Addressing Municipal Fiscal Distress

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eBlog, 04/05/17

Good Morning! In this a.m.’s eBlog, we consider some unique efforts to address municipal fiscal distress by the Illinois Legislature, based upon tag team efforts by the irrepressible fiscal tag team of Jim Spiotto and Laurence Msall of the Chicago Civic Federation. The effort matters, especially as the Volker Alliance’s William Glasgall, its Director of State and Local Programs, has raised issues and questions vis-à-vis state roles relating to addressing severe municipal fiscal distress. As we have noted—with only a minority of states even authorizing municipal bankruptcy, there are significant differences in state roles relating to severe municipal fiscal distress and insolvency. Thus, this Illinois initiative could offer a new way to think about state constructive roles. Then we turn to Ferguson, Missouri to assess its municipal election results—and its remarkable, gritty fiscal recovery from the brink of insolvency.

Addressing Municipal Fiscal Distress. The Illinois Legislature is considering House Bill 2575, the Illinois Local Government Protection Authority Act, offered by Rep. David Harris (R-Arlington Heights), which would establish an Authority for the purpose of achieving solutions to financial difficulties faced by units of local government, creating a board of trustees, and defining the Authority’s duties and powers, including the ability to obtain the unit of local government’s records—and to recommend revenue increases. The legislation provides for a petition process, whereby certain entities may petition the Authority to review a unit of local government; it also sets forth participation requirements. The effort comes in the wake of distressed local governments struggling under the weight of pension, healthcare, and other debts: it would propose this new, special authority for fiscal guidance to fiscally strapped local units of government, but without mandating severe budget cuts—or, as Rep. Harris described it: a “cooperative effort between the state and financially unit of local government…(one which) involves local elected officials and local governmental bodies and taxpayers, workers, and business entities developing a plan of financial recovery — is the best way to find a permanent solution to current financial challenges.” According to the Chicago Civic Federation, which asserts the intent is to help the state’s municipalities recover without being forced into chapter 9 municipal bankruptcy, such an authority could be valuable—especially in a state which, like the majority of states, does not generally permit a city, county, or other municipal entity to file for bankruptcy. Under the proposal, nine trustees would oversee the new authority, including four appointed by the Illinois Municipal League; the Governor, Speaker of the House, and Minority Leader, and their state Senate counterparts would each appoint one member: the new authority would rely on the Illinois Comptroller’s office to provide reports and some operational support; the legislation would also set a fee schedule to enable coverage of its administrative costs.

The exceptional leader of the Federation, Laurence Msall, noted: “The LGPA would serve as a resource to assist distressed municipalities in making determinations as to what essential governmental services are sustainable and affordable and what combination of revenue increases and service cuts, and other actions would be necessary to ensure fiscal sustainability and access to critical services.” Under the proposed legislation, a municipality could petition the authority to intervene; but also, the Illinois Comptroller, a public pension fund, or even a large creditor owed a substantial debt could. The proposal would authorize a municipality to petition too—provided it committed to participate—and provided it met specific criteria, including inadequate liquidity, overdue debt, weak pension funding ratios, or signal budget imbalances. If triggered, the suggested new authority would be authorized to recommend budget cuts, tax increases, and/or pension funding actions: as proposed, the authority would be charged with reviewing whether the city, county, or other unit of government should:

  • try to negotiate a debt restructuring,
  • explore public-private partnerships, or
  • asset sales and consolidation.

The authority would be authorized to consider potential pension reforms, such as whether the municipality should offer more corporate-style retirement plans, as well as whether it should establish a trust to fund its OPEB post-retirement healthcare obligations.

The proposed legislation authorizes authority to set fiscal targets; it offers the option for the proposed new authority to serve as a mediator in negotiations between a municipality and debtors, to endorse tax increases—increases which might trigger a public referendum, and issue recommendations to the Illinois state government with regard to the diversion of funds to address specific municipal funding mandates—granting authority too to seek declaratory and injunctive relief with regard to the exercise of its powers and implementation of its findings and recommendations. Finally, as a last resort, the authority could recommend pursuit of chapter 9 municipal bankruptcy. The nation’s architect of the federal municipal chapter 9 municipal bankruptcy law, Jim Spiotto, notes: “This municipal protection authority concept could be the means of providing state and local government cooperation and oversight while allowing the municipality, its elected officials, workers and unions, creditors and bondholders to have a means of participation with a definitive end result.” For his part, Mr. Msall described the rationale as vital to establishing “a systematic means of evaluating and assisting these governments,” instead of taking on municipal fiscal distress on a case-by-case effort, noting that “The Civic Federation is very concerned about the financial condition of many local governments in the state of Illinois, and many of them which will not be able to seek assistance unless there is the creation of this authority.”

& The Winner is: Ferguson, Missouri voters have reelected incumbent Mayor James Knowles III to a third term in the municipality’s first mayoral election since protests erupted there three years ago in the wake of one of the city’s white police officer’s shooting of an unarmed black 18-year-old—a shooting which ignited a national protest and led to a federal Justice Department intervention and harsh fiscal penalties for the nearly insolvent municipality. Mayor Knowles won by a 56%–44% margin against Councilwoman Ella Jones, who is black, in a small municipality which was once an overwhelmingly white “sundown town” where, until the 1960s, African-Americans were banned after dark. Perhaps ironically, the Mayor’s reelection followed just one day in the wake of U.S. Attorney General Gen. Jeff Sessions’ order that the U.S. Justice Department review its existing consent decrees with municipal police departments—the agreement in Ferguson, imposed under the Obama administration, imposed unfunded federal mandates, including demands to levy new taxes. In its report, the Obama Justice Department had alleged that the Ferguson Police Department and the City of Ferguson relied on unconstitutional practices in order to balance the city’s budget through racially motivated excessive fines and punishments, so that former U.S. Attorney General Eric Holder stated the federal government would use its authority to dismantle the Ferguson Police Department—a threat, which at the time, Ferguson’s then-Mayor had warned could mark the first time in the nation’s history that the federal government might force a municipality into municipal bankruptcy, and led credit rating agency Moody’s to place the municipality’s municipal bond rating on review for downgrade because of threats to the city’s solvency—with the downgrade of the city’s general obligation rating reflecting what the credit rating agency described as “the continued pressure on the city’s finances from a persistent structural imbalance and incorporating the recently approved U.S. Department of Justice (DOJ) consent decree, projected to increase annual General Fund expenses over the next several years,” in the wake of Moody’s assessment after the U.S. Justice Department lawsuit against the small city, noting its downgrade then had reflected concerns related to the uncertainty of the potential financial impact of litigation costs from the federal lawsuit and the price tag for implementing the proposed DOJ consent decree, writing: “We believe fiscal ramifications from these items will be significant and could result in insolvency.”

Indeed, the Justice Department’s unfunded federal mandates included federally imposed financial penalties, and the mandate to levy new, municipal taxes: leading to voter approval of a utility tax hike projected to generate $700,000 annually—an increase which Mayor Knowles, at the time, described as a critical vote, because, had the measure failed, the city’s police force’s authorized number would have been cut to 44, and firefighter jobs would also have been cut; he had warned, in addition, that the vote was intended to make clear the city was fiscally viable. So, today, in the wake of resignations and elections, Ferguson features three black council members, a black police chief, and a black city manager—and, in the interim, Mayor Knowles has survived a recall attempt (in 2015), noting in a Facebook post during the campaign that he wanted to follow the example set by former President Abraham Lincoln: “For those familiar with history, during the Civil War, Lincoln was often criticized by people on both sides of the issues of slavery and the war because of his even-handedness and his resistance to the pressures of radicals on both sides. He knew radicalism, even after the war, would further divide us, which it has for generations.”

Mayor Knowles’ challenger, Councilmember Jones, ran, because, she said, it was “time for Ferguson to unite and become one Ferguson, and we cannot move forward under the leadership that we are under at this point,” harshly criticizing the U.S. Attorney General’s move to review the city’s consent decree—one which Mr. Sessions had previously claimed was based on a report that was “anecdotal” and “not so scientifically based,” with Councilmember Jones warning that the Attorney General’s action was “not going to help Ferguson at all,” adding: “We need that consent decree in order to keep Ferguson moving forward.” Nevertheless, the gritty, can-do leadership of the city’s elected officials appears to have defied the odds: City Manager De’Carlon Seewood recently wrote that in the wake of a “drastic decline” in revenue, “the city’s operating budget is beyond lean. It’s emaciated.”

 

Governance & Fiscal Recovery

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eBlog, 04/03/17

Good Morning! In this a.m.’s eBlog, we consider the ongoing recovery efforts in Ferguson, Missouri; then we return to the Motor City to assess what and how home ownership might have changed in the wake of the city’s recovery from the largest chapter 9 municipal bankruptcy in U.S. history, before returning to the azure waters of Puerto Rico to assess its most recent fiscal developments.

A Recovering City’s Future? Ferguson, Missouri voters tomorrow will pick between Mayor James Knowles III and Councilwoman Ella Jones in the Mayoral election–for a 3-year term: Mayor Knowles was first elected Mayor on April 5, 2011, after serving on the Ferguson City Council for six years: he became the youngest mayor in Ferguson’s history when he took office at the age of 31, while Councilwoman Jones became the first African-American woman to be elected to her position. But tomorrow could mark a check point in the wake of the dramatic leadership changes since the 2014 shooting of Michael Brown put the St. Louis suburb at the center of the debate over the treatment of blacks by the nation’s police forces–and on the brink of insolvency. Mayor Knowles, who is finishing his second term, noted: “These past three years have been very difficult, but I’ve been the one who has shown I can lead through tough times…That I can take the heat, but also make the changes, the reforms necessary to make the community move forward.” Nevertheless, in the wake of the killing of an unarmed black teenager, by a white police officer nearly three years ago, Mayor Knowles has borne the brunt of considerable anger, as Ferguson went from a mostly unheard-of St. Louis suburb to a flash-point of racial unrest. After months of protests following the shooting, people rioted that November when a grand jury declined to charge the officer, who resigned that month. There was further unrest the following March when the U.S. Department of Justice cleared the officer of wrongdoing—and issued a scathing report alleging racial bias and profiling by the small city’s police department and courts—a report which appeared to lead to the resignations of the city’s police chief, city manager, municipal judge, and city attorney. Indeed, of all the city’s top officials, only Mayor Knowles remains—and that notwithstanding threats in phone calls and emails, a stolen identity, and having his home’s windows broken.  In contrast, Councilwoman Jones has lived most of her life in Ferguson: she is serving her first term as a Councilwoman, and, in her campaign, assert she wants the Mayor’s office to be “inclusive for everyone, instead of exclusive,” noting: “We have to listen and stop turning our heads and turning a deaf ear to people, because they’re just like you and I. They want to be heard and they have a right to be heard.”

Whomever the voters elect will confront a daunting fiscal challenge: the city lost millions of dollars of revenue after municipal court reforms were implemented following Mr. Brown’s death: sales and use tax revenues dropped as businesses victimized by looters were burned and closed: many have not returned. Similarly, the city has more than a dozen police vacancies: the city lacks sufficient budget resources to compete with larger, better funded governments in St. Louis County—and still is handicapped by its unfunded costs of compliance with U.S. the Justice Department imposed consent decree to improve the police and municipal court systems and eliminate racial bias: an unfunded federal mandate projected to cost the impoverished city budget and taxpayers more than $2 million. The city of about 20,000, which actually experienced a population decline of nearly 6% since 2000, nevertheless has experienced a gradual increase in median income to $43,998 by 2015—approximately 86% of average statewide household income.

And, irrespective of whom the voters select, this is not a position of responsibility that pays much: the Mayor’s pay is $4,200 annually; rather, as the incumbent notes: it’s the love of their community and the opportunity to be its face to the outside world: “These past three years have been very difficult, but I’ve been the one who has shown I can lead through tough times…That I can take the heat but also make the changes, the reforms necessary to make the community move forward.” In contrast, Councilwoman Jones said she wants the Mayor’s office to be “inclusive for everyone, instead of exclusive…We have to listen and stop turning our heads and turning a deaf ear to people, because they’re just like you and I. They want to be heard and they have a right to be heard,” she said.

A Lost Fiscal Decade? Joel Kurth and Mike Wilkinson, writing in Bridge Magazine, note that still, today, home mortgages remain a rarity in Detroit: “Home sales with mortgages are rare in Detroit, occurring in just a few areas: Miles from downtown Detroit and its debates about gentrification, a more modest question surrounds the real estate in many city neighborhoods. Cash or charge?” The pair found that “sales with mortgages are rare in Detroit, occurring in just a few areas.”  Their piece outlines remarkable oscillations in assessed property values, noting that the average home sale price in the city went from $84,109 in 2001 down to $12, 517 in 2009, and then back up to $50,308 by last year—still far below the unadjusted 2001 level—albeit they found that the average price last year for homes purchased with a mortgage was $155,650. In comparing homeownership rates, they noted that last year’s rate of 47% remained under the year 2000 rate of 55%. Thus, they found that obtaining a mortgage continues to be challenging in outlying neighborhoods across Detroit, with the vast majority of homes sold for cash to landlords and investors, rather than homeowners, according to sales data and numerous interviews—posing hard questions about who will benefit in a revival rooted in downtown and Midtown in what remains the nation’s poorest city—a city where, according to the Census Bureau, 39.3% of people live below the poverty line (defined as $24,250 for a family of four), making it “the poorest in America with more than 300,000 people, followed by Cleveland (39.2%), Fresno, Calif., (30.5%), Memphis (29.8%), and Milwaukee (29%), albeit finding the Motor City’s rate has actually decreased from 2012, when it was 42.3%. The authors quoted a real estate agent: “Detroit is evolving into a new place, but outside of hot areas, neighborhoods just aren’t where they need to be to increase property values enough for banks to lend money.”

Nevertheless, a joint report by Bridge and Detroit public radio station WDET did find some grounds for optimism, determining that home sales and prices are increasing citywide after bottoming out after the mortgage meltdown, which left in excess of 65,000 foreclosures; the report noted that in some neighborhoods, prices are rising so swiftly that they are creating bidding wars, albeit the gains are uneven, and mortgage lending is mostly confined to more affluent neighborhoods, according to records from Realcomp Ltd. II: last year, only 19% of 3,800 Detroit homes sold by conventional means were financed with mortgages, demonstrating signal disparities: homes with mortgages sold for an average of $155,000; cash sales averaged $30,000—an imbalance Mayor Mike Duggan fears could “cripple” the Motor City’s recovery, according to Erica Ward Gerson, Chairwoman of the Detroit Land Bank Authority, which assembles and sells properties: she deemed the number of cash sales a “serious, serious problem,” because they can deter home ownership and depress property values, noting that cheap sales are usually rentals or vacant houses, while pricier sales are often out of reach for ordinary buyers. Most home sales in Detroit require cash; only 19 percent of the 3,800 sales in 2016 involved a mortgage, reflecting the difficulty to secure loans in a city where property values are less than half what they were a decade ago. 

In response, Mayor Duggan has sought to team with banks, foundations, and nonprofits to offer a number of programs to increase the availability of home loans; to date, as one non-profit in the city notes, the programs have demonstrated some success; however, most focus on stable neighborhoods, e.g., not where the most serious challenges remain: in more impoverished east side neighborhoods, homes last year sold for $4,000 to $40,000 in cash, according to Realcomp data—even as, a few miles away in downtown and Midtown, homes and lofts sell for $250,000 or more, according to records. Indeed, according to the Urban Institute, in 2014, 97% of Detroit homes sold for cash—nearly thrice the national average of 36%; cities with comparable populations, such as Memphis, Columbus, and El Paso, last year had at least five times as many mortgages as the approximately 710 mortgages sold in Detroit, according to data from RealtyTrac, a California-based company that tracks real estate. Indeed, according to the Urban Institute, Detroit once had one of the highest rates of home ownership among African-Americans nationwide; but, today, the city is majority renters: since 2000, the percentage of renters has increased to 53 percent from 45 percent, according to the U.S. Census.

Don’t Bank on the City’s Future. A key fiscal issue appears to be the reluctance of banks in Detroit to offer home mortgages for less than $50,000, a figure higher than many Detroit homes are worth—a seeming legacy of the sharp withering of assessed property values after the real-estate crash. Moreover, acquiring clear titles necessary for mortgages has become more difficult, because all too many Detroit homes have liens, and way too many are in such disrepair that making them livable can multiply purchase prices. Then, almost as if adding injury to insult, current federal regulations promulgated after the crash have increased the cost of issuing mortgages. Indeed, according to the Urban Institute: only one in five Detroit residents have credit scores high enough to obtain a mortgage. Erica Ward Gerson, Chair of the Detroit Land Bank, notes that Mayor Duggan, even before he took office three years ago, had recognized how critical mortgages would be to the city’s fiscal recovery: he went, in 2015, to Denver to the Clinton Global Initiative America to plead his case to the former President and leaders of foundations and banks: afraid that low appraisals and the refusal to loan small amounts would undercut any long-term recovery chances for the city. That leadership turned out to be key: In the wake of Mayor Duggan personally taking at least one bank leader on tours of stable neighborhoods in Detroit where lending was impossible, Ms. Gerson noted that in “lightning speed,” five banks, community foundations, and nonprofits teamed to form the Detroit Home Mortgage program, which removes barriers to lending and issues mortgages for up to $75,000 more than appraised value. Now, in this new initiative, announced in February, the Mayor hopes to secure financing for 1,000 mortgages over the next 3-5 years.

Governing from Afar. It is now expected to take the PROMESA Oversight Board several more months to set up the administrative structure to pass judgment over the budgetary impact of every law enacted by Puerto Rico; nevertheless, the announcement that this process will be set in motion marks the consolidation of Puerto Rico’s public finances, coming just as Puerto Rico bondholders and bond insurers have repeated a request to the Oversight Board to initiate immediate debt negotiations. The Ad Hoc Group of GO Bondholders, which had requested the negotiations get started last week, had joined with other creditors in asking the PROMESA Board to commence negotiations this morning in New York City, with the creditors having rejected the Board’s request for a mediator to oversee the negotiations. The creditors complained it would take too long to set up the mediation ground rules and that there are only a few weeks to complete the debt negotiations, writing they had “all agreed not to participate in a mediation that lacks basic process,” seeking to trigger the PROMESA provision on a consensual debt negotiation process, which can run until May 1, when a stay on litigation allowed by PROMESA and the board will end. PROMESA Board Chair José Carrión III, for his part, has claimed that his plan is not to create a “super government,” at least in terms of the amount of people in the organism, notwithstanding that the Board’s new executive director and former Ukraine Minister of Finance, Natalie Jaresko, has been tasked with creating an office which, among other things, should have the capacity to pass judgment over the fiscal impact of each law passed in the last few months and those which might be ratified from now onward—or, as the Chairman describes it: “She will start hiring (personnel), of whom the vast majority will be Puerto Rican. We are searching for people who don’t just see this as an employment opportunity, but as a patriotic duty.”

To date, the PROMESA Board’s primary task has been to certify a long-term fiscal plan, but now the hard part of agreeing on the details and putting the legislative process under the magnifying glass commence—much like the long and painful process of reaching resolution of a plan of debt adjustment under chapter 9. To date, via letters addressed to the Governor and the leaders of the legislative chambers, the PROMESA Board first established a work calendar to which the Puerto Rico Legislature is to comply with the budget the Governor must submit before the end of the month—then granting the legislature just two weeks in May to assess and amend said budget—upon which the PROMESA Board will have the final say. Indeed, if, by the end of June, the Governor and the Legislature have not complied with the Board’s mandates, the Board—which has powers greater than Puerto Rico’s elected officials—could impose its own budget for Puerto Rico’s FY2018 year that begins on July 1st.

The process, in contrast to chapter 9 in local governments, will not include all branches; rather, the PROMESA Board is expected to continue to makes its exchanges with the Governor—not the legislators, which make up a branch of government with two leaders and where, at least on paper, Senate President Thomas Rivera Schatz promises to ignore the members of the fiscal authority. Indeed, according to PROMESA, the exchange related to the revision of every law is made directly with the Governor, to whom the Board has granted seven days—after the statute is adopted—to present the fiscal impact estimate, if any, on the Governments revenues and expenditures. Or, as former Senator Fernando Martín, who is the executive president of the Puerto Rican Independence Party, put it: “As long as they take their draconian powers seriously, I believe they will do what they announced: examine passed legislation; repeal any legislation that proves contradictory with the fiscal plan; or, to soften the blow, try to make the Legislature modify it,” adding that the PROMESA Board’s defense against the Government of Puerto Rico’s bondholders is to be rigorous in controlling expenses: “Paraphrasing the current Governor’s father, the worst is yet to come: austerity, by itself, cannot be a recipe,” rather they will have to encourage solving “the structural problem in the relations between Puerto Rico and the U.S., since the solution means ending colonialism”.

Mr. Martin believes that the Governor—as the leader of the Executive branch—, the Senate President, and the House Speaker could have the judicial strength to sue: “If the Governor accepts my call to challenge the Board and the intervention in the Island’s governmental affairs, I am more than willing to help combat the Board. If I was Governor and they rejected a law I signed, I would challenge the Board’s actions in court.” However, because the PROMESA Board was imposed by Congress, in exchange for offering Puerto Rico the possibility of a quasi-chapter 9 territorial bankruptcy procedure, and because the federal law bases the Board’s control over the Island on the power Congress has to legislate through the territorial clause of the United States Constitution; it would seem his advice would be unlikely to pass judicial muster—even as Mr. Martin notes: “The Governor of Puerto Rico is Ricardo Rosselló, elected by the people’s votes. It is not Mr. Carrión. Even though Ricardo Rosselló does not belong to my party, I respect the position he holds and the power he has according to what is established by our Constitution.” Ferrer added.

Donde Estamos? Currently, while the PROMESA Board is still reviewing the workday reduction for public employees and the elimination of the Christmas bonus if its members believe that there will not be enough cash in the coffers by July 1st, the tax reduction for doctors would cost $185 million per year. Thus, the Representative from the New Progressive Party, José Enrique “Quiquito” Meléndez, opines that Governor Rosselló’s government has had “a particular worry,” which is if the Board’s power over Puerto Rico’s laws includes measures passed before the certification of the fiscal plan. Ergo. Rep. Meléndez considers that the one with the greatest cost will be the doctors’; however, among the laws which would be subject to the Board’s review would lie the financing for the plebiscite and the office of the Inspector General—or as he described it: “The plebiscite’s impact is not substantial, even without the $2.5 million that the federal government can grant.” The cost of the plebiscite—whose possible celebration is mentioned in PROMESA, has been estimated at $5 million at least—an amount that Mr. Martín does not foresee that the Board would want to say that holding a consultation on Puerto Rico’s political future, even under a Board that could only exist under the territorial status, to be “a superfluous cost.”

The Uneven Shape of Colonial Governance. Because of the PROMESA Board’s absolute power over Puerto Rico’s elected officials and even the finances of the Puerto Rico Judicial Branch, the governance situation appears to be without precedence since Congress granted Puerto Rico a structure to form a local government.

Re-Thinking Municipalites’ Post-Bankruptcy Futures

eBlog, 9/14/16

In this morning’s eBlog, we consider the foundering fiscal state of the Detroit Public School system—a system so vital to the city’s long-term fiscal recovery; then we try to prep for next November’s elections in San Bernardino—its first post-bankruptcy election—when citizens will determine the city’s future charter. Can a city remake itself? Then we head east to another question about remaking of a city: for insolvent East Cleveland—and adjacent Cleveland, would consolidation make better sense than municipal bankruptcy? After that, we jet south to Dade County, Florida to ask what will be next – might it be municipal bankruptcy? – for the small municipality in Dade County of Opa-locka. Finally, we consider the inexcusably delayed state of the implementation of the new PROMESA law Congress adopted last June.

An Unpassing Grade? For the second time in two months, the Detroit Public Schools’ state-backed debt credit rating has been downgraded—raising apprehensions that the bonds may not be refinanced by the start of the state’s new fiscal year—with the schools already open, and that new fiscal year just 16 days away.  S&P Global Ratings wrote it had cut its rating on bonds held by the former Detroit public school district from BB to B for those issued in 2011 and BB- to B for those issued in 2012, noting: “The downgrade is based on the lack of a finalized plan regarding bondholder repayment terms following the district’s recent restructuring, and the resultant elimination of a pledged revenue stream at the end of the state’s fiscal year.” In her report, S&P credit analyst Jane Ridley noted: “Although the Michigan Finance Authority’s intent is to take out the existing debt at full value, in our view, as October looms closer and ushers in the new fiscal year, it creates greater uncertainty as to whether bondholders will receive full and timely payment on their bonds.” Danelle Gittus, a spokeswoman for the Michigan Department of Treasury, attributed the downgrade to the $617 million rescue package: “The focus of the downgrade is on bonds that are being refinanced as part of the recent DPS legislation…This downgrade does not impact the ability to refinance the bonds. The Michigan Finance Authority continues to work on a financing plan to refund the bonds, which is expected to be completed later this month. Once the bonds are refunded, the rating becomes irrelevant.” What is, however, relevant, is that S&P has now displayed an increasing lack of confidence: it has cut its ratings on the Detroit school debt by six levels between late June and mid-August, placing them in junk status. The issue is if S&P is giving the system and state program such failing grades, what kind of message might that give to young families with kids who are thinking about moving into Detroit?

Actually, we are beginning to have the answer to that question, as, yesterday, lawyers representing Detroit schoolchildren filed suit against Gov. Rick Snyder and state officials in what they are terming the nation’s first federal case that pushes for literacy as a right under the U.S. Constitution: their complaint alleges that the state has denied Detroit students access to literacy — the most basic building block of education—through decades of “disinvestment…and deliberate indifference.” The suit seeks significant remedies, including a statewide accountability system in which the state “monitors conditions that deny access to literacy” and intervenes. In plain words, as attorney Mark Rosenbaum described it yesterday outside the U.S. District Court: “For the last 15 years, the state has run the Detroit schools, has run them into the ground.”  The suit documents the low reading and math proficiency rates of Detroit students, as well as classes without teachers and outdated or insufficient classroom materials; it also notes poor conditions, including vermin and building problems, at some schools as recently as this month. The seven plaintiffs are students listed by pseudonyms who attend some of Detroit’s lowest-performing schools, of which three are run by the Detroit Public Schools Community District. In addition to naming Gov. Rick Snyder as a defendant, the suit also names the Michigan state Board of Education, state school Superintendent Brian Whiston, David Behen, Director of the Michigan Department of Technology, Management and Budget, and Natasha Baker, the state school reform officer. In response, John Austin, President of the Michigan state Board of Education, said he did not believe the state board merited being the target of the suit, because it has made recommendations to the Governor and legislature for increased education funding — and it, itself, has no power to approve such funding—or, as he plainly put it: “It’s the Legislature that holds the purse strings, and the Governor who proposes budgets.” Indeed, for anyone who cares about Detroit’s long-term recovery from the nation’s largest ever municipal bankruptcy, Kathryn Eidmann, a staff attorney for Public Counsel, yesterday said attorneys in the case decided to focus on Detroit because it has the lowest proficiency rates of any large urban school district in the country on national assessment tests. The suit charges that students in Detroit do not have adequate supplies, the textbooks are outdated, classrooms are overcrowded, and school buildings are dangerous: or, as alleged in the suit: “In one elementary school, the playground slide has jagged edges, causing students to tear their clothing and gash their skin, and students frequently find bullets, used condoms, sex toys, and dead vermin around the playground equipment,” adding that students are taught by insufficient or unqualified staff, with many schools lacking properly trained teachers assigned to classes within their area of expertise. The suit charges that by its actions and inactions, “the State of Michigan’s systemic, persistent, and deliberate failure to deliver instruction and tools essential for access to literacy in plaintiffs’ schools, which serve almost exclusively low-income children of color, deprives students of even a fighting chance,” bringing its claims under the 14th Amendment of the U.S. Constitution and the Civil Rights Act.

Can a City Remake Itself? Leaders of the campaigns for and against implementing the proposed new city charter in San Bernardino are set to debate tomorrow evening as the city awaits next month’s likely exit from the nation’s longest ever municipal bankruptcy and then November’s election in which the city’s voters will consider Measure L, a proposal to replace the city’s existing charter. The debate, hosted by the Verdemont Neighborhood Association and moderated by Michael Craft, the association’s co-president and a member of the city’s charter review committee (Mr. Craft has been neutral on Measure L), will feature John Longville, president of the San Bernardino Community College District board of trustees and previously a member of the state Assembly and Mayor of Rialto versus James Penman, San Bernardino’s long-time (26 years) City Attorney until his retirement three years ago. The charter functions as the city’s constitution. The existing charter was first passed in 1905 and periodically amended, while the proposed new one was mostly based on a national model and how other mid-sized cities typically operate today. Three years ago, in our report, we noted—with regard to the charter: “In the estimation of most individuals, a key challenge for the city is in its charter. Decision-making authority over budgets, personnel, development and other matters is fragmented between and among the mayor, city manager, city council and city attorney—as well as several boards and commissions. Elected officials do not have the power to alter the salary calculations resulting from these provisions (except through voluntary negotiations with the representatives of that set of employees). These provisions greatly reduce the ability and flexibility of the city to adapt to economic and fiscal conditions as they change over time.”

Unlocking Opa-locka. David Chiverton, the former City Manager of insolvent Opa-locka, the small municipality of about 16,000 in Florida, plead guilty Monday to accepting pay-offs in his former capacity as city manager in entering a felony plea in federal District Court for improperly paying himself city benefits: his felony: extortion and accepting bribes; prosecutors charge Mr. Chiverton participated with other city officials to solicit pay-offs in exchange for using their official positions to help residents and businesses obtain city services and deal with billing issues. His plea is similar to one entered by the city’s former Public Works supervisor last month of guilt for bribery. In each instance, the former city officials have agreed to cooperate with investigators against other Opa-locka officials in return for lighter sentence recommendations. The pleas come as a Florida state financial oversight board is seeking to prevent Opa-locka from payment default on its bonds and, ultimately, filing for municipal bankruptcy. In Florida, one of eighteen states that authorize municipal bankruptcy, the statute §§218.01, requires that to file, a municipality must first receive prior approval from the Governor. While two utility and two transportation districts have previously filed, no Florida municipality ever has. Indeed, the state is already involved, with, as we have previously noted, Florida Chief Inspector General Melinda Miguel, chair of the Governor’s appointed state oversight board, having ordered city officials to develop procedures to segregate financial duties and prevent the kind of improper access Mr. Chiverton had obtained. (Note: Mr. Chiverton also faces an ethics complaint filed with Miami-Dade County for the benefit payouts.) Mr. Chiverton has also been accused of accepting bribes in return for using his influence to obtain city licenses and preventing water from being shut off for delinquent payments, according to court filings—this has been an exceptionally leaky problem for the city: after examination of its water and sewer accounts, the state oversight panel found Opa-locka’s collection rates are as low as 27% and that many properties are not even being billed—findings which contributed to the takeover of the billing by Miami-Dade County—which the small municipality has also requested to extend it a loan because Opa-locka’s general fund balance is so low it is projected to run out of funds soon to pay for basic services and make payroll.

Off to a Rocky Start? What Promise Is there in PROMESA? Last June, when Rep. Nydia M. Velázquez (D-NY) released her statement regarding the Senate passage of legislation allowing Puerto Rico to restructure its debt, she noted: “I know first-hand that the situation in Puerto Rico is extremely dire.  And as I stated on House passage, PROMESA is far from perfect, but it is better than the alternative of taking no action at all.  Debt restructuring is an essential first step – and without it, the island would not be able to move forward…Now that we have passed PROMESA, Congress has the legal and moral responsibility to come together again and finish its work regarding Puerto Rico. We must provide new tools so that the island can rebuild its economy for the long-term.  And, we have to resolve the island’s colonial status once and for all – without doing so, the people of Puerto Rico cannot truly move forward. In this regard, I look forward to working again with my colleagues to pass additional legislation in the coming months.” The implementation of PROMESA—especially the appointment of members of its oversight board, has, however, raised increasing questions about the federal commitment. The members were not named until August 31st; consequently, as the Board’s non-voting member, Richard Ravitch, yesterday noted after returning from Puerto Rico: members of the newly appointed Puerto Rico Oversight Board do not begin to fully understand or appreciate the depth of the fiscal problems they will have to address—comments he made both on the basis of his visits with senior Puerto Rican leaders and after talking with several of his colleagues on the oversight board; nevertheless, he noted: “I think they are going up a learning curve.” He added, he anticipates the board will probably hold its first meeting in Washington, D.C. next week—a meeting at which, presumably, he will report back on his meeting this week with Puerto Rico Gov. Alejandro García Padilla, who had advised him that Puerto Rico’s financial situation is substantially worse than it was this past winter, warning the government is in “deep” distress.

Will a City’s Residents Agree to Cede Autonomy? The ongoing uncertainty about insolvent East Cleveland’s future—whether it would be willing to cede its autonomy and control (not to mention a mostly-black community afraid of being subject to Cleveland’s police force, where, not unlike in Ferguson, the city has accepted and agreed to U.S. Justice Department exacting standards with regard to how and in which circumstances may its officers use force, as well as ongoing federal oversight—all as part of what the Justice Department has termed a pattern of unconstitutional policing and abuse, ergo triggering DOJ-mandated training in Cleveland—to be annexed or incorporated into the City of Cleveland is a harrowing issue—as well as one conflicted by Cleveland’s apprehensions that such incorporation would appear to create more negative fiscal downsides than upsides, both in terms of significant fiscal challenges, and significant new fiscal burdens on its police resources. Nevertheless, it might be that the discussion appears to be triggering what one blogger asked: should we be rethinking, after decades of glorifying the concept of home rule, that the accumulation of so many fragmented small political bodies makes fiscal sense. But, then, one has to consider not just the political challenges—but equity issues: does one propose to consolidate just the poor, struggling, disinvested entities together in one jurisdiction, but leave the well-off municipalities?  Last spring at my very favorite Lincoln Institute of Land Policy, at a journalist forum, Oklahoma City Mayor Mike Cornett spoke about his city’s amazing turnaround, followed by a searing speech from Sen. Dan Kildee (D-Mi.) contrasting the ways in which Flint been harmed by external forces. But the underlying issue is, when consolidating governments, it is one thing—as occurred in Oklahoma City—to annex wealthy enclaves and productive tax-generating areas. It is a whole other challenge to contemplate annexing adjacent jurisdictions with devastated tax bases and very high police needs.

The Exceptional Challenges of Municipal Recovery: Can a State–or the Federal Government–Make It Even More Challenging?

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eBlog, 9/02/16

In this morning’s eBlog, we consider the ongoing challenges to Detroit’s long-term recovery from the nation’s largest municipal bankruptcy: can it restore—via a unique Emergency Manager—its public schools to a level sufficient to attract families with children back into the city? Then we look southeast to the fiscal challenges and rising crime challenges of Ferguson, Missouri; and we ask to what extent has the federal government aggravated each of those challenges, potentially putting the municipality on a course to insolvency.   

New Math? According to a list released yesterday by the Michigan School Reform Office, more than a third of the lowest performing schools in the State of Michigan are in the Detroit Public Schools Community District (DPS): the list of 124 schools in the bottom 5 percent for academic achievement includes 47 in DPS. The School Reform Office also announced seven schools in which it found sufficiently improved student achievement to be removed from the list of failing schools, only one of which was in Detroit: a charter school, Frontier International Academy. The release of the highly anticipated priority schools list comes less than two weeks after the School Reform Office said low-performing schools across the state could be in jeopardy of closing; nevertheless, notwithstanding the large number of DPS schools on the list, a top aide to Gov. Rick Snyder said the Snyder administration believes the state’s $617 million DPS package would prevent any DPS school from being closed in the next three years. (Michigan law allows the School Reform Office to close schools which fall into the lowest 5 percent academically for three straight years.) John Walsh, Governor Snyder’s director of strategic policy, cited an August 2nd memo from the Miller Canfield law firm to DPS Emergency Manager Steven Rhodes which suggested the three-year countdown to close struggling schools was reset when those buildings were moved to a new, debt-free Detroit district last July. A spokeswoman for the Governor, Anna Heaton, yesterday said that no schools have been closed by the state since the priority schools list was established in 2010, noting: “We are following the law as written…Because Detroit is a new district, schools that were failing under the old district can’t be closed by the School Reform Office. Please note that they could still be closed by the district.” Interim DPS superintendent Alycia Meriweather said putting school closures on hold would provide the new Detroit district time to improve student performance: “The students of Detroit have a fresh start for a new educational opportunity as a result of this decision…I’d like to thank the Governor’s Office, State Legislators, and the SSRO for recognizing DPSCD as a new district as it relates to data, in the same way we are recognized as a new district legally and financially.”

Unsurprisingly, however, the Governor’s position attracted mathematical opposition from state Republican legislative leaders and charter school advocates, who argued that a three-year reset would give the Detroit public district an unfair advantage. In a statement, House Speaker Kevin Cotter said: “As a simple matter of common sense, it cannot be said with a straight face that the Legislature intended for the worst-of-the-worst schools in Detroit to remain open…This mistaken interpretation would also require failing charter public schools to be closed while failing traditional public schools are allowed to persist and drag down class after class of Detroit students, which is an absurd conclusion.” Senate Majority Leader Arlan Meekhof (R-West Olive) said he was disappointed by the Governor’s decision “to use the opinion of one law firm as a reason to eliminate a tool intended to help students in the Detroit Public School Community District,” noting the schools in question are persistently failing schools that are not educating Detroit children: “The Senate passed multiple bills that included mechanisms to close failing schools…Part of delivering a better education to the students of Detroit includes the ability to right-size the district to meet the needs of the community.”

The Trend Gap & Federal Intervention: What Are the Implication’s for Municipal Solvency? A year ago last March, the U.S. Justice Department released a report finding racial bias and discrimination pervading police and court practices in Ferguson, Missouri, the small city of just over 20,000, majority black, with nearly one-third female householders with no husband present. Mayhap ironically, the report came just over a year after the Boston Federal Reserve tag team of Bo Zhao and David Coyne released their working paper, “Walking a Tightrope: Are U.S. State and Local Governments on a Fiscally Sustainable Path?” In its report, the Department of Justice argued that the Ferguson Police Department and the City of Ferguson relied on unconstitutional practices in order to balance the city’s budget through racially-motivated excessive fines and punishments. U.S. Attorney General Eric Holder said the federal government would use all the power it had, including dismantling the Ferguson Police Department—a threat which the city’s then-Mayor warned could mark the first time in U.S. history that the federal government might force a city into chapter 9 municipal bankruptcy. Indeed, Moody’s has placed the city’s already junk-level rating on review for downgrade because of threats to the city’s solvency—with the downgrade of the city’s general obligation rating reflecting what the credit rating agency described as “the continued pressure on the city’s finances from a persistent structural imbalance and incorporating the recently approved U.S. Department of Justice (DOJ) consent decree, projected to increase annual General Fund expenses over the next several years.”

The downgrade also took into consideration the outcome of last April’s ballot election, in which voters rejected a proposed property tax hike (but approved a sales tax for economic development). Both ballot measures were integral to city management’s proposed solution to close a large General Fund budget gap that existed before accounting for the additional federal consent decree costs. (Moody’s had updated its assessment after the U.S. Justice Department filed a lawsuit last February, marking the latest setback in Ferguson’s struggle to recover from a controversial police shooting in 2014.) The Justice Department also accused the City of Ferguson of policing and municipal court practices that violated constitutional and federal civil rights. The credit rating company had noted that its rating concerns had been driven by the uncertainty of the potential financial impact of litigation costs from the lawsuit and the price tag for implementing the proposed DOJ consent decree: “We believe fiscal ramifications from these items will be significant and could result in insolvency.”

Today, two years after the shooting of Michael Brown put a national spotlight on Ferguson police and provoked the Justice Department fiscal intervention, Ferguson is fiscally pressed to maintain the number of police officers it needs: its department is facing 13 vacancies; the staff is more than 30% reduced from just two years ago. The combination of federal unfunded mandates and fines combined with officer fatigue and stress from months of Ferguson protests may be emboldening criminals and contributing to an uptick in crime. Ferguson Police Chief Sam Dotson and St. Louis County Chief Jon Belmar suggest that their forces may not be large enough to handle the “new normal:” Aggravated assaults and robberies are up in both jurisdictions since Michael Brown was shot to death, but arrests are down. Or, as Chief Dotson calls it: “It’s the Ferguson effect: I see it not only on the law enforcement side, but the criminal element is feeling empowered by the environment.”

Financial constraints, including federally imposed financial penalties, related to the fallout since Mr. Brown’s death, including legal fees, reduced municipal court revenue, and costs for Justice Department-mandated changes have given the city little choice but to reduce the authorized number of officers to 49 compared to 55 two years earlier.

Ferguson voters last month approved a utility tax hike which is projected to generate $700,000 annually, the municipality’s second voter-approved tax increase this year—and, in this instance, a critical step: had the measure failed, the police force’s authorized number would have been reduced to 44, and firefighter jobs would also have been cut. Mayor Knowles said last month’s action by the Council to increase the tax was intended to make clear the city is fiscally stable; he added that the city has received 20 new applicants for the police force since it was approved, noting: “I think we’re seeing more confidence in Ferguson now, and hopefully we’ll get more qualified candidates.”  

Might there Be a Federal Role in Causing Severe Municipal Fiscal Distress?

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eBlog, 8/23/16

In this morning’s eBlog, we revisit Ferguson, Missouri—a small municipality in St. Louis County struggling to recover from racial violence and an expensive U.S. Justice Department imposition of subsequent unfunded fiscal mandates. Yesterday, a federal judge found the city’s school board election system biased against black voters. The judge’s findings and a Moody’s downgrade combine to raise questions with regard to the municipality’s solvency: has the U.S. Justice Department unintentionally made the small city a candidate for municipal bankruptcy? It brings back to mind, in addition, an old question: are there too many municipalities in St. Louis County? Can we afford so many? Could a municipality dissolve itself? Then we turn to archipelago of the U.S. Virgin Islands—seemingly a hop, skip, and a jump from Puerto Rico, where the U.S. territory’s unbalanced budget, rising debt burden, and unfunded pension liabilities put still another U.S. territory at risk of insolvency.

Public Schools & Arithmetic. U.S. District Judge Rodney Sippel yesterday, writing that “The ongoing effects of racial discrimination that have long plagued the region, and the District in particular, have affected the ability of African-Americans to participate equally in the political process,” ruled that Ferguson, Missouri’s school board elections are biased against black voters. The suit, filed by the American Civil Liberties Union, claimed that the Ferguson-Florissant School District makes it unlawfully difficult for black candidates to win positions on the school board. Voters in the district elect school board members at large, rather than on a ward or sub-district basis, a process, Judge Sippel wrote, which has reduced black representation. Currently, three out of seven board members are black, a ratio that reflects the demographics of the city, the school district has argued. Black students make up four-fifths of the 13,200-student population. During the trial, a demographer demonstrated that Ferguson’s black population is concentrated and politically unified enough to affect results if the FFSD were divided into voting districts: black voters would constitute a majority in four out of seven of those theoretical districts. U.S. District Judge Rodney W. Sippel said that while he does not see evidence of intentional discrimination, there is a more subtle “complex interaction” of political processes that deter black voters from electing the candidates of their choice, writing: “Rather, it is my finding that the cumulative effects of historical discrimination, current political practices, and the socioeconomic conditions present in the District impact the ability of African-Americans in (the school system) to participate equally in Board elections.” The Ferguson-Florissant district serves about 11,200 students in parts of 11 municipalities. About 80 percent of those students are black, and 12 percent are white. District residents are nearly evenly split between black and white. (The ACLU filed the lawsuit on behalf of the Missouri National Association of the Advancement of Colored People in the wake of protests over the shooting.) The court decision comes in the wake of Moody’s placing the city’s already junk-level rating on review for downgrade because of threats to the city’s solvency—with the downgrade of the city’s general obligation rating reflecting “the continued pressure on the city’s finances from a persistent structural imbalance and incorporating the recently approved U.S. Department of Justice (DOJ) consent decree, projected to increase annual General Fund expenses over the next several years. The downgrade also took into consideration the outcome of an April 5 ballot election, in which voters rejected a proposed property tax hike (but approved a sales tax for economic development). Both ballot measures were integral to city management’s proposed solution to close a large General Fund budget gap that existed before accounting for the additional consent decree costs. Moody’s had acted after the U.S. Justice Department filed a lawsuit in February, marking the latest setback in Ferguson’s struggle to recover from a controversial police shooting in 2014. The Justice Department accused Ferguson of policing and municipal court practices that violate constitutional and federal civil rights. The credit rating company had noted that its rating concerns had been driven by the uncertainty of the potential financial impact of litigation costs from the lawsuit and the price tag for implementing the proposed DOJ consent decree: “We believe fiscal ramifications from these items will be significant and could result in insolvency.”

Is there Promise from PROMESA? Fitch ratings has reduced the U.S. Virgin Islands’ bond ratings to junk level, citing the U.S. territory’s unbalanced budget, rising debt burden, and unfunded pension liabilities. Fitch noted that the enactment of the PROMESA legislation for neighboring Puerto Rico could open the door for a comparable restructuring of the Virgin Island’s debt. The territory, where the author trained for his Peace Corps service in Liberia, West Africa, is comprised of a number of islands in the Caribbean not far from Puerto Rico. The islands cover just under 134 square miles and boast a population of just over 100,000. Tourism is the primary economic activity, with the manufacture of rum a significant sector. The islands are classified as a non-self-governing territory—one which since 1954 has held five constitutional conventions—with its most recent, its fifth, adopting in 2009 a proposed Constitution—one rejected by Congress the following year, with Congress urging the convention to reconvene to address the concerns Congress and the Obama Administration had with the proposed document. The convention subsequently reconvened in October of 2012, but was not able to produce a revised Constitution before its October 31 deadline. In its ratings, Fitch downgraded the Virgin Island’s gross receipts tax bonds, affecting $722 million in debt; Fitch also downgraded the territory’s senior lien matching fund revenue bonds to BB from BBB and subordinate lien matching fund revenue bonds to BB from BBB-minus. In amounts of debt, the former affected $773 million and the latter affected $428 million. Fitch also downgraded the Virgin Islands’ issuer default rating to B-plus from BB-minus. In its release, Fitch noted that the Virgin Islands plans to sell $217 million in gross receipts taxes bonds, $126 million in senior lien matching fund bonds, and $69 million in subordinate lien matching fund bonds near the end of next month—noting that the U.S. territory has a “severely unbalanced operating budget” and multiple years of borrowing to fund operating needs—and is expected to feature ongoing budget imbalances: its debt burden has increased, and its unfunded public pension liability has increased at a faster pace.

The Import of Integrity to Municipal Solvency

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eBlog, 5/25/16

In this morning’s eBlog, we consider the ongoing struggle of the small municipality of Ferguson, Missouri to find the revenues to comply with onerous federal mandates—penalties that risk the municipality’s fiscal future. We watch and await the outcome of House Speaker Paul Ryan’s and House Natural Resources Committee Chair Rob Bishop’s (R-Utah) markup of legislation to address Puerto Rico’s looming insolvency; and, finally, we observe the desperate fiscal collapse of the small municipality of Opa-Locka, Florida—where a combination of seeming malfeasance and fiscal distress seems certain to force a choice between municipal bankruptcy or a state takeover.

Will the Federal Mandate Help or Hurt Municipal Solvency? Voters in Ferguson, Missouri will be forced back to the polls this summer by still another unfunded federal mandate: they will vote on whether or not pay a higher utility tax in order to raise still more revenues to address U.S. Justice Department unfunded mandates to revamp the city’s police department and municipal court system—with Mayor James Knowles III and the City Council meeting Sunday to consider whether to place a 2-percent increase in the city utility tax on the August ballot—a consideration to which they unanimously agreed, even as they voted to table a proposed property tax hike also intended to help meet the city’s financial obligation under the city’s imposed agreement with the Justice Department. The unique Sunday session was forced by yesterday’s St. Louis County election deadline for items to appear on the August 2nd. But their decision was not unanimous—as some councilmembers supported submitting both tax hikes to voters, even though city voters had, earlier this year, rejected a proposed property tax increase. Nevertheless, there was consensus that gaining approval of two tax increases in one election to satisfy not the city’s residents, but rather the federal government, would be an uphill battle. In addition, while the utility tax increase needs only simple-majority approval for passage, any property tax increase would require approval by two-thirds of voters.

Mayor Knowles noted that he believes voters would support a higher utility tax even if it would not end all the city’s budget problems, or, as he put it: “I think we can stop some of the bleeding and keep up services with the utility tax.” The city estimated a 33% utility tax hike from 6 to 8 percent would generate $700,000 in annual revenue; whereas the potential property tax hike increase would have raised $500,000 annually. The utility tax hike would, if approved, come on top of the half-cent municipal sales and use tax increase adopted last April for economic development. The exceptional challenge for the small municipality as it works to adopt its FY2017 budget by the end of next month is how to balance federal mandates versus maintaining current services and not laying off three firefighters. While the federal government does not worry itself about balancing the federal budget, such imbalance is not an option for states, counties, or cities. City leaders are crossing their fingers in hopes there might be some federal grant funds that would help to address some of the costs of meeting Justice Department requirements that mandate police staffing levels, including—as we have observed on the opposite end of the country in San Bernardino, transferring some emergency response dispatching to St. Louis County.

The Promise of PROMESA. House Natural Resources Committee Chair Rob Bishop (R-Utah) opened yesterday’s markup of (HR 5278), the Puerto Rico Oversight, Management, and Economic Stability Act (PROMESA) by stating: “Puerto Rico is in the midst of a financial and economic crisis of historic proportions…Article IV of the U.S. Constitution states: ‘The Congress shall have Power to dispose of and make all needful Rules and Regulations respecting the Territory and other Property belonging to the United States.’ Stating the obvious, Puerto Rico is an American territory. Therefore, Congress has the power to enact laws affecting Puerto Rico. However, with power comes responsibility. Power without responsibility leads to tyranny on one hand, or abject neglect on the other. For too long, Congress has neglected its duties under Article IV. Congress has sown the wind, and Puerto Rico has reaped the whirlwind. We have a constitutional, political, and moral imperative to act, and this Committee has done so. Given the crisis, the question before us today is whether we fulfill this constitutional responsibility. H.R. 5278, the Puerto Rico Oversight, Management and Economic Stability Act, or ‘PROMESA’ establishes an Oversight Board to work with the government of Puerto Rico. The Board will audit their finances, figure out the true asset picture, and develop fiscally responsible budgets to repay creditors and meet basic human needs. It will restore the island’s access to credit markets, and review laws, regulations, and expenditures to assure compliance with fiscal plans and fair treatment of investors…This bill is Puerto Rico’s last and best chance to get on sound financial footing and put its economy on the path to recovery and prosperity…”
The markup which the Chair expects to complete today, has gained bipartisan support: it would create a mechanism for Puerto Rico to restructure $72 billion in debt and establish a financial control board. With the Memorial Day recess, however, the Committee’s reported bill is unlikely to go to the full House until next month, after the Memorial Day recess.

The markup commenced even as Puerto Rico Gov. Alejandro García Padilla late Monday proposed a budget for the upcoming fiscal year with 86% less allocated to pay debt service than the approved current-year budget: he stated his budget includes $209 million for interest payments on Puerto Rico’s debt; however, his proposal does not provide for funding for principal payments in the coming fiscal year. His comments left uncertain the fiscal treatment of the U.S. territory’s public authorities, municipalities, or the Puerto Rico Sales Tax Finance Corp. (COFINA); their debt is not paid from the General Fund. Gov. Padilla said that his proposed spending level was $9.1 billion for the new fiscal year—a level which, he said, would not require any new borrowing or any tax increases; nor would it, he said, force reductions or eliminations of several programs, even as he proposed increases in the budget’s contributions to certain items such as the teachers’ and employees’ pension systems and the Puerto Rico Medical Center. The Governor’s remarks came even as the Puerto Rico House of Representatives voted overwhelmingly to override the Governor’s veto of the legislature’s rejection of an increase in business-to-business taxes from 4% to 11.5%–a vote the Puerto Rico Senate is expected to take up anon.

Nopealocka? In a city government close to insolvency, Opa-locka, Florida, City Finance Director Charmaine Parchment broke ranks and warned her supervisors the city will run out of money after its payroll next week and that its recovery plans will not be enough to save Opa-locka from insolvency. Ms. Parchment on Sunday emailed acting city manager Yvette Harrell to report that the small municipality’s budget deficit is three times larger than what the city has revealed to its taxpayers; she demanded that her name be removed from a city recovery plan submitted to the state, adding: “After the next payroll, the city will not be able to pay its bills.” Opa-locka, a small municipality inside Dade County of about 6,000 households, but with a vacancy rate nearing 15 percent, and where more than one-third of households are headed by a female householder with no husband present, and nearly 30 percent are non-families—and where nearly one-third of families fall below the poverty level, is a potpourri of Cuban, Dominican, and Haitian residents with very low per capita annual incomes. The foundering municipality operates under a commission/city manager form of government: incorporated in 1926, its city commission consists of the mayor and four commissioners, who are responsible for enacting ordinances, resolutions and regulations governing the city. In 2004 Opa-locka had the highest rate of violent crime for any city in the United States; in an editorial nearly a decade later, a Miami Herald editorial described the municipality as “crime-plagued” with a “steadily deteriorating” police department—a department which had decreased from 50 to 16. Nevertheless, Ms. Parchment’s email appears to present an even more depressing and urgent fiscal distress picture than what has been made publicly available by either the city’s elected or senior appointed officials—including City Manager David Chiverton, who pledged at a public meeting earlier this month that Opa-locka would have a balanced budget by the end of the fiscal year—a far cry from what Ms. Parchment instead estimated would will soon be a $4.5 million deficit. Now, with City Manager Chiverton an apparent target of an FBI investigation of bribery and kickback, the issue seems to be whether the municipality will be forced to seek chapter 9 municipal bankruptcy under Florida’s §218.01, or whether Gov. Rick Scott might, somewhat as in New Jersey, declare an emergency and impose a state takeover of the city (while utility and transportation districts in the state have filed for chapter 9, no municipality has). For months, Opa-locka’s elected officials have been alerted about the looming fiscal collapse, but the city fired former City Manager Steve Shiver last November in the wake of his alerting state officials about the mounting municipal debts that had reached $8 million. Similarly, a financial task force warned that the city would have to make drastic cuts. Nevertheless, as City Commissioner Terence Pinder stated: “They kept kicking the can down the road.”

What Are the End Games in East Cleveland, Atlantic City, & Puerto Rico?

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eBlog, 5/13/16

In this morning’s eBlog, we wonder if the end game is nearing in East Cleveland—and what lessons might be learned with regard to growing fiscal disparities—and where municipal bankruptcy falls short. We observe the hint of an end game in Atlantic City—and muse about apprehensions about fallout or municipal contagion from the almost certain state takeover of Atlantic City. Finally, we try to update readers on the evolving efforts in the U.S. House of Representatives by House Speaker Paul Ryan to help Puerto Rico—watching, at the same time, for what the looming U.S. Supreme Court decision on Puerto Rico expected the day before the U.S. territory is projected to default on as much as $1.9 billion might mean to the efforts in Congress.

A City on the Brink. The City of East Cleveland has scheduled a public meeting for next Thursday to discuss finances, potentially filing for municipal bankruptcy, and updates on a potential East Cleveland-Cleveland merger. The session is scheduled in the wake of Ohio Tax Commissioner Joe W. Testa’s notification to the City with regard to a list of items the city must prepare before requesting approval of its request to file for chapter 9 municipal bankruptcy. The reply came as the city is considering what such a filing might mean with regard to a possible merger with the City of Cleveland—a merger which would require a comparable, detailed fiscal plan, similar to one required for federal bankruptcy court. Either would require legal assistance—in effect draining away already diminishing fiscal resources. In East Cleveland’s case, the decision how to proceed is further complicated in that chapter 9 is a federal tool to permit a municipality to address debt—something which East Cleveland hath not: its problem is insufficient and eroding revenue, so that its ability to finance essential services, such as police and fire, is increasingly at risk. However, Council President Thomas Wheeler notes that municipal bankruptcy would protect the city’s assets, so that it can make payroll: East Cleveland currently struggles to make its $250,000 payroll every two weeks. Chapter 9 would also provide some options to renegotiate contracts that were made in “better times,” as well as address some of the city’s looming liabilities from pending suits against the city.

Indeed, East Cleveland currently struggles to make its $250,000 payroll every two weeks. That means, too, that with an eroding population and average annual family income of about $20,000 and nearly a 50 percent poverty rate, the option of raising taxes—as the U.S. Justice Department had insisted upon for Ferguson, Missouri, could be a self-defeating effort. East Cleveland’s fiscal slide has been such that it has not had a bond rating since 1988. The other option—a merger with the City of Cleveland—could be considered next week, when the Council will consider an ordinance to enter negotiation for annexation with Cleveland and to appoint three commissioners to represent the city in negotiations. There are, however, according to Cleveland Council President Kevin Kelley, no comparable efforts in Cleveland—although the state appears willing to appropriate as much as $10 million to facilitate such a merger. Council President Kelley seems uncertain what the impact of a municipal bankruptcy filing by East Cleveland would have on the discussions of a potential merger.

The End Game for Atlantic City? Senate President Steve Sweeney and Assembly Speaker Vincent Prieto came together behind the scenes yesterday and are, reportedly, close to resolving the crisis in Atlantic City—with the only—but very large only—risk that New Jersey Governor and VP aspirant Chris Christie might not sign it. With the end game nearing and a state takeover of the city increasingly likely, Atlantic City’s employees—where police and firefighters comprise two-thirds of the city’s payroll and command generous salaries, are evincing a willingness to make concessions—unsurprising concessions in the wake of Gov. Christie’s claim that Atlantic City had not “addressed the rich benefits and the salaries of the police and fire departments,” apparently savoring the power he would gain in a takeover, which would grant the state power to tear up their contracts: police officers and firefighters make up two-thirds of the city’s salary cost, according to a May 6 city employee list, and there are 418 public safety workers who earn more than $92,000 in base salary. But the potential savings might turn out to be less: of the reductions in the city’s budget under Mayor Don Guardian since last year, nearly $12 million has come from public safety — more than any other department — according to former emergency manager Kevin Lavin’s final report. In fact, the 2014 Hanson Report reported that “right-sized” police and fire departments for the city should include 285 police officers (there are now 282) and 180 firefighters (there are now 227, but the city only pays for 143 thanks to a federal grant). As for benefits, last year Atlantic City went to arbitration with International Association of Fire Fighters Local 198, the city’s the firefighters union, over the very same benefits the state has criticized the city for not reducing. The city’s position going in was to cut salaries and eliminate terminal leave, longevity and education incentives in their entirety, taking the position “the city cannot and will not be able to afford the extravagant benefits currently provided in the collective negotiations agreement,” according to the procedural background in the arbitration award. In the outcome, an arbitrator froze education and longevity pay for current firefighters, and eliminated the longevity benefit for firefighters hired after January 2012. In addition, terminal leave payouts were capped at $15,000 for firefighters hired after January 2010—changes that Mayor Guardian described Trump-like as “huge savings,” adding that the city was “looking for the same type of reductions in the police department.”

Contagion? In its “Issuer in Depth” update Wednesday, Moody’s looked at a related, key issue: contagion fallout for other New Jersey municipalities, commenting that “While Atlantic City is an extreme case and no other New Jersey municipality is currently facing such acute financial pressure, the state’s posture toward Atlantic City reduces the likelihood that it would unconditionally rescue other financially distressed cities. While the state has no legal obligation to support Atlantic City’s general obligation (GO) bonds, its historically strong support for local governments has bolstered the credit quality of financially weak municipalities in the past: Moody’s incorporated a potential change in the state’s perspective in a credit review of seven distressed cities last year. Going forward, the rating agency expects its ratings process to further consider the potential impact from a change in state oversight, noting: “This applies regardless of whether or not default is accompanied by Chapter 9 bankruptcy. A default can occur outside of bankruptcy and can take the form of a voluntary restructuring with bondholders.” The report notes that under the proposed state takeover bill that passed the New Jersey Senate, the state would be able to file for bankruptcy protection on behalf of the city with approval from the legislative Joint Budget Oversight Committee. In both cases, the city would also need to meet a number of preconditions under the Bankruptcy Code, including insolvency.

Puerto Rico. Work on Puerto Rico legislation in the U.S. House of Representatives has stalled yet again; however leaders in both parties insist they can see the finish line. House Natural Resources Committee Chairman Rob Bishop (R-Utah) said a markup is still on track for next week. The legislation, which House Speaker Paul Ryan (R-Wisc.) has been pressing for, also appears to have garnered bipartisan support, albeit House Minority Leader Nancy Pelosi (D-Ca.) said Democrats were unable to back the bill they saw Tuesday evening, but were committed to crafting a workable alternative, noting: “We were disappointed that the bill we saw yesterday wasn’t something we could support. And so another few days of back and forth, I think, will produce something that we can take to the floor…It absolutely must happen.” The difficulty has been to try to find a fine balance between establishing a financial control board, such as was previously created for both New York City and Washington, D.C., in return for allowing the island to restructure its $70 billion in debt. Remaining obstacles to agreement include proposals in the bill to allow a lower minimum wage to young workers in the U.S. territory. Nevertheless, House Natural Resource Committee Chairman Bishop believes there will “be a majority of Republicans and a majority of Democrats voting for it,” adding the effort “rises above a partisan bill.”

Here Come the Judges. The leadership efforts to assist Puerto Rico by Speaker Paul Ryan and Minority Leader Nancy Pelosi could be jolted by parallel action by the third branch, the Supreme Court, which could rule as early as the end of next month—the day before Puerto Rico faces a $1.9 billion debt payment that its Governor has said it cannot afford—on the validity of a Puerto Rico law which would allow Puerto Rico to restructure the portion of its debt issued by public agencies—or as much as $20 billion, in a bankruptcy-like process.[The Commonwealth of Puerto Rico v. Luis M. Sanchez and Jaime Gomez Vasquez] where the question before the Court is whether the Commonwealth of Puerto Rico and the federal government are separate sovereigns for purposes of the Double Jeopardy Clause of the United States Constitution. The pending House proposal would preempt the Recovery Act, the Puerto Rican restructuring law that was thrown out in U.S. courts prior to Puerto Rico’s appeal to the Supreme Court to reinstate it. Thus, a Supreme Court ruling could change the political dynamics for Congress by resurrecting a law that is viewed by those opposing the Ryan-Bishop bill as even less palatable. That is, were the Supreme Court to, in effect, reinstate the Recovery Act, the Bishop proposal might be perceived by hedge funds and other opponents to the pending bill to be the ‘lesser of two evils,’ because a reinstituted Recovery Act would allow Puerto Rico to restructure debt at public utilities like power authority PREPA and water authority PRASA—and maybe even expand the authority to cover other debts. Some commentators and tea leaf readers conjecture that last March’s oral arguments strongly hinted the Justices could uphold the law—effectively ramping up pressure on creditors heretofore opposed to the Ryan-Bishop efforts to reverse field and press for prompt passage of the soon to be revised PROMESA legislation, because of the perception the emerging federal legislation would provide more protections for municipal bondholders than the Recovery Act.