Is There a “Right” Structure to Resolve Fiscal Insolvency?

06/19/17

Good Morning! In this a.m.’s eBlog, we consider the ongoing challenges to restoring fiscal solvency in the U.S. territory of Puerto Rico, so that chapter 9 does not apply—nor does that process provide a mechanism to address the territory’s municipalities, much less the existing federal discrimination against Puerto Rico vis-à-vis other Caribbean nations The challenge, if anything, has been heightened by the absence of mixed messages from Congress-where the PROMESA Oversight Board has sent a letter to Puerto Rico’s leaders warning of what the Board described as a waning resolve to deal with a dire financial situation.

Trying to Shock? House Natural Resources Committee Chairman Rob Bishop R-Utah) has notified PROMESA’s oversight board that its failure to approve the Puerto Rico Electric Power Authority’s restructuring support agreement is seen as “very problematic” by some federal legislators: “It appears there is no consensus from the oversight board in favor of certifying the PREPA [RSA] under…PROMESA…This is troubling, as the decision to implement the RSA had already been made by Congress with the passage of PROMESA. The oversight board’s dilatory tactics run counter to the plain language of PROMESA.” At the same time, PROMESA Board Chair José Carrión III stated that Puerto Rico needs to create implementation plans to reduce government spending and ensure adequate liquidity—writing last  Friday at a key time as the Puerto Rico legislature worked to try to reach consensus on a balanced FY2018 budget, in compliance with a board-approved 10-year fiscal plan. Chairman Carrión wrote: “I write to you out of a concern that some of the progress we appeared to have made in the past few weeks as a result of the close and positive collaboration between the board and the administration–and their respective teams of advisors–may be receding and that the necessary resolve to attain the goals set forth in the certified fiscal plan may be waning…It is equally of concern that some of the narrative taking hold in the public discourse fails to characterize adequately the truly dire fiscal situation the Commonwealth is facing.”  Chairman Carrión, in his epistle to Gov. Ricardo Rosselló, Senate President Thomas Rivera Schatz, and House of Representatives Speaker Carlos Méndez Núñez, noted it was an incorrect “narrative” for Puerto Rico’s government to say that if the government generates $200 million in additional cash reserves by June 30th, the PROMESA Board would not mandate a government furlough program and reduction or elimination of the Christmas bonus; rather, to avoid these measures, the Board is mandating a spending-reduction implementation plan in addition to the cash reserve intended to ensure ongoing liquidity—with Chairman Carrión warning that if the plan is inadequate or poorly executed, “Puerto Rico is all but certain to run out of money to fund the central government’s payroll come November or December of this year.” The PROMESA Board also called on Governor Rosselló to explain which public services are essential.

The stern warning—to a government where some of the most essential services are lacking—produced a response from Governor Rosselló’s non-voting representative to the PROMESA Board, Elías Sánchez Sifonte: “This administration has demonstrated an unwavering commitment to face this inherited crisis with the seriousness it deserves,” adding that: “We have also been demonstrating implementation plans to ensure we provide resources to cover essential services as required by PROMESA and in accordance with our Certified Tax Plan,” including progress in the Puerto Rico legislature on the budget proposed by the Governor based upon consultation with the PROMESA Board—a budget the Puerto Rican Senate expects to consider later this week.

The discussions came as U.S. District Judge Laura Taylor Swain, who is overseeing Puerto Rico’s Title III municipal bankruptcy process, taking a page from Detroit’s chapter 9 bankruptcy, named U. S. District Court Judges, including the remarkable Judge Christopher Klein, who presided over Stockton’s municipal bankruptcy trial, to help address critical issues. She also named Judge Barbara Houser of the U.S. Bankruptcy Court of the Northern District of Texas, designating her to lead the mediation team; Judge Thomas Ambro, of the U.S. Court of Appeals for the 3rd Circuit; U.S. District Court Judge Nancy Atlas of U.S. District Court for the Southern District of Texas; and Judge Victor Marrero of U.S. District Court for the Southern District of New York. Judge Swain made clear that participation in any mediation will be voluntary and confidential—and that she will not participate in mediation sessions, and mediators will not disclose information about the parties’ positions or the substance of the mediation process to her—with this process—as was the case in Stockton and Detroit’s chapter 9 cases—ongoing concurrently with trial in her courtroom. Judge Swain added that she plans to make final appointments prior to the June 28th Title III hearing in San Juan, where she will further explain the mediation process.

Who’s in Charge? The PROMESA Oversight Board has warned Puerto Rico’s leaders that the Board is apprehensive of a waning resolve to address the U.S. territory’s dire fiscal situation, with Chairman José Carrión III warning that Puerto Rico needs to create implementation plans for reducing government spending and assuring adequate liquidity at all times. The letter—coming between the emerging quasi-bankruptcy proceedings under Judge Taylor and as the Puerto Rico legislature is attempting to put together a balanced FY2018 budget, in compliance with a board-approved 10-year fiscal plan—came as PROMESA Board Chair José Carrión III urged greater resolve, writing: “I write to you out of a concern that some of the progress we appeared to have made in the past few weeks as a result of the close and positive collaboration between the Board and the administration–and their respective teams of advisors–may be receding and that the necessary resolve to attain the goals set forth in the certified fiscal plan may be waning…It is equally of concern that some of the narrative taking hold in the public discourse fails to characterize adequately the truly dire fiscal situation the Commonwealth is facing.” Chairman Carrión, in his epistle to Gov. Ricardo Rosselló, Senate President Thomas Rivera Schatz, and House of Representatives Speaker Carlos Méndez Núñez, added that there is an incorrect “narrative” that says that if the Puerto Rican government generates $200 million in additional cash reserves by the end of this month, the PROMESA Board would not mandate a government furlough program, nor a cut or elimination of the Christmas bonus. To avoid such a mandate, he added that the PROMESA Board is mandating a spending-reduction implementation plan in addition to a cash reserve plan intended to assure government liquidity, with the Chairman adding that if the plan is inadequate or poorly executed, “Puerto Rico is all but certain to run out of money to fund the central government’s payroll come November or December of this year.” Noting that: “Now we are at a critical juncture that requires that we collectively strengthen…,” the Board demanded that Gov. Rosselló explain which public services are essential.

Does Accountability Work Both Ways? Unlike chapter 9 bankruptcy cases in Detroit, San Bernardino, Central Falls, Jefferson County, and Stockton—Puerto Rico is unique in that the issue here does not involve municipalities, but rather a quasi-state. There have been no public hearings. PROMESA Chair José B. Carrion has not testified before the legislature. Now Puerto Rico Rep. Luis Raúl Torres has asked the Puerto Rico Finance Committee to invite Chair Carrión to appear to explain to Puerto Rico’s elected leaders the demands the PROMESA Board is seeking to mandate—and to justify the $60 million that the Fiscal Supervision Board is scheduled to receive as part of the resolution of special assignments. That Board, headed by Natalie Jaresko, the former Finance Minister of the Ukraine, is, according to PROMESA Chair Jose Carrión, to be in charge of the implementation of the plan, or, failing that, to achieve the fiscal balance of Puerto Rico and its return to the capital markets. (Ms. Jaresko has agreed to work for a four-year term: she is expected to earn an annual salary of $ 625,000 without additional compensation or bonuses, except for reimbursement of travel and accommodation expenses related to the position he will hold, according to PROMESA Board Chair Carrión, who has previously noted: “I know it’s going to be a controversial issue…We have a world-class problem, and we have a world-class person. This is what the rooms cost.”)

Getting Back in like Flint

Good Morning! In this a.m.’s eBlog, we consider the lessons learned from Flint—lessons that were not unrelated to the largest municipal bankruptcy in U.S, history in Detroit.

Immunity for State & Municipal Employees: What Does it Mean in Flint? U.S. Judge Judith Levy, in her 101-page decision this week, held that Flint and Michigan employees can be sued over the city’s lead water contamination; however, she found that Michigan Governor Rick Snyder and the State of Michigan have governmental immunity. The ruling came in response to a suit brought by a resident of Flint, against Gov. Snyder and 13 other public officials. Judge Levy dismissed many of the counts; however, she concurred that Flint resident Shari Guerin, who had brought the suit against the city and the other public officials, had had both her and her child’s “bodily integrity” unknowingly exposed by the dangerous levels of lead in Flint’s drinking water—levels of which the state was aware, but had hidden from the public. Indeed, the Judge wrote: “The conduct of many of the individual governmental defendants was so egregious as to shock the conscience.” Despite dismissing the charges against the Governor, the Michigan Departments of Environmental Quality and Health and Human Services—and the city’s water treatment plant operator, Judge Levy found that some key state leaders, including the state’s Chief Medical Executive and Health and Human Services Director could be sued in their individual capacities—and that Flint officials have no state governmental immunity, writing: “As this case highlights, the more governmental actors that are involved in causing a massive tort in Michigan, the less likely it is that state tort claims can proceed against the individual government actors given the way the state immunity statutes operate…Because the harm that befell plaintiffs was such a massive undertaking, and took so many government actors to cause, the perverse result is that none can be held responsible under state tort law.”

A Vicious Fiscal Whirlpool? For the city, the severe water contamination had not just physical fiscal implications, but also fiscal ones. Indeed, one of the plaintiffs was one of nearly 8,000 homeowners who was in danger of losing homes under tax foreclosure proceedings (Real property tax delinquency in the state entails a three-year forfeiture and foreclosure process)—proceedings which had been scheduled to commence last week until the Flint City Council approved a one-year moratorium—a moratorium which covered residents with two years of unpaid water and sewer bills going back to June 2014. While that temporary reprieve is in question, confronting an unknown outcome before the state-appointed Receivership Transition Advisory Board, which has monitored Flint’s finances since the city’s emergence from state oversight in two years ago last April—and is scheduled to vote on the moratorium at its June meeting; the outstanding water liens and inability to collect have further emptied the city’s coffers—even as, unsurprisingly, assessed property values  have become the latest fiscal hardship as an impoverished Flint still reels from a lead-in-water crisis which was first publicly acknowledged less than two years ago.

According to a recent Michigan State University study, “Flint Fiscal Playbook: An Assessment of the Emergency Manager Years, 2011-2015),” Flint has lost nearly 75 percent of its tax base—and of that base, assessed property valuations reeled to a 50 percent drop from $1.5 billion to $750 million.  Thus, unsurprisingly, more than 100 residents showed up at this week’s Council meeting—understandably upset that they face foreclosure even as they have been confronted by bills for drinking water, which they could neither drink, nor use in any way that might jeopardize the health and safety of their children. Those citizens received a temporary, one-year reprieve from the city—but the reprieve implies greater fiscal challenges to the city.

With liabilities high and revenues and property taxes struggling, Flint Mayor Karen Weaver reports that Flint has trimmed $2 million in annual garbage collection expenses by rebidding the service; expects to cut annual water expenses to $12 million from $21 million; and, due to federal grants, is hiring 33 more firefighters. The city is proceeding with a $37 million renovation of the Capitol Theatre downtown, seeking to create a central, historic space which could enhance the downtown—or, as the Mayor puts it: “I don’t think people should take their eyes off Flint.”

But assessing the dimensions of this disaster, created in no small part under the state’s original takeover of the city via the appointment of the emergency manager who had made the fatal decisions to change the city’s sourcing of drinking water, also includes looking back to the critical governmental decisions—especially Flint’s opting to abandon reliance on the  Karegnondi Water Authority (KWA) and instead rely upon the Great Lakes Water Authority (GLWA), a regional water authority created as part of Detroit’s chapter 9 plan of debt adjustment—meaning Flint’s citizens will keep drawing Detroit water from their taps—or, as the Mayor put it: “Staying with our water source gives us reassurance our water is good…It gets us out of our $7 million (annual) debt to the KWA. We did not have the finances to be able to do that.” Under the city’s 30-year agreement with the  30-year deal with GLWA, the city will receive a $7 million annual credit equal to its annual municipal bond payment to KWA for as long as Flint remains current with scheduled debt service. In addition, the agreement also enables the city to redirect water plant improvements to upgrading the city’s water distribution system—or, as Mayor Weaver notes: “We have pipes going into the ground now (referring to the planned replacement of lead service lines).We’re addressing this water crisis. The water quality is better. There are some good things going on.”

Mayor Weaver notes Flint has cut its $2 million in annual garbage collection expenses by rebidding the service; the city expects to cut annual water expenses to $12 million from $21 million; and the city continues to work with the Governor to address the public health concerns associated with the Flint water crisis. To try to become an economic magnet or hub, rather than a city to be avoided, the city is focused on a $37 million renovation of the Capitol Theatre, creating a central, historic space which could draw folks to events, restaurants, and bars. As the Mayor puts it: “I don’t think people should take their eyes off Flint…They should know the rest of the story. One of the things I’ve learned is we were going to get more done if we work together. If people are going to help you, why would you not sit down and work things out?”

Are There non-Judicial Avenues to Solvency?

Good Morning! In this a.m.’s eBlog, we consider the increasing threat to Hartford, Connecticut’s capitol, of insolvency; then we look at the nearing referendum in Puerto Rico to address the U.S. Territory’s legal status.

Can Chapter 9 Be Avoided? As the Connecticut legislature nears ending its session, House Majority Leader Matthew Ritter (D-Hartford) has been taking the lead in efforts to commit tens of millions of state dollars to rescue the city—but, as the Leader noted: “There are going to be strings;” the price to the municipality will be greater state control—however, what that control will be and how implemented remains unclear. One key issue will be the city’s looming pension challenge: the city’s current $33 million in annual obligations is projected to increase to $52.6 million by FY2023—ergo, one option for the state would be to utilize an oversight board to re-negotiate union contracts, a move used before by the state for Waterbury—and a step Mayor Luke Bronin had proposed last year—only to see it rejected. His efforts to seek a commitment for $15 million in givebacks by the unions this year succeeded in getting only one tenth that amount, $1.5 million—and came as the local AFSCME Council recently rejected a contract which could have saved the city $4 million.

The inability to agree upon voluntary steps to address the nearing insolvency has pushed state leaders, increasingly, to discuss the creation of a state financial control board as a linchpin to any state bailout of the city—with leaders discussing a board composed evenly of state, local, and union representatives. Connecticut’s law (§7-566) requires the express prior written consent of the Governor—obligating him to submit a report to the Treasurer and General Assembly—actions taken twice before in the cases of Bridgeport (1991) and the Westport Transit District; however, each case was resolved without going through the legal process and submission of a plan off debt adjustment. Indeed, there is, as yet, little consensus in the state legislature with regard to what oversight governance would include: one option under consideration would impose a spending cap, while another would provide for state preemption of the city’s authority to negotiate with its unions: the Majority Leader notes: “I think that if we could get these concessions agreed to and reach the savings that have been targeted…it would go a long way to limiting the amount of oversight in the city of Hartford.” Whatever route to restoring solvency, tempus fugit as the Romans used to say: time is fleeing: the city’s deficit is just under $50 million, even as the departure of one of its biggest employers, Aetna, looms—and, as we had reported in Providence, the city has a disproportionate hole in its property tax base: state and local government agencies, hospitals, and universities occupy 50% of the city’s property. Add to that, the city’s current authority to levy property tax limits such collections to an assessed value of 70 percent.

Mayor Bronin, recognizing that state help is critical, notes his “goal and hope is that legislators from around the state of Connecticut will recognize that Hartford cannot responsibly solve a crisis of this magnitude at the local level alone.” State aid will be critical for an additional reason: absent such assistance, the city’s credit rating is almost certain to deteriorate, thereby driving up its costs for capital borrowing.  Adding to the urgency of fiscal action is the pending departure of Aetna from the city: even though city leaders believe the giant health care corporation will keep many of its 6,000 employees in Connecticut, notwithstanding its negotiations with several states to relocate its corporate headquarters from Hartford, Aetna has stated it remains committed to its Connecticut employees and its Hartford campus. (Aetna and Hartford’s other four biggest taxpayers contribute nearly 20% of the city’s $280 million of property-tax revenues which make up nearly half the city’s general fund revenues.) The companies have imposed a fiscal price, however: Aetna, together with Hartford Financial Services and Travelers have offered to contribute a voluntary payment of $10 million annually over the next five years to help the city avoid chapter 9 municipal avoid bankruptcy, but only on the condition there are comprehensive governing and fiscal changes. But the companies have said they want to see comprehensive changes in how Hartford is run—including vastly reducing reliance on the property tax—a tax rate which the city has raised seven times in the past decade and a half to rates 50% greater than they were in 1998. Thus, with time fleeing, the city confronts coming up with the fiscal resources to finance nearly $180 million in debt service, health care, pensions, and other fixed costs for its upcoming fiscal budget—an amount equal to more than half of the city’s budget, excluding education; that is, the city’s options are increasingly limited—and the Mayor has made clear that he will not reduce essential public safety. As the Majority Leader describes it, it is in the state’s best interest to make sure the city has a sustainable future, noting that a municipal bankruptcy would not “just affect Hartford: It would affect neighboring communities, it would affect the state, it would probably affect our credit ratings.”

Eliminating local power? Hartford City Council President Thomas Clark is apprehensive with regard to state preemption of local authority, noting hisconcern has always been if this bill is passed–in whatever form it gets passed–what does that do to the elected leadership at the local level?…And I think until we see what that actually includes, we’re just going to be uncomfortable with this concept.” From the Mayor’s perspective, he notes: “Understandably, Connecticut residents do not want their hard-earned tax dollars being used wastefully, or simply funding an increase in the cost of city government…I don’t mind anybody looking over my shoulder…and I don’t mind having the books open. I’m confident in the decisions that we’ve made.” That contrasts with his colleagues on the City Council—and the city’s unions, who have previously charged: “The Governor and this mayor are clutching at their last chance at unconditional and overreaching power.” The unions have claimed there are measures which could be taken without resorting to negating collective bargaining rights and municipal bankruptcy; yet, as we have seen in Detroit, San Bernardino, etc., those efforts were ineffective compared to the pressure of a U.S. bankruptcy judge.

Chartering a Post Insolvency Future? Voters and taxpayers in the U.S. Territory of Puerto Rice go to the polls this Sunday to vote on a referendum on Puerto Rico’s political status—the fifth such referendum since it became an unincorporated territory of the United States. Although, originally, this referendum would only have the options of statehood versus independence, a letter from the Trump administration had recommended adding “Commonwealth,” the current status, in the plebiscite; however, that recommendation was scotched in response to the results of the plebiscite in 2012 which asked whether to remain in the current status—which the voters rejected. Subsequently, the administration cited changes in demographics during the past 5 years as a reason to add the option once again, leading to amendments incorporating ballot wording changes requested by the Department of Justice, as well as adding a “current territorial status” as provided under the original Jones-Shafroth Act as an option. Notwithstanding what the voters decide, however, it remains uncertain what might happen—much less how a Trump Administration or how Congress would react. The referendum was approved last January by the Puerto Rico Senate—and then by the House, and signed by Gov. Rossello last February.

How Does A City Turn Around Its Fiscal Future?

Good Morning! In this a.m.’s eBlog, we consider a state’s response to a municipal fiscal insolvency, before turning to the challenge the Windy City is facing in the virtually politically insolvent State of Illinois, before finally turning to the uncertain political, governing, and fiscal future of East Cleveland, Ohio.  

Addressing Disparate Municipal Fiscal Distress. More than a century ago, Petersburg, Virginia, was a highly industrialized city of 18,000 people—and the hub and supply center for the Confederacy: supplies arrived from all over the South via one of the five railroads or the various plank roads; it was also the last outpost. Today, it is one of the last fiscal outposts, but, mayhap, because of its fiscal distress, set to be a model for the nation and federalism with regard to how the Commonwealth of Virginia—unlike, for instance, Ohio, is responding. More than 53 percent of Virginia’s counties and cities have reported above-average or high fiscal stress, according to a report by the Commission on Local Government. Petersburg, a city grappling with a severe financial crisis, placed third on the state fiscal stress index behind the cities of Emporia and Buena Vista. Del. Lashrecse Aird (D-Petersburg) noted: “Petersburg does have some financial challenges, but they’re actually not unique. There are a lot of counties and localities within the commonwealth right now that are facing similar fiscal distressers.”  

The Virginia Legislature has dropped a proposed study of local government finances in its just completed legislative session, a legislative initiative which co-sponsor Rosalyn Dance (D-Petersburg) had described to her colleagues as necessary, because:  “Currently, there is no statutory authority for the Commission on Local Government to intervene in a fiscally stressed locality, and the state does not currently have any authority to assist a locality financially;” nevertheless, Virginia’s new fiscal year state budget did revive a focus on fiscal stress in Virginia cities and counties. Motivated by the City of Petersburg’s financial crisis, Sen. Emmett Hanger (R-Augusta County), who co-Chairs the Virginia Senate Finance Committee, had filed a bill (SJ 278) to study the fiscal stress of local governments: his bill proposed the creation of a joint subcommittee to review local and state tax systems, as well as reforms to promote economic assistance and cooperation between regions. Under SJ 278, a 15-member joint subcommittee would have reviewed local government and state tax systems, local responsibilities for delivery of state programs, and causes of fiscal stress among local governments. In addition, the study would have been focused on creating financial incentives and reforms to promote increased cooperation among Virginia’s regions. We will have to, however, await developments, as his proposal was rejected in the House Finance Committee, as members deferred consideration of tax reform for next year’s longer session; however, the adopted state budget did incorporate two fiscal stress preventive measures originally introduced in Sen. Hanger’s bill.

Del. Aird had identified the study as a top priority for this session, identifying: “what we as a Commonwealth need to do to put protections into place and allow localities to have tools and resources to prevent this type of challenge from occurring into the future,” noting: “I believe that this legislation will help address fiscal issues that localities are experiencing: ‘Currently, there is no statutory authority for the Commission on Local Government to intervene in a fiscally stressed locality, and the state does not currently have any authority to assist a locality financially.’” In the case of Petersburg, the city received technical assistance from state officials, including cataloging liabilities and obligations, researching problems, and reviewing city funds; however, state intervention could only be triggered by a request from the municipality: the state’s statutes forbid the Commonwealth from imposing reactive measures to an insolvent municipality.

To modify the conditions to enhance the ability of the state to intervene, the proposal set guidelines for state officials to identify and help alleviate signs of financial stress to prevent a more severe fiscal crisis, proposing the creation of a workgroup established by the Auditor of Public Accounts, who would have been responsible to create an early warning system for identifying fiscal stress, taking into consideration such criteria as a local government’s expenditure reports and budget information. In the event such distress was determined, such a local government would be notified and entitled to request a comprehensive review of its finances by the state. After such a review, the state would be responsible to draft an ‘action plan’ detailing: purpose, duration, and the requisite state resources for such intervention; in addition, the governor would be offered the option to channel up to $500,000 from the general fund toward relief efforts for the local government in need. As Del. Aird noted: “It is important to have someone who can speak to first-hand experience dealing with issues of local government fiscal stress: This insight will be essential in forming effective solutions that will be sustainable long-term, adding: “Prior to now, Virginia had no mechanism to track, measure, or address fiscal stress in localities…Petersburg’s situation is not unique, and it is encouraging that proactive measures are now being taken to guard against future issues. This is essential to ensuring that Virginia’s economy remains strong and that all communities can share in our commonwealth’s success.”

What Might Be a City’s Weakest Link? The state initiative comes as the city intends to write off $9 million in uncollected internal debt Petersburg has accumulated over the past 17 years: debt representing loans from Petersburg’s general fund to other city enterprises since 2000 which its leaders now concede they will never collect—or, as former Richmond City Manager—and now consultant for the city Robert Bobb notes: “This is something that the leadership should have addressed between 2000 and last year, but the issue was not being addressed.” As a result, when Petersburg officials receive the city’s financial audit for FY2017, it will show a negative fund balance that will make it even harder to secure financing for capital projects, albeit, it is expected to clear the uncollected debt from the books for the current fiscal year and the upcoming fiscal year—or, as Virginia Finance Director Ric Brown notes: “They’re taking it on the chin in FY2016 by clearing it all out of the books: To me, the most important thing is not how bad ‘16 is—it’s going forward whether FY2017 and FY2018 improve.” With its bond rating downgraded last year to BB with a negative outlook, Petersburg already faces a stiff fiscal challenge in raising capital—the municipality recently experienced an inability to raise capital to purchase police cars and fire equipment—making manifest the connection between public safety and assessed property values.

Nevertheless, Mr. Bobb has promised that this fiscal year will end without an operating deficit and the next one will begin with the first structurally balanced budget in nearly a decade—to which Secretary Brown notes: “It’s going to take some time, but I believe the sense of everyone is he’s making progress.” The Secretary noted that when the Commonwealth acted to come to Petersburg’s assistance last summer, he discovered the municipality had ended the fiscal year with $18.8 million in unpaid bills and $12 million over its operating budget; ergo, he testified the bottom line was “not going to be good” in the city’s FY2016 CAFR; however, Petersburg has worked in phases to pay its bills, reduce its costs, and rebuild its underpersonned, overwhelmed bureaucracy: The city has reduced its unpaid bills to $5.5 million, with the largest remaining obligation a $1.49 million payment to the Virginia Retirement System—a payment the city has agreed to pay by the end of December. The city’s school system has some $1.3 million in debt to its public retirement system due next month for teacher pensions. Nevertheless, in the school of lost and found, Mr. Bobb reports that city employees have scoured “every desk drawer” and discovered an additional $300,000 in unpaid bills, some of them dating back to 2015—unsurprisingly describing it as “[A] mess to clean up things from the past to where we are today.” Petersburg also has a gaping $1.9 million hole in the school system budget, in no small part by making payments this year to last year’s budget, a practice Mr. Bobb notes to be a [mal]practice the city has followed for 10 years—putting the city’s school budget near the minimum required by the Virginia Standards of Quality.

Nevertheless, Petersburg completed the first phase of recovery, focusing on short-term financing concerns, at the end of March. That has allowed it to focus on long-term financing and a fiscal plan, including developing policies for capital improvements, debt, and reserves to ensure financial stability. In the final stage, from July 1 until Mr. Bobb’s contract ends on September 30th, the city will develop five-year financial and capital improvement plans, as well as a budget transition plan, for ongoing financial performance and monitoring—as well as refilling the fiscal architecture via filling critical positions, including a finance director, which Mr. Brown notes, will be critical to filling middle management positions, such as accountants, which are vital to maintain the city’s financial stability: “If they don’t get that in place, there’s a real risk they’ll slide back.”

Petersburg wasn’t even at the top of the list of the most fiscally stressed localities ranked by the Virginia Commission on Local Government in 2014. It was third, behind Emporia and Buena Vista, and just ahead of Martinsville and Covington. “We’re only as strong as our weakest link,” said Sen. Rosalyn R. Dance, D-Petersburg, who served as the city’s mayor from 1992 to 2004. “We’re not the only ones there.”

Whither Chicago? The Windy City, nearly 350 years old, named “Chicago,” based upon a French rendering of the Native American word “shikaakwa,” from the Miami-Illinois language, is today defined by the Census Bureau as the city and suburbs extending into Wisconsin and Indiana; however, it is, today, a city experiencing population decline: last year it lost just under 20,000 residents—and its surrounding state, Illinois, saw its population decline more than any other state: 37,508 people, according to census data released last December. During the Great Recession, families chose to stay in or move to core urban areas, and migration to the suburbs decelerated; however, in the recovery, there is a reverse trend: families are deciding it is time to move back to the suburbs.

Thus, by most estimates, Chicago’s population will continue to decline, with the Chicago Tribune, from a survey of dozens of former residents, reporting the depopulation stems from reactions to: high taxes, the state budget stalemate, crime, the unemployment rate, and weather—with black residents among those leaving in search of safe neighborhoods and prosperity: it seems many are heading to the suburbs and warm-weather states: Chicago lost 181,000 black residents between 2000 and 2010, according to census data. Just under 90,000 Chicagoans left the city and its immediately surrounding suburbs for other states last year, according to an analysis of census data released in March, marking the greatest outflow since at least 1990. It appears that, more than any other city, Chicago has relied upon the increase in Mexican immigrants to offset the decline of its native-born population: during the 1990s, that immigration accounted for most of Chicago’s growth. After 2007, when Mexican-born populations began to fall across the nation’s major metropolitan areas, most cities managed to make up for the loss with the growth of their native populations, but that has not been the case for Chicago (nor Detroit, which, according to census data, realized a decline of 3,541 residents from 2015 to 2016). While Chicago’s changes may be small in context, they could be a harbinger of more losses to come.

As we had noted in our fiscal report on Chicago, Mayor Rahm Emanuel focused on drawing in new businesses, concerned that any perception that assessed property taxes might have to increase—or that schools and crime rates would not improve—would adversely affect companies’ willingness to come to Chicago—meaning an intense focus on confronting fiscal challenges: such as credit quality threats: e.g. avoiding having a disproportionate percent of the city’s budget devoted to long-term pension borrowing obligations instead of critical future investments: the more of its budget the city had to divert to meeting unsustainable pension obligations, the less it would have to address its goal of investments in the city’s infrastructure, schools, and public safety—investments the Mayor believed fundamental to the city’s economic and fiscal future.  We noted a critical change: Investing in the Future: Mayor Emanuel created enterprise funds so that a greater portion of municipal services were not financed through property taxes and the operating budget: some 83 percent of its budget was focused on schools and public safety, in an effort to draw back young families. Nevertheless, amid growing perceptions that Chicago’s cost of living has become too high, rising property taxes, and perceived growth in crime; some are apprehensive Chicago could be at a tipping point: the period in a city’s time when an increasing number of residents believe it is time to leave—or, as one leaver noted: “It’s just sad to see that people have to leave the city to protect their own future cost of living.”

Does East Cleveland Have a Fiscal Future? In the small Ohio municipality of East Cleveland, a city waiting on the State of Ohio for nearly a year to obtain permission to file for chapter 9 municipal bankruptcy, there is an upcoming Mayoral election—an election which could decide whether the city has a fiscal future—and where voters will have to decide among an array of candidates: who might they elect as most likely to turn the fortunes of the City around, and avert its continuing slide towards insolvency? One candidate, who previously served as Chairman of the East Cleveland Audit Committee, noted a report to the Council detailing twenty-four budget appropriations totaling approximately $2,440,076 in unauthorized and questionable expenditures—and that his committee had provided documentation to the Auditor of State’s Office of Local Government Services regarding the hiring of 10 individuals in violation of a Council-mandated hiring freeze, costing the City approximately $408,475 in unauthorized payroll costs, adding: “All told, the Audit Committee uncovered approximately $3,055,351 in illegal and suspicious spending by the Norton Administration…The truth is, as I stated in the beginning, the municipal government of East Cleveland is afflicted with the cancer of corruption that has been allowed to grow because of two main reasons: The first being, the indifference displayed by Ohio and Cuyahoga County government officials who failed in their respective responsibility when confronted with documented facts.  They collectively have turned a blind eye to what was, and is, happening in East Cleveland.  No one wants to get their hands dirty with so-called ‘black politics,’ even if the legal and financial evidence is given to them on a ‘silver platter.’  Personally, I smell the stench of secret political deals which produced a ‘hands off policy.’”

He added that a symptom of what he described as “this cancer” included some “$41, 857, 430 in unwarranted expenses and debt that was generated during the first 3 years of Mayor Norton’s first term as Mayor. I anticipate that whenever an audit is conducted for 2013 thru 2016, the $41 million figure will grow by an additional $25 million to $35 million.” Addressing the unresponsiveness of the State of Ohio, he described the Governor’s Financial Planning and Supervision Commission as a “joke:  It has been wholly unimpressive and has not provided the necessary oversight and forced accountability one would have expected from the Commission at the beginning.  Furthermore, The Commission became tainted when Governor Kasich appointed Helen Forbes Fields to the Commission.  She has a number of personal conflicts of interests that prevent her from being an impartial member of the Commission.  I can recall a conversation I had with the former Commission Chair, Sharon Hanrahan when she admitted to me that the State Government did not have the ‘political will’ to clean up the mess we were trying to get them to address.” He added, that, if elected, in order to bring accountability for the mismanagement of public funds, he would seek assistance from Ohio and federal law enforcement agencies to ensure those responsible for the mismanagement of East Cleveland’s financial resources would be held accountable, estimating that between $5 million and $15 million dollars could be recovered. 

A Hole in Puerto Rico’s Fiscal Safety Net: Should Congress Amend Chapter 9 Municipal Bankruptcy?

eBlog

Good Morning! In this a.m.’s eBlog, we consider the growing physical and fiscal breakdown in the U.S. Territory of Puerto Rico as it seeks, along with the oversight PROMESA Board, an alternative to municipal bankruptcy—but we especially focus on the fiscal plight of the territory’s many, many municipalities—or muncipios, which, because Puerto Rico is not a state, do not have access to chapter 9 municipal bankruptcy .   

Tropical Fiscal Typhoon. When former President Ronald Reagan signed Public Law 100-597, legislation authorizing municipal into law 29 years ago, no one was contemplating a U.S. territory, such as Puerto Rico—so that the federal statute, in coherence and compliance with the concepts of dual sovereignty, which served as the unique foundation of the nation, provided that a city, county, or other municipality could only file for chapter 9 if authorized by state law—something a majority of states have not authorized. Unsurprisingly, none of us contemplated or thought about U.S. territories, such as Puerto Rico, Guam, etc.: Puerto Rico is to be considered a state for purposes of the bankruptcy code, except that, unlike a state, it may not authorize its municipalities (and by extension, its utilities) to resolve debts under Chapter 9 of the code. Ergo, no municipio in Puerto Rico has access to a U.S. bankruptcy court, even as 36 of the island’s 78 muncipios have negative budget balances; 46% are experiencing fiscal distress. Their combined total debt is $3.8 billion. In total, the combined debt borne by Puerto Rico’s municipalities is about 5.5% of Puerto Rico’s outstanding debt.  

The fiscal plight of Puerto Rico’s municipalities has also been affected by the territory’s dismal fiscal condition: From 2000 to 2010, the population of Puerto Rico decreased, the first such decrease in census history for Puerto Rico, declining by 2.2%; but that seemingly small percentage obscures a harsher reality: it is the young and talented who are emigrating to Miami, New York City, and other parts on the mainland, leaving behind a declining and aging population—e.g. a population less able to pay taxes, but far more dependent on governmental assistance. At the same time, Puerto Rico’s investment in its human infrastructure has contributed to the economy’s decline: especially the disinvestment in its human infrastructure: a public teacher’s base salary starts at $24,000—even as the salary for a legislative advisor for Puerto Rico starts at $74,000. That is, if Puerto Rico’s youngest generation is to be its foundation for its future—and if its leaders are critical to local fiscal and governing leadership in a quasi-state where 36 of the island’s 78 municipalities, or just under half, are in fiscal distress—but, combined, have outstanding debt of about $3.8 billion; something will have to give. These municipalities, moreover, unlike Detroit, or San Bernardino, or Central Falls, have no recourse to municipal bankruptcy: they are in a fiscal Twilight Zone. (Puerto Rico has a negative real growth rate; per capita income in 2010 was estimated at $16,300; 46.1% of the territory’s population is in poverty, according to the most recent 2106 estimate; but that poverty is harsher outside of San Juan.) A declining and aging population adversely affects economic output—indeed, as former Detroit Emergency Manager Kevyn Orr who steered the city out of the largest municipal bankruptcy in U.S. history recognized, the key to its plan of debt adjustment was restoring its economic viability.

U.S. Supreme Court Justice Sonia Sotomayor, who is of Puerto Rican descent, has indicated there should be a more favorable interpretation of the law to make the system fairer to Puerto Rico: to allow the Commonwealth of Puerto Rico to create its own emergency municipal bankruptcy measures—something, however, which only Congress and the Trump administration could facilitate. It seems clear that Justice Sotomayor does believe Puerto Rico ought to be considered the equivalent of a state, i.e. empowered to create its own bankruptcy laws. However, as the First Circuit Court of Appeals has interpreted, Puerto Rico is barred from enacting its own bankruptcy laws: it is treated as a state—in a country of dual federalism wherein the federal government, consequently, has no authority to authorize state access to bankruptcy protection.

Puerto Rico & Municipal Bankruptcy: a process of pain where “failure is not an option.”

eBlog

Good Morning! In this a.m.’s eBlog, we consider the opening under U.S. Judge Laura Swain of the unique, quasi chapter 9 municipal bankruptcy process which opened this week in Puerto Rico, where Judge Swain noted the process “will certainly involve pain,” but that “failure is not an option.”

Getting Ready to Rumble. Judge Swain has combined two major PROMESA Title III filings made earlier this month by Puerto Rican authorities—one for its general obligation debt, and one for debt which is backed by the Puerto Rico’s Commonwealth or COFINA sales tax revenues. Reuters helps explain, writing: “The island’s initial bankruptcy filing on [May 3] included only its central government, which owes some $18 billion in general obligation, or GO debt, backed by its constitution…The COFINA filing [on May 5] will pull in another $17 billion or so in debt under the Title III umbrella. Overall the island’s government and various agencies have a debt load of $74 billion that they cannot repay.” Unsurprisingly, as Bloomberg notes, a sizeable separation between general obligation and COFINA bondholders has already emerged. Judge Swain’s early decision to merge the two filings for administrative purposes appears to denote a small victory for the PROMESA Board, as some COFINA stakeholders had objected (COFINA bondholders were the first to sue the government of Puerto Rico after the freeze on creditor litigation under PROMESA expired at Midnight May 1st.) They accuse Puerto Rico, Governor Ricardo Rossello and other officials of angling to repurpose the tax revenue earmarked to pay COFINA debt.: they argued that COFINA is a separate entity whose assets, in the form of sales tax revenue, are earmarked only for creditors.” The debt here dwarfs any we have seen in Detroit, San Bernardino, etc.: Puerto Rico, according to the PROMESA Board, cannot even meet 25% of its $900 million necessary to service its municipal debt. And, in some sense, that debt—owed to investors in the 50 states, pales compared to the human obligations at home: NPR’s Greg Allen describes: “retirees who are owed pensions; 180 closed public schools, $500 million in cuts proposed for the university here…So lots of pain to come here—and the governor is going to be releasing a budget later this month, which will show a lot more pain coming. Among the things that are going to happen is, I think, big cuts in health care benefits.” He estimated the trial could exceed the duration of Detroit’s chapter 9, taking as many as five years to conclude. Judge Swain will—as Judge Rhodes had to in Detroit, and as was the very hard case in Central Falls, Rhode Island’s municipal bankruptcy‒Puerto Rico’s $49 billion in government pension obligations. But Puerto Rico’s debt is not just fiscal: the island has a poverty rate of 45%–a level dwarfing what we have experienced in previous chapter 9 bankruptcies. The current case may not affect all of these because some are for the employees of semi-autonomous Puerto Rico entities like the Puerto Rico Electric Power Authority. And, the trial here dwarfs the previous largest U.S. municipal bankruptcy in Detroit, where the stakes involved $18 billion in debt, pension obligations, and other OPEB benefits. The pension obligations have been described as liabilities of as much as $45 billion. On the trial’s first day, Judge Swain heard presentations with regard to whether the case should include mediation—and, if so, which parties should be included: that is, she will have a Solomon-like set of choices, choosing between Puerto’s Rico’s citizens, its municipal bondholders, suppliers owed money, pensioners, and government employees. Judge Swain will also hear presentations with regard to whether—and when‒Puerto Rico should be required to submit lists of its creditors and in what manner and how notice to creditors will be made. The PROMESA Oversight Board attorney Martin Bienenstock said he anticipates other Puerto Rico public entities, including the Highways and Transportation Authority, would soon file for Title III later. The considerations in the court will also have to address how some $800 million set aside in Puerto Rico’s certified 10-year fiscal recovery plan will be apportioned between competing claims–including those of constitutionally backed general obligation debt (GO) and sales-tax backed or COFINA bonds.

Solomon’s Choices: Who Will Define Puerto Rico’s Fiscal Future–and How?

eBlog

Good Morning! In this a.m.’s eBlog, we consider the growing physical and fiscal breakdown in the U.S. Territory of Puerto Rico as it seeks, along with the oversight PROMESA Board, an alternative to municipal bankruptcy. 

Tropical Fiscal Typhoon. U.S. Supreme Court Chief Justice John Roberts has selected Southern District of New York Judge Laura Taylor Swain, who previously served as a federal bankruptcy Judge for the Eastern District of New York from 1996 until 2000 to preside over Puerto Rico’s PROMESA Title III bankruptcy proceedings—presiding, thus, over a municipal bankruptcy nearly 500% larger than that of Detroit’s–one which will grapple with creating a human and fiscal blueprint for the future of some 3.5 million Americans—and force Judge Swain to grapple with the battle between the citizens of the country and the holders of its debt spread throughout the U.S. (Title III of PROMESA, which is modeled after Chapter 9 of the Municipal Bankruptcy Code and nearly a century of legal precedent, provides a framework for protecting Puerto Rico’s citizens while also respecting the legitimate rights and priorities of creditors.) For example, the recent Chapter 9 restructuring in Detroit sought reasonable accommodations for vulnerable pensioners and respected secured creditors’ rights.

The action came in the wake of Puerto Rico’s announcement last week that it was restructuring a portion of its nearly $73 billion in debt—an action which it was clear almost from the get-go that the requisite two-thirds majority of Puerto Rico’s municipal bondholders would not have supported. (Puerto Rico’s constitution provides that payments to holders of so-called “general obligation” bonds have priority over all other expenditures—even as another group of creditors has first access to revenues from the territory’s sales tax.) More critically, Judge Swain will be presiding over a process affecting the lives and futures of some 3.5 million Americans—nearly 500% greater than the population of Detroit. And while the poverty rate in Detroit was 40%, the surrounding region, especially after the federal bailout of the auto industry, differs signally from Puerto Rico, where the poverty rate is 46.1%–and where there is no surrounding state to address or help finance schools, health care, etc. Indeed, Puerto Rico, in its efforts to address its debt, has cut its health care and public transportation fiscal support; closed schools; and increased sales taxes. With the Bureau of Labor Statistics reporting an unemployment rate of at 12.2%, and, in the wake of last year’s Zika virus, when thousands of workers who were fighting the epidemic were let go from their jobs; the U.S. territory’s fiscal conditions have been exacerbated by the emigration of some of its most able talent—or, as the Pew Research Center has noted:  “More recent Puerto Rican arrivals from the island are also less well off than earlier migrants, with lower household incomes and a greater likelihood of living in poverty.”

For Judge Swain—as was the case in Detroit, Central Falls, San Bernardino, Stockton, etc., a grave challenge in seeking to fashion a plan of debt adjustment will resolve around public pensions. While the state constitutional issues, which complicated—and nearly led to a U.S. Supreme Court federalism challenge—do not appear to be at issue here; nevertheless the human aspect is. Just as former Rhode Island Supreme Court Judge Robert G. Flanders, Jr., who served as Central Falls’ Receiver during that city’s chapter 9 bankruptcy—and told us, with his voice breaking—of the deep pension cuts which he had summarily imposed of as much as 50%—so too Puerto Rico’s public pension funds have been depleted. Thus, it will fall to Judge Swain to seek to balance the desperate human needs on one side versus the demands of municipal bondholders on the other. Finally, the trial over which Judge Swain will preside has an element somewhat distinct from the others we have traced: can she press, as part of this process to fashion a plan of debt adjustment, for measures—likely ones which would have to emanate from Congress—to address the current drain of some of Puerto Rico’s most valuable human resources: taxpayers fleeing to the mainland. Today, Puerto Rico’s population is more than 8% smaller than seven years ago; the territory has been in recession almost continuously for a decade—and Puerto Rico is in the midst of political turmoil: should it change its form of governance: a poll two months’ ago found that 57% support statehood. Indeed, even were Puerto Rico’s voters to vote that way, and even though the 2016 GOP platform backed statehood; it seems most unlikely that in the nation’s increasingly polarized status the majority in the U.S. Congress would agree to any provision which would change the balance of political power in the U.S. Senate.