Municipal Governance: The Challenges of Severe Fiscal Distress

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eBlog, 11/30/16

Good Morning! In this a.m.’s eBlog, we consider the difficult trials and tribulations of governance in a municipality confronting severe fiscal distress—in this case in the historic municipality of Petersburg, Virginia, before heading West to San Bernardino where the old expression “When it rains, it pours,” might be an apt description as a physical rather than fiscal earthquake appears to be adding to the city’s fiscal challenges as it seeks to emerge early next year from the nation’s longest ever chapter 9 municipal bankruptcy. Then we journey back to Ohio, where a municipal election next week in the virtually insolvent municipality of East Cleveland appears to offer little optimism of any resolution of its insolvency. Then we continue east to Connecticut, a state now confronting serious fiscal pressures. Finally, we head south, not to escape winter, but rather to observe the difficulty of governance created by a federal oversight board and an incoming new Governor.    

Is It a Municipal Government of the People? The ACLU of Virginia released a letter Monday criticizing the Petersburg City Council for meeting practices it said violate “the spirit of open government laws.” The organization claimed the City Council over-relied on special meetings, sometimes called at the last-minute, during the work day, or held in cramped quarters, to vote on matters of governance and financial management even as the city veered into insolvency. In the letter, ACLU executive director Claire Guthrie Gastañaga warned: “Holding meetings at inconvenient times and in small spaces that cannot accommodate the public violates the spirit of open government laws that serve to promote an increased awareness by all persons of government activities and afford every opportunity to citizens to witness the operations of government.” Part of the reaction reflects the growing anger of city residents and taxpayers with regard to the ways in which the Mayor and Council allowed the fiscal crisis to grow unattended—and then to hire at steep prices turnaround specialists from Washington, D.C. Indeed, some believe that the Council’s decision to hire the Robert Bobb Group—especially the way it did so—to try to avert insolvency and potential chapter 9 bankruptcy violated the municipality’s own rules and possibly the city charter, because of the procedure of forcing the matter to a second vote days after an initial vote for the partnership failed to pass, with two council members absent. The Petersburg City Council’s rules require a month delay; the city’s charter provides that a reconsideration vote must have as many members present as were there for the initial vote. The city attorney has defended the vote, asserting that nothing illegal or untoward transpired during the second consideration of the Bobb Group contract, which sealed the $350,000, five-month fee from the nearly bankrupt municipality with the firm. The aftertaste led citizens to publicly lambaste Mayor W. Howard Myers at a council meeting following the vote: now those citizens are actively circulating a recall petition to force the Mayor to step down. As Barb Rudolph, an organizer of the community group Clean Sweep Petersburg, put it: “For the many citizens of Petersburg who want to better understand what our elected leaders are deciding and why, this letter is most welcome…It puts City Council on notice that they can’t hide behind their misinterpretation of FOIA laws and inadequate commitment to open government.”

The vote last month on hiring the Bobb Group took place at one of 13 special meetings called by the City Council between March and October, according to the ACLU’s review. The Council publicized some in advance as being called solely for closed-session discussions, which “has the result of suppressing interest in attending and participating,” according to Ms. Gastañaga, who is pressing for the Council to be more open and resort less to executive sessions, or, as she puts it: “Even if legally permitted, the Council should hold all meetings in public unless there is a specific and important policy reason for the Council to meet outside of the hearing of the residents and public the Council was elected to serve.”

A Physical, not a Fiscal Quake. San Bernardino municipal employees are one step closer to completely moving out of City Hall, not because of the city’s chapter 9 bankruptcy—from which the city expects to emerge next March, but rather in response to a substantial earthquake risk: the City Council voted 7-0 Monday night to authorize City Manager Mark Scott to lease office space in two adjacent buildings in the wake of seismic experts’ warnings that the 43-year-old City Hall building is likely to collapse during a strong earthquake. The plan is to seek a grant to retrofit City Hall so that it could comply with modern earthquake standards and employees can return; however, for the municipality hoping to emerge from the nation’s longest chapter 9 municipal bankruptcy early next year, the physical disruption will be costly: it will take more than $14 million and an extended period of time, according to the city’s engineering study. Moreover, because the city was unable to obtain a lease for less than two years, the city will pay a total of $42,688 and $21,566—per month for the first year of the two-year lease, and a bit more for the second year. Additional costs associated with the move, including Information Technology costs and a moving company, approach $500,000, according to the staff report. Mayhap unsurprisingly, the plan was blasted at a Council session Monday by all of the members of the public who spoke—with one member of the public telling the Mayor and Council: “Anybody that votes yes on (the lease proposal) at this time, with as little studying as has been done, deserves to be removed from their office.”

The city, now addressing its fiscal earthquake, has received two independent engineering evaluations, in 2007 and 2016, which warn that City Hall sits atop two large faults, making it unsafe in an earthquake. The February study concluded that a magnitude 6.0 earthquake would lead to “a likelihood of building failure” for City Hall, which was designed before code updates following the 1971 Sylmar and 1994 Northridge earthquakes. With a greater than 90 percent chance of an earthquake of 6.0 or greater striking the region within 50 years, it would appear that steps not anticipated in the city’s chapter 9 plan of debt adjustment will require spending not included in that plan—spending not well received by the city’s taxpayers, who fear such spending will likely come at the expense of what they already complain is inadequate spending to combat crime, homelessness, and other issues. Moreover, the time contemplated—nine years—has added to citizen frustrations. Or as one citizen testified before the Council referring to the seismic information provided to the city nearly a decade ago: “Nine years?…I’ve heard of slow bureaucracy, but what kind of an emergency is it, if it’s nine years down the road?”

Municipal Integrity. The old expression that “when it rains, it pours,” might be apt for East Cleveland Mayor Gary Norton, who is seemingly waiting for Godot—that is, the State of Ohio to respond to the City’s request for authorization to file for chapter 9 municipal bankruptcy, but, instead, is confronted by an Ohio state board’s large fines for filing incomplete and late campaign finance reports related to next week’s municipal elections—in this case a recall election. Last month, the Ohio Elections Commission fined the Mayor $114,000—nearly sextuple the levy imposed by Ohio’s Attorney General last year. The most recent fines were levied in response to complaints from the Cuyahoga County Board of Elections that Mayor Norton did not file an annual report for 2015, turned in his 2014 report late, and did not resolve issues with his 2013 reports. In a series of letters, the Board of Elections asked Mayor Norton to fix a number of discrepancies in his 2013 reports—including incorrect fundraising totals and missing addresses. The board also requested proof of mileage, bank fees, phone expenses, and other spending for that year. Mayor and candidate Norton also is confronted by complaints over several missing finance reports from years prior to 2013, according to elections commission case summary records. Many of those reports have since been submitted and posted on the county board of elections website: a year ago last August, the elections commission imposed a $20,000 fine in connection with many of those cases. Mayor Norton’s last reported fundraising was in 2013, when he won a second term. He reported raising no money in 2014. Election commission fines balloon quickly. Mayor Norton’s grew by $100 for every day the problems remained unaddressed.

State Fiscal Sustainability? In Connecticut, where the state motto is Qui transtulit sustinet, or he who is transplanted still sustains, fiscal sustainability appears to be uncertain. Indeed, downgrades and related underperformance of the state’s debt are anticipated in the near-term, in no small measure due to weaker than expected revenue performance and rising fixed costs. The state confronts an expected expenditure reduction of more than 12 percent in FY2018, or $1.2 billion in non-fixed costs in FY18—a fiscal gap made more stressful because this year’s state budget relied on nearly $200 million in non-recurring revenues. The state’s Office of Fiscal Accountability recently revised state income and sales and use tax estimates down for FY17 by an aggregate of -$115.4 million; general fund revenues for FY18 are expected to post a decline of approximately $190 million from FY17 and aggregate revenue growth assumptions for FY19 and FY20 have also been downgraded. A significant factor has been fixed costs, especially from public pension obligations and other post-employment or OPEB benefits—in addition to municipal debt service and entitlements—which, together—like a Pac-Man are projected to account for 53% of expenditures in FY18. The state projects that pensions, OPEB, and debt service costs will rise by nearly 15%, while entitlements grow by nearly 5% in FY18. Worse, anticipated higher interest rates will add to future fixed costs in the form of debt service costs, while at the same time reducing bond premiums which the state has used over the past several years to reduce debt service appropriations. If there is any upside, it is that Connecticut has fully funded its pensions since 2012, albeit it has computed the liability using a relatively aggressive discount rate of 8 percent. Should the funds return less than this rate, pension costs will rise more than projected as the higher liability is amortized.

The Promise of PROMESA. Our insightful colleagues at Municipal Market Analytics note that the federally created PROMESA board has demanded that any fiscal reform plan adopted by the U.S. territory of Puerto Rico be:

  • honest with regard to any incremental federal aid Congress and the new Trump administration might provide,
  • that recurring revenues must actually be set to afford recurring expenses and vice-versa, and
  • that traditional capital market access cannot be assumed, but rather must be cultivated through balanced settlements.

MMA noted this to be “an unexpectedly earnest expression by the board and a very positive development for Puerto Rico in the long-term, although it also exacerbates short-term volatility by making standard extend-and-pretend restructuring strategies more difficult to pull off.” In response (or really non-response), outgoing Alejandro Javier García Padilla noted that although his own plan assumes massive injections of new federal aid, leaves current commonwealth spending levels unchanged, and disregards the market access issue entirely; he would not be submitting an amended version—a response that makes more difficult the PROMESA Board’s ambitious December 15th deadline for submitting its plan. MMA perspicaciously notes that the federal oversight board’s perspective could also pose a threat to the recent price appreciation in Puerto Rico’s municipal bonds, noting that to the extent to which the Commonwealth, nearing next month’s change of administrations, is forced to meaningfully address its massive structural budget deficit, there will be little room to project payment of debt service in the near– or medium-terms, with MMA noting: “In theory, more sustainable projections will reduce the size of any bondholder recovery, but will allow for higher bond ratings once a restructuring has been completed. Adding to medium-term issues, an acceptable plan’s likely need for sweeping layoffs, service austerity, and, potentially, pension payout reductions increases the potential for social unrest on the island: a development that will aid no parties besides partisans for independence.”  

Is There Promise in PROMESA? The Puerto Rico PROMESA Financial Oversight and Management Board has appealed a U.S. District Court ruling that stopped it from intervening in several consolidated suits filed against the government, having filed a motion in October to intervene in four consolidated lawsuits in order to make known its views on the plaintiffs’ pending motions to lift the automatic stay imposed under §405 of the Puerto Rico Oversight, Management and Economic Stability Act (PROMESA). Thus, two weeks ago, U.S. District Court Judge Francisco Besosa denied the oversight board’s request to intervene in the suits filed by U.S. Bank Trust, Brigade Leveraged Capital Structures Fund Ltd, National Public Finance Guarantee Corp. and the Dionisio Trigo group of bondholders—a suit in which the plaintiffs were challenging the constitutionality of the Moratorium Act, which stopped payments to bondholders. Judge Besosa, early this month, had upheld a block on creditors’ ability to file lawsuits against the government of Puerto Rico in an attempt to extract repayment on defaulted municipal bonds to give time to the territory to restructure its $69 billion debt load—with the stay order part of the PROMESA Act: Judge Besosa consolidated the lawsuit filed by Altair with the suits by three other claimants and imposed a stay on them, writing: “The Court hastens to add that the Commonwealth defendants must not abuse or squander the ‘breathing room’ that the Court’s decision fosters. The purpose of the PROMESA stay is to allow the Commonwealth to engage in meaningful, voluntary negotiations with its creditors without the distraction and burden of defending numerous lawsuits.” (Besides Altair, the lawsuit was brought by Peaje Investments LLC and Assured Guaranty Corp against the government and outgoing Governor Alejandro Garcia Padilla.)

Unpromising? Puerto Rico Governor-Elect Ricardo Rosselló has opted to select his campaign manager, Elías Sánchez Sifonte, to replace public finance veteran Richard Ravitch as Puerto Rico’s non-voting representative to the PROMESA Oversight Board. Commencing next year, Senor Sánchez Sifonte will replace Mr. Ravitch, and losing the experience and expertise of a public finance veteran of the Detroit oversight board, as well as someone who played a key oversight role in the cases of both New York City and Washington, D.C. Mr. Sánchez Sifonte has held a variety of positions in recent years. Most recently he was campaign manager for Gov.-elect Rosselló’s bid for governorship. Prior to that he was human resources director for the city of Toa Baja, which according to the El Nuevo Día news web site had a payroll from $16 million to $23 million per year in the last 10 years. Senor Sifonte, a Republican, is a licensed attorney and provided legal advice to the Puerto Rico Senate from 2009 to 2011. He has run Veritas Consulting since 2011. According to El Nuevo Día he worked as a lobbyist to the Puerto Rico legislature without properly being registered as a lobbyist.