On the Edge of Municipal Fiscal Cliffs

September 20, 2017

Good Morning! In today’s Blog, we consider the upcoming challenge for voters in Detroit—with a Mayoral election around the bend—and the city aspiring to be in the competition for selection by Amazon as its second site. Then we look at the physical and fiscal storm threats to Puerto Rico, before finally looking back at post-riot Ferguson, Missouri.

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On the Edge of a Fiscal State/Local Cliff.  The Latin incantation, “Speramus meliora; resurget cineribus,or, translated: “We hope for better things; it will arise from the ashes,” is Detroit’s motto: it came from a French Roman Catholic priest, Father Gabriel Richard, who was born in France in 1767 and moved to Baltimore in 1792 to teach math. Reassigned to do missionary work, he moved first to Illinois and later to Detroit, where he was the assistant pastor at St. Anne’s Church—a church founded in 1701 and possibly the oldest continuously operating Roman Catholic parish in the U.S. Two hundred twelve years ago, on June 11th, a fire destroyed nearly all of then-Detroit, just weeks before the Michigan Territory was established. Today, nearly three years after the once-great city, the “arsenal of democracy” during World War II and home of the world’s most innovative manufacturers, emerged from the nation’s largest ever chapter 9 bankruptcy, national interest in Detroit has waned: in some ways, it has become a tale of two cities: One a city still mired in poverty and unemployment; one an emerging vibrant metropolis and global self-driving car center. And all this is occurring as the voters prepare to re-elect Mike Duggan—whose most profound achievement has been to raze much of the city, after first being elected in a write-in campaign. But, last month, voters in the primary gave him 68% of the votes—likely foretelling November’s re-election—in a campaign against the son of Coleman Young, Detroit’s first black mayor. Almost more than any other city in the nation, Detroit is not just a city emerging from the ashes, but also a city of profound racial transition: Over the past forty-year, Detroit has undergone a racial transformation: from 70% white in the 1960s to just 10% today. The Detroit News described the Mayor’s self-referral as a “metrics nut:” describing cabinet meeting room as one blanketed in graphs charting the city’s employment, ambulance delivery and crime rates, among other statistics. “The police are going to show up in under 14 minutes; the ambulance is going to show up in under 8 minutes; the grass is going to be cut in the parks every 10 to 12 days—it just is.” The paper notes that: “City employees who do not meet these targets do not last long.”  But, as the city’s emergency manager charged by Gov. Snyder with taking the Motor City into chapter 9 bankruptcy and then out noted to me on that very first morning, the critical distinction between municipal and corporate bankruptcy is to ensure the streetlights, traffic lights, police and fire are working. That has been an ongoing, post-plan of debt adjustment priority, and, the numbers have continued to improve: today police response times are down from an average of 40 minutes to 13.

Mayhap a far greater governance challenge, however, has been to reverse the flight of residents from the city—flight which bequeathed 40,000 abandoned properties—properties which could become havens for crime, paid no property taxes, and adversely affected the assessed values of neighboring properties in one of the nation’s largest—by land area of 139 square miles—a city once the home to 1.8 million—thrice today’s population. Or, as David Schleicher of Yale Law School described the city: it “is just too big,” to accommodate “the expense of providing services.” The Mayor has sought to “right-size,” as it were, by means of razing abandoned homes, in part via the expansion of the Detroit Land Bank, a quasi-governmental authority which now owns 96,000 properties across the city—most of them acquired through foreclosure because of unpaid taxes. Thus, the land bank has succeeded in centralizing the city’s control over abandoned and vacant properties; Detroit has replaced an antiquated registry scattered across 83 data sets, and erased liens and back taxes as a means to facilitate the clearing and demolition or restoration of properties. Since his election, the city has focused on the highest density districts, where the city has demolished 11,900 residential properties. The results indicate that the demolition of a blighted property increases the value of a nearby home by 4.2%, according to one study. And the pace has been unprecedented—indeed, so fast there have been allegations of improper contract awards; there has been a federal investigation; and Michigan’s state housing agency suspended funds for two months, after a state audit found improper controls in place. Land bank officials, including the director of demolitions, have resigned. Mayor Duggan, who has not been a subject of the investigation, blames the mistakes on a desire to increase the pace of demolitions, but acknowledges that regulators were right to rap his knuckles.

Under the program there has been, consequently, a high pace of tax foreclosures—the main pipeline for properties which end up in the land bank’s possession: under Michigan law, owners who do not pay taxes after three years lose their property—properties last comprehensively reassessed decades before market values plummeted, meaning many are set too high. Between 2006 and 2012, median sale prices for city houses fell from $70,000 to $16,200; thus, the owner of a house worth $15,000 could owe $3,000 in property taxes. The state-mandated interest rate on property-tax debt is 18% per year. Thus, an update completed at the beginning of this calendar year should lead to lower bills, but it will not be retroactive; thus, up to 53,000 properties will receive foreclosure notices this autumn. While not every foreclosed property will necessarily end up lost, tax foreclosures, driven by government policy rather than market forces, could force out longtime residents, ironically exacerbating the very problem the Mayor is focused upon: even as the demolition drive has already cost the city’s taxpayers some $162 million, the average back taxes for homes put up for auction are $7,700—much less than the cost of demolition. Or, as Michele Oberholtzer, Director of the Tax Foreclosure Prevention Project puts it: “It’s like an auto-immune disorder: We penalize people for not paying, and then we end up paying more for the punishment.” Nevertheless, Mayor and candidate Duggan believes that at the current pace of demolitions, he can clear the city’s long-standing blight within five years—mayhap paving the way for a smaller but much more vibrant city.

Fiscal Hurricane. With still another hurricane bearing down on Puerto Rico (damages caused by Hurricane Irma are estimated at more than $600 million), a fiscal storm appears in the offing after, yesterday, an agreement among Senate Finance Committee leaders to push this month the reauthorization of the Children’s Health Insurance Program for five years raised doubts about with regard to whether Medicaid funds to stabilize the finances of the Puerto Rican health system could be included in that legislation: according to the agreement between the Chairman, Republican Orrin Hatch (R-Utah), and Ranking Member Ron Wyden (D-Oregon), that program would be refinanced for another five years; however, the agreement did not include funds to close the so-called “abyss” in Medicaid funds, which would reach $ 369 million this fiscal year and then rise to about $ 1.2 billion that has been asked annually for reimbursement under the Affordable Care Act, or, as former Puerto Rico Governor Aníbal Acevedo Vilá, who was representing Gov. Ricardo Rosselló, noted: “From what I’ve been told, we are not included.” His statement came as Gov. Rosselló arrived last night in Washington, D.C. along with former Governors Acevedo Vilá and Alejandro García Padilla to meet with House Minority Leader Nancy Pelosi (D-Ca.), as the Senate Finance Committee hurries to approve the reauthorization of the CHIP program before the law expires at the end of this month. Chairman Hatch, however, has indicated that his intention is that the reauthorization of the program not increase the federal deficit—an intention which could singularly complicate the mission—even as House Speaker Paul Ryan (R-Wis.) earlier this year had told resident commissioner, Jennifer Gonzalez, that CHIP’s reauthorization was the ideal vehicle for legislating new Medicaid allocations, due to the depletion of Affordable Care Act funds in April. (For the current fiscal year, Puerto Rico’s allocation is $172 million. Meanwhile, there are already 12 Puerto Rican municipalities within  the  federally declared disaster zone: the first ones were the municipalities of Vieques and Culebra. Yesterday, Adjuntas, Canóvanas, Carolina, Guaynabo, Juncos, Loíza, Luquillo, Orocovis, Patillas and Utuado were added—with Gov. Rosselló making the announcement yesterday accompanied by FEMA Administrator William Long,  albeit the Governor added: “This does not imply that the list of municipalities is finished, it´s not over. This simply implies that as we receive  information (from the affected municipalities) and we send it to the federal government, then, we are able make these declarations.”

Good Gnus. Puerto Rico’s median household income climbed 7.8% from 2015 to 2016 according to the U.S. Census Bureau American Community Survey statistics, with the survey showing that mean household income was up 2.3% after inflation—a stark contrast with the generally negative economic data coming out of Puerto Rico. For example, Puerto Rico’s economic activity index declined 2.1% in July from a year earlier, according to a report from the Government Development Bank for Puerto Rico: according to the U.S. Bureau of Labor Statistics’ household survey, total employment in August on the island was down 0.25% from a year earlier. According to its survey of workplaces, total employment was down 1.1%. In addition, the American Community Survey showed that net migration to the rest of the United States increased to 67,000 in 2016 from an average of 44,400 per year from 2006 to 2015—that is nearly 50%. Data from the Puerto Rico Ports Authority show that the average net migration was 65,700 per year from 2006 to 2015. The difference may reflect that some Puerto Ricans migrate to countries beside the U.S., according to Mario Marazzi, executive director for the Puerto Rico Statistics Institute.

Coming Back. Moody’s has revised upwards its credit rating for Ferguson, Missouri in the wake of efforts to recover fiscally from the aftermath of a controversial police shooting, the rating agency has revised the city’s outlook on its junk-level Ba3 general obligation rating to positive from negative. The city lost its investment grade rating as it dealt with the aftermath of the August 2014 fatal shooting of Michael Brown, an unarmed African-American, by a white police officer. The shooting led to local protests and a federal probe in the city of about 21,000 just northwest of St. Louis. The city faced rising legal expenses as it dealt with a federal probe into policing and court tactics and then the costs of a settlement, and took a hit on sales and other taxes. The city has also lost a chunk of court-fine related revenue it relied on as the state government cracked down on local government use of fine levies to balance budgets. After spending cuts and other management efforts, the city is expected to begin to shore up its balance sheet as voter approved tax revenues flow into city coffers. “The positive outlook reflects the likelihood the city’s materially improved fiscal condition will continue over the next two years, especially because new taxes implemented during fiscal years 2016 through 2018 will lead to the greater likelihood of operating surpluses and improving reserve levels,” Moody’s noted, as it affirmed the B1 rating on the city’s 2013 certificates of participation and the B2 rating on its 2012 COPs: the upgrade reflects Ferguson’s current fiscal condition in the wake of several years of rapidly declining reserves and uncertainty for further operating declines; it incorporates a moderately sized tax base with a trend of declining assessed valuation, below average resident wealth, and above average yet manageable debt burden. The agency notes that the rating remains challenged by ebbing reserves and the costs of federal consent decree measures which contributed to operating deficits in fiscal 2014 through 2017; the city anticipates a $312,000 deficit for FY 2017, but, with fully phased in, voter approved taxes coming in next year, the FY2018 budget estimates a $48,000 general fund surplus. From a high in fiscal 2013, the general fund balance declined to $3.6 million or 33.5% of revenues from $10.5 million. Reserve levels remain healthy on a relative basis compared to its peer group but the city’s operating flexibility is notably narrower than it has been. The city is working towards meeting milestones and establishing policies as required in its 2016 Department of Justice consent decree. Consent decree annual expenses have declined to $500,000 from projections of $700,000 to $1.5 million. Tax hikes are projected to generate an additional $2.9 million in annual revenue for the general fund in FY2018.

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How Do State & Local Leaders Confront & Respond to Significant Population Declines?

eBlog, 04/21/17

Good Morning! In this a.m.’s eBlog, we consider the unique fiscal challenge confronting Detroit: how does it deal with the fiscal challenges—challenges also confronting cities such as Cleveland, Philadelphia, Toledo, Dayton, Baltimore, and Philadelphia—which are experiencing significant population declines? What to do with vacant lots which no longer bring in property tax revenues—but enhance criminal proclivities?  

Fiscal & Physical Municipal Balancing. While Detroit has emerged fiscally from the nation’s largest ever municipal bankruptcy, it continues to be fiscally and governmentally bedeviled by the governance challenge of such a significant population contraction—it is, after all, a city of about 132 square miles, dotting with neighborhoods which have become splotches of vacant lots and abandoned homes: post-bankrupt Detroit, with neighborhoods that have been gradually emptying out, in a physical sense, is a shadow of its former self, with a population nearly 60% smaller than it was in 1950, but with a stock of some 40,000 abandoned homes and vacant lots—space which brings in no property taxes, but can breed crime and safety costs for the city: between 1978 and 2007, Detroit lost 67% of its business establishments and 80% of its manufacturing base. This untoward, as it were, “ungrowth” has come even as the city has spent $100 million more, on average, than its revenues since 2008: Census figures inform us that more than one in three of the city’s citizens fall below the poverty level—ranking the Motor City, along with Cleveland, Dayton, Toledo, Philadelphia, and Baltimore, as cities realizing major depopulation. Thus, while downtown Detroit today is gleaming towers along a vibrant waterfront, one need not drive far from the internationally acclaimed Detroit Institute of Arts to witness neighborhoods which are nearly abandoned as residents continue to move to the suburbs. Thus, with some of the fiscal issues effectively addressed under the city’s approved plan of debt adjustment, Detroit is commencing a number of initiatives to try to address what might be deemed its physical devastation—a challenge, in some ways, more complex than its finances: How does an emptier city restore blighted neighborhoods and link the islands of neighborhoods which have been left? Or, mayhap better put: how does the city re-envision and rebuild?

Here it seems the city is focused on four key initiatives: draw new families into the city (look at Chicago and how Mayor Emanuel succeeded); convert vacant lots from crime havens to community gardens; convert vast empty spaces to urban farms; devise a strategy to fill empty store fronts; and, again as did Mayor Emanuel, create a strategy to bring back young families with children to live in the city.

Already, Detroit’s downtown core is a new world from my first visit when the National League of Cities convened its annual meeting there in the 1980’s—a time when at the front desk of the hotel I was staying, the attendant told me that even though I could see the convention site from the hotel, it would be a grave risk to life and limb to even think about taking the bus or walking—a situation unchanged on a similar day, Detroit’s very first day in chapter 9 bankruptcy, when I had proposed setting out to walk to the Governor Rick Snyder’s Detroit office to meet just-appointed Emergency Manager Kevyn Orr. Today, the revived downtown has attracted young people, often in redeveloped historic buildings; but that emerging vibrancy does not include housing options for people at different stages of life. Thus, the city is making an effort to offer more differentiated housing options, including townhouses, apartments, carriage homes and more—as well as housing for seniors. Or, as Melissa Dittmer, director of architecture and design for Bedrock LLC, the company leading the development, notes with regard to an initiative just outside of downtown: “For so long, Detroit had a low-self-confidence issue and was willing to take just about” any residential development: “Now the city of Detroit has crossed a threshold. We can do better.”

Outside of the downtown area, one sample neighborhood, Fitzgerald, today has 131 vacant houses and 242 vacant lots; but the city’s Director of Housing and Revitalization, Arthur Jemison, notes these lots need not be filled with houses; instead, the city is moving to invest more than $4 million into the neighborhood to renovate 115 homes, landscape 192 vacant lots, and create a park with a bicycle path, or, as Mr. Jemison notes: “We can’t possibly rebuild every vacant lot with new construction…What we can do is rehabilitate a whole lot of houses, and we can have an intentional landscape scene. The landscape is important, because frankly, if it’s done and managed well, it’s inexpensive and people like it.”

But the comprehensive effort also recognizes the city does not need additional housing stock: it needs less; so it has unearthed a program, RecoveryPark Farms, to construct greenhouses on a 60-acre plot, a plot which until recently represented two dozen blighted blocks on Detroit’s east side. This unique project has diverse goals: it eliminates breeding territory for crime, eliminates blight, and creates opportunities for the unemployed, especially ex-offenders and recovering addicts. The program’s CEO Gary Wozniak, who spent more than three years in federal prison, notes farming offers a career with a lower bar for hiring and gives immediate feedback because “plants grow relatively quickly, so people can start to feel really good about building skill sets. Plus, Detroit has a lot of land.” Already, its harvests are purchased by some of Detroit’s top restaurants on a year-round basis, or, as CEO Wozniak put it: “What we’re doing is commercial-scale agriculture in an urban environment.”

On Detroit’s first day of bankruptcy, the walk from my downtown hotel to the Governor’s uptown office almost seem to resemble post-war Berlin: empty, abandoned buildings and storefronts. Thus, another post-bankruptcy challenge has been how to fill the vacant storefronts along Detroit’s half-abandoned commercial corridors—and, here, a partnership between the City of Detroit and other economic-development organizations, Motor City Match, works to create links between selected landlords and new small businesses, with a goal of converting blighted commercial districts to make them both more livable and more effective at providing job opportunities for residents—or, as Michael Forsyth, Director of small-business services at the Detroit Economic Growth Corp., notes: Motor City Match “helps get businesses from ideas to open.” The program awards $500,000 in grants every quarter, assisting businesses in completing a business plan, finding a place to open, and renovating office space: its CEO, Patrick Beal, CEO of the Detroit Training Center, received $100,000 during the first round of the program and matched it with a $100,000 loan. Now, with the help of Motor City Match, the company has trained more than 5,000 Detroiters in construction, heavy-equipment operation and other skills.

Finally, again as with Mayor Emanuel, the City respects the importance of children—meaning it must focus on public safety, and schools—governance challenges of the first order, especially as we have been long-writing, the parallel financial insolvency of the Detroit public schools. Thus, Ethan Lowenstein, the Director of the Southeast Michigan Stewardship Coalition, is working with educators and local organizations in the region to help young people address environmental challenges in their communities, noting that families with children “leave because they don’t see the strength in their community and they don’t feel recognized as someone who has knowledge.” Mr. Lowenstein is seeking to reverse the city’s depopulation trend by working with the Detroit Public Schools. At two schools he works with in southwest Detroit, he says, students were on a walk around their community and noticed tires were being illegally dumped. The schools helped the students and worked with community members to identify areas with illegally dumped tires, and eventually the tires were recycled into doormats.  

In recovery from chapter 9 bankruptcy, sometimes the fiscal part can seem easy compared to the human dimension.

The Key Lessons Learned after a Decade of Municipal Bankruptcies

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eBlog, 04/07/17

Good Morning! In this a.m.’s eBlog, we consider Detroit’s first steps to address the blight which crisscrossed the city leading to its municipal bankruptcy. Then we look to New Hampshire to assess whether the state legislature will preempt municipalities’ authority to set election dates. Then we slip south to assess fiscal developments in the efforts to recover from insolvency in Puerto Rico. Finally, we assess and consider some of the broader issues related to municipal bankruptcy.

Post Chapter 9 Recovery. One of Detroit’s first tests with regard to whether it can find new use for the vast stretches of land it cleared of blight went into effect this week when development teams announced by  Mayor Mike Duggan, along with partners: The Platform, a Detroit-based firm, and Century Partners announced they would be investing an estimated $100 million to rehab the architectural jewels in the city’s downtown—the Fisher and Albert Kahn buildings, with the two organizations declaring they will take the lead in overhauling 373 parcels of vacant land and houses in the Fitzgerald neighborhood on the northwest side, where they will coordinate with other firms on a $4 million development plan to rehab 115 vacant homes over two years, create a two-acre park, and landscape 192 vacant lots—with the work occurring in neighborhoods wherein the Detroit Land Bank took control of most of the properties and razed some abandoned homes. Mayor Duggan and other officials described the plan as a kind of reverse gentrification—or, as Mayor Duggan framed it: “We are going to keep the families here while improving the neighborhoods,” making his announcement on an empty lot which is scheduled to become a city park and include a greenway path to nearby Marygrove College: the city leaders hope to transform the neighborhood into a “Blight-Free Quarter Square Mile,” and, if the model works, seek to propagate it other neighborhoods.

Granite State Preemption or Cure? House Speaker Shawn Jasper wants to give New Hampshire towns that postponed their municipal elections due to a snowstorm a way out of facing potential lawsuits from voters who may have been disenfranchised. Speaker Jasper had proposed letting towns ratify the results of their elections by holding another vote, offering a bill to give towns which moved Election Day the option of letting townspeople vote to ratify, or confirm, the results on May 23rd. However, in the wake of about five hours of testimony, the House Election Law Committee voted 10-10 on the Jasper plan, so that a tie vote killed the Speaker’s amendment, leaving 73 towns on their own to address potential legal problems resulting from their decisions to hold their elections on days other than March 14th. The fiscal blizzard in the Granite State now depends upon whether state legislators determine whether or not a special election is needed with regard to those results. New Hampshire Deputy Secretary of State David Scanlan noted: “The concept is not entirely new…what is different is that it is applying to an entire class of towns that decided to postpone.”

In the past, the Legislature has voted to “cure” individual election defects. Speaker of the House Shawn Jasper, (R-Hudson, N.H.) noted: “Well, the fact that a bunch of towns moved the day of their town election was unprecedented…And so as a result of doing that, those towns that moved had to start bending other laws to make other issues related to the election work…The Legislature is just granting the authority to allow the towns to correct any defects that may exist,” he added, listing changed time listings, lack of proper notice, and absentee ballot date issues as possible defects in the process. All of those questions, of course, have fiscal consequences—or, as Atkinson Town Administrator Alan Phair put it; “Well, I don’t know the exact cost, what it would be, but I do know that in our case we certainly don’t have the money budgeted to (hold a special election), because we obviously just budgeted for one election…We would certainly go considerably over and have to find the money elsewhere to do it.” Under the proposed amendment, towns and school districts which postponed would hold a hearing, at which the respective governing body would vote on whether to hold a special election with one question: whether or not to ratify results, where a “no” vote would kick out anyone elected in a postponed vote, while nullifying warrant articles, with elected roles to be appointed until the next election. Salem Town Manager (Salem is a town of just under 30,000 in Rockingham County) Leon Goodwin said his elected leaders were of the opinion that its postponement was legal, so that the municipality is moving forward on projects voted on last month, noting: We’re moving on as if the votes were accepted even though there is a cloud hanging over us from Concord,” adding that town counsel advised the town moderator that it was legal to move elections. Yet, even as he remained confident the election issue will be resolved, he cautioned that the town has not budgeted for an additional election; Windham (approximately 14,000) Town Manager David Sullivan said the municipality’s town Counsel would sign off on the town’s fire truck bond, notwithstanding bond counsel elsewhere in the state advising that ratification of the elections would be necessary.

Municipal authority to act has been hampered by different state House and Senate approaches: while the two bodies have been moving on parallel tracks in the wake of state officials’ questioning the authority of town moderators to reschedule the March 14 voting sessions of their town meetings, the Senate this week passed SB 248, a bill introduced to ratify actions taken at the rescheduled meetings; however, the bill passed with a committee amendment which deletes all of the original language and provides instead for the creation of a committee to “study the rescheduling of elections.” Senators acknowledged that the bill was not likely to pass through the House in that form—asserting the intent was simply to get a bill to the House for further work. Subsequently, a floor amendment was introduced to restore the bill’s original language, ratifying all actions taken at the rescheduled meetings; however, that amendment failed on a party-line vote, with all nine Democrats voting in favor and all fourteen Republicans voting against, leaving most unclear how this could have become a partisan issue. The question comes down to what level of control local officials should have over local elections. The Speaker described the outcome thusly: “I think it was a case of 10 people (on the committee) thinking that what happened was legal;” however, he maintained that the postponed votes were not legal, adding: “The sad thing is that for school districts with bond issues that passed in those meetings, I don’t see a path forward for them,” adding: “I think if you’re afraid of snowstorms, you ought to move your meetings, probably to May,” noting that state officials are forbidden by law from moving state primary and general elections, as well as the first-in-the-nation presidential primary. Unsurprisingly, town moderators and attorneys who work with them on municipal bond issues disagreed with the Speaker’s interpretation that the postponed elections were illegal and his belief that the only way to rectify the issue was for them to act to individually ratify them, with many arguing they acted legally under a state law which allows them to postpone and reschedule the “deliberative session or voting day” of a town meeting to another day; however, the Speaker maintains that law applies only to town meetings, while town elections are governed under a different statute, which provides: “All towns shall hold an election annually for the election of town officers on the second Tuesday in March.” He also noted that the state’s official political calendar, which has the force of law, states that town elections must be held on March 14, adding: “Without trying to place blame, laws are sometimes very confusing if you look only at parts of them,” noting: “I don’t believe for one second that moving the election was legal.”

The Speaker added that still another state law provides that at special town meetings, no money may be raised or appropriated unless the number of ballots cast at the meeting is at least half the number of those on the checklist who were eligible to vote in the most recent town meeting, albeit adding that such meetings do not apply to the current situation, because they are not elections. The state’s Secretary of State said that after three weeks of research, he was able to report on voter turnout at town elections for the past 11 years, advising that 210 towns held elections in March, and 137 of them “followed the law” by holding their elections on March 14th, while 73 towns had postponed their elections by several days. Now Speaker Jasper asks: “Why would we give over 300 individual moderators the ability to do that when our Secretary of State doesn’t have the ability to do that for a snowstorm in our general election or our presidential primary?” The Speaker notes: “I think we need to provide a way to ensure that we don’t clog up the courts, and we don’t have people spend a lot of their own money to fight this, and the towns don’t have to spend a lot of money fighting it.”

Un-positive Credit Rating for Puerto Rico. Moody’s Investors Service has lowered the credit ratings on debt of the Government Development Bank and five other Puerto Rico issuers, with a total of approximately $13 billion outstanding, and revised down the Commonwealth’s fiscal outlook, and the outlooks for seven affiliated obligors linked to the central government to negative from developing, with the downgrades reflecting what the agency described as “persistent pressures on Puerto Rico’s economic base that indicate a diminishing perceived capacity to repay,” noting that while it continues to “believe that essentially all of Puerto Rico’s debt will be subject to default and loss in a broad restructuring, the securities being downgraded face more severe losses than we had previously expected, in the light of Puerto Rico’s projected economic pressures. For this reason, we downgraded to C from Ca not only the senior notes issued by the now defunct Government Development Bank, but also bonds issued by the Puerto Rico Infrastructure Financing Authority and backed by federal rum tax transfer payments, the Convention Center District Authority’s hotel occupancy tax-backed bonds, the Employees Retirement System’s bonds backed by government pension contributions, and the 1998 Resolution bonds of the Puerto Rico Highways and Transportation Authority.”

Puerto Rico Governor Rossello late Wednesday said that the U.S. territory’s fiscal plan, approved by the PROMESA Board, does not contemplate any double taxation, adding that, between the increase in the property tax and the reduction of expenses in the municipalities, he favored the latter as a measure to compensate for the absence of the state subsidy of $350 million. He reiterated that, as a substitute for these funds, the properties which are not currently paying taxes to the Centro de Recaution de Ingresos Municipales (CRIM: the Municipal Revenue Collection Center) should be identified, because they are not included in their registry. The Governor also stressed that the economic outcome of these two fiscal initiatives is still being evaluated, albeit he estimated that they could generate about $100 million, noting: “Whatever the differential after that for the municipalities, there are two mechanisms that can be worked: One, a mechanism to seek an additional source of income, or, two, to avail cuts…The central government has taken the cutting position. We are already establishing a protocol to cut in the agencies, to consolidate, to eliminate the expenses that are not necessary, to go from 131 to between 35 to 40 agencies. That has been our action. The municipalities—now we will have a conversation with our technical team—will have several options: ‘either cut as did the central government or seek mechanisms to raise more funds or impose taxes.’” Currently, mayors evaluate to increase the arbitrage of the real property to 11.83% or to 12.83% in all the municipalities; the concept is for members of the Executive to offer assistance to do the modeling. Thus, the president of the board of CRIM, Cidra Mayor Javier Carrasquillo, said CRIM will be “sensitive to the reality of the pockets of Puerto Ricans: We have to be cautious and responsible in the recommendation that we are going to make…There is nothing definitive yet. There are recommendations.” The Governor noted that the PROMESA Board approved fiscal plan approved last month does not contemplate an increase in property taxation, asserting it was “false to imply that our fiscal plan entails an increase in the rate or a double rate on properties,” albeit recalling that the disappearance of $350 million in transfers to municipalities begins on July 1, when the fiscal year begins, promising it will be done progressively, so that in the next budget (2017-2018) $175 million disappear, and the remaining $175 million, the next fiscal year, describing it as a “two-year fade out.” Unsurprisingly, he did not specify when or how the plan would fiscally benefit this island’s municipalities, stating: “We have already been able to have pilot efforts to identify different municipalities where 60% of their properties are not being assessed…We are going to commit ourselves so that all these properties are in the system.”

The End of a Chapter 9 Era? Municipal bankruptcy is a rarity: even notwithstanding the Great Recession which produced a significant number of corporate bankruptcies—and federal bailouts to large for-profit corporations and quasi-federal corporations, such as Fannie Mae; the federal government offered no bailouts to cities or counties. Yet from one of the nation’s smallest cities, Central Falls, to major, iconic cities such as Detroit and Jefferson County, the nation experienced a just-ended spate, before—with San Bernardino’s exit last month, the likely closure of an era—even as we await some resolution of the request by East Cleveland to file for chapter 9 municipal bankruptcy. The lessons learned, compiled by the nation’s leading light of municipal bankruptcy, therefore bear consideration. Jim Spiotto, with whom I had the honor and good fortune over nearly a decade of effort leading to former President Reagan’s signing into law of the municipal bankruptcy amendments of 1988, offers us a critical guide of ten lessons learned:

  1. Do not defer funding of essential services and infrastructure: Detroit is a wake- up call for others that there is never a good reason to defer funding of essential services and infrastructure at an acceptable level. If you do, Detroit’s fate will be yours.
  2. Labor and pension contracts under state constitutional and statutory provisions should not be interpreted as a mutual suicide pact: It appears one of the reasons why resolution of pension and labor costs was not achieved in Detroit prior to filing Chapter 9 was the belief of the workers and retirees that, under the Michigan constitution, those contractual rights could not be impaired or diminished to any degree. This position failed to take into consideration that the municipality can only pay that which it has revenues to pay and, in an eroding declining financial situation, there will never be sufficient funds to pay all obligations, especially those that may be unaffordable and unsustainable.
  3. Don’t question that which should be beyond questioning and is needed for the long-term financial survival of the municipality: A dedicated source of payment, statutory lien or special revenues established under state law must be honored and should not be contested. Capital markets work effectively when credibility and predictability of outcome are clear and unquestioned. Current effort to pass new legislation (California SB222 and Michigan HB5650) to grant statutory first lien on dedicated revenues. Further, as noted in the Senate Report for the 1988 Amendments to the Bankruptcy Code and Chapter 9 “Section 904 [of Chapter 9 limiting the jurisdiction and power of the Bankruptcy Court] and the tenth amendment prohibits the interpretation that pledges of revenues granted pursuant to state statutory or constitutional provisions to bondholders can be terminated by filing a Chapter 9 proceeding”. This follows the precedent from the 1975 financial distress of New York City and the State of New York’s highest court ruling the state imposed moratorium was unconstitutional given the constitutional mandate to pay available revenues to the general obligation bondholders. See Flushing Nat. Bank et. al. v. Mun. Assistance Corp. of New York, 40 N.Y.S.2nd 731, 737-738 (N.Y. 1976). Just as statutory liens and special revenues, there is a strong argument that state statutory and constitutional mandated payments (mandated set asides, priorities, appropriations and dedicated tax revenue payments) should not and cannot be impaired, limited, modified or delayed by a Chapter 9 proceeding given the rulings of the Supreme Court in the Ashton and Bekins cases and the prohibitions of Sections 903 and 904 of Chapter 9 of the Bankruptcy Code.
  4. Debt adjustment is a process, but a recovery plan is a solution: As noted above, while Detroit has proceeded with debt adjustment which provides some additional runway so it can take takeoff in a recovery, such plan is not the cure for the systemic problem. Rather, the plan provides additional breathing room so that the municipality, through its Mayor and its elected officials, may proceed with a recovery plan, reinvest in Detroit, stimulate the economy, create new jobs, clear and develop blighted areas and raise the level of services and infrastructure to that which is acceptable and attract new business and new citizens.
  5. Successful plans of debt adjustment have one common feature: virtually all significant issues have been settled and resolved with major creditors: While the Detroit Plan started with sound and fury between the emergency manager and creditors and what they would receive, in the end, similar to what occurred in Vallejo, Jefferson County and even in Stockton (with one exception), major creditors ultimately reached agreement and supported the Plan of Debt Adjustment that allowed the municipality to move forward, confirm the Plan and begin its journey to recovery.
  6. One size does not fit all: There are many ways to draft a plan of debt adjustment and sometimes the more creative, the better. As noted above, traditionally major cities of size with significant debt did not file Chapter 9. They refinanced their debt with the backing of the state which reduced their future borrowing costs and allowed them to recover by having the liquidity and the reduced costs necessary to deal with their financial difficulties. Detroit chose a different path.
  7. A recovery plan must provide for essential services and infrastructure: “Best interest of creditors” and “feasibility” can only mean an appropriate reinvestment in the municipality through a recovery plan where there is funding of essential services and infrastructure at an acceptable level to stimulate the municipality’s economy to attract new employers and taxpayers thereby increasing tax revenues and addressing the systemic problem. While no plan of debt adjustment is perfect or assured, there should be, as the Bankruptcy Court in Detroit throughout the case pointed out, a plan to show the survivability and future success of the City.
  8. Confirmation of a plan of debt adjustment is only the beginning of the journey to financial recovery, not the end: It is important to recognize, as noted above, that Chapter 9 is a process, not a solution. The recovery plan, which will take dedication and effort by the elected officials of the City along with residents, public workers and other creditors is the only way to achieve success. It is measured not by months, but by years, and by the constant vigilance to ensure that the systemic problem is addressed effectively in a permanent fix.