnitude of Atlantic City’s immediate and long term problems, the traditional solutions may not work. The immediate issues: cash flow, the need for stability of calculating casino property values and the tax revenue they represent, and monetizing accumulated debt and deficits. Further, he wrote, city officials need to understand that the current and prior generations of elected officials could have done a better job of managing their resources. The city has traditionally been overstaffed with pay scales in excess.

He added that New Jersey’s plans for the City over the last 6 years have not met expectations: “political decisions along the way resulted in the today’s crisis. Instead of waiting until 2015 to engage via an emergency manager who only recommended actions, if stronger state action had been taken several years ago, we could have avoided the immediate crisis…But we are where we are, and the parties need to quickly align and understand that dramatic action is needed now to avoid a bankruptcy filing which will only prolong the problem and add more costs.”

Defining the Fiscal Future of Schools, Cities, and U.S. Territories

February 3, 2016. Share on Twitter

Democracy. Elections, & Municipal Bankruptcy. In yesterday’s runoff elections in bankrupt San Bernardino, Bessine Littlefield Richard was easily elected to represent the 6th Ward on the City Council over Roxanne Williams, by an almost 2-to-1 margin, while incumbent Councilman Jim Mulvihill was re-elected over challenger Scott Beard in the 7th Ward based on final, unofficial results—albeit Mr. Beard has not yet conceded. Before the election, Ms. Littlefield Richard had garnered endorsements and financial support from a broad range of groups — from the police and fire unions to many of the city’s political heavyweights, including some who’ve sharply differed with each other on policy questions — but she said she would not be beholden to any of them. In the wake of the election, Councilmember Mulvihill, a certified city planner and urban planning professor at Cal State San Bernardino, said it was important to keep him on the council to stick to the plan of implementing a precarious bankruptcy exit plan. Last November in a then five-candidate race, Councilmember Mulvihill had finished first, while Mr. Beard edged third-place finisher Kim Robel, sending the two to yesterday’s runoff. The election results are not expected to become official until Lincoln’s birthday, a week from Friday, according to the Registrar of Voters. The newly elected council member is scheduled to be seated March 7. Ms. Littlefield Richard supervises a staff of 20 employees with San Bernardino County’s Workforce Development Department in Victorville.

Detroit’s Future. Even as hearings in the Michigan legislature to restructure Detroit’s schools (DPS) are poised to begin Thursday, Gov. Rick Snyder’s designated DPS Emergency Manager—the former Emergency Manager for Flint, Darnell Earley, has announced he will resign effective at the end of this month. This marks the second early departure for Mr. Earley: he was previously the state-appointed emergency manager of Flint during its controversial shift from Detroit’s regional water system to the Flint River—a switch with fatal human and fiscal consequences which will linger in some of Flint’s children for decades. The abrupt announcements came just before tomorrow’s scheduled hearings by the Michigan legislature on Gov. Rick Snyder’s proposed plans to restructure the nearly bankrupt Detroit Public School system. Senate Bills 710 and 711, sponsored by state Sen. Goeff Hansen (R-Hart), would split Detroit Public Schools into two entities, and would also change the legal structure of the school district’s outstanding debt, creating a lockbox to ensure that investors would be paid in full, and on time: under the proposed bill, the existing Detroit Public Schools entity would remain intact only for the purpose of collecting tax revenue until its outstanding debt is retired, while a new entity, the Detroit Community District, would operate the schools—all part of an effort by the state to convey to both Detroit and Michigan municipal bondholders that the state will make an extraordinary effort to avert any municipal bankruptcy by the Detroit Public School system—a system which has been under state oversight for the last seven years—and which has accumulated massive debts, including some $1.5 billion of unlimited-tax general obligation bonds, $199 million in borrowing from Michigan’s School Loan Revolving Fund, and $259 million in limited-tax GO debt paid by district operating revenues, rather than a dedicated debt service levy. The proposal by Gov. Snyder would include an appropriation of $715 million, with $515 million to eliminate the school system’s accumulated structural operating deficit and help with overdue pension payments and unpaid bills, and the remainder as start-up funding for the new operating entity—with the Gov.’s office warning that without action, DPS will be “virtually insolvent” by April.

It is uncertain either how quickly the legislature will act—or whether there will be consensus: Sen. Goeff Hansen, a veteran of four years’ service as a Hart Township supervisor, and the current Chair of the Senate Appropriations Subcommittee on K-12, School Aid, Education—as well as Assistant Senate Majority Leader, has proposed bills to appropriate $250 million from the state’s general fund for the start-up costs, but there appear to be no bills yet to address DPS’s operating deficits. Under Sen. Hansen’s proposed legislation, the new Detroit Community District would shift in 2017 to an elected board. Responsibility for the district’s $1.5 billion of unfunded pension liabilities would lie with the new district. The City of Detroit’s Financial Review Commission would have responsibility for overseeing the new school district’s finances.

Hearings before the state Senate’s Government Operations Committee are expected to continue for two weeks, with the Senator hoping his bill might mark a first step toward a long-term solution, noting: “Detroit is on the rebound, with a sound financial footing, improving economy and a rising population, but numerous efforts to improve K-12 education there have not worked.” Arithmetic will matter: DPS’ monthly expenses are projected, this month, to rise by $26 million to begin repaying cash flow notes issued to paper over operations—a level which is equal to about one-third of DPS’ monthly expenses, according to the mathematicians at Moody’s. Outgoing Emergency Manager Earley has warned that DPS will exhaust cash to maintain operations by April due to its debt overload.

So in Latin class, the words would be tempus fugit: time is flying, even as the proposed hearings will mark the first steps toward legislation and state appropriations since Gov. Snyder first unveiled a general outline nearly a year ago—a plan—with a budget match expected to be attached when the Governor proposes his FY2017 budget recommendations a week from today—budget recommendations which could pit Detroit’s school children versus Flint’s lead-threatened children. The state plan is expected to provide for a new Detroit public school system entity which would be in charge of educating students, and to continue to borrow and issue bonds for operating purposes on a longer-term basis. That will matter: this year, debt service payment obligations are projected to nearly triple to $2,982 per student from $1,105 last year in 2015, mainly because the district pushed its 2015, $83 million cash-flow note repayment onto the current school year’s budget. Just as negligence has put the children of Flint at risk, so too fiscal negligence has put Detroit’s children at risk—as increased debt service obligations compete directly with the fiscal resources critical to financing the education of the children who will define Detroit’s future—and drive families to either contemplate moving into—or out of—the city, where, as Moody’s has moodily noted, declining enrollment has already hurt DPS’s balance sheet and attendance—attendance which has declined more than one third in just the last five years.

There are risks and balances, because Detroit’s schools’ debt is backed by the state via Michigan’s Qualified School Bond and Loan Program—meaning, as the ever prescient Yvette Shields of the Bond Buyer writes: “That means that the state could ultimately be on the hook for a good portion of DPS’s operating debt in a municipal bankruptcy [Chapter 9], although the bankruptcy court would have the final word.”

Out Like Flint. Gov. Snyder is expected to propose $30 million in Michigan state funding to help pay the water bills of Flint’s residents confronted by the emergency over the city’s lead-contaminated water supply, with the Governor expected to brief Flint officials and pastors about the plan today–and outline it to the legislature next week as part of his FY’2017 budget proposal.

In Like Puerto Rico? House Natural Resources Committee Chair Rob Bishop (R-Utah) has announced he intends to begin drafting legislation intended to aid Puerto Rico in the near future in the wake of a hearing yesterday, which included testimony from several witnesses with histories of working with control boards. The goal is to meet House Speaker Paul Ryan’s (R-Oh.) March 31 deadline for House committees with jurisdiction over Puerto Rico to cobble together a legislative proposal—one which Chair Bishop yesterday said would involve Delegate Pedro Pierluisi (Puerto Rico), the U.S. territory’s sole representative in Congress—and a member of the Committee. Del. Pierluisi said he supports creating an independent financial control board to oversee Puerto Rico’s long-term financial plan, annual budgets, and efforts to complete accurate and timely financial information—adding, however, that if the Committee’s bill were to propose “to extinguish rather than enhance” Puerto Rico’s democracy at the local level, he would “do everything in [his] power to defeat it.” The sole pending legislation that appears to have any likelihood of garnering bipartisan support in the House is authored by Rep. Sean Duffy (R-Wis.), the Puerto Rico Financial Stability and Debt Restructuring Choice Act, which would provide public authorities in Puerto Rico with Chapter 9 municipal bankruptcy protection in exchange for Puerto Rico’s acceptance of oversight from a Presidentially-appointed five-member Financial Stability Council. Indeed, there appears to be consensus at the committee level that there should be—as there has been previously for New York City and Washington, D.C., some type of oversight authority; there has yet, however, been no consensus on just what specific powers such an authority should have. Former Washington, D.C. Mayor Anthony Williams, who had experience working with D.C.’s financial control board, yesterday stated that any discussions of restructuring the territory’s debt should follow a joint effort by Puerto Rico’s government and an appointed authority to put the commonwealth’s “basic housekeeping in order” by reforming key fiscal basics, such as Puerto Rico’s revenue collecting capabilities, adding that any federally-imposed authority should have to approve the Commonwealth’s financial plans and have goals of both achieving financial stability and a balanced budget for the Territory, adding that such an authority ought to be composed of no more than five to seven members who have the necessary experience to address Puerto Rico’s crisis—and that there would have to be some representatives on the panel who are Puerto Rican residents or of Puerto Rican ancestry.

Threats to San Bernardino’s Future. Francis Wilkerson, writing this week in Bloomberg [“The War in San Bernardino”] about the terrorist attack in San Bernardino last December—an attack which led GOP Presidential candidate Sen. Ted Cruz (R-Tx.) to claim: “This horrific murder underscores that we are in a time of war—” provoked Mr. Wilkerson to write that Sen. Cruz’s comments appear to find no such reflection in the bankrupt city. He wrote: “In long interviews with city leaders or short conversations with residents, none felt compelled to mention where he or she had been at the fateful hour. Some presidential candidates seem to view the attack in San Bernardino as evidence of an existential threat to the nation, and invoke it every chance they get. In San Bernardino, it hasn’t registered as an existential danger even to San Bernardino. It’s rarely mentioned.” Rather, as he recognizes, there are very real threats to the city’s future: “San Bernardino has long been at war, and losing. The steady erosion of the American working class, with a commensurate rise in local poverty, has been killing the city for decades. It is now emblematic of some of the nation’s most intractable problems – violent crime, drug addiction, joblessness, urban blight, political dysfunction, low-skill immigration, white flight, and widespread civic apathy. Like Detroit, the heaping culmination of those troubles ended in a municipal bankruptcy.” In his tour of the city with San Bernardino Police Department Lt. Richard Lawhead, he noted “a dozen prostitutes plied the streets 100 yards from a downtown school, walking, talking on phones, watching for signals from a man near the corner, assiduously avoiding eye contact with the occupants of the police car…working-class neighborhoods that had been commandeered by gangs and never relinquished.” Then he made a fascinating contrast:

The attack cast the city in a weirdly positive light. Famous for failure, San Bernardino unexpectedly basked in a glow of competence. The police rapidly tracked down the killers, cornered them and killed them, preventing a likely second round of mayhem.

He wrote that Lt. Lawhead was optimistic about the city’s future: “even a little infectious,” but then wrote that MIT economist David Autor had written him, via e-mail, “We have almost no firm knowledge of how to ‘turn around’ places in deep decline,” adding, “San Bernardino’s own efforts over the years have been flamboyantly luckless. Cited as an ‘All-American’ city in 1977, its long, ignominious skid reached a grim destination on Aug. 1, 2012, with Chapter 9 bankruptcy. Other battered cities have traveled a similar route. No one can be certain it’s the last stop.”

Human & Fiscal Disruption & Mayhem and the Importance of Municipal Bankruptcy

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December 10, 2015. Share on Twitter

Human & Fiscal Disruption and Municipal Bankruptcy. Last week’s mass shooting in San Bernardino, in which 14 persons were killed, was reportedly planned up to a year in advance. It was not an event which could have been anticipated—much less incorporated in the city’s plan of debt adjustment to submit to U.S. Bankruptcy Judge Meredith Jury. It raises the question with regard to mass tragedies and their impact on municipal coffers: after all, San Bernardino could hardly afford such devastation and loss of lives in the midst of the longest municipal bankruptcy in U.S. history: are other municipalities prepared for comparable tragic eventualities? Now the city will have to bear not just the costs of its responses to this tragedy, but also significant new costs in the wake of it and to prepare for the future. What will these tragic events imply for the city’s residential assessed property values? Just as the elimination of blight and violent crime was a critical issue for Detroit’s plan of debt adjustment before now retired U.S. Bankruptcy Judge Steven Rhodes, so too San Bernardino will have little choice but to modify any proposed plan of debt adjustment to take into account the events with which it was beset. Might the federal government or the MIA State of California step in to provide some fiscal assistance?

It appears the suspected killers devoted as much time as the city has on its plan of debt adjustment in devising their own plan of human and fiscal destruction, commencing nearly two years ago, practicing with guns and making their own kinds of financial preparations in 2014: Syed Farook and Tashfeen Malik began honing their own fiscal and firearms skills last year at a shooting range in nearby Riverside, according to NBC, citing two sources, even as counter-terrorism officials said the pair began making monetary savings for their child and Mr. Farook’s mother during the same period—or, as one official noted; “[They wanted to] take care of both Grandma and the baby…They had purposely thought through that problem…[Some transactions] would be consistent with them making preparations for grandma and the kid.” The FBI is now investigating the incident for potential ties with terrorist organizations including the Islamic State in Iraq and Syria.

A week after the terrorist attack at the Inland Regional Center in San Bernardino that killed 14 people and left 21 wounded, more details have begun to emerge about the married couple the FBI believes to be responsible for the attack, Redlands residents Syed Farook and Tashfeen Malik, along with Farook’s former Riverside neighbor, Enrique Marquez. In testimony before the U.S. Senate Judiciary Committee yesterday, FBI Director James Comey said Farook and Malik had discussed jihad and martyrdom as early as 2013 and that both had embraced extremist Islamic ideology before their relationship had even begun — even before ISIS separated from Al-Qaida in 2014. Ironically, of course, these discussions and plan-makings were occurring even as the Congressionally imposed sequesters were reducing resources which might have helped save lives.

Letting Puerto Rico Help Itself. Sen. Orrin Hatch (R-Utah) yesterday blocked an effort by Sen. Charles Schumer (D-N.Y.) to pass to pass legislation to give the U.S. territory access to U.S. bankruptcy courts and allow Puerto Rico to restructure its debts in the same fashion as Detroit, Jefferson County, Central Falls, and other municipalities—rather than a bailout such as General Motors received. Indeed, Sen. Schumer specifically stressed that his proposal was not a “bailout,” warning that Puerto Rico’s fiscal and financial crisis will worsen absent action from Congress to permit the island to help itself: “If we fail to offer Puerto Rico assistance now, the problem will not be contained to the island…We have the tools to fix the problem. They’re sitting in the toolbox. The problem is Puerto Rico isn’t allowed to use them.”

Sen. Schumer’s comments came as the Chairs of three U.S. Senate committees, Sens. Orrin Hatch (R-Utah), Lisa Murkowski (R-Alaska), and Charles Grassley (R-Iowa) with jurisdiction over Puerto Rico and bankruptcy introduced a bill yesterday, the Puerto Rico Assistance Act of 2015, to create an authority which could issue municipal bonds and provide up $3 billion in resources to help Puerto Rico stabilize its budget and debt. While the proposed legislation would, if enacted, render some fiscal resources, it would not, however, provide the kind of bankruptcy protection available to every other U.S. corporation in the U.S.; rather, the bill would make clear that the U.S. is not bailing out Puerto Rico or pledging its full faith and credit to any bonds issued by the Financial Responsibility and Management Assistance Authority, whose six members would be appointed by the President; instead the measure would provide a 50% cut in the employee side of the payroll tax for five years and reduce the employee share of the tax to 3.1% from 6.2%. It proposes a number of studies, including on the Commonwealth’s pension plans and liabilities and the commonwealth’s healthcare treatment by the federal government. The legislation proposes to provide assistance to the island in improving its accounting and disclosure practices.

There was, mayhap, more constructive movement in the House yesterday, where Rep. Sean Duffy (R-Wis.), Chair of the House Financial Services Subcommittee on Oversight & Investigations, introduced legislation, the Puerto Rico Financial Stability and Debt Restructuring Choice Act, which would, if enacted, provide public authorities in Puerto Rico with Chapter 9 bankruptcy protection in exchange for the commonwealth’s acceptance of oversight from a Presidentially-appointed five-member Financial Stability Council, with Chairman Duffy stating: “This bill empowers the Government of Puerto Rico with the choice to partner with the Federal Government and put the island on a path towards balanced budgets and a return to fiscal security. If Congress does not act, it would have a devastating effect on the people of Puerto Rico and countless Americans throughout the states who stand to lose billions in the bond markets…This is a multi-pronged approach and a long-term solution. It cannot happen without adoption of legislation by the Puerto Rico Legislative Assembly which must be signed by the Governor. We know bailouts do not change spending habits. We need all sides to be fully committed to changing the way Puerto Rico manages its budgets, tax collection and finances.”

Chairman Duffy added: “The Puerto Rico Financial Stability and Debt Restructuring Choice Act gives the island’s leadership a choice: through the adoption of legislation passed by the Assembly and signed by the Governor, the Government of Puerto Rico will have access the same chapter 9 bankruptcy process that America’s States do if it also agrees to an independent Financial Stability Council to oversee the island’s path toward balanced budgets and a return to financial stability…The Puerto Rico Financial Stability and Debt Restructuring Choice Act will restore Puerto Rico’s access to an orderly debt restructuring process, without which the result would be disorderly litigation which is neither good for the island or its bondholders.”

In addition, the proposed bill would permit the appointment of a Puerto Rico Financial Stability Council: “In order to restore investor confidence and improve tax collection and budgeting practices, the Government of Puerto Rico may choose to accept the establishment of a 5-member Financial Stability Council with the authority to oversee the island’s financial planning and annual budgets. Unlike the D.C. Control Board of the 1990s, this Council will not be imposed on Puerto Rico – the island’s elected leaders in San Juan must agree to accept the Council. The Council’s duration will also be limited and it will not have the blanket authority to impose changes to Puerto Rico’s government. Rather, the Financial Stability Council will focus on just that: restoring financial stability to Puerto Rico.” Under the proposed bill, members of the Financial Stability Council would have to have knowledge and expertise in finance, management, and the organization or operation of business or government and would have to either have a primary residence in Puerto Rico or have their primary place of business on the island, according to the bill’s text. They could not provide goods or services to the commonwealth’s government and could not be a member of the government. Once established, the council would review an annual financial plan and budget from the governor and would have to approve it before the materials would be sent to Puerto Rico’s legislature. Any borrowing the commonwealth plans would also have to go through the council.

Gov. Alejandro García Padilla, speaking at the Puerto Rico Federal Affairs Administration in Washington yesterday, stressed that an extension of Chapter 9 municipal bankruptcy protections to Puerto Rico’s public authorities would not constitute a federal bailout; rather it would simply be a way to give Puerto Rico the “tools” it needs to fix its problems, adding that Puerto Rico is a lost ship of 3.5 million people sending a distress call to the federal government: “We are not asking for a bailout; we are asking for the tools to do the job,” adding that it was up to the federal government whether it wishes to answer the commonwealth’s calls. Nevertheless, he warned, if Congress continues its inaction, there will be a humanitarian crisis on the island.

Puerto Rico’s problem extends further than its $72 billion public debt and includes a lack of health care funding and federal tax credits that can put a halt to the large out-migration of its citizens and bolster the commonwealth’s economy. The governor, who has continually said the government does not have the funds to repay its debt, signed an executive order on Dec. 1 to pay $355 million in Government Development Bank notes that were due. But the order implemented claw back procedures that would take funds away from some lower priority bonds to pay back obligations backed by the commonwealth’s constitution. Puerto Rico has to pay $1 billion of debt service by Jan. 1 and the fate of that payment is uncertain with the lack of action from Congress. Gov. Padilla said he plans to meet with Treasury officials this week to further discuss the commonwealth’s position, but he did not have specific details on the meeting at the press conference.

The Drain. As we experienced in Detroit, a spiral of fiscal distress drains a municipality’s resources, costing streetlights, police response time, etc.—events and changes in fiscal capacity that can cause families to leave—that is, those that can afford to. Just as Detroit experienced a signal exodus before its filing for municipal bankruptcy, so too more than 200 Puerto Ricans leave the island for the mainland U.S. each and every day—those most able to afford to move, leaving behind those least able to make their own way and further sapping the Puerto Rican economy. At 5.7 percent, the unemployment rate in the Motor City is now ten percent below what it was six years ago—in a city where, between 2000 and 2014, 90,000 of its citizens moved out. The critical loss, of course, and most critical cause of its largest municipal bankruptcy in U.S. history, was the out-migration of its labor forces. As in Puerto Rico, key population shifts come from those most able to move—leaving those too old or too poor and dependent behind—and, of course, adding to the upside down imbalance on a city – or, in this instance – territory’s pension obligations. Puerto Rico biggest pension program has sufficient funds today to meet just 0.7 percent of its future obligations.

Forty percent of Puerto Rico’s citizens live below the poverty line. It is difficult, albeit, unfortunately, not impossible, to imagine the federal government ignoring the humanitarian crisis that would probably follow. But the longer Congress waits, the more vicious this cycle of those who can most afford to emigrate to the mainland and leave behind an ever accelerating shrinking tax base, rising taxes, and curtailed essential services will be. As U.S. citizens, the island’s migrants will be eligible for public support of various kinds on the mainland. There is no question, in other words, that the U.S. will end up bearing much of the cost of Puerto Rico’s past profligacy. The only question is how considered and efficient its assistance will be.