The Potential Consequences of a State Takeover of a Municipality

 

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eBlog, 2/03/17

Good Morning! In this a.m.’s eBlog, we consider the long-term costs and consequences of state takeovers of a municipality, and of a broken state financial system.

The Fiscal Costs of Incompetence. Michigan taxpayers, including those in Flint, will be paying litigation and legal defense expenses for two former officials implicated in contributing to Flint’s lead-contaminated water crisis. Governor Rick Snyder’s Office confirmed that the Michigan Treasury Department will reimburse the city of Flint for legal and defense fees for former state-imposed Flint Emergency Managers Darnell Earley and Gerald Ambrose—officials appointed by the Governor who have now been charged by Michigan Attorney General Bill Schuette with committing false pretenses and conspiracy to commit false pretenses, 20-year felonies. The duo also face a charge of misconduct in office, a five-year felony, and a one-year misdemeanor count of willful neglect of duty. Gov. Rick Snyder’s spokeswoman notes that state officials do not have any estimates on costs to state taxpayers for their defense—or if there is any ceiling with regard to what state taxpayers will be chipping in.

The Fiscal Costs of a Broken State Financial System. Dan Gilmartin, the Executive Director of the Michigan Municipal League, this week noted that “A lot of people feel as if we’ve turned the corner here in Michigan, you know, we’ve got more people employed, and the big three are doing better, and there’s some good things happening in the tourist economy and all kinds of different areas, so they think things are getting better…they might be getting better for state coffers; but they’re actually getting worse at the local level because of the system that we’re in right now.” Noting that, despite the state’s strong economic recovery, that recovery has not filtered down to its cities—which, in the wake of some $7 billion in state cuts to general revenue sharing since 2002—has left the state’s municipalities confronting an increasingly harder time to finance public infrastructure and public safety. The League’s report also recommends the state help cities come up with more modern health care plans which would allow them to control costs and stay competitive with other employers. Perhaps most intriguing, Mr. Gilmartin recommended that state aid for public infrastructure be allocated on a regional basis, rather than jurisdiction by jurisdiction. Finally, he urged the Michigan legislature to make up for the steep cuts made to revenue sharing in the last 15 years.

Exiting Receivership. The Michigan Department of Treasury has announced that the small municipality of Allen Park—a city of about 28,000 in Wayne County, where the annual per capita income is $27,000 and the estimated median assessed property value is $91,000, is no longer under receivership—meaning the city’s elected leaders have effectively had their authority to govern restored. The small city, which had also been charged in 2014 by the Securities and Exchange Commission with fraud, with the SEC charging public officials as “control persons,” came in the wake of a recommendation from members of the Allen Park Receivership Transition Advisory Board, which was state-appointed in 2014 in the wake of Gov. Rick Snyder’s announcement that the city’s 2012 financial emergency had been resolved after its structural and cumulative deficits had been eliminated. Gov. Snyder had imposed an Emergency Manager from March 2013 to September 2014, the same month in which the Michigan Receivership Transition Advisory Board was appointed. According to the Treasury, Allen Park “has made significant financial and operational progress,” including increasing its general fund balance; passing 10-year public safety and road millages; and saving $1.1 million by tendering 62 percent of Allen Park’s outstanding municipal bonds issued through the Michigan Finance Authority. In addition, the municipality made its required contributions into the pension and retiree healthcare systems, including an additional $500,000 annual payment toward other OPEB liabilities. Allen Park Mayor William Matakas responded: “On behalf of the city, I express my gratitude to the members of the Receivership Transition Advisory Board for their professionalism during Allen Park’s transition from emergency management to local control…I look forward to working with local and state officials to ensure we continue down a path of financial success.” Michigan Treasurer Nick Khouri, in the wake of the release of the municipality under Michigan’s Local Financial Stability and Choice Act, said Allen Park leaders are thus authorized to regain control and proceed with tasks such as approving ordinances, noting: “This is an important day for the residents of Allen Park, the city, and all who worked diligently to move the city back to fiscal stability…The cooperation of state and city officials to problem-solve complex debt issues now provides the community an opportunity to succeed independently. I am pleased to say that the city is released from receivership and look forward to working with our local partners in the future…The cooperation of state and city officials to problem-solve complex debt issues now provides the community an opportunity to succeed independently.” According to Mr. Khouri, since the state intervention, Allen Park has increased the city’s general fund balance in the wake of adopting a 10-year public safety millage and a 10-year road millage; in addition, the city completed a successful tendering of 62% of the outstanding municipal bonds issued via the Michigan Finance Authority used to fund a failed movie studio project for a savings of $1.1 million in 2015. An additional remarketing of the remaining amount was finalized in 2016, saving the city another $900,000. It makes one wonder whether New Jersey Governor Chris Christie might benefit from observing the constructive relationship between the state and Allen Park as a means to help an insolvent city regain its fiscal feet.

The Challenges of Fiscal Disparities

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eBlog, 12/29/16

Good Morning! In this a.m.’s eBlog, we consider Detroit’s ongoing challenges to recovery from the nation’s largest ever municipal bankruptcy—a city unbailed out by the federal government, but which, as we noted earlier this week, Detroit News editorial writer Daniel Howes described as “perceptively changing,” especially as we write this rainy morning with regard to its thousands of abandoned homes and buildings. Then we turn to Virginia’s Petersburg, the historic city which danced on the edge of municipal bankruptcy—threatening the solvency of regional public utilities—as it faces challenges to its future. Finally, we look at the newly released census figures to better grasp the scope of fiscal disparities in the State of Ohio—especially with regard to the fiscally depleted municipality of East Cleveland.

Unbuilding & Rebuilding a City’s Future. In the final week of the year, Detroit neared the razing of an industrial building which once covered an entire city block—marking the razing of some 3,130 structures razed this year, bringing the total razed since the city emerged from chapter 9 bankruptcy to around 10,700 over the last three years—with the vast bulk of those owned by Detroit’s Land Bank Authority. Nevertheless, giving some idea of the vast scope of the city’s challenge, its blight task force in 2014 had projected that the city would need to tear down 40,000—and that some 38,000 others were at risk of collapse. Indeed, still today, many blocks in the city have more abandoned houses and empty lots than lived-in homes, a scar reminding us of the exodus of whites and much of the black middle class from the city: an exodus of more than half the city’s population since the 1950’s. In 1950, there were 1,849,568 people in Detroit, but, by 2010, there were 713,777. The city today is home to an estimated 40,000 abandoned lots and structures. Between 1978 and 2007, Detroit lost 67 percent of its business establishments and 80 percent of its manufacturing base. Thus, as Detroit Mayor Mike Duggan has stated, he believes the mass demolitions are necessary for Detroit if it is to attract families to city neighborhoods and staunch the decades of population loss.

Detroit Fire Investigations Division Capt. Winston Farrow adds that the removal of dangerous buildings and empty houses is vital to public safety and the quality of life in Detroit: “It eliminates the opportunities for criminals to set fires in vacant houses…The problem was more just the sheer numbers of dwellings that we had.” In another sign that the strategy is working, the average sale prices of over 100 houses sold in Detroit has increased over the past three years, according to the Land Bank.

Nevertheless, the challenge to the city’s future remains: the Detroit News quoted the owner of 3D Wrecking, Sheila Davenport: “You can tear down a house on one block and go back several months later and where houses were occupied (they) are now abandoned and need to be demolished…It just seems like it never ends.” And, of course, it is a costly process; on average, the city expends $12,616 to knock down a house—a process made fiscally easier through the receipt of more than $128 million in federal funds over the past three years—with another $130 million in the pipeline—along with $40 million from the city’s general fund set aside for further demolitions. (Federal funding had been temporarily halted earlier this year, but resumed after an audit determined demolition costs above a federal cap of $25,000 per house were redistributed to 350 other properties to have those houses appear to meet the cap.)

Syncopating Time. Notwithstanding the cold rain falling in Petersburg this morning, work has finally commenced to restore one of the city’s highest-profile landmarks after months of delay caused by the city’s budget crisis—with the construction to repair a nearly 180-year-old clock tower and roof, a $1.2 million project financed by the Virginia Resource Authority—financed, according to a city spokesperson who stated the VRA municipal bond was “approved prior to the financial crisis.” The work—to properly coordinate the clocks on the clock tower, had been deferred last year when the city discovered its fiscal cupboards were bare—even as city officials had been ordered to close the building two years because of structural problems with the historic edifice—during which time Circuit Court jury trials were temporarily moved to the Dinwiddie County Circuit Courthouse. But it is now in a different courthouse where the U.S. Fourth Circuit Court of Appeals is weighing a lawsuit over a Petersburg Bureau of Police policy concerning social media which could result in a finding that would cost the fiscally challenged municipality millions of dollars after a federal court ruled that a lower court must decide whether the city government can be held liable for damages in the case. In its ruling, the court determined that the police department’s social media policy, put in place in 2013, violated employees’ First Amendment free speech rights. Moreover, the federal judges ordered the case be sent back to U.S. District Court in Richmond to determine whether “the city may also be held liable for the injuries that were caused by the applications of that policy.” The case arose two years ago last March, when two former Petersburg police officers claimed they were unjustly punished for posting comments on Facebook which criticized the department for promoting officers they considered too inexperienced. Their comments were reported to former Police Chief John I. Dixon III. The two officers were found to have violated a policy that Chief Dixon had instituted in April of 2013—a policy which prohibited department employees from giving out information “that would tend to discredit or reflect unfavorably upon the [department] or any other City of Petersburg department or its employees,” according to the appeals court opinion. The two officers were reprimanded and placed on probation—ergo, because they were on probation, they were barred from taking a test to qualify for promotion to sergeant. In addition, the officers had also been investigated over allegations of misconduct, which they claimed were filed in retaliation after the police department learned of their intent to file suit. The appeals court, however, has upheld the district court’s ruling that those investigations were not retaliatory, because “each arose from discrete allegations of misconduct” not related to the Facebook postings or the social media policy. For a municipality on the edge of chapter 9, the stakes on this appeal are high: the two officers are seeking compensatory damages of $2 million, plus punitive damages amounting to $350,000, plus attorney fees.

Ohio Fiscal Disparities. It was a generation ago that Congress eliminated the General Revenue Sharing program signed into law by former President Richard Nixon to address signal fiscal disparities. Today, it is possible to see how significant those disparities are becoming. According to the latest estimates available from the U.S. Census Bureau, median family incomes in Ohio cities range from $221,148 in the Columbus suburb of New Albany to $30,411 in East Cleveland, the city unbalanced between its waiting for Godot efforts to file for chapter 9 municipal bankruptcy or a response to its efforts to become part of the City of Cleveland. The new Census figures make clear the extraordinary fiscal disparities in the state: after New Albany, the rest of the top five in Ohio are: Indian Hill near Cincinnati ($208,158), the Cleveland suburb of Pepper Pike ($162,292), and two Columbus suburbs: Powell at ($147,344) and Dublin ($139,860). The statistics are from surveys conducted from 2011 through 2015 and released this month—the latest estimates available from the U.S. Census Bureau for smaller areas.

The Key Role of States in Acting to Allow Fiscally Sustainable Municipalities.

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eBlog, 8/31/16

In this morning’s eBlog, we consider the narrowing fiscal options for Atlantic City—in a state which appears to have abandoned its long and strong reputation for working with—rather than against—its cities. Then we return to the seeming inability of  near-insolvent East Cleveland—the small Ohio municipality still awaiting authority to file for chapter 9 municipal bankruptcy—to craft a proposal to seek consolidation with neighboring Cleveland. Finally, we turn to grim fiscal findings in Michigan, where—notwithstanding a strong state fiscal recovery—the state’s municipalities—for the first time since the Great Recession are reporting a decline in fiscal health.

Is the Fiscal Deck Stacked Against Atlantic City? Atlantic City has reduced its budget by about 10 percent from a year ago; however, the new, proposed budget assumes requested state aid—assistance the city appears unlikely to receive. The proposed $243 million budget assumes some $106 million in state aid, including $37 million of requested Transitional Aid, or state funds for financially distressed municipalities. The request is more than double the $13 million in Transitional Aid the city received last year (along with eleven other municipalities), and Council President Marty Small, Chair of the city’s Revenue and Finance Committee, warns: “If they say they’re only going to give $15 million and the fund doesn’t come from another source, it will be a monumental tax increase on the city side.” To carve the budget as much as the city did, salaries and wages were cut by nearly 25 percent or $30 million from the current $110 million, according to a summary of budget appropriations—or, as Mayor Guardian put it: “I think everybody took a hit, a haircut…No one group represented the big savings.” The cuts were partially offset by the city making up for deferred group health insurance obligations and higher debt service. And although the budget assumes no change in the municipal tax rate, increases in county and school tax rates raised the total rate nearly 29 cents to an estimated $3.71 per $100 of assessed value, according to the tax assessor’s office. But even with those increases, the total revenues are down about 15 percent from last year, because the city’s ratable base has plunged from $20.5 billion in 2008 to about $6.6 billion today. The next step is to forward the proposed budget to the New Jersey Local Finance Board for adoption, albeit a spokesperson for the Board warns that any Department of Community Affairs said Transitional Aid “must be resolved prior to the adoption of the budget.” Councilman Frank Gilliam, who has proposed a public hearing on the budget, has expressed apprehension and stated: “I don’t think we should basically move forward with a line item in the budget that does not have either something committed in writing or some type of credits set aside for the city,” while his colleague, Councilman Jesse Kurtz, is urging the state to “sign an affidavit that they’re going provide this pledged revenue,” adding: “Because last time they didn’t, and as far as I’m concerned they still owe us over $30 million from last year’s budget.” Equally apprehensive, Councilman Moisse Delgado said he has “the smallest bit of trust that the state will provide the funds that we need.”

Play it Again, Sam. The East Cleveland City Council has voted once again to enter into annexation negotiations with Cleveland, with City Council President Thomas Wheeler noting: “When you make a mistake, you realize you make a mistake, and you correct your mistake. I think that’s big of us.” As we noted last week, Cleveland City Council President Kevin Kelley had termed East Cleveland’s proposal a “non-starter” because of the conditions that came with it. East Cleveland, with little tax base and almost no economic development, appears to offer little attraction to Cleveland—especially when, as last week, East Cleveland came to the table with significant demands. The situation governance-wise is complicated, as each city would have to opt to approve a proposal—and East Cleveland appears to have no other irons in the fire—except to press the state to allow it to file for chapter 9 bankruptcy.

Why is what’s good for the goose not so for the gander? A new study by the University of Michigan’s Center for Local, State, and Urban Policy reports that for the first time since the Great Recession, more of the state’s municipalities are reporting a decline in fiscal health: of Michigan’s 1,856 units of local government, 31 percent report they are better able to meet their financial needs this year—compared to 38 percent last year—all of which denotes a singular reversal in the wake of what had been five years of steady statewide improvement. If anything, the state’s exceptional role as a center of innovation in the emerging self-driving emergence has been a keystone to the state’s economic rise. However, according to Centers Director Tom Ivacko, the reversal in fiscal health at the municipal level is what he terms “an early warning sign here that even though the Michigan economy is still improving, [but] what we have seen this year in fiscal health in terms of local governments is reversal in a trend that we’ve been tracking since 2010…It appears that there is a disconnect now between economic growth and local fiscal health in Michigan.” He attributes that to what he calls Michigan’s broken funding system for local governments. The findings have emerged from eight statewide surveys conducted annually since the sharp economic decline of the Great Recession, with local governments responding to questions about changes in fiscal health: whether their jurisdictions are better able or less able to meet their financial needs at that time, compared to the previous year.

Perhaps the most important marker of the turn in local fiscal fortunes can be gleaned from local property tax revenues—the most important source of funding for Michigan municipalities: according to the report, the slow increase in property tax revenues dating from 2010 appears to have topped: this year 42% of Michigan municipalities reported their property tax revenues as increasing compared to 25% reporting them decreasing; last year, 45% reported such revenue growth. Mr. Ivacko notes the trend is of such great concern, because, should the economy falter, the state’s municipalities will face an even greater risk for fiscal declines. And, worryingly, the University of Michigan Research Seminar in Quantitative Economics expects both the U.S. and Michigan economies to expand at a slightly slower rate in the coming year—and Michigan is generally expected to grow more slowly than the nation as a whole.

Adding a double whammy, the report also found a worsening trend in state aid to local governments: only 18% of local governments reported an increase in state aid compared to 28% the previous year—the first such decline since 2011. The state preemption or limitation—the so-called Headlee Amendment and Proposal, which preempt local revenue authority have, as Mr. Ivacko notes: “really restricted revenue growth for local governments even as the economy has improved and many housing markets and home values have improved significantly…I think that is probably the single most important factor in why we are seeing local governments’ finances not improving as much as they should.” Worse, the state preemption is more than offsetting the gradual increase by the state in general revenue sharing—which, even if rising slightly, is down some 25% or $6 billion since 2000. Or, as the ever insightful Richard Ciccarone, President & CEO of Merritt Research Services, puts it: “When you look at the credit of Michigan cities, you have some that are ranked among the worst in the county like Wayne, Lincoln Park, Detroit, Flint, and even Lansing are among the bottom 1% of all cities; One thing that makes it worse is that their debt levels are up and that put more burden on these cities…Their flexibility is limited…It looks like cities in Michigan are headed for challenges yet. Some of the most challenged cities in America are in Michigan and yet the majority also look like they are faced with the challenge of rising debt and decreasing reserves.” According to the report, 60% of Michigan’s local jurisdictions claim their general fund balances are at the right level.

A guest editorial, “Lansing, are you listening to Michigan cities?” was posted yesterday by the Tribune News Services.

For the first time since 2010, a growing number of local governments are worried about money — and the future.

We hope Lansing is listening.

After the 2008 economic crash, local governments lost tax revenue, in part because the state continued to cut the amount of tax dollars it sends back to cities, but also because a wave of foreclosures dropped the value of commercial and residential property on which owners are taxed. Think about your own tax bill — if you paid less, it means your city, county and school district had less money to pay cops and firefighters, pave roads and pay teachers.

But since 2010, things have been looking up, according to the University of Michigan’s Center for Local, State, and Urban Policy’s annual survey of local leaders. As the state’s economy has improved, those leaders have reported improved financial stability, and a positive outlook.

This year, that changed.

Just 31% of Michigan local leaders said they’re better able to meet their community’s fiscal needs, down from 38% in 2015. While 42% say property tax growth is increasing, that’s also down from last year, when 45% of leaders saw growth — and the number of communities who say state aid is declining grew, from 18% in 2015 to 20% this year. Thirty percent say they’ll rely on savings to cover budget gaps, up from 26% last year. And only 28% believe their area will be better able to meet its financial needs next year, down from 36% in 2015.

In other words, thanks to stagnant property-tax growth and declining state aid, as well as rising costs for infrastructure — many communities delayed or deferred necessary maintenance during the recession — and higher personnel costs, including pensions and retiree health care, a growing number of local leaders say they’re worried about the financial future.

It’s true that the study’s findings don’t represent radical jumps. But taken in total, it’s a worrisome reversal of a six-year long trend of improving conditions.

And it’s just another reminder that our elected officials in Lansing should amend the way our state funds cities.

Because Proposal A and the Headlee amendment cap the way cities collect property tax, dramatic losses in value like the ones our state experienced in the foreclosure crisis — an unprecedented crash that the authors of Prop A couldn’t have foreseen — can’t be quickly recouped.

The state has aggressively cut the number of tax dollars it returns to cities. Between 2003 and 2013, a Michigan Municipal League analysis found, the state cut $6 billion in revenue-sharing. In 2003, the state sent about $900 million to cities each year. In 2013, it was $250 million. The impulse to disconnect state and local government financial health is a peculiar understanding that’s informed Gov. Rick Snyder’s budgetary priorities. Snyder has focused on improving the state’s fiscal health, even if that means making cuts to local governments. But the plain truth is that the state cannot claim financial health while its cities, counties and townships struggle to provide services.

Neither Snyder nor the legislative leaders who set Lansing’s agenda have shown willing to take these problems on. But a reconsideration of the way we fund cities — the way we pay for retiree pensions and health care, the way cities collect property tax, and the state’s obligation to fund local government — is long overdue.

 

What Is the State Role in Municipal Fiscal Distress?

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eBlog, 8/16/16

 In this morning’s eBlog, we consider, again, the un-considerable: could a city fall back into municipal bankruptcy? Is Detroit’s recovery sustainable? Is it municipal-wide—or have we only really been able to witness the remarkable renaissance of its sparkling downtown? And, as we often have, we also consider the important state-local fiscal relationships and roles—especially in Michigan where the combination of seemingly relentless state reductions in revenue sharing to address such stark fiscal disparities has been a critical factor in the state’s takeover or so-called Emergency Manager program—a program which was seemingly the critical step to getting Detroit into and out of chapter 9 municipal bankruptcy, but which—in imposing a state actor with no accountability to the citizens and taxpayers of a city or public school system, not only displaces democracy, but—in the case of Flint, led to signal human and health risks and costs, and, in the case of the Detroit Public School System forced a massive state bailout.

Now, as the small Detroit municipal neighbor of Wayne nears insolvency, still another Michigan state takeover looms. It is difficult to balance how much the state has contributed to this looming insolvency and how the elimination of democracy and accountability to the citizens of a city whose fiscal misery is, in some significant part, caused by the state, not by the city, should be assessed.

Post Municipal Bankruptcy Blues II.  Perry Applebaum, writing about “Detroit’s Recovery, Downtown Roars and Neighborhoods Sputter,” in the New York Times, described post chapter 9 Detroit as “an urban dystopia of poverty, crime and blight,” adding that “Detroit used to be a pretty clear story. It was a symbol of American economic might and then it was a symbol of American urban ruin. But in a place not given to deep philosophizing — where the literary canon is defined by the razor-edged crime novels of Elmore Leonard — almost no one here seems entirely sure what to make of this moment’s Detroit.” He concurs that the “swift exit in 2014 from the city’s traumatic bankruptcy has been followed, almost everyone agrees, by significant progress on improving city services long deemed hopeless…But what that means for the rest of the city and who is benefiting have set in motion a layered conversation about development, equity, race and class. It is playing out with particular force here in what was once the nation’s fourth-largest city and is now a place at once grappling with poverty, crime and failing schools, but also still animated by the bones of its former glory.” Mr. Applebaum also notes that: “Downtown is 90 percent better than it was 10 years ago, but you go a few blocks in any direction, and it’s terrible,” according to Lulzim Shaqiri, whose wife’s family has owned a restaurant since 1983. Ms. Shaqiri told him: “You can talk about helping the neighborhoods, but there’s really no neighborhood at all here. It’s just as dead as dead can be.”

In contrast, he notes the enthusiasm of Mayor Mike Duggan, who told him: “People in this city understand where we are and where we are going…This city went from 1.8 million people in the 1950s to less than 700,000 now. There’s been a 60-year decline, where we lost more than a million people, and those people who left didn’t take their houses with them. So, the magnitude of what we’re recovering from is enormous, but the recovery has started,” adding that there is “ample evidence that he is right. No one doubts how serious the problems are from the disastrous state of the schools to the threadbare transit system to the challenges of adding enough jobs to fuel a sustainable recovery. But more than 10,000 blighted properties have been demolished, removing dangerous eyesores and usually allowing neighbors to buy the vacant lots for $100. An additional 2,000 homes are being rehabilitated and reoccupied…There are about 5,000 new housing units either planned for construction or being built. Housing prices have ticked up, and the city’s toxic foreclosure problem shows signs of improving…In a city notorious for not even being able to even light its streets, more than 62,000 new LED street lamps have been installed. Officials say the whole city will be relit by the end of the year. And the most recent Census Bureau estimate showed the smallest population decline in decades. Officials predict that next year’s figures will show a population gain.” But he closes his article with a darker perspective, based upon a blog post, “Why I Hate Detroit,” by Eric Thomas, who is black and a partner at a local marketing firm; the post focused on the discouraging situation with the city’s schools, the lack of opportunity for the majority of the city, and what he deemed “the weird way the resurgence in relatively privileged warrens, about 5 percent of the city’s 140 square miles, is seen as a proxy for the city as a whole.”

The Challenge which can pit Democracy against Solvency. Wayne, the small municipality in Wayne County, Michigan near Detroit, now awaits a state takeover in the wake of its voters’ rejection last week of a tax proposal to support police and fire protection. Wayne has struggled for some time to reign in expenses: city expenditures have exceeded revenue by roughly $2 million over the past few years, albeit the city balanced its books for the current fiscal year by draining other funds, including its internal service fund and its OPEB retiree healthcare trust—so that city officials report closing FY2016 with near depletion of the OPEB trust and a $400,000 draw on general operating reserves. The city expects to draw another $1.6 million of general fund balance in FY’2017 and estimates likely depletion of fund balance by December of 2017. Aside from property taxes, Michigan’s municipalities are mainly dependent on Michigan’s state revenue sharing program—a program which itself has consistently declined since 1998. Indeed, over the last 14 years, Michigan has led the nation in cuts to its municipalities of state aid. According to the US Census Bureau, from 2002 to 2012, municipal revenue from state sources increased in 45 states and the average increase was 48.1%; in Michigan, municipal revenue from state sources declined 56.9% from 2002 to 2012, according to a Michigan Municipal League report.

Now it appears the state is likely to reap what it has sowed: it appears more and more certain the state will take over the city—an action which the city’s elected leaders fear—especially in the wake of the human and fiscal devastation that came from the state’s takeover in Flint—a state action which has left a residue of state governmental fear and distrust. Indeed, despite the steep fiscal hole in which the small city finds itself, Wayne’s Mayor, Susan Rowe, after watching the extraordinary damage to human health and safety as well as fiscal distress caused by Flint’s state-appointed Emergency Manager (who later, inexplicably, was named by the Governor as Emergency Manager for the Detroit Public Schools) vowed she would never put her residents at the mercy of the state. However, in the wake of last February’s Moody’s downgrade, Mayor Rowe not unreasonably fears her city will become the first municipality since Flint to be placed in state emergency financial management. She notes: “I think it will happen, and I think it would be devastating…People tell us to live within our means, but we can’t shut the doors. We can’t say we’re not going to have police or fire or trash collection…We just have no way of bringing in any more money.”

Michigan’s emergency manager program, under which the Governor appoints a manager with extensive powers over a troubled municipality or school district that meets certain criteria, was initiated in 1990: to date, 11 Michigan municipalities and three school districts have had such emergency managers appointed. Unsurprisingly, it is a program that has drawn sharp criticism not only for its usurpation of local authority, but, in the wake of Flint and the Detroit Public Schools, it has, increasingly, been perceived as a damaging failure with signal unaccountability.

Nevertheless, for Mayor Rowe, a retiree whose munificent mayoral salary is $3,000 annually, the squeeze is almost unimaginable: assessed housing values cratered during the recession and revenue has plunged more than 40 percent since 2010. The city lost a property-tax appeal with Ford Motor Co., its largest employer. State limitations prevent local property taxes from increasing at a rate higher than annual inflation. If anything, the tipping point came last week when the city’s voters resoundingly rejected a tax increase that would have enabled the city to share public-safety expenses with two other municipalities. Mayor Rowe said people are frustrated, and she does not hold the vote against them. Now, because the small city lost its investment grade rating, its costs of borrowing seemingly are adding insult to fiscal injury: Moody’s has downgraded Wayne two notches to Ba1 from Baa2 and its general obligation limited tax (GOLT) rating fell to Ba2 from Baa3, with the credit rating agency noting: “The downgrade of the city’s issuer rating to Ba1 reflects a very stressed financial position given an ongoing structural imbalance with few remaining options for increasing revenues or cutting expenditures.” Further, Moody’s placed the ratings under review for a further downgrade pending developments related to the city’s request for a financial review by the state—a request made in the wake of the Aug. 2nd rejection of the city’s proposal to join a suburban authority and levy a tax to fund fire and rescue services. On the first item, the municipality’s voters rejected the proposal to join the South Macomb Oakland Regional Services Authority, which was created by the cities of Eastpointe and Hazel Park in 2015. On the second, voters rejected a millage proposal which would have raised approximately $5 million to help the city’s strained liquidity: the anticipated revenues had the citizens adopted the measure would have enabled Wayne to stabilize its general fund balance according to Moody’s; however, as Mayor Rowe noted: “Our residents do not want to give us the revenue we requested. Now, this is the avenue we have to take.”

9-1-1. If the state declares a fiscal emergency, the city will have four options:

  • a consent agreement with the state,
  • appointment of an emergency manager by the state,
  • request for approval to file Chapter 9 municipal bankruptcy, or
  • mediated negotiation among creditors.

Mayor Rowe has indicated that that city will likely opt for appointment of an emergency manager.

The review for a further downgrade is tied to the decision to seek a state review. “A declaration of fiscal emergency would give the city greater power to cut expenditures, it also increases the risk that the city may seek to restructure its debt,” according to Moody’s.

How States Can Threaten a Municipality’s Fiscal Future

March 17, 2016. Share on Twitter

Because the federal government–and, increasingly, states no longer address fiscal disparities within states, that has provoked or invoked greater challenges for states–and increased fiscal despair for municipalities. Congressional elimination of general revenue sharing and countercyclical fiscal assistance has meant that states, such as New jersey and Michigan, for instance, now bear a burden and challenge. Will they opt for a constructive, passive, or destructive state fiscal policy?

Shutting Down a Municipality. Atlantic City Mayor Don Guardian yesterday reported that because of his city’s near insolvency (city officials have warned the city will run out of cash on April Fools’ Day), the city would be forced to halt all nonessential government services beginning in early April absent urgent state assistance: Mayor Guardian said the shutdown would start on April 8th and was likely to last until at least May 2nd, the date when quarterly tax revenues are due. During the shutdown, police, fire, and sanitation workers would perform their jobs—but without pay, which would be deferred pending receipt of taxes due; health care benefits would continue uninterrupted. Moreover, Mayor Guardian warned this was unlikely to be a one-time event, especially if the State of New Jersey does not step up with some kind of fiscal assistance, noting: “The city is in discussions with the state to avoid and forestall what may be an imminent financial predicament…Unfortunately, due to financial circumstances beyond our control, we will be forced to close City Hall.” The increasingly dire fiscal standoff comes as New Jersey Governor Chris Christie has warned he will not sign legislation to provide fiscal assistance to Atlantic City unless the New Jersey Legislature approves a state takeover of the city government. Atlantic City police union President Thomas Moynihan yesterday reported that Atlantic City’s police officers would report to work even if they “miss a paycheck or two in the meantime.”

Even though Gov. Christie claimed he had reached an agreement with New Jersey Senate President Steve Sweeney (D-West Deptford) to give the state control over the finances of Atlantic City for five years, that agreement has not secured House support, and has drawn criticism from New Jersey Assembly Speaker Vincent Prieto (D-N.J), who has made clear he would not ask the House to consider state legislation to alter or terminate union contracts unless and until local and state officials reach a compromise, noting: “The governor already has authority to help Atlantic City avoid financial disaster…It’s time for Gov. Christie to do his job and use his existing authority to resolve this once and for all.” In addition, Speaker Prieto’s spokesman notes that the New Jersey Local Government Supervision Act of 1947 already allows the state to control Atlantic City’s finances and government. For his part, Gov. Christie has made clear he will not sign any bill into state law that changes even a word of the Senate version.

Atlantic City, which has seen its tax base contract 64% since 2010, is deep in debt and not only unable to issue debt through the municipal bond market because of its low credit rating, but also faces a severe contraction of its tax base in the wake of the closure of four of its twelve casinos. It now faces worse odds of avoiding a state takeover. Even though Mayor Guardian yesterday said “We are making every effort to find solutions” prior to April 1st, his plan would mean that no employees would be paid until at least May 2nd, the date the city will receive its next installment of taxes. While essential services such as public safety and revenue collections will continue, other functions will cease and City Hall will close 4:30 pm local time on April 8. Moody’s Investors Service has warned that the city could default on debt as early as next month without state action, meaning its cost of borrowing is increasing—as are the possibilities the city could file for chapter 9 municipal bankruptcy.

Unbalancing. The Michigan Municipal League yesterday reported Michigan is the only state in the country in which there was an overall revenue decline for cities, townships, and counties over the decade from 2002 to 2012, due in large measure to state cuts in revenue sharing with cities, townships, villages, and counties by $7.5 billion over the decade—assistance vital to finance essential public services and to address fiscal disparities. The League, in its report, noted that U.S. Census Bureau data finds that Michigan’s municipalities experienced an 8 percent drop in revenues from what it has experienced from failed state fiscal policies toward cities and towns, noting that, according to the U.S. Census Bureau, Michigan is the only state in the country providing fewer economic resources to its cities in 2012 than it did a decade ago in 2002, adding that the tragic outcome in Flint reflects in many ways what should have been anticipated in a state which has adopted a state fiscal policy which incentivizes new building at the expense of what currently exists: “Our system attempts to balance budgets by only addressing the cost side of the equation. We have no mechanism to invest in our cities as a way of improving the financial well-being of a community.” The League’s report further points to the extraordinary state powers under Michigan law for Emergency Managers—powers the League warns which “virtually all relate in one way or another to cutting costs,” rather than taking into consideration the provision of essential services, such as drinking water, public safety, etc.: “Cost-cutting measures, with few very exceptions, result in a reduction in the services that the community will receive. Usually those reductions do not have tragic consequences, but make no mistake: the decision to switch from the Detroit Water and Sewer Department to the Flint River was an economic one driven by state laws and policies that significantly impact and restrain local government…This decision was not about improved service, water quality, infrastructure investment, or any other altruistic goal. This was an opportunity to save money and nothing more.”

A System Designed for Failing a Municipality: The special report notes that the state law and practice of appointing Emergency Managers has proven contrary to the long-term fiscal and human sustainability of the state’s communities, noting: “By design, emergency managers are outsiders with a single mission to reduce costs. I am in no way suggesting that this decision was made with malice or without forethought, but the emergency manager and, by extension, the state has only one objective during a financial emergency. That goal is to reduce costs until the budget is balanced. It is this approach that has brought us to where we are today. Emergency managers do not have to live, long-term, with service reductions and the diminishment to the community that they bring. When they have completed the mission, they move on. They have one focus: to balance the budget by cutting expenses until they equal revenues. But this approach fails to recognize, and in fact is in direct conflict with one of the fundamental tenants of Michigan’s municipal finance model, which is that the value of a community directly impacts the revenue that a community can generate to sustain services. It’s a system designed for failure.”

Think for a moment about how cities (& counties) generate revenue. Property taxes are a function of two variables: millage rates and taxable value. What makes taxable value higher in one community versus another, is, in essence, what makes one city or village more desirable than another. Great places can command higher prices, which translate into greater taxable value. This in turn generates more revenue. It is simple math. When an emergency manager balances the books by closing parks, eliminating programs and services and forgoing investments in infrastructure, he or she) makes it a less desirable place. This, of course, diminishes the value of the city and its revenue generating power. Consequently, the city offers even fewer services, which further diminishes it as a place where people want to live, which diminishes value, and so on. It’s a death spiral — a fundamentally flawed process that will never work given Michigan’s current municipal finance model. The system is broken.

Now think of that approach in the context of Flint. What have we bought with our cost-reduction approach to balancing budgets? A significantly damaged community in both a social and economic sense. If taxes are a function of value and millage, how have property values been impacted in Flint as a result of this cost-cutting decision? I think it is fair to suggest that the property values in Flint have been severely impacted as a result of the current crisis. Which will mean deep reductions in local tax revenue, which of course will mean reductions in service, which means a diminishment of value. The death spiral continues. Sadly, our only existing mechanism to address this will be through more cuts. We need a new way forward.

Our first priority must be to address the social and health impacts Flint is experiencing. Beyond that, we must address the policy that brought us here. We must invest in our local communities. Cuts beget more cuts. It is a race to the bottom, and in this case a tragic illustration of flawed public policy. Creating vibrant, desirable communities is proven to have positive economic impact as well as social value that we have lost sight of with our current approach. We must recognize that by investing to create great places we can improve both the quality of life and the economy of a city at the same time. A cut-only approach can only diminish the strength of a community and in extreme instances like this have a devastating human impact. We must learn from this disaster and redefine how we invest in Michigan cities.

The Daunting Fiscal Challenges of Smaller, Poorer Municipalities

February 10, 2016. Share on Twitter

In this morning’s  blog post, we consider the growing fiscal and governing challenges of smaller cities with disproportionate lower income populations: here, Flint, Michigan, and Ferguson, Missouri–both smaller cities struggling with disproportionate levels of poverty. But there, as Robert Frost would have noted, their paths diverge. Because the fiscal disaster and human crisis from the lead poisoning for Flint’s children emerged from neglect and other state and federal failures–and because the crisis has put the city’s children at greatest risk–there seem to be signal federal and state efforts to make amends, including the provision of fiscal help. There is no such comparison in Ferguson, where the U.S. Justice Department yesterday filed suit against the city–a city characterized by disproportionately low incomes and race–but which has sought to fill its municipal coffers through the imposition of traffic fines levied disproportionately on those travelling into the city, rather than through more traditional and equitable means. There are two trends: the increasing fiscal disparities between municipalities in the U.S. as the concept of revenue sharing by the federal government and states has dissipated, and the growing apprehension over the cost of operating too many municipalities in metropolitan regions. 

Out Like Flint. Flint Michigan Mayor Karen Weaver has proposed a plan to replace the lead pipes in the city—pipes which have become a major health threat to the city’s future because of drinking water contamination and lead poisoning in the wake of a decision by a former gubernatorially appointed emergency manager, Darnell Earley, to begin pumping water from the Flint River to homes in what used to be one of the state’s largest cities two years ago. Her plan could be assisted by appropriations recommended this week by Gov. Rick Snyder. The hope is that replacing lead service lines would prove to be a key step to reducing the highest risk for lead to leach into the city’s drinking water—notwithstanding that there are other sources of lead in plumbing, including older soldered joints and fixtures containing leaded brass. Mayor Weaver noted: “We’ll let the investigations focus on who is to blame for Flint’s water crisis…I’m focused on solving it.” Mayor Weaver stated the $55 million project could begin by March: the goal is to replace an estimated 15,000 lead service lines within one year at no cost to homeowners: her plan is to target homes, but not schools, businesses, or other nonresidential sites—or, as she put it: “We are going to restore safe drinking water one house at a time, one child at a time until the lead pipes are gone.” The Mayor said the project would be a joint partnership between the National Guard and the city, but would require coordination with state government and funding from the Michigan Legislature.

Flint is the gritty rustbelt metropolis, where General Motors was founded in 1908, but which, since 2011, has been run by a series of state-appointed emergency managers: It has lost half its population since the 1960s, as GM cut its local workforce from 80,000 to around 5,000; fewer than 100,000 people now live there. More than 40% of the city’s mostly black population lives below the poverty line. Crime and unemployment rates are sky-high. Around 15% of Flint’s houses are abandoned. But for Flint, the stakes are higher: its tax base is most likely to erode—beginning with its property tax revenues, where as if the unacceptable levels of lead in the drinking water would not be sufficient to deter new homeowners from bolstering the city’s property tax revenues, some mortgage lenders are now warning home buyers in the city that they must prove there is no contamination at a property, or else they will not make a loan for its purchase. It is difficult to imagine a more immediate source of critical tax revenue erosion: now local real-estate agents and lenders must be apprehensive that the new limitation could be another punch in the gut of the city’s key tax revenues—revenues already on a long, downhill slide in the wake of the departure of major auto industry employers. Or, as Daniel Jacobs, an executive with Michigan Mutual, which recently issued a notice to its employees requiring that homes pass a water test before it will make a loan put it: “The tragedy in an already depressed community is now likely to see housing values plummet not only because of the hazardous water, but because folks cannot obtain financing.” Indeed, the Flint water contamination crisis and Detroit’s public school restructuring took center stage yesterday when Gov. Snyder presented his FY2017 budget—in which he told legislators he was “committed to providing critical investments needed for the Flint water crisis and Detroit Public Schools, while maintaining the long-term focus on the key priorities of education, job creation, health and human services, public safety and fiscal responsibility.” His budget seeks an additional $195 million to help restore safe drinking water to Flint—appropriations which would be in addition to the $37 million already approved from a supplemental budget action, bringing total state funding for Flint to $232 million, telling legislators the level includes the $37 million to help with water infrastructure; $15 million for food and nutrition; $63 million for the health and well-being of Flint children and other vulnerable residents; and $30 million to provide water bill payment relief for Flint. In addition, Gov. Snyder proposed that $50 million be set aside in a reserve fund for legislative oversight of the Flint programs after a six-to nine-month period, noting legislators would have the opportunity to assess where the resources could be deployed most effectively with good accountability, efficiency, and outcomes. Indeed, the proposal appears consistent with the levels Mayor Weaver reported yesterday, noting that her plan to remove and replace all lead water pipes in city homes carries a $55 million price tag. Gov. Snyder’s budget recommendation also seeks funding for statewide water infrastructure improvement. He introduced the creation of a commission to look at 21st century water infrastructure in his state of the state address earlier this year.

For a legislature already apprehensive about the distribution of annual appropriations, however, the Governor’s new requests might create some balancing issues—especially with the swelling costs for the struggling Detroit Public Schools’ (DPS) restructuring—for which the Governor is asking for $715 million from the legislature, stating yesterday: “The action plan here is to devote resources, not from the school aid fund, but instead use tobacco settlement proceeds at the rate of $72 million a year for 10 years to deal with the $515 million deficit and $200 million for additional investment.” In addition, he sought an additional $50 million to help with DPS current debt situation that, he said, is already reserved in the state’s 2016 budget supplemental. The governor is apprehensive DPS could be insolvent by this summer, urging state legislators to act swiftly, waring: “If we don’t, this is an issue that will be resolved in the court system where the outcomes can be much more devastating to the citizens of Michigan and other school districts in the state. The clock is ticking and action is required.”

Transferred Water Woes. Somehow it almost seems as if Detroit has channeled some of its fiscal woes north to Flint—yesterday Moody’s restored Detroit’s old water and sewer debt to an investment-grade rating for the first time since Detroit exiting municipal bankruptcy the city left bankruptcy a year ago last November. Ergo, yesterday, Moody’s upgraded the newly created Great Lakes Water Authority bonds—some the $5.5 billion of water and sewer revenue municipal bond debt—of the post-bankruptcy created regional authority (The water system treats water from Lake Huron, Lake St. Clair and the Detroit River and distributes treated water to a service area population of about 3.8 million. The sewer system treats and disposes of wastewater produced by a service area population of approximately 2.8 million.) to investment grade, with a stable outlook, with the rating agency recognizing that the new authority has assumed all the debt secured by the net revenues of the Detroit Water and Sewerage Department. The regional authority manages regional water and wastewater services, assets, and handles rate-setting responsibilities, even as Detroit retains control of water and sewer services within city limits. Under the terms of the lease, the regional authority has sole ownership interest in revenue generated by the combined regional and local system—or, as Moody’s observed: “This significantly limits the risk that a future bankruptcy filing by the city of Detroit or intensified fiscal pressure on the city in general would contribute to bondholder impairment with respect to the water revenue debt,” adding that the upbeat ratings also reflect the massive scale of water operations, as well as a customer base that extends beyond Detroit’ boundaries, very strong operational and fiscal management, healthy liquidity, and the expectation of stable or improved debt service coverage. Nevertheless, the ratings were tempered by what Moody’s characterized as the authority’s credit challenges, such as high leverage of pledged revenue, extensive capital needs, and labor market and demographic weaknesses. Under Detroit’s chapter 9 municipal bankruptcy plan of debt adjustment, the city had successfully sought to monetize its water and sewer assets: a key provision of the regional system’s 40-year lease with Detroit provides the Motor City will receive $50 million a year to overhaul its aging infrastructure as well as $4.5 million in assistance for low-income customers.

Recall. Michigan Governor Rick Snyder yesterday presented his budget—with the twin emergency focus on Flint and Detroit’s fiscally failing public schools even as the Michigan Board of State Canvassers three days’ ago approved a recall petition to force him out of office—with a statewide vote potentially as early as August 2nd, provided the requisite signatures are gathered by the deadline: The petition seeks the recall for moving the state School Reform Office to a department under the governor’s control; nine other petitions involving the Flint water crisis were rejected because of technical errors such as misspelled or omitted words. Almost as if Pandora’s box has been opened, Gov. Snyder is also likely to confront challenges in court: According to Great Lakes Law, lawsuits have been filed on three fronts: “class action citizen suits filed by environmental groups, class action and torts, coupled with constitutional claims against the governor, government investigations both state and federal, that may result in civil and criminal enforcement actions,” even though special legal protections make it difficult to hold governments liable for damages such as those filed by Flint residents.

The U.S. Sues Ferguson over Municipal Taxes and Charges. The U.S. Justice Department, in a lawsuit filed on Wednesday against the small city of Ferguson, Missouri, charged the municipality with regard to an effort to end an allegedly longstanding pattern of unconstitutional policing. The suit, coming in the wake of inability to reach a settlement with the city’s Mayor and Council, charges that the city’s police and court systems routinely violate the civil rights of the city’s black residents, in part to generate revenue from tickets, claiming in its suit that the city’s “routine violation of constitutional and statutory rights, based in part on prioritizing the misuse of law enforcement authority as a means to generate municipal revenue over legitimate law enforcement purposes, is ongoing and pervasive,” adding: Ferguson’s municipal code confers broad authority on the Court Clerk, including authority to collect all fines and fees, accept guilty pleas, sign and issue subpoenas, and approve bond determinations. The Court Clerk and assistant clerks routinely issue arrest warrants and perform other judicial functions without judicial supervision. As the number of charges initiated by Ferguson Police Department has increased in recent years, the size of the court’s docket has also increased. According to data the City reported to the Missouri State Courts Administrator, at the end of fiscal year 2009, the court had roughly 24,000 traffic cases and 28,000 non-traffic cases pending….In January 2013 the City Manager requested and secured City Council approval to fund additional assistant court clerk positions because “each month we are setting new all-time records in fines and forfeitures,” and the funding for the additional positions “will be more than covered by the increase in revenues.” The federal suit includes a count noting: “The City’s desire to generate revenue influences fine amounts. City officials have extolled that Ferguson’s preset fines are “at or near the top of the list” compared with other municipalities across a large number of offenses, and have cited these fine amounts—which were lowered during the pendency of the United States’ investigation—as one of several measures taken to increase court revenues. For violations that do not have preset fines, the siut noted: “Defendant has also taken measures to ensure fines are set sufficiently high for revenue purposes.”

Puerto Rico in the Twilight Zone. U.S. Senate Judiciary Committee Chairman Orrin Hatch (R-Utah) yesterday demanded Puerto Rico Gov. Alejandro Garcia Padilla provide detailed financial information by March 1st and stated he intends to come up with a plan to help the commonwealth by the end of March—relatively consistent with House Speaker Paul Ryan’s time frame, discussing his goals for a solution to Puerto Rico’s fiscal and debt crisis during a Finance Committee hearing on the President’s FY2017 budget with Treasury Secretary Jack Lew—with the Secretary making clear that any restructuring solution has to pass before Puerto Rico faces major bond payments in May and June—even as Mr. Hatch called the administration’s position an “unprecedented debt-restructuring authority” for Puerto Rico that would give “an explicit preference for public pension liabilities over debt issued by the Puerto Rican government, even though the territory’s constitution gives preference to some of [the] debt.” Chairman Hatch seems focused on requesting up-to-date details about the Territory’s three largest pension systems, stating he understands that the systems are only 4% funded and that the commonwealth-wide bankruptcy regime Treasury has floated would give preference to those unfunded liabilities.

The U.S. House Natural Resources Committee has scheduled a February 25th hearing at which Treasury Counselor Antonio Weiss has been asked to discuss an analysis of Puerto Rico, as the House presses to meet House Speaker Paul Ryan’s deadline of April 1st for the House to complete and send legislation to the Senate, with a focus on legislation authored by Rep. Sean Duffy (R-Wisc.) which would give the U.S. territory some sort of access to bankruptcy—as well as impose a financial stability council. Treasury Counselor Weiss last Friday, at a panel sponsored by the Bipartisan Policy Center, reported there have been “very positive discussions taking place on both sides of the aisle” in Congress, adding that there now seems to be greater agreement that any Congressional plan to help Puerto Rico avoid default and insolvency should include both restructuring and oversight. In his presentation last week, Mr. Weiss said the administration believes that restructuring of Puerto Rico’s debt could come through the Constitution’s Territorial Clause instead of through an addition to the U.S. bankruptcy code. (The clause in question reads: “Congress shall have power to dispose of and make all needful rules and regulations respecting the territory or other property belonging to the United States.”) Mr. Weiss added that not all the territory’s debt would have to “be treated with a broad brush equally,” and that restructuring could take into account the many differences between Puerto Rico’s various debts, noting: “A special legislative act is required, tailored to the territories, consistent with Article 4 of the Constitution and that is neither for cities nor for states…It is on Congress recognizing the severity of this problem to agree in a bipartisan fashion on what those tools should be. It’s emergency legislation to deal with an emergency situation.”

Resident Commissioner Pedro Pierluisi, Puerto Rico’s sole representative in Congress, noted, in response to the emerging resolution, that he and other elected Puerto Rican leaders are concerned that any Congressional action not create a federal oversight authority that would impose too much control over the island’s municipalities: he said he would support an oversight authority as long as it respected Puerto Rico’s local governance, something both Republicans and Democrats have agreed is important to a final bill.

The Hard School Odds against Recovering from Municipal Bankruptcy

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April 29, 2015
Visit the project blog: The Municipal Sustainability Project

Going to School on Municipal Bankruptcy. Detroit’s road to recovery from the largest bankruptcy in U.S. history was never projected to be easy, but actions by the Michigan House yesterday and the desperate fiscal status of the city’s Detroit Public Schools (DPS) have added significant obstacles. Yesterday, the Michigan House passed and sent to the Senate a $37.8 billion general government spending plan that slashes state revenue sharing for Detroit by $4.1 million. In its 59-51 vote, House Republicans rejected a Democratic amendment to adopt Gov. Rick Snyder’s recommended $1.7 million increase in funding for Detroit’s municipal operations. The rejection of the Governor’s funding request came as the Governor is poised to release a plan tomorrow to address the teetering fiscal situation of the Detroit Public Schools—a plan to overhaul the troubled district, which has been under state control since 2009, yet still faces a $160 million deficit. Absent a fix for the city’s troubled school system, Detroit’s ability to attract families to move to the city appears dim. Thus, in the wake of months of work by Michigan local and state officials, Gov. Snyder is expected to announce his legislative package―a package that is already drawing opposition from the Detroit Federation of Teachers, who yesterday protested what they anticipate to be a plan to expand charters and the Education Achievement Authority in Detroit, and against what the union termed “all the destruction that 15 years of state mismanagement has brought Detroit Public Schools.” Last week, the Detroit News reported the Gov. was considering splitting DPS into two districts: one which would educate 47,000 students under a new structure, and one which would use DPS’s 18-mill non-homestead levy to pay off the district’s debt. The “new district” would have a board named by Gov. Snyder and Detroit Mayor Mike Duggan. Under such a revised structure, one would take on legacy debt and the other educational responsibilities. Adding to the already severe fiscal challenge confronting the city, however, Municipal Market Analytics, in its weekly “Municipal Issuer Brief,” on Monday suggested that holders of municipal debt issued by DPS would “likely [realize] more to gain from selling than holding [DPS debt] at this point,” noting that schools in Michigan and Illinois, so far this year, have accounted for 13% of all super downgrades—in large part because of state level fiscal challenges: “[A]ll Michigan local school bondholders are effectively long the risk that the governor of Michigan will not look to impair bondholders in a hypothetical DPS Chapter 9. That is not a good bet,” noting that the school system’s emergency manager is positioned to recommend a filing for municipal bankruptcy “if no reasonable alternative exists to repair the existing financial emergency,” and adding that [Gov.] “Snyder’s demonstrated ‘contempt’ for bondholders in Detroit’s bankruptcy, where the city’s unlimited-tax general obligation bonds were treated as unsecured, was hardly reassuring.” In its warning to holder of DPS municipal debt, the firm noted that no Michigan school district has ever filed for federal bankruptcy protection, the fate of enhanced municipal bonds would be most uncertain. According to DPS’s official statement: “In the absence of a legal precedent addressing the obligation of the State Treasurer to make an Act 92 payment in the context of a Chapter 9 proceeding, no assurance can be given that if the school district were to become a debtor under a Chapter 9 proceeding, the obligation of the state Treasurer to pay principal and interest on the municipal obligations post-bankruptcy filing would not be impaired”―a statement which the firm notes marks a “dramatic shift,” adding that “Michigan’s recent actions vis-a-vis bondholders give us little reason not to assume the worst.”

Superdowngrades. Municipal Market Analytics this week also provided a fiscal storm alert for Illinois municipalities, where Gov. Bruce Rauner has proposed a 50 percent cut in state income tax revenues provided as aid to local governments—a cut, which MMA notes, if agreed to by the legislature, “would be the kind of event to trigger superdowngrades.” While MMA considers such an event as “unlikely,” because there is no precedent for such action in the state and rarely have such actions occurred in other states; nevertheless, it is a fiscal warning.

Fiddling in Congress While Puerto Rico Squirms. Presidential candidate and former Florida Governor Jeb Bush, in a visit to Puerto Rico yesterday stated that Puerto Rico’s public agencies should be able to seek bankruptcy, during a visit to the U.S. territory. His visit came as yields on Puerto Rico’s newest general obligation bonds are setting record highs as lawmakers struggle to resolve a debate on tax changes that might pave the way for a $2.9 billion bond sale needed to ease a cash crunch. With about two months left in the fiscal year, the U.S. territory’s House of Representatives is not ready to vote on a plan to revamp its levy on goods and services, even as yields on tax-exempt Puerto Rico general obligation bonds maturing in July 2035 traded early this week with an average yield of 10.36 percent, according to data compiled by Bloomberg. The yield reached 10.42 percent last week, the highest since the bonds’ sale in March 2014. Mr. Bush’s visit came as the Government Development Bank, which warned last week that the government risks shutting down within three months, warned that tax overhaul is essential to attract investors to the planned bond sale. Without cash from the new bonds, Puerto Rico may fail to shield its general obligations and sales-tax debt, dubbed Cofinas, from restructuring. Philip Fischer at Bank of America Merrill Lynch, in not an understatement, said: “They’ve run out of many of their options…The administration has indicated very strongly that it would like to preserve the integrity of Cofina and the general obligations. When you’re in a situation of a possible insolvency, it’s not clear how much you can control it.” The territory and its state agencies have amassed $73 billion of debt―more than any U.S. state except California and New York, even as it is losing population; its public power utility, PREPA, is negotiating with creditors and may ask them to take a loss, which would be the biggest restructuring ever in the U.S. municipal-bond market. Gov. Bush’s visit came as the Puerto Rico House may vote as early as this week on a plan to boost the island’s sales and use tax by nearly 40% in June to 10 percent from 7 percent; then a new 14 percent levy, to be called a goods-and-services tax, would expand the sales-tax base beginning in January―the proposed tax plan would also include tax breaks for lower-income individuals as soon as July 2015. The projected changes could reap as much as $900 million of new revenue in the fiscal year beginning July 1, and would go toward paying debt service and retirement costs for public workers; the proposed $2.9 billion in new borrowing, to be backed by oil taxes, would repay loans the highway agency owes the Government Development Bank. The bank’s net liquidity fell to $1.1 billion as of March 31, from $2 billion in October. In his visit, Mr. Bush told Puerto Rican leaders: “Puerto Rico should be given the same rights as the states…In order for Puerto Rico to eventually become a state, it must begin by being treated as a state.” Like U.S. states, Puerto Rico, a self-governing island of 3.5 million, cannot file for bankruptcy, but, unlike states, Puerto Rico cannot authorize its municipalities to file for bankruptcy—and, to date, as Mr. Bush noted, Congress has demonstrated no willingness to consider amending the law to provide for such protections for Puerto Rico’s municipalities.