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

08/11/17

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

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

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

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

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

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

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

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

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

Post Municipal Bankruptcy Leadership

08/07/17

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Good Morning! In this a.m.’s blog, we consider the fiscal challenge as election season is upon the Motor City: what kind of a race can we expect? Then we observe the changing of the guard in San Bernardino—as the city’s first post-chapter 9 City Manager settles in as she assumes a critical fiscal leadership role in the city emerging from municipal bankruptcy. Third, we consider the changing of the fiscal guard in Atlantic City, as outgoing (not a pun) Gov. Chris Christie begins the process of restoring municipal authority. Then we turn to what might be a fiscal turnaround underway in Puerto Rico, before, fourth, considering the special fiscal challenge to Puerto Rico’s municipios—or municipalities.

Post Municipal Bankruptcy Leadership. Detroit Mayor Mike Duggan, the city’s first post-chapter 9 mayor, has been sharing his goals for a second term, and speaking about some of his city’s proudest moments as he seeks a high turnout at tomorrow’s primary election mayoral primary election‒the first since the city exited municipal bankruptcy three years ago, noting he is: “very proud of the fact the unemployment rate in Detroit is the lowest it has been in 17 years: today he notes there are 20,000 more Detroiters working than 4 years ago. In January 2014, there were 40,000 vacant houses in the city, and today 25,000. We knocked down 12,000 and 3,000 had families who moved in and fixed them up,” adding: “For most Detroiters, that means the streetlights are on, grass is cut in the parks, busses are running on time, police and ambulances showing up in a timely basis and trash picked up and streets swept.” Notwithstanding those accomplishments, however, he confronts seven contenders—with perhaps the signal challenge coming from Michigan State Senator Coleman Young, Jr., whose father, Coleman Young, served as Detroit’s first African-American Mayor from 1974 to 1994. Mr. Young claims he is the voice for the people who have been forgotten in Detroit’s neighborhoods, noting: “I want to put people to work and reduce poverty of 48% in Detroit. I think that’s atrocious. I also want mass transit that goes more than 3 miles,” adding he is seeking ‘real change,’ charging that today in Detroit: “We’re doing more for the people who left the city of Detroit, than the people who stayed. That’s going to stop in a Young administration.” Remembering his father, he adds: “I don’t think there will ever be another Coleman Young, but I am the closest thing to him that’s on this planet that’s living.” (Other candidates in tomorrow’s non-partisan primary include Articia Bomer, Dean Edward, Curtis Greene, Donna Marie Pitts, and Danetta Simpson.)  

According to an analysis by the Detroit News, voters will have some interesting alternatives: half of the eight candidates have been convicted of felony crimes involving drugs, assault, or weapons—with three charged with gun crimes and two for assault with intent to commit murder, albeit, some of the offenses date back as far as 1977. (Under Michigan election law, convicted felons can vote and run for office, just as long as they are neither incarcerated nor guilty of crimes breaching public trust.

Taking the Reins.  San Bernardino has named its first post-chapter 9 bankruptcy city manager, selecting assistant City Manager and former interim city manager, Andrea Miller, to the position—albeit with some questions with regard to the $253,080 salary in a post-chapter 9 recovering municipality where the average household income is less than $36,000 and where officials assert the city’s budget is insufficient to fully address basic public services, such as street maintenance or a fully funded police department. Nevertheless, Mayor Cary Davis and the City Council voted unanimously, commenting on Ms. Miller’s experience, vision, and commitment to stay long-term, or, as Councilman Fred Shorett told his colleagues: “As the senior councilmember—I’ve been sitting in this dais longer than anybody else—I think we’ve had, if we count you twice, eight city managers in a total of 9 years: We have not had continuity.”  However, apprehension about continuity as the city addresses and implements its plan of debt adjustment remains—or, as Councilmember John Valdivia insisted, there needs to be a “solemn commitment to the people of San Bernardino” by Ms. Miller to serve at least five years, as he told his colleagues: “During Mayor (Carey) Davis’ four years in office, the Council is now voting on the third city manager: San Bernardino cannot expect a successful recovery with this type of rampant leadership turnover at City Hall…Ms. Miller is certainly qualified, but I am concerned that she has already deserted our community once before.” Ms. Miller was the city’s assistant city manager in 2012, when then-City Manager Charles McNeely abruptly resigned, leaving Ms. Miller as interim city manager to discover that the city would have to file for chapter 9 bankruptcy—a responsibility she addressed with aplomb: she led San Bernardino through the first six months of its municipal bankruptcy, before leaving without removing “interim” from her title, instead assuming the position of executive director of the San Gabriel Valley Council of Governments.

Ms. Miller noted: “I would remind the Council that I was here as your interim city manager previously, and I did not accept the permanent appointment, because I felt like I could not make that commitment given some of the dynamics…(Since then) this Council and this community have implemented a new city charter, the Council came together in a really remarkable way and had a discussion with me that we had not been able to have previously: You committed to some regular discussion about what your expectations are, you committed to strategic planning. And so, with all those things and a strategic plan that involves all of us in a stronger, better San Bernardino, yes I can make that commitment.” Interestingly, the new contract mandates at least two strategic planning sessions per year—and, she told the Council additional sessions would probably be wise. The contract the city’s new manager signed is longer than the city’s most recent ones—mayhap leavened by experience: the length and the pay are higher than the $248,076 per year the previous manager received. Although Ms. Miller is not a San Bernardino resident, she told the Mayor and Council she is committed to the city and said the city should strive to recruit other employees who do live in the city.

Not Gaming Atlantic City’s Future. New Jersey Governor Chris Christie’s administration last week announced it had settled all the remaining tax appeals filed by Atlantic City casinos, ending a remarkable fiscal drain which has contributed to the city’s fiscal woes and state takeover. Indeed, it appears to—through removal of fiscal uncertainty and risk‒open the door to the Mayor and Council to reduce its tax rate over the long-term as the costs of the appeal are known and able to be paid out of the bonds sold earlier this year—effectively spinning the dial towards greater fiscal stability and sustainability. Here, the agreements were reached with: Bally’s, Caesars, Harrah’s, the Golden Nugget, Tropicana, and the shuttered Trump Plaza and Trump Taj Mahal: it comes about half a year in the wake of the state’s tax appeal settlement with Borgata, under which the city agreed to pay $72 million of the $165 million the casino was owed. While the Christie administration did not announce dollar amounts for any of the seven settlements announced last week, it did clarify that an $80 million bond ordinance adopted by the city will cover all the payments—effectively clearing the fiscal path for Atlantic City to act to reduce its tax rate over the long term as the costs of the appeal are known and can be paid out of the municipal bonds sold earlier this year.  

In these tax appeals, the property owners have claimed they paid more in taxes than they should have—effectively burdening the fiscally besieged municipality with hundreds of millions in debt over the last few years as officials sought to avoid going into chapter 9 municipal bankruptcy. Unsurprisingly, Gov. Christie has credited the state takeover of Atlantic City for fostering the settlements, asserting his actions were the “the culmination of my administration’s successful efforts to address one of the most significant and vexing challenges that had been facing the city…Because of the agreements announced today, casino property tax appeals no longer threaten the city’s financial future.” The Governor went on to add that his appointment of Jeffrey Chiesa, the former U.S. Senator and New Jersey Attorney General to usurp all municipal fiscal authority in Atlantic City when, in his words, Atlantic City was “overwhelmed by millions of dollars of crushing casino tax appeal debt that they hadn’t unraveled,” have now, in the wake of the state takeover, resulted in the city having a “plan in place to finance this debt that responsibly fits within its budget.” The lame duck Governor added in the wake of the state takeover, the city will see an 11.4% drop in residents’ overall 2017 property tax rate. For his part, Atlantic City Mayor Don Guardian described the fiscal turnaround as “more good news for Atlantic City taxpayers that we have been working towards since 2014: When everyone finally works together for the best interest of Atlantic City’s taxpayers and residents, great things can happen.”

Puerto Rican Debt. The Fiscal Supervision Board in the U.S. territory wants to initiate a discussion into Puerto Rico’s debt—and how that debt has weighed on the island’s fiscal crisis—making clear in issuing a statement that its investigation will include an analysis of the fiscal crisis and its taxpayers, and a review of Puerto Rico’s debt and issuance, including disclosure and sales practices, vowing to carry out its investigation consistent with the authority granted under PROMESA. It is unclear, however, how that report will mesh with the provision of PROMESA, §411, which already provides for such an investigation, directing the Government Accounting Office (GAO) to provide a report on the debt of Puerto Rico no later than one year after the approval of PROMESA (a deadline already passed: GAO notes the report is expected by the end of this year.). The fiscal kerfuffle comes as the PROMESA Oversight Board meets today to discuss—and mayhap render a decision with regard to furloughs and an elimination of the Christmas bonus as part of a fiscal oversight effort to address an expected cash shortfall this Fall, after Gov. Ricardo Rosselló, at the end of last month, vowed he would go to court to block any efforts by the PROMESA Board to force furloughs, apprehensive such an action would fiscally backfire by causing a half a billion dollar contraction in Puerto Rico’s economy.

Thus, we might be at an OK Corral showdown: PROMESA Board Chair José Carrión III has warned that if the Board were to mandate furloughs and the governor were to object, the board would sue. As proposed by the PROMESA Board, Puerto Rican government workers are to be furloughed four days a month, unless they work in an excepted class of employees: for instance, teachers and frontline personnel who worked for 24-hour staffed institutions would only be furloughed two days a month, law enforcement personnel not at all—all part of the Board’s fiscal blueprint to save the government $35 million to $40 million monthly.  However, as the ever insightful Municipal Market Advisors managing partner Matt Fabian warns, it appears “inevitable” that furloughs and layoffs would hurt the economy in the medium term—or, as he wrote: “To the extent employee reductions create a protest environment on the island, it may make the Board’s work more difficult going forward, but this is the challenge of downsizing an over-large, mismanaged government.” At the same time, Joseph Rosenblum, the Director of municipal credit research at AllianceBernstein, added: “It would be easier to comment about the situation in Puerto Rico if potential investors had more details on their cash position on a regular basis…And it would also be helpful if the Oversight Board was more transparent about how it arrived at its spending estimates in the fiscal plan.”

Pensiones. The PROMESA Board and Puerto Rico’s muncipios appear to have achieved some progress on the public pension front: PROMESA Board member Andrew Biggs asserts that the fiscal plan called for 10% cuts to pension spending in future fiscal years, while Sobrino Vega said Gov. Ricardo Rosselló has promised to make full pension payments. Natalie Ann Jaresko, the former Ukraine Minister of Finance whom former President Obama appointed to serve as Executive Director of PROMESA Fiscal Control Board, described the reduction as part of the fiscal plan that the Governor had promised to observe: the fiscal plan assumed that the Puerto Rican government would cut $880 million in spending in the current fiscal year. Indeed, in the wake of analyzing the government’s implementation plans, the PROMESA Board appeared comfortable that the cuts would save $662 million—with the Board ordering furloughs to make up the remaining $218 million. The fiscal action came as PROMESA Board member Carlos García said that the board last Spring presented the 10 year fiscal plan guiding government actions with certain conditions, Gov. Rosselló agreed to them, so that the Board approved the plan with said conditions, providing that the government achieve a certain level of liquidity by the end of June and submit valid implementation plans for spending cuts. Indeed, Puerto Rico had $1.8 billion in liquidity at the end of June, well over the $291 million that had been projected, albeit PROMESA Board member Ana Matosantos asserted the $1.8 billion denoted just a single data point. Ms. Jaresko, however, advised that this year’s government cuts were just the beginning: the Board fiscal plan calls for the budget cuts to more than double from $880 million in this year, to $1.7 billion in FY 2019, to $2.1 billion in FY2020.  No Puerto Rican government representative was allowed to make a presentation to the board on the issue of furloughs.

Not surprisingly, in Puerto Rico, where the unemployment rate is nearly triple the current U.S. rate, the issue of furloughs has raised governance issues: Sobrino Vega, the Governor’s chief economic advisor non-voting representative on the PROMESA Oversight Board, said there was only one government of Puerto Rico and that was Gov. Rosselló’s, adding that under §205 of PROMESA, the board only had the powers to recommend on issues such as furloughs, noting: “We can’t take lightly the impact of the furloughs on the economy,” adding the government will meet its fiscal goals, but it will do it according its own choices, but that the Puerto Rican government will cooperate with the Board on other matters besides furloughs. His statement came in the wake of PROMESA Board Chair José Carrión III’s statement in June that if Puerto Rico did not comply with a board order for furloughs, the Board would sue.

Cambio?  Puerto Rico Commonwealth Treasury Secretary Raul Maldonado has reported that Puerto Rico’s tax revenue collections last month were was ahead of projections, marking a positive start to the new fiscal year for an island struggling with municipal bankruptcy and a 45% poverty rate. Secretary Maldonado reported the positive cambio (in Spanish, “cambio” translates to change—and may be used both to describe cash as well as change, just as in English.): “I think we are going to be $20 to $30 million over the forecast: For July, we started the fiscal year already in positive territory, because we are over the forecast. We have to close the books on the final adjustment but we feel we are over the budget.” His office had reported the revenue collection forecast for July, the start of Puerto Rico’s 2017-2018 fiscal year, was $600.8 million: in the previous fiscal year, Puerto Rico’s tax collections exceeded forecasts by $234.9 million, or 2.6%, to $9.33 million, with the key drivers coming from the foreign corporations excise tax, the sales and use tax, and the motor vehicle excise tax. Sec. Maldonado, who is also Puerto Rico’s CFO, reported that each government department is required to freeze its spending and purchase orders at 95% of the monthly budget, noting: “I want to make sure that they don’t overspend. By freezing 5%, I am creating a cushion so if there is any variance on a monthly basis we can address that. It is a hardline budget approach but it is a special time here.” Sec. Maldonado also said he was launching a centralized tax collection pilot program, with guidance from the U.S. Treasury—one under which three large and three small municipalities have enrolled in an effort to assess which might best increase tax collection efficiency while cutting bureaucracy in Puerto Rico’s 78 municipalities, noting: “We are going to submit the tax reform during August, and we will include that option as an alternative to the municipalities.”

Addressing Municipal Fiscal Distress at the White House and State House

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07/31/17

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Good Morning! In today’s Blog, we consider whether President Trump’s appointment of new White House Communications Director of Communications might have fiscal implications for Puerto Rico’s fiscal future; then we turn to leadership efforts in the Virginia General Assembly to refine what a state’s role in oversight of municipal fiscal distress might be. 

Might There Be a Change in White House Direction vis-à-vis Puerto Rico? Prior to his new appointment as White House Director of Communications, Anthony Scaramucci, more than a year ago, questioned whether the U.S. territory of Puerto Rico should be granted authority more akin to a sovereign nation than a state—power which would, were it granted, authorize Puerto Rico to authorize its muncipios the authority to file for chapter 9 municipal bankruptcy, writing in an op-ed, “The shame of leaving Puerto Rico in limbo,” in Medium a year ago last May, just as the U.S. House Natural Resources Committee was seeking to report the PROMESA legislation. Mr. Scaramucci then indicated that creditors wanted to file with regard to the actions taken by the Puerto Rican government as if they were “equal to the intransigence of the Kirchner government in Argentina, but in reality the situations (of both countries) are completely different.” He explained: Not only does Puerto Rico not have the same public policy options as Argentina, but its economy and ability to pay its debts are worse off: Not only does Puerto Rico not have the same public policy options as Argentina, but its economy and ability to pay its debts are worse off.” He further noted that House Speaker Paul Ryan (R.-Wis.) was in a difficult situation to deal with the situation in Puerto Rico, amid what he described as a “civil war” within the Republican Party—a war he described as “induced by Donald Trump.”

Now, of course, Mr. Scaramucci is in a starkly different position—one where he might be able to influence White House policy. Having written, previously, that the “tax code of the Commonwealth must be revised to be more friendly to economic development…Social assistance programs should be drastically reduced and labor laws softened,” Mr. Scaramucci has also called for public-private partnerships to make “essential” government services more efficient, such as the Puerto Rico Electric Power Authority—noting: “Ultimately…we must also allow Puerto Rico to operate as a sovereign country or grant them legal protections more similar to those of the states (which is the preference of the Puerto Rican people).” He argued that the case of Puerto Rico represents a “failure on multiple levels: the insatiable desire of US investment funds for Puerto Rico triple exemption bonds; U.S. Congressmen of the status of the Congressionally-created territory, and misappropriation of funds by the Puerto Rican government: “We must now face our failures and take pragmatic measures to create a better future:  The tax code of the Commonwealth must be revised to be more friendly to economic development; social assistance programs should be drastically reduced, and labor laws softened.” He noted that public-private partnerships could be vital in rendering “essential” government services more efficient, such as the Puerto Rico Electric Power Authority, noting: “Ultimately, we must also allow Puerto Rico to operate as a sovereign country or grant them legal protections more similar to those of the states (which is the preference of the Puerto Rican people).” Referencing that, as in the Great Recession of 2008, he noted the case of Puerto Rico represents a “failure on multiple levels: the insatiable desire of US investment funds for Puerto Rico triple exemption bonds; U.S. Congressmen of the status of ELA (Estado Libre Asociado de Puerto Rico), and misappropriation of funds by the Puerto Rican government…But as we did after 2008, we must now face our failures and take pragmatic measures to create a better future.”

Mr. Scaramucci’s comments came as the City or Pueblo of San Juan has filed a legal challenge to the PROMESA Oversight Board’s approval of the Government Development Bank (GDB) for Puerto Rico debt restructuring agreement: San Juan is seeking a declaratory judgement and injunctive relief against the PROMESA Oversight Board, the GDB, and the Puerto Rico Fiscal Agency and Financial Advisory Authority before U.S. Judge Laura Swain Taylor in the U.S. District Court for Puerto Rico—a judge by now immersed in multiple bankruptcy filings, after the Bastille Day PROMESA Board’s approval of a restructuring agreement for the GDB’s $4.8 billion in debt—an approval for which the Board asserted it had authority under PROMESA’s Title VI.

San Juan’s filing claims the GDB holds more than $152 million in San Juan deposits—deposits which the city asserts are the property of San Juan, and thereby ineligible for Title VI restructuring, which explicitly addresses only municipal bonds, loans, and other similar securities. San Juan then claims the GDB deposits are “secured,” unlike the funds which the GDB owes to municipal bondholders—even as the PROMESA Board’s approved Restructuring Support Agreement provides for the municipalities to vote in the same class as all the other GDB creditors, asserting that such a voting practice would be contrary to PROMESA. The suit also notes that, under Puerto Rico statutes, municipal depositors are allowed to set-off their deposits against their GDB loan balances; however, the Restructuring Support Agreement (RSA) is grossly inaccurate in accounting for these deposits against the loans and, thus, the agreement is breaching the law—asserting:

“The ultimate effect of the RSA would be to provide a windfall to the GDB’s bondholders by using the resources of San Juan and other municipalities for the payment of bondholder claims while imposing enormous losses on those same municipal depositors through the confiscation of their excess [special tax deposit] and their statutorily guaranteed right to setoff deposits at the GDB against their loans from the GDB.” The suit further charged that the PROMESA Board convened illegal executive private sessions concerning the creation of the RSA—sessions which included representatives of the GDB and FAFAA. (The federal statute only allows executive sessions with board members and its staff present, according to the suit.)  Thus, in its complaint , the city is requesting that Judge Swain find the board’s approval of the agreement invalid, and that Judge Swain further find that PROMESA and Article VI, Clause 2 of the U.S. Constitution preempt Puerto Rican laws and executive order that have stopped the municipalities from withdrawing their funds from the GDB for over a year.

Not Petering Out. In the Virginia Legislature, Del. Lashrecse Aird (D-Petersburg), the youngest woman ever elected to the House of Delegates, recently noted: “In this session, I’m carrying a very light load, just four or five bills, that are locality bill requests: As a lawmaker overall, you will always see me supporting those initiatives and those policy issues that reference those three priorities: jobs, education, and healthcare. I think that if I can execute on those priorities, that will definitely improve the quality of life for the citizens, the families and kids, not just for Petersburg but the entire district.” Del. Air noted that last year, the City of  Petersburg’s financial situation made headlines throughout the Commonwealth, and led to serious conversations about the financial health of Virginia’s cities and counties: “What we saw in Petersburg, in addition to a declining economy nationwide, was longstanding financial mismanagement, negligence, and declining cash balances dating back to 2009. And, what we saw in localities like Emporia, Martinsville, Lynchburg, Buena Vista—all classified as having significant fiscal stress—is that these historic cities were displaying similar indicators, and they were largely going unaddressed.” Thus, she played a key role in creating a work group which has examined local fiscal distress—and which has produced an action plan, a plan from which components have been incorporated into the state’s new budget: including:

  • improving how the Commonwealth of Virginia monitors fiscal activity and increases the level of oversight by the auditor of public accounts;
  • establishing a mechanism which is responsive to situations of local fiscal distress; and
  • providing readily available resources should intervention become necessary.

As a start, she noted that Virginia House has adopted a budget which allocates up to $500,000 to conduct intervention and remediation efforts in situations of local fiscal distress that have been previously documented by the Office of the State Secretary of Finance prior to January 1st, 2017. As part of a longer-term approach, the effort incorporates additional language establishing a Joint Subcommittee on Local Government Fiscal Stress, with the new subcommittee charged to review:

  • savings opportunities for increased regional cooperation and consolidation of services;
  • local responsibilities for service delivery of state-mandated or high-priority programs;
  • causes of fiscal stress; potential financial incentives and other governmental reforms for regional cooperation; and
  • the different taxing authorities of cities and counties.

Or, she she put it:

“An integral part of the approach we take towards addressing fiscal distress must also include conversations about electing capable local leadership and providing training in areas most critical to effective governance and financial management. Where there are gaps in knowledge and understanding, elected officials must be willing to educate themselves in every area necessary for good governance.”

Municipal Moral & Fiscal Obligations

07/27/17

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Good Morning! In today’s iBlog, we consider the state & local fiscal challenge fiscal in the event of a moral obligation pledge failure; the ongoing, long-term revival and recovery of Detroit from the largest municipal bankruptcy in American history, and the revitalization fiscal challenges in Atlantic City and Puerto Rico.

A Fiscal Bogie or a Moral Municipal Bond? Buena Vista, Virginia, a small, independent city located in the Blue Ridge Mountains of Virginia with a population of about 6,650, where the issue of its public golf course became an election issue—with the antis winning office and opting not to make the bond payments on the course they opposed—rejecting a moral obligation pledge on what has become a failed economic development project, as the city’s elected leaders chose instead to focus—in the wake of the Great Recession—on essential public services, putting the city in a sub par fiscal situation with Vista Links, which was securing the bonds, according to Virginia state records. The company, unsurprisingly,  has sued to get the monies it was promised—potentially putting at risk the city’s city hall and other municipal properties which had been put up as collateral. Buena Vista City Attorney Brian Kearney discerns this to be an issue of a moral obligation bond, rather than a general obligation municipal bond, so that “[W]e could not continue to do this and continue to do our core functions.” In the wake of the fiscal imbroglio, the Virginia Commission on Local Government (COLG)—which provides an annual fiscal stress study‒ended up playing a key role in the Petersburg effort in the General Assembly—finding that very poor management had led to an $18 million hole.

Here, the municipality’s default triggered negotiations with bond insurer, ACA Financial Guaranty Corp., which led to a forbearance agreement—one on which the city subsequently defaulted—triggering the Commonwealth of Virginia  to bar financing backup to the city from the state’s low-cost municipal borrowing pool, lest such borrowing would adversely impact the pool’s credit rating—and thereby drive up capital borrowing costs for cities and counties all across the state. In this instance, the Virginia Resources Authority refused to allow Buena Vista to participate in the Virginia Pooled Financing Program to refinance $9.25 million of water and sewer obligations to lower debt service costs—lest inclusion of such a borrower from the state’s municipal pool would negatively impact the pool’s offering documents—where some pooled infrastructure bonds, backed by the Commonwealth’s moral obligation pledge, are rated double-A by S&P Global Ratings and Moody’s Investors Service.

Seven years ago, the municipality entered into a five-year forbearance agreement with bond insurer ACA Financial Guaranty Corp.—an agreement which permitted Buena Vista to make 50% of its annual municipal bond payments for five years—an agreement on which Buena Vista defaulted when, two years ago, the City Council voted against inclusion of its FY 2015 budgeted commitment to resume full bond payments. That errant shot triggered UMB Bank NA to file a lawsuit in state court in 2016 in an effort to enforce Buena Vista’s fiscal obligation. In response, the municipality contended the golf course deal was void, because only four of the city’s seven council members had voted on the bond resolution and related agreements—which included selling the city’s interest in its “public places,” arguing that Virginia’s constitution mandates that all seven council members be present to vote on the golf course deal, because the agreement granted a deed of trust lien on city hall, police, and court facilities which were to serve as collateral for the bonds.

Subsequently, last March 22nd, the city filed a motion to dismiss the federal suit for failure to state a claim—a claim on which U.S. District Judge Norman K. Moon held a hearing last Friday—with the municipality arguing that the golf course’s lease-revenue debt is not a general obligation. Therefore, the city appears to be driving at a legal claim it has the right to stop payment on its obligation, asserting: “The city seeks to enforce the express terms of the bonds, under which the city’s obligation to pay rent is subject to annual appropriations by the City Council, and ceases upon a failure of appropriations.” Moreover, pulling another fiscal club from its bag, the city claimed the municipal bonds here are not a debt of the city; rather, the city has told the court that the deed of trust lien for the collateral backing the bonds is void. That is an assertion which ACA, in its motion to dismiss, deemed an improper attempt to litigate the merits of the suit at the pleading stage, noting: “Worse, the city wants this court to rule that the city only has a ‘moral obligation’ to pay its debts, and that [ACA’s] only remedy upon default is to foreclose on a fraction of the collateral pledged by the city and the Public Recreational Facilities Authority of the city of Buena Vista….If adopted, this court will be sending a message to the market that no lender should ever finance public projects in Virginia because municipalities: (a) have unbridled discretion to not repay loans; and (b) can limit the collateral that can be foreclosed upon.” In a statement subsequently, ACA added: “It’s unfortunate that Buena Vista’s elected officials have forced ACA into court after recklessly choosing to have the city default on $9.2 million in debt even though the city has ample funds to make the payments that are owed…This is particularly troubling, because ACA spent years negotiating in good faith after the city claimed financial hardship, and even provided a generous forbearance agreement that reduced payments by 50% starting in 2011…After the city defaulted on that deal in 2014, it offered ACA only pennies on the dollar, while seeking to be absolved of all future burdens of this financing. Left with no reasonable alternative, we must look to the court for an equitable and fair outcome.”

In the nonce, as its legal costs mount, Buena Vista’s access to the municipal credit markets has not only adversely affected its ability to borrow from state financing programs, but also there is growing apprehension there could be implications for other local governments and potentially the Commonwealth of Virginia. Virginia Finance Secretary Ric Brown, when this issue first cropped up, had written previous Buena Vista Mayor Mike Clements: “This ability cannot be jeopardized or put at risk by permitting a defaulting locality to participate in a state pool financing program such as the VPSA: The Commonwealth certainly expects localities to do what is necessary to meet their debt obligations and to protect Virginia localities’ reputation for fiscal discipline.” (Virginia’s Commission on Local Government has revealed that 53% of Virginia’s counties and cities are experiencing above average or high fiscal stress.).

Motor City Recovery. Louis Aguilar of the Detroit News this week reported that Detroit is expected to grow by some 60,000 residents by 2040—growth which would mark the first time Detroit’s population will have increased since the 1950s, according to a study by the Urban Institute, “Southeast Michigan Housing Futures,” which notes that Detroit will finally end its decades-long loss of residents. Xuan Liu, manager of research and data analysis for the Southeast Michigan Council of Governments, said the study builds on recent analyses done by SEMCOG, the Michigan Department of Transportation, and the University of Michigan: “It is a reflection of both the improvements we’ve seen in the city and the changing demographic trends.” The report indicates the region’s population base will include a larger percentage of residents over the age of 65 who are more inclined to remain where they are; the population increase in population will be influenced by the continued inflow of young adults and a small but steady rise of the Latino population. The study warns these changes will present major challenges, including the doubling of senior-headed households over the next three decades: by 2040, the study projects these households will make up 37% of the region’s households versus 22% in 2010; it adds that African-American households in the Detroit metro area disproportionately suffered from the effects of the housing crisis:  African-American homeownership rates dropped from a higher than the national average in 1990 and 2000 to be in line with the national average by 2014. Interestingly, it projects that the demand for rental housing is expected to grow throughout the region, with aging households likely comprising the bulk of this net growth as established renter households age—but warning that the region, and Michigan more broadly, lack affordable rental housing for low-income households. Overall, the Metro Detroit region is expected to gain approximately 380,000 households by 2040, according to the study.

For the Motor City, the report found that by 2016, Detroit’s population had slowed to its lowest pace in decades, according U.S. Census data: as of one year ago, Detroit’s population was 672,795, a loss of 3,541 residents—a decline comparable to the previous year: between 2000 to 2010, Detroit was losing more than 23,700 annually, on average, according to the Southeast Michigan Council of Governments; in the first decade of this century, the region lost 372,242 jobs, its population shrank by 137,375; and inflation-adjusted personal income retreated from 13.7% above the U.S. average to 4.8% below in 2010.

A Bridge to Tomorrow? The Detroit City Council this week okayed the $48 million agreement to open the way for the sale of city-owned property and streets in the path of the new Gordie Howe International Bridge to Canada—with the agreement also incorporating provisions to help residents living near the Delray neighborhood where the bridge will be located. Under the pact, the city will sell 36 city-owned parcels of land–land which Windsor-Detroit Bridge Authority Director of Communications Mark Butler siad was needed for the Gordie Howe bridge project. Courtesy of Windsor-Detroit Bridge Authority noted: “The funding relates to activities in advance of the P3 partner coming on board…As a normal course of business, WDBA, either directly or through the Michigan Department of Transportation, is providing funds to Detroit for property, assets, and services. The city in turn, is using those funds to purchase or swap homes outside of the project footprint, job training etc.” The bridge authority, a Canadian Crown corporation, will manage the Public-Private Partnership procurement process; the authority will also responsible for project oversight, including the actual construction and operation of the new crossing—whilst Canadian taxpayers will be fronting the funding to pay for the deal under an arrangement with the State of Michigan—under which there will be no cost or financial liability to Michigan or to Michigan taxpayers: Canada plans to recoup its money through tolls after the bridge is constructed. The Motor City will sell 36 city-owned parcels of land, underground assets, and approximately 5 miles of city owned streets needed for the bridge project. Under the agreement, the underlying property has been conveyed to the State of Michigan, but Canada is providing the funds. The bridge authority is expected to select a contractor for the project at the end of this year; construction will begin sometime next year.

Is There a Promise of Revitalization? The PROMESA Board this week appointed Noel Zamot to serve as Revitalization Coordinator for the U.S. territory—with Governor Ricardo Rosselló concurring the appointment would benefit Puerto Rico’s ability to compete—a key issue for any meaningful, long-term fiscal recovery. He added: “With over 25 years of experience in the aerospace and defense industry, we are convinced that Mr. Zamot will contribute to our economic development agenda and increase Puerto Rico’s competitiveness.” The federal statute’s Title V provided for such an appointment, a key part to any post chapter 9 plan of debt adjustment. Direct. PROMESA Board Chair José Carrión III noted: “Noel Zamot’s successful career and multifaceted experience interfacing between the government and the private sector in critical defense infrastructure areas will allow him to hit the ground running to foster strategic infrastructure investment expeditiously.” Mr. Zamot noted: “I am honored by this opportunity to serve and give back to Puerto Rico, my birthplace, and contribute to its success…Over more than two decades of professional experience, I have seen firsthand how investments in infrastructure can have a catalyzing effect on economic growth and prosperity.”

New Jersey & You. With major new developments under construction, renewed investor interest, and a slowly diversifying economy, it appears Atlantic City might be moving more swiftly from the red to the black—at a key point in political time, as voters in the city and New Jersey head to the polls next November for statewide and municipal elections—and, potentially, the end of state oversight of the city. Moreover, two new major projects are set to open next year, mayhap setting the stage for the city’s fiscal recovery—but also economic revitalization. Some of the stir relates to the purchase and $500 million renovation of the former Trump Taj Mahal Casino Resort—an opening projected to bring thousands of jobs and a strong brand to the city’s famed boardwalk. But mayhap the more promising development will be the completion of the $220 million Atlantic City Gateway project: a 67,500 square foot development which will serve as a new campus for Stockton University, including an academic building and housing for 500 students, and the new South Jersey Gas headquarters: the company believes its cutting-edge headquarters will trigger recruitment and growth, as it is projected to bring 15,000 square feet of new retail to the boardwalk.  

Interestingly, what has bedeviled the city, low land prices‒at their lowest in decades, is now attracting successful developers, who have been buying up buildings: commercial real estate brokers note an uptick in leasing activity since the Gateway project was announced: the promise of jobs, residents, and revenue no longer overwhelmed by the gaming industry appears to be remaking the city’s image and adding to its physical and fiscal turnaround. Bart Blatstein, CEO of Tower Investments, notes: “Of course I see upside. This is what I do for a living. And it’s incredible–the upside in Atlantic City is like nowhere else I’ve seen in my 40-year career. Atlantic City is a great story. It’s got a wonderful new chapter ahead of it.”

Rising from Municipal Bankruptcies’ Ashes

07/24/17

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Trying to Recover on all Pistons

07/19/17

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

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

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

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

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

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

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

Foundering Federalism?

07/12/17

Good Morning! In this a.m.’s eBlog, we consider the seemingly increasing likelihood of chapter 9 bankruptcy for Connecticut’s capital city, Hartford, before veering south to consider the ongoing fiscal storms in the U.S. Territory of Puerto Rico.

Moody Blues. In the latest blow from the capital markets to Connecticut’s capital city, Standard & Poor’s Global Ratings late Tuesday lowered Hartford’s general obligation ratings to junk bond status—with the action coming less than a week after we had reported the city had hired a firm to help it explore options for chapter 9 or other steps involving severe fiscal distress. Moody’s Investors Service had already downgraded Hartford’s bonds to a speculative-grade (Ba2), and it has placed the city on review for yet another downgrade.  S&P’s action appeared to reflect an increased likelihood Connecticut’s capital could default on its debt or seek to renegotiate its obligations to its bondholders, with S&P credit analyst Victor Medeiros noting: “The downgrade to BB reflects our opinion of very weak diminished liquidity, including uncertain access to external liquidity and very weak management conditions as multiple city officials have publicly indicated they are actively considering [municipal] bankruptcy.” The ratings actions occurred as the city continues to seek more state aid and concessions from the city’s unions—even as the state remains enmired in its own efforts to adopt its budget. Mayor Luke Bronin, in an interview yesterday, confirmed the possibility of bond restructuring negotiations. This is all occurring at a key time, with the Governor and legislators still negotiating the state’s budget—on which negotiations for the fiscal year which began at the beginning of this month, remain unresolved. In a statement yesterday, Mayor Bronin noted:  “I have said for months that we cannot and will not take any option off the table, because our goal is to get Hartford on the path to sustainability and strength.” He added that any long-term fiscal solution would “will require every stakeholder—from the State of Connecticut to our unions to our bondholders—to play a significant role,” adding: “Today’s downgrade should send a clear message to our legislature, to labor, and to our bondholders that this is the time to come together to support a true, far-sighted restructuring.”

A key fiscal dilemma for the city is that approximately 51 percent of the property in the city is tax-exempt. While the state provides a payment in lieu of local property taxes (PILOT) for property owned and used by the State of Connecticut (such payment is equal to a percentage of the amount of taxes that would be paid if the property were not exempt from taxation, including 100% for facilities used as a correctional facility, 100% for the Mashantucket Pequot Tribal land taken into trust by federal government on or after June 8, 1999, 100% for any town in which more than 50% of all property in the town is state-owned real property, 65% for the Connecticut Valley Hospital facility, and 45% for all other property; such state payments are made only for real property.  

Unretiring Debt. U.S. Federal Judge Laura Taylor Swain gave the government of Puerto Rico and the Employees Retirement Systems (ERS) bondholders until yesterday to settle their dispute over these creditors’ petition for adequate protection—warning that if a deal was not reached, she would issue her own ruling on the matter—a ruling which could mean setting aside at least $18 million every month in a separate account, albeit Judge Swain noted she was not ready at this time to say whether that would entail adequate protection. Her statement came even as Puerto Rico Governor Ricard Rossello Nevares yesterday stated that, contrary to complaints made by the Chapter of Retirees and Pensioners of the Federation of Teachers, the House Joint Resolution does not represent a “threat,” but rather comes to ensure pension payments to public workers who once served the U.S. Territory, adding, however, that the retirement system as it was known no longer exists, stating it “is over,” in the absence of resources that can ensure long-term pension payments: What we have done is that we have changed from a system where it was a fund to a pay system where what implies is that now the government under the General Fund assumes responsibility for the payment of the pension…That is, the retired do not have to fear, quite the opposite. The measure that we are going to do saves and guarantees the System. If we had not implemented this in the fiscal plan…the retirement system would run out of money in the next few months.” Describing it as a “positive measure for pensioners,” because, absent the action, it was “guaranteed to run out of money,” the Governor spoke in the wake of a demonstration, in front of La Fortaleza, where spokesmen of the Chapter of Retirees and Pensioners of the Federation of Teachers denounced the measure—a measure approved by both legislative bodies and sent to the Executive last month as a substitute retirement system for teachers.

Unsurprisingly, the Puerto Rico government and representatives of labor unions and retirees opposed the ERS bondholders’ request to lift the stay under PROMESA’s Title III. In response to Judge Swain’s query to the bondholders: “If I were to enter a sequestration in the manner you stipulated…What would that do for you?” Jones Day attorney Bruce Bennett responded; “Not enough,” as the ERS bondholders argued they needed adequate protection, because Puerto Rico has not made the requisite employer contributions to the ERS, which guarantee payments of their bonds. In contrast, opponents argued the resolution authorizing the issuance of these bonds was an obligation of Puerto Rico’s retirement system‒not the Commonwealth, and creditors were going beyond contractual rights in forcing the government to make appropriations from the general fund and remit them as employer contributions. An attorney representing the retirement system argued the ERS security interest filings were defective in reference to claims by bondholders that they have a right to receive employer contributions; however, an attorney representing the PROMESA Board countered that just because the collateral to their municipal bonds has been reduced, those bondholders are not entitled to such protection, testifying: “What is the claim worth when you have the GOs saying ‘we get all the money because we are in default.’”

Due to Puerto Rico’s perilous fiscal condition, it currently is making pension payments, for the most part, on a pay-as-you-go basis: public corporations and municipalities are making their employer contributions; however, those contributions are going into a segregated account; in addition, the fiscal plan contemplates making public corporations and municipalities similarly transform to a pay-go pension system—with the Territory supporting its position before Judge Swain by its police power authority.

The State of Puerto Rico’s Municipalities. The Puerto Rico Center for Integrity and Public Policy has reported that Puerto Rico’s municipal government finances deteriorated in FY2016 after improving in the prior two fiscal years. Arnaldo Cruz, a co-founder of the Center, said the cause of the deterioration was likely related to the election year, based on the collection of data and responses from 68 of the territory’s 78 municipios. Mr. Cruz added that the ten non-responders happened to be ones which had received D’s and F’s in past years. The updated study found that 30 municipalities nearly have the muncipios received more than 40% of their general fund revenue from the central government—mayhap presaging fiscal mayhem under the PROMESA Board’s intentions to eliminate such state aid to local governments over the next two fiscal years—i.e,: a cut of some $428 million. Such severe cuts would come even as the study found that more than half the muncipios realized a decrease their net assets last year, and half realized a decrease in their general fund balance—even as 27 municipios allocated more than 15% of their general fund income to debt repayment.

According to the March fiscal plan, Puerto Rico’s municipalities have:

  • $556 million in outstanding bond debt;
  • $1.1 billion in loans to private entities; and
  • Owe $2 billion to Puerto Rico government entities, primarily the Government Development Bank for Puerto Rico.

Mr. Cruz notes a potentially greater fiscal risk is related to Government Development Bank loans, which Puerto Rico’s municipalities continued to receive last year: last month, however, the Puerto Rico Senate approved a bill to allow the municipalities to declare an emergency and declare a moratorium on the payment of their debt. The fate of the effort, however, is uncertain, because the legislation died when the legislature adjourned before House action—mayhap to be taken up next month when they reconvene.