What Could Be the State Role in Municipal Fiscal Distress?

 

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eBlog, 03/08/17

Good Morning! In this a.m.’s eBlog, we consider the state role in addressing fiscal stress, in this instance looking at how the Commonwealth of Virginia is reacting to the fiscal events we have been tracking in Petersburg. Then we spin the roulette table to check out what the Borgata Casino settlement in Atlantic City might imply for Atlantic City’s fiscal fortunes, a city where—similar to the emerging fiscal oversight role in Virginia, the state is playing an outsized role, before tracking the promises of PROMESA in Puerto Rico.

The State Role in Municipal Fiscal Stress. One hundred fifty-three years ago, Union General George Meade, marching from Cold Harbor, Virginia, led his Army of the Potomac across the James River on transports and a 2,200-foot long pontoon bridge at Windmill Point, and then his lead elements crossed the Appomattox River and attacked the Petersburg defenses on June 15. The 5,400 defenders of Petersburg under command of Gen. Beauregard were driven from their first line of entrenchments back to Harrison Creek. The following day, the II Corps captured another section of the Confederate line; on the 17th, the IX Corps gained more ground, forcing Confederate General Robert E. Lee to rush reinforcements to Petersburg from the Army of Northern Virginia. Gen. Lee’s efforts succeeded, and the greatest opportunity to capture Petersburg without a siege was lost.

Now, the plight of Petersburg is not from enemy forces, but rather fiscal insolvency—seemingly alerting the Commonwealth of Virginia to rethink its state role with regard to the financial stress confronting the state’s cities, counties, and towns. Thus, last month, Virginia, in the state budget it adopted before adjournment, included a provision to establish a system for the state to detect fiscal distress among localities sooner than it did with Petersburg last year, as well as to create a joint subcommittee to consider the broader causes of growing fiscal stress for the state’s local governments. Under the provisions, the Co-Chairs of the Senate Finance Committee are to appoint five members from their Committee, and the Chairman of the House Appropriations Committee is to name four members from his Committee and two members of the House Finance Committee to a Joint Subcommittee on Local Government Fiscal Stress. The new Joint Subcommittee’s goals and objectives encompass reviewing: (i) savings opportunities from increased regional cooperation and consolidation of services; (ii) local responsibilities for service delivery of state-mandated or high priority programs, (iii) causes of fiscal stress among local governments, (iv) potential financial incentives and other governmental reforms to encourage increased regional cooperation; and (v) the different taxing authorities of cities and counties. The new initiative could prove crucial to impending initiatives to reform state tax policies and refocus economic development at the regional level, as the General Assembly considers the fiscal tools and capacity local governments in the commonwealth have to raise the requisite revenues they need to provide services—especially those mandated by the state. Or, as Gregory H. Wingfield, former head of the Greater Richmond Partnership and now a senior fellow at the L. Douglas Wilder School of Government and Public Affairs at Virginia Commonwealth University, puts it: “I hope they recognize we’ve got to have some restructuring, or we’re going to have other situations like Petersburg…This is a very timely commission that’s looking at something that’s really important to local governments.”

The Virginia General Assembly drafted the provisions in the state budget to create what it deems a “prioritized early warning system” through the auditor of public accounts to detect fiscal distress in local governments before it becomes a crisis. Under the provisions, the auditor will collect information from municipalities, as well as state and regional entities, which could indicate fiscal distress, as well as missed debt payments, diminished cash flow, revenue shortfalls, excessive debt, and/or unsupportable expenses. The new Virginia budget also provides a process for the auditor to follow and notify a locality that meets the criteria for fiscal distress, as well as the Governor and Chairs of the General Assembly’s finance committees. The state is authorized to draw up to $500,000 in unspent appropriations for local aid to instead finance assistance to the troubled localities. The Governor and money committee Chairs, once notified that “a specific locality is in need of intervention because of a worsening financial situation,” would be mandated to produce a plan for intervention before appropriating any money from the new reserve; the local governing body and its constitutional officers would be required to assist, rather than resist, such state intervention—or, as House Appropriations Chairman S. Chris Jones (R-Suffolk) describes it: “The approach was to assist and not to bring a sledgehammer to try to kill a gnat,” noting he had been struck last fall by the presentation of Virginia’s Auditor of Public Accounts Martha S. Mavredes with regard to the fiscal stress monitoring systems used by other states, including one in Louisiana which, he said, “would have picked up Petersburg’s problem several years before it came to light…At the end of the day, it appears you had a dysfunctional local government, both on the administrative and elected sides, that was ignoring the elephant that was in the room.”

The ever so insightful Director of Fiscal Policy at the Virginia Municipal League, Neal Menkes, a previous State & Local Leader of the Week, notes that Petersburg is far from alone in its financial stress, which was caused by factors “beyond just sloppy management: It included a series of economic blows,” he noted, citing the loss of the city’s manufacturing base in the 1980s and subsequently its significant retail presence in the region. The Virginia Commission on Local Government identified 22 localities—all but two of them cities—which experienced “high stress” in FY2013-14, of which Petersburg was third, and an additional 49 localities, including Richmond, which had experienced “above average” fiscal stress. Or as one of the wisest of former state municipal league Directors, Mike Amyx, who was the Virginia Municipal League Director for a mere three decades, notes: “It’s a growing list.”

The Commonwealth’s new budget, ergo, creates the Joint Subcommittee on Local Government Fiscal Stress, charged with taking a sweeping look at the reasons for stress, including:

  • Unfunded state mandates for locally delivered services, and
  • Unequal taxing authority among localities.

The subcommittee will look at ways for localities to save money by consolidating services and potential incentives to increase regional cooperation, or as Virginia Senate Finance Co-Chairman Emmett Hanger (R-Augusta) notes: “We need to dig deeply into the relationship of state and local governments,” expressing his concerns with regard to potential threats to local revenues, such as taxes on machinery and tools, and on business, professional and occupational licenses (BPOL), as well as fiscal disparities with regard to local capacity or ability to finance core services such as education and mental health treatment, or, as he puts it: “We do need to address the relative levels of wealth of local governments…We need to look at all of the formulas in place for who gets what from state government…Our tax system is still antiquated, and local governments have to rely too heavily on real estate taxes.”  

The subcommittee will include Sen. Hanger and Chairman Jones, as chairs of the respective Budget Committees, and House Finance Chairman R. Lee Ware Jr. (R-Powhatan), whose panel grapples every year with the push to reduce local tax burdens and the need to give localities the ability to generate revenue for services. Chairman Jones, a former Suffolk Mayor and city councilmember, said he is “keenly aware of the relationship between state and local governments. It is a complex relationship. The solutions aren’t simple…You’ve got to be able to replace that revenue at the local level—you can’t piecemeal this.”

Municipal Credit Roulette. State intervention and a settlement of tax refunds owed to a casino drove a two-notch S&P Global Ratings upgrade of Atlantic City’s general obligation debt to CCC from CC. The rating remains deep within speculative grade, the outlook is developing. S&P analyst Timothy Little wrote that the upgrade reflected a state takeover of Atlantic City finances that took effect in November which has helped “diminish” the near-term likelihood of a default. A $72 million settlement with the Borgata Hotel Casino & Spa over $165 million in owed tax refunds that saves Atlantic City $93 million also contributed to the city’s first S&P upgrade since 1998, according to S&P. Mayor Don Guardian noted that obtaining a CCC rating was “definitely a step in the right direction: As we continue to implement the recommendations from our fiscal plan submitted last year, and working together with the state, we know that our credit rating will continue to improve higher and higher.” Nevertheless, notwithstanding the credit rating lift, Mr. Little warned that Atlantic City’s financial recovery is “tenuous” in the early stages of state intervention, ergo the low credit rating reflects what he terms “weak liquidity” and an “uncertain long-term recovery,” reminding us that Atlantic City has upcoming debt service payments of $675,000 due on none other than April Fool’s Day, followed by another $1.6 million on May Day, $1.5 million on June 1st, and $3.5 million on August 1st. Nevertheless, Atlantic City and the state fully contemplate making the required payments in full and on time. Mr. Little sums up the fiscal states:  “In our opinion, Atlantic City’s obligations remain vulnerable to nonpayment and, in the event of adverse financial or economic conditions, the city is not likely to have the capacity to meet its financial commitment…Due to the uncertainty of the city’s ability to meet its sizable end-of-year debt service payments, we consider there to be at least a one-in-two likelihood of default over the next year.” He adds that, notwithstanding the State of New Jersey’s enhanced governing role with Atlantic City finances, chapter 9 municipal bankruptcy remains an option for the city if adequate gains are not accomplished to improve the city’s structural imbalance, as well as noting that S&P does not consider the city to have a “credible plan” in place to reach long-term fiscal stability. For his part, Evercore Wealth Management Director of Municipal Credit Research Howard Cure said that while the municipal credit upgrade reflects the Borgata Casino tax resolution, the rating, nonetheless, makes clear how steep the road to fiscal recovery will be: “You really need the cooperation of the city, but also the employees of the city for there to be a real meaningful recovery…This could go bad in a hurry.”

Is There Promise in Promesa? Elias Sanchez Sifonte, Puerto Rico’s representative to the PROMESA Fiscal Supervision Board, late Tuesday wrote to PROMESA Board Chairman José B. Carrión to urge that the Board take concrete actions in its final recommendations to address the U.S. territory’s physical health and the renegotiation of public debt—that is, to comply with the provisions of PROMESA and advocate for Puerto Rico with the White House and Congress in order to avoid “the fiscal precipice” which Puerto Rico confronts, especially once the federal funds which are used in My Health expire. Mr. Sifonte also requested additional time for Puerto Rico to renegotiate its debt, reminding the Board that PROMESA “makes it very clear that an extension of the funds under the Affordable Care Act is critical.” With grave health challenges, the board representative appears especially apprehensive with regard to the debate commencing today in the House of Representatives to make massive changes in the existing Affordable Care Act.

Recounting Governor Ricardo Rosselló Nevares efforts to address Puerto Rico’s severe fiscal situation, he further noted that the Governor’s efforts would little serve if the PROMESA Board bars Puerto Rico from a voluntary process through which to renegotiate what it owes to various types of creditors, arguing that Puerto Rico ought to be able to negotiate with its municipal bondholders, and, ergo, seeking an extension of the current suspension of litigation set to expire at the end of May to the end of this year, noting: “It would be very unfair that after all the progress achieved in the past two months, the government cannot achieve a restructuring under Title VI simply because the past government intentionally or negligently truncated the Title VI process at the expense of the new administration.” His letter came as Gerardo Portela Franco, the Executive Director of the Puerto Rico Fiscal Agency and Financial Advisory Authority (FIFAA), reported that administration officials have had initial talks with the PROMESA board about the plan and are in the process of making suggested changes. FIFAA will manage the implementation the measures and lead negotiations with Puerto Rico’s creditors over restructuring the government’s $70 billion of debt.

The See-Saw of Municipal Fiscal Solvency

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eBlog, 12/27/16

Good Morning! In this a.m.’s eBlog, we consider the remarkable turnaround in fiscal fortunes in Detroit—a city unbailed out by the federal government, but now, as Detroit News editorial writer Daniel Howes writes, is “perceptively changing,” albeit, interestingly in light of the President-elect’s choice to be the new Secretary of Education, the state of Detroit’s public schools “burdens an already difficult financial picture.” Then we turn to the challenge of trying (in the frigid Winter no less!) to describe fiscal contagion from the insolvent East Cleveland, before finally trying to escape the cold by journeying south to Puerto Rico to explore the worsening demographic trends and their implications for the changing administrations both in Washington, D.C. and Puerto Rico.

Winnerville? Daniel Howes, an editor for the Detroit News, in his editorial “Loserville,” wrote that two years “after Detroit emerged from the largest municipal bankruptcy in the nation’s history, the city America gave up for dead is showing that it is anything but,” writing that vacant space downtown is “is growing increasingly hard to find,” a stark contrast from the city’s first day of municipal bankruptcy when I was specifically warned not to walk from my downtown hotel to the Governor’s Detroit offices to meet Kevyn Orr, the then newly named Emergency Manager. Thus, Mr. Howes writes:

He tempered his column by noting that violent crime continues to be an issue in parts of the city—and that neighborhood revitalization “lags the pace set by downtown,” adding that the “exodus from Detroit Public Schools burdens an already difficult financial picture,” albeit writing that Detroit’s makeover is “a process, not a destination with guaranteed arrival,” indeed, comparing it the comparable (and related) comeback of the auto industry—albeit with the profound difference that the latter was bailed out—something Detroit was not, noting: “Detroit’s automakers, effectively a ward of the federal government at the outset of the Obama administration, are closing an eight-year span their leaders used to re-engineer companies that tottered on the edge of collapse on Election Day 2008…Eight years later, at least two of Detroit’s three automakers — as well as many of its suppliers—are emerging as players to be reckoned with in both the traditional car and truck business as well as the emerging mobility space. Loserville? Hardly…The creation of the American Center for Mobility at Willow Run and the Michigan Legislature’s move to enact the most far-reaching autonomous-vehicle laws in the country underscore the state’s bid to become the nation’s epicenter of mobility development and testing.”

Loserville? Fiscal Contagion? Just as the flu can be contagious, so too municipal fiscal distress does not necessarily stop at municipal borders. So it is that a growing number of residents of Forest Hill, a twenty-five acre historic neighborhood spanning parts of Cleveland Heights and East Cleveland, Ohio, founded by John D. Rockefeller and a seeming stark contrast from the virtually bankrupt East Cleveland, are upset by the increasing number of long-abandoned homes in both municipalities: assessed property values are tanking, and there is increasing apprehension at the seeming inability of the municipality to provide even basic services. There is also a sense that East Cleveland’s possible merger with Cleveland will not happen soon enough (if ever) to help Forest Hill’s issues: incorporating as a village would take cooperation from both cities, several voter elections, and the approval of Cuyahoga County. Similarly, there are no answers to the questions of where tax dollars would come from to hire police, firefighters, and provide basic, essential public services. Ironically, the neighborhood hosts municipally influential citizens—or at least formerly so, including East Cleveland’s recalled Mayor Gary Norton, the city’s new mayor Cheryl Stephens, and former Mayor Ed Kelley. The silence of the State of Ohio must weigh heavily on their hopes for the New Year.

Unfeliz Navidad? Puerto Rican demographer Raul Figueroa released information this morning that if the current demographic trends in the U.S. territory continue, by 2020, citizens older than 60 will—for the first time ever—surpass the number of those under 18, writing that between July of 2015 and July of this year, some 60,000 island residents had departed—and that this year marked the first in which the number of deaths exceeded the number of births. He noted increasing apprehensions of an increasing schism for the young generation—whose most productive members have “established themselves outside of the U.S. territory” and are forming families there, while their counterparts who have stayed behind are, increasingly, becoming caught up in criminal activities. Thus, he wrote, “Only a significant reduction in emigration or increase in immigration could reverse this demographic trend…it will be necessary to search for a strategy to permit and facilitate strategies to create employment opportunities.” Indeed, island economists like Elías Gutiérrez and José Alameda have expressed apprehension that the island is converting into a “gueto” of the poor and aged, likening it to a “Greek tragedy.” Mr. Gutiérrez added that the middle class has receded on “every front.” He noted, too, that the increasing demographic imbalance will increase the public pension imbalance: as the young flee, fewer will be paying in, while the number of retirees will continue to grow.

The demographic pressures on the island’s fiscal challenges come as soon-to-depart Puerto Rico Gov. Alejandro García Padilla released more pessimistic figures for the next decade—as he cast increasing doubt with regard to the viability of a negotiated debt solution—explaining that his updated projection of Puerto Rico’s financial shortfall over the next decade would be $8.8 billion worse than its forecast of just two months ago, when he had submitted a 10-year fiscal plan to the PROMESA Puerto Rico Oversight Board—a plan in which the government had projected that if the government stayed on its then current fiscal course—its so-called “Baseline”—it would be short some $58.7 billion, that is, in an ever accelerating state of debt. Moreover, in a revision released yesterday, that figure had increased by nearly $10 billion to $67.5 billion—the deficit reduction target the outgoing administration estimated it would have to achieve in reductions to achieve a balanced budget by 2026. That is, the debt situation has reached such an extreme that even were all its $35 billion in debt service to be magically eliminated, the island would still be overburdened with debt.

The newly released baseline also uncovers a related fiscal challenge which the new one does: what are the fiscal implications on Puerto Rico’s economy? The government’s new baseline projects government spending cuts would lead to a more negative nominal gross national product trajectory over the next decade, with the nominal, annual GNP shrinking by 1.03 percent instead of the previously projected growth from the October plan—even as the revised assumptions about economic growth and inflation added some $3.4 billion to the new baseline compared to the October baseline. The tab? The revised projections over the next decade project $232 billion in government spending, but only $165 billion in revenue—with the difference to be bridged by unspecified budget cuts.

The revised projections come as the PROMESA Oversight Board has commenced its discussions with creditors as part of its mission, similar to a chapter 9 municipal bankruptcy, to achieve a negotiated and consensual debt cut under Title VI of the new PROMESA law. But, to Gov. Padilla, the increasingly deteriorating fiscal and economic projections over the next decade mean that “that a comprehensive restructuring under Title III (the debt restructuring title) of PROMESA is inevitable.” Yet this all comes in the midst of changing administrations in Washington, D.C. and against an encroaching deadline: under the new federal law, creditors’ rights to sue have only been suspended until the middle of February. Ergo, Gov. Padilla’s office notes: “If Puerto Rico does not seek Title III protection before the termination of the claims on February 15, 2017, the government will run out of money and essential services will be severely affected.”

The Avoidance of Fiscal Contagion

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eBlog, 12/15/16

Good Morning! In this a.m.’s eBlog, we consider the role of leaders appointed or named by municipalities with regard to the integrity of coming back from chapter 9 municipal bankruptcy or insolvency; then we turn to some of the critical factors which have played key roles in San Bernardino’s emergence from the nation’s longest municipal bankruptcy, before, finally, heading into the frigid physical gale and fiscal maelstrom of Atlantic City to consider not only the challenge for a state in taking over a municipality—but also the challenge of avoiding fiscal distress contagion.

Doubting Governance. The Detroit News, in its analysis of state and federal court records, tax filings, and interviews; reported that said analysis raised questions about the ability of some Detroit Development Authority (DDA) members to oversee one of the largest publicly subsidized downtown construction projects since Detroit emerged from chapter 9 municipal bankruptcy. The paper’s analysis also revealed a shortcoming of the city’s appointment process—noting it omitted any requirement for DDA members to undergo criminal or financial background checks, despite the fact that the Motor City’s DDA has approved some $250 million in taxes on Little Caesars Arena, even as the DDA is “dominated by tax delinquents with financial problems and in some cases criminal records,” according to public records.

As in most cities, the arena is being financed via the issuance of municipal bonds, under an agreement approved three years ago, where municipal taxes are to be dedicated to paying off $250 million worth of bonds issued by a branch of state government financed by the Michigan Treasury department—a department which has charged a number of DDA members of being tax delinquents. The paper adds that a majority of those appointed have a “history of financial issues,” including more than $500,000 in state and federal tax debt, according to public records. The News noted that details about the DDA members’ financial history offered some insight into a municipal public authority which all too often operates in secret—in this instance an authority whose members are appointed by the Mayor, approved by the City Council, and who then work with professional staff from the nonprofit Detroit Economic Growth Corp.; however, unlike almost every municipal or county public authority, the DDA board does not post agendas, minutes, or accurate meeting schedules; its members are not required to submit to a criminal or financial background check. (Members on the board are not compensated.) Indeed, Mayor Mike Duggan’s chief of staff Alexis Wiley, responding to inquiries by the News, said: “Really, every single person on the board has served the city of Detroit well…They’ve had personal financial challenges, but they have displayed good judgment as board members.” Malinda Jensen, the Detroit Economic Growth Corp.’s senior vice president of board administration and governmental affairs, in a statement to the News, noted: “The public funds contributing to the repayment of construction bonds to build the downtown arena come from a dedicated stream of revenue authorized by state law, approved by the DDA board as a whole, ratified by several votes of the full City Council…audited by independent accountants, and safeguarded in the terms of the sale of the bonds to financial institutions…Those funds are very well protected.” She added: “No individual on the board has any direct ability to access any public funds, and all decisions of the DDA are by majority votes in a public meeting,” adding that the DDA has a quarter-century of clean audits by an independent certified public accounting firm, she said. And DDA members are barred from voting on issues in which they have a direct financial interest, Ms. Jensen added, noting: “We all were impacted in some way through this financial crisis…I’d be curious about what some of that had to do with some of the reports you are hearing on some of these individuals.”

Would that governance and personal integrity were so simple, but, in this case, it turns out that two DDA members with a history of financial problems are also high-ranking members of the Mayor’s administration, with one running Detroit’s neighborhoods department—in this case a long-time municipal employee who has worked for every Mayoral administration since former Mayor Coleman Young, but who has also filed for bankruptcy, lost a home to foreclosure, and failed to pay $250,691 in state and federal taxes, according to public records—and served two years in federal prison in the wake of being found guilty in 1984 of receiving more than $16,000 in illegal payoffs from a sludge-hauling company—at the very time he was serving as Detroit’s Director of the city’s ill-fated Water and Sewerage Department. The paper notes that his colleague at City Hall, Corporation Counsel Melvin “Butch” Hollowell, has faced his own series of state and federal tax liens over the most recent five years: he has been accused of failing to pay more than $60,000 in federal and state taxes, although he has, according to public records, this year managed to pay off all of the debt. The News quoted University of Virginia Law School tax expert George Yin about its findings with regard to the troubled financial records of DDA members, and their fiscal integrity as it relates to their public responsibilities to oversee publicly funded sports arenas—to which Mr. Yin responded: “Given the kind of doubtful or questionable nature of public subsidies for these facilities, you want the people making decisions to be people whose judgment has been proven to be right over and over again.”

The Precipitous Road to Bankruptcy’s Exit Ramp. The City of San Bernardino, once the home to Norton Air Force Base, Kaiser Steel, and the Santa Fe Railroad—yesterday, some twenty-two years later, received a report from the Inland Valley Development Agency’s annual review that, for the first time, it has more than restored all of the jobs and economic impact lost when the base closed: indeed, the review found that the 14,000-acre area of the former base now employs 10,780 people and is responsible for an economic output of $1.89 billion, surpassing the totals lost when the base closed in 1994. What has changed is the nature of the jobs: today these are predominantly logistics, with Amazon’s 4,200 employees and Stater Bros. Markets’ 2,000 employees accounting for more than half of the total. Economist John Husing, whose doctoral thesis studied the economic impact of Norton Air Force Base, yesterday told the San Bernardino Sun: “The jobs that have come in are comparable or better than the jobs that were lost…Because of the spending pattern difference between civilians and military personnel, you only needed 75 percent of the number of people working there to replace the economic impact,” adding that that was because much of the spending by Norton’s employees was at the on-base store, so the money did not recirculate into the local economy—adding that that job total does not include an additional 5,000 part-time jobs created by Amazon and Kohl’s during the Christmas shopping season; nor does it include an additional 5,000 indirect jobs that help build nearly $1.9 billion of total economic benefit. Moreover, with the exception of the San Bernardino International Airport itself (the fourth-largest source of jobs in the project area, with 1,401), the major employers are not directly tied to the former role of the base. Nevertheless, as Mr. Burrows noted: it took planning and preparation to get those companies to come to San Bernardino: “Without a lot of inducement from us—infrastructure, roadway improvements, Mountain View Bridge, for example, we wouldn’t have those jobs…“It’s been a longtime strategic effort, and we’re very pleased that we’re seeing some results.” Mr. Burrows added, moreover, that the Inland Valley Development Agency has more projects (and more jobs) in the works for 2017, including continued infrastructure work and a focus on workforce development: “We’re particularly going to focus on our K-12 schools, San Bernardino Valley College, and the (San Bernardino) Community College District in making sure we’re doing more on the workforce development side.” To do so will be a regional effort, via the agency—which is composed of representatives from San Bernardino County and the cities of Colton, Loma Linda, and San Bernardino—who are responsible for the development and reuse of the non-aviation portions of the former Norton Air Force Base. San Bernardino Mayor Carey Davis noted the Development Authority’s “development of the Norton Air Force Base has proven to be a great asset to the San Bernardino community. We have positively impacted the economy with the creation of jobs and new business,” adding it was “a fine example of the progress we have made in rebuilding San Bernardino.”

Fiscal Distress Contagion & State Preemption. The Atlantic City Council had a quick meeting yesterday in the wake of the state pulling two ordinances for further review—measures which would have raised rates and revised regulations for Boardwalk trams and adopted a redevelopment plan for Atlantic City’s midtown area, with the state asking the Council to pull the ordinances “indefinitely,” according to Council President Marty Small. Subsequently, Timothy Cunningham, the Director of the New Jersey Division of Local Government Services Director and the quasi-takeover manager of the city government, said his agency has had insufficient time to review the ordinances, stating:  “We’ll just revisit them in the new year…I don’t think there’s any objection to them. Just not enough time to fully vet them.” The statement reflects the post-state takeover governance and preemption of local authority. In this case, the issue in question relates to proposed tram rules, including increasing fares to $4 one way and $8 all day in the summer, and $3 one way and $6 all day in the off season—compared to $2.25 one way and $5.50 for an all-day pass. The ordinance would also have allowed the trams to carry advertisements—from which, according to sponsor Councilman Jesse Kurtz, the city would receive half the revenue from the ads.

Nevertheless, the discordant governance situation and unresolved insolvency of the city do not, at least according to Moody’s analyst Douglas Goldmacher, appear to be contagious, with the analyst writing there is only a “relatively mild” chance that the massive fiscal and governance problems of Atlantic City will contaminate Atlantic County: “While Atlantic City remains the largest municipality in the county and its casinos are currently the largest taxpayers, the county’s dependence on Atlantic City’s tax revenues continues to decline.” Moreover, he wrote: “State law offers considerable protection from the city’s financial trauma, and the county has demonstrated a history of strong governance.” Mr. Goldmacher added that the neighboring county has managed to partially offset Atlantic City’s declining tax base and gambling activity with growth in other municipalities—with Atlantic City’s share of the county tax base less than half what it was at its peak of 39% in 2007. The report notes that the county also benefits from a New Jersey statute which insulates the county from the city’s fiscal ills, because cities are required to make payments to counties and schools prior to wresting their share—noting that Atlantic City has never missed a county tax payment and was only late once—and, in that situation, only after special permission was granted in advance. Thus, Mr. Goldmacher wrote: “While Atlantic City has endured political gridlock, the county has achieved structural balance and demonstrated stability through budgeting accuracy, strong reserves and contingency plans…The county also has substantial fund balance and other trust funds and routinely prepares multiple budgets and tax schedules to account for Atlantic City’s uncertain fate.”

Schooled in Public Service & Municipal Bankruptcy

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eBlog, 12/08/16

Good Morning! In this a.m.’s eBlog, we salute the soon to be retiring Emergency Manager of the Detroit Public Schools, the exceptional former U.S. Bankruptcy Judge Steven Rhodes, who presided over the largest municipal bankruptcy in the nation’s history before accepting the grueling challenge to be the emergency manager of the near bankrupt Detroit public schools system.

Yes We Can. The extraordinary public servant and electric rhythm guitar playing retired U.S. Bankruptcy Judge Steven Rhodes, currently the outgoing (yes, a pun) Emergency Manager of the Detroit Public Schools Community District (DPSCD)said an investigation by the school district’s inspector general could produce more criminal charges in the district—and, likely, more fiscal pain for the city. He had hired Inspector General Bernadette Kakooza last April, in the midst of an ongoing federal investigation of a $2.7 million kickback scheme with a contractor involving 13 school administrators who are no longer employed by the school district, although he was careful not to address the specifics in speaking to the Detroit News this week about what potential wrongdoing there might be after testifying before a House committee on the District’s progress since the legislature last June enacted a $617 million financial rescue of the school system; however, Judge Rhodes noted, referring to Ms. Kakooza: “She does have several matters under investigation at the present time that may result in further criminal investigations and charges.” Those charges relate to new cases of fraud the DPSCD inspector general had outlined in a report, including a payroll error resulting in an employee being overpaid by $50,000, fraudulent teaching credentials, and missing equipment and public funds. Judge Rhodes did say that the new debt-free Detroit school has developed “much stricter controls” on purchasing in an effort to try to prevent fraud, adding, however: “Still, we understand that there are no financial controls that are foolproof against clever and smart criminals who are intent upon theft and fraud.” His statement came before the Michigan House School Aid Appropriations Subcommittee in what might prove to be one of his last state public appearances as he nears the end of his service to Detroit’s kids on the last day of this month. At the hearing, Judge Rhodes also disclosed for the first time that the school district has paid Michigan’s public pension fund nearly $30 million—money which had been diverted from federal grants to the public school district’s general fund by his predecessors. DPSCD’s past-due pension debt to the Michigan Public School Employee Retirement System stood at $132.6 million as of last November 11th, significantly paid down from $163 million on June 30th, according to the Michigan Office of Retirement Services; nevertheless, it will likely take nearly a decade to fully pay down past arrears. .

For his part, Judge Rhodes said he would be handing over authority of the school district to a newly elected Detroit school board with a projected fund balance of between $40 million and $50 million for the current fiscal year, telling reporters: “The school board is the new control for public education in the city of Detroit.” Rhodes told reporters; albeit, as part of the state’s bailout of the Detroit Public Schools, Detroit’s Financial Review Commission retains veto power over the school board’s spending plans once Judge Rhodes leaves office at the end of the month; Judge Rhodes said the surplus will help the district with cash-flow next summer when there is a projected gap in School Aid payments from the state. His swan song, as it were, comes as the legislature continues to scrutinize the finances and operations of the state’s largest school system. As a parting, if poignant, message, Judge Rhodes advised: “I think DPS just needs to be left alone for a little while to give this academic plan a chance, to give our fresh start a chance and to prove to our city, our region, and our state that we can succeed.”

While the there is separate and distinct governance between Detroit’s municipal and school governance, the two are inextricably linked, because, as we have noted too often (likely), the perceived quality of a municipality or county’s public schools is critical to the interest of parents to move to such a municipality or county–and, ergo–to assessed property values. 

TheExceptional Governing Challenges on Roads to Fiscal Recovery

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eBlog, 12/02/16

Good Morning! In this a.m.’s eBlog, we consider the hard role to recovery not just from San Bernardino’s longest-ever municipal bankruptcy, but also the savage terrorist attack a year ago. Then we venture East to observe the evolving state role in New Jersey’s takeover of Atlantic City, where the new designee named by Gov. Chris Christie, Jeffrey Chiesa, yesterday introduced himself to residents and taxpayers, but offered little guidance about exactly how he will usurp the roles of the Mayor and City Council in governing and trying to get the famed boardwalk city out of insolvency and back to fiscal stability. Finally, we look north to the metropolitan Hartford, Connecticut region, where the municipalities in the region are seeking to work out fiscal mechanisms to address Hartford’s potential municipal bankruptcy in order to ensure no disruption of metropolitan water and sewer services—a different, but in this case critical element of a “sharing economy.”  

The Jagged Road to Chapter 9 Recovery. It was one year ago today that terrorists struck in San Bernardino—the city in chapter 9 municipal bankruptcy longer than any other city in U.S. history, marking, then, a day of 14 deaths—with victims caught in the crossfire of gun shots and carnage in the wake of the wanton attack by Syed Rizwan Farook and Tashfeen Malik—and a horror still not over, as it will be another nine months before the trial against Enrique Marquez Jr., who has been charged with buying some of the weapons which were used in the attack, commences in September—months after the beleaguered city anticipates exiting from bankruptcy. Because the shootings took place at a San Bernardino County facility in San Bernardino, the long-term recovery has been further complicated from a governance perspective: many of the shooting survivors are accusing San Bernardino County of cutting off much-needed support for the survivors of the attack, including refusing to approve counseling or antidepressant medication. Others, who were physically wounded are seeking, so far unsuccessfully, to get surgeries and physical therapy covered. The San Bernardino County Board of Supervisors earlier this week convened a closed-door session at which survivors said they felt betrayed and abandoned, left to deal with California’s complicated workers’ compensation program without guidance or help. Their health insurers will not cover their injuries because they occurred in a workplace attack. Congressman Pete Aguilar (D-Ca.), whose district includes San Bernardino, reports that his hometown had been added to a list of cities with which people are familiar for a terrible reason, such as Littleton, Colo., or Newtown, Conn. Nevertheless, he is defiant, insisting “We will not be defined by this tragedy.”

However, murder rates in the city have been climbing: the city of just over 200,000 is grappling with a spike in violent crime, homicides especially: to date, this year, the city has reported 49 killings, already more than last year’s total, which included the terrorist victims—its homicide rate tops that of Chicago, which has become the poster child for big-city violent crime and is on pace for more than 600 killings this year. San Bernardino Police Chief Jarrod Burguan, however, said the crime wave is not unique to the chapter 9 municipality—a currently bankrupt city where empty storefronts and pawn shops have long lined downtown streets. Nevertheless, Brian Levin, a criminal justice professor at California State University, San Bernardino, who studies hate crimes, yesterday noted: “we’re a better community now, even though we’re hurt.” Professor Levin is one who, in the days and weeks which ensued after the mass tragedy, met with faith leaders, law enforcement, and families of the victims—where he discovered a unity of shock and shared pain. Today, he notes: “The attack will always be a part of our history…But here’s the thing: so will the heroics of those police officers and first responders and medical staff, and so will the grace of the families. We’re writing the rest of the history. The bastards lost.” Now the city awaits early next year for emerging not just from the physical tragedy, but also the longest chapter 9 municipal bankruptcy ever.  

Atlantic City Blues.  Jeffrey Chiesa, a former New Jersey Attorney General, U.S. Senator, and, now, Governor Chris Christie’s designee to run the state takeover of Atlantic City, yesterday introduced himself at a City Council meeting and took questions from city taxpayers and residents. He provided, however, in this first public meeting no details on plans to address either the city’s fiscal plight—or its interim governance. He reported the State of New Jersey does not yet have a plan to address the city’s $100 million budget hole, much less to pay down the Atlantic City’s $500 million debt, noting: “It has been two weeks…My plan is to do what I think is necessary to create a structural financial situation that works not for six months, not for a year, but indefinitely so that this place can flourish in a way that it deserves to flourish.” He noted he and his law firm will be paid hourly for their work, albeit he did not report what that hourly rate will be—especially as the state retention agreement remains incomplete, albeit promising: “We’ll make sure that’s available once it’s been finalized.” Related to governance, he noted that—related to his state-granted authority to sell city assets, hire or fire workers or break union contracts, among other powers—he would listen to residents and stakeholders before making major decisions: “What this designation has done is consolidate authority, per the legislation, in the designee to make those decisions…That does not mean that I’m not listening. That does not mean I’m pretending I have all the answers without consulting with other people.” Describing the seaside city as a “jewel” and “truly unique,” he added that he understood concerns about an outsider overseeing the city: “I know that most of you don’t know who I am…All I can do is be judged by my actions and the decision that I make, and I hope you give me time to do that.” He did say that he would have to move swiftly to address immediate issues, likely referring to reaching agreements with casinos to make payments in lieu of property taxes, and then focusing on the city’s expenses—noting: “That timeframe is pretty compressed…So we will take the steps we need to take.”

Fiscally Hard for Hartford. As we have recounted in the fiscally strapped municipality of Petersburg, Virginia, municipal fiscal insolvency cannot occur in a geographic vacuum: whether in Detroit—or as we note above today, in San Bernardino, fiscal insolvency has repercussions for adjacent municipalities. So too in Hartford, the Metropolitan District Commission (MDC) completed its planned $173 million municipal bond sale late last week, temporarily ending the controversy over a $5.5 million reserve fund. Under the provisions, that fund would be paid by seven of the eight MDC municipalities to cover the sewage fee for the second half of 2017 if the City of Hartford is unable to contribute its share, as it has indicated it will be unable to do. Ergo, it means that adjacent Windsor, the first English settlement in the state which abuts Hartford on its northern border, with a population of under 30,000 would contribute over $700,000, with East Hartford contributing about $900,000. The other group members in the metro region, Bloomfield, Newington, Rocky Hill, West Hartford, and Wethersfield, would pay the remaining $900,000, proportionately. One outcome of this watery alliance and experience is that the MDC will, when the state legislature convenes next February, propose two laws to avoid the necessity for a reserve fund in the future, with MDC Chairman William DiBella suggesting that the eight member municipalities be required to set aside as untouchable the percentage of their property taxes the cities and towns already know they will owe to the MDC for sewage services. (Currently, property taxes go into the municipalities’ general funds, and the cities extract the sewage fee when it is due, provided the funds are, in fact, available; however, like water at the tap, that has not always been the experience.) In effect, the consortium is recommending a selves-imposed budgeting municipal mandate, with Chairman DiBella noting: “Every town would have to do it. That way, one town can’t stiff us. You wouldn’t have to go out and borrow money or take charity and hope you get it back.” As the Chairman noted: “We never had a problem like this…Who thought a town would go bankrupt? With the proposed law, if a town were to go bankrupt, the sewage fund would be in a dedicated account and can’t be reached,” or touched in a bankruptcy proceeding. Another potential resolution would be to allow the MDC to borrow money over a long-term for operating expenses. The MDC would then be able to pay Hartford’s $5.5 million bill and look for a city reimbursement in other ways.

There has been increased pressure for a resolution—especially in the wake of municipal bond holders of the MDC, holders who, last week, made clear to the authority they would not buy its municipal bonds if a reserve fund was not put into place. That appeared to be a key incentive for the board’s action earlier this week for the MDC board, including representatives of all eight municipal members, to vote unanimously to adopt the water and sewer service provider’s 2017 budget, which contains the unwelcome “bail-out” fund for Hartford—albeit Chair DiBella said there would be no guarantee the agency could cover a Hartford default or continue operating or pay the bondholders. A key part of the incentive to try to work together relates to potential fiscal contagion: because of concerns over Hartford’s finances and fiscal condition, credit rating agencies have recently downgraded MDC’s bond rating from AA+ to AA, a downgrade expected to cost the agency and its member towns an estimated $500,000 in a higher interest rate for the bonds. The towns, unsurprisingly, are apprehensive the credit rating agencies will now consider changing their credit ratings. In contrast, creating the reserve fund would keep MDC’s credit rating where it is: thus, MDC officials hope that passing the two proposed laws would prompt the credit rating agencies to return its rating to AA+.

 

Can Municipal Insolvency Be Contagious?

eBlog, 10/24/16

Good Morning! In this a.m.’s eBlog, we consider the risks of fiscal contagion emanating from the historic city of Petersburg, Virginia, where the city’s virtual insolvency risks the solvency of the regional wastewater authority—and, therefore, the other participating municipalities. Next, with Election Day approaching, we travel to post-chapter 9 Stockton where the ballot issue of a sales tax increase on next month’s municipal ballot has divided the city’s candidates for Mayor and Council. Finally, we consider the exceptional challenges for the U.S. territory of Puerto Rico in the wake of the first PROMESA board meeting.

Can Municipal Insolvency Be Contagious? The South Central Wastewater Authority (SCWA), which provides wastewater treatment services to protect and enhance the environment for the City of Petersburg, the City of Colonial Heights, Chesterfield County, Dinwiddie County, and Prince George County, Virginia, may have to dip into its cash reserves and raise rates for its four other member municipalities if Petersburg fails to resume making its monthly payments very soon: to make up for the gap, each of the other four member jurisdictions would have to increase its monthly payments by approximately 61 percent. At a special meeting at the end of last week, the boards of the SCWA and the Appomattox River Water Authority were briefed on the outlook for SCWA’s finances due to Petersburg’s looming insolvency—with SCWA accounting manager Melissa B. Wilkins warning that unless the authority can tap some of its cash reserves, without Petersburg’s monthly payments, the Authority will be insolvent by the middle of next month—or, as she put it: “Right now, mid-October, we’re broke.” Indeed, forecasts provided to the directors, all municipal government officials from Petersburg, Chesterfield County, Colonial Heights, Dinwiddie County, and Prince George County, make clear that if SCWA does not begin to receive payments consistently by Petersburg and does not tap into its reserves, its operating cash will go into the red as early as next month: by the end of the fiscal year next June, the figures show the authority’s cash balance will be nearly $3 million in arrears. Ms. Wilkens advised that if Petersburg were to start making regular monthly payments beginning with the amount due for this month, and if SCWA were to shift about $996,000 in unused construction funds from a reserve account to the authority’s operating account, the authority would end the fiscal year with a positive cash balance of $35. Ms. Wilkin’s forecast assumes that SCWA will continue to operate under a “bare bones” budget—one which would not include any deposits into the authority’s reserves and puts a hold on any non-mandated construction projects. The key issue is that Petersburg imposes a disproportionate burden on the joint authority: the city accounts for approximately 55 percent of SCWA’s treatment load; ergo its share is of SCWA’s operating and maintenance costs. Its failure to do so means that to make up for the non-payment, each of the other four member municipalities would have to increase its monthly payments by about 61 percent.

The urgency and briefing come in the wake of the suit the authority filed against Petersburg last month, seeking the appointment of a receiver to oversee the city’s utility revenue and make sure the money collected from residents is used to pay SCWA and not for other purposes: the authority claims Petersburg owed it more than $1.5 million in overdue payments. Two weeks ago, Petersburg Circuit Court Judge Joseph M. Teefey Jr. opined that the suit contained “sufficient information that an emergency exists, and it is necessary that this court appoint a special receiver” to make sure residents’ wastewater payments are not used for other purposes, naming attorney Bruce Matson of the Richmond-based law firm LeClairRyan as the receiver. In addition, Judge Teefey, on his own initiative, ordered the city and the wastewater authority to meet with a mediator, McCammon Group of Richmond, because of “the special relationship of the parties to this action and the potential conflicts that are a consequence of these relationships.” In response, the City of Petersburg’s attorneys have filed a motion asking Judge Teefey to issue a stay of his order or to vacate it, because the appointment of a receiver automatically puts the city in technical default on more than $12 million in debt. The court has scheduled a hearing in the case for next Monday.)

For her part, Petersburg Interim City Manager Dironna Moore Belton, who represents the city on the SCWWA’s board, indicated she was hopeful the city would be able to resume making its monthly payments in the very near future, stating that the city is currently seeking a short-term loan to help that effort, advising the board Petersburg has identified a list of “key obligations” to be paid each month, which includes payments to regional authorities such as SCWWA, the Appomattox River Water Authority, and Riverside Regional Jail—albeit acknowledging that to keep current on those payments, that would “still not address some past-due payments.” Ms. Belton stated that city officials and their financial advisers “have a long-term package we are working on to address fiscal year 2016 past-due payments.”

Financing Post Municipal Bankruptcy City Services. Stockton residents in two weeks will have a say on whether to approve a quarter-cent restricted sales tax increase where the new revenues would be dedicated toward funding libraries, a recreation program, and other services in the city. The vote on Measure M is projected to generate $9 million a year and $144 million overall for library and recreation services, including after-school programs, homework centers, and children’s story times. It will be a heavy lift: Measure M requires approval of two-thirds of voters to pass. Since 1980, proponents argue, the city has underfunded its library and recreation services; they add that the city’s municipal bankruptcy and the recession “only compounded previously existing problems;” moreover, they argue that since 1980, the city’s population has doubled, but not a single new library has been built. The main goal for proponents of the tax is to get Stockton to go from an average spending per resident of $15 on public libraries and recreation to California’s median of $35 per capita. Last June, the City Council voted 5-2, with councilmen Michael Tubbs and Dan Wright opposing, to reopen the Fair Oaks Library; however, the facility is not expected to open for several months. The City’s Community Service Director John Alita, speaking as a private citizen, told the Stockton Record the city has had to close pools, has under maintained playing fields, and has reduced the average time libraries are open to less than 30 hours per week, noting: “The more that those things continue, then the less and less there is opportunity for our community members to actually benefit from these amenities that we made and created to provide for them…(The) combined benefit of restoring what would be a normal schedule to residents and then being able to enhance that in areas where there’s nothing right now, I think we see that as Measure M’s greatest benefit.” (Last year, the Stockton Unified School District had the lowest third-grade literacy rate in San Joaquin County at 16 percent, according to University of the Pacific’s annual San Joaquin Literacy Report Card.) All six of the city’s Council Members have endorsed Measure M, as have civil rights leader Dolores Huerta, San Joaquin County Superintendent of Schools James Mousalimas, the League of Women Voters, and the Greater Stockton Chamber of Commerce. As proposed, Measure M would essentially leave the sales tax unchanged, as a state sales tax increase approved by the passage of Proposition 30 in 2012 will expire this year.

Nonetheless, incumbent Mayor and candidate for re-election Anthony Silva, City Council candidate Steve Colangelo, and former Councilman Ralph Lee White have expressed apprehensions, testifying before the City Council last May they opposed approving a new tax when Measure A funds are not being used to fund library services. (Measure A, a three-quarter cent tax, was a tax increase approved by voters in 2014 with no restrictions, but with the city’s promise funds would be used to hire more police officers—a promise as yet unmet.) Mayor Silva, at a candidate’s forum last week, said: “I’m kind of caught in the middle on this one: All that money that we promised has not been spent exactly on what it was promised to you. So here comes another tax,” adding that Measure A had also promised to fund essential services, including opening libraries and pools; however, but none of those things were done…I love libraries…I love books, but the schools already have libraries.” Another opponent. Ned Leiba, a CPA, who closely monitors the Stockton’s finances, noting what he termed was poor management of Measure A funds and the city’s overall “problem with accounting and auditing,” stated: “You don’t want to give money to an entity that can’t be responsible.” Mr. Leiba, a member of the Measure A oversight committee, said that instead, Measure M proponents should pressure the city into using budgeted but unspent funds and not a new tax to open libraries. Stockton wants to “hold on to every shekel,” but there’s no basis for management’s claim that there’s no money, he added: “You want to exhaust all other remedies before you turn to taxes.” Were voters to adopt Measure M, a seven-member oversight committee would be appointed to do an annual review of how much money is generated and how funds are used. It appears that were the measure to pass, all dollars collected by the restricted sales tax would be placed in a separate city fund to be used for libraries and recreation services in Stockton.  

Wherefore the Promise of PROMESA? The process of unravelling insolvency is slow and frustrating: it can be even more trying where it involves a quasi-state and there are issues of sovereignty. Ergo, despite two meetings, the federal control board has, to date, evidenced scant progress—likely awaiting the outcome of both U.S. and Puerto Rico elections. Moreover, despite the ongoing recovery from the Great Recession, our respected colleagues at Municipal Market Analytics note that the fifty-two year-to-date first time payment defaulters so far this year has broken above last year’s trend (forty-eight between January and October), noting that in order for this year to finish with fewer defaults than last year (a trend that has held every year since MMA began collecting this data in 2009), “there can be no more than six additional defaults in November and December. Those two months have together averaged 14 defaults since 2013, strongly suggesting that 2016 will see a break in the downtrend.” For its part, the representatives of the U.S. territory advised the PROMESA Board it lacked any fiscal ability to finance any of its debt service over the next decade absent changes in federal laws to address both the island’s economy—and those provisions which harm its ability to compete against other Caribbean nations, noting that Puerto Rico’s GDP has contracted for nine of the last ten years in real terms, driven by the expiration of incentives provided under §936 of the U.S. tax code and the U.S. financial crisis, both of which were exacerbated by out-migration and extraordinary austerity measures taken by the Commonwealth, measures including reducing government consumption by 12% in real terms from 2006 through 2015, cutting the public administration headcount by approximately a quarter; reducing or deferring critical capital expenditures; delaying tax refunds and vendor payments; implementing significant new revenue measures, including recent sales and petroleum products tax increases generating approximately $1.4 billion annually; depleting liquidity and undertaking extraordinary short-term borrowings from pension and insurance systems; reforming pensions, converting defined benefit plans to defined contribution plans—austerity measures which they said had been insufficient to eliminate deficits, thereby incurring significant deficit financing, a ballooning debt load, and persistent economic decline, as evidenced by driving emigration to the U.S. mainland: a loss of not just some 9% of the island’s population—but disproportionately a loss for the best-educated.

The statistics, part of a 100-page fiscal plan submitted to the PROMESA Board, sought to identify the resources available to support basic governmental services and promote growth; it promised to put together a specific debt restructuring proposal in the wake of receipt of input from the Oversight Board. The plan warns that if the U.S. territory were to take various steps to improve revenues, reduce spending, and improve economic growth, it would still face a $6 billion gap over the decade—leaving no resources to meet commonwealth-supported debt. The plan addressed neither the financial outlook for Puerto Rico’s public corporations or municipalities (which also owe roughly $17 billion of debt). The plan treats $50.2 billion of debt as being addressed by the fiscal plan and the remainder of Puerto Rico’s debt as independent of it, because it is supported by the public corporations, municipalities, and other public entities. For priorities, Puerto Rico’s first is for Congress to continue Affordable Care Act funding to the Commonwealth beyond its planned end in FY2018—a continuation which the territory projects this could mean an additional $16.1 billion in direct Puerto Rico government revenues and an additional $8.4 billion in indirect revenues due to improved economic performance. Gov. Padilla also asked for an indefinite extension of the Affordable Care Act and that Congress treat Puerto Rico similarly to the 50 states with regard to Medicaid spending—and the extension of the earned income tax credit program to Puerto Rico, noting that such changes would lead to an $18.9 billion surplus, which could be used for the payments. This would be out of a total scheduled debt service of $34.2 billion. In its plan, the Governor recommended seven principals critical to reducing the government financing gap and restoring economic growth: any austerity must be minimal; the government must introduce improved budgetary controls and financial transparency; Puerto Rico needs to improve tax enforcement, consolidate agencies, reduce workforce, and reform its tax policy to eliminate the revenue impact of the planned end of the Act 154 tax in fiscal 2018; change local labor regulations, simplify permitting in order to promote economic growth, and invest in strategic growth-promoting projects. Fifth, Puerto Rico’s government must continue to protect vulnerable members of the population, such as the elderly, young, disabled, and poor through government services. The territory must reduce its debt to a “sustainable” level. And, seventh, the federal government must be involved to help generate economic growth.

He identified other concerns, as well, including caution in balancing amongst the island’s creditors, noting a “contingent value right or growth bond that pays creditors in the event growth targets set in the plan are exceeded should therefore be considered as part of any debt restructuring,” and that, because local municipal bondholders are believed to hold $8 billion to $12 billion of Puerto Rico’s debt, according to an official with the Puerto Rico Fiscal Agency and Financial Authority, the plan says there must be consideration of the impact of debt restructuring on the local economy. Finally, Puerto Rico Secretary of the Treasury Juan Zaragoza advised the board that Puerto Rico currently owes $1.3 billion to $1.35 billion to suppliers.

 

What Is a State’s Role in Averting Municipal Fiscal Contagion?

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eBlog, 9/28/16

Good Morning! In this a.m.’s eBlog, we consider, again, the risk of municipal fiscal contagion—and what the critical role of a state might be as the small municipality of Petersburg, Virginia’s fiscal plight appears to threaten neighboring municipalities and utilities: Virginia currently lacks a clearly defined legal or legislated route to address not just insolvency, but also to avoid the spread of fiscal contagion. Nor does the state appear to have any policy to enhance the ability of its cities to fiscally strengthen themselves. Then we try to go to school in Detroit—where the state almost seems intent on micromanaging the city’s public and charter schools so critical to the city’s long-term fiscal future. Then we jet to O’Hare to consider an exceptionally insightful report raising our age-old question with regard to: are there too many municipalities in a region? Since we’re there, we then look at the eroding fiscal plight of Cook County’s largest municipality: Chicago, a city increasingly caught between the fiscal plights of its public schools and public pension liabilities.  From thence we go up the river to Flint, where Congressional action last night might promise some fiscal hope—before, finally, ending this morn’s long journey in East Cleveland—where a weary Mayor continues to await a response from the State of Ohio—making the wait for Godot seem impossibly short—and the non-response from the State increasingly irresponsible.

Where Was Virginia While Petersburg Was Fiscally Collapsing? President Obama yesterday helicoptered into Fort Lee, just 4.3 miles from the fiscally at risk municipality of Petersburg, in a region where Petersburg’s regional partners are wondering whether they will ever be reimbursed for delinquent bills: current regional partners to which the city owes money include the South Central Wastewater Authority, Appomattox River Water Authority, Central Virginia Waste Management, Riverside Regional Jail, Crater Criminal Justice Academy, and Crater Youth Care Commission. Acting City Manager Dironna Moore Belton has apparently advised these authorities to expect a partial payment in October—or as a spokesperson of a law firm yesterday stated: “The City appears committed to meeting its financial obligations for these important and necessary services going forward and to starting to pay down past due amounts dating back to the 2016 fiscal year…We appreciate the plan the city presented; however we have to reserve judgment until we see whether the City follows through on these commitments.” One option, it appears, alluded to by the Acting City Manager would be via a tax anticipation note. Given the municipality’s virtual insolvency, however, such additional borrowing would likely come at a frightful cost.

The municipality is caught in a fiscal void. It appears to have totally botched the rollout of new water meters intended to reduce leakage and facilitate more efficient billing. It appears to be insolvent—and imperiling the fiscal welfare of other municipalities and public utilities in its region. It appears the city has been guilty of charges that when it did collect water bills, it diverted funds toward other activities and failed to remit to the water authority. While it seems the city has paid the Virginia Resources Authority to stave off default, questions have arisen with regard to the role of the Commonwealth of Virginia—one of the majority of states which does not permit municipalities to file for chapter 9 bankruptcy. But questions have also arisen with regard to what role—or lack of a role—the state has played over the last two fiscal years, years in which the city’s auditor has given it a clean signoff on its CAFRs; and GFOA awarded the city its award for financial reporting. There is, of course, also the bedeviling query: if Virginia law does not permit localities to go into municipal bankruptcy, and if Petersburg’s insolvency threatens the fiscal solvency of a public regional utility and, potentially, other regional municipalities, what is the state role and responsibility—a state, after all, which rightly is apprehensive that is its coveted AAA credit rating could be at risk were Petersburg to become insolvent.

In this case, it seems that Petersburg passed the Virginia State Auditor’s scrutiny because (1) it submitted the required documents according to the state’s schedule, regardless of whether or not the numbers were correct; (2) the firm used by the city was probably out of its league. (It appears Petersburg used a firm that specialized in small town audits); (3) the City Council apparently did not focus on material weaknesses identified by the private CPA (nor did the State Auditor). The previous city manager, by design, accident, or level of competence, simply did not put up much of a struggle when the Council would amend the budget in mid-year to increase spending—a task no doubt politically challenging in the wake of the Great Recession—a fiscal slam which, according to the State Auditor’s presentation, devastated the city’s finances, forcing the city in a posture of surviving off cash reserves. (http://sfc.virginia.gov/pdf/committee_meeting_presentations/2016%20Interim/092216_No2b_Mavredes_SFC%20Locality%20Fiscal%20Indicators%20Overview.pdf). Now, in the wake of fiscal failures at both levels of government, the Virginia Senate Finance Committee last week devoted a great deal of time discussing “early warning systems,” or fiscal distress trip wires which would alert a state early on of impending municipal fiscal distress. Currently, in Virginia, no state agency has the responsibility for such an activity. That augurs ill: it means the real question is: is Petersburg an anomaly or the beginning of a trend?

The challenge for the state—because its credit rating could be adversely affected if it fails to act, and Petersburg’s fiscal contagion spreads to its regional neighbors and public utilities, a larger question for the Governor and legislators might be with regard to the state’s strictures in Virginia which bar municipal bankruptcy, bar annexation, prohibit local income taxes, cap local sales tax, and have been increasing state-driven costs for K-12, line-of-duty, water and wastewater, etc.

Who’s Governing a City’ Future? Michigan Attorney General Bill Scheutte yesterday stated the state would close poorly performing Detroit schools by the end of the current academic year if they ranked among the state’s worst in the past three years in an official legal opinion—an opinion contradictory to a third-party legal analysis that Gov. Rick Snyder’s administration had said would prevent the state from forcing closure any Detroit public schools until at least 2019, because they had been transferred to a new debt-free district as part of a financial rescue package legislators approved this year—a state law which empowers the School Reform Office authority to close public schools which perform in the lowest five percent for three consecutive years. Indeed, in his opinion, Attorney General Scheutte wrote that enabling the state’s $617 million district bailout specified Detroit closures should be mandatory unless such closures would result in an unreasonable hardship for students, writing: “The law is clear: Michigan parents and their children do not have to be stuck indefinitely in a failing school…Detroit students and parents deserve accountability and high performing schools. If a child can’t spell opportunity, they won’t have opportunity.” The Attorney General’s opinion came in response to a request by Senate Majority Leader Arlan Meekhof (R-West Olive) and House Speaker Kevin Cotter (R-Mount Pleasant) as part of the issue with regard to whether the majority in the state legislature, the City of Detroit, or the Detroit Public Schools ought to be guiding DPS, currently under Emergency Manager retired U.S. Bankruptcy Judge Steven Rhodes would best serve the interest of the city’s children. It appears, at least from the perspective of the state capitol, this will be a decision preempted by the state, with the Governor’s School Reform Office seemingly likely to ultimately decide whether to close any number of struggling schools around the state—a decision his administration has said would likely be made—even as the school year is already underway—“a couple of months” away. The state office last month released a list of 124 schools that performed in the bottom 5 percent last year, on which list more than a third, 47, were Detroit schools.

Nevertheless, the governance authority to so disrupt a city’s public school system is hardly clear: John Walsh, Gov. Snyder’s director of strategic policy, had told The Detroit News that the state could not immediately close any Detroit schools, citing an August 2nd legal memorandum Miller Canfield attorneys sent Detroit school district emergency manager Judge Rhodes, a memorandum which made clear that the transferral of Detroit schools to a new-debt free district under the provisions of the state-enacted legislation had essentially reset the three-year countdown clock allowing the state to close them—a legal position the state attorney general yesterday rejected, writing: a school “need not be operated by the community district for the immediately preceding three school years before it is subject to closure.” Michigan State Rep. Sherry Gay-Dagnogo (D-Detroit) reacted to the state opinion by noting it would not give Detroit’s schools a chance to make serious improvements as part of so-called “fresh start” promised by the legislature as part of the $617 million school reform package enacted last June, noting that she believes the timing of its release—just one week before student count day—is part of an intentional effort to destabilize the district: “We could possibly lose students, because parents are afraid and confused, that’s what this is all about…They want the district to implode…They want to completely remake public education, and implode the district to charter the district. There’s big money in charter schools…This is about business over children.”

Are There Too Many Municipalities? Can We Afford Them All? The Chicago Civic Federation recently released a report, “Unincorporated Cook County: A Profile of Unincorporated Areas in Cook County and Recommendations to Facilitate Incorporation,” which examines unincorporated areas in Cook County—a county with a population larger than that of 29 individual states—and the combined populations of the seven smallest states—a county in which there are some 135 incorporated municipalities partially or wholly within the county, the largest of which is the City of Chicago, home to approximately 54% of the population of the county. Approximately 2.4%, or 126,034, of Cook County’s 5.2 million residents live in unincorporated areas of the County and therefore do not pay taxes to a municipality. According to Civic Federation calculations, Cook County spends approximately $42.9 million annually in expenses related to the delivery of municipal-type services to unincorporated areas, including law enforcement, building and zoning and liquor control. Because the areas only generate $24.0 million toward defraying the cost of these special services, County taxpayers effectively pay an $18.9 million subsidy, even as they pay taxes for their own municipal services. The portion of Cook County which lies outside Chicago’s city limits is divided into 30 townships, which often divide or share governmental services with local municipalities. Thus, this new report builds on the long-term effort by the Federation in the wake of its 2014 comprehensive analysis of all unincorporated areas in Cook County as well as recommendations to assist the County in eliminating unincorporated areas. .In this new report, the Federation looks at the $18.9 million cost to the County of providing municipal-type services in unincorporated areas compared to revenue generated from the unincorporated areas, finding it spent approximately $18.9 million more on unincorporated area services than the total revenue it collected in those areas in FY2014, including nearly $24.0 million in revenues generated from the unincorporated areas of the county compared to $42.9 million in expenses related to the delivery of municipal-type services to the unincorporated areas of the county—or, as the report notes: “In sum, all Cook County taxpayers provide an $18.9 million subsidy to residents in the unincorporated areas. On a per capita basis, the variance between revenues and expenditures is $150, or the difference between $340 per capita in expenditures versus $190 per capita in revenues collected. The report found that in that fiscal year, Cook County’s cost to provide law enforcement, building and zoning, animal control and liquor control services was approximately $42.9 million or $340.49 per resident of the unincorporated areas. The following chart identifies the Cook County agencies that provide services to the unincorporated areas and the costs associated with providing those services. The county’s services to these unincorporated areas are funded through a variety of taxes and fees, including revenues generated from both incorporated and unincorporated taxpayers to fund operations countywide: some revenues are generated or are distributed solely within the unincorporated areas, such as income taxes, building and zoning fees, state sales taxes, wheel taxes (the wheel tax is an annual license fee authorizing the use of any motor vehicle within the unincorporated area of Cook County). The annual rate varies depending on the type of vehicle as well as a vehicle’s class, weight, and number of axles. Receipts from this tax are deposited in the Public Safety Fund. In FY2014 the tax generated an estimated $3.8 million., and business and liquor license fees, but the report found these areas also generated revenues from the Cook County sales and property taxes, which totaled nearly $15.5 million in revenue, noting, however, those taxes are imposed at the same rate in both incorporated and unincorporated areas and are used to fund all county functions. With regard to revenues generated solely within the unincorporated areas of the county, the Federation wrote that the State of Illinois allocates income tax funds to Cook County based on the number of residents in unincorporated areas: if unincorporated areas are annexed to municipalities, then the distribution of funds is correspondingly reduced by the number of inhabitants annexed into municipalities. Thus, in FY2014, Cook County collected approximately $12.0 million in income tax distribution based on the population of residents residing in the unincorporated areas of Cook County. The report determined the Wheel Tax garnered an estimated $3.8 million in FY2014 from the unincorporated areas; $3.7 million from permit and zoning fees (including a contractor’s business registration fee, annual inspection fees, and local public entity and non-profit organization fees (As of December 1, 2014, all organizations are required to pay 100% of standard building, zoning and inspection fees.). The County receives a cut of the Illinois Retailer’s Occupation Tax (a tax on the sale of certain merchandise at the rate of 6.25%. Of the 6.25%, 1.0% of the 6.25% is distributed to Cook County for sales made in the unincorporated areas of the County. In FY2014 this amounted to approximately $2.8 million in revenue. However, if the unincorporated areas of Cook County are annexed by a municipality this revenue would be redirected to the municipalities that annexed the unincorporated areas.) Cook County also receives a fee from cable television providers for the right and franchise to construct and operate cable television systems in unincorporated Cook County (which garnered nearly $1.3 million in revenue in FY2104). Businesses located in unincorporated Cook County pay an annual fee in order to obtain a liquor license that allows for the sale of alcoholic liquor. The minimum required license fee is $3,000 plus additional background check fees and other related liquor license application fees. In FY2014 these fees generated $365,904. Finally, businesses in unincorporated Cook County engaged in general sales, involved in office operations, or not exempt are required to obtain a Cook County general business license—for which a fee of $40 for a two-year license is imposed—enough in FY2014 for the county to count approximately $32,160 in revenue.

Who’s Financing a City’s Future? It almost seems as if the largest municipality within Cook County is caught between its past and its future—here it is accrued public pension liabilities versus its public schools. The city has raised taxes and moved to shore up its debt-ridden pension system—obligated by the Illinois constitution to pay, but under further pressure and facing a potential strike by its teachers, who are seeking greater benefits. The Chicago arithmetic for the public schools, the nation’s third-largest public school district is an equation which counts on the missing variables of state aid and union concessions—neither of which appears to be forthcoming. Indeed, this week, Moody’s, doing its own moody math, cut the Big Shoulder city’s credit rating deeper into junk, citing its “precarious liquidity” and reliance on borrowed money, even as preliminary data demonstrated a continuing enrollment decline drop of almost 14,000 students—a decline that will add fiscal insult to injury and, likely, provoke potential investors to insist upon higher interest rates. According to the Chicago Board of Education, enrollment has eroded from some 414,000 students in 2007 to 396,000 last year: a double whammy, because it not only reduces its funding, but likely also means the Mayor’s goal of drawing younger families to move into the city might not be working. In our report on Chicago, we had noted: “The demographics are recovering from the previous decade which saw an exodus of 200,000. In the decade, the city lost 7.1% of its jobs. Now, revenues are coming back, but the city faces an exceptional challenge in trying to shape its future. With a current debt level of $63,525 per capita, one expert noted that if one included the debt per capita with the unfunded liability per capita, the city would be a prime “candidate for fiscal distress.” Nevertheless, unemployment is coming down (11.3% unemployment, seasonally adjusted) and census data demonstrated the city is returning as a destination for the key demographic group, the 25-29 age group, which grew from 227,000 in 2006 to 274,000 by end of 2011.) Ergo, the steady drop in enrollment could signal a reversal of those once “recovering” demographics. Or, as Moody’s notes, the chronic financial strains may lead investors to demand higher interest rates—rates already unaffordably high with yields of as much as 9 percent, according to Moody’s. Like an olden times Pac-Man, principal and interest rate costs are chewing into CPS’s budget consuming more than 10 percent of this year’s $5.4 billion budget, or as the ever perspicacious Richard Ciccarone of Merritt Research Services in the Windy City put it: “To say that they’re challenged is an understatement…The problems that they’re having poses risks to continued operations and the timely repayment of liabilities.” Moody’s VP in Chicago Rachel Cortez notes: “Because the reserves and the liquidity have weakened steadily over the past few years, there’s less room for uncertainty in the budget: They don’t have any cash left to buffer against revenue or expenditure assumptions that don’t pan out.” And the math threatens to worsen: CPS’ budget for FY2016-17 anticipate the school district will gain concessions from the union, including phasing out CPS’ practice of covering most of teachers’ pension contributions—a phase-out the teachers’ union has already rejected; CPS is also counting on $215 million in aid contingent on Illinois adopting a pension overhaul—the kind of math made virtually impossible under the state’s constitution, r, as Moody’s would put it: an “unrealistic expectations.” Even though lawmakers approved a $250 million property-tax levy for teachers’ pensions, those funds will not be forthcoming until after the end of the fiscal year—and they will barely make a dent in CPS’s $10 billion in unfunded retirement liabilities.

Out Like Flint. The City of Flint will continue to receive its water from the Great Lakes Water Authority for another year, time presumed to be sufficient to construct a newly required stretch of pipeline and allow for testing of water Flint will treat from its new source, the Karegnondi Water Authority (KWA). The decision came as the Senate, in its race to leave Washington, D.C. yesterday, passed legislation to appropriate some $170 million—but funds which would only actually be available and finally acted upon in December when Congress is scheduled to come back from two months’ of recess—after the House of Representatives adopted an amendment to a water projects bill, the Water Resources Development Act, which would authorize—but not appropriate—the funds for communities such as Flint where the president has declared a state of emergency because of contaminants like lead. Meanwhile, the Michigan Strategic Fund, an arm of the Michigan Economic Development Corp., Tuesday approved a loan of up to $3.5 million to help Flint finance the $7.5-million pipeline the EPA is requiring to allow treated KWA water to be tested for six months before it is piped to Flint residents to drink. While the pipeline connecting Flint and Lake Huron is almost completed, the EPA wants an additional 3.5-mile pipeline constructed so that Flint residents can continue to be supplied with drinking water from the GLWA in Detroit while raw KWA water, treated at the Flint Water Treatment Plant, is tested for six months. The Michigan Department of Environmental Quality is expected to pay $4.2 million of the pipeline cost through a grant, with the loan covering the balance of the cost. Even though the funds the Strategic Fund has approved is in the form of a loan, with 2% interest and 15 years of payments beginning in October of 2018, state officials said they were considering various funding sources to repay the loan so cash-strapped Flint will not be on the hook for the money. Time is of the essence; Flint’s emergency contract for Detroit water, which has already been extended, is currently scheduled to end next June 30th.  

Waiting for Godot. Last April 27th, East Cleveland Mayor Gary Norton wrote to Ohio State Tax Commissioner Joseph W. Testa for approval for his city to file chapter 9 bankruptcy: “Given East Cleveland’s decades-long economic decline and precipitous decrease in revenue, the City is hereby requesting your approval of its Petition for Municipal Bankruptcy. Despite the City’s best Efforts, East Cleveland is insolvent pursuant…Based upon Financial Appropriations projections for the years 2016, 2017, 2018 and 2019, the City will be unable to sustain basic Fire, Police, EMS or rubbish collection services. The City has tried to negotiate with its creditors in good faith as required by 11 U.S.C. 109. It has been a somewhat impracticable effort. The City’s Financial Recovery Plan, approved by the City Council, the Financial Commission and the Fiscal Supervisors, while intended to restore the City to fiscal solvency, will have the effect of decimating our safety forces. Hence, our goal to effect a plan that will adjust our debts pursuant to 11 U.S.C. 109 puts us in a catch-22 that is unrealistic. This is particularly true now that petitions for Merger/Annexation with the City of Cleveland have been delayed by court action in the decision of Cuyahoga County Common Pleas Judge Michael Russo, Court Case No. 850236.” Mayor Norton closed his letter: “Thank you for your prompt consideration of this urgent matter.” He is still waiting.