Disparate Fiscal Solvency Challenges

06/23/17

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

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

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

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

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

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

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

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

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

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

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

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

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

 

The Indelicate Challenge of Restoring Political Authority in the Wake of Municipal Insolvency

Good Morning! In this a.m.’s eBlog, we consider the historic Civil War municipality of Petersburg’s, Virginia’s steps back to solvency and restoration of municipal control, and then to the indelicate imbalance of fiscal power in Puerto Rico—and whether the federal preemption might be causing more fiscal damage to its fiscal future.

Returning to Solvency. The Petersburg, Virginia City Council last night approved its FY2018 budget, a budget which includes outsourcing jobs—with more than a dozen city employees slated to lose their jobs as a result. The new municipal budget includes an increase in water rates—an increase of nearly 15%–an increase the city’s elected officials deemed necessary in order to finance needed repairs, as well as to update its systems for billing and collections—and to cover its past due arrears of $1.9 million. The session came as the Council began discussions with regard to hiring a new city manager and police chief—and whether to beef up is personal property tax enforcement: the city estimates it could be losing as much as $7 million annually from inadequate collection efforts. The actions by the Mayor and Council reflect a restoration of municipal authority in the wake of state intervention.

The Unpromise of PROMESA? Neither the government of Puerto Rico, nor the PROMESA Oversight Board has been able to state how much in municipal bond interest payments will be made for the next fiscal year—even as the gates of the University of Puerto Rico have been locked, depriving the U.S. territory of the jewel in its crown. The University, which has relied upon 30% of its financing from the government—financing critical to Puerto Rico’s hopes to keep its most promising future generation on the island, rather than incentivized to leave for New York City or Miami—increasingly threatening to leave behind an older and less educated population, more dependent on governmental services, but less able to pay taxes. However, as the PROMESA Board struggles over its preemptive decision with regard to what percent of Puerto Rico’s debt obligations to its municipal bondholders should be mandated, (according to the Board’s March approved fiscal plan, the bonds most closely associated with Puerto Rico’s government would pay $404 million in debt service in the coming fiscal year—approximately one-eighth of the $3.28 billion debt service due), the question with regard to investing in Puerto Rico’s fiscal and physical future remains murky—indeed, murky enough that the balance between Puerto Rico’s $404 million in debt service costs versus investments in its future has been left hanging.

Part of the challenge of preemptive governance is, as we perceived in the first instance of the Michigan takeover of Flint, that there can be signal human and fiscal damage to life, property, and fiscal solvency. Thus, the imbalance where the federal takeover under PROMESA, the Act intended to serve as the fiscal guide through FY2026, is to what extent disinvestment in Puerto Rico’s physical infrastructure and its municipalities might aggravate, rather than restore the territory’s solvency and create a fiscal foundation for its future. And that future is at stake—a future where the gates of its premier university are locked, and where demographers report the loss of population of 61,874 in one year—and where last Sunday’s plebiscite witnessed a drop of more than 50% in voter participation, with markedly reduced percentages in Puerto Rico’s 78 municipalities—where participation was 23%, less than a third the level of 1998. Demographer Raúl Figueroa noted: “The population is declining…To give people an idea, from 2015 to 2016, the loss of population was 61, 874,” adding that every year between 1% and 2% of the population is lost. The Mayors of Yauco (a municipality which lost nearly 10% of its population over the last decade) and Ponce, Puerto Rico’s second largest city, known as the City of Lions (population of 194,636), founded in 1692, an important trading and distribution center, as well as a key port of entry—indeed, one of the busiest ports in the Caribbean, which has seen a 9.36% decline in its population—a decline which Mayor Maria Mayita Meléndez, attribute to emigration: Mayor Meléndez notes that since 2006, more than 25,000 Puerto Ricans have left Ponce.

Getting Back in like Flint

Good Morning! In this a.m.’s eBlog, we consider the lessons learned from Flint—lessons that were not unrelated to the largest municipal bankruptcy in U.S, history in Detroit.

Immunity for State & Municipal Employees: What Does it Mean in Flint? U.S. Judge Judith Levy, in her 101-page decision this week, held that Flint and Michigan employees can be sued over the city’s lead water contamination; however, she found that Michigan Governor Rick Snyder and the State of Michigan have governmental immunity. The ruling came in response to a suit brought by a resident of Flint, against Gov. Snyder and 13 other public officials. Judge Levy dismissed many of the counts; however, she concurred that Flint resident Shari Guerin, who had brought the suit against the city and the other public officials, had had both her and her child’s “bodily integrity” unknowingly exposed by the dangerous levels of lead in Flint’s drinking water—levels of which the state was aware, but had hidden from the public. Indeed, the Judge wrote: “The conduct of many of the individual governmental defendants was so egregious as to shock the conscience.” Despite dismissing the charges against the Governor, the Michigan Departments of Environmental Quality and Health and Human Services—and the city’s water treatment plant operator, Judge Levy found that some key state leaders, including the state’s Chief Medical Executive and Health and Human Services Director could be sued in their individual capacities—and that Flint officials have no state governmental immunity, writing: “As this case highlights, the more governmental actors that are involved in causing a massive tort in Michigan, the less likely it is that state tort claims can proceed against the individual government actors given the way the state immunity statutes operate…Because the harm that befell plaintiffs was such a massive undertaking, and took so many government actors to cause, the perverse result is that none can be held responsible under state tort law.”

A Vicious Fiscal Whirlpool? For the city, the severe water contamination had not just physical fiscal implications, but also fiscal ones. Indeed, one of the plaintiffs was one of nearly 8,000 homeowners who was in danger of losing homes under tax foreclosure proceedings (Real property tax delinquency in the state entails a three-year forfeiture and foreclosure process)—proceedings which had been scheduled to commence last week until the Flint City Council approved a one-year moratorium—a moratorium which covered residents with two years of unpaid water and sewer bills going back to June 2014. While that temporary reprieve is in question, confronting an unknown outcome before the state-appointed Receivership Transition Advisory Board, which has monitored Flint’s finances since the city’s emergence from state oversight in two years ago last April—and is scheduled to vote on the moratorium at its June meeting; the outstanding water liens and inability to collect have further emptied the city’s coffers—even as, unsurprisingly, assessed property values  have become the latest fiscal hardship as an impoverished Flint still reels from a lead-in-water crisis which was first publicly acknowledged less than two years ago.

According to a recent Michigan State University study, “Flint Fiscal Playbook: An Assessment of the Emergency Manager Years, 2011-2015),” Flint has lost nearly 75 percent of its tax base—and of that base, assessed property valuations reeled to a 50 percent drop from $1.5 billion to $750 million.  Thus, unsurprisingly, more than 100 residents showed up at this week’s Council meeting—understandably upset that they face foreclosure even as they have been confronted by bills for drinking water, which they could neither drink, nor use in any way that might jeopardize the health and safety of their children. Those citizens received a temporary, one-year reprieve from the city—but the reprieve implies greater fiscal challenges to the city.

With liabilities high and revenues and property taxes struggling, Flint Mayor Karen Weaver reports that Flint has trimmed $2 million in annual garbage collection expenses by rebidding the service; expects to cut annual water expenses to $12 million from $21 million; and, due to federal grants, is hiring 33 more firefighters. The city is proceeding with a $37 million renovation of the Capitol Theatre downtown, seeking to create a central, historic space which could enhance the downtown—or, as the Mayor puts it: “I don’t think people should take their eyes off Flint.”

But assessing the dimensions of this disaster, created in no small part under the state’s original takeover of the city via the appointment of the emergency manager who had made the fatal decisions to change the city’s sourcing of drinking water, also includes looking back to the critical governmental decisions—especially Flint’s opting to abandon reliance on the  Karegnondi Water Authority (KWA) and instead rely upon the Great Lakes Water Authority (GLWA), a regional water authority created as part of Detroit’s chapter 9 plan of debt adjustment—meaning Flint’s citizens will keep drawing Detroit water from their taps—or, as the Mayor put it: “Staying with our water source gives us reassurance our water is good…It gets us out of our $7 million (annual) debt to the KWA. We did not have the finances to be able to do that.” Under the city’s 30-year agreement with the  30-year deal with GLWA, the city will receive a $7 million annual credit equal to its annual municipal bond payment to KWA for as long as Flint remains current with scheduled debt service. In addition, the agreement also enables the city to redirect water plant improvements to upgrading the city’s water distribution system—or, as Mayor Weaver notes: “We have pipes going into the ground now (referring to the planned replacement of lead service lines).We’re addressing this water crisis. The water quality is better. There are some good things going on.”

Mayor Weaver notes Flint has cut its $2 million in annual garbage collection expenses by rebidding the service; the city expects to cut annual water expenses to $12 million from $21 million; and the city continues to work with the Governor to address the public health concerns associated with the Flint water crisis. To try to become an economic magnet or hub, rather than a city to be avoided, the city is focused on a $37 million renovation of the Capitol Theatre, creating a central, historic space which could draw folks to events, restaurants, and bars. As the Mayor puts it: “I don’t think people should take their eyes off Flint…They should know the rest of the story. One of the things I’ve learned is we were going to get more done if we work together. If people are going to help you, why would you not sit down and work things out?”

The Hard Road to Fiscal Sustainability

eBlog

Good Morning! In this a.m.’s eBlog, we consider, Detroit’s remarkable route to fiscal recovery, before returning to the stark fiscal challenges to Puerto Rico’s economic sustainability.

The Road to Recovery from Municipal Bankruptcy.  Detroit, which has roared back from the largest municipal bankruptcy ever, but, in doing so paid an average 81% of what it owed to its municipal bondholders as part of its plan of debt adjustment, nearly 25% more than either San Bernardino or Stockton, now, in the wake of its decades of its more than 50% population decline  (In 1950, there were 1,849,568 people in Detroit; in 2010, there were 713,777.), is ready to tackle its housing dilemma. Post-chapter 9 Detroit inherited an estimated 40,000 abandoned lots and structures and an 80% erosion of its manufacturing base—that in a municipality where 36 percent of its citizens were below the federal poverty level, and, the year it filed for chapter 9, had reported the highest violent crime rate for any U.S. city with a population over 200,000.

Thus, Mayor Mike Duggan now vows that his administration plans to launch a street-by-street initiative effective August 1st to board up abandoned homes in the city while demolition crews continue razing blighted houses. That will be a painstaking challenge: in a city of 142 square miles, the city reports some 25,000 unsecured houses, the bulk of which have been scheduled to be razed—but, up to now, the pace of demolitions has been limited to 4,000-5,000 annually, according to the Mayor. Thus, he posits: “We’re going to go through and board up every house we can’t get to so we’re not just saying to people, ‘It’s going to be five years before we get to everything. Wait!’”

Mayor Duggan, speaking at the Mackinac Policy Conference, vowed the city will begin deploying six crews beginning at the end of next month, with the teams slated to go through each neighborhood and close off vacant and abandoned homes—homes that are susceptible to crime, to being scrapped for metal and finishings, and becoming uninhabitable safety hazards. Mayor Duggan made the announcement, as the city’s plan of adjustment and the city’s actions in implementing it appear certain to be fodder for the upcoming mayoral primary election set for August 8th—with whichever candidate is chosen slated to confront Michigan state Sen. Coleman Young II (D) in the November 7th general election. Indeed, unsurprisingly, Sen. Young (1st District), who previously served two terms in the Michigan House prior to being elected to the State Senate, is the son of former Detroit Mayor Coleman Young—who served as the Motor City’s Mayor from 1973-1994, this week blasted Mayor Duggan for waiting until his fourth year in office to address the safety hazard of unsecured houses: he accused his upcoming opponent of “playing games with the people and the public, because it’s election time,” adding he was “just amazed now all of sudden that he cares about the neighborhoods and he wants to do this…Where was he for the last 3.5 years in office? They just should have addressed that first.”

Currently the Duggan administration estimates city crews can board up 100-200 homes each week and that the effort will take two years to complete, so that, as Mayor Duggan notes: “By the end of two years, we’ll have every house in the city either demolished, reoccupied, or boarded…So at least it will be secure. Kids won’t be wandering in and out.” In making the statement, Mayor Duggan acknowledged the city has fallen well short of its avowed initial goal of razing 10,000 blighted homes annually, describing that as “not a practical goal.” Since Mayor Duggan took office in 2014, Detroit has razed some 11,593 blighted structures; there are 331 more contracted for demolitions, and then another 2,141 in the pipeline.

In making his responses, Mayor Duggan acknowledged that his initial commitment to raze more than 5,000 homes per year had gotten him into “trouble,” noting: “I feel bad for the people who took the grief for it, because I pushed them;” he said the city will post notices on unsecured privately owned homes for which city crews will be covering the windows and doors with plywood, noting: “We’ll go down and board up every house that’s not scheduled to come down in the next six to 12 months,” adding that the city’s budget is bearing the burden more often than not, because the cost of going after the home owners of such abandoned homes has proved impractical and costly: “You’ve got a lot of people in this town (who say), ‘My uncle died, left me the house, the house is in a bad neighborhood,’ they don’t even live here…To send them bills is not practical.” To date, for the most part, Mayor Duggan said the city has been delivering plywood to some neighborhood groups and relying on volunteers to board up houses on their streets; however, he added that there are a lot of neighborhoods with mostly senior citizens who “just physically can’t put these huge sheets of wood onto these houses…We finally said, ‘You know the most efficient way to do it just roll through the city.’”

On the Road to Fiscal Recovery. As we reported earlier this week, Detroit completed its most recent fiscal year with a $63 million surplus according to its Comprehensive Annual Financial Report, which the city filed with the Michigan Treasury Department on Tuesday, with Detroit CFO John Hill noting the FY2016 surplus was some $22 million higher than the city had projected, an outcome  to which he attributed the city’s improved financial controls, stronger-than-anticipated revenues, and lower costs due to unfilled vacancies—something, he told the Detroit News, the city believes “will have a lot of positive implications on the future.” In the near future, it offers the potential for Detroit to exit from state oversight by the Financial Review Commission under terms of Detroit’s plan of debt adjustment. Or, as Mayor Mike Duggan noted: “This audit confirms that the administration is making good on its promise to manage Detroit’s finances responsibly…With deficit-free budgets two years in a row, we have put the city on the path to exit Financial Review Commission oversight.” In fact, the city now projects an FY2017 $51 million surplus.

All this is increasing optimism that the 2017 audit of the Motor City’s finances could trigger a vote by the Commission to suspend its direct financial oversight, obviating the current required state oversight and requisite approvals on all the city’s budgets and contracts. Of the city’s reported $143 million in accumulated unassigned fund balances, including this year’s surplus, the city has allocated $50 million from its FY2016 balance as a down payment to help set up the city’s Retiree Protection Fund to help it address pension obligations scheduled to come due in 2024 under the terms of the city’s plan of debt adjustment. In addition, the city has set aside $50 million in its FY2018 budget for blight remediation and capital improvements—an amount which would leave a cushion of about $43 million in an unassigned fund balance—but which account could only be drawn from with the approval of Mayor Duggan, the City Council, or the state review commission. The city primarily draws from this account for one-time costs, such as to address blight and for its capital budget. CFO Hill has expressed hope the ongoing, positive cash flow and budget balances will enhance the city’s credit rating—and, thereby reduce its borrowing or capital costs.

What Constitutes Economic Sustainability? Puerto Rico Gov. Ricardo Rosselló has proposed an austere Fy2018 General Fund budget which, he reports, would reduce the territory’s operating expenses by 9.1%, describing his plan as comparable to “those we had established in the fiscal plan.” As proposed, the Governor would allocate at least $2.04 billion for pensions—an amount that would leave naught to meet Puerto Rico’s debt obligations: he noted that funding pensions was vital to protect Puerto Rico’s most vulnerable citizens—and that the “measures implemented in this budget are those that we had established in the fiscal plan.” Nevertheless, Gov. Rosselló said his budget was different from past budgets, because it was balanced: it projects that the central government would have sufficient balance to remit $404 million of $3.283 billion in scheduled debt service, or 12.3%, in FY2018. The budget does not include the debt from semi-autonomous and autonomous public sector entities, but shows near balance: $9.1 billion in revenue and $8.987 billion in spending, according to the Puerto Rico Office of Management and Budget, with an increase of nearly 6% in spending. In the Governor’s proposed budget, all General Fund payments for debt would be eliminated—guaranteeing a battle with the PROMESA Board, which, in its plan, had projected there would be $404 million available cash flow “post-measures” for FY2018, with the Board seemingly pressing to ensure funds were included in the budget to address Puerto Rico’s debt services to municipal bond holders—even as the Governor appears focused on protecting the territory’s most vulnerable citizens. In contrast, the PROMESA board certified decade-long quasi plan of debt adjustment incorporated the amount of municipal bond debt service to be paid each year—providing that amount be $3.28 billion.

The challenge is complex: with apprehension that the territory’s young professionals are increasingly leaving to New York and Miami, leaving behind an increasingly elderly and impoverished population—less able to remit taxes, but in greater and greater need for public services, and for promised pension payments, the critical planned increase by the Governor in public pension funding is imperiled: each of Puerto Rico’s three government pension systems is projected to run out of liquid assets in FY2018, unsurprisingly leading the Governor to propose allocating at least $2.04 billion in his budget to cover pension funding—marking a stark change from his previous budget, when the line item to cover “pay-as-you-go” pension funding was absent. (Puerto Rico has three public pension systems: the Employee Retirement System, the Teacher’s Retirement System, and the Judiciary Retirement System.) In contrast, the PROMESA Board, last March, in its decade-long oversight fiscal plan, ordered a cut in public pension obligations effective in FY2020, projecting fiscal savings for the subsequent six years in the range of $83 million. It is unclear whether those projections incorporated the potential fiscal impacts on either sales tax revenues, or the increased costs of aid to those falling below the poverty level.

In his proposed budget, Gov. Rosselló has recommended to the legislature a $9.56 billion FY2018 General Fund budget, seeking a 6.4% increase—but, after compensating for public pension obligations, actually providing 21.8% less for spending. Within his proposed budget, the Governor is asking for $583 million more for “other operating expenses,” but $555 million less for salaries and related costs, and retaining $195 million as a reserve. (In the wake of the final action by the Puerto Rico legislature, the PROMESA Board is authorized to reject any final budget and substitute its own.)

However, there is now a third party to this increasingly complex fiscal process, in the form of U.S. Judge Laura Swain, who, under PROMESA’s Title III municipal bankruptcy process, has some discretion of her own to consider changes in the amounts of debt paid in the next fiscal year—albeit, as we have learned from the chapter 9 proceedings in Detroit, San Bernardino, etc., the judicial system in these exceptionally complex chapter 9 cases acts with  considerable deliberation—not haste; moreover, unlike a normal chapter 9 process, PROMESA section 106(e) prohibits Judge Swain from deviating from the PROMESA Board’s certified fiscal plan and budgets.

Gov. Rosselló’s budget, unlike previous proposals, includes a $2 billion payment for Puerto Rico’s three public pension systems, noting: “One of the most important differences, he said, as mandated by the PROMESA Board, in this budget is that, contrary to the previous ones, it really is balanced,” adding that, as proposed, Puerto Rico had created a $200 million reserve. In addition, the Governor reported he would soon propose measures to simplify Puerto Rico’s tax system. Overall, his proposed plan contains some $924 million in revenue increases versus $851 million expense cuts for FY2018: among the key fiscal plan measures to increase FY2018 revenues is $519 million by extending the Act 154 foreign corporation tax and $150 million through improving tax compliance.

What Might it Mean to Puerto’s Rico’s Fiscal Future? The PROMESA Oversight Board, which had requested a structurally balanced budget, seeking a “once and done” approach to the Puerto Rico government’s fiscal crisis, had focused on immediate large spending cuts and revenue increases in the budget. Indeed, as proposed by the Governor, there are significant changes, including reductions in support for the University of Puerto Rico ($411 million) and $250 million to the island’s municipalities or muncipios. The plan encompasses freezing payroll increases and eliminating vacation and sick day liquidations—all with the aim to reduce Puerto Rico’s debt service costs by 76% through FY2026. San Juan Mayor Carmen Yulín Cruz said, “The governor’s public policy has been to act as the messenger of the junta [i.e. the Oversight Board] and, in this way, has hidden behind it to become the executioner of Puerto Rico,” according to the El Vocero news web site. “The budget message will be another sign that the governor turns his back on the people.”

How Does A City Turn Around Its Fiscal Future?

Good Morning! In this a.m.’s eBlog, we consider a state’s response to a municipal fiscal insolvency, before turning to the challenge the Windy City is facing in the virtually politically insolvent State of Illinois, before finally turning to the uncertain political, governing, and fiscal future of East Cleveland, Ohio.  

Addressing Disparate Municipal Fiscal Distress. More than a century ago, Petersburg, Virginia, was a highly industrialized city of 18,000 people—and the hub and supply center for the Confederacy: supplies arrived from all over the South via one of the five railroads or the various plank roads; it was also the last outpost. Today, it is one of the last fiscal outposts, but, mayhap, because of its fiscal distress, set to be a model for the nation and federalism with regard to how the Commonwealth of Virginia—unlike, for instance, Ohio, is responding. More than 53 percent of Virginia’s counties and cities have reported above-average or high fiscal stress, according to a report by the Commission on Local Government. Petersburg, a city grappling with a severe financial crisis, placed third on the state fiscal stress index behind the cities of Emporia and Buena Vista. Del. Lashrecse Aird (D-Petersburg) noted: “Petersburg does have some financial challenges, but they’re actually not unique. There are a lot of counties and localities within the commonwealth right now that are facing similar fiscal distressers.”  

The Virginia Legislature has dropped a proposed study of local government finances in its just completed legislative session, a legislative initiative which co-sponsor Rosalyn Dance (D-Petersburg) had described to her colleagues as necessary, because:  “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;” nevertheless, Virginia’s new fiscal year state budget did revive a focus on fiscal stress in Virginia cities and counties. Motivated by the City of Petersburg’s financial crisis, Sen. Emmett Hanger (R-Augusta County), who co-Chairs the Virginia Senate Finance Committee, had filed a bill (SJ 278) to study the fiscal stress of local governments: his bill proposed the creation of a joint subcommittee to review local and state tax systems, as well as reforms to promote economic assistance and cooperation between regions. Under SJ 278, a 15-member joint subcommittee would have reviewed local government and state tax systems, local responsibilities for delivery of state programs, and causes of fiscal stress among local governments. In addition, the study would have been focused on creating financial incentives and reforms to promote increased cooperation among Virginia’s regions. We will have to, however, await developments, as his proposal was rejected in the House Finance Committee, as members deferred consideration of tax reform for next year’s longer session; however, the adopted state budget did incorporate two fiscal stress preventive measures originally introduced in Sen. Hanger’s bill.

Del. Aird had identified the study as a top priority for this session, identifying: “what we as a Commonwealth need to do to put protections into place and allow localities to have tools and resources to prevent this type of challenge from occurring into the future,” noting: “I believe that this legislation will help address fiscal issues that localities are experiencing: ‘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.’” In the case of Petersburg, the city received technical assistance from state officials, including cataloging liabilities and obligations, researching problems, and reviewing city funds; however, state intervention could only be triggered by a request from the municipality: the state’s statutes forbid the Commonwealth from imposing reactive measures to an insolvent municipality.

To modify the conditions to enhance the ability of the state to intervene, the proposal set guidelines for state officials to identify and help alleviate signs of financial stress to prevent a more severe fiscal crisis, proposing the creation of a workgroup established by the Auditor of Public Accounts, who would have been responsible to create an early warning system for identifying fiscal stress, taking into consideration such criteria as a local government’s expenditure reports and budget information. In the event such distress was determined, such a local government would be notified and entitled to request a comprehensive review of its finances by the state. After such a review, the state would be responsible to draft an ‘action plan’ detailing: purpose, duration, and the requisite state resources for such intervention; in addition, the governor would be offered the option to channel up to $500,000 from the general fund toward relief efforts for the local government in need. As Del. Aird noted: “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, adding: “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.”

What Might Be a City’s Weakest Link? The state initiative comes as the city intends to write off $9 million in uncollected internal debt Petersburg has accumulated over the past 17 years: debt representing loans from Petersburg’s general fund to other city enterprises since 2000 which its leaders now concede they will never collect—or, as former Richmond City Manager—and now consultant for the city Robert Bobb notes: “This is something that the leadership should have addressed between 2000 and last year, but the issue was not being addressed.” As a result, when Petersburg officials receive the city’s financial audit for FY2017, it will show a negative fund balance that will make it even harder to secure financing for capital projects, albeit, it is expected to clear the uncollected debt from the books for the current fiscal year and the upcoming fiscal year—or, as Virginia Finance Director Ric Brown notes: “They’re taking it on the chin in FY2016 by clearing it all out of the books: To me, the most important thing is not how bad ‘16 is—it’s going forward whether FY2017 and FY2018 improve.” With its bond rating downgraded last year to BB with a negative outlook, Petersburg already faces a stiff fiscal challenge in raising capital—the municipality recently experienced an inability to raise capital to purchase police cars and fire equipment—making manifest the connection between public safety and assessed property values.

Nevertheless, Mr. Bobb has promised that this fiscal year will end without an operating deficit and the next one will begin with the first structurally balanced budget in nearly a decade—to which Secretary Brown notes: “It’s going to take some time, but I believe the sense of everyone is he’s making progress.” The Secretary noted that when the Commonwealth acted to come to Petersburg’s assistance last summer, he discovered the municipality had ended the fiscal year with $18.8 million in unpaid bills and $12 million over its operating budget; ergo, he testified the bottom line was “not going to be good” in the city’s FY2016 CAFR; however, Petersburg has worked in phases to pay its bills, reduce its costs, and rebuild its underpersonned, overwhelmed bureaucracy: The city has reduced its unpaid bills to $5.5 million, with the largest remaining obligation a $1.49 million payment to the Virginia Retirement System—a payment the city has agreed to pay by the end of December. The city’s school system has some $1.3 million in debt to its public retirement system due next month for teacher pensions. Nevertheless, in the school of lost and found, Mr. Bobb reports that city employees have scoured “every desk drawer” and discovered an additional $300,000 in unpaid bills, some of them dating back to 2015—unsurprisingly describing it as “[A] mess to clean up things from the past to where we are today.” Petersburg also has a gaping $1.9 million hole in the school system budget, in no small part by making payments this year to last year’s budget, a practice Mr. Bobb notes to be a [mal]practice the city has followed for 10 years—putting the city’s school budget near the minimum required by the Virginia Standards of Quality.

Nevertheless, Petersburg completed the first phase of recovery, focusing on short-term financing concerns, at the end of March. That has allowed it to focus on long-term financing and a fiscal plan, including developing policies for capital improvements, debt, and reserves to ensure financial stability. In the final stage, from July 1 until Mr. Bobb’s contract ends on September 30th, the city will develop five-year financial and capital improvement plans, as well as a budget transition plan, for ongoing financial performance and monitoring—as well as refilling the fiscal architecture via filling critical positions, including a finance director, which Mr. Brown notes, will be critical to filling middle management positions, such as accountants, which are vital to maintain the city’s financial stability: “If they don’t get that in place, there’s a real risk they’ll slide back.”

Petersburg wasn’t even at the top of the list of the most fiscally stressed localities ranked by the Virginia Commission on Local Government in 2014. It was third, behind Emporia and Buena Vista, and just ahead of Martinsville and Covington. “We’re only as strong as our weakest link,” said Sen. Rosalyn R. Dance, D-Petersburg, who served as the city’s mayor from 1992 to 2004. “We’re not the only ones there.”

Whither Chicago? The Windy City, nearly 350 years old, named “Chicago,” based upon a French rendering of the Native American word “shikaakwa,” from the Miami-Illinois language, is today defined by the Census Bureau as the city and suburbs extending into Wisconsin and Indiana; however, it is, today, a city experiencing population decline: last year it lost just under 20,000 residents—and its surrounding state, Illinois, saw its population decline more than any other state: 37,508 people, according to census data released last December. During the Great Recession, families chose to stay in or move to core urban areas, and migration to the suburbs decelerated; however, in the recovery, there is a reverse trend: families are deciding it is time to move back to the suburbs.

Thus, by most estimates, Chicago’s population will continue to decline, with the Chicago Tribune, from a survey of dozens of former residents, reporting the depopulation stems from reactions to: high taxes, the state budget stalemate, crime, the unemployment rate, and weather—with black residents among those leaving in search of safe neighborhoods and prosperity: it seems many are heading to the suburbs and warm-weather states: Chicago lost 181,000 black residents between 2000 and 2010, according to census data. Just under 90,000 Chicagoans left the city and its immediately surrounding suburbs for other states last year, according to an analysis of census data released in March, marking the greatest outflow since at least 1990. It appears that, more than any other city, Chicago has relied upon the increase in Mexican immigrants to offset the decline of its native-born population: during the 1990s, that immigration accounted for most of Chicago’s growth. After 2007, when Mexican-born populations began to fall across the nation’s major metropolitan areas, most cities managed to make up for the loss with the growth of their native populations, but that has not been the case for Chicago (nor Detroit, which, according to census data, realized a decline of 3,541 residents from 2015 to 2016). While Chicago’s changes may be small in context, they could be a harbinger of more losses to come.

As we had noted in our fiscal report on Chicago, Mayor Rahm Emanuel focused on drawing in new businesses, concerned that any perception that assessed property taxes might have to increase—or that schools and crime rates would not improve—would adversely affect companies’ willingness to come to Chicago—meaning an intense focus on confronting fiscal challenges: such as credit quality threats: e.g. avoiding having a disproportionate percent of the city’s budget devoted to long-term pension borrowing obligations instead of critical future investments: the more of its budget the city had to divert to meeting unsustainable pension obligations, the less it would have to address its goal of investments in the city’s infrastructure, schools, and public safety—investments the Mayor believed fundamental to the city’s economic and fiscal future.  We noted a critical change: Investing in the Future: Mayor Emanuel created enterprise funds so that a greater portion of municipal services were not financed through property taxes and the operating budget: some 83 percent of its budget was focused on schools and public safety, in an effort to draw back young families. Nevertheless, amid growing perceptions that Chicago’s cost of living has become too high, rising property taxes, and perceived growth in crime; some are apprehensive Chicago could be at a tipping point: the period in a city’s time when an increasing number of residents believe it is time to leave—or, as one leaver noted: “It’s just sad to see that people have to leave the city to protect their own future cost of living.”

Does East Cleveland Have a Fiscal Future? In the small Ohio municipality of East Cleveland, a city waiting on the State of Ohio for nearly a year to obtain permission to file for chapter 9 municipal bankruptcy, there is an upcoming Mayoral election—an election which could decide whether the city has a fiscal future—and where voters will have to decide among an array of candidates: who might they elect as most likely to turn the fortunes of the City around, and avert its continuing slide towards insolvency? One candidate, who previously served as Chairman of the East Cleveland Audit Committee, noted a report to the Council detailing twenty-four budget appropriations totaling approximately $2,440,076 in unauthorized and questionable expenditures—and that his committee had provided documentation to the Auditor of State’s Office of Local Government Services regarding the hiring of 10 individuals in violation of a Council-mandated hiring freeze, costing the City approximately $408,475 in unauthorized payroll costs, adding: “All told, the Audit Committee uncovered approximately $3,055,351 in illegal and suspicious spending by the Norton Administration…The truth is, as I stated in the beginning, the municipal government of East Cleveland is afflicted with the cancer of corruption that has been allowed to grow because of two main reasons: The first being, the indifference displayed by Ohio and Cuyahoga County government officials who failed in their respective responsibility when confronted with documented facts.  They collectively have turned a blind eye to what was, and is, happening in East Cleveland.  No one wants to get their hands dirty with so-called ‘black politics,’ even if the legal and financial evidence is given to them on a ‘silver platter.’  Personally, I smell the stench of secret political deals which produced a ‘hands off policy.’”

He added that a symptom of what he described as “this cancer” included some “$41, 857, 430 in unwarranted expenses and debt that was generated during the first 3 years of Mayor Norton’s first term as Mayor. I anticipate that whenever an audit is conducted for 2013 thru 2016, the $41 million figure will grow by an additional $25 million to $35 million.” Addressing the unresponsiveness of the State of Ohio, he described the Governor’s Financial Planning and Supervision Commission as a “joke:  It has been wholly unimpressive and has not provided the necessary oversight and forced accountability one would have expected from the Commission at the beginning.  Furthermore, The Commission became tainted when Governor Kasich appointed Helen Forbes Fields to the Commission.  She has a number of personal conflicts of interests that prevent her from being an impartial member of the Commission.  I can recall a conversation I had with the former Commission Chair, Sharon Hanrahan when she admitted to me that the State Government did not have the ‘political will’ to clean up the mess we were trying to get them to address.” He added, that, if elected, in order to bring accountability for the mismanagement of public funds, he would seek assistance from Ohio and federal law enforcement agencies to ensure those responsible for the mismanagement of East Cleveland’s financial resources would be held accountable, estimating that between $5 million and $15 million dollars could be recovered. 

A Hole in Puerto Rico’s Fiscal Safety Net: Should Congress Amend Chapter 9 Municipal Bankruptcy?

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Good Morning! In this a.m.’s eBlog, we consider the growing physical and fiscal breakdown in the U.S. Territory of Puerto Rico as it seeks, along with the oversight PROMESA Board, an alternative to municipal bankruptcy—but we especially focus on the fiscal plight of the territory’s many, many municipalities—or muncipios, which, because Puerto Rico is not a state, do not have access to chapter 9 municipal bankruptcy .   

Tropical Fiscal Typhoon. When former President Ronald Reagan signed Public Law 100-597, legislation authorizing municipal into law 29 years ago, no one was contemplating a U.S. territory, such as Puerto Rico—so that the federal statute, in coherence and compliance with the concepts of dual sovereignty, which served as the unique foundation of the nation, provided that a city, county, or other municipality could only file for chapter 9 if authorized by state law—something a majority of states have not authorized. Unsurprisingly, none of us contemplated or thought about U.S. territories, such as Puerto Rico, Guam, etc.: Puerto Rico is to be considered a state for purposes of the bankruptcy code, except that, unlike a state, it may not authorize its municipalities (and by extension, its utilities) to resolve debts under Chapter 9 of the code. Ergo, no municipio in Puerto Rico has access to a U.S. bankruptcy court, even as 36 of the island’s 78 muncipios have negative budget balances; 46% are experiencing fiscal distress. Their combined total debt is $3.8 billion. In total, the combined debt borne by Puerto Rico’s municipalities is about 5.5% of Puerto Rico’s outstanding debt.  

The fiscal plight of Puerto Rico’s municipalities has also been affected by the territory’s dismal fiscal condition: From 2000 to 2010, the population of Puerto Rico decreased, the first such decrease in census history for Puerto Rico, declining by 2.2%; but that seemingly small percentage obscures a harsher reality: it is the young and talented who are emigrating to Miami, New York City, and other parts on the mainland, leaving behind a declining and aging population—e.g. a population less able to pay taxes, but far more dependent on governmental assistance. At the same time, Puerto Rico’s investment in its human infrastructure has contributed to the economy’s decline: especially the disinvestment in its human infrastructure: a public teacher’s base salary starts at $24,000—even as the salary for a legislative advisor for Puerto Rico starts at $74,000. That is, if Puerto Rico’s youngest generation is to be its foundation for its future—and if its leaders are critical to local fiscal and governing leadership in a quasi-state where 36 of the island’s 78 municipalities, or just under half, are in fiscal distress—but, combined, have outstanding debt of about $3.8 billion; something will have to give. These municipalities, moreover, unlike Detroit, or San Bernardino, or Central Falls, have no recourse to municipal bankruptcy: they are in a fiscal Twilight Zone. (Puerto Rico has a negative real growth rate; per capita income in 2010 was estimated at $16,300; 46.1% of the territory’s population is in poverty, according to the most recent 2106 estimate; but that poverty is harsher outside of San Juan.) A declining and aging population adversely affects economic output—indeed, as former Detroit Emergency Manager Kevyn Orr who steered the city out of the largest municipal bankruptcy in U.S. history recognized, the key to its plan of debt adjustment was restoring its economic viability.

U.S. Supreme Court Justice Sonia Sotomayor, who is of Puerto Rican descent, has indicated there should be a more favorable interpretation of the law to make the system fairer to Puerto Rico: to allow the Commonwealth of Puerto Rico to create its own emergency municipal bankruptcy measures—something, however, which only Congress and the Trump administration could facilitate. It seems clear that Justice Sotomayor does believe Puerto Rico ought to be considered the equivalent of a state, i.e. empowered to create its own bankruptcy laws. However, as the First Circuit Court of Appeals has interpreted, Puerto Rico is barred from enacting its own bankruptcy laws: it is treated as a state—in a country of dual federalism wherein the federal government, consequently, has no authority to authorize state access to bankruptcy protection.

Perspectives on Municipal Bankruptcy

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Good Morning! In this a.m.’s eBlog, we consider the potential descent into municipal bankruptcy by Hartford—and whether, if, and if so, how, the state might help. Then, as U.S. Judge Laura Swain preps for deliberations to begin tomorrow in Puerto Rico, we consider preliminary agreements yesterday with the U.S. territory’s Government Development Bank. 

A State Capital’s Near Bankruptcy. The Hartford City Council is letting Mayor Tony George get his way in dealing with the Connecticut city’s crushing debt, having voted 3-2 to borrow up to $52 million to restructure the city’s long-term debt (the city has $550 million total debt outstanding), a plan Mayor George has been seeking for months—indeed, the Mayor had given an ultimatum to the Council to approve the plan, or he would seek to have the city declared financially distressed under the state’s Act 47. Councilman Tony Brooks, who had previously opposed the plan, broke the tie, stating: “If I have to choose between debt or a tax increase, I will choose debt.” The votes came in the wake of Mayor Bronin and Hartford Corporation Counsel Howard Rifkin acknowledging that Hartford had been soliciting proposals for law firms in the event of a Chapter 9 bankruptcy filing, even as Gov. Malloy was proposing to draw on the state’s reserves in an effort to the Nutmeg State’s current fiscal-year budget balance in the wake of his Budget Secretary’s reduction in projected state revenues by $409.5 million, a reduction plunging the general fund deficit to minus $389.8 million—making it seem as if the pleading was to Mother Hubbard just when her cupboard was bare.

The cratering fiscal situation was underlined by the additional credit rating downgrade yesterday from S&P Global Ratings, with analyst Victor Medeiros noting: “The downgrade and the credit watch placement reflect the heightened uncertainty on whether the state will increase intergovernmental aid or otherwise lend the necessary state support to enable Hartford to achieve structural balance and prevent it from further fiscal deterioration.” Last year, S&P and Moody’s each hit the city with four-notch downgrades, citing rising debt-service payments, higher required pension contributions, health-care cost inflation, costly legal judgments from years past, and unrealized concessions from most labor unions. Now the Mayor and Council face deficits of $14 million this year and nearly 400% higher next year. Yet even with such projected deficits, Mayor George he has been unable to gain meaningful union concessions—and the outlook for his requested $40 million in additional state aid seems bleak. Mayor Bronin describes the fiscal crisis this way: “Acting alone, Hartford has no road to a sustainable budget path.” Hartford City Administrator Ted Wampole advised the elected officials that the proposed borrowing and debt restructuring plan would put the city in a better cash flow position headed into the new year, albeit warning it would just be the first in a series of difficult decisions the city faces when it comes to finances; he added that all expenses will be evaluated, as will possible ways to increase revenues, noting: “This is the very beginning of what will be a long process…This is something we needed to do. The alternative is we run out of money.”

Could the State Really Help? If there is grim news for Hartford, it is that the state is itself fiscally strapped: Connecticut Governor Danel Malloy has called for virtually wiping out the state’s rainy-day fund.  In Connecticut, a municipality may only file with the express prior written permission or consent from the Governor (see Conn. §7-566)—with Bridgeport, in 1991, the only previous city to ever file for chapter 9 [a filing dismissed in August of the same year]). Now legislative gridlock persists as thousands of state employees face layoffs. Bond rating agencies have hammered both the state and capital city Hartford over the past year. Fitch Ratings at the end of last week dropped Connecticut’s issuer default rating to A-plus from AA-minus, the first to move the state out of the double-A category. Nevertheless, according to Mr. Medeiros, uncertainty over state aid prompted Hartford to seek solicitations for a bankruptcy lawyer: “While a bankruptcy filing remains distant, in our opinion, by raising the possibility, we believe that elected officials are seeking to better understand the legal qualifications, process, and consequences associated with this action if there is no budgetary support at the state level.” Governor Malloy has also announced deficit-mitigation actions in an effort to close the current-year shortfall, writing to Nutmeg state legislators: “I find it necessary to take aggressive steps.” Such steps include draining all but $1.3 million of the budget reserve fund, nearly $100 million in revenue transfers, $33.5 million in rescissions, and $22.6 million in other actions—including cuts in state aid to local governments—cuts which will require legislative approval. Gov. Malloy has also begun a contingency plan for laying off state workers—especially in anticipation, as the state faces a possible FY2018-19 $5 billion shortfall—and political as well as fiscal challenges in a state where the Senate is split evenly between Democrats and Republicans 18-18, and the Democrats hold a slim 79-72 advantage in the House of Representatives.

Gov. Malloy last February proposed a $40.6 billion biennial budget, proposing a shift of teacher pension costs to municipalities—hardly a proposal which would help Hartford—and one which has, so far, encountered little support in the legislature. In a seeming understatement, S&P Ratings noted: “This could help stabilize the share of the state’s budget devoted to its substantial fixed costs, a potentially positive credit development, although it may pressure local government finances.” According to Moody’s, Connecticut continues to have the highest debt-service costs as a percent of own-source governmental revenues among the 50 states, even though it declined from 14.3% to 13.3%. 

Tropical Fiscal Typhoon. Preparations in the Federal Court, in Hato Rey, the U.S. territoriy’s banking district and the closest thing to a downtown that Puerto Rico has, for tomorrow’s first hearing related to the process of restructuring the public debt of Puerto Rico, under Title III of PROMESA before federal Judge Laura Swain are underway: the preparations alone will necessitate rejiggering court rooms, including ensuring one is available for closed circuit TV coverage and another for the general public.  Title III of the federal law PROMESA permits a process of public debt restructuring, which is supervised by a Tribunal, as long as the creditors and the government do not reach agreements that benefit them both.

The trial begins after, yesterday, Puerto Rico announced that the Government Development Bank, which had served as the primary fiscal agent for the U.S. territory, had reached a liquidation agreement with its creditors, avoiding a protracted bankruptcy, with the agreement executed under the terms of Title VI of the PROMESA statute, according to Gov. Ricardo Rossello’s office—an agreement which would avoid a Title III bankruptcy, and, under which the bank’s assets will be split between two separate entities, according to a term sheet made public yesterday. Under the agreement, the first entity, holding $5.3 billion in GDB assets, would issue three tranches of debt with different protections in exchange for varying principal reductions: beneficiaries would include municipal depositors and bondholders, such as Avenue Capital Management, Brigade Capital Management, and Fir Tree Partners. The second entity, funded with public entity loans and $50 million in cash, would benefit all other depositors. While the details remain to be confirmed, the agreement would appear to mean a haircut of approximately 45% for a group of small municipal bondholders in Puerto Rico, with potential losses of up to 45 percent for some bondholders. A spokesperson for the Governor issued a statement on his behalf noting: “[B]efore we are bondholders, we are Puerto Ricans, and we recognize the circumstances that Puerto Rico faces.”

The government bank’s plan represents an end to what was once the equivalent of a central bank in charge of holding deposits from government agencies and Puerto Rico’s nearly 100 municipalities—and marks the steps to comply with the PROMESA Board’s approval last month of steps to wind down the bank.