Rising from Municipal Bankruptcies’ Ashes

07/24/17

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Good Morning! You might describe this a.m.’s e or iBlog as The Turnaround Story, as we consider the remarkable fiscal recovery in Atlantic City and observe some of the reflections from Detroit’s riot of half a century ago—a riot which presaged its nation’s largest chapter 9 bankruptcy, before we assess the ongoing fiscal turmoil in the U.S. territory look at Puerto Rico.

New Jersey & You. Governor Chris Christie on Friday announced his administration is delivering an 11.4% decrease in the overall Atlantic City property tax rate for 2017—a tax cut which will provide an annual savings of $621 for the City’s average homeowner, but which, mayhap more importantly, appears to affirm that the city’s fiscal fortunes have gone from the red to the black, after, earlier this month, the City Council accepted its $206 million budget with a proposed 5% reduction in the municipal purpose tax rate, bringing it to about $1.80 per $100 of assessed valuation. Atlantic City’s new budget, after all, marks the first to be accepted since the state took over the city’s finances last November; indeed, as Mayor Don Guardian noted, the fiscal swing was regional: the county and school tax rates also dropped—producing a reduction of more than 11%—and an FY2018 budget $35 million lower than last year—and $56 million below the FY2016 budget: “We had considerably reduced our budget this year and over the last couple of years…I’m just glad that we’re finally able to bring taxes down.” Mayor Guardian added the city would still like to give taxpayers even greater reductions; nevertheless, the tax and budget actions reflect the restoration of the city’s budget authority in the wake of last year’s state takeover: the budget is the first accepted since the state took over the city’s finances in November after the appointment last year of a state fiscal overseer, Jeff Chiesa—whom the Governor thanked, noting:

“Property taxes can be lowered in New Jersey, when localities have the will and leaders step in to make difficult decisions, as the Department of Community Affairs and Senator Jeff Chiesa have done…Our hard work to stop city officials’ irresponsible spending habits is bearing tangible fruit for Atlantic City residents. Annual savings of more than $600 for the average household is substantial money that families can use in their everyday lives. This 11.4% decrease is further proof that what we are doing is working.”

Contributing to the property tax rate decrease is a $35-million reduction in the City’s FY2017 budget, which, at $206.3 million, is about 25% lower than its FY2015 budget, reflecting reduced salaries, benefits, and work schedules of Atlantic City’s firefighters and police officers, as well as the outsourcing of municipal services, such as trash pickup and vehicle towing to private vendors. On the revenue side, the new fiscal budget also reflects a jackpot in the wake of the significant Borgata settlement agreement on property tax appeals—all reflected in the city’s most recent credit upgrade and by Hard Rock’s and Stockton University’s decisions to make capital investments in Atlantic City, as well as developers’ plans to transform other properties, such as the Showboat, into attractions intended to attract a wider variety of age groups to the City for activities beyond gambling—or, as the state-appointed fiscal overseer, Mr. Chiesa noted: “The City is on the road to living within its means…We’re not done yet, but we’ve made tremendous progress that working families can appreciate. We’ll continue to work hard to make even more gains for the City’s residents and businesses.

The Red & the Black. Unsurprisingly, there seems to be little agreement with regard to which level of government merits fiscal congratulations. Atlantic City Mayor Guardian Friday noted: “We had considerably reduced our budget this year and over the last couple of years…“I’m just glad that we’re finally able to bring taxes down.” Unsurprisingly, lame duck Gov. Christie credited the New Jersey Department of Community Affairs and Mr. Chiesa, stating: “Our hard work to stop city officials’ irresponsible spending habits is bearing tangible fruit for Atlantic City residents.” However, Tim Cunningham, the state director of local government services, earlier this month told the Mayor and Council the city and its budget were moving in the “right direction,” adding hopes for the city’s fiscal future, citing Hard Rock and Stockton University’s investment in the city; while Mr. Chiesa, in a statement, added: “The city is on the road to living within its means…We’re not done yet, but we’ve made tremendous progress that working families can appreciate. We’ll continue to work hard to make even more gains for the city’s residents and businesses.”

Do You Recall or Remember at All? Detroit Mayor Mike Duggan, the white mayor of the largest African-American city in America, last month spoke at a business conference in Michigan about the racially divisive public policies of the first half of 20th century which helped contribute to Detroit’s long, painful decline in the second half of the last century—a decline which ended in five torrid nights and days of riots which contributed to the burning and looting of some 2,509 businesses—and to the exodus of nearly 1.2 million citizens. The Mayor, campaigning for re-election, noted: “If we fail again, I don’t know if the city can come back.” His remarks appropriately come at the outset of this summer’s 50th anniversary of the summer the City Detroit burned.

Boston University economics Professor Robert Margo, a Detroit native who has studied the economic effects of the 1960’s U.S. riots, noting how a way of life evaporated in 120 hours for the most black residents in the riot’s epicenter, said: “It wasn’t just that people lived in that neighborhood; they shopped and conducted business in that neighborhood. Overnight all your institutions were gone,” noting that calculating the economic devastation from that week in 1967 was more than a numbers exercise: there was an unquantifiable human cost. That economic devastation, he noted, exacerbated civic and problems already well underway: job losses, white flight, middle-income black flight, and the decay and virtual wholesale abandonment of neighborhoods, where, subsequently, once-vibrant neighborhoods were bulldozed, so that, even today, if we were to tour along main artery of the riot, Rosa Parks Boulevard (which was 12th Street at the time of the riots), you would see overgrown vacant lots, lone empty commercial and light industrial buildings, boarded-up old homes—that is, sites which impose extra security costs and fire hazards for the city’s budget, but continue to undercut municipal revenues. Yet, you would also be able to find evidence of the city’s turnaround: townhouses, apartments, and the Virginia Park Community Plaza strip mall built from a grassroots community effort. But the once teeming avenue of stores, pharmacies, bars, lounges, gas stations, pawn shops, laundromats, and myriad of other businesses today have long since disappeared.

In the wake of the terrible violence, former President Lyndon Johnson created the Kerner Commission, formally titled the National Advisory Commission on Civil Disorders, to analyze the causes and effects of the nationwide wave of 1967 riots. That 426-page report concluded that Detroit’s “city assessor’s office placed the loss—excluding building stock, private furnishings, and the buildings of churches and charitable institutions—at approximately $22 million. Insurance payouts, according to the State Insurance Bureau, will come to about $32 million, representing an estimated 65 to 75 percent of the total loss,” while concluding the nation was “moving toward two societies, one black, one white—separate and unequal.” Absent federal action, the Commission warned, the country faced a “system of ’apartheid’” in its major cities: two Americas: delivering an indictment of a “white society” for isolating and neglecting African-Americans and urging federal legislation to promote racial integration and to enrich slums—primarily through the creation of jobs, job training programs, and decent housing. In April of 1968, one month after the release of the Kerner Commission report, rioting broke out in more than 100 cities across the country in the wake of the assassination of civil rights leader Martin Luther King, Jr.

In excerpts from the Kerner Report summary, the Commission analyzed patterns in the riots and offered explanations for the disturbances. Reports determined that, in Detroit, adjusted for inflation, there were losses in the city in excess of $315 million—with those numbers not even reflecting untabulated losses from businesses which either under-insured or had no insurance at all—and simply not covering at all other economic losses, such as missed wages, lost sales and future business, and personal taxes lost by the city because the stores had simply disappeared. Academic analysis determined that riot areas in Detroit showed a loss of 237,000 residents between 1960 and 1980, while the rest of the entire city lost 252,000 people in that same time span. Data shows that 64 percent of Detroit’s black population in 1967 lived in the riot tracts. U. of Michigan Professor June Thomas, of the Alfred Taubman College of Architecture and Urban Planning, wrote: “The loss of the commercial strips in several areas preceded the loss of housing in the nearby residential areas. That means that some of the residential areas were still intact but negatively affected by nearby loss of commercial strips.” The riots devastated assessed property values—creating signal incentives to leave the city for its suburbs—if one could afford to.

On the small business side, the loss of families and households, contributed to the exodus—an exodus from a city of 140 square miles that left it like a post WWII Berlin—but with lasting fiscal impacts, or, as Professor Bill Volz of the WSU Mike Ilitch School of Business notes: the price to reconstitute a business was too high for many, and others simply chose to follow the population migration elsewhere: “Most didn’t get rebuilt. They were gone, those mom-and-pop stores…Those small business, they were a critical part of the glue that made a neighborhood. Those small businesses anchored people there. Not rebuilding those small businesses, it just hurt the neighborhood feel that it critical in a city that is 140 square miles. This is a city of neighborhoods.” Or, maybe, he might have said: “was.” Professor Thomas adds that the Motor City’s rules and the realities of post-war suburbanization also made it nearly impossible to replace neighborhood businesses: “It’s important to point out that, as set in place by zoning and confirmed by the (city’s) 1951 master plan, Detroit’s main corridors had a lot of strip commercial space that was not easily converted or economically viable given the wave of suburban malls that had already been built and continued to draw shoppers and commerce…This, of course, all came on top of loss of many businesses, especially black-owned, because of urban renewal and I-75 construction.”

Left en Atras? (Left Behind?As of last week, two-thirds of Puerto Rico’s muncipios, or municipalities, had reported system breakdowns, according to Ramón Luis Cruz Burgos, the deputy spokesman of the delegation of the Popular Democratic Party (PPD) in the Puerto Rico House Of Representatives: he added that in Puerto Rico, a great blackout occurs every day due to the susceptibility of the electric power system, noting, for instance, that last month, for six consecutive days, nearly 70 percent of Puerto Rico’s municipalities had problems with electricity service, or, as he stated: “In Puerto Rico we have a big blackout every day. We have investigated the complaints that have been filed at the Autoridad de Energía Eléctrica (AEE) for blackouts in different sectors, and we conclude that daily, two-thirds of the island are left without light. This means that sectors of some 51 municipalities are left in the dark and face problems with the daily electricity service.”

It seems an odd juxtaposition/comparison with the events that triggered the nation’s largest ever chapter 9 municipal bankruptcy in Detroit—even as it reminds us that in Puerto Rico, not only is the Commonwealth ineligible for chapter 9 municipal bankruptcy, but also its municipalities. Mr. Cruz Burgos noted that reliability in the electric power system is one of the most important issues in the economic development of a country, expressing exasperation and apprehension that interruptions in service have become the order of the day: “Over the last two months, we have seen how more than half of the island’s villages are left dark for hours and even for several days, because the utility takes too long to repair breakdowns,” warning this problem will be further aggravated during the month of August, when energy consumption in schools and public facilities increases: “In the last two months, there are not many schools operating and the use of university facilities is also reduced for the summer vacation period. In addition, many employees go on vacation so operations in public facilities reduce their operation and, therefore, energy consumption.”

Jose Aponte Hernandez, Chair of the International and House Relations Committee, blamed the interruptions on the previous administration of Gov. Luis Fortuno, claiming: it had “abandoned the aggressive program of maintenance of the electrical structure implemented by former Gov. Luis Fortuna, claiming: “In the past four years the administration of the PPD did not lift a finger to rehabilitate the ESA structure. On the contrary, they went out of their way to destroy it in order to justify millionaire-consulting contracts. That is why today we are confronting these blackouts.”

The struggle for basic public services—just as there was a generation ago in Detroit, reflect the fiscal and governing challenge for Puerto Rico and its 88 municipalities at a time when non-Puerto Rican municipal bondholders have launched litigation in the U.S. Court of Federal Claims to demand payment of $3.1 billion in principal and interest in Puerto Rico Employment Retirement System bonds (In Altair Global Credit Opportunities Fund (A), LLC et al. v. The United States of America)—the first suit against the U.S. government proper, in contrast to prior litigation already filed against the Puerto Rico Oversight Board, with the suit relying on just compensation claims and that PROMESA is a federal entity. Here, as the Wizard of chapter 9 municipal bankruptcy, Jim Spiotto, notes, the key is whether the PROMESA board was acting on behalf of the federal government or on behalf of Puerto Rico—adding that he believes it was acting for Puerto Rico and, ergo, should not be considered part of the federal government, and that the U.S. Court of Federal Claims may find that the federal government’s actions were illegal. Nevertheless, the issue remains with regard to whether the bonds should be paid from the pledged collateral—in this case being Puerto Rico employer contributions. (The Altair complaint alleges that the PROMESA Board is a federal entity which has encouraged, directed, and even forced Puerto Rico to default on its ERS bonds—a board created by Congress which has directed the stream of employer contributions away from the bondholders and into the General Fund, according to these bondholders’ allegations.

Emerging from Chapter 9–and the conflict between fiscal and physical safety.

07/07/17

Good Morning! In this a.m.’s eBlog, we consider the final emergence of Orange County, California from chapter 9 municipal bankruptcy; then we consider the ongoing fiscal and fiscal challenges for Flint’s leaders from its fiscal & physical challenges.

Free at Last? Twenty-three years ago, when the former Orange County, California Treasurer, Robert Citron, then managing an investment pool for southern California municipalities, speculated unwisely, the municipal pool he managed lost $1.64 billion—plunging the county into the first chapter 9 municipal bankruptcy of the modern era (California §53760)—a chapter 9 bankruptcy from which the County emerged this week in the wake of its final payment on the $1 billion worth of municipal bonds it had issued. Orange County, however, still owes approximately $20 million to various cities and agencies that have a separate repayment agreement—debt Orange County expects to resolve by late next year. (A subsequent grand jury investigation later found that Mr. Citron, who had earned praise for his investment skills, relied on a mail order astrologer and a psychic for interest rate predictions as Orange County’s Treasurer.)

For this writer, the emergence evokes memories of how controversial the concept of municipal bankruptcy had been—at the time—for the National League of Cities to advocate for the changes in chapter 9: the then Executive Director and the then President of NLC (former New York City Council Chair Carol Bellamy) decried the notion that an association of municipal elected leaders would support facilitating filing for municipal bankruptcy; yet the Orange County case illuminated its importance by demonstrating how important it was to have a mechanism in federal law to ensure continuity in the provision of essential municipal public services.  

In the case of Orange County, the insolvency of an investment pool it ran on behalf of itself and other municipalities in the region would have, absent the kinds of protections provided under chapter 9, risked plunging municipalities in the region into insolvency without a mechanism to ensure vital public services and operations. The County’s insolvency and threat to the other municipalities in the region was its own kind of tremor: a fiscal, rather than physical tremor. In the end, the access to chapter 9 meant the county was able to issue $1 billion in municipal bonds to avoid a critical default and ensure avoidance of any disruption in essential municipal services—bonds the payments on which ($1.5 billion including interest) were finally completed at the beginning of this month when the County made its final payment on that bankruptcy bond debt. While the price to its taxpayers was steep–repayments averaged $68 million a year, and the loss of vital public improvements and services great; the shock it sent to the nation’s cities was key in helping Congress better understand that while an Eastern Airlines could file for federal bankruptcy protection and simply walk away from its services and debts; that could never be the case for a city or county: there had to be a mechanism in federal law to ensure that a city, county, or public school system could continue to operate during insolvency.  

In managing these municipalities’ investment pool, Mr. Citron made unlucky/unwise wagers on interest rates—so unwise that the multi-jurisdiction investment pool suffered a crippling $1.64 billion loss. Now California State Senator John Moorlach, who prior to his Senate service was twice re-elected Orange County Treasurer-Tax Collector after running against Mr. Citron in 1994, has noted: “The bankruptcy dramatically changed my life…I sort of feel like I lived in a movie. I was an officer of the county when those recovery bonds were issued, and I wondered if I’d live long enough to see them paid off. It was a great turn-around opportunity. A lot has changed since then, and the county is better for it. It’s been nearly 23 years, and no one has been able to pull a stunt like this again. It’s a good day.”

While the “day” is not quite over: there are still another $19.7 million which must be settled before all municipal bankruptcy-related bills are resolved; the fiscal lesson appears to have been learned—or as current Supervisor William Steiner put it: “Despite the checks and balances now, and a commitment to strategic planning, there is always the chance that institutional memory will fade as time goes by and as leadership changes…The county has essentially fared well over the years despite the bankruptcy. Still, millions of dollars have been diverted from other important county departments and priorities.” The godfather of modern-day chapter 9 municipal bankruptcy, the incomparable Jim Spiotto, with whom I had the great fortune to work for so many years to achieve enactment of today’s municipal bankruptcy laws, appropriately notes: “Chapter 9 is the most extreme remedy, the last resort, if you can even call it a last resort.” Nevertheless, as he puts it, it creates a powerful tool for a municipality to avoid a potentially devastating “run on the bank.”

Out Like Flint? The State of Michigan, whose former Emergency Manager law played the critical role precipitating the grave physical and fiscal crisis affecting Flint, is now pressing the Flint City Council to vote on a long-term water contract under which Flint would lose rights to a municipal bond financed water pipeline—after the City Council two weeks ago voted to extend the city’s water delivery contract with the Great Lakes Water Authority (GLWA) until September, but delayed a vote on a longer term proposal by Mayor Karen Weaver to extend the contract for 30-years. Unsurprisingly, the state is now ramping up the pressure: in the wake of this week’s City Council vote, the state Department of Environmental Quality (MDEQ) filed suit against the city over the delay on a long-term arrangement, with the state alleging that the City Council’s refusal to approve a long-term water contract is endangering public health in the wake of the city’s lead contamination crisis. The complaint seeks a declaration that the Council’s failure to act is a violation of the federal Safe Drinking Water Act and a mandate that the city must enter into the long-term agreement with the GLWA negotiated by Mayor Weaver. The MDEQ charges that the city would be wasting its resources if it refuses to quit its current Karegnondi water pipeline plan: “The MDEQ has determined that the City Council’s failure to approve the agreement with GLWA and continued consideration of other options that may require operation of the water treatment plant places public health at risk.”

Under the proposed long-term contract, Flint would lose water rights to the Karegnondi Water Authority (KWA) (a new pipeline to Lake Huron, which is currently under construction). Thus, as Flint has awaited completion of the Karegnondi pipeline, it has been drawing its water from the Flint River—withdrawals which contributed to corroding pipes and lead contamination. Flint has been preparing to shift to KWA supplied, un-treated water in two years—with plans to construct vital upgrades to its treatment plant to meet EPA-mandated standards. In April, Mayor Weaver dropped the plan to make the switch to the bond-financed pipeline and recommended the city continue to purchase water from GLWA, believing that the GLWA supplied and treated water is more affordable—and apprehensive about the risk of another supply shift. With the city’s fiscal and physical health scarred by the water contamination crisis which came in the wake of the state-appointed emergency manager’s fateful decision to allow the city’s contract with Detroit for Lake Huron-treated water to expire—Mayor Weaver advised: “The recommendation I put forward months ago is the best option to protect public health and is supported by the public health community…[It] would also allow the City to avoid a projected 40 percent water rate increase and ensure the City of Flint gets millions of dollars to continue replacing lead tainted pipes and make much-needed repairs to our damaged infrastructure so we are able to deliver quality water to residents. The people of Flint have waited long enough for a reliable, permanent water source. Implementing my recommendation will provide that, and will allow us to move forward as a community and focus more on rebuilding our City.” Under her plan, Flint would recoup the roughly $7 million in annual debt service by transferring its KWA water rights to the GLWA.

Nevertheless, as Flint Councilmember Eric Mays described his apprehensions with regard to Flint losing its rights to the KWA pipeline, he recommended the city retain the asset: “My position is that the since the Governor won’t apologize, and the state has the money they can pay the bond; and whether we ever use the KWA asset, I don’t want, at this juncture, to turn over that asset and lose those rights under the deal with GLWA…I would be almost ready to vote for the GLWA deal if we could tweak it and get that bond off to the state and still retain the asset.” He added that he is the only Councilmember to propose an alternative to Mayor Weaver’s plan—a plan, he added, on which the Council “has done nothing.” Rather, he believes the State of Michigan, the precursor of the fiscal and physical crisis, should bear the burden for the municipal bond payments: “Since the MDEQ issued a suspicious administrative consent order for minor repairs and put it into the bond prospectus at the initial bond sale, my position is that Governor has the money and can pay the bond.”

The Fiscal Agony of the Absence of Chapter 9

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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. With the expiration of the freeze on litigation against the U.S. territory of Puerto Rico expiring yesterday, municipal bondholders filed suit against the Puerto Rico, likely marking the front end of a number of suits in the wake of Puerto Rico’s under the PROMESA law after its default on $1.3 billion of principal owed since the previous Governor declared the $70 billion public debt load unpayable in June of 2015. Bondholders filed two new lawsuits, even as the stay was lifted from at least 13 others. In the suits, the plaintiffs are seeking 11 declaratory judgments, two writs of mandamus, and three permanent injunctions. The fiscal meltdown came against a wavering political backdrop, as a demonstration in Puerto Rico’s capital, San Juan, against the PROMESA board’s austerity measures Monday turned violent: there was extensive damage to a Banco Popular office building’s windows, fires being lit, and car windows being smashed. The newest suits come after the administration of Gov. Ricardo Rosselló was unable to negotiate any agreement with the territory’s municipal bondholders after the May 1st deadline of the litigation freeze. His Chief of Staff, William Villafane, told the AP just hours before the freeze expired that the government preferred to reach a deal with bondholders, adding, however, that a municipal bankruptcy-like process could be an option if negotiations were to fail. A group representing those who bought a portion of the $16 billion worth of municipal bonds backed by Puerto Rico’s sales tax, charged that the government plan to cut its $70 billion debt was unconstitutional; they accused government leaders of perpetrating “unfair, unjust, and illegally punitive terms.” Ambac Assurance Corp. filed its own suit, accusing the government of illegally retaining $300 million owed to bondholders. The suit alleges it had been forced to pay more than $52 million in insurance claims because of ongoing defaults by Puerto Rico’s government. The tropical storm of litigation, coming on top of nearly a dozen lawsuits prior to the freeze imposed under the PROMESA law, came as Aurelius Capital Management LP, and other hedge funds, sued Puerto Rico in New York state court, seeking to recoup past-due payments on some $1.4 billion in defaulted general obligation bonds.

The precipitous storm of litigation appeared to mark the collapse of restructuring negotiations, as well as to signal the PROMESA board will vote to trigger the PROMESA Title III provisions to trigger a quasi-chapter 9 municipal bankruptcy proceeding. The fiscal disruption, at the same time, appeared to come as a physical disruption of riots and active lawsuits, leading the Dean of chapter 9 municipal bankruptcy, Jim Spiotto, to note: “Sometimes it is darkest before the dawn.” Counselor Spiotto added that a “litigation meltdown is not a solution” to the Puerto Rico debt problem; rather, he added: “You may have all the rights in the world, but if the [debtor] party doesn’t survive, thrive, your ability to get repaid is severely diminished,” noting that litigation is the least likely means of reaching a long-term solution, since the debtor is going to be hit by substantial attorney’s fees. Further, he explained, even were the PROMESA Oversight Board to initiate Title III to consolidate all Puerto Rico debt cases into a single quasi-bankruptcy process, that would simply open the way to a long and costly trail of appeals; thus, he notes that instead, all parties need a “time out” if there is to be a realistic chance of a fiscal solution, noting that would almost surely lead to a better outcome for all parties. Or, as U.S. Rep. Nydia Velázquez (D.-NY.) put it: “The power to comprehensively restructure 100 per cent of Puerto Rico’s debt is the reason why I voted ‘yes’ on [PROMESA] last year….Inconceivably, today, May 2, 2017, the island is on the same path as it was prior to the enactment of the law. This is unconscionable. It is imperative the board use this powerful tool and vote to file for a Title III proceeding immediately.”

The fiscal collapse also creates a constitutional and governance crisis. Article VI of Puerto Rico’s constitution (§8) provides that: “In case the available revenues including surplus for any fiscal year are insufficient to meet the appropriations made for that year, interest on the public debt and amortization thereof shall first be paid, and other disbursements shall thereafter be made in accordance with the order of priorities established by law;” however, Title III of the federal PROMESA statute would supersede this.

The growing challenge spread also, as Ambac filed suit against the U.S. Treasury Secretary Steven Mnuchin, seeking to bar access by the U.S. territory to a federal excise tax imposed on rum manufactured in the territory and sold in the mainland U.S. Moreover, Ambac also filed two other lawsuits over Puerto Rico’s alleged efforts to break the lien securing some $17 billion in sales-tax municipal bonds—one suit in federal court, the other in New York state court. One, in federal court, sought a court order safeguarding the revenue stream that backs those bonds.

Amid the various court challenges, Gerardo Portela, the Executive Director of Puerto Rico’s Financial Advisory and Tax Agency, yesterday claimed: “We are talking to all the different groups of bondholders,” after leaving La Fortaleza after holding a meeting with Governor Rosselló. Moreover, with the increasing threat to critical public services, Puerto Rico Property Secretary Raul Maldonado yesterday provided assurances that the government already has part of the money required by the Fiscal Supervision Board to avoid the reduction of working hours in public employees.

Just to provide some scale of what is unfolding, the quasi chapter 9 municipal bankruptcy here under a federal court-supervised restructuring for a portion of Puerto Rico’s $70 billion debt would be 800% larger than Detroit’s—which to date, has marked the largest chapter 9 bankruptcy in American history. However, with Puerto Rico neither a municipality, nor a state, it falls into a legal and fiscal Twilight Zone. In the wake of bondholder rejection, over the weekend, of an offer to pay 50 cents on the dollar to holders of Puerto Rico general obligation and sales-tax bonds backed by Puerto Rico’s constitution, it increasingly appears a non-federal bankruptcy court will be pressed to try to put Humpty Dumpty back together again.

Meanwhile, in Congress, federal legislation, HR 1366, the U.S. Territories Investor Protection Act of 2017, a bill to try to close a legal loophole which some in Congress believe allowed broker-dealers to defraud Puerto Rico investors was passed on a voice vote by the House and will now move to the Senate for consideration. The legislation would extend all the rules under the Investment Company Act of 1940, which apply, to investment companies on the U.S. mainland to those investment companies operating in Puerto Rico and the other U.S. territories. Rep. Velázquez, in introducing the bill, noted: “Today’s bipartisan action in the House is a huge step for the people of Puerto Rico, and I will keep applying pressure for Senate action.” A companion bill in the Senate (S. 484), sponsored by Sen. Robert Menendez, D-N.J., has already cleared the Senate Banking Committee. The Congresswoman said that the legislators had “acted in the best interest of retirees and individual investors in Puerto Rico,” adding that: “For far too long, Puerto Rican retirees and others have been preyed on by unscrupulous investors who have exploited this disparity in the rules…By passing this measure in the House, we are one step closer to putting an end to these abuses.”

What Lessons Can State & Local Leaders Learn from Unique Fiscal Challenges?

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eBlog, 04/25/17

Good Morning! In this a.m.’s eBlog, we consider the unique fiscal challenges in Michigan and how the upswing in the state’s economy is—or, in this case, maybe—is not helping the fiscal recovery of the state’s municipalities. Then we remain in Michigan—but straddle to Virginia, to consider state leadership efforts in each state to rethink state roles in dealing with severe fiscal municipal distress. Finally, we zoom to Chicago to glean what wisdom we can from the Godfather of modern municipal bankruptcy, Jim Spiotto: What lessons might be valuable to the nation’s state and local leaders?  

Fiscal & Physical Municipal Balancing I. Nearly a decade after the upswing in Michigan’s economic recovery, the state’s fiscal outlook appears insufficient to help the state’s municipalities weather the next such recession. Notwithstanding continued job growth and record auto sales, Michigan’s per-capita personal income lags the national average; assessed property values are below peak levels in 85% of the state’s municipalities; and state aid is only 80% of what it was 15 years ago.  Thus, interestingly, state business leaders, represented by the Business Leaders for Michigan, a group composed of executives of Michigan’s largest corporations universities, is pressing the Michigan Legislature to assume greater responsibility to address growing public pension liabilities—an issue which municipal leaders in the state fear extend well beyond legacy costs, but also where fiscal stability has been hampered by cuts in state revenue sharing and tax limitations. Michigan’s $10 billion general fund is roughly comparable to what it was nearly two decades ago—notwithstanding the state’s experience in the Great Recession—much less the nation’s largest ever municipal bankruptcy in Detroit, or the ongoing issues in Flint. Moreover, with personal income growth between 2000 and 2013 growing less than half the national average (in the state, the gain was only 31.1%, compared to 66.1% nationally), and now, with public pension obligations outstripping growth in personal income and property values, Michigan’s taxpayers and corporations—and the state’s municipalities—confront hard choices with regard to “legacy costs” for municipal pensions and post-retirement health care obligations—debts which today are consuming nearly 20 percent of some city, township, and school budgets—even as the state’s revenue sharing program has dropped nearly 25 percent for fiscally-stressed municipalities such as Saginaw, Flint, and Detroit just since 2007—rendering the state the only state to realize negative growth rates (8.5%) in municipal revenue in the 2002-2012 decade, according to numbers compiled by the Michigan Municipal League—a decade in which revenue for the state’s cities and towns from state sources realized the sharpest decline of any state in the nation: 56%, a drop so steep that, as the Michigan Municipal League’s COO Tony Minghine put it: “Our system is just broken…We’re not equipped to deal with another recession. If we were to go into another recession right now, we’d see widespread communities failing.” Unsurprisingly, one of the biggest fears is that another wave of chapter 9 filings could trigger the appointment of the state’s ill-fated emergency manager appointments. From the Michigan Municipal League’s perspective, any fiscal resolution would require the state to address what appears to be a faltering revenue base: Michigan’s taxable property is appreciating too slowly to support the cost of government (between 2007 and 2013, the taxable value of property declined by 8 percent in Grand Rapids, 12% in Detroit, 25% in Livonia, 32% in Warren, 22% in Wayne County values, and 24% in Oakland County.) The fiscal threat, as the former U.S. Comptroller General of the General Accounting Office warned: “Most of these numbers will get worse with the mere passage of time.”

Fiscal & Physical Municipal Balancing II. Mayhap Michigan and Virginia state and local leaders need to talk:  Thinking fiscally about a state’s municipal fiscal challenges—and lessons learned—might be underway in Virginia, where, after the state did not move ahead on such an initiative last year, the new state budget has revived the focus on fiscal stress in Virginia cities and counties, with the revived fiscal focus appearing to have been triggered by the ongoing fiscal collapse of one of the state’s oldest cities, Petersburg. Thus, Sen. Emmett Hanger (R-Augusta County), a former Commissioner of the Revenue and member of the state’s House of Delegates, who, today, serves as Senate Finance Co-Chair, and Chair of the Health and Human Services Finance subcommittee, has filed a bill, SJ 278, to study the fiscal stress of local governments: his proposal would create a joint subcommittee to review local and state tax systems, as well as reforms to promote economic assistance and cooperation between regions. Although the legislation was rejected in the Virginia House Finance Committee, where members deferred consideration of tax reform for next year’s longer session, the state’s adopted budget does include two fiscal stress preventive measures originally incorporated in Senator Hanger’s proposed legislation—or, as co-sponsor Sen. Rosalyn Dance (D-Petersburg), noted: “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.” To enhance the state’s authority to intervene fiscally, the budget has set guidelines for state officials to identify and help alleviate signs of financial stress to prevent a more severe crisis. Thus, a workgroup, established by the auditor of public accounts, would determine an appropriate fiscal early warning system to identify fiscal stress: the proposed system would consider such criteria as a local government’s expenditure reports and budget information. Local governments which demonstrate fiscal distress would thence be notified and could request a comprehensive review of their finances by the state. After a fiscal review, the commonwealth would then be charged with drafting an “action plan,” which would provide the purpose, duration, and anticipated resources required for such state intervention. The bill would also give the Governor the option to channel up to $500,000 from the general fund toward relief efforts for the fiscally stressed local government.

Virginia’s new budget also provides for the creation of a Joint Subcommittee on Local Government Fiscal Stress, with members drawn from the Senate Finance Committee, the House Appropriations, and the House Finance committees—with the newly created subcommittee charged to study local and state financial practices, such as: regional cooperation and service consolidation, taxing authority, local responsibilities in state programs, and root causes of fiscal stress. Committee member Del. Lashrecse Aird (D-Petersburg) notes: “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…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.”

Municipal Bankruptcy—or Opportunity? The Chicago Civic Federation last week co-hosted a conference, “Chicago’s Fiscal Future: Growth or Insolvency?” with the Federal Reserve Bank of Chicago, where experts, practitioners, and academics from around the nation met to consider best and worst case scenarios for the Windy City’s fiscal future, including lessons learned from recent chapter 9 municipal bankruptcies. Chicago Fed Vice President William Testa opened up by presenting an alternative method of assessing whether a municipality city is currently insolvent or might become so in the future: he proposed that considering real property in a city might offer both an indicator of the resources available to its governments and how property owners view the prospects of the city, adding that, in addition to traditional financial indicators, property values can be used as a powerful—but not perfect—indicators to reflect a municipality’s current situation and the likelihood for insolvency in the future. He noted that there is considerable evidence that fiscal liabilities of a municipality are capitalized into the value of its properties, and that, if a municipality has high liabilities, those are reflected in an adjustment down in the value of its real estate. Based upon examination, he noted using the examples of Chicago, Milwaukee, and Detroit; Detroit’s property market collapse coincided with its political and economic crises: between 2006 and 2009-2010, the selling price of single family homes in Detroit fell by four-fold; during those years and up to the present, the majority of transactions were done with cash, rather than traditional mortgages, indicating, he said, that the property market is severely distressed. In contrast, he noted, property values in Chicago have seen rebounds in both residential and commercial properties; in Milwaukee, he noted there is less property value, but higher municipal bond ratings, due, he noted, to the state’s reputation for fiscal conservatism and very low unfunded public pension liabilities—on a per capita basis, Chicago’s real estate value compares favorably to other big cities: it lags Los Angeles and New York City, but is ahead of Houston (unsurprisingly given that oil city’s severe pension fiscal crisis) and Phoenix. Nevertheless, he concluded, he believes comparisons between Chicago and Detroit are overblown; the property value indicator shows that property owners in Chicago see value despite the city’s fiscal instability. Therefore, adding the property value indicator could provide additional context to otherwise misleading rankings and ratings that underestimate Chicago’s economic strength.

Lessons Learned from Recent Municipal Bankruptcies. The Chicago Fed conference than convened a session featuring our former State & Local Leader of the Week, Jim Spiotto, a veteran of our more than decade-long efforts to gain former President Ronald Reagan’s signature on PL 100-597 to reform the nation’s municipal bankruptcy laws, who discussed finding from his new, prodigious primer on chapter 9 municipal bankruptcy. Mr. Spiotto advised that chapter 9 municipal bankruptcy is expensive, uncertain, and exceptionally rare—adding it is restrictive in that only debt can be adjusted in the process, because U.S. bankruptcy courts do not have the jurisdiction to alter services. Noting that only a minority of states even authorize local governments to file for federal bankruptcy protection, he noted there is no involuntary process whereby a municipality can be pushed into bankruptcy by its creditors—making it profoundly distinct from Chapter 11 corporate bankruptcy, adding that municipal bankruptcy is solely voluntary on the part of the government. Moreover, he said that, in his prodigious labor over decades, he has found that the large municipal governments which have filed for chapter 9 bankruptcy, each has its own fiscal tale, but, as a rule, these filings have generally involved service level insolvency, revenue insolvency, or economic insolvency—adding that if a school system, county, or city does not have these extraordinary fiscal challenges, municipal bankruptcy is probably not the right option. In contrast, he noted, however, if a municipality elects to file for bankruptcy, it would be wise to develop a comprehensive, long-term recovery plan as part of its plan of debt adjustment.

He was followed by Professor Eric Scorsone, Senior Deputy State Treasurer in the Michigan Department of Treasury, who spoke of the fall and rise of Detroit, focusing on the Motor City’s recovery—who noted that by the time Gov. Rick Snyder appointed Emergency Manager Kevyn Orr, Detroit was arguably insolvent by all of the measures Mr. Spiotto had described, noting that it took the chapter 9 bankruptcy process and mediation to bring all of the city’s communities together to develop the “Grand Bargain” involving a federal judge, U.S. Bankruptcy Judge Steven Rhodes, the Kellogg Foundation, and the Detroit Institute of Arts (a bargain outlined on the napkin of a U.S. District Court Judge, no less) which allowed Detroit to complete and approved plan of debt adjustment and exit municipal bankruptcy. He added that said plan, thus, mandated the philanthropic community, the State of Michigan, and the City of Detroit to put up funding to offset significant proposed public pension cuts. The outcome of this plan of adjustment and its requisite flexibility and comprehensive nature, have proven durable: Prof. Scorsone said the City of Detroit’s finances have significantly improved, and the city is on track to have its oversight board, the Financial Review Commission (FRC) become dormant in 2018—adding that Detroit’s economic recovery since chapter 9 bankruptcy has been extraordinary: much better than could have been imagined five years ago. The city sports a budget surplus, basic services are being provided again, and people and businesses are returning to Detroit.

Harrison J. Goldin, the founder of Goldin Associates, focused his remarks on the near-bankruptcy of New York City in the 1970s, which he said is a unique case, but one with good lessons for other municipal and state leaders (Mr. Goldin was CFO of New York City when it teetered on the edge of bankruptcy). He described Gotham’s disarray in managing and tracking its finances and expenditures prior to his appointment as CFO, noting that the fiscal and financial crisis forced New York City to live within its means and become more transparent in its budgeting. At the same time, he noted, the fiscal crisis also forced difficult cuts to services: the city had to close municipal hospitals, reduce pensions, and close firehouses—even as it increased fees, such as requiring tuition at the previously free City University of New York system and raising bus and subway fares. Nevertheless, he noted: there was an upside: a stable financial environment paved the way for the city to prosper. Thus, he advised, the lesson of all of the municipal bankruptcies and near-bankruptcies he has consulted on is that a coalition of public officials, unions, and civic leaders must come together to implement the four steps necessary for financial recovery: “first, documenting definitively the magnitude of the problem; second, developing a credible multi-year remediation plan; third, formulating credible independent mechanisms for monitoring compliance; and finally, establishing service priorities around which consensus can coalesce.”

The Key Lessons Learned after a Decade of Municipal Bankruptcies

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eBlog, 04/07/17

Good Morning! In this a.m.’s eBlog, we consider Detroit’s first steps to address the blight which crisscrossed the city leading to its municipal bankruptcy. Then we look to New Hampshire to assess whether the state legislature will preempt municipalities’ authority to set election dates. Then we slip south to assess fiscal developments in the efforts to recover from insolvency in Puerto Rico. Finally, we assess and consider some of the broader issues related to municipal bankruptcy.

Post Chapter 9 Recovery. One of Detroit’s first tests with regard to whether it can find new use for the vast stretches of land it cleared of blight went into effect this week when development teams announced by  Mayor Mike Duggan, along with partners: The Platform, a Detroit-based firm, and Century Partners announced they would be investing an estimated $100 million to rehab the architectural jewels in the city’s downtown—the Fisher and Albert Kahn buildings, with the two organizations declaring they will take the lead in overhauling 373 parcels of vacant land and houses in the Fitzgerald neighborhood on the northwest side, where they will coordinate with other firms on a $4 million development plan to rehab 115 vacant homes over two years, create a two-acre park, and landscape 192 vacant lots—with the work occurring in neighborhoods wherein the Detroit Land Bank took control of most of the properties and razed some abandoned homes. Mayor Duggan and other officials described the plan as a kind of reverse gentrification—or, as Mayor Duggan framed it: “We are going to keep the families here while improving the neighborhoods,” making his announcement on an empty lot which is scheduled to become a city park and include a greenway path to nearby Marygrove College: the city leaders hope to transform the neighborhood into a “Blight-Free Quarter Square Mile,” and, if the model works, seek to propagate it other neighborhoods.

Granite State Preemption or Cure? House Speaker Shawn Jasper wants to give New Hampshire towns that postponed their municipal elections due to a snowstorm a way out of facing potential lawsuits from voters who may have been disenfranchised. Speaker Jasper had proposed letting towns ratify the results of their elections by holding another vote, offering a bill to give towns which moved Election Day the option of letting townspeople vote to ratify, or confirm, the results on May 23rd. However, in the wake of about five hours of testimony, the House Election Law Committee voted 10-10 on the Jasper plan, so that a tie vote killed the Speaker’s amendment, leaving 73 towns on their own to address potential legal problems resulting from their decisions to hold their elections on days other than March 14th. The fiscal blizzard in the Granite State now depends upon whether state legislators determine whether or not a special election is needed with regard to those results. New Hampshire Deputy Secretary of State David Scanlan noted: “The concept is not entirely new…what is different is that it is applying to an entire class of towns that decided to postpone.”

In the past, the Legislature has voted to “cure” individual election defects. Speaker of the House Shawn Jasper, (R-Hudson, N.H.) noted: “Well, the fact that a bunch of towns moved the day of their town election was unprecedented…And so as a result of doing that, those towns that moved had to start bending other laws to make other issues related to the election work…The Legislature is just granting the authority to allow the towns to correct any defects that may exist,” he added, listing changed time listings, lack of proper notice, and absentee ballot date issues as possible defects in the process. All of those questions, of course, have fiscal consequences—or, as Atkinson Town Administrator Alan Phair put it; “Well, I don’t know the exact cost, what it would be, but I do know that in our case we certainly don’t have the money budgeted to (hold a special election), because we obviously just budgeted for one election…We would certainly go considerably over and have to find the money elsewhere to do it.” Under the proposed amendment, towns and school districts which postponed would hold a hearing, at which the respective governing body would vote on whether to hold a special election with one question: whether or not to ratify results, where a “no” vote would kick out anyone elected in a postponed vote, while nullifying warrant articles, with elected roles to be appointed until the next election. Salem Town Manager (Salem is a town of just under 30,000 in Rockingham County) Leon Goodwin said his elected leaders were of the opinion that its postponement was legal, so that the municipality is moving forward on projects voted on last month, noting: We’re moving on as if the votes were accepted even though there is a cloud hanging over us from Concord,” adding that town counsel advised the town moderator that it was legal to move elections. Yet, even as he remained confident the election issue will be resolved, he cautioned that the town has not budgeted for an additional election; Windham (approximately 14,000) Town Manager David Sullivan said the municipality’s town Counsel would sign off on the town’s fire truck bond, notwithstanding bond counsel elsewhere in the state advising that ratification of the elections would be necessary.

Municipal authority to act has been hampered by different state House and Senate approaches: while the two bodies have been moving on parallel tracks in the wake of state officials’ questioning the authority of town moderators to reschedule the March 14 voting sessions of their town meetings, the Senate this week passed SB 248, a bill introduced to ratify actions taken at the rescheduled meetings; however, the bill passed with a committee amendment which deletes all of the original language and provides instead for the creation of a committee to “study the rescheduling of elections.” Senators acknowledged that the bill was not likely to pass through the House in that form—asserting the intent was simply to get a bill to the House for further work. Subsequently, a floor amendment was introduced to restore the bill’s original language, ratifying all actions taken at the rescheduled meetings; however, that amendment failed on a party-line vote, with all nine Democrats voting in favor and all fourteen Republicans voting against, leaving most unclear how this could have become a partisan issue. The question comes down to what level of control local officials should have over local elections. The Speaker described the outcome thusly: “I think it was a case of 10 people (on the committee) thinking that what happened was legal;” however, he maintained that the postponed votes were not legal, adding: “The sad thing is that for school districts with bond issues that passed in those meetings, I don’t see a path forward for them,” adding: “I think if you’re afraid of snowstorms, you ought to move your meetings, probably to May,” noting that state officials are forbidden by law from moving state primary and general elections, as well as the first-in-the-nation presidential primary. Unsurprisingly, town moderators and attorneys who work with them on municipal bond issues disagreed with the Speaker’s interpretation that the postponed elections were illegal and his belief that the only way to rectify the issue was for them to act to individually ratify them, with many arguing they acted legally under a state law which allows them to postpone and reschedule the “deliberative session or voting day” of a town meeting to another day; however, the Speaker maintains that law applies only to town meetings, while town elections are governed under a different statute, which provides: “All towns shall hold an election annually for the election of town officers on the second Tuesday in March.” He also noted that the state’s official political calendar, which has the force of law, states that town elections must be held on March 14, adding: “Without trying to place blame, laws are sometimes very confusing if you look only at parts of them,” noting: “I don’t believe for one second that moving the election was legal.”

The Speaker added that still another state law provides that at special town meetings, no money may be raised or appropriated unless the number of ballots cast at the meeting is at least half the number of those on the checklist who were eligible to vote in the most recent town meeting, albeit adding that such meetings do not apply to the current situation, because they are not elections. The state’s Secretary of State said that after three weeks of research, he was able to report on voter turnout at town elections for the past 11 years, advising that 210 towns held elections in March, and 137 of them “followed the law” by holding their elections on March 14th, while 73 towns had postponed their elections by several days. Now Speaker Jasper asks: “Why would we give over 300 individual moderators the ability to do that when our Secretary of State doesn’t have the ability to do that for a snowstorm in our general election or our presidential primary?” The Speaker notes: “I think we need to provide a way to ensure that we don’t clog up the courts, and we don’t have people spend a lot of their own money to fight this, and the towns don’t have to spend a lot of money fighting it.”

Un-positive Credit Rating for Puerto Rico. Moody’s Investors Service has lowered the credit ratings on debt of the Government Development Bank and five other Puerto Rico issuers, with a total of approximately $13 billion outstanding, and revised down the Commonwealth’s fiscal outlook, and the outlooks for seven affiliated obligors linked to the central government to negative from developing, with the downgrades reflecting what the agency described as “persistent pressures on Puerto Rico’s economic base that indicate a diminishing perceived capacity to repay,” noting that while it continues to “believe that essentially all of Puerto Rico’s debt will be subject to default and loss in a broad restructuring, the securities being downgraded face more severe losses than we had previously expected, in the light of Puerto Rico’s projected economic pressures. For this reason, we downgraded to C from Ca not only the senior notes issued by the now defunct Government Development Bank, but also bonds issued by the Puerto Rico Infrastructure Financing Authority and backed by federal rum tax transfer payments, the Convention Center District Authority’s hotel occupancy tax-backed bonds, the Employees Retirement System’s bonds backed by government pension contributions, and the 1998 Resolution bonds of the Puerto Rico Highways and Transportation Authority.”

Puerto Rico Governor Rossello late Wednesday said that the U.S. territory’s fiscal plan, approved by the PROMESA Board, does not contemplate any double taxation, adding that, between the increase in the property tax and the reduction of expenses in the municipalities, he favored the latter as a measure to compensate for the absence of the state subsidy of $350 million. He reiterated that, as a substitute for these funds, the properties which are not currently paying taxes to the Centro de Recaution de Ingresos Municipales (CRIM: the Municipal Revenue Collection Center) should be identified, because they are not included in their registry. The Governor also stressed that the economic outcome of these two fiscal initiatives is still being evaluated, albeit he estimated that they could generate about $100 million, noting: “Whatever the differential after that for the municipalities, there are two mechanisms that can be worked: One, a mechanism to seek an additional source of income, or, two, to avail cuts…The central government has taken the cutting position. We are already establishing a protocol to cut in the agencies, to consolidate, to eliminate the expenses that are not necessary, to go from 131 to between 35 to 40 agencies. That has been our action. The municipalities—now we will have a conversation with our technical team—will have several options: ‘either cut as did the central government or seek mechanisms to raise more funds or impose taxes.’” Currently, mayors evaluate to increase the arbitrage of the real property to 11.83% or to 12.83% in all the municipalities; the concept is for members of the Executive to offer assistance to do the modeling. Thus, the president of the board of CRIM, Cidra Mayor Javier Carrasquillo, said CRIM will be “sensitive to the reality of the pockets of Puerto Ricans: We have to be cautious and responsible in the recommendation that we are going to make…There is nothing definitive yet. There are recommendations.” The Governor noted that the PROMESA Board approved fiscal plan approved last month does not contemplate an increase in property taxation, asserting it was “false to imply that our fiscal plan entails an increase in the rate or a double rate on properties,” albeit recalling that the disappearance of $350 million in transfers to municipalities begins on July 1, when the fiscal year begins, promising it will be done progressively, so that in the next budget (2017-2018) $175 million disappear, and the remaining $175 million, the next fiscal year, describing it as a “two-year fade out.” Unsurprisingly, he did not specify when or how the plan would fiscally benefit this island’s municipalities, stating: “We have already been able to have pilot efforts to identify different municipalities where 60% of their properties are not being assessed…We are going to commit ourselves so that all these properties are in the system.”

The End of a Chapter 9 Era? Municipal bankruptcy is a rarity: even notwithstanding the Great Recession which produced a significant number of corporate bankruptcies—and federal bailouts to large for-profit corporations and quasi-federal corporations, such as Fannie Mae; the federal government offered no bailouts to cities or counties. Yet from one of the nation’s smallest cities, Central Falls, to major, iconic cities such as Detroit and Jefferson County, the nation experienced a just-ended spate, before—with San Bernardino’s exit last month, the likely closure of an era—even as we await some resolution of the request by East Cleveland to file for chapter 9 municipal bankruptcy. The lessons learned, compiled by the nation’s leading light of municipal bankruptcy, therefore bear consideration. Jim Spiotto, with whom I had the honor and good fortune over nearly a decade of effort leading to former President Reagan’s signing into law of the municipal bankruptcy amendments of 1988, offers us a critical guide of ten lessons learned:

  1. Do not defer funding of essential services and infrastructure: Detroit is a wake- up call for others that there is never a good reason to defer funding of essential services and infrastructure at an acceptable level. If you do, Detroit’s fate will be yours.
  2. Labor and pension contracts under state constitutional and statutory provisions should not be interpreted as a mutual suicide pact: It appears one of the reasons why resolution of pension and labor costs was not achieved in Detroit prior to filing Chapter 9 was the belief of the workers and retirees that, under the Michigan constitution, those contractual rights could not be impaired or diminished to any degree. This position failed to take into consideration that the municipality can only pay that which it has revenues to pay and, in an eroding declining financial situation, there will never be sufficient funds to pay all obligations, especially those that may be unaffordable and unsustainable.
  3. Don’t question that which should be beyond questioning and is needed for the long-term financial survival of the municipality: A dedicated source of payment, statutory lien or special revenues established under state law must be honored and should not be contested. Capital markets work effectively when credibility and predictability of outcome are clear and unquestioned. Current effort to pass new legislation (California SB222 and Michigan HB5650) to grant statutory first lien on dedicated revenues. Further, as noted in the Senate Report for the 1988 Amendments to the Bankruptcy Code and Chapter 9 “Section 904 [of Chapter 9 limiting the jurisdiction and power of the Bankruptcy Court] and the tenth amendment prohibits the interpretation that pledges of revenues granted pursuant to state statutory or constitutional provisions to bondholders can be terminated by filing a Chapter 9 proceeding”. This follows the precedent from the 1975 financial distress of New York City and the State of New York’s highest court ruling the state imposed moratorium was unconstitutional given the constitutional mandate to pay available revenues to the general obligation bondholders. See Flushing Nat. Bank et. al. v. Mun. Assistance Corp. of New York, 40 N.Y.S.2nd 731, 737-738 (N.Y. 1976). Just as statutory liens and special revenues, there is a strong argument that state statutory and constitutional mandated payments (mandated set asides, priorities, appropriations and dedicated tax revenue payments) should not and cannot be impaired, limited, modified or delayed by a Chapter 9 proceeding given the rulings of the Supreme Court in the Ashton and Bekins cases and the prohibitions of Sections 903 and 904 of Chapter 9 of the Bankruptcy Code.
  4. Debt adjustment is a process, but a recovery plan is a solution: As noted above, while Detroit has proceeded with debt adjustment which provides some additional runway so it can take takeoff in a recovery, such plan is not the cure for the systemic problem. Rather, the plan provides additional breathing room so that the municipality, through its Mayor and its elected officials, may proceed with a recovery plan, reinvest in Detroit, stimulate the economy, create new jobs, clear and develop blighted areas and raise the level of services and infrastructure to that which is acceptable and attract new business and new citizens.
  5. Successful plans of debt adjustment have one common feature: virtually all significant issues have been settled and resolved with major creditors: While the Detroit Plan started with sound and fury between the emergency manager and creditors and what they would receive, in the end, similar to what occurred in Vallejo, Jefferson County and even in Stockton (with one exception), major creditors ultimately reached agreement and supported the Plan of Debt Adjustment that allowed the municipality to move forward, confirm the Plan and begin its journey to recovery.
  6. One size does not fit all: There are many ways to draft a plan of debt adjustment and sometimes the more creative, the better. As noted above, traditionally major cities of size with significant debt did not file Chapter 9. They refinanced their debt with the backing of the state which reduced their future borrowing costs and allowed them to recover by having the liquidity and the reduced costs necessary to deal with their financial difficulties. Detroit chose a different path.
  7. A recovery plan must provide for essential services and infrastructure: “Best interest of creditors” and “feasibility” can only mean an appropriate reinvestment in the municipality through a recovery plan where there is funding of essential services and infrastructure at an acceptable level to stimulate the municipality’s economy to attract new employers and taxpayers thereby increasing tax revenues and addressing the systemic problem. While no plan of debt adjustment is perfect or assured, there should be, as the Bankruptcy Court in Detroit throughout the case pointed out, a plan to show the survivability and future success of the City.
  8. Confirmation of a plan of debt adjustment is only the beginning of the journey to financial recovery, not the end: It is important to recognize, as noted above, that Chapter 9 is a process, not a solution. The recovery plan, which will take dedication and effort by the elected officials of the City along with residents, public workers and other creditors is the only way to achieve success. It is measured not by months, but by years, and by the constant vigilance to ensure that the systemic problem is addressed effectively in a permanent fix.

Addressing Municipal Fiscal Distress

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eBlog, 04/05/17

Good Morning! In this a.m.’s eBlog, we consider some unique efforts to address municipal fiscal distress by the Illinois Legislature, based upon tag team efforts by the irrepressible fiscal tag team of Jim Spiotto and Laurence Msall of the Chicago Civic Federation. The effort matters, especially as the Volker Alliance’s William Glasgall, its Director of State and Local Programs, has raised issues and questions vis-à-vis state roles relating to addressing severe municipal fiscal distress. As we have noted—with only a minority of states even authorizing municipal bankruptcy, there are significant differences in state roles relating to severe municipal fiscal distress and insolvency. Thus, this Illinois initiative could offer a new way to think about state constructive roles. Then we turn to Ferguson, Missouri to assess its municipal election results—and its remarkable, gritty fiscal recovery from the brink of insolvency.

Addressing Municipal Fiscal Distress. The Illinois Legislature is considering House Bill 2575, the Illinois Local Government Protection Authority Act, offered by Rep. David Harris (R-Arlington Heights), which would establish an Authority for the purpose of achieving solutions to financial difficulties faced by units of local government, creating a board of trustees, and defining the Authority’s duties and powers, including the ability to obtain the unit of local government’s records—and to recommend revenue increases. The legislation provides for a petition process, whereby certain entities may petition the Authority to review a unit of local government; it also sets forth participation requirements. The effort comes in the wake of distressed local governments struggling under the weight of pension, healthcare, and other debts: it would propose this new, special authority for fiscal guidance to fiscally strapped local units of government, but without mandating severe budget cuts—or, as Rep. Harris described it: a “cooperative effort between the state and financially unit of local government…(one which) involves local elected officials and local governmental bodies and taxpayers, workers, and business entities developing a plan of financial recovery — is the best way to find a permanent solution to current financial challenges.” According to the Chicago Civic Federation, which asserts the intent is to help the state’s municipalities recover without being forced into chapter 9 municipal bankruptcy, such an authority could be valuable—especially in a state which, like the majority of states, does not generally permit a city, county, or other municipal entity to file for bankruptcy. Under the proposal, nine trustees would oversee the new authority, including four appointed by the Illinois Municipal League; the Governor, Speaker of the House, and Minority Leader, and their state Senate counterparts would each appoint one member: the new authority would rely on the Illinois Comptroller’s office to provide reports and some operational support; the legislation would also set a fee schedule to enable coverage of its administrative costs.

The exceptional leader of the Federation, Laurence Msall, noted: “The LGPA would serve as a resource to assist distressed municipalities in making determinations as to what essential governmental services are sustainable and affordable and what combination of revenue increases and service cuts, and other actions would be necessary to ensure fiscal sustainability and access to critical services.” Under the proposed legislation, a municipality could petition the authority to intervene; but also, the Illinois Comptroller, a public pension fund, or even a large creditor owed a substantial debt could. The proposal would authorize a municipality to petition too—provided it committed to participate—and provided it met specific criteria, including inadequate liquidity, overdue debt, weak pension funding ratios, or signal budget imbalances. If triggered, the suggested new authority would be authorized to recommend budget cuts, tax increases, and/or pension funding actions: as proposed, the authority would be charged with reviewing whether the city, county, or other unit of government should:

  • try to negotiate a debt restructuring,
  • explore public-private partnerships, or
  • asset sales and consolidation.

The authority would be authorized to consider potential pension reforms, such as whether the municipality should offer more corporate-style retirement plans, as well as whether it should establish a trust to fund its OPEB post-retirement healthcare obligations.

The proposed legislation authorizes authority to set fiscal targets; it offers the option for the proposed new authority to serve as a mediator in negotiations between a municipality and debtors, to endorse tax increases—increases which might trigger a public referendum, and issue recommendations to the Illinois state government with regard to the diversion of funds to address specific municipal funding mandates—granting authority too to seek declaratory and injunctive relief with regard to the exercise of its powers and implementation of its findings and recommendations. Finally, as a last resort, the authority could recommend pursuit of chapter 9 municipal bankruptcy. The nation’s architect of the federal municipal chapter 9 municipal bankruptcy law, Jim Spiotto, notes: “This municipal protection authority concept could be the means of providing state and local government cooperation and oversight while allowing the municipality, its elected officials, workers and unions, creditors and bondholders to have a means of participation with a definitive end result.” For his part, Mr. Msall described the rationale as vital to establishing “a systematic means of evaluating and assisting these governments,” instead of taking on municipal fiscal distress on a case-by-case effort, noting that “The Civic Federation is very concerned about the financial condition of many local governments in the state of Illinois, and many of them which will not be able to seek assistance unless there is the creation of this authority.”

& The Winner is: Ferguson, Missouri voters have reelected incumbent Mayor James Knowles III to a third term in the municipality’s first mayoral election since protests erupted there three years ago in the wake of one of the city’s white police officer’s shooting of an unarmed black 18-year-old—a shooting which ignited a national protest and led to a federal Justice Department intervention and harsh fiscal penalties for the nearly insolvent municipality. Mayor Knowles won by a 56%–44% margin against Councilwoman Ella Jones, who is black, in a small municipality which was once an overwhelmingly white “sundown town” where, until the 1960s, African-Americans were banned after dark. Perhaps ironically, the Mayor’s reelection followed just one day in the wake of U.S. Attorney General Gen. Jeff Sessions’ order that the U.S. Justice Department review its existing consent decrees with municipal police departments—the agreement in Ferguson, imposed under the Obama administration, imposed unfunded federal mandates, including demands to levy new taxes. In its report, the Obama Justice Department had alleged that the Ferguson Police Department and the City of Ferguson relied on unconstitutional practices in order to balance the city’s budget through racially motivated excessive fines and punishments, so that former U.S. Attorney General Eric Holder stated the federal government would use its authority to dismantle the Ferguson Police Department—a threat, which at the time, Ferguson’s then-Mayor had warned could mark the first time in the nation’s history that the federal government might force a municipality into municipal bankruptcy, and led credit rating agency Moody’s to place the municipality’s municipal bond rating on review for downgrade because of threats to the city’s solvency—with the downgrade of the city’s general obligation rating reflecting what the credit rating agency described as “the continued pressure on the city’s finances from a persistent structural imbalance and incorporating the recently approved U.S. Department of Justice (DOJ) consent decree, projected to increase annual General Fund expenses over the next several years,” in the wake of Moody’s assessment after the U.S. Justice Department lawsuit against the small city, noting its downgrade then had reflected concerns related to the uncertainty of the potential financial impact of litigation costs from the federal lawsuit and the price tag for implementing the proposed DOJ consent decree, writing: “We believe fiscal ramifications from these items will be significant and could result in insolvency.”

Indeed, the Justice Department’s unfunded federal mandates included federally imposed financial penalties, and the mandate to levy new, municipal taxes: leading to voter approval of a utility tax hike projected to generate $700,000 annually—an increase which Mayor Knowles, at the time, described as a critical vote, because, had the measure failed, the city’s police force’s authorized number would have been cut to 44, and firefighter jobs would also have been cut; he had warned, in addition, that the vote was intended to make clear the city was fiscally viable. So, today, in the wake of resignations and elections, Ferguson features three black council members, a black police chief, and a black city manager—and, in the interim, Mayor Knowles has survived a recall attempt (in 2015), noting in a Facebook post during the campaign that he wanted to follow the example set by former President Abraham Lincoln: “For those familiar with history, during the Civil War, Lincoln was often criticized by people on both sides of the issues of slavery and the war because of his even-handedness and his resistance to the pressures of radicals on both sides. He knew radicalism, even after the war, would further divide us, which it has for generations.”

Mayor Knowles’ challenger, Councilmember Jones, ran, because, she said, it was “time for Ferguson to unite and become one Ferguson, and we cannot move forward under the leadership that we are under at this point,” harshly criticizing the U.S. Attorney General’s move to review the city’s consent decree—one which Mr. Sessions had previously claimed was based on a report that was “anecdotal” and “not so scientifically based,” with Councilmember Jones warning that the Attorney General’s action was “not going to help Ferguson at all,” adding: “We need that consent decree in order to keep Ferguson moving forward.” Nevertheless, the gritty, can-do leadership of the city’s elected officials appears to have defied the odds: City Manager De’Carlon Seewood recently wrote that in the wake of a “drastic decline” in revenue, “the city’s operating budget is beyond lean. It’s emaciated.”