The Fiscal Challenges of Exiting from Fiscal Oversight

April 23, 2018

Good Morning! In this morning’s eBlog, we return to Michigan to assess the unbalanced state of its municipal public pension and post-retirement health care obligations, before turning to the state’s largest city, Detroit, which appears to be on the brink of earning freedom from state oversight—marking the remarkable fiscal exodus from the largest chapter 9 municipal bankruptcy in American history. Then we return to Puerto Rico, a territory plunged once again into darkness and an exorbitant and costly set of fiscal overseers. 

Imbalanced Fiscal Stress. In the Michigan Treasury Department’s first round of assessments under a new state law, the Treasury reported that 110 of 490 local units of government across the state are underfunded for retiree health care benefits, pension obligations‒or both. That number is expected to increase. Nineteen municipalities in Wayne County, including Allen Park, Dearborn and two of the five Grosse Pointes (Farms and Woods), are behind on their retiree health care funding, the state says, as well as six Wayne County jurisdictions, including Redford Township, Trenton, Wayne and Westland are underfunded on both, as are Hazel Park, Oak Park, and Madison Heights in Oakland County. The state fiscal oversight effort to highlight the expanding obligations competing for scarce taxpayer dollars in the state which is home to the largest chapter 9 municipal bankruptcy in American history, the result of the state’s “Protecting Local Government Retirement and Benefits Act,” Act 202, which was enacted last December, marks a pioneering effort to put tighter local data to detect and assess the likelihood of severe fiscal distress—kind of a municipal fiscal radar—or, as Michigan Deputy Treasurer Eric Scorsone, who is the designated head of the State and Local Finance Group,  describes it: “By working together, we can help ensure the benefits promised by communities are delivered to their retirees and help ensure that the fiscal health of communities allows them to be vibrant now and into the future,” Eric Scorsone, deputy state treasurer and head of Treasury’s State and Local Finance Group, put it: “This is just a start. One of the common denominators of the financial crisis has been legacy costs. We know this is a big liability out there”—and it continues to grow for current and retired public employees, as well as their counterparts in public schools, whose districts are not covered by the new state law. In an era featuring longer lifespans, the unfunded liability of the Michigan Public School Employees Retirement System totaled $29.1 billion, or 40.3 percent, at the end of FY2015-16—an aggregate number, the likes of which have not been previously available at the municipal level. Now, under the new statute, a municipality’s post-retirement health care plan is deemed underfunded if its assets are “less than 40 percent” of its obligations, or require annual contributions “greater than 12 percent” of a jurisdiction’s annual operating revenues. A pension plan is deemed underfunded if it is “less than 60 percent funded,” or its annual contributions are “greater than 10 percent” of annual operating revenues. The new state mandates require the state’s panoply of cities, villages, townships, counties, and county commissions to report pension and retiree health care finances by the end of January. (Municipalities whose books close later could be included in future lists.) The aim is to underline the fiscal need to local elected leaders to do something the federal government simply does not do: reconcile reconciling long-term obligations with current contributions and recurring revenue—that is, not only adopt annual balanced budgets, but also longer term. The new state law, an outgrowth of the Responsible Retiree Reform for Local Government Task Force, is intended to enhance transparency and community awareness of local government finance, as well as to emphasize that failure to account for such obligations could negatively impact municipal bond ratings—effectively raising the costs of capital infrastructure. Indeed, as East Lansing City Manager George Lahanas stated last week, “The city’s pension plan was 80 percent funded in 2003 and is 50 percent funded today…The city has implemented numerous cost-controlling measures over the years to address the legacy cost challenges…City officials have identified that more aggressive payments need to be made moving forward to further address the challenges.”

Nevertheless, in one of the very few states which still try to address municipal fiscal disparities, the Michigan Senate General Government subcommittee met last week and reported (Senate Bill 855) its budget recommendations, including for revenue sharing, the subcommittee matched the Governor’s recommendation, which eliminate the 2.5% increase cities, villages, and townships received this year—a cut, ergo, of some $6.2 million for FY2019; the Senate version retained the counties current year 1% increase (which the Governor had also recommended removing) and added another 1% to the county revenue sharing line item—with the accompanying report language noting the increase was intended to ensure “fairness and stability” across local unit types, since counties do not receive Constitutional revenue sharing payments.  Estimates for sales tax growth related to Constitutional payments anticipate an additional 3.1% next year for cities, villages, and townships, distributed on a per capita basis. 

Moving into the Passing Lane? The Legislature’s actions came as the Detroit Financial Review Commission has approved the Motor City’s Four-Year Financial Plan, setting the stage for the city’s exit from direct state supervision as early as this month, enabling the city with the largest chapter 9 municipal bankruptcy in U.S. history to glimpse the possibility of exiting state oversight—or, as Detroit CFO John Hill put it:  “Today’s FRC approval of the City’s 2019 budget and plan for fiscal years 2020-2022, is another key milestone in the city’s financial recovery: It demonstrates the continued commitment of city leaders to prepare and enact budgets that are realistic and balanced now and into the future. It also demonstrates continued progress toward the waiver of active State oversight, which we expect will occur later this month.” The Commission is scheduled to meet at the end of this month for a vote to end state fiscal oversight, albeit the Commission would remain in existence, so that it could be jump started in the event of any reversal in the city’s fiscal comeback. Thus, Mr. Hill said there would likely be a memorandum of understanding between Detroit and the Commission to lay out the kinds of information the city would need to provide to the Commission for review, as he noted: “They still can at any time decide to change the waiver, although we hope and will make sure that doesn’t happen.” Mr. Hill noted that the now approved financial plan includes Mayor Mike Duggan’s budget for FY2019, as well as fiscal years 2020-2022—and that the Motor City now projects ending the current fiscal year with an operating surplus of $33 million: that would mark Detroit’s fourth consecutive municipal budget surplus since exiting from the nation’s largest ever chapter 9 municipal bankruptcy. He also noted that, as provided for under the city’s plan of debt adjustment, Detroit continues to put aside funds to address the city’s higher-than-expected pension payments, payments starting in 2024, when annual payments of at least $143 million begin. Payments of $20 million run through 2019 with no payments then due through 2023.

Unbalanced Budgets & Power–& Justice. Although they are still evaluating the impact that a new reduction of their budget would have, Puerto Rico’s Judicial Branch has expressed apprehension with regard to the PROMESA Board’s imposed cuts, with Sigfredo Steidel Figueroa, Puerto Rico’s Director of the Office of Court Administration, expressing apprehension: “At the moment, we are evaluating the impact that the proposals of the Fiscal Oversight Board, contained in the fiscal plan published yesterday, could have on the Judicial Branch,” referring to the Board certified plan of staggered cuts for the Judiciary—cuts of $31.9 million, rising to a cut of $161.9 million by 2023. He noted: “In the light of the measures already taken, any proposal for additional reduction to our budget is a matter of concern. Therefore, we will remain vigilant to ensure that the Judicial Branch has the resources it needs to ensure its efficiency and that any budgetary measures taken do not affect the quality of judicial services and the access to justice that corresponds to all the citizens and residents of Puerto Rico,” as he stressed that, “At present, even with the budgetary limitations of recent years, the Judicial Branch has managed to draw and execute the work plan defined by the presiding judge, Maite D. Oronoz Rodríguez, for an increasingly more judicial administration—one of efficiency, transparency, and accessibility.” He added:An independent and robust judiciary is essential to guarantee the legal security necessary for the stability and economic development of Puerto Rico.”

PROMESA Board Chair Jose Carrion, at the end of last week, issued a warning: “We hope the government and the legislature will comply. We don’t want to sue the government, but we have to fulfill the duties that we understand the law gives us.” That is to write that in this fiscal governance Rod Serling Twilight Zone, somewhere between chapter 9 municipal bankruptcy and hegemony; there is an ongoing question with regard to sovereignty, autonomy, and, as they would say in Puerto Rico, al fin (in the end): who is ultimately responsible for making decisions in Puerto Rico? We have a federal, quasi U.S. bankruptcy judge, a federal oversight board, a Governor, and a legislature—with only the latter two representing the U.S. citizens of Puerto Rico.

And now, in the midst of a 21st century exodus of the young and educated to Florida and New York, it appears that banks are joining this exodus—threating, potentially, to further not only isolate Puerto Rico’s financial system—a system in which the number of consumer banks has dropped by half over the past decade, and in which two of the largest, Bank of Nova Scotia and Bank of Santander SA, have been quietly shrinking—the challenge of governance and fiscal recovery as Puerto Rico seeks to emerge from recession and rebuild after last year’s Hurricane Maria, a small number of financial institutions could end up in charge of deposits and lending for its 3 million citizens. Poplar, Inc., First Bancorp/Puerto Rico, and OFG Bancorp, are cash rich and have many branches, but these financial institutions appear to have limited ability to facilitate trade beyond the Caribbean and Florida—and, as economist Antonio Fernos of the Interamerican University of Puerto Rico notes: “What would really be negative is if we lose access to the network of international banks.” The U.S. territory, once was an attractive place for banks to invest, with pharmaceutical manufacturing driving growth, meant that financial institutions entered and opened what had been scarce financing for everything from homes and cars to consumer electronics. However, as Congress changed the rules which had incentivized pharmaceutical companies to locate there—and as Congress moved to make it more attractive to provide shipping to other Caribbean nations, rather than the U.S. territory, many drug companies departed. Today, in the wake of a decade-long recession, Puerto Rico’s economy is 14% smaller, and the emigration of college graduates to the mainland appears to have accelerated—leaving behind the elderly and those who could not afford to leave—increasing a crushing public pension burden, while imposing greater fiscal burdens to serve an increasingly elderly and poor population left behind—and left with over $120 billion in debt and pension liabilities, and now, in then wake of Maria’s devastation, a spike in mortgage delinquency.

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