Municipal Bankruptcies Are Complicated Affairs. Really.

August 17, 2018

Good Morning! In this morning’s eBlog, we consider a rejection of an appeal challenging Jefferson County’s approved plan of debt adjustment from its chapter 9 municipal bankruptcy, and the recurring governance challenge in the U.S. territory of Puerto Rico whether the elected Governor and Legislature—or a federal Judge, or a Control Board ought to be making vital governing decisions.

Please note, there will be a temporary respite for eGnus and eBlog readers before publications resume the last week of this month.

A Fiscally Appealing Chapter 9 case? The U.S. Eleventh Court of Appeals has dismissed a challenge to Jefferson County’s chapter 9 municipal bankruptcy plan of debt adjustment, holding (please see Andrew Bennett et al v. Jefferson County, No. 15-11690, 11th U.S. Circuit Court of Appeals, August 16, 2018), holding that the U.S. District Court had erred when  it dismissed Jefferson County’s appeal, holding that the Chapter 9 case brought by a group of ratepayers of Jefferson County’s sewer system could be brought due to the concept of “equitable mootness,” a doctrine the court wrote which, until yesterday, “we have not been asked to apply in a chapter 9 municipal bankruptcy case,” with the court adding: “Municipal bankruptcy proceedings are usually complicated affairs, and the chapter 9 proceeding for Jefferson County, Alabama, involving about $3.2 billion in total sewer-related debt—has proved no different.”

Under the terms of the decision, the County would cut over $100 million in general fund expenditures, and the creditors will write off a significant amount of outstanding debt—over the course of the next four decades, the County is directed to implement a series of single-digit sewer rate increases—totaling about 365%–an amount which the court noted was “not far off of the national increase in inflation in the previous 40 years.” The court, in effect, with its decision, rejected the assertion by County ratepayers that their plan “validated corrupt government activity.”

The court also reviewed, de novo, the lower court’s conclusion that the doctrine of equitable mootness applied to this case—at that lower court, Jefferson County had argued the doctrine of equitable mootness applied and barred the ratepayers’ appeal from the U.S. bankruptcy court. The court here agreed, explaining why said doctrine could apply in a municipal bankruptcy case. (Essentially, the doctrine, the court explained, the courts may, under certain circumstances, reject bankruptcy appeals if the underlying rulings which would have gone into effect would have been “extremely burdensome.” The court went on to decide that some of the principles “will weigh more heavily in chapter 9 municipal bankruptcy cases “precisely because of how many people may be affected,” unlike in a chapter 11 bankruptcy, noting previous chapter 9 municipal bankruptcies we have written about in Stockton and Vallejo, where the district courts’ reasoning involved the implications that “municipalities and their bankruptcies implicate issues of sovereignty; whereas corporations or individuals and their bankruptcies do not—and that, accordingly, it is important for us to tread carefully where self-governance is concerned.” The court further noted: “In addition, it is not at all clear in which direction the ratepayers’ federalism arguments will cut from one chapter 9 bankruptcy to the next. Given the interests of the municipality and those of its residents (among others), there is a countervailing argument that a court ought to be more solicitous to the municipality that has obtained confirmation of its plan….”

Finally, the court recognized that “given the centrality of the constitutional rights to the fabric of the republic, there is a fair argument to be made that we should allow some leniency when a party which has allowed a bankruptcy plan to go into effect asserts,” adding, with regard to federalism concerns, “it will be appropriate to note them when deciding whether the doctrine should bar an appeal in a particular bankruptcy case,” which, is, as the court noted: “precisely what we did.”

 Jefferson County Commissioner David Carrington, a previous State & Local Leader of the Week, who led the county’s negotiations during its municipal bankruptcy case, said County leaders are pleased with the ruling, noting: “We were always confident in our Chapter 9 plan of adjustment,” but wincing that the years of litigation had come at great expense to county taxpayers running into “hundreds of thousands of dollars in frivolous litigation fees that could have been used for capital improvements to the sewer system.” (The County had filed its plan of debt adjustment in November of 2011—a plan subsequently approved by the court five years ago. Nevertheless, as the dean of chapter 9 municipal bankruptcy, Jim Spiotto, noted, the case had become one of the longest municipal bankruptcy cases in U.S. history.

Another Appeal. Meanwhile, south of Jefferson County, Puerto Rico Governor Ricardo Rosselló confirmed yesterday that the executive branch will also appeal the decision of Judge Laura Taylor Swain, the judge assigned by the federal court to deal with the quasi chapter 9 municipal bankruptcy of Puerto Rico—a decision in which it was determined that the PROMESA Oversight Board has the authority to impose its certified fiscal plan and budget, with the Governor stating: “It has become very clear what is the unworthy colonial situation in Puerto Rico, where some courts have decided that in some aspects of the budget the hands are tied to the Legislative Assembly and somewhat to the executive to make determinations, so of course we are going to appeal,” with his comments coming in the wake of Judge Swain’s dismissal, earlier this month, of nine of the allegations presented in the suit of the Financial Advisory Authority and Fiscal Agency (Aafaf), as well as all the allegations of the lawsuit filed by the Puerto Rico Legislature—and the legislative leadership, where the respective leaders, Thomas Rivera Schatz and Carlos “Johnny” Méndez, already filed an information motion before the court notifying it they would attend the First Circuit of Appeals of Boston—albeit, Governor Rosselló, noted, he would not provide them with the power to “make executive decisions with the vehicle of the executive order.”

Colocar el Interruptor. Nearly a year after Hurricane Maria plunged Puerto Rico into physical and fiscal darkness, NPR’s Adrian Florida reports: “Now nearly 11 months after Hurricane Maria plunged Puerto Rico into darkness, officials there say they are done restoring the island’s power: no more lanterns, and no more “candles.” PREPA has announced its work restoring power to the island is done: it took almost a year, tens of thousands of new poles, thousands of miles of wire, and help from two federal agencies. She described it as a “restoration plagued by scandal and delays. It cost some $3 billion. And now that it’s done, experts agree the power grid is just as fragile as before the hurricane. This morning, Jose Ortiz, the fifth CEO to head the power utility since the storm, was offering a reality check on local radio station WKAQ. Some homes still don’t have power because they’re damaged

Advertisements

The Once & Future Puerto Rico?

April 17, 2018

Good Morning! In this morning’s eBlog, we try to assess the fiscal and future governance options for Puerto Rico: will it become a second class state? A nation? Or, at long last, an integral part of the nation? And governance: who is in charge of its governance?

Before Hurricane Maria wracked its terrible human, fiscal, and physical toll; more than 50% of Americans knew not that Puerto Ricans were U.S. citizens. Still, today, some six months after the disaster, more than 50,000 have no electricity. The fiscal and physical toll on low-income Americans on the island has been especially harsh: of the nearly 1.2 million applications to FEMA for assistance to help fix damaged homes, nearly 60% have been rejected: FEMA provided no assistance, citing the lack of lack of title deeds or because the edifices in need were constructed on stolen land or in contravention of building codes. That is to write that this exceptionally powerful storm took a grievous toll not just on life and limb, but especially on the local and state economy, destroying an estimated 80% of Puerto Rico’s agricultural crop, including coffee and banana plantations—where regrowing is projected to take years. The super storm devastated 20% of businesses—today an estimated 10,000 firms remain closed. Discouragingly, the government forecasts output will shrink by another 11% in the year to June 2018.

It might be, ojala que si (one hopes) that a burst of growth will ensue, with estimates of as much as 8% next year, in no small part thanks to federal recovery assistance and as much as $20 billion in private-insurance payments—as well as Puerto Ricans dipping into their own savings to make repairs to their own homes and businesses. Yet, even those positive signs can appear to pale against the scope of the physical misery: by one estimate, Puerto Rico and the U.S. Virgin Islands will lose nearly $48 billion in output—and employment equivalent to 332,000 people working for a year. Of perhaps longer term fiscal concern are the estimated thousands of Puerto Ricans who left the island for Florida and other points on the mainland—disproportionately those better educated and with greater fiscal resources—leaving behind older and poorer Americans, and a greater physical and fiscal burden for Puerto Rico’s government.

The massive storm—and disparate treatment by the Trump administration and Congress—have encumbered Puerto Rico with massive debts, both to its central government and municipalities, but also to its businesses. Encumbered with massive debts—including $70 billion to its municipal bondholders and another $50 billion in public pension liabilities; Governor Ricardo Rosselló’s administration is making deep cuts: prior to the massive storm, the government had been committed to slashing funding to its local governments by $175 million, closing 184 schools, and cutting public pensions—pensions which, at just over $1,000 are not especially generous. Now, that task will be eased, provided the PROMESA oversight Board approves, to moderate the proposed cuts in services in order to do less harm the reviving economy.

Assisted by federal tax incentives, Puerto Rico’s economic model was for decades based on manufacturing, especially of pharmaceuticals. However, what Congress can bestow; it can take away. Thus it was that over the last decade, Congress steadily eroded economic incentives—Congressional actions which contributed to the territory’s massive debt crisis, and contributing to the World Bank dropping Puerto Rico 58 places in its ranking compared to the mainland with regard to the ease of doing business.

The havoc wreaked by Maria could be especially creative for the island’s private sector, which represents a chronically missed opportunity. Puerto Rico, for all its problems, is a beautiful tropical island, with white-sanded beaches, rainforest, fascinating history, lovely colonial buildings and a vibrant mix of Latin-American and European culture. Yet, with 3.5 million visitors a year, its tourism industry is less than half the size of Hawaii’s. It has an excellent climate for growing coffee and other highly marketable products, yet its agriculture sector is inefficient and tiny. The island has a well-educated, bilingual middle-class, including a surfeit of engineers, trained at the well-regarded University of Puerto Rico for the manufacturing industry, and cheap to hire. But in the wake of the departing multinationals, they are also leaving. Isabel Rullán, a 20-something former migrant, who has returned to the island from Washington to try to improve linkages to the diaspora, estimates that half her university classmates are on the mainland.

Quien Es Encargado? (Who is in charge?) Unlike a normal chapter 9 municipal bankruptcy proceeding, the process created by Congress under the PROMESA law created a distinct governance model—one which does create a quasi emergency manager, but here in the form of a board, the PROMESA Board, which, today, will submit its proposed fiscal plan, or quasi plan of debt adjustment to U.S. Judge Laura Swain Taylor; it will maintain its requirement to propose the reduction of the public pensions of Puerto Ricans by an average of 10 percent. Until last weekend, the PROMESA Board had kept under review the complaints to Governor Ricardo Rosselló with regard to the inclusion in its revised fiscal plan of the central government the base of a labor reform which, among other proposals, calls for the immediate reduction in vacation and sick leaves from 15 to 7 days for workers of private companies, according to two sources close to the Board. Under the fiscal plan proposed by the Governor Rosselló, the cuts would reach $1.45 billion in five years. The PROMESA Board has requested that they total $1.58 million by June of 2023. The proposal, unsurprisingly, has raised questions with regard to whether the Congress has the authority to impose on the government of Puerto Rico a reform of its labor laws—any more than its inability under our form of federalism to dictate changes in any state’s retirement systems—contracts which are inherent in state constitutions.

Pension reductions in chapter 9 cases, because they involve contracts, are difficult, as contracts are protected under state constitutions—moreover, as we saw in Detroit’s plan of debt adjustment approved by now retired U.S. Bankruptcy Judge Steven Rhodes, the court wanted to ensure that any such reductions would not subject the retiree to income below the federal poverty level—a level which, Puerto Rico Governor Ricardo Rossello told Reuters, in an interview this past week, “many retirees are already under,” as he warned  that any further pension cuts could “cast them out and challenge their livelihood.” That is, in the U.S. territory struggling with a 45 percent poverty rate and unemployment more than double the U.S. national average, the fiscal challenge of how to restructure nearly $70 billion in debt, where public pensions, which owe $45 billion in benefits, are also virtually insolvent, makes the challenges which had confronted Judge Rhodes pale in comparison.  Moreover, with the current pensions already virtually insolvent, paying pension benefits out of Puerto Rico’s general fund, on a pay-as-you-go basis, could cost the virtually bankrupt Puerto Rico $1.5 billion a year. The PROMESA Board has recommended that Gov. Rossello reduce pensions by 10 percent.  

For their part, the island’s pensioners have formed a negotiating committee, advised by Robert Gordon, an attorney who advised retirees in Detroit’s chapter 9 municipal bankruptcy, as well as Hector Mayol, the former administrator of Puerto Rico’s public pensions. The fiscal challenge in Puerto Rico, however, promises to be more stiff than Detroit—or, as Moody’s put it: Puerto Rico’s “unusual circumstances mean that it will not conform exactly” to recent public bankruptcies, in which “judges reduced creditor claims far more than amounts owed to pensioners.” Moreover, the scope or size of Puerto Rico’s public pension chasm is exacerbated by the ongoing emigration of young professionals from Puerto Rico to the mainland—making it almost like an increasingly unbalanced teeter totter.  The U.S. territory’s largest public pension, the Employee Retirement System (ERS), which covers nearly 100,000 retirees, is projected to run out of cash this year: it is confronted by a double fiscal whammy: in addition to paying retiree benefits, ERS owes some $3.1 billion to repay debts on municipal bonds it issued in 2008—bonds issued to finance Puerto Rico’s public pension obligations. Last year, Governor Rosselló had agreed to a reduction in pensions for government retirees, indicating a willingness to seek as much as a 6% reduction. That appears not, however, to be something he currently supports.

A few weeks ago, in the wake of negotiations with the PROMESA Board, Governor Rosselló proposed a labor reform similar to the one he negotiated with members of the Board, with differences with regard to how to balance it with an increase in the minimum wage and when to implement such changes. The Governor, however, withdrew the proposal when the Board required that the labor reform be in full force by next January, instead of applying it gradually over the next three years, and conditioned the increase from $ 7.25 to $ 8.25 per hour in the minimum wage to the increase in labor participation rates. It seems the PROMESA Board is intent upon labor reform as an essential element for future economic growth.

The Challenge of “Shared” Governance. Unlike in Central Falls, San Bernardino, Detroit, Jefferson County, or other chapter 9 cases where state enacted chapter 9 statutes prescribed governance through the process, the PROMESA statute created a territorial judicial system to restructure Puerto Rico’s public debt, creating a Board empowered to reign until four consecutive balanced budgets and medium and long-term access to the financial markets are achieved—or, as our colleague and expert, Gregory Makoff, of the Center for International Governance Innovation, who worked for a year as an advisor to the Department of Treasury in the Puerto Rican case, put it: “While the lack of cooperation with the Board may be good in political terms in the short-term, it simply delays the return of confidence and extends the time it will take for the Oversight Board to leave the island.” Mr. Makoff has recommended the Board and Gov. Rosselló propose to Judge Swain a cut of from $45 down to $6 billion of the public debt backed by taxes, with a payment of only 13.6 cents per each dollar owed, with the intent of equating it with the average that the states have. His suggestion comes as the Board aims to disclose its plans as early as this evening in advance of its scheduled sessions at the end of the week at the San Juan Convention Center, where, Thursday, the Board wants to certify Puerto Rico’s and PREPA’s proposed plans, and then, Friday, vote on the plans of the other public corporations: the Aqueducts and Sewers Authority (PRASA), the Highways and Transportation Authority (PRHTA), the Government Development Bank, the University of Puerto Rico (UPR) and the Cooperatives Supervision & Insurance Corporation (COSSEC).

Fiscal Balancing. The PROMESA law authorizes the Board the power to impose a fiscal plan and propose to Judge Swain a quasi plan of debt adjustment, as under chapter 9, on behalf of the government, much as in a chapter 9 plan of debt adjustment‒albeit the PROMESA statute does not grant the Board the power to enact laws or appoint or replace government officials. The Congressional act retained for the government of Puerto Rico the capacity and responsibility to enact laws consistent with the fiscal plan and the fiscal adjustment plan, as well as, obviously, to operate the government.

The Promise & Unpromise of PROMESA: Who Is Encargado II? Unlike in a, dare one write “traditional” chapter 9 municipal bankruptcy, where state enacted legislation defines governing authority in the interim before a municipality receives approval of its plan of debt adjustment to exit municipal bankruptcy, the Congressional PROMESA statute has left blurred the balance—or really imbalance—of authority between the power of the Board to approve a budget and fiscal plans, with its possible lack of authority to implement reforms, such as changes to federal regulations it promotes. An adviser to House Natural Resources Committee Chairman Rob Bishop ((R-Utah) recently noted that if the Rosselló administration does not implement the labor reform proposed by the PROMESA Board, the option for the Board would be to further reduce the expenses of the government of Puerto Rico—or, as Constitutional Law Professor Carlos Ramos González, at the Interamerican University of Puerto Rico, describes it, notwithstanding the impasse, “in one way or another, the Board will end up imposing its criteria. How it will do it remains to be seen.” An adviser to Chair Bishop said recently that if Gov. Rosselló’s administration does not implement the labor reform proposed by the Board, the option for the PROMESA Board would be to further reduce the expenses of the government of Puerto Rico—or, as Professor González put it: “In one way or another, the Board will end up imposing its criteria. How it will do it remains to be seen.”

The Uncertain State of the State. An ongoing challenge to full recovery for Puerto Rico is its uncertain status—a challenge that has marked it from its beginning: in February of 1917, during debate on the Senate floor of HR 9533 to provide for a civil government for Puerto Rico, when Sen. James Wadsworth (R-N.Y) inquired of Senate sponsor John F. Shafroth of Colorado whether it would “provide woman suffrage in Puerto Rico?” Sen. Shafroth made clear his intent that the eligibility of voters in Puerto Rico—as in other states—“may be prescribed by the Legislature of Puerto Rico.” That debate, more than a century ago, lingers as what some have described as “the albatross hanging around the island’s neck: the uncertainty over its status.” Is it a state? A country? Or some lesser form of government?  Even though thousands of Puerto Ricans have fought and died serving their country in World Wars I and II, in Vietnam and Afghanistan, Puerto Rico has never been treated as a state—and its own citizens have been unable to decide themselves whether they wish to support statehood.

Some believe Puerto Rico will become a state eventually. But to get there, especially without risking a violent nationalist repulse, Puerto Rico needs to understand what the federal requirements and barriers will be—and what the promise of PROMESA really will mean. And, as they used to say in Rome: tempus fugit. Time is running out: for, absent economic and fiscal recovery soon, the flood of emigration of young Americans from Puerto Rico will become a brain-drain boding a demographic death-spiral, leaving the island with too few taxpayers to cover its more rapidly growing health care costs for an aged population.

April 3, 2018

Good Morning! In this morning’s eBlog, we consider the challenges of governance in insolvency. Who is in charge of steering a municipality, county, or U.S. territory out of insolvency? How? How do we understand and assess the status of the ongoing quasi chapter 9 municipal bankruptcy PROMESA deliberations in the U.S. territory of Puerto Rico. Then we head north to assess the difficult fiscal balancing challenges in Connecticut.

Governance in Insolvency.  Because, in our country, it was the states which created the federal government, making the U.S. unique in the world; chapter 9 municipal bankruptcy is only, in this country, an option in states which have enacted state legislation to authorize municipal bankruptcy. Thus, unsurprisingly, the process is quite different in the minority of states which have authorized municipal bankruptcy. In some states, such as Rhode Island and Michigan, for instance, the Governor has a vital role in which she or he is granted authority to name an emergency manager–a quasi-dictator to assume governmental and fiscal authority, usurping that of the respective city or county’s elected officials. That is what happened in the cases of Detroit and Central Falls, Rhode Island, where, in each instance, all authority was stripped from the respective Mayors and Councils pending a U.S. Bankruptcy Court’s approval of respective plans of debt adjustment, allowing the respective jurisdictions to emerge from municipal bankruptcy. Thus, in the case of those two municipalities, the state law preempted the governing authority of the respective Mayors and Councils.

That was not the case, however, in Jefferson County, Alabama–a municipal bankruptcy precipitated by the state’s refusal to allow the County to raise its own taxes. Nor was it the case in the instances of Stockton or San Bernardino, California: two chapter 9 cases where the State of California played virtually no role. 

Thus, the question with regard to governance in the event of a default or municipal bankruptcy is a product of our country’s unique form of federalism.

In the case of Puerto Rico, the U.S. territory created under the Jones-Shafroth Act, however, the issue falls under Rod Sterling’s Twilight Zone–as Puerto Rico is neither a municipality, nor a state: a legal status which has perplexed Congress, and now appears to plague the author of the PROMESA law, House Natural Resources Committee Chair Rob Bishop (R-Utah) with regard to who, exactly, has governing or governance authority in Puerto Rico during its quasi-chapter 9 bankruptcy process: is it Puerto Rico’s elected Governor and legislature? Is it the PROMESA Board imposed by the U.S. Congress? Is it U.S. Judge Laura Swain, presiding over the quasi-chapter 9 bankruptcy trial in New York City? 

Chairman Bishop has defended the PROMESA’s Board’s authority to preempt the Governor and Legislature’s ruling and governance authority, stressing that the federal statute gave the Board the power to promote “structural reforms” and fiscal authority, writing to Board Chair Jose Carrion: “It has been delegated a statutory duty to order any reforms–fiscal or structural–to the government of Puerto Rico to ensure compliance with the purpose of PROMESA, as he demanded the federally named Board use its power to make a transparent assessment of the economic impact of Hurricanes Irma and Maria on Puerto Rico’s fiscal conditions–and to ensure that the relative legal priorities and liens of Puerto Rico’s public debt are respected–leaving murky whether he intended that to mean municipal bonholders and other lien holders living far away from Puerto Rico ought to have a priority over U.S. citizens of Puerto Rico still trying to recover from violent hurricanes which received far less in federal response aid than the City of Houston–even appearing to link his demands for reforms to the continuity of that more limited federal storm recovery assistance to compliance with his insistence that there be greater “accountability, goodwill, and cooperation from the government of Puerto Rico…” Indeed, it seems ironic that a key Chairman of the U.S. Congress, which has voted to create the greatest national debt in the history of the United States, would insist upon a quite different standard of accountability for Puerto Rico than for his own colleagues.

It seems that the federal appeals court, which may soon consider an appeal of Judge Swain’s opinion with regard to Puerto Rico’s Highway and Transportation Authority not to be mandated to make payments on its special revenue debt during said authority’s own insolvency, could help Puerto Rico: a positive decision would give Puerto Rico access to special revenues during the pendency of its proceedings in the quasi-chapter 9 case before Judge Swain.

Stabilizing the Ship of State. Farther north in Connecticut, progressive Democrats at the end of last week pressed in the General Assembly against Connecticut’s new fiscal stability panel, charging its recommendations shortchange key priorities, such as poorer municipalities, education and social services—even as the leaders of the Commission on Fiscal Stability and Economic Growth conceded they were limited by severe time constraints. Nevertheless, Co-Chairs Robert Patricelli and Jim Smith asserted the best way to invest in all of these priorities would be to end the cycle of state budget deficits and jump-start a lagging state economy. The co-chairs aired their perspectives at a marathon public hearing in the Hall of the House, answering questions from members of four legislative committees: Appropriations; Commerce; Finance, Revenue and Bonding; and Planning and Development—where Rep. Robyn Porter (D-New Haven) charged: “I’m only seeing sacrifice from the same people over and over again,” stating she was increasingly concerned about growing income inequality, asking: “When do we strike a balance?” Indeed, New York and Connecticut, with the wealthiest 1 percent of households in those states earning more than 40 times the average annual income of the bottom 99 percent, demonstrate the governance and fiscal challenge of that trend. In its report, the 14-member Commission made a wide array of recommendations centered on a major redistribution of state taxes—primarily reducing income tax rates across the board, while boosting the sales and corporation levies. Ironically, however, because the wealthy pay the majority of state income taxes, the proposed changes would disproportionately accrue to the benefit of the state’s highest income residents—in effect mirroring the federal tax reform, leading Rep. Porter to question why the Commission made such recommendations, including another to do away immediately with the estate tax on estates valued at more than $2 million, but gradually phase in an increase to the minimum wage over the next four years.  From a municipal perspective, Rep. James Albis (D-East Haven), cited a 2014 state tax incidence report showing that Connecticut’s heavy reliance on property taxes to fund municipal government “is incredibly regressive,” noting it has the effect of shifting a huge burden onto lower-middle- and low-income households—even as the report found that households earning less than $48,000 per year effectively pay nearly one-quarter of their annual income to cover state and local taxes. Rep. Brandon McGee (D-Hartford), the Vice Chair of the legislature’s Black and Puerto Rican Caucus, said the Committee’s recommendations lack bold ideas on how to revitalize Connecticut’s poor urban centers—with his concerns mirrored by Rep. Toni E. Walker (D-New Haven), Chair of the House Appropriations Committee, who warned she fears a commission proposal to cut $1 billion from the state’s nearly $20 billion annual operating budget would inevitably reduce municipal aid, especially to the state’s cities. Co-Chair Patricelli appeared to concur, noting: “Candidly, I would agree we came up a little short on the cities,” adding that the high property tax rates in Hartford and other urban centers hinder economic growth: “They really are fighting with one or more hands tied behind their backs.”

The ongoing discussion comes amidst the state’s fiscal commitment to assume responsibility to pay for Hartford’s general obligation debt service payments, more than $50 million annually—a fiscal commitment which understandably is creating equity questions for other municipalities in the state confronted by fiscal challenges. Like a teeter-totter, balancing fiscal needs in a state where the state itself has a ways to go to balance its own budget creates a test of fiscal and moral courage.

Federal Tax Reform in a Post-Chapter 9 Era

December 4, 2017

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

Visit the project blog: The Municipal Sustainability Project 

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

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

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

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

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

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

Trying to Recover on all Pistons

07/19/17

Share on Twitter

iBlog

Good Morning! In this a.m.’s eBlog, we look back at the steep road out of the nation’s largest ever municipal bankruptcy—in Detroit, where the Chicago Federal Reserve and former U.S. Chief Bankruptcy Judge Thomas Bennett, who presided over Jefferson County’s chapter 9 municipal bankruptcy case, has noted: “[S]tates can have precipitating roles as well as preventative roles” in work he did for the Chicago Federal Reserve. Indeed, it seems the Great Recession demarcated the nation’s states into distinct fiscal categories: those with state oversight programs which either protected against or offered fiscal support to assist troubled municipalities, versus those, such as Alabama or California—with the former appearing to aid and abet Jefferson County’s descent into chapter 9 bankruptcy, and California, home to the largest number of chapter 9 bankruptcies over the last two decades, contributing to fiscal distress, but avoiding any acceptance of risk. Therefore, we try to provide our own fiscal autopsy of Detroit’s journey into and out of the nation’s largest municipal bankruptcy.

I met in the Governor’s Detroit offices with Kevyn Orr, whom Governor Rick Snyder had asked to come out from Washington, D.C. to serve as the city’s Emergency Manager to take the city into—and out of chapter 9 municipal bankruptcy: the largest in American history. Having been told by the hotel staff that it was unsafe to walk the few blocks from my hotel to the Governor’s Detroit offices on the city’s very first day in insolvency—a day in which the city was spending 38 cents on every dollar of taxes collected from residents and businesses on legacy costs and operating debt payments totaling $18 billion; it was clear from the get go, as he told me that early morning, there was no choice other than chapter 9: it was an essential, urgent step in order to ensure the provision of essential services, including street and traffic lights, emergency first responders, and basic maintenance of the Motor City’s crumbling infrastructure—especially given the grim statistics, with police response times averaging 58 minutes across the city, fewer than a third of the city’s ambulances in service, 40% of the city’s 88,000 traffic lights not working, “primarily due to disrepair and neglect.” It was, as my walk made clear, a city aptly described as: “[I]nfested with urban blight, which depresses property values, provides a fertile breeding ground for crime and tinder for fires…and compels the city to devote precious resources to demolition.” Of course, not just physical blight and distress, but also fiscal distress: the Motor City’s unbalanced fiscal condition was foundering under its failure to make some $108 million in pension payments—payments which, under the Michigan constitution, because they are contracts, were constitutionally binding. Nevertheless, in one of his early steps to staunch the fiscal bleeding, Mr. Orr halted a $39.7 million payment on $1.4 billion in pension debt issued by former Detroit Mayor Kwame Kilpatrick’s administration to make the city pension funds appear better funded than they really were; thus, Mr. Orr’s stop payment was essential to avoid immediate cash insolvency at a moment in time when Detroit’s cash position was in deepening debt. Thus, in his filing, Mr. Orr aptly described the city’s dire position and the urgency of swift action thusly: “Without this, the city’s death spiral I describe herein will continue.”

Today, the equivalent of a Presidential term later, the city has installed 65,000 new streetlights; it has cut police and emergency responder response times to 25% of what they were; it has razed 11,847 blighted buildings. Indeed, ambulance response times in Detroit today are half of what they were—and close to the national average—even as the city’s unrestricted general fund finished FY2016 fiscal year with a $143 million surplus, 200% of the prior fiscal year: as of March 31st, Detroit sported a general fund surplus of $51 million, with $52.8 million more cash on hand than March of last year, according to the Detroit Financial Review Commission—with the surplus now dedicated to setting aside an additional $20 million into a trust fund for a pension “funding cliff” the city has anticipated in its plan of debt adjustment by 2024.  

Trying to Run on all Pistons. The Detroit City Council has voted 7-1 to approve a resolution to allow the Motor City to realize millions of dollars in income tax revenues from its National Basketball Association Pistons players, employees, and visiting NBA players—with such revenues dedicated to finance neighborhood improvements across the Motor City, under a Neighborhood Improvement Fund—a fund proposed in June by Councilwoman (and ordained Minister) Mary Sheffield, with the proposal coming a week after the City Council agreed to issue some $34.5 million in municipal bonds to finance modifications to the Little Caesars Arena—where the Pistons are scheduled to play next season. Councilwoman Sheffield advised her colleagues the fund would also enable the city to focus on blight removal, home repairs for seniors, educational opportunities for young people, and affordable housing development in neighborhoods outside of downtown and Midtown—or, as she put it: “This sets the framework; it expresses what the fund should be used for; and it ultimately gives Council the ability to propose projects.” She further noted the Council could, subsequently, impose additional limitations with regard to the use of the funds—noting she had come up with the proposal in response to complaints from Detroit constituents who had complained the city’s recovery efforts had left them out—stating: “It’s not going to solve all of the problems, and it’s not going to please everyone, but I do believe it’s a step in the right direction to make sure these catalyst projects have some type of tangible benefits for residents.”

Detroit officials estimate the new ordinance will help generate a projected $1.3 million annually. In addition, city leaders hope to find other sources to add to the fund—sources the Councilmember reports, which will be both public and private: “We as a council are going to look at other development projects and sources that could go into the fund too.” As adopted, the resolution provides: “[I]t is imperative that the neighborhoods, and all other areas of the City, benefit from the Detroit Pistons’ return downtown …In turn, the City will receive income tax revenue, from the multimillion dollar salaries of the NBA players as well as other Pistons employees and Palace Sports & Entertainment employees.” The Council has forwarded the adopted proposals to Mayor Duggan’s office for final consideration and action. The proposed new revenues—unless the tax is modified or rejected by the Mayor—would be dedicated for use in the city’s Neighborhood Improvement Fund in FY2018—with decisions with regard to how to allocate the funds—by Council District or citywide—to be determined at a later date. The funds, however, could also be used to address one of the lingering challenges from the city’s adopted plan of debt adjustment from its chapter 9 bankruptcy: meeting its public pension obligations when general fund revenues are insufficient, “should there be any unforeseen shortfall,” as the resolution provides.

This fiscal recovery, however, remains an ongoing challenge: Detroit CFO John Hill laid up the proverbial hook shot up by advising the Council that the reason the city reserved the right to use the Pistons tax revenue to cover pension or debt obligation shortfalls was because of the large pension obligation payment the city will confront in 2024: “We knew that in meeting our pensions and debt obligation in 2024 and 2025 that those funds get very tight: If this kind of valve wasn’t there, I would have a lot of concerns that in those years its tighter and we don’t get revenues we expect we don’t get any of those funds to meet those obligations.”

But, as in basketball, there is another side: at the beginning of the week, the NBA, Palace Sports & Entertainment, and Olympia Entertainment were added to a federal lawsuit—a suit filed in late June by community activist Robert Davis and Detroit city clerk candidate D. Etta Wilcox against the Detroit Public Schools Community District. The suit seeks to force a vote on the $34.5 million public funding portion of the Pistons’ deal, under which Detroit, as noted above, is seeking to capture the school operating tax, the proceeds of which are currently used to service $250 million of bonds DDA bonds previously issued for the arena project in addition to the $34.5 million of additional bonds the city planned to issue for the Pistons relocation.

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.”)

The Art & Commitment of Municipal Fiscal Recovery

eBlog, 04/11/17

Good Morning! In this a.m.’s eBlog, we consider the ongoing recovery of the city of Flint, Michigan, before heading east to one of the smallest municipalities in America, Central Falls, Rhode Island, as it maintains its epic recovery from chapter 9 municipal bankruptcy, before finally turning south to assess recent developments in Puerto Rico. We note the terrible shooting yesterday at North Park Elementary School in San Bernardino; however, as former San Bernardino School Board Member Judi Penman noted, referring to the police department: “It is one of the most organized and well-prepared police departments around, and they are well prepared for this type of situation.” Indeed, even if sadly, the experience the city’s school police department gained from coordinating with the city’s police department in the wake of the December 2, 2015 terrorist attack appeared to enhance the swift and coordinated response—even as calls came in yesterday from the White House and California Gov. Jerry Brown to offer condolences and aid, according to San Bernardino Mayor Carey Davis.

Could this be a Jewel in the Crown on Flint’s Road to Fiscal Recovery? In most instances of severe municipal fiscal distress or bankruptcy, the situation has been endemic to the municipality; however, as we have noted in Jefferson County, the state can be a proximate cause. Certainly that appears to have been the case in Flint, where the Governor’s appointment of an emergency manager proved to be the proverbial straw that broke the camel’s back at an exceptional cost and risk to human health and safety. The fiscal challenge is, as always, what does it take to recover? In the case of Flint, the city’s hopes appear to depend upon the restoration of one of the small city’s iconic jewels: the historic, downtown Capitol Theatre—where the goal is to restore it to its original glory, dating back to 1928, when it opened as a vaudeville house: it was listed on the National Register of Historic Places in 1985, but has been empty now for more than a decade—indeed, not just empty, but rather scheduled to become still another parking lot. Instead, however, the property will undergo a $37 million renovation to become a 1,600-seat movie palace and performance venue, which will provide 28,000 square feet of ground-floor retail and second-floor office space; an additional performance space will be created in the basement for small-scale workshops, experimental theater, and other performances. Jeremy Piper, chairman of the Cultural Center Corp., a Flint lawyer, will manage the new performing arts venue in the cultural center; he will also serve as co-chair of a committee that is raising the last $4 million of the $37 million needed to bring the theater back to life. The goal and hope is that the renovated theater will, as has been the experience in other cities, such as New York City’s Lincoln Center for the Performing Arts, help serve as a foundation for Flint’s fiscal and physical recovery. The new theater is intended to become the focal point of 12,000, 13,000, or 14,000 people coming into downtown Flint for a performance and then going out for dinner—that is, to benefit and revive a downtown economy. Indeed, already, the venture firm SkyPoint is planning to open a large fine-dining restaurant on the ground floor and mezzanine timed to the rejuvenated theater’s reopening—SkyPoint Ventures being the company co-founded by Phil Hagerman, the CEO of Flint-based Diplomat Pharmacy Inc., and his wife, Jocelyn, whose Hagerman Foundation (the author, here, notes his middle name, derived from his great grandfather, is Hagerman) donated $4 million toward the Capitol’s renovation. In 2016, the Flint-based C.S. Mott Foundation announced a grant of $15 million for the Capitol Theatre project as part of $100 million it pledged to the city in the wake of the water crisis. The project also received $5.5 million from the Michigan Strategic Fund.

The ambitious effort comes as Michigan has paid $12 million to outside attorneys for work related to the Flint drinking water crisis, but out of which nearly 30% has gone to pay criminal and civil defense attorneys hired by Gov. Rick Snyder—an amount expected to climb as the lead poisoning of Flint’s drinking water has proven to be devastating for Flint and its children, but enriching for the state’s legal industry: Jeffrey Swartz, an associate professor at Western Michigan University-Cooley Law School, notes: “It’s a lot of money…I can see $10 million to $15 million being eaten up very quickly.” He added, moreover, that the state is still “on your way up the slope” in terms of mounting legal costs. The approved value of outside legal contracts, not all of which has been spent, is at least $16.6 million, adding that the Michigan Legislature may want to appoint a commission to review the appropriateness of all outside legal bills before they are approved for payment: already, Gov. Rick Snyder’s office has spent a combined $3.35 million for outside criminal and civil defense lawyers; the Michigan Department of Environmental Quality has spent $3.65 million; the Department of Health and Human Services has spent $956,000; and the Treasury Department has spent $35,555, according to figures released to the Free Press. In addition, the state has paid $340,000 to reimburse the City of Flint for some of its civil and criminal legal defense costs related to the drinking water crisis, which a task force appointed by Gov. Snyder has said was mainly brought on by mistakes made at the state level. Yet to be equitably addressed are some $1.3 million in Flint legal costs. Michigan Attorney General Bill Schuette, whose investigation is still ongoing, has charged 13 current or former state and municipal officials, including five from the Dept. of Environmental Quality, the Dept. of Health and Human Safety, the City of Flint, and two former state-appointed emergency managers who ran the city and reported to the state’s Treasury Department; no one, however, from Gov. Snyder’s office has been charged.

The Remarkable Recovery of Chocolateville. Central Falls, Rhode Island Mayor James A. Diossa, the remarkable elected leader who has piloted the fiscal recovery of one of the nation’s smallest cities from chapter 9 municipal bankruptcy, this week noted: “Our efforts and dedication to following fiscally sound budgeting practices are clearly paying off, leaving the City in a strong position. I would like to personally thank the Council and Administrative Financial Officer Len Morganis for their efforts in helping to lead the comeback of this great City.” The Mayor’s ebullient comments came in the wake of credit rating agency Standard and Poor’s rating upgrade for one of the nation’s smallest cities from “BB” to “BBB,” with S&P noting: “Central Falls is operating under a much stronger economic and management environment since emerging from bankruptcy in 2012. The City of Central Falls now has an investment grade credit rating from S&P due to diligently following the post-bankruptcy plan in conjunction with surpassing budgetary projections.”

One of the nation’s smallest municipalities (population of 19,000, city land size of one-square-mile), Central Falls is Rhode Island’s smallest and poorest city—and the site of a George Mason University class project on municipal fiscal distress—and guidebook for municipal leaders. Its post-bankruptcy recovery under Mayor Diossa has demonstrated several years of strong budgetary performance, and has “fully adhered to the established post-bankruptcy plan,” or, as Mayor Diossa put it: “S&P’s latest ratings report is yet another sign of Central Falls’ turnaround from bankruptcy.” Mr. Morganis noted: “The City of Central Falls now has an investment grade credit rating from S&P due to diligently following the post-bankruptcy plan in conjunction with surpassing budgetary projections,” adding that the credit rating agency’s statement expressed confidence that strong budgetary performance will continue post Rhode Island State oversight. S&P, in its upgrade, credited Mayor Diossa’s commitment to sound and transparent fiscal practices, noting the small city has an adequate management environment with improved financial policies and practices under their Financial Management Assessment (FMA) methodology—and that Central Falls exhibited a strong budgetary performance, with an operating surplus in the general fund and break-even operating results at the total governmental fund level in FY2016. Moreover, S&P reported, the former mill town and manufacturer of scrumptious chocolate bars has strong liquidity, with total government available cash at 28.7% of total governmental fund expenditures and 1.9 times governmental debt service, along with a strong institutional framework score. Similarly, Maureen Gurghigian, Managing Director of Hilltop Securities, noted: “A multi-step upgrade of this magnitude is uncommon: this is a tribute to the hard work of the City’s and the Administrative Finance Officer’s adherence to their plan and excellent relationship with State Government.” The remarkable recovery comes as one of the nation’s smallest cities heads towards a formal exit from chapter 9 municipal bankruptcy at the end of FY2017. S&P, in its upgrade, noted the city is operating under a “much stronger economic and management environment,” in the wake of its 2012 exit from municipal bankruptcy, or, as Mayor Diossa, put it: “Obviously we’ve had a lot of conversations with the rating agencies, and I was hoping we’d get an upgrade of at least one notch…When we got the triple upgrade, first, I was surprised and second, it reaffirmed the work that we’re doing. Our bonds are no longer junk. We’re investment level. It’s like getting good news at a health checkup.”  S&P, in its report, noted several years of sound budgeting and full adherence to a six-year post-bankruptcy plan which state-appointed receiver and former Rhode Island Supreme Court Justice Robert Flanders crafted. The hardest part of that recovery, as Judge Flanders noted to us so many years ago in City Hall,was his swift decision to curtail the city’s pension payments—cuts of as much as 55 percent—a statement he made with obvious emotion, recognizing the human costs. (Central Falls is among the approximately one-quarter of Rhode Island municipalities with locally administered pension plans.) Unsurprisingly, Mayor Diossa, maintains he is “fully committed” to the fiscal discipline first imposed by Judge Flanders, noting the municipality had a general fund surplus of 11% of expenditures in FY2016, and adding: “That reserve fund is very important.” He noted Central Falls also expects a surplus for this fiscal year, adding that the city’s expenses are 3% below budget, and that even as the city has reduced the residential property tax rate for the first time in a decade, even as it has earmarked 107% of its annual required contribution to the pension plan and contributed $100,000 toward its future OPEB liability.

The End of an Era? Mayor Diossa, recounting the era of chapter 9 bankruptcies, noted Pennsylvania’s capital, Harrisburg, in 2011; Jefferson County, Alabama; Stockton, Mammoth Lakes and San Bernardino, California; and Detroit: “I think Central Falls is a microcosm of all of them…I followed Detroit and heard all the discussions. They had the same issues that we had…sky-high costs, not budgeting appropriately,” adding his credit and appreciation—most distinctly from California—of the State of Rhode Island’s longstanding involvement: “The state’s been very involved,” commending Governors Lincoln Chafee and Gina Raimondo. Nevertheless, he warns: fiscal challenges remain; indeed, S&P adds: “The city’s debt and contingent liability profile is very weak…We view the pension and other post-employment benefit [OPEB] liabilities as a credit concern given the very low funded ratio and high fixed costs…They are still a concern with wealth metrics and resources that are probably below average for Rhode Island, so that’s a bit of a disadvantage…That adds more importance to the fact that they achieved an investment-grade rating through what I think is pretty good financial management and getting their house in order.” The city’s location, said Diossa, is another means to trumpet the city.

The Uncertainties of Fiscal Challenges. Natalie Jaresko is the newly named Executive Director of the PROMESA federal control board overseeing Puerto Rico’s finances, who previously served during a critical time in Ukraine’s history from 2014 to 2016 as it faced a deep recession, and about whom PROMESA Board Chair Jose Carrion noted: “Ukraine’s situation three years ago, like Puerto Rico’s today, was near catastrophic, but she worked with stakeholders to bring needed reforms that restored confidence, economic vitality and reinvestment in the country and its citizens. That’s exactly what Puerto Rico needs today;” came as Ms. Jaresko yesterday told the Board that with the tools at its disposal, Puerto Rico urgently needs to reduce the fiscal deficit and restructure the public debt, “all at once,” while acknowledging that the austerity measures may cause “things to get worse before they get better.” Her dire warnings came as the U.S. territory’s recovery prospects for the commonwealth’s general obligation and COFINA bonds continued to weaken, and, in the wake of last week’s moody Moody’s dropping of the Commonwealth’s debt ratings to its lowest rating, C, which equates with a less than 35% recovery on defaulted debt. Or, as our respected colleagues at Municipal Market Analytics put it: “[T]he ranges of potential bondholder outcomes are much wider than those, with a materially deeper low-end. For some (or many) of the commonwealth’s most lightly secured bonds (e.g., GDB, PFC, etc.) recoveries could hypothetically dip into the single digits. Further, any low end becomes more likely the longer Puerto Rico’s restructuring takes to achieve as time:

1) Allows progressively more negative economic data to materialize, forcing all parties to adopt more conservative and sustainable projections for future commonwealth revenues;

2) Allows local stakeholder groups—in particular students and workers—to organize and expand nascent protest efforts, further affecting the political center of gravity on the island;

3) Worsens potential entropy in commonwealth legislative outcomes;

4) Frustrates even pro-bondholder policymakers in the US Congress, which has little interest in, or ability to, re-think PROMESA and/or Federal aid compacts with the commonwealth.”

On the other hand, the longer the restructuring process ultimately takes, the more investable will be the security that the island borrows against in the future (whatever that is). So while the industry in general would likely benefit from a faster resolution that removes Puerto Rico from the headlines, the traditional investors who will consider lending to a “fixed” commonwealth should prefer that all parties take their time. Finally, if bleakly, MMA notes: “In our view, reliable projections of bondholder recovery impossible, and we fail to understand how any rating agency with an expected loss methodology can rate Puerto Rico’s bonds at all…Remember that the Governor’s Fiscal Plan, accepted by the Oversight Board, makes available about a quarter of the debt service to be paid on tax-backed debt through 2027, down from about 35% that was in the prior plan that the Board rejected. As we’ve noted before, the severity of the proposal greatly reduces the likelihood that an agreement will be reached with creditors by May 1 (when the stay on litigation ends), not only increasing the prospect of a Title III restructuring (cram down) un-der PROMESA, but also a host of related creditor litigation against the plan itself and board decisions both large and small. The outcomes of even normal litigation risks are inherently unpredictable, but the prospects here for multi-layered, multi-dimensional lawsuits create a problem several orders of magnitude worse than normal.