Motoring Back from Chapter 9 Bankruptcy

March 9, 2018

Good Morning! In this morning’s eBlog, we consider the state of the City of Detroit, the state of the post-state takeover Atlantic City, and the hard to explain delay by the U.S. Treasury of a loan to the U.S. Territory of Puerto Rico.

An Extraordinary Chapter 9 Exit. Detroit Mayor Mike Duggan yesterday described the Motor City as one becoming a “world-class place to put down your roots” and make an impact: “We’re at a time where I think the trajectory is going the right way…We all know what the issues are. We’re no longer talking about streetlights out, getting grass cut in the parks. We’re making progress. We’re not talking all that much about balancing the budget.” His remarks, coming nearly five years after I met with Kevin Orr on the day he had arrived in Detroit at the request of the Governor Rick Snyder to serve as the Emergency Manager and steer the city into and out of chapter 9 municipal bankruptcy, denote how well his plan of debt adjustment as approved by U.S. Bankruptcy Judge Steven Rhodes has worked.

Thus, yesterday, the Mayor touted the Detroit Promise, a city scholarship program which covers college tuition fees for graduates of the city’s school district, as well as boosting a bus “loop” connecting local charter schools, city schools and after-school programs. Maybe of greater import, the Mayor reported that his administration intends to have every vacant, abandoned house demolished, boarded up, or remodeled by next year—adding that last year foreclosures had declined to their lowest level since 2008. Over the last six months, the city has boarded up 5,000 houses, sold 3,000 vacant houses for rehab, razed nearly 14,000 abandoned houses, and sold an estimated 9,000 side lots. The overall architecture of the Motor City’s housing future envisions the preservation of 10,000 affordable housing units and creation of 2,000 new ones over the next five years.

The Mayor touted the success of the city’s Project Green Light program, noting that some 300 businesses have joined the effort, which has realized, over the last three years a 40% in carjackings, a 30% decline in homicides since 2012, and 37% fewer fires, adding that the city intends to expand the Operation Ceasefire program, which has decreased shootings and other crimes, to other police precincts. On the economic front, the Mayor stated that Lear, Microsoft, Adient, and other major enterprises are moving or planning to open sites: over the last four years, more than 25 companies of 100-500 jobs relocated to Detroit. On the public infrastructure radar screen, Mayor Duggan noted plans for $90 million in road improvements are scheduled this year, including plans to expand the Strategic Neighborhood Fund to target seven more areas across the city, add stores, and renovate properties. Nearly two years after Michigan Senate Majority Leader Arlan Meekhof (R-West Olive) shepherded through the legislature a plan to pay off the Detroit School District’s debt, describing it to his colleagues as a “realistic compromise for a path to the future…At the end of the day, our responsibility is to solve the problem: Without legislative action, the Detroit Public Schools would head toward bankruptcy, which would cost billions of dollars and cost every student in every district in Michigan,” the Mayor yesterday noted that a bigger city focus on public schools is the next front in Detroit’s post-bankruptcy turnaround as part of the city’s path to exiting state oversight. He also unveiled a plan to partner with the Detroit Public Schools Community District, describing the recovery of the district as vital to encourage young families to move back into the city, proposing the formation of an education commission on which he would serve, as well as other stakeholders to take on coordinating some city-wide educational initiatives, such as putting out a universal report card on school quality (which he noted would require state support) and coordinating bus routes and extracurricular programs to serve the city’s kids regardless of what schools they attend.

The Mayor, who at the end of last month unveiled a $2 billion balanced budget, noted that once the Council acts upon it, the city would have the opportunity to exit active state oversight: “I expect in April or May, we’re going to see the financial review commission vote to end oversight and return self-determination to the City of Detroit,” adding: “As everybody here knows, the financial review commission doesn’t entirely go away: they go into a dormancy period. If we in the future run a deficit, they come back.”

His proposed budget relies on the use of $100 million of an unassigned fund balance to help increase spending on capital projects, including increased focus on blight remediation, stating he hopes to double the rate of commercial demolition and get rid of every vacant, “unsalvageable” commercial property on major streets by the end of next year—a key goal from the plan he unveiled last October to devote $125 million of bond funds towards the revitalization of Detroit neighborhood commercial corridors, part of the city’s planned $317 million improvements to some 300 miles of roads and thousands of damaged sidewalks—adding that these investments have been made possible from the city’s $ billion general fund thanks to increasing income tax revenues—revenues projected to rise 2.7% for the coming fiscal year and add another $6million to $7 million to the city’s coffers. Indeed, CFO John Hill reported that the budget maintains more than a 5% reserve, and that the city continues to put aside fiscal resources to address the  higher-than-expected pension payments commencing in 2024, the fiscal year in which Detroit officials project they will face annual payments of at least $143 million under the city’s plan of debt adjustment, adding that the retiree protection fund has performed well: “What we believe is that we will not have to make major changes to the fund in order for us to have the money that we need in 2024 to begin payments; In 2016 those returns weren’t so good and have since improved in 2017 and 2018, when they will be higher than the 6.75% return that we expected.” He noted that Detroit is also looking at ways to restructure its debt, because, with its limited tax general obligation bonds scheduled to mature in the next decade, Detroit could be in a position to return to the municipal market and finance its capital projects. Finally, on the public safety front, the Mayor’s budget proposes to provide the Detroit Police Department an $8 million boost, allowing the police department to make an additional 141 new hires.

Taking Bets on Atlantic City. The Atlantic City Council Wednesday approved its FY2019 budget, increasing the tax levy by just under 3%, creating sort of a seesaw pattern to the levy, which three years ago had reached an all-time high of $18.00 per one thousand dollars of valuation, before dropping in each of the last two years. Now Atlantic City’s FY2019 budget proposal shows an increase of $439,754 or 3.06%, with Administrator Lund outlining some of the highlights at this week’s Council session. He reported that over the years, the city’s landfill has been user fee-based ($1 per occupant per month) to be self-sufficient; however, some unforeseen expenses had been incurred which imposed a strain on the landfill’s $900,000 budget. Based on a county population of 14,000, the money generated from the assessment amounts to roughly $168,000 per year, allowing the Cass County Landfill to remain open. However, the financing leaves up to each individual city the decision of fee assessments. Thus, he told the Council: “The Per Capita payment to the landfill accounted for about .35 to .40 cents of the increase.”  Meanwhile, two General Department heads requested budget increases this year and five Department Heads including; the Police Department and Library submitted budgets smaller than the previous year. Noting that he “never advocate(s) for a tax increase,” Mr. Lund stated: “But it is what it is. It was supposed to go up to $16.98 last year and now we are at $16.86, so it’s still less,” adding that the city’s continuous debt remains an anchor to Atlantic City’s credit rating—but that his proposed budget includes a complete debt assumption and plan to deleverage the City over the next ten years.

Unshelter from the Storm. New York Federal Reserve Bank President, the very insightful William Dudley, warns that Puerto Rico should not misinterpret the economic boost from reconstruction following hurricanes that hit it hard last year as a sign of underlying strength: “It’s really important not to be seduced by that strong recovery in the immediate aftermath of the disaster,” as he met with Puerto Rican leaders in San Juan: “We would expect there to be a bounce in 2018 as the construction activity gets underway in earnest,” warning, however, he expects economic growth to slow again in 2019 or 2020: “It’s “important not to misinterpret what it means, because a lot still needs to be done on the fiscal side and the long-term economic development side.”

President Dudley and his team toured densely populated, lower-income, hard hit  San Juan neighborhoods, noting the prevalence of “blue roofs”—temporary roofs overlaid with blue tarps which had been used as temporary cover for the more permanent structures devastated by the hurricanes, leading him to recognize that lots of “construction needs to take place before the next storm season,” a season which starts in just two more months—and a season certain to be complicated by ongoing, persistent, and discriminatory delays in federal aid—delays which U.S. Treasury Secretary Steven Mnuchin blamed on Puerto Rico, stating: “We are not holding this up…We have documents in front of them that [spell out the terms under which] we are prepared to lend,” adding that the Trump Administration has yet to determine whether any of the Treasury loans would ultimately be forgiven in testimony in Washington, D.C. before the House Appropriations Subcommittee on Financial Services and General Government.

Here, the loan in question, a $4.7 billion Community Disaster Loan Congress and the President approved last November to benefit the U.S. territory’s government, public corporations, and municipalities—but where the principal still has not been made available, appears to stem from disagreements with regard to how Puerto Rico would use these funds—questions which the Treasury had not raised with the City of Houston or the State of Florida.  It appears that some of the Treasury’s apprehensions, ironically, relate to Gov. Ricardo Rosselló’s proposed tax cuts in his State of the Commonwealth Speech, in which the Governor announced tax cuts to stimulate growth, pay increases for the police and public school teachers, and where he added his administration would reduce the size of government through consolidation and attrition, with no layoffs, e.g. a stimulus policy not unlike the massive federal tax cuts enacted by President Trump and the U.S. Congress. It seems, for the Treasury, that what is good for the goose is not for the gander.

At the end of last month, Gov. Rosselló sent a letter to Congress concerned that the Treasury was now offering only $2.065 billion, writing that the proposal “imposed restrictions seemingly designed to make it extremely difficult for Puerto Rico to access these funds when it needs federal assistance the most.” This week, Secretary Mnuchin stated: “We are monitoring their cash flows to make sure that they have the necessary funds.” Puerto Rico reports it is asking for changes to the Treasury loan documents; however, Sec. Mnuchin, addressing the possibility of potential loans, noted: “We’re not making any decision today whether they will be forgiven or…won’t be forgiven.” Eric LeCompte, executive director of Jubilee USA, a non-profit devoted to the forgiveness of debt on humanitarian grounds, believes the priority should be to provide assistance for rebuilding as rapidly as possible, noting: “Almost six months after Hurricane Maria, we are still dealing with real human and economic suffering…It seems everyone is trying to work together to get the first installment of financing sent and it needs to be urgently sent.”

Part of the problem—and certainly part of the hope—is that President Dudley might be able to lend his acumen and experience to help. While the Treasury appears to be most concerned about greater Puerto Rico public budget transparency, Mr. Dudley, on the ground there, is more concerned that Puerto Rican leaders not misinterpret the economic boost from reconstruction following the devastating hurricanes as a sign of underlying strength, noting: “It’s really important not to be seduced by that strong recovery in the immediate aftermath of the disaster: We would expect there to be a bounce in 2018 as the construction activity gets underway in earnest,” before the economic growth slows again in 2019 or 2020, adding, ergo, that it was “important not to misinterpret what it means, because a lot still needs to be done on the fiscal side and the long-term economic development side.”


Let there Be Light & Emergency Relief

February 12, 2018

Good Morning! In today’s Blog, we consider the courtroom efforts to secure emergency relief so that electric service is not disrupted in Puerto Rico—threatening critical services and the island’s only hopes for recovery from its quasi chapter 9 municipal bankruptcy.

Dark Fiscal Imbalances.  U.S. District Judge Laura Taylor Swain last night rejected a motion filed by the PROMESA Oversight Board for the central government to grant an emergency loan to the Electric Power Authority (PREPA), indicating that the federal agency failed to demonstrate the need for this financing although there is an immediate need for liquidity, albeit, she indicated the Board may file a new amended motion requesting a lesser amount and make adjustments to clarify the payment priority that financing will have without affecting the rights of the creditors—with her ruling coming down in the wake of a six and a half hour hearing at which the court was unconvinced of their respective arguments that PREPA needed the nearly $1 billion it had requested in its initial motion. Judge Swain indicated that any new financing requested should not exceed about $ 300 million—telling the court: “The lights cannot be turned off in Puerto Rico,” as she advised the parties she will need a clearer understanding of the priorities for any new financing. She made that ruling notwithstanding the warning from PREPA financial advisor Todd Filsinger, who advised the court that if a loan were not received as soon as possible, PREPA would be forced to activate its emergency plan to begin the cessation of operations and an eventual suspension of electric service.

The courtroom drama came as the Chief Financial Advisor of the Electric Power Authority (AEE), Todd Filsinger, yesterday indicated that the public corporation intends to implement an emergency plan starting today which could lead to the suspension of its employees as well as disruption of the operations of its generating plants—actions which would force the “rationing” of electric services, likely plunging homes, businesses, and industries into darkness” an emergency loan from the central government.  Mr. Filsinger made clear that should the plan be triggered, there would be a warning, as early as this morning, followed by a rolling suspension of operations, and a gradual suspension of employees; services to hospitals, police stations, firefighters, and gas stations would continue.

PREPA is seeking a loan of as much as $1.3 billion—a request the Board did not reject out of hand, but rather indicated a lesser amount of as much as $1 billion might be considered. In principle, the loan would be around $ 1,300 million, but last night the Board of Fiscal Supervision (JSF), acting on behalf of the government and the AEE, modified its request to about $ 1,000 million. There is urgency: Mr. Filsinger warned that unless PREPA receives an emergency loan by this weekend, the utility would only be able to maintain its operations for several additional weeks, after which it would no longer even be able to pay for the fuel it needs to generate electricity, testifying: “If we do not have the loan, and we do not receive the cash, we could be implementing the contingency measures on Saturday.”

Earlier in the hearing, Joseph Davis, the lawyer representing the Financial Advisory Authority and Fiscal Agency, warned of the fiscal cliff the agency faces, advising the panel it has delayed payments to suppliers as much as possible in an effort to preserve as much of its funds as possible, in attempt to render the cash they have available, but that there will be little option but to trigger additional contingencies, such as rationing services, partly because fuel suppliers have already threatened to halt service. The power authority’s emergency plan would be enforced even as some 400,000 subscribers remain without power, and after approximately 1.1 million subscribers had already experienced the longest interruption of electric service in Puerto Rico’s history in the immediate wake of Hurricane Maria. The threat to human life and safety came as the respective parties in the New York City courtroom—parties representing the Board, bondholders, and Puerto Rico, as well as insurers continued to file motions.

As if these human risks were insufficient, Judge Swain has also been confronted with arguments from contractors, such as ARC, Lord Electric, and Whitefish Holdings, who claim that PREPA must meet its payment obligations for restoration of the electricity grid after Hurricane Maria, as well as bondholders—who, for the most part, live far, far from Puerto Rico, but are seeking compensation for impairment of the rights of municipal bondholders.

The Board, at the end of last month, alleging that PREPA faces losses in excess of $1 billion, had requested Judge Swain to approve a post-requisition loan for the public utility—a loan critical to . According to the motion issued by the JSF, seeking a super priority, as PREPA sought the fiscal and physical capacity to insure its operations until the end of the fiscal year and avoid closing operations this month—in effect, asking the court to provide a super priority of payment to the central government.

Yesterday, in a last-ditch effort to assist the power authority, the Ad Hoc-AEE group and the insurance company, Syncora, which guarantee part of the public corporation’s debt, presented a new financing proposal, a proposal which the oversight Board rejected outright, noting: “The notification of the group of bondholders of the ESA is not a valid proposal and does not have a strong reason to deny the motion for post-petition financing for the PREPA.”

Fiscal Economic Dislocation?

January 22, 2017

Good Morning! In today’s Blog, we consider the ongoing federal and fiscal challenges to fiscal recovery for the U.S. territory of Puerto Rico.

‘Twas in another lifetime, one of toil and blood
When blackness was a virtue the road was full of mud
I came in from the wilderness, a creature void of form
Come in, she said
I’ll give ya shelter from the storm ∞ Bob Dylan

Modern Day Okies. Since Hurricane Maria struck Puerto Rico, nearly 300,000 Puerto Ricans have left their homes and fled to Florida. These Americans have fled to other states too, with New York a key new home. The departures raise a host of fiscal challenges, including: for how much longer will FEMA assistance be available to these U.S. citizens? Are these Americans permanent departees from Puerto Rico? In addition, if so, are they predominantly younger, and higher income?

Under the Federal Emergency Management Agency (FEMA) program, FEMA has provided hotel or lodging assistance to evacuees; however, the duration of that assistance, which has just been extended until March under the FEMA Transitional Shelter Assistance program (not as form of temporary shelter while rebuilding her damaged home in Puerto Rico, remains uncertain: is it a way to relocate and start a new life on the mainland? In the beginning, most of those leaving were elderly, disabled, or in need of critical medical care. But that appears to have changed: today young Puerto Ricans appear to be the primary departees, threatening to compound what we have previously noted to be an historic, migratory wave in the wake of the U.S. territory’s physical and fiscal crisis: mayhap as many as 25 percent of the population will have departed by the end of the decade.

Ironically, especially given President Trump’s attitude towards Puerto Rico, including the disparate response to Puerto Rico compared to Houston and Florida, the disproportionately younger Puerto Ricans coming to the mainland have been sought after—often recruited. Last November, the agency offered to airlift victims of Hurricane Maria to the U.S. mainland to reach temporary housing–a first of its kind for the agency: under the program, the Transitional Shelter Assistance (TSA) program, displaced residents and families who are still living in shelters on Puerto Rico can opt to relocate to housing in Florida and New York. Mike Byrne, a federal coordinating officer for FEMA, said the program is the first time the agency has attempted what it calls an “air bridge,” or a relief operation requiring the transportation of individuals from a disaster area. In most disasters, FEMA pays displaced residents to stay in hotels under the TSA program. In Puerto Rico, the hotels are filled to capacity, so FEMA is turning to the mainland and working with states to find accommodations.

At the same time, because of anticipated labor shortages because of the White House anti-immigration policies, many domestic employers are eager to hire bilingual workers for whom the minimum wage of a U.S. state represents a significant boost in income compared to grim options on Puerto Rico. Likewise, both the federal and Puerto Rican governments have facilitated departures: that is, in the ongoing absence of an equitable or comprehensive recovery plan for Puerto Rico, migration has become a substitute for federal disaster relief and recovery: for the first time ever, FEMA created an “air bridge” and chartered cruise ships to evacuate residents. In the beginning, new arrivals were forced to seek shelter with family members or in homeless shelters; subsequently, such families are being offered hotel stays for up to three months. (Traditionally, FEMA offers temporary shelter to homeowners who have been adversely affected by a disaster while they carry out the arduous task of rebuilding; however, in the case of Hurricane Maria, the process of recovery has been severely undercut by the lack of electricity and running water, and the inability of the federal government to supply even the most basic materials.

The increasing challenge is that, as we have noted before, those Puerto Ricans fleeing destroyed homes, devastated public infrastructure, and a shattered economy, are, disproportionately, those who can afford to leave—and those whose jobs and livelihoods have been washed away. After all, some nearly four months after the hurricanes, many restaurants, stores and offices remain closed: how can one be competitive with operating on generators, operating with reduced personnel serving only FEMA workers, and with massive layoffs? Just last week, Walmart, Puerto Rico’s largest private employer, announced it was closing three of its Sam’s Club stores; pharmaceutical companies, which, today, account for nearly 50% of Puerto Rico’s manufacturing jobs, are rethinking their location in the wake of the implementation of the new federal tax reform law—a law which treats Puerto Rico as a foreign jurisdiction. The new tax law imposes a 12.5% tax on profits derived from intellectual property held in foreign jurisdictions. (The U.S. territory of Puerto Rico is a domestic jurisdiction in U.S. law—except for federal tax purposes.) The pre-existing tax law exempted Puerto Rico residents from paying federal income taxes, a provision which sought to attract investment in manufacturing, something which, prior to the hurricane, accounted for 47% of Puerto Rico’s gross domestic product—more than $48 billion, with the bulk of the incentives encouraging pharmaceuticals and medical devices that generate revenue from patented drugs and technologies.

However, the new federal tax changes were enacted to render offshore operations less profitable, thereby rewarding corporations which opt to relocate back to the U.S. mainland—because, the IRS considers Puerto Rico to be foreign, and because many of the most significant manufacturers on the island are foreign-owned.

Perhaps unsurprisingly, the economic dislocation in Puerto Rico has led to mainland employers recognizing a diamond in the rough—meaning that they have been recruiting Puerto Rican workers to places such as Florida, North Carolina, Georgia, and Kansas: in Texas and Florida, developers hope that Puerto Rican labor will alleviate an expected shortage of construction workers as their own hurricane recovery gets underway. The efforts, piggy-backing on a trend that has accelerated over the last decade, has been focused on teachers, doctors, police officers, nurses, and engineers—exactly the positions most critical for Puerto Rico’s physical and fiscal recovery. But how to compete against Houston—a city where approximately one-third of schoolchildren are native Spanish speakers—and a city which received disproportionately greater federal hurricane assistance? The city’s school districts have already conducting multiple recruitment trips to Puerto Rico. Similarly, the police departments of Dallas, Charlotte, Baltimore, and even the nation’s capitol, Washington, D.C., have all turned to Puerto Rico as they have sought to diversify their departments with more Latino officers. In these instances, the recruiters lure workers with what appear to be high salaries when compared with the depressed incomes of a U.S. territory in physical and fiscal crisis.

Some have noted, moreover, that with the U.S. federal government closed, in no small part due to opposition to extending the DACA or Deferred Action for Childhood Arrivals program, it may be coincidental that the influx of Puerto Ricans to the mainland who were displaced by the storm coincides with the expiration of and, most recently, the end of temporary protected status for Central American and Caribbean migrants who had also fled natural disasters. That is, the combination furloughs, wage cuts, and higher prices for Puerto Rico’s working poor, combined with the massive damage to the island’s public infrastructure and disparate federal response, appears to have contributed to fueling a mass exodus—an exodus, however, of the young and qualified.

Is the Federal Government Using a Double Standard in Responding to Puerto Rico, adding to its Fiscal and Physical Distress?


January 19, 2017

Good Morning! In today’s Blog, we consider the ongoing federal and fiscal challenges to fiscal recovery for the U.S. territory of Puerto Rico.

Denial of Assistance. As if there has not been enough evidence of a double standard with regard to the provision of federal aid to the hurricane devastation to Puerto Rico, the Federal Emergency Management Agency (FEMA) and the U.S. Treasury have written to the Puerto Rico Fiscal Agency and Financial Advisory Authority Executive Director Gerardo Portela that, because the Commonwealth of Puerto Rico’s  central cash balance, as publicly reported, has consistently exceeded $1.5 billion in the months following the hurricanes, and “considering the implications of the $6.875 billion of total cash deposits across the Commonwealth, the federal government will institute, as a matter of policy, a cash balance policy that will determine the timing of Community Disaster Loans (CDLs) to the Commonwealth and its instrumentalities, including the Puerto Rico Electric Power Authority and the Puerto Rico Aqueduct and Sewer Authority.” Translated into English, that means Puerto Rico may have too much cash to be eligible for a federal loan—notwithstanding the discriminatory treatment compared to Houston or Florida, much less that still, nearly four months after the devastating storm—a storm to respond to which President Trump offered paper towels—some four months after the storm, many residents are still without electricity. Nevertheless, according to FEMA, the island is at risk of not receiving federal community disaster loans, because its cash balances may be too high.

For its part, the government of Puerto Rico has opted to pay up its arrears accounts with both the Electric Power Authority and the Aqueduct and Sewer Authority—as well as focus its efforts on legislation to address FEMA’s concerns—in a critical effort to free up federal assistance—assistance already approved by Congress. At the same time, Puerto Rico’s Financial Advisory Authority and Fiscal Agency Wednesday admitted that if FEMA opts not to grant the disaster loan to the U.S. territory, very hard decisions will confront the citizens of Puerto Rico and their leaders—or, as Sen. Anibal Jose Torres put it: the challenge will be to “ensure basic services to the population, the payment of pensions, and the payroll of public employees,” concerns which appear not to be apprehensions of the Trump Administration, even as Gerardo Portela Franco, the Executive Director and Chairman of the Board of Puerto Rico’s Fiscal Agency & Financial Advisory Authority, noted: “We will continue negotiating with the Treasury until we achieve that CDL,” adding: “We have faithfully complied with all the requirements,” referring to the negotiations his agency has had with the U.S. Treasury since last October. The contretemps emerged after El Nuevo Día Wednesday  revealed that FEMA and the U.S. Treasury had halted the disbursement of funds to Puerto Rico under the CDL program until adopting “a cash balance policy” which will determine when and how much funding FEMA will provide to Puerto Rico to address its operational expenses in trying to recover from the effects of Hurricane Maria, theoretically in “consultation” with the Fiscal Oversight Board created by Congress, even as the two stateside federal agencies made clear Puerto Rico will have to “cover its cash needs and those of the PREPA and the AAA.

Unsurprisingly, Héctor Figueroa, the President of the SEIU noted that it was “inconceivable that FEMA and the Treasury retain the aid funds approved three months ago for Puerto Rico following the scourge of Hurricane Maria…Puerto Rican working families continue to be considered second class citizens by the administration of (Donald) Trump and by Congress.”

The situation is further complicated, despite some four months of negotiations, by the fact that FEMA and the U.S. Treasury have yet to specify the specific conditions to be mandated—now, nearly four months after Congress approved a package of aid for Puerto Rico, as well as for the states of Florida, Texas, California, and the U.S. Virgin Islands: in that aid package which Congress approved, however, it appears there was a stipulation that, before the federal government could be obliged to provide aid, Puerto Rico, as collateral, had to pledge the unencumbered revenues from the Sale and Use Tax (IVU) or those paid by foreign corporations under Law 154—albeit it remains unclear whether the specific terms with regard to collateral are still being negotiated. What is clear, however, is a double standard, as the epistle from FEMA does not seem to reflect the human or fiscal urgency of the situation, especially in the wake of the fiscal warnings at the end of last September that “As a result of hurricanes Irma and María, the government, PREPA and AAA projected at the end of September 2017 that it would deplete its operational funds on or near October 31, 2017.” In their letter, however, FEMA and the Treasury opined that, as of December 29, 2017, the central government’s cash balance was approximately $1,700 million—an amount which, according to Portela Franco, does not detract from the fact that Puerto Rico is in a state of “insolvency.”

The head of the Puerto Rico Fiscal Agency and Financial Advisory Authority, the public corporation and governmental instrumentality in Puerto Rico which has assumed the majority of the fiscal agency and financial advisory responsibilities previously held by the Government Development Bank for Puerto Rico, and the Puerto Rican entity in charge of collaboration, communication, and cooperation between the Government of Puerto Rico and the PROMESA Oversight Board, noted that the figure cited in the letter includes the reserves required by La Junta de Supervisión y Administración Financiera (JSF) to finance the process of renegotiation of the debt in court, as well as the payment of pensions and public payroll, two priority items for Governor Rosselló Nevares.

Indeed, a review of Puerto Rico’s most recent liquidity report seems to validate Mr. Portela Franco’s views, noting, for instance, in his January 5th report, that the Department of Hacienda projections include the collections which are regularly sent to Cofina—reports still awaiting the attention of U.S. Judge Laura Taylor Swain—a figure in the range of  $316 million. In addition, the report reveals that, so far this fiscal year, Puerto Rico’s central government has withheld $ 437 million from the Automobile Accident Administration (ACAA) and the Highway and Transportation Authority (ACT), among others—even as government suppliers are owed about $ 331 million and government agencies hold $ 276 million in debt to each other, including water and electricity bills. Thus, as Portela Franco and Andrés Méndez, in charge of liquidity matters in the Aafaf, noted: the government seems to undress a saint to dress others such as the AEE and the AAA: “As we have to inject liquidity to the AAA and the AEE, that balance of the Treasury’s TSA account will fall precipitously,” adding that, without the FEMA loan, it would be necessary to continue adopting what he termed “difficult decisions,” such as stretching payments to suppliers.

Unsurprisingly, Governor Rosselló Nevares, described the epistle from Washington, D.C. as one in which the “government of Puerto Rico and the Treasury have reached an agreement. The agreement is that when the collections go down in Puerto Rico, the loans begin to arrive. What does this mean? That at the moment, we still have resources that are going to be running out,but that they will want to transfer those loans once it happens to that.” The Governor also rejected that the Oversight Board has an additional responsibility in the process of granting the CDL, because PROMESA had already established that the federal entity will have authority to interfere in any loan that Puerto Rico receives. (The epistle from FEMA and the U.S. Treasury notes that the cash policy for the loan from Puerto Rico will be adopted “in consultation with the government and the JSF.”

As of the end of last month, Puerto Rico had $1.7 billion of available cash, notwithstanding earlier predictions by local officials that the government would run out of money in late October because of the economic toll of responding to the hurricanes: by the end of November, it still had funds in other accounts, albeit some of it was earmarked for specific uses and could not be used to keep Puerto Rico’s government operating.

In FEMA’s epistle to Gerardo Portela, the Executive Director of Puerto Rico’s Fiscal Agency and Financial Advisory Authority, FEMA noted: “Under this cash balance policy, funds will be provided through the CDL program when the commonwealth’s central cash balance decreases to a certain level.” Executive Director Portela, earlier this week, noted that, because of the delay in federal loans, Puerto Rico’s central government will begin procedures to allow it to lend money to the island’s public electricity and water utilities, even as he urged the federal government to distribute the loans, stating: “AAFAF has complied with all the demands of federal agencies; however, despite our continuous efforts, to date, the Treasury Department and FEMA have not provided the final terms and conditions under which they will disburse the funds granted by the Congress.” With damage from Hurricane Maria estimated to total as much as $100 billion, Governor Ricardo Rossello earlier this month warned that Puerto Rico’s electric utility may be unable to continue recovery work in February due to lack of funds—even though, more than 100 days after the storm slamming into an island which had already filed a record-setting quasi chapter 9 municipal bankruptcy in May devastated Puerto Rico’s economy and destroyed its electrical grid: still today, about 45 percent of Puerto Rico Electric Power Authority customers are still without power.

The Epistle:

Mr. Gerardo J. Portela Franco

Executive Director and Chairman of the Board

Fiscal Agency and Financial Advisory Authority

Government of Puerto Rico

Robe1io Sanchez Vilella Government Center

De Diego Avenue, Stop 22

San Juan, Puerto Rico, 00907

Dear Mr. Portela Franco:

This letter summarizes the Federal Government’s policy for providing Community Disaster Loan (CDL) Program assistance to the Commonwealth of Puerto Rico, its instrumentalities, and municipalities as a result of Hurricanes Irma (DR-4336-PR) and Maria (DR-4339-PR). The purpose of the CDL Program is to provide loans to eligible recipients that have suffered a substantial loss of tax and other revenues as a result of a major disaster and that demonstrate a need for Federal financial assistance to perform essential governmental functions. The Additional Supplemental Appropriations for Disaster Relief Requirements Act of 2017, signed into law by the President on October 26, 2017, included $4.9 billion for CD Ls to assist the Commonwealth of Puerto Rico, the U.S. Virgin Islands, and local governments in Florida and Texas in maintaining essential services as a result of Hurricanes Harvey, Irma, and Maria.

Implementing the CDL Program in the Commonwealth must be undertaken in a manner that is compatible with the ongoing financial restructuring of the Commonwealth’s financial obligations, including pursuant to the Puerto Rico Oversight, Management, and Economic Stability Act (PROMESA). For example, pursuant to PROMESA the Financial Oversight and Management Board (FOMB) must approve any new debt incun-ed by the Conunonwealth or by any of its instrumentalities that the FOMB has designated as covered territorial instrumentalities under PRO MESA, including the Puerto Rico Electric Power Authority (PREP A) and the Pue1io Rico Aqueduct and Sewer Authority (PRASA). Title III of PRO MESA also established a bankruptcy-like restructuring process for Puerto Rico and its covered territorial instrumentalities. As you are aware, the Commonwealth and PREPA have filed for Title III restructuring; PRASA has not.

As a result of Hurricanes Irma and Maria, the Commonwealth, PREP A, and PRASA projected in late

September 2017 that they would exhaust their operating funds on or about October 31, 2017. However, as of December 29, 2017, the Commonwealth’s central cash balance was approximately $1.7 billion. It is our understanding that the higher-than-expected central cash balance three months after the hurricanes resulted from greater-than-expected receipts, strategic management of payables, and the structure of relief funds from FEMA and other federal agencies, among other factors, although a review of the underlying detail is still underway. In addition to its central cash balance, on December 18, 2017, the Commonwealth released a report indicating that $6.875 billion in unrestricted and restricted cash was on deposit in over 800 accounts across all Commonwealth governmental entities. Despite these Commonwealth cash balances, the Commonwealth now indicates that PREPA and PRASA have an imminent need for liquidity in January 2018, and, as a result, each entity has applied for a CDL to cover operating expenditures.

Because the Commonwealth’s central cash balance, 1\S publicly reported, has consistently exceeded $1.5 billion in the months following the hurricanes, and considering the implications of the reported $6.875 billion of total cash across the Commonwealth, the Federal Government will institute, as a matter of policy, a Cash Balance Policy that will determine the timing of CD Ls to the Commonwealth and its instrumentalities, including PREP A and PRASA. Under this Cash Balance Policy, funds will be provided through the CDL Program when the Commonwealth’s central cash balance decreases to a certain level. This Cash Balance Policy level will be dete1mined by the Federal Government in consultation with the Commonwealth and the FOMB.

The current posture of the Federal Government is to disburse CDL program financing directly to the Commonwealth, which could then sub-lend to its various entities (including PREP A and PRASA), although this approach may be revised over time. Subsidiary borrowers will be expected to comply with remmitting, repayment, and collateral requirements that apply to the primary borrower. Unless the Cash Balance Policy level is reached, however, the Commonwealth will need to support its own liquidity needs and those of PREPA and PRASA.

Notwithstanding the above policy, local governments (as such term is defined in 42 U.S.C. §5122(8)) in Puerto Rico, including the 78 municipalities, will be eligible to apply directly for CD Ls independent of the Commonwealth under the traditional terms and conditions of Section 417 of the Robert T. Stafford Disaster Relief and Emergency Assistance Act, 42 U.S.C. §5184 (irrespective of the cash balance of the Commonwealth). Under these terms, a local government demonstrating a substantial loss of revenues may receive a streamlined CDL up to 25 percent of its annual budget, subject to a $5 million cap. FEMA will make arrangements to meet directly with the local governments and their management associations the week of January 15, 2018, in Puerto Rico to facilitate applications to the CDL Program onthe most timely basis possible consistent with program terms and requirements. If it is determined that a local government should require assistance beyond the $5 million cap, the Federal Government will consider providing additional financing under different terms and conditions, as appropriate.

FEMA and the Department of Treasury look forward to continuing to work with the Commonwealth of Puerto Rico and its instrumentalities and local governments to ensure funding is available for operating expenses to perform governmental functions while respecting the PROMESA Title III proceedings, the statutory authorities granted to the FOMB under PROMESA, and the overall fiscal condition of the Commonwealth and its instrumentalities and local governments.


Alex Amparo

Assistant Administrator Recovery Directorate

Federal Emergency Management Agency

Gary Grippo

Deputy Assistant Secretary for Public Finance

U.S. Department of Treasury


cc: Governor Ricardo Rossello Nevares, Commonwealth of Puerto Rico

Financial Oversight and Management Board, Commonwealth of Puerto Rico

Puerto Rico State Agency for Emergency and Disaster Management

U.S. Office of Management and Budget

Disparate Physical & Fiscal Responses to Municipal Physical & Fiscal Distress


January 16, 2017

Good Morning! In today’s Blog, we consider the ongoing fiscal and physical challenges of restoring power in hurricane devastated Puerto Rico, which the Trump Administration and Congress have opted to treat in a very different manner than other hurricane devastated municipalities and states.

Prospects for Recovery. Notwithstanding the opposition of his own designated coordinator for the restoration of electric power, Puerto Rico Governor Ricardo Rossello yesterday gave the go-ahead to sign an agreement which will allow Puerto Rico’s muncipios to hire companies and experts to repair the island’s electric distribution lines, with Puerto Rico Secretary of the Interior, William Villafañe, announcing—in the wake of a demonstration by residents of bigger muncipios which remain without electricity since Hurricanes Irma and María passed last September, that the Electric Power Authority (AEE) will sign an agreement with the muncipios to allow them to hire companies to repair power lines. The breakthrough came in the wake of a meeting with the presidents of the Federation and the Association of Mayors, Carlos Molina (Arecibo) and Rolando Ortiz (Cayey), respectively, as well as the Mayor (Alcalde) of Bayamón, Ramón Luis Rivera, and others officials. The agreement, which until yesterday had not been shown to the Mayors, is supposed to have a series of security restrictions; in addition, the agreement is intended to empower the muncipios to offer injury insurance, as well as be eligible for FEMA reimbursement. Secretary Villafañe noted that Governor disagreed with the result of last Monday’s meeting, in which the coordinator designated for the restoration efforts of electric power, Carlos Torres, and the AEE refused to establish an agreement with the municipios out of security concerns.

Thus, among the security conditions the agreement mandates, is that Mayors will be required to establish contracts exclusively with contractors who have specialized equipment and trucks. In a clarification, Secretary Villafañe assured reporters that PREPA retirees may continue to provide services, as is the case of the Pepino Power Authority, an initiative of the Mayor Javier Jiménez of San Sebastian—a muncipio founded in 1752 by Captain Cristóbal González de la Cruz, who among other neighbors, had an interest in converting some cow farms into an agricultural village. The foundation of the town from the religious aspect, was consummated in December 1762 by Mariano Martin, the then Puerto Rico Catholic Bishop: by the beginning, 1700, San Sebastian was a conglomerate of a few cow farms, owned by some residents of the Partido de Aguada. Las Vegas was the former plain site of one of the first cow farms located by the Guatemala riverside at the north; another of those cow farms was Pepinito (today’s downtown), which was a low green mountain with a white calcium carbonate face. From these geographical accidents come the first names of the then new village, albeit one of the oldest municipalities in the United States: Las Vegas del Pepino (Cucumber Fields). Indeed, the permission to found the muncipio was officially given in 1752.

By the beginning of the 19th century, wealthy Spanish families arrived in Pepino, fleeing the revolutions of Venezuela and the Dominican Republic. Subsequently, families from Catalonia and the Basque country in Spain came to Puerto Rico as well as a significant number of isleños (Canary Islanders)—with the isleños taking over the local political power and developing a coffee industry. Much as they did in Nevada, the Basques brought some material progress to the muncipio; in addition, the new resident Basques, in remembrance of their home region and its religious patron, saw the need of upgrading the old traditional Pepino used by the Canary Islanders to the new and “up-dated” San Sebastián—even though, still today, the citizens of San Sebastián are called “pepinianos.” Permission to found the muncipio was officially given in 1752, under the leadership of the founder, Captain Cristóbal González de la Cruz, who sought to convert cattle fincas (ranches/farms) into an agricultural village—with the governmental transformation consummated in December of 1762 by Mariano Martin, the island Catholic bishop at that time. The muncipio grew by the beginning of the 19th century, with the arrival of wealthy Spanish families, fleeing the revolutions of Venezuela and the Dominican Republic. Nearly a century later, several Catalon families from northern Spain and the Canary Islands joined the large number of isleños (Canary Islanders) who had made El Pepino their home—new arrivals who, in the wake of taking over the local political power, developing a coffee industry, and changing the muncipio’s name, in remembrance of their home region and its religious patron, to the new and “up-dated” San Sebastián, notwithstanding that, still today, the citizens of San Sebastián are called “pepinianos.”

For his part, the Mayor Rivera, who had notified the government last September of his interest in collaborating in the restoration of electricity, only learned yesterday that the agreement had been approved; however, the municipal executive of Cayey and President of the Association of Mayors said that as long as they do not see the document, they will not believe it, because, to date, they have neither been allowed to see or sign the document in question: Mayor Ortiz said that during the meeting yesterday, Coordinator Torres again expressed his disagreement with allowing municipalities to collaborate in the restoration of light: “He (Torres) will have control of the materials, will have control of the brigades, control of resources–and that this resource, which is so important in the process of re-energizing the country, says that he does not agree with the Mayors intervening in this process or giving us the agreement to sign…They said that they were going to give us the power to energize the system and work with brigades that we can hire, and that they will give us brigades to work with the municipalities, and they will give us materials, (but) we leave here with nothing in the hand, with a promise of agreement.” Mayor Ortiz explained that in Cayey the muncipio has retirees from PREPA willing to start working, however, absent an agreement, they are not only barred by law from doing so, but also prevented from obtaining protection from the State Insurance Fund Corporation in case of injury to these workers. The Mayor added: “What he (Coordinator Torres) does not know is that in all of our communities and in all of our cities there are people trained with extraordinary resources to work on that system, because they have done it in all the previous events.”  Nevertheless, Mayor Rivera assured that as soon as the document is sent and signed, he has two companies with three brigades ready to work in the Bayamón distribution lines. He estimated that these works can begin today, if the legal division of La Fortaleza advances in the drafting of the agreement with the municipalities.

Unbalanced Politics? The restoration efforts have also been hampered by allegations of partisan discrimination: the number of brigades distributed among the municipalities of the northern region supposedly differed by 480 in the municipalities of the New Progressive Party (PNP) versus 174 in those led by the PPD, according to the President of the Municipal Legislature of Dorado, Carlos Alberto López. However, Secretary Villafañe refuted those data with others: he indicated that among the six municipalities with less than 20% of electric power service restored, five are NPOPs, while among the 35 that already have more than 60% service, 20 are from PPD.

What Would Rod Serling Say? The former host of the Twilight Zone, Rod Serling, who opened each week’s show by saying a “Dimension of sound, a dimension of sight, and dimension of mind: you just crossed over into The Twilight Zone,” seems consistent with Moody’s characteristically moody new report on Puerto Rico’s fiscal plan, writing: “These repeated delays in revising Puerto Rico’s fiscal plan…underscore the economic uncertainties that Puerto Rico faces as a result of post-Maria factors, including surging migration to the U.S. mainland, potentially unsustainable operating conditions for the territory’s manufacturers, and the federal recovery and rebuilding assistance that may fall short of what Puerto Rico needs to prevent lasting and severe damage to its economic base…Together, the growing challenges from these factors may further reduce already low recovery prospects for holders of Puerto Rico’s 17 rated debt types.” The insights, provided by Moody’s senior at least 200,000 Puerto Ricans have left Puerto Rico since Hurricane Maria struck, or about 6% of the pre-Maria population—adding that manufacturing, an important part of Puerto Rico’s economy, has been steadily dropping over the last two decades—and warning that, in the bitter wake of Maria, some manufactures may decide to move to other areas less likely to be hit by future hurricanes. The analysts further warned that the federal government’s new 12.5% excise tax on profits derived from patents and other intangible assets is another negative. Finally, they noted that the amount of federal aid to Puerto Rico in the aftermath of Hurricane Maria will affect Puerto Rico’s trajectory of recovery amid growing doubt and uncertainty whether Gov. Rosselló’s request for $94.4 billion in aid will be honored—especially, with the federal government on the verge of shutting down this week—and its failure, to date—in disbursing any portion of a Congressionally-approved $4.9 billion Community Disaster Loan to Puerto Rico, the U.S. Virgin Islands, and some other jurisdictions hit by recent natural disasters. Last week, Reorg Research reported that Puerto Rico’s debt restructuring and arguments between the U.S. Treasury and Puerto Rico over the latter’s control of the funds has delayed the funds’ release.

If anything, the federal inability to act has been further clouded by unclear governance: last week, Puerto Rico Sen. Minority Leader Eduardo Bhatia, who, during his tenure as Senate President, had been selected as Chair of the Council of State Governments of the Eastern Regional Conference (CSG-ERC) and later elected as President of the National Hispanic Caucus of State Legislators, thereby becoming the first Senate President and the first Puerto Rican to preside over the organization, as well as serve on the Board of the Council of State Government (CSG), National Association of Latino Elected Officials (NALEO) and the National Hispanic Leadership Agenda (NHLA); brought up a different concern about the fiscal plan’s delay: in the new style of Trumpian governance, he tweeted to Gov. Ricardo Rosselló: “This is your great opportunity to regain lost confidence…Make your fiscal plan public today, so that there is no doubt, the people know your proposal and participate in the reconstruction of Puerto Rico,” adding that the people of Puerto Rico deserved a chance to comment prior to the draft’s submission to the PROMESA Oversight Board, tweeting: “In all countries of the world, ideas are discussed before decisions are made, not later…Otherwise, the process is a mockery of the serious people of Puerto Rico who want to contribute to the common good.”

Recovering after a Quasi-State Takeover

December 8, 2017

Good Morning! In this a.m.’s Blog, we consider the fiscal and governing challenges of a city emerging from a quasi-state takeover—and report that last night, House Republicans voted 235-193 to pass and send to the Senate a stopgap bill to keep the federal government open for another two weeks, freeing up space to finish both the federal budget for the year that began last October 1st—and to try to craft a conference report on federal tax reform. The House vote now awaits Senate action, where leaders plan to act swiftly to put the bill on President Trump’s desk and avoid a shutdown on Saturday.

.Visit the project blog: The Municipal Sustainability Project 

A Founding Municipality. Petersburg, Virginia—where archaeological excavations have found evidence of a prehistoric Native American settlement dated to 6500 BC, was, when the English first began to settle America, arriving in Virginia in 1607, in a region then occupied by Algonquin speaking early Americans—was founded at a strategic point along the Appomattox River. Nearly four decades later, the Virginia Colony established Fort Henry along the banks of the Appomattox River. The colony established Fort Henry—from which Colonel Abraham Wood sent several famous expeditions in subsequent years to explore points to the west; by 1675, his son-in-law, Peter Jones, who commanded Fort Henry opened the aptly named Peter’s Point trading post. In 1733, the founder of Virginia’s capitol of Richmond, Col. William Boyd, settled on plans for a municipality there—to be called Petersburgh—an appellation the Virginia General Assembly formally incorporated as Petersburg on December 17, 1748.

By the 20th century, the upward growth in one of the nation’s oldest cities peaked—at just over 41,000 residents: by 2010, the population had declined more than 20 percent—and the municipality had a poverty rate of 27.5%, double the statewide average, and nearly 33% greater than in 1999. The city’s largest employer, Brown & Williamson, departed in the mid-1980s. By last year, 100% of Petersburg School District students were eligible for free or reduced price lunch—even as the district lagged behind state graduation rates; the  and the rate of students receiving advanced diplomas. Last year, the city’s violent crime rate was just under twice the U.S. average. By 2014, Petersburg’s violent crime rate of 581 per 100,000 residents was nearly 30% higher than the violent crime rate in Danville—even though, unlike Danville, Petersburg is in the thriving Richmond metropolitan area—and has potential partners in higher education (Virginia State University and Richard Bland College) and philanthropy (Cameron Foundation), as well as a unique concentration of affordable, historic housing. Yet the city’s unassigned General Fund reverses grew from $20.4 million in FY2005 to $35.0 million by FY2014, or 55% of operating expenditures; it has very strong liquidity, with total government available cash equal to 11.5% of total governmental fund expenditures and more than ten times greater than annual debt service payments. Nevertheless, as we have previously noted, a state technical assistance team’s review last year determined that the City had exhausted most of its unrestricted reserves—also noting that in FY 2015, the City’s final budget called for General Fund revenue of $81.4 million and spending of $81.1 million, even as the municipality’s CAFR reported that actual revenue was $77 million, while spending was $82.9 million—leading to a conclusion that, based on General Ledger reports, all funds expenditures exceeded all funds revenue by at least $5.3 million.

Moreover, notwithstanding its string of operating deficits, Petersburg undertook a series of costly, low return economic development investments—purchasing a hotel, supporting a local baseball team, and building a new library—all investments beyond the city’s means. Nevertheless, after a state intervention, after nearly a decade of near insolvency, the city’s most recent Comprehensive Annual Finance Report demonstrates Petersburg is emerging from its fiscal bog—closing FY2017 having collected $73,069,843 in revenues, while spending $65,861,125 in expenditures: meaning the positive $7,208,718 difference nearly eclipsed the $7.7 million deficit which had been carried over from FY2016—unsurprisingly leading Blake Rane, the city’s Finance Director, to note: “We’re really excited about the changes that occurred in 2017: As the new administration, we are super excited that the road we have to go on is starting at a better position than where we thought it would be.” Similarly, Mayor Samuel Parham, at a news conference, noted: “We’re showing outside development that Petersburg is a safe investment…There was a time when people thought we were going to fall into the Appomattox.”

Much of the fiscal recovery credit, as we have previously noted, may be credited in part to strict expenditure practices instituted by the Robert Bobb Group, the turnaround team headed by the former City of Richmond Manager, which ran the city administration from October 2016 until September—where the team found Petersburg had always overestimated revenues, according to former Finance Director Nelsie Birch, so that the fiscal challenge was to get a “handle on spending,” a challenge met via the adoption of a very conservative FY2017 budget with a strong focus on improving Petersburg’s collection practices—including enforcement:  For the first time in several years, the city put delinquent properties up for tax sale—or, as City Manager Aretha Ferrell Benavides put it: “The new billing and collecting office is moving on collecting now: People are realizing that we’re not going to sit and wait.”  The results are significant: Petersburg’s fund balance is nearly at zero after dropping to a negative $7.7 million. Today that balance is a shadow of its former level at negative $143,933, and Manager Benavides notes: “We’re working on building up [the fund balance], because we’ve been very dependent on short-term loans through Revenue Anticipation Notes.”

Other key steps on the city’s road to recovery included selling excess water from the city’s water system, selling pieces of city-owned property, and even selling the city’s water system, or, as Mr. Bobb put it: “Moving forward, the city still needs that liquidity event (that was not intended to be a pun), because a major snowstorm, or a major water line break, sinkhole, etc., those things would be a significant drain on the city, unless it has a major fund balance.” As part of its fiscal diet, Manager Benavides notes Petersburg is still examining options to sell as many as 320 pieces of city-owned property, with the City Council already having approved the disposition of some of these properties over the past several months. The fiscal road, like the city’s history and geography, has been steep, but the fiscal exertions appear to be paying off, as it were.

Federal Tax Reform in a Post-Chapter 9 Era

December 4, 2017

Good Morning! In this a.m.’s Blog, we consider the fiscal and governing challenges that the pending federal tax “reform” legislation might have for the nation’s city emerging from the largest municipal bankruptcy in American history, before returning to the governance challenges in Puerto Rico.  

Visit the project blog: The Municipal Sustainability Project 

Harming Post Chapter 9 Recovery? As the House and Senate race, this week, to conference on federal tax legislation, the potential fiscal impact on post chapter 9 Detroit provides grim tidings. The proposed changes would eliminate federal tax credits vital to Detroit’s emergency from chapter 9 municipal bankruptcy; the elimination of low-income housing tax credits would reduce financing options for the city: the combination, because it would adversely affect business investment and development, could undercut the pace of the city’s recovery. Most at risk are historic rehabilitation and low income housing tax credits: the House version of the tax “reform” legislation proposes to eliminate historic tax credits—the Senate version would reduce them by 50%; both versions propose the elimination of new market tax credits. The greatest threat is the potential elimination of the Low Income Housing Tax Credit (LITC), proposed by the House, potentially undercutting as much as 40% of the current financing for low income housing in the Motor City. While both the House and Senate versions retain a 9% low income housing tax credit, the credit, as proposed, would limit how much the Michigan State Housing Development Agency may award on an annual basis—putting as much as $280 million at risk. According to the National Housing Conference, the production of low income housing could decline by as much as 50%. The combined impact could leave owners and developers of low income housing with fewer options for rehabilitation—an impact potentially with disproportionate omens for post-chapter 9 municipalities such as Detroit.   

Is There Promise or Democracy in PROMESA? Since the imposition by Congress of the PROMESA, quasi-chapter 9 municipal bankruptcy legislation, under which a board named by former President Obama appointed seven voting members, with Gov. Puerto Rico Governor Ricardo Rosselló serving as an ex officio member, but with no voting rights—there have been singular disparities, including between the harsh fiscal measures imposed on the U.S. territory, measures imposing austerity for Puerto Rico, even as the PROMESA Executive Director receives an annual salary of $625,000—an amount 500% greater than the executive director of Detroit’s chapter 9 bankruptcy oversight board, and some $225,000 more than the President of the United States—with Puerto Rico’s taxpayers footing the tab for what is perceived as an unelected board acting as an autocratic body which threatens to undermine the autonomy of Puerto Rico’s government. Unsurprisingly, the Congressional statute includes few incentives for transparency, much less accountability to the citizens and taxpayers of Puerto Rico. Indeed, when the Center for Investigative Journalism and the Legal Clinic of the Interamerican University Law School, attorneys Judith Berkan, Steven Lausell, Luis José Torres, and Annette Martínez—both in one case before the San Juan Superior Court and in another before federal Judge Jay A. García-Gregory, as well as the Reporter’s Committee for Freedom of the Press submitted an amicus brief seeking clarification with regard to the legal standards of transparency and accountability which should be applied to the board, the PROMESA Board asserted that the right of access to information does not apply to it. 

Governance in Insolvency. As we have followed the different and unique models of chapter 9 and insolvencies from Central Falls, Rhode Island, through San Bernardino, Stockton, Detroit, Jefferson County, etc., it has been respective state laws—or the absence thereof—which have determined the critical role of governance—whether it be guided via a federal bankruptcy court, a state oversight board, in large part determined by the original authority under the U.S. system of governance whereby the states—because they created the federal government—individually determine the eligibility of municipalities to file for chapter 9 municipal bankruptcy. In Puerto Rico, sort of a hybrid, being neither a state, nor a municipality, the issue of governing oversight is paving new ground. Thus, in Puerto Rico, it has opened the question with regard to whether the Governor or Congress ought to have the authority to name an oversight board—a body—whether overseeing the District of Colombia, New York City, Detroit, Central Falls, Atlantic City, etc.—to exercise oversight in the wake of insolvency. Such boards, after all, can protect a jurisdiction from pressures by partisan and outside actors. Moreover, the appointment of experts with both experience and expertise not subject to voters’ understandable angst can empower such appointed—and presumably expert officials, to take on complex fiscal and financial questions, including debt restructuring, access to the municipal markets, and credit.  Moreover, because appointed board members are not affected by elections, they are in a sometimes better position to impose austerity measures—measures which would likely rarely be supported by a majority of voters—or, as former D.C. Mayor Marion Barry said the District of Columbia oversight Board, it “was able to do some things that needed to be done that, politically, I would not do, would not do, would not do,” such as firing 2,000 human-service workers. 

In Puerto Rico—which, after all, is neither a municipality nor a state, the bad gnus is that these governance disparities are certain to continue: indeed, despite the PROMESA Board’s November 27th recommendations, Gov. Rosselló announced he would spend close to $113 million on government employees’ Christmas bonuses-an announcement the PROMESA Board responded to by stating that its members expect “to be consulted during the formulation and prior to the announcement of policies such as this to ensure the Government is upholding the principles of fiscal responsibility.” (Note: it would have to be a challenge for PROMESA Board members to observe the current federal tax bills in the U.S. House and Senate as measured by Congress’ Joint Committee on Taxation and the Congressional Budget Office and believe that Congress is actually exercising “fiscal responsibility.”)

Nevertheless, there might be some help at hand for the U.S. territory: House Ways and Means Committee Chairman Kevin Brady (R-Tx.), in trying to mold in conference with the Senate the pending tax reform legislation, is considering options to avert what top Puerto Rican officials fear could be still another devastating blow to its already tottering economy: both versions would end Puerto Rico’s status as an offshore tax haven for U.S. companies—a devastating potential blow, especially given the current federal Jones Act which imposes such disproportionate shipping costs on Puerto Rico compared to other, competitive Caribbean nations. Now, the Governor, as well as Puerto Rico’s Resident Commissioner Jenniffer Gonzalez, Puerto Rico’s sole nonvoting member of Congress, are warning that Puerto Rico’s slow recovery from Hurricane Maria could suffer an irreparable setback if manufacturers decide to close their factories. Commissioner Gonzalez said 40% of Puerto Rico’s economy relies on manufacturing, with much of that related to pharmaceuticals; ergo, she is worried that any drop in the $2 billion of annual revenue these businesses provide would undercut the economic recovery plan instituted by the PROMESA Board. The Commissioner notes: “Forty percent of the island is living in poverty,” even though the federal child tax credit only applies to a third child for residents of Puerto Rico.

Thus, many eyes in Puerto Rico—and, presumably in the PROMESA Board—are laser focused on the House-Senate tax conference this week, where the House version would extend, for five years, the so-called rum cover which provides an excise tax rebate to Puerto Rico and the U.S. Virgin Islands on locally produced rum—a provision which Republican leaders appear unlikely to retain, albeit, they appear to be amenable to changes which could help reboot the island’s economy. (Puerto Rico produces 77% of the rum consumed in the U.S., according to the Puerto Rico Industrial Development Agency.) In a sense, part of the challenge is that for Puerto Rico, the issue has become whether to focus its lobbying on retaining its quasi-tax haven status. Gov. Rosselló worries that if that status were altered, “companies with a strong presence on the island would be forced to shutter those operations and decamp for the mainland or, worse, a lower-tax country…This would put tens of thousands of U.S. citizens in Puerto Rico out of work and demolish our tax base right as we are trying to rebound from historic storms.” Chairman Brady, after meeting with Commissioner Gonzalez at the end of last week, told reporters the meeting was with regard to “ideas on how best to help Puerto Rico…I know the Senate too has some ideas as well…“Yeah, we’re going to keep working on that.” In conference, the House bill imposes a 20% excise tax on payments by a U.S. company to a foreign subsidiary; the Senate bill proposes a tax ranging from 12.5% to 15.625% on the income of foreign corporations with intangible assets in the U.S. Unsurprisingly, Puerto Rico officials and U.S. businesses operating there describe both the House and Senate versions as putting Puerto Rico at a disadvantage—or, as one official noted: “The companies are asking from exemptions from all of this if Puerto Rico is involved…They want to be exempted from the taxes going forward that would prevent companies from accumulating untaxed profits abroad.” Foreign earnings, which includes revenues earned by corporations operating in Puerto Rico, could be repatriated at a 14% rate if the funds were held in cash and 7% if its illiquid assets under the House bill; the Senate version would tax cash at 10% and illiquid assets at 5%. Companies operating in Puerto Rico would be taxed at the same rate on the mainland of the U.S. and in foreign countries. In addition, the average manufacturing wage is three times lower in Puerto Rico than on the mainland and companies operating there can claim an 80% tax credit for taxes paid to the territorial government, according to officials. Senate Finance Committee Chair Orrin Hatch (R-Utah) noted he wishes to “help Puerto Rico, but not in this tax bill.”