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

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Rebuilding the Motor City, and Reconsidering Colonialism in Puerto Rico

July 27, 2018

Good Morning! In this morning’s eBlog, we consider post-chapter 9 municipal bankruptcy challenges in Detroit, before turning to legislative and legal challenges to Puerto Rico.

A Foreclosed Motor City Future? In Detroit, time is running out for the owners of foreclosed properties under a new program which arose out of a legal settlement two years ago intended to protect the rights of low-income owner-occupants of foreclosed homes to purchase back their properties back for $1,000—a plan which provided that occupied homes on tap for this coming fall’s tax auction will instead be purchased by the City of Detroit and sold to owner-occupants who can prove they qualify for the city’s poverty tax exemption or have in the past—an exemption which would reduce or eliminate property tax liabilities for those who qualify. The plan is an indication of one of the most challenging aspects of fashioning a plan of debt adjustment for recovering from the largest chapter 9 municipal bankruptcy in U.S. history: how does one enhance the property tax base by attracting higher income families to move back into the city without jeopardizing thousands upon thousands of the city’s poorest families?

To date, with a looming deadline in a month, the United Community Housing Coalition has received about 140 applications—the foundation received funds from the City and foundations to purchase the homes—with the assistance available to prospective homeowners who can prove they could have qualified for the tax exemption between 2014 and 2017, but did not receive one—and that they agree to sign a sworn statement they would have qualified in the past. The effort matters: Wayne County Treasurer Eric Sabree estimates as many as 700 owner-occupied homes in Detroit are at risk of being sold at the fall tax foreclosure auction.

Quien Es Encargado? (Who is in charge?) U.S. District Court Judge Laura Taylor Swain Wednesday stated she would issue an opinion soon with regard to the hard federalism question emerging from the by Puerto Rico versus the PROMESA Oversight Board over their authority, noting at the end of the Title II bankruptcy hearing: “I realize the urgency of the situation,” at the end of a Title III bankruptcy hearing in San Juan, referring to two adversary proceedings against the Board–one brought by Gov. Ricardo Rosselló, and the other by the Presidents of the Puerto Rico Senate and House of Representatives—while PROMESA Board attorney Martin Bienenstock described the Governor’s effort to challenge the Board’s efforts to preempt the legislative power and authority of the U.S. Territory’s elected Governor and Legislature as “ineffectual.” Mr. Peter Friedman, representing the Governor and Puerto Rico’s Fiscal Agency and Financial Advisory Authority (FAFAA), responded that the Governor was just trying to raise a narrow set of issues: they want the federal court to reject the notion that they have no meaningful role in governing.  But the unelected Mr. Bienenstock said the Governor’s challenge is based on five discrete issues intertwined with the PROMESA Board’s ability to revive the economy, regain capital markets access, and do other things mandated by the PROMESA law, as he focused especially on two issues: what he characterized as the Board’s power over “reprogramming” the use of unused Puerto Rico government funds, arguing before Judge Swain that if the Governor were permitted to appropriate and authorize funding to carry out his responsibilities, then the PROMESA Board would have lost control over the budget, fiscal plan, and debt restructuring.

In response to this extraordinary claim, Judge Swain said that while she recognized the Board has some authority, she questioned whether it applies to funding lines that had been authorized before PROMESA’s passage, describing the issue as a “conundrum,” even as Mr. Bienenstock testified that the Governor wants to make it legal to “knowingly and willingly” spend more than the PROMESA Board budget authorizes. This raised an issue which goes to the heart of governance in a democracy: should those elected by the citizens of a jurisdiction have the final say as opposed to those who neither reside in nor come from such a jurisdiction have the final governing authority?

Crossing Swords. Puerto Rico Governor Ricardo Rosselló, stated he would not testify before the U.S. House Natural Resources Committee unless Chairman Rob Bishop (R-Utah) said he was sorry for a Tweet tweeted from the Committee’s account last week: “Call your office, @ricardorossello,” accompanied an invitation to the hearing, where invited witnesses were to be grilled on a management crisis at PREPA. Gov. Rosselló noted the tweet falsely suggested that he was hard to reach. Perhaps more importantly, for the Governor, the Chairman’s comments appeared to reflect a disrespect which would not be shown to the Governor of any State, emphasizing the perception that the federal government has a colonialist attitude toward the Commonwealth, where residents are U.S. citizens, but are barred from having a vote in the House and Senate. Chairman Bishop did not apologize for the demeaning tweet, asserting that its removal meant no apology was required—a position hard to imagine he would make to Utah Governor Gary Herbert.

Converting Swords to Plowshares? With Congress adjourning today for six weeks, Puerto Rico Resident Commissioner Jenifer Gonzalez hopes her pro-democracy project can be discussed by Chairman Bishop’s Committee in September: her legislation, HR 6246, would enable the admission of the territory of Puerto Rico into the Union as a State. Chair Bishop, according to the Commissioner, “has a plan” to move the prospects for statehood forward in the short 19-day legislative window before this Congress adjourns in November. Rep. Gonzalez affirmed that her legislative goal is to incorporate Puerto Rico as a territory, which would be considered as a promise of statehood, and create a Congress Working Group, so that, within a period of just over a year, there would be a report on changes to laws that would have to be put in place to admit the island as a state in January of 2021.

Lighting up PREPA? Puerto Rico’s Governor Ricardo Rosselló was a no-show at a Congressional hearing Wednesday afternoon on efforts to wrench control of the bankrupt Puerto Rico Electric Power Authority from Puerto Rico’s government—a hearing, “Management Crisis at the Puerto Rico Electric Power Authority and Implications for Recovery,” with regard to which Chairman Rob Bishop (R-Utah) had written: “Despite your recognition of the politicization that has plagued PREPA and your commitment towards allowing for independence, the recent departure of PREPA’s CEO after only four months of service and the resignation of the majority of PREPA’s governing board are the most recent signs of the utility’s continued dysfunction and a sign that ‘political forces…continue to control PREPA.’” The Governor, late Tuesday had announced he would not be able to participate in the hearing—a hearing at which there was to be a focus on corruption within the utility and the possibility of privatization—but at which the Committee was scheduled to receive testimony from the invaluable chapter 9 expert Jim Spiotto, as well as DOE Assistant Secretary Bruce Walker.  In its most recent audit, Ernst & Young had noted there substantial  doubt whether PREPA could continue as a going concern, since it does not have sufficient funds to fully repay its obligations as they come due and is restructuring its long-term debt. (PREPA utility filed for bankruptcy one year ago in the face of accruing $9 billion in debt, under PROMESA’s provisions in Title III.

Human, Fiscal, & Physical Challenges

April 20, 2018

Good Morning! In this morning’s eBlog, we return to Flint, Michigan to assess its human and fiscal challenges in the wake of its exit from state receivership; then we return to Puerto Rico, a territory plunged once again into darkness and an exorbitant and costly set of fiscal overseers. 

Out Like Flint. Serious fiscal challenges remain for Flint, Michigan, after its exit from state financial receivership. Those challenges include employee retirement funding and the aging, corroded pipes that caused its drinking water crisis, according to Mary Schulz, associate director for Michigan State University’s Extension Center for Local Government Finance and Policy. In the public pension challenge, Michigan’s statute enacted last year mandates that the state’s municipalities report underfunded retirement benefits. That meant, in the wake of Flint’s reporting that it had only funded its pension at 37%–with nothing set aside for its other OPEB benefits, combined with the estimated $600 million to finance the infrastructure repair of its aging water infrastructure, Director Schulz added the small city is also confronted by a serious problem with its public schools—describing the city’s fiscal ills as “Michigan’s Puerto Rico,” adding it would “remain Michigan’s Puerto Rico until the state decides Flint is part of Michigan.”

Michigan Municipal League Director Dan Gilmartin notes that Flint is making better decisions financially, but still suffers from state funding cuts. He observed that Flint’s leaders are making better decisions fiscally—that they have put together a more realistic budget than before its elected leaders were preempted by state imposed emergency managers, noting: “The biggest problem Flint faces now is what all cities in Michigan face, and that is the state’s system of municipal financing, which simply doesn’t work.”

Perhaps in recognition of that, Michigan State Treasurer Nick Khouri, on April 10th announced the end of state-imposed receivership under Michigan’s Local Financial Stability and Choice Act, and he dissolved the Flint Receivership Transition Advisory Board. Treasurer Khouri also signed a resolution repealing all remaining emergency manager orders, noting: “Removing all emergency manager orders gives the City of Flint a fresh start without any lingering restrictions.” Concurrently, Michigan Governor Rick Snyder, in an email, wrote: “Under the state’s emergency manager law, emergency managers were put in place in a number of cities facing financial emergencies to ensure residents were protected and their local governments’ fiscal problems were addressed: This process has worked well for the state’s struggling cities, helping to restore financial stability and put them on a path toward long-term success. Flint’s recent exit from receivership marks the end of emergency management for cities in Michigan and a new chapter in the state’s continued comeback.” Indeed, the state action means that Detroit is the only Michigan municipality city still under a form of state oversight, albeit Benton Harbor Area Schools, Pontiac Public Schools, Highland Park School District, and the Muskegon Heights school district remain under state oversight.

The nation’s preeminent chapter 9 municipal bankruptcy expert Jim Spiotto notes that a financial emergency manager is supposed to get a struggling municipality back to a balanced budget, to find a means to increase revenue, to cut unnecessary expenses, and to keep essential services at an acceptable level:  “To the degree that they achieve that, then you want to continue with best practices: If they don’t accomplish that, then even if you return the city back to Mayor and City Council, then they have to do it: Someone has to come up with viable sustainable recovery plan, not just treading water.”

From his perspective, Director Gilmartin notes: “Flint has more realistic numbers in place, especially when it comes to revenues. I think that is the most important thing the city has accomplished from a nuts and bolts standpoint…The negative side of it is the system in which they are working under just doesn’t work for them or any communities in the state. In some cases making all the right decisions at the local level still doesn’t get to where you need to get to, and it will require a change in the state law.” Referencing last year’s Michigan Municipal League report which estimated the state’s municipalities had been shortchanged to the tune of $8 billion since 2002, Director Gilmartin noted: “A lot of the fiscal pressures that Flint and other cities in Michigan find themselves in are there by state actions.” No doubt, he was referencing the nearly $55 million in reduced state aid to Flint by 2014—as the state moved to pare revenue sharing—the state’s fiscal assistance program to provide assistance based upon population and fiscal need—funds which, had they been provided, would have sufficed to not only balance the city’s budget, but also cut sharply into its capital debts—enhancing its credit quality. Indeed, it was the state’s Emergency Manager program that voters repealed six years ago after devastating decisions had plunged Flint into not just dire fiscal straits, but also the fateful decision to change its public drinking water source—a decision poisoning children, and the city’s fisc by decimating its assessed property values. During those desperate human and fiscal times, local elected leaders were preempted—even as two of the gubernatorially named Emergency Managers were charged with criminal wrongdoing in relation to the city’s lead contamination crisis and ensuing Legionnaire’s disease outbreak which claimed 12 lives in the wake of the fateful decision to  change Flint’s water source to the Flint River in April of 2014. Now, as Director Schulz notes: “Until we come up with other solutions that aren’t really punitive in nature and leave communities like Flint vulnerable as repeat customer for emergency management law, these communities will remain in financial and service delivery purgatory indefinitely.”

Director Schulz notes a more profound threat to municipal fiscal equity: she has identified at least 93 Michigan municipalities with a taxable value per capita under $20,000, describing that as a “good indicator” for which municipalities in the state are prime candidates for finding themselves under a gubernatorially imposed Emergency Manager, in addition to 32 other municipalities in the state which  are either deemed service insolvent or on the verge of service insolvency. Flint’s taxable value per capita of $7575 comes in as the second lowest behind St. Louis, Michigan, which has a taxable value of $6733. Ms. Schulz defines such insolvency as the level below which a municipality is likely unable to fiscally provide “a basic level of services a city need to provide to its residents.” Indeed, a report released by Treasurer Khouri’s office has identified nearly 25% of the state’s local units of government as having an underfunded pension plan, retirement health care plan, or both—an issue which, as we have noted in the eGnus, comes after the State, last December enacted legislation creating thresholds on pensions and OPEB which all municipalities must meet in order to be considered funded at a viable level, meaning OPEB liabilities must be at least 40% funded, and pensions 60% funded. While the Treasurer may grant waivers, such granting is premised on plans approved to remedy the underfunding—failure to do so could trigger oversight by a three-member Michigan Stability Board appointed by the Governor. As Director Schulz notes: “The winds here are blowing such that the municipality stability board is going to be up and running soon, and there will be an effort to give that board emergency manager powers…That means they can break contacts, they can sell assets…whatever it needs to put money in the OPEB.” But in the face of such preemption—preemption which, after all, had caused such human and fiscal damage to Detroit, Detroit’s public schools, and to the City of Flint; Director Gilmartin notes: “Getting the community back to zero is the easy part and is just a function of budgeting, but having it function and provide services is harder: I would say that a lot of the support for emergency management by the state has dwindled based on the experience over the last several years.”

A Storm of Leaders. If the human health and safety, and fiscal challenges created by state oversight in Michigan give one pause; the multiplicity—and cost—of the many overseers of Puerto Rico and its future by the inequitable storm response by Congress and the Trump Administration—and by the costly “who’s on first…” sets of conflicting fiscal overseers could experience at least some level of greater clarity today, as the PROMESA Board releases its proposed fiscal plans it intends to certify, including the maintenance of its mandate to the federal court for an average public pension cut of 10 percent—after having kept under advisement the concerns of Governor Ricardo Rosselló the inclusion in the revised fiscal, quasi chapter 9 plan of debt adjustment immediate reductions in sick and vacation leave.

Thus, it appears U.S. Judge Laura Taylor Swain will consider a proposed adjustment plan to reduce public pensions later this year which would total savings of as much as nearly $1.45 billion over the next five years—a level below the PROMESA Board’s proposed $1.58 million—but massive when put in the context that the current average public pension on the island is roughly $1,100 a month, but more than 38,000 retired government employees receive only $500, because of the type of job they had and the number of years worked.

Thus, there are fiscal and human dilemmas—and governance challenges: even though the PROMESA law authorizes the restructuring of retirement systems, it is unclear whether the Congressionally-created Board has the authority to impose such a significant, unfunded federal mandate on the government of Puerto Rico, including labor reforms, and restrictions of vacation and sick leaves. Last year, Governor Rosselló agreed to a reduction in pensions for government retirees, but then his aim was to propose cuts of 6 percent.

At the moment, he is against it. A few weeks ago, after negotiations with the Board, Governor Rosselló proposed a labor reform similar to the one he negotiated with members of the Board, with differences on how to balance it with an increase in the minimum wage and when to put it in into effect—a proposal he subsequently withdrew after the PROMESA Board mandated that the labor reform be in full force in January 2019, instead of phasing it in over next three years, and conditioning the increase from $7.25 to $8.25 per hour in the minimum wage to the increase in labor participation rates—proposals which, in any event, made clear the “too many leaders” governance challenges—as these were proposals with little chance of approval by the Puerto Rican House. That is, for the Governor, there is not only a federal judge, and a PROMESA Board, but also his own legislature elected by Puerto Ricans—not appointed by non-Puerto Ricans. (Under the PROMESA Law, which also created the territorial judicial system to restructure the public debt of Puerto Rico, the PROMESA Board also has power over the local government until four consecutive balanced budgets and medium and long-term access to the financial markets are achieved. Thus, as the ever insightful Gregory Makoff of the Center for International Governance Innovation—and former U.S. Treasury Advisor 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.” Thus, he has recommended the Board and Gov. Rosselló propose to Judge Swain a cut from $45 billion to $6 billion of the public debt backed by taxes, with a payment of only 13.6 cents per each dollar owed, with the aim of equating it with the average that the states have. All of this has been complicated this week by the blackout Wednesday, before the Puerto Rico Electric Power Authority, PREPA, yesterday announced it had restored power to some 870,000 customers.

As in  Central Falls, Rhode Island, and in Detroit, in their respective chapter 9 bankruptcies, the issue and debate on pensions appears to be a matter which will be settled or resolved by the court—not the parties or Board. While the Board has the power to propose a reform in the retirement systems, it appears to lack the administrative or legislative mechanisms to implement a labor reform. The marvelous Puerto Rican daily newspaper, El Nuevo Día asked one of the PROMESA Board sources if it were possible for the Board to go to Court and demand the implementation of a labor reform in case the Governor does not propose such legislation—the response to which was such a probability was “low.” Concurrently, an advisor to House Natural Resources Committee Chairman Rob Bishop (R-Utah) with regard to proposing legislation to address the issue receive a doubtful response, albeit an official in the Chairman’s office said recently that if the Rosselló administration does not implement the labor reforms proposed by the PROMESA Board, the option for the Board would be to further reduce the expenses of the government of Puerto Rico. Put another way, Carlos Ramos González, Professor of Constitutional Law at the Interamerican University of Puerto Rico, is of the view that, 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.”

Physical, Not Fiscal—But Fiscal Storms.  Amid the governance and fiscal storm, a physical storm in the form of am island-wide blackout hit Puerto Rico Wednesday after an excavator accidentally downed a transmission line, contributing to the ongoing physical and fiscal challenge to repair an increasingly unstable power grid nearly seven months after Hurricane Maria. More than 1.4 million homes and businesses lost power, marking the second major outage in less than a week, with the previous one affecting some 840,000 customers. PREPA estimated it would take 24 to 36 hours to restore power to all customers—it is focusing first on re-establishing service for hospitals, water pumping systems, the main airport in San Juan and other critical facilities. The physical blackout came as the PROMESA Board has placed PREPA, a public monopoly with $9 billion of debt, in the equivalent of its own quasi chapter 9 bankruptcy, in an effort to help advance plans to modernize the utility and transform it into a regulated private utility—after, last January, Gov. Ricardo Rosselló announced plans to put the utility up for sale.

Several large power outages have hit Puerto Rico in recent months, but Wednesday was the first time since Hurricane Maria that the U.S. territory has experienced a full island-wide blackout. Officials said restoring power to hospitals, airports, banking centers and water pumping systems was their priority. Following that would be businesses and then homes. By late that day, power had returned to several hospitals and at least five of the island’s 78 municipalities. Federal officials who testified before Congress last week said they expect to have a plan by June on how to strengthen and stabilize Puerto Rico’s power grid, noting that up to 75% of distribution lines were damaged by high winds and flooding. Meanwhile, the U.S. Army Corps of Engineers, which is overseeing the federal power restoration efforts, said it hopes to have the entire island fully restored by next month: some 40,000 power customers still remain without normal electrical service as a result of the hurricane. The new blackout occurred as Puerto Rico legislators debate a bill that would privatize the island’s power company, which is $14 billion in debt and relies on infrastructure nearly three times older than the industry average.

 

Looming Municipal Insolvencies?

October 10, 2017

Good Morning! In today’s Blog, we consider the looming municipal fiscal threat to one of the nation’s oldest municipalities, and the ongoing fiscal, legal, physical, and human challenges to Puerto Rico.

Visit the project blog: The Municipal Sustainability Project 

Cascading Insolvency. One of the nation’s oldest municipalities, Scotland, a small Connecticut city founded in 1700, but not incorporated until 1857, still maintains the town meeting as its form of government with a board of selectmen. It is a town with a declining population of fewer than 1,700, where the most recent median income for a household in the town was $56,848, and the median income for a family was $60,147. It is a town today on the edge of insolvency—in a state itself of the verge of insolvency. The town not only has a small population, but also a tiny business community: there is one farm left in the town, a general store, and several home businesses. Contributing to its fiscal challenges: the state owns almost 2,000 acres—a vast space from which the town may not extract property taxes. In the last six years, according to First Selectman Daniel Syme, only one new home has been built, but the property tax base has actually eroded because of a recent revaluation—meaning that today the municipality has one of the 10 highest mill rates in the state. To add to its fiscal challenges, Gov. Malloy’s executive-order budget has eliminated Connecticut’s payment in lieu of taxes program—even as education consumes 81 percent of Scotland’s $5.9 million taxpayer-approved  budget: under Gov. Malloy’s executive order, Scotland’s Education Cost Sharing grant will be cut by 70 percent—from $1.42 million to $426,900. Scotland has $463,000 in its reserve accounts, or about 9 percent of its annual operating budget—meaning that if the Gov. and legislature are unable to resolve the state budget crisis, the town will have to dip into its reserves—or even consider dissolution or chapter 9 bankruptcy. Should the municipality opt for dissolution, however, there is an unclear governmental future. While in some parts of the country, municipalities can disappear and become unincorporated parts of their counties, that is not an option in Connecticut, nor in any New England state, except Maine, where more than 400 settlements, defined as unorganized territories, have no municipal government—ergo, governmental services are provided by the state and the county. Thus it appears that the fiscal fate of this small municipality is very much dependent on resolution of the state budget stalemate—but where part of the state solution is reducing state aid to municipalities.

Connecticut Attorney General George Jepsen has offered a legal opinion which questioned the legality of Gov. Dannel P. Malloy’s plan to administer municipal aid in the absence of a state budget,  he offered the Governor and the legislature one alternative—draft a new state budget. Similarly, Senate Republican leader Len Fasano (R-North Haven), who requested the opinion and has argued the Governor’s plan would overstep his authority, also conceded there may be no plan the Governor could craft—absent a new budget—which would pass legal muster, writing: “We acknowledge the formidable task the Governor faces, in the exercise of his constitutional obligation to take care that the laws are faithfully executed, to maintain the effective operations of state government in the absence of a legislatively enacted budget.” The fiscal challenge: analysts opine state finances, unless adjusted, would run $1.6 billion deficit this fiscal year, with a key reason attributed to surging public retirement benefits and other debt costs, coupled with declining state income tax receipts:  Connecticut is now about 14 weeks into its new fiscal year without an enacted budget—and the fiscal dysfunction has been aggravated by a dispute between Sen. Fasano and Gov. Malloy over the Governor’s plans to handle a program adopted two years ago designed to share sales and use tax receipts with cities and towns: a portion of those funds would go only to communities with high property tax rates to offset revenues they would lose under a related plan to cap taxes on motor vehicles.

Aggravating Fiscal & Human Disparities. The White House has let a 10-day Jones Act shipping waiver expire for Puerto Rico, meaning a significant increase in the cost of providing emergency supplies to the hurricane-ravaged island from U.S. ports, in the wake of a spokesperson for the Department of Homeland Security confirming yesterday that the Jones Act waiver, which expired on Sunday, will not be extended—so that only U.S‒built and‒operated vessels are make cargo shipments between U.S. ports. The repercussions will be fiscal and physical: gasoline and other critical supplies to save American lives will be far more expensive on an island which could be without power for months. The administration had agreed to temporarily lift the Jones Act shipping restrictions for Puerto Rico on September 28th; today, officials have warned that the biggest challenge for relief efforts is getting supplies distributed around Puerto Rico.

Even as President Trump has acted to put more lives and Puerto Rico’s recovery at greater risk, lawmakers in Congress are still pressing to roll back the Jones Act, with efforts led by Sens. John McCain (R-Ariz.) and Mike Lee (R-Utah), the Chairman of the House Water and Power Subcommittee of the Energy and Natural Resources Committee, recently introducing legislation to permanently exempt Puerto Rico from the Jones Act; indeed, at Sen. McCain’s request, the bill has been placed on the Senate calendar under a fast-track procedure that allows it to bypass the normal committee process; it has not, however, been scheduled for any floor time. Sen. McCain stated: “Now that the temporary Jones Act waiver for Puerto Rico has expired, it is more important than ever for Congress to pass my bill to permanently exempt Puerto Rico from this archaic and burdensome law: Until we provide Puerto Rico with long-term relief, the Jones Act will continue to hinder much-needed efforts to help the people of Puerto Rico recover and rebuild from Hurricane Maria.”

The efforts by Sen. McCain and Chairman Lee came as Puerto Rico Gov. Ricardo Rosselló, citing an “unprecedented catastrophe,” urged Congress to provide a significant new influx of money in the near term as Puerto Rico is confronted by what he described as “a massive liquidity crisis:” facing an imminent Medicaid funding crisis, putting nearly one million people at risk of losing their health-care coverage: “[a]bsent extraordinary measures to address the halt in economic activity in Puerto Rico, the humanitarian crisis will deepen, and the unmet basic needs of the American citizens of Puerto Rico will become even greater…Financial damages of this magnitude will subject Puerto Rico’s central government, its instrumentalities, and municipal governments to unsustainable cash shortfalls: As a result, in addition to the immediate humanitarian crisis, Puerto Rico is on the brink of a massive liquidity crisis that will intensify in the immediate future.” Even before Hurricane Maria caused major damage to Puerto Rico’s struggling health-care system, the U.S. territory’s Medicaid program barely had enough funds left to last through the next year; now, however, nearly 900,000 U.S. citizens face the loss of access to Medicaid—more than half of total Puerto Rican enrollment, according to federal estimates: experts predict that unless Congress acts, the federal funding will be exhausted in a matter of months, and, if that happens, Puerto Rico will be responsible for covering all its costs going forward, or, as Edwin Park, Vice President for health policy at the Center on Budget and Policy Priorities notes: “Unless there’s an assurance of stable and sufficient funding…[the health system] is headed toward a collapse.” Nearly half of Puerto Rico’s 3.4 million residents participate in Medicaid; however, because Puerto Rico is a U.S. territory, not a state, Puerto Rico receives only 57 percent of a state’s Medicaid benefits. Under the Affordable Care Act, Puerto Rico received a significant infusion, of about $6.5 billion, to last through FY2019, and, last May, Congress appropriated an additional $300 million. However, those funds were already running low prior to Hurricane Maria, a storm which not only physically and fiscally devastated Puerto Rico and its economy, but also, with the ensuing loss of jobs, meant a critical increase in Medicaid eligibility.

The White House submitted a $29 billion request for disaster assistance; however, none of it was earmarked for Puerto Rico’s Medicaid program. House Energy and Commerce Committee Republicans have proposed giving Puerto Rico an additional $1 billion over the next two years as part of a must-pass bill to fund the Children’s Health Insurance Program (CHIP), with one GOP aide stating the $1 billion is specifically meant to address the Medicaid cliff. Adding more uncertainty: the Senate has not given any indication if it will take up legislation to address Puerto Rico’s Medicaid cliff: The Senate Finance Committee passed its CHIP bill this past week, without any funding for Puerto Rico attached. 

In a three-page letter sent to Congressional leaders, Gov. Ricardo Rosselló is requesting more than $4 billion from various agencies and loan program to “meet the immediate emergency needs of Puerto Rico,” writing that while “We are grateful for the federal emergency assistance that has been provided so far; however, [should aid not be available in a timely manner], “This could lead to an acceleration of the high pace of out-migration of Puerto Rico residents to the U.S. mainland impacting a large number of states as diverse as Florida, Pennsylvania, New Hampshire, Indiana, Wisconsin, Ohio, Texas, and beyond.”

On Puerto Rico’s debt front, with the PROMESA Board at least temporarily relocated to New York City, President Trump has roiled the island’s debt crisis with his suggestion that Puerto Rico’s $73 billion in municipal bond debt load may get erased—or, as he put it: “You can say goodbye to that,” in an interview on Fox News, an interview which appeared to cause a nose dive in the value of Puerto Rico’s municipal bonds, notwithstanding his lack of any authority to unilaterally forgive Puerto Rico’s debt. Indeed, within 24 hours, OMB Budget Director Mick Mulvaney discounted the President’s comments: he said the White House does not intend to become involved in Puerto Rico’s debt restructuring. Indeed, the Trump administration last week sent Congress a request for $29 billion in disaster aid for Puerto Rico, including $16 billion for the government’s flood-insurance program and nearly $13 billion for hurricane relief efforts, according to a White House official. No matter what, however, that debt front looms worse: Gov. Rosselló has warned Puerto Rico could lose up to two months of tax collections as its economic activity is on hold and residents wait for power and basic necessities. Bringing some rational perspective to the issue, House Natural Resource Committee Chair, Rep. Rob Bishop (R-Utah), said the current debt restructuring would proceed under the PROMESA Oversight Board: “Part of the reason to have a board was to have a logical approach [to the debt restructuring]. We need to have this process played out…There’s not going to be one quick panacea to a situation that has developed over a long time…I don’t think it’s time to jump around…when we already have a structure to work with.” Chairman Bishop noted that Hurricane Maria’s devastation would require the board to revise its 10-year fiscal plan, with the goal to achieve a balanced budget pushed back from the current target of FY2019; at the same time, however, Chairman Bishop repeated that the Board must retain its independence from Congress. He also said Congress would consider extending something like the Puerto Rico Oversight, Management, and Economic Stability Act to the U.S. Virgin Islands—an action which would open the door to a debt restructuring for the more than $2 billion in public sector Virgin Islands municipal debt.

The godfather of chapter 9 municipal bankruptcy, Jim Spiotto, noted that it would be Congress, rather than the President, which would pass any municipal bankruptcy legislation, patiently reminding us: “You can’t just use an edict to wipe out debt: If Congress were to wipe out debt, there would be constitutional challenges…Past efforts to repudiate debt debts have had very serious consequences in terms of future access to capital markets and cost of borrowing.” In contrast, if the federal government were to provide something like the Marshall Plan to Puerto Rico, Mr. Spiotto added: the economy could strengthen, and Puerto Rico would be in a position to pay off some its debts.

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.”