Balancing the Odds for Puerto Rico’s Fiscal Future

eBlog, 03/15/17

Good Morning! In this a.m.’s eBlog, we consider the tea leaves from the outcome of yesterday’s snowy session on Puerto Rico in New York City’s Alexander Hamilton Building, where the PROMESA Board considered Puerto Rico Governor Ricardo Rosselló’s most recent efforts to reassert ownership and control of Puerto Rico’s fiscal future.

Is There Promise or UnPromise in PROMESA? The Puerto Rico Oversight Board, meeting yesterday in the Alexander Hamilton Building in New York, unanimously certified the latest turnaround plan by Governor Ricardo Rosselló to alleviate the U.S. territory’s fiscal insolvency, albeit with some critical amendments, including the implementation of a 10% progressive reduction in public pension benefits by FY2020, albeit, as was the case in Detroit’s plan of debt adjustment, adjusted so that no retiree would fall below the federal poverty level: the decade-long plan thus permits the payment of 26.2% of debt due, while imposing austerity measures including partial government employee furloughs and elimination of their Christmas bonus, unless the government meets targets for liquidity and budgeting. The plan would cut pension spending by 10%, in what the Board determined would ensure sufficient fiscal resources to fund 26% of debt due in the next nine years as a “first salvo.” Emphasizing the critical need to address a $50-billion debt load among Puerto Rico’s three main public retirement systems and a depletion of available funds by 2022, the PROMESA Board added it would also formulate efforts to fund existing pension obligations on a pay-as-you-go basis, liquidating assets and using revenues of the government’s General Fund to that end.  Board Executive Director Ramón Ruiz Comas said the Oversight Board wanted to implement additional “safeguards to ensure sufficient liquidity and budgetary savings,” designed to generate $35 to $40 million in monthly savings, including the elimination of Christmas bonus payments to public employees, and a furlough program to begin July 1st—the furlough would eliminate four work days per month for most personnel working in the executive branch, and two work days per month for teachers and other front-line personnel—the furlough would exempt law enforcement personnel. In addition, the Board conditioned the Christmas bonus elimination and work reduction program on the budget proposal for FY2018 which the government is scheduled to submit by April 30: if the government’s liquidity plan and right-sizing measures are able to generate an additional $200 million in cash reserves by June 30th, the furlough program would be deferred to September 1st or eliminated outright; likewise, the removal of Christmas bonuses could be reduced or eliminated if the Oversight Board finds that the government’s plan is producing enough cash-flow. Subsequent to that part of the session, Gerardo Portela, Director of the commonwealth’s Fiscal Agency and Financial Advisory Authority made a presentation on behalf of Puerto Rico’s muncipios of the fiscal plan—a plan which had undergone various changes over last weekend in a contentious set of negotiations between local officials and the PROMESA Board. Puerto Rico Governor Gov. Rosselló Nevares is slated to give a live televised address to provide his public response to the board’s recommendations. 

The Dean of municipal insolvency debt, Jim Spiotto, noted the import of having creditors involved in these efforts, as their support could be vital to spurring reinvestment in Puerto Rico’s economy. Mr. Spiotto’s comments came in the context of a possible agreement by some creditors to reinvest in some part of Puerto Rico, enhancing the possibility that the PROMESA Board may be willing to consider Puerto Rico’s willingness to increase its payback of debt, according to Mr. Spiotto, something which could occur under PROMESA’ Title VI.

At the session, the Oversight Board was asked about the status of debt negotiations with Puerto Rico’s bondholders and about the possibility, already requested by Gov. Ricardo Rosselló, of pushing back a stay on litigation beyond its current end on May 1st—to which Oversight Board member Arthur González responded that negotiations had yet to proceed to an outline with regard to what fiscal resources would be available for debt service: he did say that the fiscal plan would provide such an outline, and that he thought there was real hope to reaching agreements with creditors, adding that the PROMESA Board had yet to determine whether the current stay on litigation should be extended.

Balance or Imbalance. Brad Setser, a senior fellow at the Council on Foreign Relations, told the Bond Buyer that the proposed plan’s near term fiscal austerity may be too severe, warning that the “drag on Puerto Rico’s economy–and ultimately on its ability to collect tax revenues–may still be underestimated.” As in Detroit’s plan of debt adjustment, U.S. Bankruptcy Judge Steven Rhodes’s recognition that preserving the Detroit Institute of Arts was vital to the Motor City’s long-term recovery, so too, Mr. Setser recognizes that any final agreement which would handicap Puerto Rico’s economic growth prospects could backfire.  

 

 

Fiscal & Public Service Insolvency

eBlog, 03/03/17

Good Morning! In this a.m.’s eBlog, we consider the ongoing challenges for the historic municipality of Petersburg, Virginia as it seeks to depart from insolvency; we consider, anew, the issues related to “service insolvency,” especially assisted by the exceptional insights of Marc Pfeiffer at Rutgers, then turning to the new fiscal plan by the Puerto Rico Fiscal Agency and Financial Advisory Authority, before racing back to Virginia for a swing on insolvent links. For readers who missed it, we commend the eBlog earlier this week in which we admired the recent wisdom on fiscal disparities by the ever remarkable Bo Zhao of the Federal Reserve Bank of Boston with regard to municipal fiscal disparities.

Selling One’s City. Petersburg, Virginia, the small, historic, and basically insolvent municipality under quasi state control is now trying to get hundreds of properties owned by the city off the books and back on the tax rolls as part of its effort to help resolve its fiscal and trust insolvency. As Michelle Peters, Economic Development Director for Petersburg, notes: “The city owns over 200 properties, but today we had a showcase to feature about 25 properties that we group together based on location, and these properties are already zoned appropriate for commercial development.” Thus the municipality is not only looking to raise revenues from the sale, but also to realize revenues through the conversion of these empty properties into thriving businesses—or as Ms. Peters puts it: “It’s to get the properties back on the tax rolls for the city, because, currently, the city owns them so they are just vacant, there are no taxes being collected,” much less jobs being filled. Ms. Peters notes that while some of the buildings do need work, like an old hotel on Tabb Street, the city stands ready to offer a great deal on great property, and it is ready to make a deal and has incentives to offer:  “We’re ready to sit down at the table and to negotiate, strike a deal and get those properties developed.”

New Jersey & Its Taken-over City. The $72 million tax settlement between Borgata Hotel Casino & Spa and Atlantic City’s state overseers is a “major step forward” in fixing the city’s finances, according to Moody’s Investors Service, which deemed the arrangement as one that has cleared “one of the biggest outstanding items of concern” in the municipality burdened by hundreds of millions of dollars in debt and under state control. Atlantic City owed Borgata $165 million in tax refunds after years of successful tax appeals by the casino, according to the state. The settlement is projected to save the city $93 million in potential debt—savings which amount to a 22 percent reduction of the city’s $424 million total debt, according to Moody’s, albeit, as Moody’s noted: “[W]hile it does not solve the city’s problems, the settlement makes addressing those problems considerably more likely.” The city will bond for the $72 million through New Jersey’s state Municipal Qualified Bond Act, making it a double whammy: because the bonds will be issued via the state MQBA, they will carry an A3 rating, ergo at a much better rate than under the city’s Caa3 junk bond status. Nevertheless, according to the characteristically moody Moody’s, Atlantic City’s finances remain in a “perilous state,” with the credit rating agency citing low cash flow and an economy still heavily dependent upon gambling.

Fiscal & Public Service Insolvency. One of my most admired colleagues in the arena of municipal fiscal distress, Marc Pfeiffer, Senior Policy Fellow and Assistant Director of the Bloustein Local Government Research Center in New Jersey, notes that a new twist on the legal concept of municipal insolvency could change how some financially troubled local governments seek permission to file for federal bankruptcy protection. Writing that municipal insolvency traditionally means a city, county, or other government cannot pay its bills, and can lead in rare instances to a Chapter 9 bankruptcy filing or some other remedy authorized by the state that is not as drastic as a Chapter 9, he notes that, in recent years, the description of “insolvency” has expanded beyond a simple cash shortage to include “service-delivery insolvency,” meaning a municipality is facing a crisis in managing police, fire, ambulance, trash, sewer and other essential safety and health services, adding that service insolvency contributed to Stockton, California, and Detroit filings for Chapter 9 bankruptcy protection in 2012 and 2013, respectively: “Neither city could pay its unsustainable debts, but officials’ failure to curb violent crime, spreading blight and decaying infrastructure was even more compelling to the federal bankruptcy judges who decided that Stockton and Detroit were eligible to file for Chapter 9.”

In fact, in meeting with Kevyn Orr, the emergency manager appointed by Michigan Governor Rick Snyder, at his first meeting in Detroit, Mr. Orr recounted to me that his very first actions had been to email every employee of the city to ensure they reported to work that morning, noting the critical responsibility to ensure that street lights and traffic lights, as well as other essential public services operated. He wanted to ensure there would be no disruption of such essential services—a concern clearly shared by the eventual overseer of the city’s historic chapter 9 municipal bankruptcy, now retired U.S. Bankruptcy Judge Steven Rhodes, who, in his decision affirming the city’s plan of debt adjustment, had written: “It is the city’s service delivery insolvency that the court finds most strikingly disturbing in this case…It is inhumane and intolerable, and it must be fixed.” Similarly, his colleague, U.S. Bankruptcy Judge Christopher Klein, who presided over Stockton’s chapter 9 trial in California, had noted that without the “muscle” of municipal bankruptcy protection, “It is apparent to me the city would not be able to perform its obligations to its citizens on fundamental public safety as well as other basic public services.” Indeed, in an interview, Judge Rhodes said that while Detroit officials had provided ample evidence of cash and budget insolvency, “the concept of service delivery insolvency put a more understanding face on what otherwise was just plain numbers.” It then became clear, he said, that the only solution for Detroit—as well as any insolvent municipality—was “fresh money,” including hundreds of millions of dollars contributed by the state, city, and private foundations: “It is a rare insolvency situation—corporate or municipal—that can be fixed just by a change in management.”

Thus, Mr. Pfeiffer writes that “Demonstrating that services are dysfunctional could strengthen a local government’s ability to convince a [federal bankruptcy] judge that the city is eligible for chapter 9 municipal bankruptcy protection (provided, of course, said municipality is in one the eighteen states which authorize such filings). Or, as Genevieve Nolan, a vice president and senior analyst at Moody’s Investors Service, notes: “With their cases focusing on not just a government’s ability to pay its debts, but also an ability to provide basic services to residents, Stockton and Detroit opened a path for future municipal bankruptcies.”

Mr. Pfeiffer notes that East Cleveland, Ohio, was the first city to invoke service insolvency after Detroit. In its so far patently unsuccessful efforts to obtain authority from the State of Ohio to file for municipal bankruptcy protection—in a city, where, as we have noted on numerous occasions, the city has demonstrated a fiscal inability to sustain basic police, fire, EMS, or trash services. East Cleveland had an approved plan to balance its budget, but then-Mayor Gary Norton told the state the proposed cuts “[would] have the effect of decimating our safety forces.” Ohio state officials initially rejected the municipality’s request for permission to file for municipal bankruptcy, because the request came from the mayor instead of the city council; the city’s status has been frozen since then.

Mr. Pfeiffer then writes:

Of concern.  [Municipal] Bankruptcy was historically seen as the worst case scenario with severe penalties – in theory the threat of it would prevent local officials from doing irresponsible things. [Indeed, when I first began my redoubtable quest with the Dean of chapter 9 municipal bankruptcy Jim Spiotto, while at the National League of Cities, the very idea that the nation’s largest organization representing elected municipal leaders would advocate for amending federal laws so that cities, counties, and other municipal districts could file for such protection drew approbation, to say the least.] Local officials are subject to such political pressures that there needs to be a societal “worst case” that needs to be avoided.  It’s not like a business bankruptcy where assets get sold and equity holders lose investment.  We are dealing with public assets and the public, though charged with for electing responsible representatives, who or which can’t be held fully responsible for what may be foolish, inept, corrupt, or criminal actions by their officials. Thus municipal bankruptcy, rather than dissolution, was a worst case scenario whose impact needed to be avoided at all costs. Lacking a worst case scenario with real meaning, officials may be more prone to take fiscal or political risks if they think the penalty is not that harsh. The current commercial practice of a structured bankruptcy, which is commonly used (and effectively used in Detroit and eventually in San Bernardino and other places) could become common place. If insolvency were extended to “service delivery,” and if it becomes relatively painless, decision-making/political risk is lowered, and political officials can take greater risks with less regard to the consequences. In my view, the impact of bankruptcy needs to be so onerous that elected officials will strive to avoid it and avoid decisions that may look good for short-term but have negative impact in the medium to long-term and could lead to serious consequences. State leaders also need to protect their citizens with controls and oversight to prevent outliers from taking place, and stepping in when signs of fiscal weakness appear.”

Self-Determination. Puerto Rico Gov. Ricardo Rosselló has submitted a 10-year fiscal plan to the PROMESA Oversight Board which would allow for annual debt payments of about 18% to 41% of debt due—a plan which anticipates sufficient cash flow in FY2018 to pay 17.6% of the government’s debt service. In the subsequent eight years, under the plan, the government would pay between 30% and 41% per year. The plan, according to the Governor, is based upon strategic fiscal imperatives, including restoring credibility with all stakeholders through transparent, supportable financial information and honoring the U.S. territory’s obligations in accordance with the Constitution of Puerto Rico; reducing the complexity and inefficiency of government to deliver essential services in a cost-effective manner; implementing reforms to improve Puerto Rico’s competitiveness and reduce the cost of doing business; ensuring that economic development processes are effective and aligned to incentivize the necessary investments to promote economic growth and job creation; protecting the most vulnerable segments of our society and transforming our public pensions system; and consensually renegotiating and restructuring debt obligations through Title VI of PROMESA. The plan he proposed, marvelously on the 100th anniversary of the Jones-Shafroth Act making Puerto Rico a U.S. territory, also proposes monitoring liquidity and managing anticipated shortfalls in current forecast, and achieving fiscal balance by 2019 and maintaining fiscal stability with balanced budgets thereafter (through 2027 and beyond). The Governor notes the Fiscal Plan is intended to achieve its objectives through fiscal reform measures, strategic reform initiatives, and financial control reforms, including fiscal reform measures that would reduce Puerto Rico’s decade-long financing gap by $33.3 billion through:

  • revenue enhancements achieved via tax reform and compliance enhancement strategies;
  • government right-sizing and subsidy reductions;
  • more efficient delivery of healthcare services;
  • public pension reform;
  • structural reform initiatives intended to provide the tools to significantly increase Puerto Rico’s capacity to grow its economy;
  • improving ease of business activity;
  • capital efficiency;
  • energy [utility] reform;
  • financial control reforms focused on enhanced transparency, controls, and accountability of budgeting, procurement, and disbursement processes.

The new Fiscal Plan marks an effort to achieve fiscal solvency and long-term economic growth and to comply with the 14 statutory requirements established by Congress’ PROMESA legislation, as well as the five principles established by the PROMESA Oversight Board, and intended to sets a fiscal path to making available to the public and creditor constituents financial information which has been long overdue, noting that upon the Oversight Board’s certification of those fiscal plans it deems to be compliant with PROMESA, the Puerto Rico government and its advisors will promptly convene meetings with organized bondholder groups, insurers, union, local interest business groups, public advocacy groups and municipality representative leaders to discuss and answer all pertinent questions concerning the fiscal plan and to provide additional and necessary momentum as appropriate, noting the intention and preference of the government is to conduct “good-faith” negotiations with creditors to achieve restructuring “voluntary agreements” in the manner and method provided for under the provisions of Title VI of PROMESA.

Related to the service insolvency issues we discussed [above] this early, snowy a.m., Gov. Rosselló added that these figures are for government debt proper—not the debt of issuers of the public corporations (excepting the Highways and Transportation Authority), Puerto Rico’s 88 municipalities, or the territory’s handful of other semi-autonomous authorities, and that its provisions do not count on Congress to restore Affordable Care Act funding. Rather, Gov. Rosselló said he plans to determine the amount of debt the Commonwealth will pay by first determining the sums needed for (related to what Mr. Pfeiffer raised above] “essential services and contingency reserves.” The Governor noted that Puerto Rico’s debt burden will be based on net cash available, and that, if possible, he hopes to be able to use a consensual process under Title VI of PROMESA to decide on the new debt service schedules. [PROMESA requires the creation of certified five-year fiscal plan which would provide a balanced budget to the Commonwealth, restore access to the capital markets, fund essential public services, and pensions, and achieve a sustainable debt burden—all provisions which the board could accept, modify, or completely redo.]  

Adrift on the Fiscal Links? While this a.m.’s snow flurries likely precludes a golf outing, ACA Financial Guaranty Corp., a municipal bond insurer, appears ready to take a mighty swing for a birdie, as it is pressing for payback on the defaulted debt which was critical to the financing of Buena Vista, Virginia’s unprofitable municipal golf course, this time teeing the proverbial ball up in federal court. Buena Vista, a municipality nestled near the iconic Blue Ridge of some 2,547 households, and where the median income for a household in the city is in the range of $32,410, and the median income for a family was $39,449—and where only about 8.2 percent of families were below the poverty line, including 14.3 percent of those under age 18 and 10 percent of those age 65 or over. Teeing the fiscal issue up is the municipal debt arising from the issuance by the city and its Public Recreational Facilities Authority of some $9.2 million of lease-revenue municipal bonds insured by ACA twelve years ago—debt upon which the municipality had offered City Hall, police and court facilities, as well as its municipal championship golf course as collateral for the debt—that is, in this duffer’s case, municipal debt which the municipality’s leaders voted to stop repaying, as we have previously noted, in late 2015. Ergo, ACA is taking another swing at the city: it is seeking:

  • the appointment of a receiver appointed for the municipal facilities,
  • immediate payment of the debt, and
  • $525,000 in damages in a new in the U.S. District Court for Western Virginia,

Claiming the municipality “fraudulently induced” ACA to enter into the transaction by representing that the city had authority to enter the contracts. In response, the municipality’s attorney reports that Buena Vista city officials are still open to settlement negotiations, and are more than willing to negotiate—but that ACA has refused its offers. In a case where there appear to have been any number of mulligans, since it was first driven last June, teed off, as it were, in Buena Vista Circuit Court, where ACA sought a declaratory judgment against the Buena Vista and the Public Recreational Facilities Authority, seeking judicial determination with regard to the validity of its agreement with Buena Vista, including municipal bond documents detailing any legal authority to foreclose on city hall, the police department, and/or the municipal golf course. The trajectory of the course of the litigation, however, has not been down the center of the fairway: the lower court case took a severe hook into the fiscal rough when court documents filed by the city contended that the underlying municipal bond deal was void, because only four of the Buena Vista’s seven City Council members voted on the bond resolution, not to mention related agreements which included selling the city’s interest in its “public places.” Moreover, pulling out a driver, Buena Vista, in its filing, wrote that Virginia’s constitution filing, requires all seven council members to be present to vote on a matter which involved backing the golf course’s municipal bonds with an interest in facilities owned by the municipality. That drive indeed appeared to earn a birdie, as ACA then withdrew its state suit; however, it then filed in federal court, where, according to its attorney, it is not seeking to foreclose on Buena Vista’s municipal facilities; rather, in its new federal lawsuit, ACA avers that the tainted vote supposedly invalidating the municipality’s deed of trust supporting the municipal bonds and collateral does not make sense, maintaining in its filing that Buena Vista’s elected leaders had adopted a bond resolution and made representations in the deed, the lease, the forbearance agreement, and in legal opinions which supported the validity of the Council’s actions, writing: “Fundamental principles of equity, waiver, estoppel, and good conscience will not allow the city–after receiving the benefits of the [municipal] bonds and its related transactions–to now disavow the validity of the same city deed of trust that it and its counsel repeatedly acknowledged in writing to be fully valid, binding and enforceable.” Thus, the suit requests a judgment against Buena Vista, declaring the financing documents to be valid, appointing a receiver, and an order granting ACA the right to foreclose on the Buena Vista’s government complex in addition to compensatory damages, with a number of the counts seeking rulings determining that Buena Vista and the authority breached deed and forbearance agreements, in addition to an implied covenant of good faith and fair dealing, requiring immediate payback on the outstanding bonds, writing: “Defendants’ false statements and omissions were made recklessly and constituted willful and wanton disregard.” In addition to compensatory damages and pre-and post-judgment interest, ACA has asked the U.S. court to order that Buena Vista pay all of its costs and attorneys’ fees; it is also seeking an order compelling the city to move its courthouse to other facilities and make improvements at the existing courthouse, including bringing it up to standards required by the ADA.

Like a severe hook, the city’s municipal public course appears to have been errant from the get-go: it has never turned a profit for Buena Vista; rather it has required general fund subsidies totaling $5.6 million since opening, according to the city’s CAFR. Worse, Buena Vista notes that the taxpayer subsidies have taken a toll on its budget concurrent with the ravages created by the great recession: in 2010, Buena Vista entered a five-year forbearance agreement in which ACA agreed to make bond payments for five years; however, three years ago, the city council voted in its budget not to appropriate the funds to resume payment on the debt, marking the first default on the municipal golf course bond, per material event notices posted on the MSRB’s EMMA.

A Midwestern Tale of Two Cities

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eBlog, 2/14/17

Good Morning! In this a.m.’s eBlog, we consider the tale of two cities in Detroit: is a city set to displace Chicago as the capitol of the Midwest—or is a city with its fiscal future in re-jeopardy, because of its inability and conflicts with the state over how to educate its children in a way that will create incentives for families to want to move back into the city?

Post Chapter 9 Reinvention? In opting to relocate its regional headquarters to downtown Detroit, Microsoft has sent a message that the city’s emergence from the largest chapter 9 municipal bankruptcy in American history is a success: the city is even threatening to displace Chicago as a regional headquarters of choice for the Midwest. That’s an honor long owned by Chicago. The extraordinary changes in the city—fashioned through the path-breaking efforts not just of former emergency manager Kevyn Orr and now retired U.S. Bankruptcy Judge Steven Rhodes, but also the fiscal rebuilding blueprint, the city’s court-approved plan of debt adjustment, a plan aptly described by the Detroit News an “arc of change, the redemptive power of reinvention, and critical facts on the ground say a bid by Detroit and southeast Michigan to be part of that conversation could be real for those with the courage to take a real, hard look.”  The paper, continuing its own comparison of Detroit to the Windy City—two cities which appear to be fiscally headed in opposite directions, aptly notes the respective state roles, contentious as they are, but noting that while the Michigan government is “aggressively attacking its unfunded liabilities,” instead of being (in Illinois) a state legislature “deaf to the fiscal ticking time bomb of its state pensions.” An iconic city’s recovery from bankruptcy is, after all, not just designing and implementing an architectural and fiscal turnaround, but also reversing the fiscal and economic momentum; thus, unsurprisingly, in a reminder of the old aphorism: “Go West, young man;” today it is civic leader, Quicken Loans Inc. Chairman Dan Gilbert who actively recruits young talent to the Motor City, telling potential new Detroiters: anyone can go work in Chicago and most will change nothing, but you could make a difference working and living in Detroit. Or, as the News describes it: “So could companies looking to reduce costs, find a vibrant food, arts and culture scene, and join an enthusiastic business community with global connections. They could find both in Detroit. Or in Ann Arbor, with the University of Michigan.”  

Might There Be a Fly in the State Ointment? Yet for a city one-third its former size, the more pressing challenge to its fiscal future is likely to rest on the perceived quality of its public schools—schools in a city where the Detroit Public School system became physically and fiscally insolvent—and where the state intervened to not just appoint an emergency manager, but also where the legislature created and imposed what some deem the nation’s most economically disparate school system—or, as the New Jersey nonprofit EdBuild, in its report “Fault Lines: America’s Most Segregating School District Borders,” described it: nearly half of the households in Detroit Public Schools—49.2%—live in poverty, compared with 6.5% in Grosse Pointe Public Schools—with the non-profit noting to the Detroit News: “Fault Lines shows how school finance systems have led to school segregation along class lines within communities around the country, and how judicial and legislative actions have actually served to strengthen these borders that divide our children and our communities:” its report traces the economic gap between Detroit and Grosse Pointe schools to a 1974 U.S. Supreme Court ruling, Milliken v. Bradley, which blocked busing between districts to achieve racial integration, writing: “Income segregation in the Detroit metropolitan area parallels the racial segregation that inspired the Milliken case and has worsened since the case was first argued.” Today, there are some 97 traditional public schools in Detroit, 98 charter schools, and 14 schools in the Education Achievement Authority, a controversial state-run district created in 2012—that is, there are an estimated 30,000 more seats than students in the city in the wake of the state’s 2015 “rescue” of the Detroit Public Schools—a rescue of a public school district which had been under state control, and a rescue which pledged some $617 million to address the debt, but also invoked a number of unorthodox “reforms” which state legislators argued would promise a brighter future: the reforms included provisions which permit the hiring uncertified teachers, penalization of striking employees, and the outsourcing of academic roles, like the superintendent position, to surrounding districts, and the state closure of all schools that fall in the bottom 5 percent of academic performance for three years in a row: a category into which dozens of Detroit public schools fall. The state also authorized charter schools for Detroit.

Now, a new Michigan School Reform Office school closing plan has reignited debate in Detroit over how to fix the Motor City’s fractured system of public schools, less than seven months after the Michigan Legislature spent $617 million relieving Detroit Public Schools of crushing debt which had hovered on the brink of its own chapter 9 municipal bankruptcy. Indeed, the perceived fiscal threat to the city’s future has led Mayor Mike Duggan to deem the state school closing plan “irrational,” because many of the other nearby public schools in Detroit are on the brink of being deemed failing schools—or, as Mayor Duggan noted: “You don’t throw people out of the boat without looking out to see if there’s a life raft.” Moreover, the Mayor and the newly elected Board of Education for the Detroit Public Schools Community District have threatened to sue Gov. Rick Snyder’s administration to stop the proposed closures—closures which the state is evaluating to determine whether such closures would create unreasonable hardships for students, such as distance to other schools with capacity, if the buildings are closed. Ergo, unsurprisingly, Governor Snyder is confronting pressure from school leaders, parents, businesses and civic groups to consider the impact that another round of school closings might have on Detroit’s ongoing recovery—and on its neighborhoods and commercial corridors hard hit by decades of abandonment and disinvestment—or, as Veronica Conforme, Chancellor of the Education Achievement Authority, notes: such closures would “cause disruption in the neighborhoods.”

The state-municipal tussle relates to the tug-of-rope state-local challenge about how to address Detroit’s worst-performing schools under a 7-year-old state statute which has never been fully enforced—and comes as the Michigan School Reform Office has announced that twenty-five Detroit schools may be closed in June due to persistently low student test scores—creating apprehension that these closures, coming at a time when then city’s focus on fuller implementation of its approved plan of debt adjustment envisions revitalization shifting from downtown and Midtown to Detroit’s vast neighborhoods and commercial corridors. Unsurprisingly, some business and community leaders are concerned that the impact mass school closings could undercut the city’s efforts to turn around pockets of the city which have been showing signs of rebirth, or, as Sandy Baruah, President and CEO of the Detroit Regional Chamber, who worries that abruptly closing two dozen schools could “create other crises” in city neighborhoods, puts it: “I don’t want to see neighborhoods that are on the early path to recovery be dealt a setback.” That is, in the post chapter 9 city, rebuilding neighborhoods must go hand in hand with schools: the presence of a school, after all, affects the assessed values of properties, residential and commercial, in a neighborhood.

Fighting for Cities’ Futures

eBlog, 1/23/17

Good Morning! In this a.m.’s eBlog, we consider the ongoing fiscal and governing challenge to Detroit’s future—especially with regard to the quality of education for the city’s future leaders; then we learn from one of the unsung heroes, retired U.S. Judge Gerald Rosen, about his reflections and role in Detroit’s exit from the largest municipal bankruptcy in American history. Then we return to the historic Virginia municipality of Petersburg, where, in its struggle to exit insolvency, a citizen effort is underway to recall its elected leaders. Finally, in the category of ‘when it rains it pours,’ we consider the city hall relocation underway in San Bernardino—one month before it hopes to gain U.S. Bankruptcy Judge Meredith Jury’s approval of the city’s plan of debt adjustment, permitting the city to egress from the longest municipal bankruptcy in American history.

Fighting for Detroit’s Fiscal Future. The City of Detroit is siding with seven Detroit public schoolchildren suing Gov. Rick Snyder and Michigan state education officials over their right to access literacy. (See Jessie v. Snyder, #16-CV-13292, U.S. District Court), having filed an amicus brief in a proposed class action lawsuit against Gov. Snyder and Michigan education officials in a legal challenge seeking to establish that literacy is a U.S. constitutional right. The suit, which was filed last September by a California public interest law firm, claims the state has functionally excluded Detroit children from the state’s educational system; the suit seeks class-action status and several guarantees of equal access to literacy, screening, intervention, a statewide accountability system, as well as other measures. Detroit’s amicus brief urged the court to hold access to literacy as being fundamental, arguing the plaintiffs have alleged sufficient facts to show they are being denied that right: “Denying children access to literacy today inevitably impedes tomorrow’s job seekers and taxpayers; fathers and mothers; citizens and voters…That is why the Supreme Court has stressed the ‘significant social costs borne by our nation’ when children suffer the ‘stigma of illiteracy’—and are thereby denied ‘the basic tools by which (to) lead economically productive lives to the benefit of us all…The City of Detroit (though it does not control Detroit’s schools) is all too familiar with illiteracy’s far-reaching effects.”

A critical fiscal issue for every city and county is the perceived quality of its public schools—a perception critical to encouraging families with children to move into the city—thereby positively affecting assessed property values. The challenge has been greater in Detroit, where the schools’ fiscal and educational insolvencies led to the appointment of former U.S. Bankruptcy Judge Steven Rhodes to serve as DPS’s Emergency Manager. In Detroit, politics at the state level imposing a disproportionate number of charter schools has meant that today Detroit has a greater share of students in charters than any U.S. city except New Orleans; however, half the charters perform only as well, or worse than, Detroit’s traditional public schools—mayhap a challenge of having a state attempt to substitute itself over local control. Perhaps former state representative Thomas F. Stallworth III, who helped navigate the passage of the 2014 legislation that paved Detroit’s way out of bankruptcy, put it more succinctly: “We’ll either invest in our own children and prepare them to fill these jobs, or I suppose maybe people will migrate from other places in the country to fill them…If that’s the case, we are still left with this underbelly of generational poverty with no clear path out.”

But, in Michigan, it appears that it has been for-profit companies that expressed the greatest interest: they now operate about 80 percent of charters in Michigan, far more than in any other state. In the wake of the state action, and even as Michigan and Detroit continued to preside over an exodus of families, the number of charter schools grew: Michigan today has nearly 220,000 fewer students than it did in 2003, but more than 100 new charter schools. The number not only grew, but the legislature made sure accountability did not: the legislature in 2012 repealed in the Revised School Code Act 451 the state’s longstanding requirement that the Michigan Department of Education issue annual reports monitoring charter school performance; and the state even created a state-run school district, with new charters, in an effort to try to turn around Detroit’s lowest performing schools. Indeed, 24 charter schools have opened in Detroit since the legislature removed the cap 2011: eighteen charters whose existing schools were at or below Detroit’s dismal performance expanded or opened new schools—that despite increasing evidence students in one company’s schools grew less academically than students in the neighboring traditional public schools. By 2015, the Education Trust-Midwest Michigan noted that charter school authorizers’ performance overall had improved marginally over the previous year, but remained terribly low compared to leading states’ charter sectors, in its report, Accountability for All: 2016, The Broken Promise of Michigan’s Charter Sector. The report celebrates high-performing authorizers and sheds light on the devastatingly low performance of other authorizers, adding that roughly one-quarter of one group’s eligible schools ranked among the worst performing 10 percent of schools statewide. Similarly, according to the Trust, a federal review of a grant application for Michigan charter schools found an “unreasonably high” number of charters among the worst-performing 5 percent of public schools statewide, even as the number of charters on the list had doubled from 2010 to 2014.

The great press to create charter schools has led to another challenge: today Detroit has roughly 30,000 more seats, charter and traditional public, than students. For a system desperate for investment in quality education, instead it has badly failed in elementary math; and there is great risk of a discriminatory system: Detroit Public Schools today bears the human and fiscal burden of trying to educate most of Detroit’s special education students. In contrast, charter schools are concentrated downtown, with its boom in renovation and wealthier residents. With only 1,894 high school age students, there are 11 high schools. Meanwhile, northwest Detroit — where it seems every other house is boarded up, burned or abandoned — has nearly twice the number of high school age students, 3,742, and just three high schools. The northeastern part of the city is even more of an education desert: 6,018 high school age students and two high schools.

Like others elsewhere, charter schools receive roughly the same per-pupil state dollars as public schools; however, in Detroit, it is about $7,300 a year — roughly half what New York or Boston schools get, and about $3,500 less than charters in Denver or Milwaukee.

With the significant fiscal challenges to the Detroit Public Schools, Mayor Mike Duggan had proposed an appointed Detroit Education Commission to determine which neighborhoods most needed new schools and to set standards to close failing schools and ensure that only high performing or promising ones could replicate. Backed by a coalition of philanthropies and civic leaders, the teachers’ union and some charter school operators, Mayor Duggan has succeeded in restoring local control of majority-black Detroit Public Schools, and supported the proposal. In the waning days of the legislative session, House Republicans offered a deal: $617 million to pay off the debt of the Detroit Public Schools, but no commission. Lawmakers were forced to take it to prevent the city school system from going bankrupt.

An Interview with Gerald Rosen. U.S. District Court Judge Gerald Rosen, who, as we have written, played an invaluable role in the so-called “Grand Bargain,” which paved the way for Detroit to exit the largest chapter 9 municipal bankruptcy in U.S. history—and who will now join retired U.S. Bankruptcy Judge Steven Rhodes, who presided over Detroit’s municipal bankruptcy, in an interview with the Detroit Free Press, said, in response to the query how well Detroit was doing in adhering to its court approved plan of debt adjustment:  “We are hitting the marks, exceeding them in most areas — certainly revenue, I think the last report I saw was about 2 percent above the projected revenue. On budget. Expenditures are below — not much — but slightly below what was projected. Those are two important things…Certainly, investment and growth in the downtown area, certainly Midtown, and with the Ilitch development coming to fruition, the Red Wings, Pistons, some of the entertainment venues becoming a reality now, I expect the area between Midtown and downtown will become very vibrant over the next two-three years.”

Asked what the most difficult part of that case was, aside from the Grand Bargain, Judge Rosen responded: “You have to go back and see what the case was when we found it, which was an assetless bankruptcy. That was the most difficult part, for me. Certainly, there were a lot of first-impression legal issues. Certainly there were issues that could have gone all the way up to the U.S. Supreme Court, whether it was the collision between the federal bankruptcy code and the federal constitutional supremacy clause and the Michigan Constitution’s provisions to protect pensions. But there were also a lot of other really important issues: The tenor of the security instruments, of the finance instruments, the level and tenor of their security, were all major issues in the bankruptcy, whether they could be crammed down all across the rope line on the financial creditors’ side were really first-impression issues.” He added: “Overwhelmingly, the most challenging issue for me was an assetless bankruptcy—other than the art. I’ll never forget when I was reading Kevyn Orr’s proposal for creditors, coming to the asset section and realizing that there really weren’t any assets other than the art…It was devastating. Kevyn, he had just hired Christie’s to appraise the art, so he was clearly serious about it. I remember thinking, ‘What the hell have I gotten myself into?’ My job is to get deals. To get deals, you have to have revenue or assets that can be monetized into revenue, and the cupboard was pretty much bare. There didn’t seem to be much to work with for deals, other than the art.

There were other aspects to the DIA that I was concerned about. This was a time when Detroit was cannibalizing its heritage to mortgage its future, consistently over the decades. In terms of Detroit’s future, it didn’t make sense to me to do that again, but I was realistic.

Time was Detroit’s enemy. The only way to get through the bankruptcy in any sort of expeditious way was through consensual agreements, and the only asset that could be monetized was the art. So that’s basically what led to the idea of the Grand Bargain—trying to figure out a way to monetize the art without liquidating it, and giving the proceeds to the retirees. Neat trick.

I’ll never forget sitting in this little condo (in Florida) thinking, “What the hell have I gotten myself into? Is my legacy going to be that we liquidated one of the great art collections in the world for sheikhs in Dubai and oligarchs in Russia?” I wasn’t very excited about that.

There was another aspect too. One of the few nascently growing areas in Detroit was Midtown. I went on the DIA website and I saw that the DIA attracted over 600,000 people a year to Midtown. I thought, “Gee whiz, liquidating the DIA would be like dropping a hydrogen bomb in Midtown.” It would suck the life out of it. So there was that part of it.”

What would be the theme song for Detroit’s bankruptcy case?

“Don’t Stop Thinking About Tomorrow.”

We might be having some new City Council members a year from now. What would you suggest to the new ones potentially coming on board?

“I’m not in politics. I’m not a political person in the sense of being involved in the political maw, but my observation is that Mayor (Mike) Duggan is working very positively with President (Brenda) Jones and other members of the council in a way that has not been done by any mayor in years and years.

“At the same time, my word of caution is that we have to be careful to continue to provide the fertile ground that Detroit is for investment for people coming in. Part of that is not placing onerous regulation on people coming in, with artificial employment requirements. I understand the social need for that and I applaud it. I think if Detroit is going to continue the comeback that we are on, the neighborhoods have to be part of it and the African-American population has to be part of it. But you can’t disincentivize people coming in.”

You think that’s been done recently?

“I’m a little bit concerned about the community benefits ordinance. The one that was passed was certainly better than the alternative, but I’m still leery of it because it’s creating entry barriers.”

What was the most surprising individual (Kwame Kilpatrick text) message you saw?

“A lot of that is sealed. I would just refer to it generically by saying there was very little public business conducted by the Mayor and his associates. I’m sure they conducted business by communication means other than texts, but these were city-provided pagers. I assume that the city provided the pagers for people to be able to conduct city business on them, and I saw very little. I learned a lot of new text language that I hadn’t known before, and I appreciate urbandictionary.com.”

Twenty-four hours left in the Obama administration. It’s pardon and commutation time. Does the former mayor deserve one?

No. Absolutely not. I have to be a little cautious, but I presided over that grand jury for 2 ½ years.

Political Leadership & Municipal Insolvency. In Virginia, Petersburg residents who blame their elected municipal leaders for their city’s collapse into insolvency have filed dual petitions to oust both the incumbent and former mayor from their City Council seats—after, over months, gathering the legally required number of signatures from registered voters of Wards 3 and 5 to ask for the removal of Mayor Samuel Parham and W. Howard Myers, whose term as mayor ended this month; both are up for re-election next year. According to the petition, Mayor Parham “has conducted himself in the office of City Councilman, Vice Mayor and Mayor in such a way to govern the City of Petersburg chaotically, unpredictably, secretly and wastefully.” The two-page cover sheet to the petition has garnered 276 certified signatures. (Virginia law requires the petitioners to gather signatures equal to 10 percent of the voter turnout in the contest that resulted in an official’s initial election. For Parham, the number is 160.) The petitions were filed on January 20th in Petersburg Circuit Court under a provision in Virginia law which allows the court to remove officials for specific reasons, which includes certain criminal convictions. Here, in this instance, petitioners cited “neglect of duty, misuse of office, or incompetence in the performance of duties,” faulting the current and former mayor with failing to heed warnings of Petersburg’s impending insolvency, but also alleging ethical breaches and violations of open government law. “Nothing has happened in the new year, with the installation of new council officers, to demonstrate that Myers or Parham are any more capable of providing effective oversight of city government than they have over the past two years,” according to Ms. Barb Rudolph, a local activist and organizer of the good government group Clean Sweep Petersburg. The effort came as Petersburg’s mounting legal claims have now exceeded nearly $19 million in past-due invoices and the city’s budget which was $12 million over budget: the municipality has experienced a stretch of structurally imbalanced budgets dating back to 2009. The City Council fired former City Manager William E. Johnson II last March. For his part, Mayor Parham defended his decisions since taking office, reporting he has done the best he could with the guidance he has received, and noting: “I serve at the pleasure of the people of Petersburg and, with God as my witness, I have tried my best.”

The ouster filings came as former Richmond City Manager, now consultant Robert Bobb, has been hired by the City Council to try to put the city back into solvency. Mr. Bobb has issued a request for a forensic audit of spending over the past three fiscal years—notwithstanding reservations expressed by City Attorney Joseph Preston, who noted that the city’s finances are included in a special grand jury investigation which began as a probe of the Petersburg Police Department. Petersburg obtained short-term financing last month to help meet payroll and other ongoing expenses, with Mr. Bobb reporting the cost of Petersburg’s outstanding invoices has been cut from nearly $19 million to about $6 million. Next comes a session to meet with about 400 of the city’s vendors to try to begin to sort out what they are owed, with a city spokesperson Thursday stating the Petersburg has entered into a payment plan to make good on Petersburg’s share of employee and school worker pensions overdue to the Virginia Retirement System: Petersburg and the city school division collectively owed just over $4.2 million to the system as of last week; however, current payments have resumed, and plans are in place to pay down the balance by $100,000 each month, officials said.

The citizen petitions focus largely on events from last year, but reference years of mounting trouble. The issue for the courts is sufficiency, as a judge in Bath County last week demonstrated when the judge dismissed a similar petition to remove three members of the county’s Board of Supervisors, finding the complaints raised by residents there were insufficient to require a judicial reversal of election results. However, Ms. Rudolph said the Petersburg petitions contain more serious charges, noting: “We believe that, on its merits, it’s far more substantive than the Bath County removal action that was recently rejected by the circuit court there.” Included among the two-page list of grievances documenting reasons for Mayor Myers’ removal were allegations he had “flagrantly and repeatedly acted in contravention of the City of Petersburg’s Code of Ethics” by attempting to “intimidate and silence a critic,” who remains unnamed, by “attempting to harm the citizen’s good standing with her employer.” Petitioners also criticized the Myers-led council for possibly violating the Council’s own rules and the city charter in holding a re-do of a vote to bring in the Bobb Group two days after an initial measure to hire the firm failed. City Attorney Preston has said that the Council did nothing wrong.

Quake & Shake. San Bernardino, on track to end the longest chapter 9 municipal bankruptcy in U.S. history next month, now faces a physical and fiscal challenge not listed in its plan of debt adjustment: a substantial earthquake risk. San Bernardino has two independent engineering evaluations — from 2007 and 2016 — saying City Hall would be unsafe in an earthquake. Specifically, the February 2016 study concludes a magnitude 6.0 earthquake would lead to “a likelihood of building failure” for City Hall, which was designed before code updates following the 1971 Sylmar and 1994 Northridge earthquakes. The building sits along two fault lines. That means the City has plans for vacating City Hall by April, as all employees move out of a building determined to be a substantial earthquake risk, with the approximately 200 municipal employees set to relocate to several leased sites set by a unanimous Council vote. A public information counter will direct members of the public to whatever service they’re seeking, as will signs.

How Can Learning from the Past Enrich the Fiscal Future?

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eBlog, 1/11/17

Good Morning! In this a.m.’s eBlog, we consider the post-election, post-chapter 9 governing future for Stockton, before heading to the wintry streets of Detroit, where the transfer of authority and governance of the Detroit Public Schools from state back to local control in the wake of the system’s previous physical and fiscal insolvency will make for a steep learning curve—but where getting it right will be invaluable for Detroit to have a sustainable fiscal future.

A New Post-Bankruptcy Beginning. A ceremony in the heart of downtown Stockton this week marked the beginning of a new era in post-bankrupt Stockton’s municipal governance with the swearing-in of Mayor Michael Tubbs and City Council members Jesaos Andrade, Susan Lenz, and Dan Wright.  Mayor Tubbs had chosen his grandmother, Barbara Nicholson to ceremonially swear him in—after, five years ago, being sworn in by his mother in the wake if his first election to the city council in November 2012. The City’s spokeswoman, Connie Cochran, said the election of Mayor Tubbs, the youngest mayor ever in a large American city and Stockton’s first black mayor, continues to receive national media attention. Mayor Tubbs appointed City Councilman Elbert Holman as his Vice Mator, replacing the previous Vice Mayor, District 5 Councilwoman Christina Fugazi, stating: “[Ms.] Holman is an exemplar of a public servant, whose experience as a law enforcement professional and 8 years of service as a councilmember will serve the city well…” adding: “I look forward to the work we will do together. We have a unique opportunity to make a real difference in our All-America City.”

Detroit’s Future Academic Solvency. Michigan Senate Education Committee Chairman Phil Pavlov (R-St. Clair) yesterday called for the repeal of the state’s so-called “failing schools” law, with his call coming as Gov. Rick Snyder’s administration is completing plans to shut down some chronically underperforming schools. Chairman Pavlov said the “goal posts” for struggling schools have too often moved under existing state law, which was developed under what he called a “heavy-handed” federal education policy that has changed considerably in recent years. At the same time, Michigan has adopted a new standardized test for students. Thus, Chairman Pavlov said the School Reform Office has used multiple “accountability measurement systems” for schools that land on the lowest-performing list, noting: “These districts don’t know how the data is going to be used, and so it’s creating a lot of confusion.” Stating that academic failure “must not be tolerated,” the Chairman told his colleagues that the current process for addressing the system’s failures is “deeply flawed,” and warned it has caused “great anxiety” for education officials across the state—as he announced plans to introduce a repeal bill today when the session resumes with the first day of the new two-year session, so that he can help initiate a public conversation over a potential replacement law. Nevertheless, the Senator stopped short of recommending the Governor halt any planned school closures, adding he wants the Governor’s office to be a “partner” in developing a replacement—even as he warned the law has created “confusion among all the parties that are administering this, including the school districts…We heard an announcement last August that up to 100 schools could be closed…Well, what is the process and how do you get to that point? I’m not interested in protecting schools that can’t deliver, but we have to have something everybody understands, metrics people can work toward for achievement and not be subject to on-the-spot discretion.”

Under the state’s current law, Michigan created a process by which the state has authority to close schools which perform among the state’s bottom 5 percent—or the state can mandate another form of intervention, such as the appointment of a chief executive officer. Finally, of course, the Governor can invoke the state’s notorious Emergency Manager law to appoint, as Gov. Snyder has done for the Detroit Public Schools (DPS)—where, as we have reported—in the wake of such appointments, the last being the recently retired former U.S. Bankruptcy Judge Steven Rhodes—an appointment which the state followed with last year’s $617 million state bailout of DPS with new state law which mandates the Michigan School Reform Office to force closure of any city schools which make the list three years running unless it would “result in unreasonable hardship to the pupils.”

Demonstrating how challenged DPS is, of the 124 Michigan schools which fell in the bottom 5 percent for academic performance last year, 47, or more than one-third, were DPS schools. (The Michigan Department of Education will release a new top-to-bottom list of academic performance by the end of this month, after which Michigan School Reform Officer Natasha Baker will subsequently lead a review of the bottom 5 percent of schools.) Getting the schools up to snuff matters: The current median household income for Detroit is $53,628: real median household income peaked in 2005 at $61,638 and is now $8,010 (13.00%) lower; nevertheless, from a post peak low of $51,606 in 2011, real median household income for Detroit has now grown by $2,022 (3.92%). Thus, continued progress in school improvement is likely to be telling in terms of attracting families with kids from the city’s suburbs and creating a fiscal foundation for Detroit’s future. 

New Governance. The events in Lansing come even as school governance is set to revert from state to local control, with a big crowd anticipated—notwithstanding brutal winter weather—tonight to attend Detroit’s first fully empowered school board in seven years—where the new board will elect officers, set bylaws, and hear a presentation from the interim superintendent. , according to meeting agendas posted online. Thus, even as the new session of the Legislature is meeting, the new school board in Detroit will confront the challenge of trying to shore up—fiscally and educationally—a 45,000-student district which has been in fiscal, physical, and governing turmoil for years under state control. Now, in the wake of last June’s $617 million state bailout and financial restructuring of DPS, the stakes are high for the Detroit Public Schools Community District. Indeed, new DPS board member Deborah Hunter-Harvill likely hit the nail on the head when, last evening, she said: “I’ve been engaging in dialogue and activities with six very astute individuals that seem to care a whole, whole lot about children…I know that this could be the last chance we have to get it right. We will be focusing on that.”

Governance Insolvency?

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eBlog, 1/0617

Good Morning! In this a.m.’s eBlog, we consider the political and legal turmoil in the insolvent municipality of East Cleveland, before turning to the continued uncertainty with regard to Atlantic City’s future. Then we try to get schooled in the new governance set to commence for Detroit’s public schools, before returning to what appears to be a state of emergency declared this week by the new Governor of Puerto Rico.

Bankrupt Municipal Governance? The insolvent city of East Cleveland is confronted not just with fiscal insolvency, but, increasingly, governance chaos in the wake of the recall of its former Mayor and the city’s Law Director, Willa Hemmons, yesterday issuing a legal opinion that appointments made to the City Council last week were illegal. That opinion was countered late yesterday by East Cleveland Councilwoman Barbara Thomas, who issued a statement contradicting Ms. Hemmons’ opinion that appointments to council made in a December 29th meeting were illegal, writing that not only was there an absence of a quorum, but also the actions were in violation of the city’s charter. The Councilwoman, who represents Ward 2, and Nathaniel Martin, at-large council member, had selected Devin Branch and Kelvin Earby to fill the Ward 3 and at-large seats left open when voters recalled former Council President Thomas Wheeler and Mayor Gary Norton. Ward 4 councilwoman Joie Graham had left the meeting last week during executive session, because she did not agree with the interview process for new members. In response, Councilwoman Thomas, in a statement, claimed she had met with an unnamed attorney and believes that Law Director Hemmons has confused “charter positions which apply to organizational meetings of City Council following a regular election with the procedures Council is required to follow to fill a vacancy on Council.” In addition, the Councilwoman charged the document was improperly served. Thus, she stated: “I am disappointed, because I had hoped that having a new mayor would give us an opportunity for a fresh start and that the administration and Council would work together for the benefit of the citizens of East Cleveland.”

Confused Governance. Meanwhile, in Atlantic City—which has a Mayor and Council and a state appointed Emergency Manager, but which is under a state takeover, Mayor Don Guardian yesterday offered his now unofficial State of the City speech. Unsurprisingly, he listed the numerous challenges facing his city, including a state takeover and hundreds of millions of dollars in debt. Mayor Guardian also requested billionaire investor Carl Icahn to sell the abandoned Trump Taj Mahal Casino, stating the city cannot afford to allow such a critical component of its historic boardwalk to continue vacant indefinitely, deeming such inactions the “the worst of the worst” in terms of outcomes for the property—and the city’s tax rolls. The Tropicana, which was boarded up last October, not only hammered the city’s anticipated property tax revenues, but meant 3,000 people lost their jobs, and, of course, the city lost a key attraction for visitors. Mr. Icahn had shuttered it last fall in the wake of a strike by the casino’s workers’ union. Mr. Icahn, however, responded by saying he would be happy to sell the casino to the insolvent city, but only if the city made Mr. Icahn whole by paying him the $300 million he claims he had lost on his real estate gamble, adding Mayor Guardian was wrong to attack an investor who had previously rescued the city’s Tropicana casino and attempted to do the same with the Tropicana. Prior to last summer’s strike to restore health insurance and pension benefits—which had been terminated in federal bankruptcy court—and the subsequent closure, Mr. Icahn had promised to invest some $100 million into the casino—a promise never kept.

Learning to Govern in the Big D. With the retirement of former U.S. Bankruptcy Judge Steven Rhodes, who had so generously accepted the Governor’s challenge to serve as the Detroit Public School Emergency Manager, Detroit’s newly elected school board is planning a major celebration this month as it will assume control of city schools which have been under gubernatorial-appointed emergency managers for years. Moreover, with the state having creating a dual system of public and charter schools, the governing challenge for these new school board members promises to be daunting. Whom will the newly elected board select to be superintendent? Will a majority vote to file suit to prevent further school closures? How will the new board address the challenge of balancing state-created charter schools versus public schools? How can the new Board create balance so that there can be a smooth transition with long-struggling schools which will rejoin the district this summer?  The seven board members who were elected by Detroit voters in November have been doing some prep learning themselves: they have devoted the last two months in an intensive orientation on Detroit schools, trying to comprehend a complicated district which now serves about 45,000 children in 97 schools—children who will be future civic leaders, but, mayhap more importantly, a school system whose reputation will be critical in determining whether young families with children will opt to move into Detroit—or leave the city.

Extraordinary Governmental Authority & Promising Insurance? In Puerto Rico, Governor Ricardo Rosselló Nevares this week signed a decree which provides him extraordinary authority, similar to those granted a governor in the wake of a natural disaster. The new executive order declares a state of emergency, with the emergency creating a “risk of accelerating capital flight from the territory, putting at risk natural resources, and risking public health and safety.” The new Governor’s actions came as the U.S. territory of Puerto Rico and some of its instrumentalities failed to make municipal bond interest payments this week, Puerto Rico’s largest municipal bond insurer, Assured Guaranty Ltd. subsidiaries, made $43 million of interest payments to holders of insured general obligation and other municipal bonds. The payments came as Puerto Rico’s infrastructure financing authority PRIFA was unable to transfer funds to its bond trustee to pay debt due New Year’s Day on certain tax-exempt bonds, according to a regulatory filing on Tuesday, further confirmation of a default by the U.S. territory. The trustee for PRIFA’s series 2005B and 2006 bonds claimed it had not received sufficient funds from PRIFA for the payment of debt, although it held a small residual amount from prior payments that it allocated to pay interest. In addition, the trustee for its series 2005 C bonds reported it did not receive funds from PRIFA to pay debt service. The territory had said last week that PRIFA would have insufficient funds to make the full payment on its special tax revenue bonds, Series 2005A-C and Series 2006; ergo, $36 million was expected not to be paid. As of midweek, the island’s largest bond insurer, Assured Guaranty Municipal Corp. and Assured Guaranty Corp. had received and processed $43 million of claim notices for missed January 1 payments, out of $44 million of total expected claims, with the expected claims including $39 million of Puerto Rico general obligation payments and $5 million for Puerto Rico Public Buildings Authority payments. In addition, on Tuesday, the Puerto Rico Electric Power Authority made the full interest payment due on its bonds insured by Assured Guaranty; thus, no insurance claims were filed. In a statement, Assured President and CEO Dominic Frederico said: “While the outgoing Puerto Rico administration has once again chosen to violate Puerto Rico’s constitution by ignoring the senior payment priority securing the Commonwealth’s general obligation bonds, we look forward to working with the new administration, PROMESA Oversight Board and other creditors to achieve consensual restructuring agreements that respect the constitutional, statutory, contractual and property rights of creditors while also supporting the island’s economic recovery…We were pleased that PREPA made its bond interest payment, and we continue to join PREPA and the other participating creditors in seeking implementation of the consensual restructuring contemplated by the PREPA restructuring support agreement.” In its release, the company wrote that any obligor where amounts were due but no claims are expected, the payments were made by the obligor from its available funds or reserves, adding that municipal bond investors owning Puerto Rico-related bonds insured by Assured Guaranty will continue to receive uninterrupted full and timely payment of scheduled principal and interest in accordance with the terms of the insurance policies.

Emerging from Municipal Bankruptcy: a Rough Ride

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eBlog, 1/04/17

Good Morning! In this a.m.’s eBlog, we consider the ongoing challenges for the U.S. city emerging from the nation’s largest ever municipal bankruptcy, Detroit; then we veer into the warm Caribbean waters to observe the first days of the new administration of Gov. Ricardo Rosselló in Puerto Rico—where his new administration must adjust to coming to terms with its own PROMESA oversight board.

A New Detroit? The city emerging from the largest ever municipal bankruptcy is witnessing a string of major construction projects, from a massive hockey arena and street car line downtown to the resurrection of the Wayne County jail project: changes which will reshape the Motor City’s downtown in 2017—a level of activity and investment which seemed most improbable as the city shrunk and then dissolved into chapter 9 municipal bankruptcy. Today, the construction detours and closed sidewalks seem to offer a welcome sign of a new era for many who live and work near downtown. According to recent statistics, office vacancies in the downtown area are at their lowest point in a decade, and now the addition of the city’s new rail line could open demand in the New Center area, as well as increase demand for office space in neighborhoods near downtown such as Corktown and Eastern Market. Notwithstanding, the Detroit Financial Review Board, created as part of Detroit’s plan of debt adjustment to secure the U.S. bankruptcy court’s approval to exit bankruptcy, in its most recent oversight report, noted that the city continues to confront an unexpected gap in its public pension obligations and the absence of a long-term economic plan, reporting in its fourth annual report that could leave the city vulnerable to further fiscal challenges.(The next certification is due by October 1, 2017: under the plan of debt adjustment stipulations, the review board is charged with reviewing and approving annual four-year financial plans.) Both previous such plans have been approved. The most recent plan, submitted at the end of November, projects a general fund surplus of at least $41 million for FY2016, based on budget projections; Detroit expects to finish the current fiscal year with a general fund surplus of about $30 million. Nevertheless, the city faces a double-barreled fiscal challenge: its public pension liabilities and high costs of borrowing. Because its junk territory credit ratings from Moody’s and S&P, Detroit is forced it to pay disproportionately higher interest rates on its bonds.

With regard to its pension liabilities, where Detroit’s plan of debt adjustment approved by now retired U.S. Bankruptcy Judge Steven Rhodes left intact public safety monthly checks, but imposed a 4.5% cut on general employees—and reduced or eliminated post-retirement (OPEB) benefits, as part of a mechanism to address some $1.8 billion in post-retirement obligations, the approved plan nevertheless suspended the COLa’s only until 2024—so a longer term liability of what was originally projected to be $111 million pends. (Indeed, the city’s pension agreement withstood a challenge last Fall when a federal appeals court ruled in favor of Detroit in a lawsuit by city retirees whose pensions were cut as part of the city’s approved plan of debt adjustment, after some retirees had sued, claiming they deserved the pension which was promised before the city filed for bankruptcy in 2013, with U.S. Judge Alice Batchelder of the 6th Circuit Court of Appeals noting it was “not a close call.”)

But, as Shakespeare would put it: ‘There’s the rub.” Detroit’s actuaries, in their 2015 actuarial valuation reports, projected the liability in FY2024 and beyond to be nearly $200 million, based upon a thirty year amortization, with level principal payments and declining interest payments; however, as we have previously noted, those estimates were based upon optimistic estimates of assumed rates of return of 6.75 percent. In response, Detroit set aside $20 million from this year’s FY2016 fund balance, $10 million from its FY2016 budgeted contingency fund, and added an additional $10 million for each of the next three fiscal years—or, as Detroit Finance Director John Naglick told the Bond Buyer: “The city has six fiscal years to make an impact and close the gap on the [pension] underfunding. We don’t want to create such a cliff in 2024 where there is a big budget shock…The reality is to find those kind of monies over the next six fiscal years will cause some tradeoff in services.” Director Naglick added that last month Detroit completed an updated decade-long plan to update its approved plan of debt adjustment, adding: “The 10-year model will show the FRC that this incremental funding can be folded into the budget, but we aren’t naïve, it will also create some disruption in services to accommodate that…Think of it as a master plan on how we are going to make this stable.” Nevertheless, Mr. Naglick’s challenge will be hard: Moody’s last summer warned that the city’s “very weak economic profile” makes it susceptible to future downturns and population loss—threatening its ability “to meet its requirement to resume pension funding obligations in fiscal 2024.” Detroit’s next deadline looms: The City must submit its FY18-FY21 Four-Year Financial Plan to the Financial Review Commission by the statutory deadline of March 23rd.

Puerto Rico: A New Chapter? The new Governor of Puerto Rico, Ricardo Rosselló, yesterday, in the wake of his swearing in, acted straightaway on his first day in office to cut government spending and revenues, amid greater urgency to take steps to avoid a massive out-migration and end ten years of economic recession, and increase efforts to stem vital population losses which in 2013 alone witnessed some 74,000 Puerto Ricans leave the island. The new governor has already signed five executive orders, cutting annual agency spending by 20 percent, encouraging asset privatization, and proposing a zero based budgeting standard. Efforts like these, if actually implemented (a crippling risk in the context of historical Puerto Rico governance), could represent strides towards achieving fiscal solvency and help lay the groundwork for economic recovery. Governor Rosselló directed his agency heads to implement zero-based budgeting, under which agency heads start with a $0 and only adds to it when they can provide a justification for particular programs. Gov. Rosselló also created a Federal Opportunity Center attached to the governor’s office. The center will provide technical and compliance assistance to the office to make programs eligible for federal funds. For the new Governor, the three keys to recovery appear to be: how to revive the economy, fix the territory’s fiscal situation, and address the public debt.

The key, many believe, would be to opt for Title VI of the new PROMESA law, the voluntary restructuring portion. A growing concern is to create job opportunities—with one leader noting: “Many will leave if they cannot find jobs to search off the island for a better quality of life: our cities have to be habitable and safe…it has to be a place where the world wants to come to live…” Governor Rosselló also signed six executive orders, directing his department heads to cut 10 percent in spending from the current budget and to reduce the allocations for professional services by a similar amount—with even deeper cuts in other hiring; he imposed a freeze on new hires, noting: “We do not come to merely administer an archaic and ineffective scaffolding: Ours will be a transformational government.” Nevertheless, his task could be frustrated by the Puerto Rico House, where, yesterday, El Vocero reported that Puerto Rico House of Representatives President Carlos Méndez Núñez had told the newspaper last weekend that the legislature would cut Puerto Rico’s sales and use tax rate and the oil tax rate, reversing steps by the prior governor and legislature over the last four years. Governor Rosselló also pledged to work with the PROMESA Oversight Board in a collaborative way, as he departed the island to meet with members of the new Congress in Washington, D.C., where he planned to lobby for statehood for the U.S. territory.

With new administrations in San Juan and Washington, Gov. Rosselló will also have to work out a relationship with the PROMESA board, as the absence of cash to pay debt service, combined with the current payment moratoriums and federal stay on bondholder litigation appear destined to be extended deep into the year, albeit some anticipate that under the incoming Trump administration, one which will have much closer ties to creditor groups than the outgoing Obama administration, could lead to efforts to restart formal bondholder negotiations—negotiations which could become a vehicle by means of which creditors would increase their investment in Puerto Rico risks, by means of new loans and/or partial restructuring of liabilities in ex-change for a settlement which would be intended to improve long term municipal bond-holder recoveries and, most critically, work to enhance the price evaluations of Puerto Rico’s general obligation municipal bonds. Nevertheless, the territory’s structural, long-term budget deficit of nearly $70 billion over the next decade risks crowding out any medium-term payment of debt service absent serious spending reform as well as public pension reform—especially because of the ongoing outflow of young persons seeking better economic opportunities on the mainland.