Ending a State’s Fiscal Emergency Manager Preemption, & Who’s on First in Puerto Rico’s Governance?

July 2, 2018

Good Morning! In this morning’s eBlog, we consider what might be the end of the State of Michigan’s much maligned emergency manager program, before returning to assess the question with regard to whether a governor and legislature or a quasi U.S. bankruptcy court are in charge in Puerto Rico.

Exiting from Municipal Bankruptcy. For the first time in nearly two decades, a state-appointed Emergency Manager governs no municipality or school district in Michigan, after the state released Wayne County’s Highland Park School District in Wayne County from receivership under Michigan’s Local Financial Stability and Choice Act of 2012. Indeed, Michigan Treasurer Nick Khouri reports that Michigan municipalities have worked hard to become financially sound, noting: “Today’s achievement is really about the hard work our communities have accomplished to become financially sound…I commend the efforts of our local units to identify problems and bring together the resources needed to help problem-solve challenging financial conditions.” Under the terms of the release, Highland Park School District’s locally elected school board will oversee the contract for Highland Park Public School Academy and the cooperative agreement with the Detroit Public Schools Community District for the continuing education of students. In addition, the board will manage the repayment of long-term debt obligations. The Highland School District has a quasi-chapter 9 plan of debt adjustment in place to address its $7.5 million general fund deficit, with revenues from property taxes imposed on non-homestead property dedicated to finance outstanding debt, as well as an approved two-year budget. According to financial statements, as of the end of last year’s fiscal year, the District had $2.4 million in general obligation bonds outstanding.

The agreement means the school district, which had been under emergency management since January of 2012, and for which the state-appointed emergency manager had established Highland Park Public School Academy to provide educational services to district students while the school district paid off long-term debt obligations—for which, since 2015, said public school academy has been educating students from pre-kindergarten through eighth grades, and for the scholastic years through high school via a cooperative agreement with the Detroit Public Schools Community District, which has been providing educational services to students from ninth through 12th grades.

Nevertheless, the State of Michigan continues to maintain an oversight role in a limited number of Michigan communities: public school districts in Benton Harbor and Pontiac are operating under a consent agreement with the state, and the Muskegon Heights school district is overseen by a receivership-transition advisory board. The critical fiscal recoveries were marked by April’s exit from state oversight by the City of Flint, after seven years, and then, the following month: Detroit.

Conflicted Fiscal Governance. With the beginning of the new fiscal year, Governor Ricardo Rosselló Nevares still assessing fiscal options, as well as his authority to address the $8.7 billion operating budget imposed yesterday by the PROMESA Oversight Board on the U.S. territory–or, as he put it: “We are evaluating the budget certified by the Fiscal Oversight Board on the U.S. territory. Certainly, the impact on the budget of the three branches of government and municipalities will require additional adjustments that will limit our ability to provide services.” Ramon Rosario, Puerto Rico’s Secretary of Public Affairs, noted:  “The Governor and his cabinet continue to analyze all possible alternatives to the scenario.”

There was no public reaction to the imposed fiscal preemption of elected authority by House President Carlos Johnny Mendez, nor Senate President Thomas Rivera Schatz, respectively, to the budget imposed by the JSF. The Governor indicated, however, that some of the biggest concerns of the Executive are public employees and the payment of the Christmas bonus, as well as the elimination of funds for economic development.

The Board’s proposed budget, interestingly, is greater than that approved by the Legislature; however, it imposes additional cuts of up to $345 million. It does not repeal Law 80-1976, the Law Against Unjustified Dismissal. It does preserve the Christmas bonus for public employees and establish two funds, one of $ 25 million for the University of Puerto Rico, and another of $ 50 million for municipio recovery. PROMESA Board Chair José Carrión, in a written statement, noted: “The course has been drawn, and although it will be a challenge, we cannot afford to deviate. We must all work together.”

Working together would be a challenge—and a question now for Puerto Rico is whether to comply or go to court to preserve, ironically, an approved fiscal budget smaller than that to be imposed by the PROMESA Board: that is, what if the Governor and Legislature were to opt not to implement the unelected PROMESA Board’s proposed budget? One attorney noted: “There would be a confrontation that would generate a controversy in the court, because, then, the Board would have to go to the court and ask it to force the officials to comply with the budget.” Under such a scenario, the unelected fiscal oversight Board would issue a certification of non-compliance, which, were it not to compel the elected government of Puerto Rico to comply, could entail the Board availing itself of the mechanisms in the PROMESA statute preempting Puerto Rico’s governing authority. Independence Party’s Denis Márquez remarked that his “exhortation is not to obey the Fiscal Control Board, but they always tell you that you have to be against the Board, but at the end of the day you look for a reasonable accommodation that always ends up hurting the country.” However, unlike a chapter 9 governance situation, where a federal bankruptcy court assesses a municipality’s plan of debt adjustment, PROMESA allows the Board to establish the budget at its sole discretion. It appears to be virtually a form of colonialism.

As the oversight board had advanced during its approval of the fiscal plan last Friday, the public expenditure scheme contemplates reductions greater than those set in the first version of the document approved by the Legislature: the budgets of some agencies seem to have an increase compared to the current fiscal year, but this is due to the fact that, for the first time, each one was assigned an authorization corresponding to the payment of their employees’ pensions (pay as you go). A spokesperson for the Popular Democratic Party in the House noted: “The vision of the Board is the republican vision, a small government with less participation.” Indeed, the version to be imposed by the Oversight Board contemplates major cuts for the Department of Education, which ended with an allocation for this fiscal year of $2.479 billion, about a 5% cut for what the Legislature had approved, with the deepest cuts coming in payroll and operating expenses, even as the Board added nearly $30 million to “cover services related to the provision of therapies and other services for special education children, and $ 23.8 million for the payment of salary increases to teachers—leading Puerto Rico Senate Education Chair Abel Nazario to note that the PROMESA Board “itself recognizes that these measures must be maintained in the coming years is an achievement that we recognize and appreciate.”

The Board imposed a number of deep cuts, such as the Bureau of the Fire Department, where the Board cut operating expenses of $576,000, as proposed by the Legislature, to $148,000; it slashed just over $1 million for firefighter protection equipment, and cut the police department payroll by $587.1 million, as stipulated in the Legislature’s version, to $ 570.2 million, but the Board retained the proposed $18.8 million for increased police salaries.

Imbalanced Governance? The Board cut funding for the Governor’s office in excess of 10 percent, and funds for the Puerto Rico Legislature by nearly 20 percent; it cut funding for the Puerto Rico Health Department by just under 10 percent.

Can there be Shelter from the Storm? Meanwhile, in a different courtroom, U.S. District Judge Leo T. Sorokin of Massachusetts has ordered that FEMA cannot end its Transitional Sheltering Assistance program until at least midnight tomorrow, granting Puerto Ricans who fled Hurricane Maria’s devastation and have been living in temporary housing on the mainland a very brief reprieve. Christiaan Perez, manager of advocacy and digital strategy for the civil-rights group, LatinoJustice, the national civil-rights group which filed a lawsuit Saturday seeking the restraining order told the court the end of the FEMA assistance would lead to Puerto Rican evacuees being evicted. The temporary restraining order is projected to offer some protection for about 1,744 Puerto Ricans for whom the FEMA transitional assistance was to end Saturday. Judge Sorokin has scheduled a telephone hearing for today.

The outcome will impact many of the families who left Puerto Rico in the wake of the storm for the mainland who have been living in hotels in New York and Florida and those who have been unable to secure affordable housing and are now worried about what happens as FEMA assistance expires—or, as Cynthia Beard, one of the 600 Puerto Rican hurricane survivors living in New York, told NBC News this week: “I don’t know what’s going to happen. The city called me and said there’s a shelter, but there’s no guarantee; they didn’t say everything is going to be OK.” According to Mayor De Blasio’s office, New York City has a program in place to direct transportation from the hotels to the shelters. Once there, families have to find out if they are deemed eligible to register into the city’s shelter system: if accepted, families are assigned to case management and housing assistance services to help them find permanent homes. 

But FEMA has also offered displaced Puerto Ricans the option to return to Puerto Rico, asserting the agency has called more than 1,500 displaced Puerto Ricans to offer to pay for their plane tickets to return to Puerto Rico by yesterday or recommend them ways to look into their respective state’s shelter system. As of June 27, only 145 families had either booked their plane tickets or already returned to Puerto Rico. It appears the majority of displaced Puerto Rican families have opted to remain stateside, even though many do not have a permanent home. The offer came in the wake of four different deadline extensions, during which, under FEMA’s TSA program has housed Puerto Rican hurricane survivors for nearly 9 months. During other disasters, survivors participating in that program were given up to a year and a half—even though officials have said that the program normally lasts 30 days. Nevertheless, FEMA warned it was ending Transitional Sheltering Assistance for survivors of hurricanes Maria, Irma, and Harvey on Saturday, asserting it has spent more than $432 million on survivor lodging as part of the program, and that it has provided rental assistance to more than 25,000 TSA participant families to help them find permanent housing.

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Assessing the Promise of PROMESA

D-Day, 2018

Good Morning! In this morning’s eBlog, we consider the status—and promise—of the quasi chapter 9 municipal bankruptcy process in the U.S. territory of Puerto Rico.

Nearly two years after the Puerto Rico Oversight, Management, and Economic Stability Act (PROMESA) was enacted to establish a federally appointed oversight board to oversee a quasi-chapter 9 municipal bankruptcy process for restructuring or adopting a plan of debt adjustment of the U.S. territory’s debt—a statute which enabled the territory to suspend debt payments effective July 1st in 2016 on its debt in excess of $123 billion, the end might be looming. The statute also cleared the way for deep cuts in Puerto Rico’s public service budget—including cuts to health care, pensions, and education. Just over a year ago, Judge Laura Taylor Swain began the process of overseeing the quasi chapter 9 municipal bankruptcy process in search of some consensus on a quasi-plan of debt adjustment. Now that plan is beginning to take shape, with, this week, the Puerto Rico Financial Advisory Authority and Fiscal Agency (Fafaf) ) informing Judge Swain that, as early as next month, there will be a plan to adjust the debt of the Government Development Bank. Attorneys for the Agency have indicated to Judge Swain that as early as June 22nd they intend to provide drafts of the legal documents which are prerequisites to renegotiate the debt of the Government Development Bank (GDB) and the deposits of third parties which the Bank has retained in its custody since its decapitalization about two years ago. The adjustment with the creditors, whether bondholders or depositors, would occur in light of Title VI of the PROMESA statute—the title which provides for a voluntary negotiation between the parties and on which the judicial branch does not issue direct judgment regarding its reasonableness. The goal is to complete such submission by August, according to Christian Sobrino, the Governor’s chief advisor for economic development, who noted: “It is anticipated that at some point in August, the transaction must be closed,” as he discussed details of the quasi plan of debt adjustment process that would mark a milestone in the restructuring of Puerto Rico’s quasi municipal bankruptcy, noting: “This is the only agreement that has both the government and the Oversight Board, and this will demonstrate the ability of Puerto Rico to reach consensual agreements,” as he stressed the importance of the agreement reached with many of the government’s creditors, adding: “Given that they will be negotiable instruments, it will be the first issue of restructured debt issued by Puerto Rico since 2014.”

According to the agency’s motion, the government would open the application process to seek the consent of the creditors on July 5th. According to Mr. Sobrino, the process of compliance with Title VI of PROMESA would begin one day later, when it is expected that Aafaf, after receiving the approval of the Oversight Board, will file a request for a qualified modification of the GDB debt in court. He notes that PROMESA’s Title VI process requires presenting a breakdown of claims by creditors according to their guarantee or priority, but that process would have already been substantially completed upon the approval of the Debt Restructuring Agreement with various funds. (At present, some six credit unions have sued the government for the renegotiation of GDB debt.)

According to the RSA, the agreement between the Puerto Rico Electric Power Authority (PREPA) and its creditors to extend several deadlines under their restructuring support agreement, will be modified again to reflect the changes in the transaction calendar: the GDB bondholders would receive 55 cents of each dollar they lent to the former fiscal agent. Meanwhile, the depositors, including muncipios, would recover a similar amount for the deposits they have put in custody with the GDB—with, in their case, Mr. Sobrino stressing they would receive 55% of the deposits held in the bank. However, if the muncipios have loans in the GDB, their deposits would be used to settle dollar-to-dollar financing, without reflecting the 45 cents which will apply to the rest of the credits: “The approval request will seek to establish clear procedures related to the approval of the qualified amendment, including the timetable for the parties to object the vote portfolio, the request and the tabulation processes, thus ensuring that all parties with an interest in the restructuring of the GDB have an opportunity to be heard in relation to Title VI.”

To date, according to the RSA (the restructuring support agreement), through last December, the GDB owed approximately $3,765 million; it also owed $376 million in deposits to private and similar companies; and another $507 million in deposits from agencies and government entities. The proposed transaction contemplates repaying the bondholders of the municipal loans and government agencies that the GDB still hopes to recover, as well as the sale of properties of the institution, which closed its doors last March.

The Puerto Rican agency’s motion came less than 48 hours before Judge Swain is due back to preside over the general hearing of the Title III cases today—a hearing where Judge Swain must decide whether to authorize a second payment to the professionals involved in PROMESA cases.

Motor City Rising

June 1, 2018

Good Morning! In this morning’s eBlog, we consider the remarkable turnaround of Detroit—a city which, when I inquired on its very first day in chapter 9 municipal bankruptcy, for walking directions from my hotel to the Governor’s Detroit office—in response to which I was told the one mile route was not doable—not because I would be too physically challenged,  but rather because I would be slain. Yet now, as the  fine editorial writers for the Detroit News, Daniel Howes and Nolan Finley, wrote: “A regional divide that appeared to be healing since Detroit’s historic bankruptcy is busting wide open over a plan for regional transit, exposing anxiety that the city is prospering at the expense of the suburbs,” noting that the trigger is a is a proposed millage to fund expansion of the Regional Transit Authority of Southeast Michigan, a $5.4 billion plan that would seem to promise an exceptional reshaping of the metro region—indeed: a reversal a what had been a decades-long shift of the economy from downtown Detroit to is suburbs: an exodus that contributed to a wasteland and the nation’s largest ever chapter 9 municipal bankruptcy.” Or, as they wrote: “That battle reveals growing suburban resentments over the region’s shifting economic fortunes: decades-long capital flow is reversing directions as more jobs and tax revenue flee the ‘burbs for a rejuvenated downtown.”

Mr. Finley noted that Mayor Mike Duggan, this week, told him: “I can’t explain why Oakland and Macomb (suburban counties) are doing what they’re doing” three weeks ago Microsoft brought 400 employees from Southfield into the city of Detroit. And last week, Tata Technologies said they were moving 200 people from Novi and into Detroit. Google is in the process of moving people from Birmingham into the city of Detroit.” What the Mayor was alluding to was a u-turn from a decade of moderate and upper income families leaving Detroit for its suburban counties in the days when former Mayor Coleman Young had advised criminals to “hit Eight Mile” has the relationship between the Metro Motor City’s regional leaders become so difficult in the wake of the unexpected reverse exodus: this time from Detroit’s suburbs back into the city. Billions in private sector investment, spearheaded by Dan Gilbert’s Quicken Loans Inc., the Ilitch family, and growing enthusiasm among other business leaders to be part of the city’s post-chapter 9 municipal bankruptcy have been changing demographic and economic patterns.

As the city continues under decreasing state oversight to carry out its judicially approved plan of debt adjustment, Mayor Duggan notes: “Expectations are rising.” This, after all, is not a City Hall bound mayor, but rather what the editors described as a “short, stocky, balding white guy who is no stranger to block after block of dilapidated houses—and who was reelected to a second term with an amazing 72% of the vote in a city where slightly more than 82% of the voters are black—and where, when he took office, there were about 40,000 abandoned homes. He is not a stay at City Hall type fellow either—rather an inveterate inspector of this mammoth rebuilding of an iconic city, who listens—and with his cell phone—takes action immediately in response to constituents concerns. After all, as the Mayor notes: “Expectations are rising…People are putting more demands on me and more demands on the administration, and I think that’s a really good thing and that will keep us motivated to work hard.”

Already, the urban wasteland is changing—almost on a daily basis: already, under a city program which supports renovation over demolition to try to preserve the mid-century architectural character of neighborhoods, that number of abandoned homes has been halved—with many of the units set aside for affordable housing. In his State of the City address this year, Mayor Duggan said he wants 8,000 more homes demolished, 2,000 sold, another 1,000 renovated and 11,000 more boarded up by the end of next year.

On that first day of the nation’s largest ever municipal bankruptcy, Kevin Orr, whom the Governor had tapped to become the Emergency Manager for Detroit, had flown out from the Washington, D.C. region, and told me his first actions were to email every employee of Detroit that he would be filing that morning in the U.S. Bankruptcy Court, but that he expected every employee to report to work—and that the most critical priorities were that every traffic and street light work—and that there be a professional, courteous, and prompt response to every 911 call.  

That was a challenge—especially for a municipality in bankruptcy, but, by 2016, the city had completed a $185 million streetlight repair project; 911 response times have been reduced from 50 minutes in 2013 to 14.5 minutes last year, and ambulance response times fell from 20 minutes in 2014 to the national average of 8 minutes this year.

As we have previously noted, two months ago, just three and a half years after Detroit emerged from chapter 9, the city has exited from state oversight; its homeless population has, for the third consecutive year, declined—and, its unemployment rate, which had peaked during the fiscal crisis at 28%, is now below 8%. No wonder the suburbs are becoming fiscally jealous. And the downtown, which was unsafe for pedestrians when the National League of Cities hosted its annual meeting there in the 1980’s and on the city’s first day in bankruptcy, has been transformed into a modern, walkable metropolis.

Nevertheless, the seeming bulldog, relentless leader has refused to sugarcoat the fiscal and physical challenge—or, as he puts it: “I don’t spend a lot of time promising. I just say, here’s what we’re doing next and here’s why we’re doing it and then we do what we say…Over time, you don’t restore trust by making more promises; you restore trust by actually doing what you said you were going to do.”

Mr. Finley wrote that the Mayor, deemed a “truth teller” by Detroit Housing Director Arthur Jemison, has been direct in confronting the city’s harsh legacy of racist policies after the Great Depression lured thousands upon thousands of African-Americans north in the early decades of the 20th century to work in auto factories—luring them to a city at a time when Federal Housing Administration guidelines barred blacks in the city from obtaining home mortgages and even led to the construction in 1941 of a wall bordering the heavily African-American 8 Mile neighborhood to segregate it from a new housing development for whites.

Aaron Foley — the 33-year-old author of How to Live in Detroit Without Being a Jackass, noted: “When you deliver that kind of message about this is why black people are on this side of the wall in 8 Mile versus the other side of the wall, that gets people talking: This is a history that we all know in Detroit, and for the city government to acknowledge that in the way that it did on that platform, it did resonate.”

Mayor Duggan’s concern for Detroit’s people—and not forcing low-income families out, is evidenced too by his words: “Every single time that we had a building where the federal [housing] credits were expiring and people were going to get forced out of their affordable units, I had to sit down for hours with the building owner to convince them why those who stayed were entitled to be there, and I thought: I need to do just one speech and explain that this is the right thing to do…Since then there’s been just great support for the direction we’re going in the city. We have very little pushback now from our developers over making sure that what they’re doing is equitable.”

Innovative, but Challenging Paths to Exiting Municipal Bankruptcy

May 25, 2018

Good Morning! In this morning’s eBlog, we observe Detroit’s physical and fiscal progress from the nation’s largest ever chapter 9 municipal bankruptcy, before exploring the seeming good gnus of lower unemployment data from Puerto Rico.

Motor City Upgrade. Moody’s has upgraded Detroit’s issuer rating to the highest level in seven years, awarding the Motor City an upgrade from to Ba3 from B1, with a stable outlook, noting: “The upgrade reflects further improvement in the city’s financial reserves, which has facilitated implementation of a pension funding strategy that will lessen the budgetary impact of a future spike in required contributions…The upgrade also considers ongoing economic recovery that is starting to show real dividends to tax collections.” The stable outlook, according to Moody’s, incorporates the Motor City’s high leverage, weak socioeconomic profile, and “volatile nature” of local taxes. Albeit not a credit rating, Detroit likely received another economic and fiscal boost in the wake of President Trump’s actions calling for new tariffs on cars and trucks imported to the U.S., with an estimated additional duty of up to 25% under consideration.

The twin positive developments follow just weeks after the 11-member Detroit Financial Review Commission, created to oversee city finances following its 2013 chapter 9 municipal bankruptcy, voted unanimously to restore Detroit’s authority to approve budgets and contracts without review commission approval, effectively putting Detroit on fiscal and financial probation, with a prerequisite that the restoration of full, quasi home rule powers be that the city implement three straight years of deficit-free budgets—a condition Detroit has complied since 2014, according Detroit Chief Financial Officer John Hill. Or, as Councilmember Janee L. Ayers told the Commission this week: “Not to say that we don’t recognize everything that you’ve brought to the table, but I do recognize that you’re not really gone yet.” The city recorded an FY2018 surplus of $36 million, in the wake of regaining local control over its budget and contract authority, with a projected FY2018 $36 million surplus via increasing property tax revenues and plans that will earmark $335 million by 2024 to address key pension obligations in the city bankruptcy plan of debt adjustment for its two public pension funds. In addition, Moody’s revised Detroit’s outlook to stable from positive—albeit an upgrade which does not apply to any of its current $1.9 billion in outstanding debt, writing that its upgrade reflects an improvement in Detroit’s financial reserves, which have allowed Detroit to implement a funding strategy for its looming pension obligations “that will lessen the budgetary impact of a future spike in required contributions.”

As part of its approved plan of debt adjustment by former U.S. Bankruptcy Judge Steven Rhodes, Detroit must pay $20 million annually through FY2019 to its two pension funds, after which, moreover, contributions will increase significantly beginning in 2024. Moody’s noted: “The stable outlook is based on the city’s strong preparation for challenges ahead including the need to make capital investments and absorb pending spikes to fixed costs…Underperformance of pension assets and revenue volatility remain notable budgetary risks, but the city has amassed a large reserve cushion and adopted conservative budgetary assumptions that provide breathing room to respond to adverse developments,” adding that the “ongoing economic recovery that is starting to show real dividends to tax collections: Further growth in the city’s reserves and tax base growth to fund capital projects for either the city or its school district could lead to additional upgrades. In contrast, the agency warned that a downgrade could be spurred by slowed or stalled economic recovery, depletion of financial reserves, or growth in Detroit’s debt or pension burden, fixed costs, or capital needs. CFO Hill noted: “A second rating upgrade in just seven months from Moody’s shows that we have created the financial management infrastructure necessary to continue to meet our obligations and enhance our fiscal position…Working with the Mayor and City Council, our team has made a variety of improvements to financial management practices and our financial planning and budgeting practices are strong, as reaffirmed by Moody’s in their report.”

Nevertheless, while the gnus on the ratings front is exhilarating, governing and fiscal challenges remain. A key challenge is the ongoing population hemorrhaging—a hemorrhaging which has slowed to a tenth of its pace over the previous decade, but, according to the Census Bureau’s most recent release, the Bureau determined last week that the city’s population was 673,104 as of last summer, a decline of 2,376 residents, slightly down from last year’s 2,770, even as the metropolitan region continued to grow, as did cities such as Grand Rapids and Lansing, which posted among the largest gains. Nevertheless, Mayor Mike Duggan, after his reelection last November, said his performance should be measured by the milestone of reversing the outflow. He has blamed the city’s schools for the continued losses: “At this point it’s about the schools: We have got to create a city where families want to raise their children and have them go to the schools…There are a whole number of pieces that have gotten better but at the end of the day, I think the ultimate report card is the population going up or going down and our report card isn’t good enough.”

Mayor Duggan added that Detroit utility records show at least 3,000 more homes are occupied than last year; however, it appears to be one- and two-person households who are moving in; families with children are moving out. Nevertheless, researchers believe the overall trend is a marked improvement for Detroit. As we had noted in or report, and other researchers have, the Motor City lost an average of 23,700 annually in the decade from 2000 to 2010; Detroit’s population declined by nearly 1.2 million since its 1950 peak. If anything, moreover, the challenge remains if the city leaders hope to reverse the decades-long exodus: the Southeast Michigan Council of Governments forecasts Detroit will continue to experience further decline through 2024, after which the Council guesstimates Detroit will bottom out at 631,668. 

Nevertheless, Detroit, the nation’s 23rd largest city, is experiencing less of a population loss than a number of other major cities, including Baltimore, St. Louis, Chicago, and Pittsburgh, according to the most recent estimates, or as Mayor Kurt Metzger of Pleasant Ridge, a demographer and director emeritus of Data Driven Detroit put it: “Our decreasing losses should be put up against similar older urban cities, rather than the sprawling, growing cities of the south and west: “I still believe that the population of Detroit may indeed be growing.” (Last year, Detroit issued 27 permits to build single-family homes in the city, according to the Southeast Michigan Conference of Governments–another 911 building permits were issued for multi-family structures, and 60 permits for condominiums. Meanwhile 3,197 houses were razed, while according to the Detroit regional council of governments.

A key appears to be, as Chicago’s Mayor Rahm Emanuel determined in Chicago, the city’s schools. Thus, Mayor Duggan said he hopes the Detroit School Board will approve his bus loop plan as a means to help lure families back into the city proper, noting that many families in the city send their children to schools in the suburbs‒and end up moving there. In his State of the City Address, he said he intended to create a busing system in northwest Detroit to transport children to participating traditional public and charter schools and the Northwest Activities Center. This will be an ongoing governance challenge—as his colleague Mayor Metzger noted: “There’s no lessening of the interest in outlying townships: People are still looking for big houses, big lots with low taxes.” Indeed, even as Detroit continues to witness an ongoing exodus, municipalities in the metropolitan region‒the Townships of Macomb, Canton, Lyon, and Shelby are all growing. 

Detroit Chief Financial Officer John Hill notes: “A second rating upgrade in just seven months from Moody’s shows that we have created the financial management infrastructure necessary to continue to meet our obligations and enhance our fiscal position: Working with the Mayor and City Council, our team has made a variety of improvements to financial management practices and our financial planning and budgeting practices are strong, as reaffirmed by Moody’s in their report.” Thus, in the wake of the State of Michigan’s restoration of governing authority and control of the city’s finances on April 30th, more than three years after its Chapter 9 exit in December of 2014, Detroit now has the power to enter into contracts and enact city budgets without seeking state approval first, albeit, as Moody’s notes: “Underperformance of pension assets and revenue volatility remain notable budgetary risks, but the city has amassed a large reserve cushion and adopted conservative budgetary assumptions that provide breathing room to respond to adverse developments.”

Motor City Transformation?  In the wake of real estate development firm Bedrock Detroit gaining final approval from the Michigan Strategic Fund for its so-called “transformational” projects in downtown Detroit, the state has approved $618 million in brownfield incentives for the $2.1 billion project, relying in part on some $250 million secured by new brownfield tax credits, enacted last year by the legislature—a development which Mayor Duggan said represents a “major step forward for Detroit and other Michigan cities that are rebuilding: Thanks to this new tool, we will be able to make sure these projects realize their full potential to create thousands of new jobs in our cities.” In what will be the first Michigan to use the Transformational Brownfield Plan tax incentive program, a program using tax-increment financing to capture growth in property tax revenue in a designated area, as well as a construction period income tax capture and use-tax exemption, employee withholding tax capture, and resident income tax capture; the MIThrive program is projected to total $618 million in foregone tax revenue over approximately 30 years. While Bedrock noted that the tax increment financing “will not capture any city of Detroit taxes, and it will have no impact on the Detroit Public Schools Community District,” the plan is intended to support $250 million in municipal bond financing by authorizing the capture of an estimated average of $18.56 million of principal and interest payments annually, primarily supported by state taxes over the next three decades, to repay the bonds, with all tax capture limited to newly created revenues from the development sites themselves: the TIF financing and sales tax exemption will cover approximately 15% of the project costs; Bedrock is responsible for 85% of the total $2.15 billion investment, per the financing package the Detroit City Council approved last November, under which Bedrock’s proposed projects are to include the redevelopment of former J.L. Hudson’s department store site, new construction on a two-block area east of its headquarters downtown, the Book Tower and Book Building, and a 310,000-square-foot addition to the One Campus Martius building Gilbert co-owns with Detroit-based Meridian. Altogether, the projects are estimated to support an estimated 22,000 new jobs, including 15,000 related to the construction and over 7,000 new permanent, high-wage jobs occupying the office, retail, hotel, event and exhibition spaces—all a part of the ongoing development planned as part of Detroit’s plan of debt adjustment.

In an unrelated, but potentially unintended bit of fiscal assistance, President Trump’s new press for tariffs of as much as 25% on cars and trucks imported to the U.S., Detroit might well be a taking a fiscal checkered flag.

Avoiding Risks to Puerto Rico’s Recovery. Yesterday, in testifying before the PROMESA Board, Governor Ricardo Rosselló Nevares  told the members his governing challenge was to “solve problems, and not to see how they get worse,” as he defended the agreement with the Oversight Board—and as he urged the Puerto Rico Legislature to comply with his fiscal plan and repeal what he described as the unjust dismissal law (Law 80), a key item in the certified fiscal plan that the PROMESA Board is reevaluating. That law in question, the Labor Transformation and Flexibility Act, which he had signed last year, represented the first significant and comprehensive labor law reform to occur in Puerto Rico in decades. As enacted, the most significant changes to the labor law include:  

  • Effective date (there is still no cap for employees hired before the effective date);
  • Eliminating the presumption that a termination was without just cause and shifting the burden to the employee to prove the termination was without just cause;
  • Revising the definition of just cause to state that it is a “pattern of performance that is deficient, inefficient, unsatisfactory, poor, tardy, or negligent”;
  • Shortening the statute of limitations for Law 80 claims from three years to one year, and requiring all Law 80 claims filed after the Act’s effective date to have a mandatory settlement hearing within 60 days of the filing of the answer; and
  • Clarifying the standard for constructive discharge to require an employee to prove that the employer’s conduct created a hostile work environment such that the only reasonable thing for the employee to do was resign.

The Act mandates that all Puerto Rico employment laws be applied in a similar fashion to federal employment laws, unless explicitly stated otherwise in the local law. It applies Title VII’s cap on punitive and compensatory damages to damages for discrimination and retaliation claims, and eliminates the mandate for written probationary agreements; it imposes a mandatory probationary period of 12 months for all administrative, executive and professional employees, and a nine-month period for all other employees. It provides a statutory definition for “employment contract,” which specifically excludes the relationship between an employer and independent contractor. The Act also includes a non-rebuttable presumption that an individual is an independent contractor if the individual meets the five-part test in the statute. It modifies the definition of overtime to require overtime pay for work over eight hours in any calendar day instead of eight hours in any 24-hour period, and changes the overtime rate for employees hired after the Act’s effective date to time and one-half their regular rate. (The overtime rate for employees hired prior to the Act remains at two times the employee’s regular rate.). The Act provides for alternative workweek agreements in which employees can work four 10-hour days without being entitled to overtime, but must be paid overtime for hours worked in excess of 10 in one day. The provisions provide that, in order to accrue vacation and sick pay, employees must work a minimum of 130 hours per month; sick leave will accrue at the rate of one day per month—and, to earn a Christmas Bonus, employees must work 1,350 hours between October 1 and September 30 of the following year; employees on disability leave have a right to reinstatement for six months if the employer has 15 or fewer employees; employers with more than 15 employees must provide employees on disability leave with the right to reinstatement for one year, as was required prior to the Act. For employees, the law includes certain enumerated employee rights, including a prohibition against discrimination or retaliation; protection from workplace injuries or illnesses; protection of privacy; timely compensation; and the individual or collective right to sue or file claims for actions arising out of the employment contract.

In his presentation, the Governor suggested that the repeal of the statute would be a vital component to controlling Puerto Rico’s budget, in no small part by granting additional funds to municipalities, granting budgetary increases in multiple government agencies, including the Governor’s Office and the Puerto Rico Federal Affairs Administration (PRFAA), as well as increasing the salary of teachers and the Police. While the Governor proposed no cuts, a preliminary analysis of the document published by the Office of Management and Budget determined that the consolidated budget for FY 2018-19 would total $ 25.323 billion, or 82% lower than the current consolidated budget, as the Governor sought to assure the Board he has achieved some $2 billion in savings, and reduced Puerto Rico’s operating expenses by 22%.

In his presentation to the 18th Puerto Rico Legislative Assembly, the Governor warned that Puerto Rico has an approximate “18-month window” to define its future, taking advantage of an injection of FEMA funds in the wake of Hurricane Maria, as he appeared to challenge them to be part of that transformation, noting: “We have an understanding with the (Board) that allows the approval of a budget that, under the complex and difficult circumstances, benefits Puerto Rico: Ladies and gentlemen legislators: you know everything that is at risk. I already exercised my responsibility, and I fully trust in the commitment you have with Puerto Rico.”

According to Gov. Rosselló Nevares, repealing Law 80, which last year was amended to grant greater flexibility to companies in the process of dismissing workers, would be the first step for what would be a phase of greater economic activity on the island, and would join different measures which have been put into effect to provide Puerto Rico a “stronger” position to renegotiate the terms of its debt, as he contrasted his proposal versus the cuts and austerity warnings proposed by the PROMESA Board, adding that, beginning in August, the Sales and Use Tax on processed food will be reduced, and that tax rates will be reduced without fear of the “restrictions” previously established and imposed by the Board, adding that participants of Mi Salud (My Health) will be able to “choose where they can obtain health services, beyond a region in Puerto Rico,” and that the budget guarantees teachers and the police will receive an increase of $125 per month.

Shifting & Shafting? In his proposed budget, the Governor proposed that municipalities would be compensated for the supposed reduction in the contributions of the General Fund, stating: “Through the agreement, the disbursement of 78 million dollars that this Legislature approved for the municipalities during the current recovery period is secured; the Municipal Economic Development Fund of $50 million per year is created.” Under the administration’s proposed budget, the contribution to municipalities would be about $175.8 million, which would be consistent with the adjustment required for that item in the certified fiscal plan. As a result of the agreement with the Board, municipalities would, therefore, practically receive another $ 128 million. As proposed, Puerto Rico’s government payroll would be reduced for the third consecutive year: for example, payments for public services and those purchased will increase 23% and 16%, respectively; professional services would increase by 40%. Expenses for the Governor’s office would see an increase of 182%.

Ending the Long Delay? The Federal Emergency Management Agency (FEMA) yesterday announced it is accelerating community disaster loans to help Puerto Rico muncipios mitigate the loss of income due to natural disasters, the Government of Puerto Rico reaffirmed that, for the time being, as well as the approval of another $39 million in loans from the CDL program for the municipalities of Aguadilla, Cabo Rojo, Canóvanas, Carolina, Manatí, Mayagüez, Peñuelas, and Orocovis—with the approvals coming in the wake of  last month’s approvals for Bayamón, Caguas, Humacao, Juncos, Ponce, Toa Baja, and Trujillo Alto—meaning that, in total, FEMA has, to date, distributed at least $92.8 million for municipalities on the island and $371 million for the U.S. Virgin Islands, as part of the $4.9 billion loan passed by Congress to help local governments recover. At the same time, the U.S. territory’s Treasury Secretary Raúl Maldonado reported: “The administration (of Puerto Rico) has been very successful in lowering operational costs and achieving an increase in collections.” The new loans will offer access to the Puerto Rican Government through March of 2020, as Secretary Maldonado considers that it may be useful in case of another disaster or a drop in the income of public corporations.

Nevertheless, because Puerto Rico—unlike other U.S. states, is also under the authority of the PROMESA Board, it appears that Gov. Ricardo Rosselló’s budget will have to be revised and may be rejected if proposed labor reforms do not satisfy the Board—with Board Executive Director Natalie Jaresko, in the wake of the Governor’s release of his proposed $8.73 billion general fund budget to the Legislature Tuesday night dictating that the future of the budget is linked to the legislature’s approval of at-will employment. Her statement came after the Governor and the board had announced an agreement on a compromise on reforming labor practices as well as agreeing to other changes in the Board-certified fiscal plan. In exchange for the Board waiving its demands for the abolition of the Christmas bonus and reduction of the island’s mandatory 27 days of vacation and sick leave, Gov. Rosselló agreed to bring at-will employment to the territory by repealing Law 80 from 1976—a concession which Director Jaresko described this agreement as an “accommodation.” Earlier this week, Director Jaresko said that the first step for Gov. Rosselló should be to resubmit a fiscal plan consistent with the new agreement with the Board, followed by a resubmitted budget consistent with the new plan, adding she anticipated these actions should all be completed by the end of June: the agreed-to changes to the fiscal plan are expected to reduce the 30 year surplus to $35 billion from $39 billion in the April certified fiscal plan, according to Director Jaresko, who noted that most of the surplus is expected to be used for debt payment. From the Governor’s perspective, he noted: “The approval of the agreed budget makes it easier for Puerto Rico to be in a stronger position to renegotiate the terms of the debt. We have significantly improved the management and controls over the cash flow of the General Fund. Contrary to the past, there is now visibility on how cash flows in government operations. At present Puerto Rico has robust and reliable cash balances.” Finally, she stated she expected it would take 12 to 18 months for the Board to create a plan of adjustment on the debt and pensions for the central government—a plan which would likely take the Title III bankruptcy court several more months to confirm.

Planning Municipal Debt Adjustment

May 21, 2018

Good Morning! In this morning’s eBlog, we take a fiscal perspective on post-chapter 9 Vallejo, before exploring the seeming good gnus of lower unemployment data from Puerto Rico.

Fiscal Reinvention.  After Vallejo, a waterfront city in Solano County of about 115,000 in California’s Bay Area, filed for chapter 9 municipal bankruptcy, just over a decade ago, on May 17, 2008, claiming it could no longer afford to pay wages and benefits promised to its employees; it appears its chapter 9 plan of debt adjustment has worked. The municipality, which served twice as California’s capital, was the nation’s largest city to file for municipal bankruptcy when it did—a period during which, in the wake of cuts of as much as 40 percent in its police force, and closure of its fire stations, leading to sharp increases in crime—there were, consequently, serious declines in assessed property values.  The municipality’s cash reserves disappeared; it was unable to pay its bills amid falling property tax revenue, soaring costs of employee compensation and pension liabilities, and a consequent surge in foreclosures. Thus, with its official exit, the city will be able to resume its governance—albeit, as Moody’s moodily explained last month, the city’s plan of debt adjustment will bequeath “significant unfunded and rapidly rising pension obligations,” adding that in addition to higher taxes, the city will be confronted by “challenges associated with deferred maintenance and potential service shortfalls.” Further, the credit rating agency noted, the “probability of continued financial distress and possibly even a return to bankruptcy.” Today, median household income in the city is under $40,000, while average municipal employee compensation is over $114,000. The city currently has 17 police sergeants receiving compensation packages which range from $220,000-$469,000—in addition to generous promised retirement pensions.  

Vallejo Assistant City Manager Craig Whittom last week noted that the city had been left to determine its Chapter 9 bankruptcy end date in the wake of U.S. Bankruptcy Judge Michael McManus’ approval of the city’s plan of debt adjustment last August—a key component of that plan being the codification of municipal bond repayment obligations to the city’s largest creditor, Union Bank, a plan approved by the Vallejo City Council three weeks ago, with Mr. Whittom noting that Vallejo’s formal chapter 9 exit is important in tangible ways for the city. For instance, he noted the elimination of real estate agents’ requirement to disclose that the city is in bankruptcy when selling properties, albeit conceding that municipal bankruptcy-deferred lawsuits against the city will now be free to go forward.

Nevertheless, leaving municipal bankruptcy is a fiscal challenge of its own—especially in instances where a municipality’s plan of debt adjustment does not take into account public pension obligations. As Ed Mendel of Calpensions explained: “Vallejo received court approval to exit from bankruptcy last week with a plan that includes a sharp increase in pension payments to CalPERS—the opposite of what many expected when the city declared bankruptcy in May 2008,” a resolution which, left the municipality with a proverbial ball and chain around its ankle because, by 2014, the city was confronted by ballooning public pension liabilities, with CNN reporting that Vallejo’s recent public-safety retirees have annual pension benefits which top $100,000 a year, leading Wallet-Hub to describe Vallejo as the “second least recovered city.”  That is, absent the ability to trim benefits for current employees, there are few options to keep pensions from consuming ever-increasing parts of a municipality’s budget.

Nevertheless, the city’s leaders have demonstrated innovative fiscal grit and determination: it has begun reinventing itself, using technology to fill personnel gaps, rallying residents to volunteer to provide public services, and even offering its voters the chance to decide how their taxes will be used—in return for an increase in the sales tax. Now, for the first time in five years, the city expects to have enough money to address potholes, weeds in public rights of way, etc.  

Lessons Learned. Prior to its chapter 9 filing, Vallejo’s salaries for city employees had ballooned: a number of top officials were making $200,000 or $300,000—enough so that some 80 percent of the city’s budget went toward compensation, even as the city’s credit rating was downgraded to junk status—meaning that, as part of the city’s plan of debt adjustment, the municipality paid only five cents for every dollar it owed to its bondholders, while the city also reduced employees’ pay, health care and other benefits—making it harder to attract key employees.  

That meant, as former Councilmember Marti Brown noted, that for Vallejo to fiscally survive, the city needed to study best practices from around the world and bring some of them to California—an effort which, in retrospect, she said turned “out to be a really positive experience for the city.” Together with former Councilmember Stephanie Gomes, the two elected leaders focused on public safety: they went the neighborhood to neighborhood setting up e-mail groups and social media accounts so residents could, for instance, share pictures of suspicious vehicles and other information: the number of neighborhood watch groups jumped nearly 300% from 15 to 350. Moreover, the City Council worked out an unusual compact with residents: in return for agreeing to a one-penny sales tax increase, projected to generate an additional $9.5 million in revenue, the resident gained the right to vote on how the funds would be used: citizen participatory budgeting—the first in a North American city.

This fiscal and governing innovation—or “ground-up restructuring,” as Karol Denniston, a partner with Squire Patton Boggs LLP notes, has meant that, today, Vallejo is “now routinely one of the top 10 cities where people want to live, which is a huge turn-around from when they entered bankruptcy.” The median listing price in Vallejo had soared to $420,000 by last month from $290,000 in May of 2015, according to realtor.com, crediting city leaders for turning around the relationships with its police and fire employees: “It looks like someone was able to improve those relationships: You have to bring the employees and the taxpayers along at the same time to reach a good consensus on financial goals.” Thus, unsurprisingly, last week, Finance Director Ron Millard presented a structurally balanced $105 million budget to the City Council for the fifth consecutive year—proposing reserves of 17.3%, after a strict fiscal diet of austerity measures in the intervening years composed of cutting police and fire services to the bone, tax increases, and economic development measures.

The Challenging Road to Recovery. Puerto Rico’s unemployment rate slipped below 10% last month for the first time in nearly two decades—albeit the change is more a reflection of emigration than economic improvement. According to the Bureau of Labor Statistics, nonetheless, Puerto Rico’s unemployment rate was 9.9%, its lowest level since it was 9.8% in November of 2000—a rate nearly 50% lower than the Spring of 2009. The BLS reported that the number of residents with jobs declined 1% last month from April of 2017 according to the Bureau’s Current Employment Statistics, and this showed total non-farm employment declining last month by 3.6% from a year earlier, with private sector non-farm employment down 3.3% from a year earlier—denoting a further sign of the fiscal challenges ahead as the U.S. territory restructures its debt. Of concern is who is leaving, as Advantage Business Consulting President Vicente Feliciano noted that the “unemployment rate is down mainly due to emigration: Thus, there are fewer people employed, but as a result of emigration, fewer people are looking for a job; meanwhile, the Puerto Rico economy is being impacted by the start of [hurricane-related] insurance and federal transfers.” Nevertheless, he reported that the Economic Activity Index in March 2018 was up with respect to February 2018: “Cement sales are up over 20% in March 2018 compared to March 2017. While these transfers are only beginning, they are non-recurrent and therefore should not be the basis for debt renegotiation.” However, Inteligencia Económica Chairman Gustavo Vélez noted: “The [labor force] participation rate remains very low…The information that I have is that the labor market is not normalized yet. Nevertheless, key industries like construction and retail are doing well because of the federal recovery funds already deployed into the local economy ($10 billion since October 2017).” According to the most recent economic activity index release (March), the index was down 2.6% from a year earlier; however, this was a rebound from the 19.7% decline in November 2017 from November 2016.

Who’s on First? Confidential conversations between the PROMESA Board and Gov. Ricardo Rosselló Nevares’s administration continued over the past few days without the certainty to reach a balance between the revenues and expenses the Government will have during the upcoming fiscal year—a year commencing in little over a month, on July 1st. Yet, even with the adjustments made by Governor Rosselló, following some of the Board’s mandates, government expenses are proposed for some $8.73 billion, a level some $200 million higher than the revenue certified by the Board. Nevertheless, neither the Board, nor the Fiscal Agency and Financial Advisory Authority (FAFAA) have been willing to discuss the preparation of the new budget or the differences, which have been publicly outlined between the parties. For his part, the Governor has refused to accept the revenue scheme certified by the Board to prepare the budget, instead opting to use the numbers contained in the new Fiscal Plan—while the PROMESA Board has objected that pensions adjustments contained in the Fiscal Plan have not been implemented, nor have their proposed labor reforms been listed.

Some parties have indicated that, as part of the process between the parties, Puerto Rico has promised, as required by the PROMESA Board, to eliminate Law 80, a Puerto Rican law which protects workers from unjust dismissals, in exchange for the allocation of some $100 million to municipalities, as well as an increase in funds for the Legislature, the Governor’s Office, and the Federal Affairs Administration. The see-saw issue at a time of steep cuts in Puerto Rican government services and school closures, including limitations in the Government’s Health Plan, has led Gov. Rosselló Nevares’ administration to criticize the seemingly contradictory fiscal situation in which the PROMESA Board has requested nearly a 33% increase from $60 million to $80 million in the amount it receives to finance its operation and bankruptcy lawsuits of the central government and several public agencies, at the same time, as Rafael Hernández Montañez, spokesman of the Popular Democratic Party minority in the House, expressed the Board does not appear to “think the same about the elimination of workers’ rights,” and at the same time the Governor is looking to increase government investment in Puerto Rico’s future.

The Absences of Fiscal Balances

May 4, 2018

Good Morning! In this morning’s eBlog, we note the deepening road towards insolvency of the Harvey, Illinois; then we turn south to consider the potential adverse municipal fiscal impacts were the State of Georgia to enable the de-annexation of the small city of Stockbridge. Finally, we journey back to Puerto Rico, where House Natural Resources Committee Chair Rob Bishop is headed for a first-hand assessment of the ongoing fiscal and physical challenges and federal emergency assistance still needed. 

An Absence of Fiscal Balance? In the Land of Lincoln, Illinois, where the state’s courts have heard requests for municipal bankruptcy relief; but where chapter 9 municipal bankruptcy is not authorized; relief appears only to have been granted when not challenged. Under 65 Illinois Comp. Statute 5/8-5-1, smaller municipalities may, if not home rule jurisdictions, seek judicial relief. Under the state’s Local Government Financial Planning and Supervision Act (50 Ill. Comp. Stat. 3200) a municipality with a population under 25,000 suffering a “fiscal emergency” may, after securing a two-thirds vote of the governing body, petition the state to establish a financial planning and supervision commission to address such “fiscal emergency.” Ironically, Harvey, with a population of 25,282, just exceeds that level—some 1,052 Illinois municipalities have less than 25,000 residents. Now, with the municipality unable to meet its police and fire pensions, Illinois Comptroller Susana Mendoza is holding up more than $1 million in state funds the town is owed—under Illinois statutes which authorize the state to withhold tax revenues a municipality is slated to receive if it does not make the required payments into its police and firefighter pensions: the funds withheld go right into the pension fund instead of town services—which, in the case of Harvey, amount to about $1.4 million, leading to, as we have previously noted, the town’s announcement that it will lay off nearly half of its police and fire department. Making the fiscal situation more dire, the city’s Mayor, Eric Kellogg, has been banned for life from the municipal bond market for misleading investors; the municipality appears to be in a chronic pattern of underfunding its public safety pension funds, even as its operating budget chronically spends more than the revenues it brings in. Ergo, as we have written, under Illinois’ Public Act 96-1495, the Comptroller may be compelled to withhold state tax revenues, which would traditionally be in order to ensure pension payments are made to a municipality which has failed to make full pension payments for years.

In a situation which risks compromising public health and safety, Harvey has laid off nearly half its police and fire force—even as it has warned it might not be able to make payroll—especially with inadequate municipal fiscal resources now being rerouted to oppose the state actions in court.

It being Illinois—and an election year—Gov. Bruce Rauner has been uncharacteristically silent about the brewing fiscal catastrophe. The godfather of chapter 9 municipal bankruptcy, Jim Spiotto, has joined with the exceptional Chicago Civic Federation in drafting legislation, the Local Government Protection Authority, which includes a provision to:

  • establish an oversight board,
  • set up a clear procedure for dealing with a stressed city, and
  • allow filing for Chapter 9 municipal bankruptcy. (Legislation which has, to date, gained no traction in the legislature.)

Harvey Town Attorney Bob Fioretti reports: “We are going to find some solution, if possible,” signaling that the municipality was still negotiating with its police and fire pension funds, but warning that, if those discussions falter:  “Layoffs will occur. But the safety of the population is key, and that will continue.”

Mayhap ironically, Illinois adopted its pension law eight years ago as a way to ensure smaller municipalities would stop shorting their pension fund contributions—provisions upheld the week when a judge affirmed that the Illinois comptroller was within the state law to withhold the revenue. Thus, while the Comptroller’s Office issued a statement that it “does not want to see any Harvey employees harmed or any Harvey residents put at risk…the law does not give the Comptroller discretion in this case: The Comptroller’s Office is obligated to follow the law. This dispute is between the retired Harvey police officers’ pension fund and the city of Harvey.”

Nor does Harvey appear to be an isolated case: According to an analysis by Amanda Kass, a researcher at the University of Chicago, there are 74 police or fire pension funds in Illinois municipalities with similar unfunded pension liabilities—leading Chicago Civic Federation President Laurence Msall to note: “If they ignore the law and don’t make the contribution as Harvey has, then yes, those municipalities all around the state have ability to seek an intercept of state revenues that would otherwise come to the municipality.”

The complicating factor for Harvey is, however, not just that it has had years of decline and corruption in government, but also with declining assessed property values and very high property taxes, the municipality has a shrinking set of fiscal options—or, as Mr. Fioretti puts it: “We have an aging population, a declining population, a fixed-income population, and our revenues aren’t even being collected from the real estate taxes. We’re below 50 percent for the year on those collections,” noting that the delinquent real estate tax money is costing the town $12 million this year.”

Uneasy Fiscal Options. While Mr. Msall notes that the State of Illinois helped create the fiscal mess by setting up the pension funds and setting all of the pension levels; now, he notes, Illinois must either dissolve Harvey’s pension into the state fund, or put together an emergency financial team to sort through the wreckage of this and other distressed towns—adding: “Let’s create a board that could be independent with real financial expertise to guide these local governments, not to push them into [municipal] bankruptcy: The best path forward for Harvey is independent oversight that could sort out why they’re not making their financial reports on a regular basis.”

The Cost of Municipal Annexation. Municipalities across Georgia could face higher borrowing costs if the state government enables the “de-annexation” of about half of one small city, that city being Stockbridge, one settled in 1829 when the Concord Methodist Church was organized near present-day Old Stagecoach Road—and, especially, when Stockbridge was granted a post office on April 5, 1847, named for a traveling professor, Levi Stockbridge, who had passed through the area many times before the post office was built. Albeit that heritage remains a matter of some dispute: others contend that the city was named after Thomas Stock, who was State Surveyor and the Georgia State President in the 1820s. The small municipality was incorporated as a town in 1895 and, subsequently, as a city on August 6, 1920. Now, however, more change might be on the way, especially if Georgia Governor Nathan Deal signs into law Senate bills 262 and 263—bills which, if enacted, would de-annex just over half of Stockbridge’s assessable residential and commercial property. Why? Because proposed SB 263, an Act to incorporate the City of Eagles Landing, provide a charter for the City of Eagles Landing; provide for a referendum; provide for transition of powers and duties; provide for community improvement districts; and repeal conflicting laws would effectively have disconcerting fiscal impacts on City Hall in Stockbridge, which was financed with municipal revenue bonds. Neither of the two bills apportions the revenues involved between the to-be two entities—a requirement which, according to some legal experts, is based upon precedent-setting court cases before the U.S. Supreme Court and Georgia when the boundaries of a governmental entity are changed.

Thus, unsurprisingly, during the Georgia Municipal Association’s Georgia Cities Week last week, Stockbridge officials and representatives of the Eagle’s Landing effort held separate meetings with Gov. Deal.  Stockbridge City Attorney Michael Williams described their session as “very productive: The Governor said he would consider the series of points we made…I’m certainly taking him at his word that he will.” Nevertheless, the municipality is hedging its fiscal bets: it has hired three outside law firms to challenge the laws if Gov. Deal approves them.

Should that happen, however, the much reduced City if Stockbridge would still would be obligated to pay off about $13.02 million of privately placed Urban Redevelopment Agency lease-revenue bonds, and $1.5 million of water and sewer notes issued through the Georgia Environmental Facilities Authority—municipal bonds owned by Capitol One Public Funding LLC. Unsurprisingly, the Romulus and Remus of Eagles Landing have expressed no eagerness to help make those payments: sharing only goes so far. The lease-revenue bonds, issued in 2005 and 2006 for projects including funding to purchase land and build city hall, backed by general fund revenues and the city’s taxing power, if needed, even though the city does not currently impose a property tax.

Also unsurprisingly, Jim Spiotto’s firm, Chapman and Cutler LLP, which represents Capital One, wrote to the city a day after the General Assembly ended its session last month, warning it could face potential litigation: “SB 262 and SB 263 infringe Capital One’s constitutional rights under the contracts clause of the U.S. Constitution and the Georgia Constitution by taking away a significant source of the security and source of repayment for the bonds that was contractually bargained for by the bondholders,” Chapman and Cutler partner Laura Appleby wrote to the City Attorney. Unless the bonds are properly apportioned between Stockbridge and Eagle’s Landing, and the [municipal] bondholders have the benefit of the full security that they were originally promised, Ms. Appleby wrote, “We have serious concerns regarding the ability of [Stockbridge] to continue to pay debt service on the bonds because it will have lost a large portion of its ad valorem tax base.”

Jonathan Lewis, Capital One Public Funding’s president, has written to Gov. Deal also requesting a meeting, writing: “The failure of SB 262 and SB 263 to provide for the apportionment of the [municipal] bonds between the City of Stockbridge and, if formed, the City of Eagle’s Landing, is not only an inequitable result for the City of Stockbridge, it is an infringement on Capital One’s constitutional rights under the contracts clause of the U.S. Constitution and the Georgia Constitution, as it removes a significant portion of the security and source of repayment for the bonds…Capital One has come to trust that the State of Georgia will take those actions required to maintain, preserve, and protect the pledges made by its municipalities to their bondholders…Permitting SB 262 and SB 263 to become law would no longer allow us to rely in the State of Georgia [based] on the bedrock public finance principle of non-impairment,” adding that such a “de-annexation” would impair Capital One’s municipal bonds and “create new, unprecedented risks for existing holders and prospective purchasers of State of Georgia local debt.” Mr. Lewis last week also communicated to Georgia Municipal Association Executive Director Larry Hanson, whose organization is made up of 521 municipalities, that if enacted, the de-annexation would require all lenders to Georgia municipalities to “consider, and price in, the potential loss of security from future de-annexations,” because the legislation does not apportion Stockbridge’s outstanding debt: “GMA’s members would bear the burden of this new, Georgia-specific risk in the form of higher interest costs: “The uncertainty created by such a shift sets a dangerous precedent and could produce additional negative unintended consequences as lenders consider municipal financing opportunities within the state.”

Who’s on First? Chairman Rob Bishop (R-Utah) of the House Natural Resources Committee, the committee of jurisdiction for U.S. territories, yesterday confirmed he would got to Puerto Rico to meet with island leaders to assess the recovery in the wake of Hurricane Maria’s devastation, noting: “This trip will allow me to better understand the ongoing challenges and the emergency assistance that is still needed.” He is scheduled to meet with Puerto Rico’s non-voting Member of Congress, Jenniffer Gonzalez, as well as Chairman Jose Carrion of the PROMESA Board as part of an effort the Chairman described as a “first hand look at recovery efforts,” pointing out that, in his view, it would be irresponsible for Governor Rosselló, who apparently the Chairman had not advised of his visit, not to implement the government reforms ordered by the PROMESA oversight board—making clear the fiscal gulf between the two leaders, with the Governor observing that Chairman Bishop, with his demands in favor of a dialogue with creditors, seems to be supporting the causes of the territory’s municipal bondholders over the U.S. citizens of Puerto Rico.

Unlike chapter 9 municipal bankruptcy, wherein state laws create a process—where permitted—for a municipality; there are many fiscal chefs in the kitchen in Puerto Rico, with growing questions with regard to the limits of their respective legal authority under the PROMESA law. A key issue, the final decision with regard to the implementation of cuts to the pension system and the labor reform may yet take a few months. The fiscal stakes, however, especially on an island where there has been a steady stream of college graduates and young professionals moving to the mainland—leaving behind  disproportionate number of older, retired Puerto Ricans, increasingly creates a greater and greater fiscal imbalance. That is now front and center in the wake of the Board’s proposed 10 percent average reduction in pensions—a proposal Gov. Rosselló has rejected, but, as one commentator noted, it is the Board which holds all the cards. The challenge is in interpreting the PROMESA Board’s authority to use its fiscal plans to provide “adequate funding” to Puerto Rico’s public pension systems: under the proposed fiscal plan, the Board cut in pensions would not begin until FY2020—giving time for the PROMESA Board to submit to U.S. Judge Laura Taylor Swain a quasi-plan of chapter 9 debt plan of debt adjustment by the end of this year.

It is not that the Governor believes pension should be off the table—after all, he had recommended a 6% reduction last year; thus, there remains some chance that the government and the Board could reach an agreement and avoid the heavy costs of fighting the fiscal issues out before Judge Swain. Indeed, as we saw in San Bernardino, those back door negotiations between the government and creditors can save an awful lot in lawyers’ fees—or, as former U.S. Bankruptcy Judge Gerardo Carlo-Altier put it: “The ideal thing would be for the Board, the government, and the groups of creditors to reach an agreement in advance and go together to court.”

A key sticking point appears to be the Board’s insistence of labor reforms: under its proposed plan, the Puerto Rico Legislature should approve the labor reform by the end of this month, so that the seven-day reduction for vacation and sick leave would take effect immediately. The elimination of the protections against unjustified dismissal, the mandatory Christmas bonus, and work requirements for the Nutrition Assistance Program (NAP) are proposed for next January—with the PROMESA Board estimating that, absent the enactment of such labor reforms, including: such as employment at will, reductions in sick and vacation leaves, and non-mandatory Christmas bonus; the government of Puerto Rico would stop receiving $330 million within the next five years. They estimate another $ 185 million to cuts in pensions—all of which has led the PROMESA Board to project that, absent the adoption of the reforms proposed in the five-year fiscal plan, Puerto Rico’s economic growth and capacity to finance its public debt service would fail.

Who Will Govern? Are there too many fiscal cooks in the kitchen? In Central Falls, Rhode Island: there was one individual in charge of steering the small city, aka Chocolateville, out of bankruptcy. Similarly, in Detroit, Governor Snyder named Kevyn Orr as Emergency Manager—effectively suspending the governance authority of the Mayor and Council during the pendency of the city’s chapter 9 proceedings until U.S. Bankruptcy Judge Steven Rhodes approved Detroit’s plan of debt adjustment. Yet, in Puerto Rico—a territory which is neither a state, nor a municipality; there are a multiplicity of actors—including, now, Chairman Bishop, the Governor, the Legislature, and the PROMESA Board—a Board which Constitutionalist Professor Carlos Ramos González of the Inter-American University Law School believes, even given the power conferred upon it by Congress over Puerto Rico’s elected government, is uncertain with regard to its own authority to implement the structural reforms it favors—or, as he has noted: “Nobody wants to be blamed for cutting pensions: in all the chapter 9 municipal bankruptcy cases, there were pension reductions,” adding that, as we saw especially in the case of Detroit, the issue of equity is challenging: how to make those cuts without plunging many retirees into poverty—a problem of even greater resonance on an island experiencing an outflow of its young professionals, so that the demography already risks insufficient revenues to meet a clearly growing demand.  

Then there is a second challenge: while PROMESA appears clear in its grant of authority to the Board to certify the fiscal plan, it appears to lack any authority to implement it on its own. Unlike Central Falls, Detroit, San Bernardino, or other chapter 9 plans of debt adjustment approved by U.S. Bankruptcy Courts; the current PROMESA statute does not authorize a federal court to control Puerto Rico’s legislative process: there is a separation of powers issue.  Nevertheless, in the wake of the approval of the fiscal plan, the PROMESA Board is trying: it has submitted a preliminary labor reform draft to the Puerto Rico Legislature, where Senate President Thomas Rivera Schatz has invited PROMESA President José Carrión III to defend the proposed changes and cuts—an invitation, however, which has not been accepted.  

Former Governor Aníbal Acevedo Vilá, who lectures for a Separation of Powers class at the Law School of the University of Puerto Rico, finds it self-evident that the Legislature will not give way to the Boards proposed labor reforms, noting: “I think the Board has a very weak case in terms of imposing the labor reform. It has a better case in other measures, because they are directly tied to Puerto Rico’s fiscal crisis.” Similarly, Governor Rosselló usually quotes §205 of the PROMESA Act, which refers to the fact that the Board can make “recommendations to the Governor or the Legislature on actions the territorial government may take to ensure compliance with the Fiscal Plan, or to otherwise promote the financial stability, economic growth, management responsibility, and service delivery efficiency of the territorial government.” While Carlo Altieri adds to the debate §108, which, regarding the general powers of the Board, warns that: “Neither the Governor nor the Legislature may— (1) exercise any control, supervision, oversight, or review over the Oversight Board or its activities; or (2) enact, implement, or enforce any statute, resolution, policy, or rule that would impair or defeat the purposes of this Act, as determined by the Oversight Board.”

Indeed, an attorney for the Governor, Richard Cooper of Cleary Gottlieb, noted: “Congress did not grant the Board the power to pass laws or appoint or replace government officials…it left the government of Puerto Rico the capacity and responsibility to make the law (as long as it is consistent with the adopted fiscal plan and adjustment fiscal plan) and manage the government, with all that it entails.” Indeed, in an earlier ‘who’s in charge dispute,’ when the PROMESA Board tried to appoint a trustee to monitor the Puerto Rico Electric Power Authority (PREPA), alleging that PROMESA recognizes it as representative of the “debtor,” Judge Swain stated that no section of the PROMESA law granted the Board power with regard to the “the implementation of those (fiscal) plans and budgets,” instead comparing the statute Congress adopted in the 1990’s creating a fiscal control board over Washington, D.C. with PROMESA. She concluded that the Board has the task of establishing the “rails” for the “territorial government” to move “towards credibility and fiscal responsibility.” Indeed, the Congressional Record appears to make no reference to the power of the Board to impose structural governmental reforms—just as Congress lacks any authority to impose such on a state—especially in a nation where it was the states which created the nation, rather than vice versa. Rather, the Congressional debate on Puerto Rico reflected an emphasis on the power of the PROMESA Board to restructure the debt, which is the main burden of Puerto Rico—and, in Congress, Republicans and Democrats have expressed no interest in amending the act, either to strengthen or soften the powers of the Board.

For his part, Chairman Bishop believes that the act allows the Board to implement structural reforms and that it would be an irresponsible attitude of the Puerto Rican government to block them. That indicates there could well be intriguing fiscal and governmental discussions this weekend—albeit it seems most certain that, as Gov. Rosselló has made clear: “We are not going to allow an imposed Board to dictate the public policy of Puerto Rico.”

Notwithstanding their differences over the extent of the powers of the PROMESA Board, Gov. Rosselló and the Board are not at complete odds: they appear to have made common cause before regarding the case of Aurelius investment group and the Electrical Industry and Irrigation Workers Union, the main union of PREPA, to defend the constitutionality of the appointment of the Board members, because six of the seven were proposed by the Congressional leadership; rather, Gov. Rosselló’s administration has limited itself to challenging actions of the Board, not its existence—even as one of his predecessors, former Governor Acevedo Vilá, noting that, even under the colonial situation and the doctrine of Insular Cases decided a century ago by the U.S. Supreme Court, which has repeatedly validated the so-called “plenary powers” of Congress in Puerto Rico, the government of Puerto Rico must challenge the existence of the Board as a violation of the U.S. Constitution under the theory that “to the extent that Board has executive and legislative powers, even under the Insular Cases, it is unconstitutional,” adding that: “Even when organizing the territories, Congress has to guarantee a minimum system of separation of powers.”

The Puerto Rico Debt Tango. While the PROMESA Oversight Board and Gov. Rosselló are engaged in a complicated dance over future debt payments and policy, their complicated dance steps are not dissimilar: In successive versions of a fiscal plan that the Governor submitted to the Board in January, February, March, and last month; the Governor said the amount of debt Puerto Rico should carry should be determined through a comparison with debt medians in the 50 mainland states—quite similar to the Board’s certified plan.  Like the Governor’s proposed fiscal plans, the board certified plan has a comparison to the medians for the 50 states and to the 10 states with the highest levels of four measures of debt. The Board certified plan stated: “The implied debt capacity and expected growth in debt capacity in debt capacity must be sufficient to cover both the payments due on the restructured debt, and all payments due on future new money borrowings.” Accordingly, the aggregate debt service due on all fixed payment debt issued in the restructuring of the government’s existing tax-supported debt should be capped at a maximum annual debt service level: “The cap would be derived from the U.S. state rating metrics, and specifically what Moody’s [Investors Service] calls the ‘Debt Service Ratio.’” (The debt service ratio is defined as ratio of total debt payments due in a year divided by a state-government’s own source revenues.)

Under such a construct, it would appear that Puerto Rico could pay about $19 billion of the roughly $45 billion that the central government and its closely related lending entities owe, according to the plan’s exhibit 26. In the same exhibit, the PROMESA Board alternately suggests that one should use an average of a set of four measures of debt capacity and not just own-source revenues. Using this composite measure would mean that Puerto Rico should pay back about $10.7 billion in outstanding debt. But the Board plan notes this would be optimistic for a promised level of payments, rather, it reports, the fixed amount committed to should be cut by 10% to 30% to allow for “implementation risk.” It suggest that 20% should be used and the coupon be adjusted to 5%. These would lead to Puerto Rico committing to pay 19% of its debt—adding: “Any additional cash flow above the maximum annual debt service cap applied to the restructured fixed payment debt that is generated over the long-term from successful implementation of the new fiscal plan could be dedicated to a combination of contingent ‘growth bond’ payments to legacy bond creditors, debt service due on future new money borrowings needed to fund Puerto Rico’s infrastructure investments, and additional ‘PayGo’ capital investment to reduce the government’s historically out-size reliance on borrowing to fund its needs, among other purposes.”

The Uneven Challenges to Chapter 9 Recovery from Municipal Bankruptcy

Mayday, 2018

Good Morning! In this morning’s eBlog, we note the uneven recovery in Detroit from the largest chapter 9 municipal bankruptcy in American history.

An Absence of Fiscal Balance? In a new report by 24/7 Wall Street about the nation’s poorest urban regions, Detroit is ranked 5th, raising, the publication notes, the question why so many communities in such good times have been left fiscally behind. . The report — from 24/7 Wall St., a New York-based financial news organization — ranks the Detroit area at No. 5 in a list of impoverished communities. It also raises the question: During such good economic times, why are so many being left behind? While the report notes the seeming good times for the U.S. economy, it also reports that the share of Americans living below the federal poverty level ($25,100 for a family of four) has increased by nearly 10 percent since 2010. But of greater concern for state and local leaders, the concentration of poverty has also risen—or, as the report noted: “This increased concentration of poverty is far more pronounced in certain metropolitan areas: The share of poor residents living in extremely poor neighborhoods—defined as those with a poverty rate of at least 40%—climbed by more than 3.5% in 20 metro areas in the last six years.” That is, in a post-Richard Nixon era where the federal government no longer appears to believe it has a role in providing some fiscal equity, the report writes that the Detroit metro area has “long been the poster child for economic decline in postindustrial America.”

It appears we are in a state of fiscal disequilibrium, where no major municipality is any longer in chapter 9 municipal bankruptcy, and Detroit, emerging from the largest ever municipal bankruptcy and now a center of innovation again for the auto industry, with the city’s poverty rates having declined by more than 10% from 2015 to 2016—to its lowest rate in a decade. Nevertheless, with a poverty rate of 35.7% in 2016, the report found that an increasing share of residents in the metro region are, today, below the federal poverty level: 16.2%, putting the Motor City behind Bakersfield, Fresno, Springfield (Mass.), and Albuquerque, N.M. The report noted: “The share of poor residents living in extremely poor neighborhoods—defined as those with a poverty rate of at least 40%—climbed by more than 3.5% in 20 metro areas in the last six years: Such high-poverty neighborhoods are often characterized by high crime rates, low educational attainment rates, and high unemployment. Partially as a result, those living in these extremely poor neighborhoods are at a greatly reduced likelihood of success and upward economic mobility.”

The 24/7 Wall Street bears out Brooking’s 2016 report which defined the Detroit metro region (including Wayne, Oakland, Macomb, Livingston, St. Clair, and Lapeer) to have the highest rate of concentrated poverty among the most populous metro areas in the U.S. That is, in a nationally growing economy, one can, mayhap, better appreciate some of the appeal of President Trump, as there remains, in a growing economy, a large segment of the population unable to take advantage of the growing economy.

Part of it, of course, is that the issue of fiscal disparities is neither on the agenda of the President nor Congress.

Nevertheless, as our colleagues at Municipal Market Analytics note, Detroit’s exit from state oversight this week after shedding about $7 billion of its fiscal liabilities  “seems a bit fast, given the depths of the city’s challenges, and suggests that the state continues to value a narrative of quick rebound versus evidence that such can be sustained.” While MMA noted Detroit’s relatively conservative budgeting, small resulting surpluses, planning for the upcoming spike in pension payments, and decision to redeem $52M in recovery bonds; it noted the “the rising pension payments are a significant concern (even with funds set aside to temporarily smooth incremental costs) particularly when considered in conjunction with the city’s limited flexibility to address other potential events outside of its control such as reductions in federal or state aid, changes in federal policies that impact the economy in the state and/or nationally, and probably most concerning, an economic recession.”

Interestingly, MMA noted that were the Motor City’s recovery to stumble, the “potential for additional state intervention or aid is remote. Going forward, the city is likely on its own,” adding that, notwithstanding that the city has become an epicenter of the self-driving car industry; nevertheless,  this represents just a portion of the city and: “The rising living costs in these areas risks pushing existing residents out to more challenged neighborhoods, creating a greater income divide and worsening inequality. Notwithstanding the burgeoning economy in some pockets of Detroit, significant challenges remain across the vast city including horribly high poverty, crime, and poor educational outcomes. Detroit’s poverty rate is 39.4%, and only 13.8% have attained at least a bachelor’s degree.”