What Could Be the State Role in Municipal Fiscal Distress?

 

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eBlog, 03/08/17

Good Morning! In this a.m.’s eBlog, we consider the state role in addressing fiscal stress, in this instance looking at how the Commonwealth of Virginia is reacting to the fiscal events we have been tracking in Petersburg. Then we spin the roulette table to check out what the Borgata Casino settlement in Atlantic City might imply for Atlantic City’s fiscal fortunes, a city where—similar to the emerging fiscal oversight role in Virginia, the state is playing an outsized role, before tracking the promises of PROMESA in Puerto Rico.

The State Role in Municipal Fiscal Stress. One hundred fifty-three years ago, Union General George Meade, marching from Cold Harbor, Virginia, led his Army of the Potomac across the James River on transports and a 2,200-foot long pontoon bridge at Windmill Point, and then his lead elements crossed the Appomattox River and attacked the Petersburg defenses on June 15. The 5,400 defenders of Petersburg under command of Gen. Beauregard were driven from their first line of entrenchments back to Harrison Creek. The following day, the II Corps captured another section of the Confederate line; on the 17th, the IX Corps gained more ground, forcing Confederate General Robert E. Lee to rush reinforcements to Petersburg from the Army of Northern Virginia. Gen. Lee’s efforts succeeded, and the greatest opportunity to capture Petersburg without a siege was lost.

Now, the plight of Petersburg is not from enemy forces, but rather fiscal insolvency—seemingly alerting the Commonwealth of Virginia to rethink its state role with regard to the financial stress confronting the state’s cities, counties, and towns. Thus, last month, Virginia, in the state budget it adopted before adjournment, included a provision to establish a system for the state to detect fiscal distress among localities sooner than it did with Petersburg last year, as well as to create a joint subcommittee to consider the broader causes of growing fiscal stress for the state’s local governments. Under the provisions, the Co-Chairs of the Senate Finance Committee are to appoint five members from their Committee, and the Chairman of the House Appropriations Committee is to name four members from his Committee and two members of the House Finance Committee to a Joint Subcommittee on Local Government Fiscal Stress. The new Joint Subcommittee’s goals and objectives encompass reviewing: (i) savings opportunities from increased regional cooperation and consolidation of services; (ii) local responsibilities for service delivery of state-mandated or high priority programs, (iii) causes of fiscal stress among local governments, (iv) potential financial incentives and other governmental reforms to encourage increased regional cooperation; and (v) the different taxing authorities of cities and counties. The new initiative could prove crucial to impending initiatives to reform state tax policies and refocus economic development at the regional level, as the General Assembly considers the fiscal tools and capacity local governments in the commonwealth have to raise the requisite revenues they need to provide services—especially those mandated by the state. Or, as Gregory H. Wingfield, former head of the Greater Richmond Partnership and now a senior fellow at the L. Douglas Wilder School of Government and Public Affairs at Virginia Commonwealth University, puts it: “I hope they recognize we’ve got to have some restructuring, or we’re going to have other situations like Petersburg…This is a very timely commission that’s looking at something that’s really important to local governments.”

The Virginia General Assembly drafted the provisions in the state budget to create what it deems a “prioritized early warning system” through the auditor of public accounts to detect fiscal distress in local governments before it becomes a crisis. Under the provisions, the auditor will collect information from municipalities, as well as state and regional entities, which could indicate fiscal distress, as well as missed debt payments, diminished cash flow, revenue shortfalls, excessive debt, and/or unsupportable expenses. The new Virginia budget also provides a process for the auditor to follow and notify a locality that meets the criteria for fiscal distress, as well as the Governor and Chairs of the General Assembly’s finance committees. The state is authorized to draw up to $500,000 in unspent appropriations for local aid to instead finance assistance to the troubled localities. The Governor and money committee Chairs, once notified that “a specific locality is in need of intervention because of a worsening financial situation,” would be mandated to produce a plan for intervention before appropriating any money from the new reserve; the local governing body and its constitutional officers would be required to assist, rather than resist, such state intervention—or, as House Appropriations Chairman S. Chris Jones (R-Suffolk) describes it: “The approach was to assist and not to bring a sledgehammer to try to kill a gnat,” noting he had been struck last fall by the presentation of Virginia’s Auditor of Public Accounts Martha S. Mavredes with regard to the fiscal stress monitoring systems used by other states, including one in Louisiana which, he said, “would have picked up Petersburg’s problem several years before it came to light…At the end of the day, it appears you had a dysfunctional local government, both on the administrative and elected sides, that was ignoring the elephant that was in the room.”

The ever so insightful Director of Fiscal Policy at the Virginia Municipal League, Neal Menkes, a previous State & Local Leader of the Week, notes that Petersburg is far from alone in its financial stress, which was caused by factors “beyond just sloppy management: It included a series of economic blows,” he noted, citing the loss of the city’s manufacturing base in the 1980s and subsequently its significant retail presence in the region. The Virginia Commission on Local Government identified 22 localities—all but two of them cities—which experienced “high stress” in FY2013-14, of which Petersburg was third, and an additional 49 localities, including Richmond, which had experienced “above average” fiscal stress. Or as one of the wisest of former state municipal league Directors, Mike Amyx, who was the Virginia Municipal League Director for a mere three decades, notes: “It’s a growing list.”

The Commonwealth’s new budget, ergo, creates the Joint Subcommittee on Local Government Fiscal Stress, charged with taking a sweeping look at the reasons for stress, including:

  • Unfunded state mandates for locally delivered services, and
  • Unequal taxing authority among localities.

The subcommittee will look at ways for localities to save money by consolidating services and potential incentives to increase regional cooperation, or as Virginia Senate Finance Co-Chairman Emmett Hanger (R-Augusta) notes: “We need to dig deeply into the relationship of state and local governments,” expressing his concerns with regard to potential threats to local revenues, such as taxes on machinery and tools, and on business, professional and occupational licenses (BPOL), as well as fiscal disparities with regard to local capacity or ability to finance core services such as education and mental health treatment, or, as he puts it: “We do need to address the relative levels of wealth of local governments…We need to look at all of the formulas in place for who gets what from state government…Our tax system is still antiquated, and local governments have to rely too heavily on real estate taxes.”  

The subcommittee will include Sen. Hanger and Chairman Jones, as chairs of the respective Budget Committees, and House Finance Chairman R. Lee Ware Jr. (R-Powhatan), whose panel grapples every year with the push to reduce local tax burdens and the need to give localities the ability to generate revenue for services. Chairman Jones, a former Suffolk Mayor and city councilmember, said he is “keenly aware of the relationship between state and local governments. It is a complex relationship. The solutions aren’t simple…You’ve got to be able to replace that revenue at the local level—you can’t piecemeal this.”

Municipal Credit Roulette. State intervention and a settlement of tax refunds owed to a casino drove a two-notch S&P Global Ratings upgrade of Atlantic City’s general obligation debt to CCC from CC. The rating remains deep within speculative grade, the outlook is developing. S&P analyst Timothy Little wrote that the upgrade reflected a state takeover of Atlantic City finances that took effect in November which has helped “diminish” the near-term likelihood of a default. A $72 million settlement with the Borgata Hotel Casino & Spa over $165 million in owed tax refunds that saves Atlantic City $93 million also contributed to the city’s first S&P upgrade since 1998, according to S&P. Mayor Don Guardian noted that obtaining a CCC rating was “definitely a step in the right direction: As we continue to implement the recommendations from our fiscal plan submitted last year, and working together with the state, we know that our credit rating will continue to improve higher and higher.” Nevertheless, notwithstanding the credit rating lift, Mr. Little warned that Atlantic City’s financial recovery is “tenuous” in the early stages of state intervention, ergo the low credit rating reflects what he terms “weak liquidity” and an “uncertain long-term recovery,” reminding us that Atlantic City has upcoming debt service payments of $675,000 due on none other than April Fool’s Day, followed by another $1.6 million on May Day, $1.5 million on June 1st, and $3.5 million on August 1st. Nevertheless, Atlantic City and the state fully contemplate making the required payments in full and on time. Mr. Little sums up the fiscal states:  “In our opinion, Atlantic City’s obligations remain vulnerable to nonpayment and, in the event of adverse financial or economic conditions, the city is not likely to have the capacity to meet its financial commitment…Due to the uncertainty of the city’s ability to meet its sizable end-of-year debt service payments, we consider there to be at least a one-in-two likelihood of default over the next year.” He adds that, notwithstanding the State of New Jersey’s enhanced governing role with Atlantic City finances, chapter 9 municipal bankruptcy remains an option for the city if adequate gains are not accomplished to improve the city’s structural imbalance, as well as noting that S&P does not consider the city to have a “credible plan” in place to reach long-term fiscal stability. For his part, Evercore Wealth Management Director of Municipal Credit Research Howard Cure said that while the municipal credit upgrade reflects the Borgata Casino tax resolution, the rating, nonetheless, makes clear how steep the road to fiscal recovery will be: “You really need the cooperation of the city, but also the employees of the city for there to be a real meaningful recovery…This could go bad in a hurry.”

Is There Promise in Promesa? Elias Sanchez Sifonte, Puerto Rico’s representative to the PROMESA Fiscal Supervision Board, late Tuesday wrote to PROMESA Board Chairman José B. Carrión to urge that the Board take concrete actions in its final recommendations to address the U.S. territory’s physical health and the renegotiation of public debt—that is, to comply with the provisions of PROMESA and advocate for Puerto Rico with the White House and Congress in order to avoid “the fiscal precipice” which Puerto Rico confronts, especially once the federal funds which are used in My Health expire. Mr. Sifonte also requested additional time for Puerto Rico to renegotiate its debt, reminding the Board that PROMESA “makes it very clear that an extension of the funds under the Affordable Care Act is critical.” With grave health challenges, the board representative appears especially apprehensive with regard to the debate commencing today in the House of Representatives to make massive changes in the existing Affordable Care Act.

Recounting Governor Ricardo Rosselló Nevares efforts to address Puerto Rico’s severe fiscal situation, he further noted that the Governor’s efforts would little serve if the PROMESA Board bars Puerto Rico from a voluntary process through which to renegotiate what it owes to various types of creditors, arguing that Puerto Rico ought to be able to negotiate with its municipal bondholders, and, ergo, seeking an extension of the current suspension of litigation set to expire at the end of May to the end of this year, noting: “It would be very unfair that after all the progress achieved in the past two months, the government cannot achieve a restructuring under Title VI simply because the past government intentionally or negligently truncated the Title VI process at the expense of the new administration.” His letter came as Gerardo Portela Franco, the Executive Director of the Puerto Rico Fiscal Agency and Financial Advisory Authority (FIFAA), reported that administration officials have had initial talks with the PROMESA board about the plan and are in the process of making suggested changes. FIFAA will manage the implementation the measures and lead negotiations with Puerto Rico’s creditors over restructuring the government’s $70 billion of debt.

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.

Addressing Municipal Fiscal Disparities

eBlog, 03/01/17

Good Morning! In this a.m.’s eBlog, we consider the dire stakes for Chicago’s kids if the State of Illinois continues to be unable to get its fiscal act together; then we admire the recent wisdom on fiscal disparities among municipalities in Massachusetts and Connecticut by the ever remarkable Bo Zhao of the Federal Reserve Bank of Boston.

Bad Fiscal Math.  Chicago Public School CEO Forrest Claypool Monday warned the public schools in the city could be forced to close nearly three weeks early and that summer school programs could be cut if the district does not receive a fast-tracked, favorable preliminary ruling from a Cook County judge in the near future, stating: “These possibilities are deeply painful to every school community.” Mr. Claypool, a former Chief of Staff to Mayor Daley, in an epistle to families with children in the city’s school system, warned the school year could end June 1st instead of June 20th without action; moreover, he noted that CPS’s summer school could be eliminated for all elementary and middle-school students, except those in special education programs, as he sought to increase pressure on Gov. Bruce Rauner and the Illinois legislature to help, warning success would depend on the courts or what has been billed as a “grand bargain” in the state capitol of Springfield to resolve Illinois’ record budget impasse. The CEO’s actions were not coordinated with Mayor Rahm Emanuel, who campaigned hard in his first term to extend the year for CPS students—a campaign in which the Mayor sought to reverse what we had termed as a “time bomb,” how to reverse the tide of an exodus of 200,000 citizens and make the city a key demographic destination for the 25-29 age group—i.e., meaning a critical commitment to public schools and safety. Now the state’s inability to act on a budget threatens both: the city’s School Board earlier this month accused the state of employing “separate and unequal systems of funding for public education in Illinois” in its lawsuit filed against both Gov. Rauner and the Illinois State Board of Education, describing its suit as the “last stand” for a cash-strapped district which is “on the brink,” seeking to have Judge Franklin Ulyses Valderrama of the Cook County Chancery Division issue a preliminary injunction which would prevent the state from “continuing to fund two separate but massively unequal systems of education,” noting it intends to present its case for an injunction to the court on Friday. In addition to seeking judicial relief, the System, in its judicial filing, noted that reductions in summer school programs and the academic year could save about $96 million; however, a shortened school year could violate Illinois state requirements with regard to the length of the public school year.

Without any doubt, the threatened disruption is undermining the trust of teachers, students, taxpayers, and parents with regard to the system’s future—brought on here by the awkward math of Gov. Rauner’s veto last December of a measure which would have provided CPS with $215 million in state aid—a measure the Governor argued was contingent on Democratic leaders agreeing to broader state public pension reforms. The ante was upped further at the beginning of the week, when Illinois Secretary of Education Beth Purvis said that instead of threatening cuts to the school year, CPS should focus on pushing legislation to overhaul the state’s education funding formula, stating: “I hope that they would really look seriously at not cutting days from the school year…I think people need to understand that the CPS board adopted a budget with a $215 million hole in it. Why is the governor being held responsible for that instead of the CPS board?” Even as the city sought to pressure the state, however, the Chicago Teachers Union this week issued a statement accusing Mayor Emanuel and the school board of playing politics instead of turning to solutions to help schools such as raising taxes, with union President Karen Lewis stating: “The Mayor is behaving as if he has zero solutions is incredibly irresponsible…Rahm wants us to let him off the hook for under-funding our schools and instead wait for the Bad Bargain to pass the Senate or [Gov.] Rauner’s cold, cold heart to melt and provide fair funds.” For those kids imagining an earlier summer break, CEO Claypool would not say when the district would make a final decision to shorten the school year, noting: “We think it would be wrong to prematurely set a final date for a decision when we still have the opportunity to prevent a shorter school year.”

Revenue Sharing. Bo Zhao, the extraordinary writer for the Boston Federal Reserve who authored the very fine piece: “Walking a Tightrope: Are U.S. State and Local Governments on A Fiscally Sustainable Path?” has now completed another piercing study regarding municipal fiscal disparities: “From Urban Core to Wealthy Towns,” looking at fiscal disparities amongst municipalities in Connecticut, and comparing state policies and practices there with Massachusetts, noting: “Fiscal disparities occur when economic resources and public service needs are not evenly distributed across localities. There are equity concerns associated with fiscal disparities. Using a cost-capacity gap framework and a newly assembled data set, this article is the first study to quantify non-school fiscal disparities across Connecticut municipalities. It finds significant non-school fiscal disparities, driven primarily by the uneven distribution of the property tax base while cost differentials also play an important role. State non-school grants are found to have a relatively small effect in offsetting municipal fiscal disparities.

Unlike previous research focused on a single state, this article also conducts a cross-state comparison. It finds that non-school fiscal disparities in Connecticut are more severe than those in Massachusetts, and non-school grants in Connecticut are less equalizing than those in Massachusetts. This article’s conceptual framework and empirical approach are generalizable to other states and other countries.” Writing that his is the first article to quantify non-school fiscal disparities across the Nutmeg State, he notes they are “driven primarily by the uneven distribution of the property tax base, while cost differentials also play an important role,” as he assesses fiscal disparities amongst the state’s 169 municipalities, writing: “There is recent evidence that this longtime state neglect may have exacerbated non-school fiscal disparities…If state aid formulae are based only on local revenue raising-capacity and ignore cost disparities, they would not fully offset fiscal disparities.” This leads him to note: “Urban core municipalities exhibit the highest average per capita cost, mainly because they have the highest unemployment rate and population density, and the most jobs per capita…This means that nearly one-fifth of Connecticut residents live in the highest cost environments.” In contrast, he notes that “wealthier-property rural towns have the lowest average per capita municipal cost—more than 25 percent lower than the urban core municipal cost.” A key part of the fiscal challenge, he writes, is that in the state, the property tax is the only “tax vehicle authorized for municipal governments and virtually the only own-source revenue available to support the local general fund,” adding that the property tax makes up some 94 percent of own source general fund revenue. All of which led Mr. Zhao to assess or measure what he defines as the “Municipal Gap,” or the difference between municipal cost versus municipal capacity: a measure which he finds demonstrates that “a significant share of Connecticut municipalities and populations face municipal gaps”…with urban core municipalities confronting a gap of as much as $1,000 per capita.

Turning to the state role in addressing fiscal disparities, he notes that non-school grants in the state “do not have an explicit equalization goal.” Such grants are broadly spread, and not “well targeted to fiscally disadvantaged municipalities,” indeed, describing the gap as “very wide,” and noting that a comparison with neighboring Massachusetts would better enable Connecticut law and policy makers to better understand the “relative severity of Connecticut municipal fiscal disparities.” While noting that unlike many other states, neither of these two New England states have active county governments, so that municipalities bear much greater responsibilities for a wide range of public services—and property taxes are almost their sole source of municipal revenues, he distinguishes Connecticut’s greater municipal fiscal disparities in that it has a larger share of its population living in what he terms “smallest-gap” municipalities. Finally, he distinguishes the respective state roles by noting that Massachusetts has a “more explicit equalization goal and its main distribution formula directly considers the differences across municipalities in revenue-raising capacity.”

States & Municipal Accountality

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eBlog, 2/06/17

Good Morning! In this a.m.’s eBlog, we consider the new municipal accountability system proposed by Connecticut Gov. Daniel Malloy to create a new governance mechanism which could trigger early state intervention, then we head west to consider whether Detroit voters will re-elect Mayor Mike Duggan to a second term.  

Municipal Accountability, or “Preventing a Train Wreck.” Connecticut Governor Daniel P. Malloy, noting that “Our towns and cities are the foundation of a strong and prosperous state,” said: “Healthy, vibrant communities—and thriving urban centers in particular—are essential for our success in this global economy…In order to have vibrant downtowns, retain and grow jobs, and attract new businesses, we need to make sure all of our municipalities are on solid fiscal ground or on the path to fiscal health.” Ergo, the Governor has proposed a new municipal accountability system intended and designed to provide early intervention for the Nutmeg State’s cities and towns before they slip into severe fiscal trouble—a signal contrast to, for instance, New Jersey—where, as we have noted, such intervention is after the fact; Alabama, where the state not just refused to act, but actually facilitated Jefferson County’s chapter 9 municipal bankruptcy by barring the city from raising its own revenues; California, where the state has absented itself from playing any role in responding to municipal bankruptcy or fiscal distress—and Michigan, where the state acts early to intervene through the appointment of Emergency Managers—albeit such intervention has, as we have observed in the instances of the City of Flint and the Detroit Public Schools contributed to not just worsening the fiscal crises, but also endangered human lives—especially of young children and their futures.

Gov. Malloy’s proposal would create:

  • a four-tier ranking for municipalities in fiscal or budgetary distress,
  • an enhanced state evaluation of local fiscal issues, and
  • a limit on annual property tax increases for cities and towns deemed at greatest risk of fiscal insolvency.

Currently, Connecticut’s chief budget and policy planning agency, the Office of Policy and Management, routinely reviews annual audits for all municipalities. Under Gov. Malloy’s new proposal, which will be outlined in greater detail the day after tomorrow in Gov. Malloy’s new state biennial budget plan, OPM and a new state review board will have added responsibilities to review local bond ratings, budget fund balances, mill rates, and state aid levels—all with a goal of creating a new, four-tiered municipal fiscal early warning system focused on the identification of municipalities confronting fiscal issues well before their problems approach the level of insolvency. Under his proposal, Connecticut cities and towns with the most severe challenges and risks would be assigned to a higher tier—a tier in which there would be increased state focus and, if the system works, greater state-local collaboration. As proposed, a municipality might be assigned to one of the first three tiers if it has a poor fund balance or credit rating, or if it relies on state aid for more than 30 percent of its revenue needs. In such tiers, the state’s cities and towns would face additional reporting requirements. Moreover, cities and towns in Tiers 2 and 3 would be barred from increasing local property tax rates by more than 3 percent per year. For cities and towns in the lowest fiscal category, the fourth tier, the state would also impose a property tax cap. For these municipalities, the state review board could:

  • Intervene to refinance and otherwise restructure local debt;
  • Serve as an arbitration board in labor matters;
  • Approve local budgets;
  • And appoint a manager to oversee municipal government operations.

The system proposes some flexibility: for instance, a municipality would be assigned to a lowest tier, Tier 4, only if it so requested from the state, or if two-thirds of the new state review board deemed such a ranking necessary, according to Governor Malloy—who estimated that about 20 to 25 of the state’s 188 municipalities might be assigned any tier ranking under his proposal, who described those municipalities which might act to seek to work more closely with the state as ones confronted by “pockets of poverty.”

In response, Connecticut Conference of Municipalities Executive Director Joe DeLong said the Connecticut municipal association appreciated the Governor’s efforts to foster dialogue and had “no issue” with his proposals, but said they should be accompanied by other changes, noting: “The overreliance on property taxes, especially in urban areas where most of the property is tax exempt continues to be a recipe for disaster…Oversight without the necessary structural changes, only insures that we will recognize an impending train wreck more quickly. It does not prevent the wreck.”

This Is His City. Detroit Mayor Mike Duggan this weekend vowed to “fight the irrational closing” of a number of public schools in the city, as he initiated his re-election campaign—and, mayhap, cast a swipe at President Trump’s Education Secretary cabinet choice. Making clear that he would not be running what he termed a “victory lap campaign,” he vowed he would seek to change the recovering city’s focus towards “creating a city where people want to raise their families,” vowing to work hand-in-hand with the Detroit Public Schools Community District School Board in the wake of the Michigan School Reform Office’s recent decision to close low-performing public schools in Detroit and another elsewhere in the state—a state action which could shutter as many as 24 of 119 city schools at the end of this academic year, and another 25 next year if they remain among the state’s lowest performers for another year, based on state rankings released this month which mark consistently failing schools for closure. Mayor Duggan added that he had called Gov. Rick Snyder at the end of last week to tell him the closure is “wrong” and that the school reform office efforts are “immoral, reckless…you have to step in.” Mayor Duggan noted that “[R]eform means first you work with the teachers in the school to raise that performance at that school; second you don’t close the school until you’ve created a quality alternative…Neither one of those has happened here.” The Mayor met yesterday with the school board leadership, and has noted that Gov. Snyder had originally taken the position that closure of the city’s schools would create a legal issue, adding: “You do not have a legal right to have no schools when the children have no reasonable alternative nearby…I’m going to be working with the Detroit public schools…We want to start by sitting down together with the Governor and coming up with a solution. That’s going to be the first order of business.”

Detroit Public Schools Community District School Interim Superintendent Alycia Meriweather thanked Mayor Duggan over the weekend, saying: “As stated multiple times, we do not agree with the methodology, or the approach the (state school reform office) is using to determine school closures, and we are cognizant of the fact that all of the data collected is entirely from the years the district was under emergency management…Closing schools creates a hardship for students in numerous areas including transportation, safety, and the provision of wrap around services…As a new district, we are virtually debt free, with a locally elected board; we deserve the right to build on this foundation and work with our parents, educators, administrators, and the entire community to improve outcomes for all of our children.”

Ms. Ivy Bailey, the President of the Detroit Federation of Teachers, which represents about 3,000 city educators, noted: “The bottom line is this is his city…We don’t want the schools to close.” Ms. Bailey said the newly elected school board had just taken office and needs to be given an opportunity “to turn things around.” A representative for Gov. Snyder could not be immediately reached Saturday, nor could Detroit School Board President Iris Taylor.

Last week, Mayor Duggan picked up petitions to run for re-election, joining 14 others, according to records provided by the city’s Department of Elections. None of the prospective candidates have turned in signatures yet for certification. The filing deadline is April 25. The primary is August 8. The Mayor, when asked who his biggest competition is in the race, said only: “[T]his is Detroit, there’s always an opponent.” “There will be a campaign,” he said. “This is Detroit.”

Mayor Duggan comes at his re-election campaign to be the city’s first post chapter 9 leader after being schooled himself in hard knocks: in his first campaign, he had been knocked off the ballot when it was determined he had failed to meet the city’s one year residency requirement; ergo, he had run as a write-in candidate, and, clearly, run effectively: he received 45 percent of the vote in the primary, and had then earned 55 percent of the vote to become the Motor City’s first post-municipal bankruptcy Mayor. Thus, in his re-election effort, he has been able to point to milestones from his first term, including:

  • the installation of 65,000 new LED street lights,
  • improved police and EMS response times,
  • new city buses as well as added and expanded routes,
  • the launch of the Detroit Promise, a program to provide two years of free college to graduates of any city high school,
  • several major automotive manufacturing centers and suppliers,
  • and a new Little Caesars Arena which will be the future home of the Detroit Red Wings and Detroit Pistons,
  • The relocation by Microsoft (announced Friday) to downtown Detroit in the One Campus Martius building early next year,
  • The results, to date, of the city’s massive blight demolition program—a program which has led to the razing of nearly 11,000 houses, primarily with federal funding, since 2014 (albeit a program which has been the subject of a federal criminal investigation and other state, federal and local reviews after concerns were raised in the fall of 2015 over soaring costs and bidding practices.) Officials with the city and Detroit Land Bank Authority, which oversees the program, have defended the effort, and, last week, Mayor Duggan said an ongoing state review of the program’s billing practices turned up $7.3 million in what the state contends are improper costs. Ergo, Detroit will pay back $1.3 million of that total, but the remaining $6 million—mainly tied to a controversial set-price pilot in 2014—will go to arbitration.

The Potential Consequences of a State Takeover of a Municipality

 

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eBlog, 2/03/17

Good Morning! In this a.m.’s eBlog, we consider the long-term costs and consequences of state takeovers of a municipality, and of a broken state financial system.

The Fiscal Costs of Incompetence. Michigan taxpayers, including those in Flint, will be paying litigation and legal defense expenses for two former officials implicated in contributing to Flint’s lead-contaminated water crisis. Governor Rick Snyder’s Office confirmed that the Michigan Treasury Department will reimburse the city of Flint for legal and defense fees for former state-imposed Flint Emergency Managers Darnell Earley and Gerald Ambrose—officials appointed by the Governor who have now been charged by Michigan Attorney General Bill Schuette with committing false pretenses and conspiracy to commit false pretenses, 20-year felonies. The duo also face a charge of misconduct in office, a five-year felony, and a one-year misdemeanor count of willful neglect of duty. Gov. Rick Snyder’s spokeswoman notes that state officials do not have any estimates on costs to state taxpayers for their defense—or if there is any ceiling with regard to what state taxpayers will be chipping in.

The Fiscal Costs of a Broken State Financial System. Dan Gilmartin, the Executive Director of the Michigan Municipal League, this week noted that “A lot of people feel as if we’ve turned the corner here in Michigan, you know, we’ve got more people employed, and the big three are doing better, and there’s some good things happening in the tourist economy and all kinds of different areas, so they think things are getting better…they might be getting better for state coffers; but they’re actually getting worse at the local level because of the system that we’re in right now.” Noting that, despite the state’s strong economic recovery, that recovery has not filtered down to its cities—which, in the wake of some $7 billion in state cuts to general revenue sharing since 2002—has left the state’s municipalities confronting an increasingly harder time to finance public infrastructure and public safety. The League’s report also recommends the state help cities come up with more modern health care plans which would allow them to control costs and stay competitive with other employers. Perhaps most intriguing, Mr. Gilmartin recommended that state aid for public infrastructure be allocated on a regional basis, rather than jurisdiction by jurisdiction. Finally, he urged the Michigan legislature to make up for the steep cuts made to revenue sharing in the last 15 years.

Exiting Receivership. The Michigan Department of Treasury has announced that the small municipality of Allen Park—a city of about 28,000 in Wayne County, where the annual per capita income is $27,000 and the estimated median assessed property value is $91,000, is no longer under receivership—meaning the city’s elected leaders have effectively had their authority to govern restored. The small city, which had also been charged in 2014 by the Securities and Exchange Commission with fraud, with the SEC charging public officials as “control persons,” came in the wake of a recommendation from members of the Allen Park Receivership Transition Advisory Board, which was state-appointed in 2014 in the wake of Gov. Rick Snyder’s announcement that the city’s 2012 financial emergency had been resolved after its structural and cumulative deficits had been eliminated. Gov. Snyder had imposed an Emergency Manager from March 2013 to September 2014, the same month in which the Michigan Receivership Transition Advisory Board was appointed. According to the Treasury, Allen Park “has made significant financial and operational progress,” including increasing its general fund balance; passing 10-year public safety and road millages; and saving $1.1 million by tendering 62 percent of Allen Park’s outstanding municipal bonds issued through the Michigan Finance Authority. In addition, the municipality made its required contributions into the pension and retiree healthcare systems, including an additional $500,000 annual payment toward other OPEB liabilities. Allen Park Mayor William Matakas responded: “On behalf of the city, I express my gratitude to the members of the Receivership Transition Advisory Board for their professionalism during Allen Park’s transition from emergency management to local control…I look forward to working with local and state officials to ensure we continue down a path of financial success.” Michigan Treasurer Nick Khouri, in the wake of the release of the municipality under Michigan’s Local Financial Stability and Choice Act, said Allen Park leaders are thus authorized to regain control and proceed with tasks such as approving ordinances, noting: “This is an important day for the residents of Allen Park, the city, and all who worked diligently to move the city back to fiscal stability…The cooperation of state and city officials to problem-solve complex debt issues now provides the community an opportunity to succeed independently. I am pleased to say that the city is released from receivership and look forward to working with our local partners in the future…The cooperation of state and city officials to problem-solve complex debt issues now provides the community an opportunity to succeed independently.” According to Mr. Khouri, since the state intervention, Allen Park has increased the city’s general fund balance in the wake of adopting a 10-year public safety millage and a 10-year road millage; in addition, the city completed a successful tendering of 62% of the outstanding municipal bonds issued via the Michigan Finance Authority used to fund a failed movie studio project for a savings of $1.1 million in 2015. An additional remarketing of the remaining amount was finalized in 2016, saving the city another $900,000. It makes one wonder whether New Jersey Governor Chris Christie might benefit from observing the constructive relationship between the state and Allen Park as a means to help an insolvent city regain its fiscal feet.

Are American Cities at a Financial Brink?

eBlog, 1/13/17

Good Morning! In this a.m.’s eBlog, we consider the ongoing fiscal and physical challenges to the City of Flint, Michigan in the wake of the disastrous state appointment of an Emergency Manager with the subsequent devastating health and fiscal subsequent crises, before turning to a new report, When Cities Are at the Financial Brink” which would have us understand that the risk of insolvency for large cities is now higher than at any point since the federal government first passed a municipal bankruptcy law in the 1930’s,” before briefly considering the potential impact on every state, local government, and public school system in the country were Congress to adopt the President-elect’s proposed infrastructure plan; then we consider the challenge of aging: what do longer lifespans of city, county, and state employees augur for state and local public pension obligations and credit ratings?

Not In Like Flint. Residents of the City of Flint received less than a vote of confidence Wednesday about the state of and safety of their long-contaminated drinking water, precipitated in significant part by the appointment of an Emergency Manager by Governor Rick Snyder. Nevertheless, at this week’s town hall, citizens heard from state officials that city water reaching homes continues to improve in terms of proper lead, copper, alkaline, and bacteria levels—seeking to describe Flint as very much like other American cities. The statements, however, appeared to fall far short of bridging the trust gap between Flint residents and the ability to trust their water and those in charge of it appears wide—or, as one Flint resident described it: “I’m hoping for a lot…But I’ve been hoping for three years.” Indeed, residents received less than encouraging words. They were informed that they should, more than 30 months into Flint’s water crisis, continue to use filters at home; that it will take roughly three years for Flint to replace lead water service lines throughout the city; that the funds to finance that replacement have not been secured, and that Flint’s municipal treatment plants needs well over $100 million in upgrades: it appears unlikely the city will be ready to handle water from the new Karegnondi Water Authority until late-2019-early 2020. The state-federal presentation led to a searing statement from one citizen: “I’ve got kids that are sick…My teeth are falling out…You have no solution to this problem.”

Nevertheless, progress is happening: in the last six months of water sampling in Flint, lead readings averaged 12 parts per billion, below the federal action level of 15 ppb, and down from 20 ppb in the first six months of last year. Marc Edwards, a Virginia Tech researcher who helped identify the city’s contamination problems, said: “Levels of bacteria we’re seeing are at dramatically lower levels than we saw a year ago.” However, the physical, fiscal, public trust, and health damage to the citizens of Flint during the year-and-a-half of using the Flint River as prescribed by the state-appointed Emergency Manager has had a two-fold impact: the recovery has been slow and residents have little faith in the safety of the water. Mayor Karen Weaver has sought to spearhead a program of quick pipeline replacement, but that process has been hindered by a lack of funding.

State Intervention in Municipal Bankruptcy. In a new report yesterday, “When Cities Are at the Financial Brink,” Manhattan Institute authors Daniel DiSalvo and Stephen Eide wrote the “risk of insolvency for large cities in now higher than at any point since the federal government first passed a municipal bankruptcy law in the 1930’s,” adding that “states…should intervene at the outset and appoint a receiver before allowing a city or other local government entity to petition for bankruptcy in federal court—and writing, contrary to recent history: “Recent experiences with municipal bankruptcies indicates that when local officials manage the process, they often fail to propose the changes necessary to stabilize their city’s future finances.” Instead, they opine in writing about connections between chapter 9, and the role of the states, there should be what they term “intervention bankruptcy,” which could be an ‘attractive alternative’ to the current Chapter 9. They noted, however, that Congress is unlikely to amend the current municipal bankruptcy chapter 9, adding, moreover, that further empowering federal judges in municipal affairs “is sure to raise federalism concerns.” It might be that they overlook that chapter 9, reflecting the dual sovereignty created by the founding fathers, incorporates that same federalism, so that a municipality may only file for chapter 9 federal bankruptcy if authorized by state law—something only 18 states do—and that in doing so, each state has the prerogative to determine, as we have often noted, the process—so that, as we have also written, there are states which:

  • Precipitate municipal bankruptcy (Alabama);
  • Contribute to municipal insolvency (California);
  • Opt, through enactment of enabling legislation, significant state roles—including the power and authority to appoint emergency managers (Michigan and Rhode Island, for instance);
  • Have authority to preempt local authority and take over a municipality (New Jersey and Atlantic City.).

The authors added: “The recent experience of some bankrupt cities, as well as much legal scholarship casts doubt on the effectiveness of municipal bankruptcy.” It is doubtful the citizens in Stockton, Central Falls, Detroit, Jefferson County, or San Bernardino would agree—albeit, of course, all would have preferred the federal bailouts received in the wake of the Great Recession by Detroit’s automobile manufacturers, and Fannie Mae and Freddie Mac. Similarly, it sees increasingly clear that the State of Michigan was a significant contributor to the near insolvency of Flint—by the very same appointment of an Emergency Manager by the Governor to preempt any local control.

Despite the current chapter 9 waning of cases as San Bernardino awaits U.S. Bankruptcy Judge Meredith Jury’s approval of its exit from the nation’s longest municipal bankruptcy, the two authors noted: “Cities’ debt-levels are near all-time highs. And the risk of municipal insolvency is greater than at any time since the Great Depression.” While municipal debt levels are far better off than the federal government’s, and the post-Great Recession collapse of the housing market has improved significantly, they also wrote that pension debt is increasingly a problem. The two authors cited a 2014 report by Moody’s Investors Service which wrote that rising public pension obligations would challenge post-bankruptcy recoveries in Vallejo and Stockton—perhaps not fully understanding the fine distinctions between state constitutions and laws and how they vary from state to state, thereby—as we noted in the near challenges in the Detroit case between Michigan’s constitution with regard to contracts versus chapter 9. Thus, they claim that “A more promising approach would be for state-appointed receivers to manage municipal bankruptcy plans – subject, of course, to federal court approval.” Congress, of course, as would seem appropriate under our Constitutional system of dual sovereignty, specifically left it to each of the states to determine whether such a state wanted to allow a municipality to even file for municipal bankruptcy (18 do), and, if so, to specifically set out the legal process and authority to do so. The authors, however, wrote that anything was preferable to leaving local officials in charge—mayhap conveniently overlooking the role of the State of Alabama in precipitating Jefferson County’s insolvency.  

American Infrastructure FirstIn his campaign, the President-elect vowed he would transform “America’s crumbling infrastructure into a golden opportunity for accelerated economic growth and more rapid productivity gains with a deficit-neutral plan targeting substantial new infrastructure investments,” a plan the campaign said which would provide maximum flexibility to the states—a plan, “American Infrastructure First” plan composed of $137 billion in federal tax credits which would, however, only be available investors in revenue-producing projects—such as toll roads and airports—meaning the proposed infrastructure plan would not address capital investment in the nation’s public schools, libraries, etc. Left unclear is how such a plan would impact the nation’s public infrastructure, the financing of which is, currently, primarily financed by state and local governments through the use of tax-exempt municipal bonds—where the financing is accomplished by means of local or state property, sales, and/or income taxes—and some user fees. According to the Boston Federal Reserve, annual capital spending by state and local governments over the last decade represented about 2.3% of GDP and about 12% of state and local spending: in FY2012 alone, these governments provided more than $331 billion in capital spending. Of that, local governments accounted for nearly two-thirds of those capital investments—accounting for 14.4 percent of all outstanding state and local tax-exempt debt. Indeed, the average real per capita capital expenditure by local governments, over the 2000-2012 time period, according to the Boston Federal Reserve was $724—nearly double state capital spending. Similarly, according to Census data, state governments are responsible for about one-third of state and local capital financing. Under the President-elect’s proposed “American Infrastructure First” plan composed of $137 billion in federal tax credits—such credit would only be available to investors in revenue-producing projects—such as toll roads and airports—meaning the proposed infrastructure plan would not address capital investment in the nation’s public schools, libraries, etc. Similarly, because less than 2 percent of the nation’s 70,000 bridges in need of rebuilding or repairs are tolled, the proposed plan would be of no value to those respective states, local governments, or users. Perhaps, to state and local leaders, more worrisome is that according to a Congressional Budget Office 2015 report, of public infrastructure projects which have relied upon some form of private financing, more than half of the eight which have been open for more than five years have either filed for bankruptcy or been taken over by state or local governments.

Moody Southern Pension Blues. S&P Global Ratings Wednesday lowered Dallas’s credit rating one notch to AA-minus while keeping its outlook negative, with the action following in the wake of Moody’s downgrade last month—with, in each case, the agencies citing increased fiscal risk related to Dallas’ struggling Police and Fire Pension Fund, currently seeking to stem and address from a recent run on the bank from retirees amid efforts to keep the fund from failing, or, as S&P put it: “The downgrade reflects our view that despite the city’s broad and diverse economy, which continues to grow, stable financial performance, and very strong management practices, expected continued deterioration in the funded status of the city’s police and fire pension system coupled with growing carrying costs for debt, pension, and other post-employment benefit obligations is significant and negatively affects Dallas’ creditworthiness.” S&P lowered its rating on Dallas’ moral obligation bonds to A-minus from A, retaining a negative outlook, with its analysis noting: “Deterioration over the next two years in the city’s budget flexibility, performance, or liquidity could result in a downgrade…Similarly, uncertainty regarding future fixed cost expenditures could make budgeting and forecasting more difficult…If the city’s debt service, pension, and OPEB carrying charge elevate to a level we view as very high and the city is not successful in implementing an affordable plan to address the large pension liabilities, we could lower the rating multiple notches.” For its part, Fitch Ratings this week reported that a downgrade is likely if the Texas Legislature fails to provide a structural solution to the city’s pension fund problem. The twin ratings calls come in the wake of Dallas Mayor Mike Rawlings report to the Texas Pension Review Board last November that the combined impact of the pension fund and a court case involving back pay for Dallas Police officers could come to $8 billion—mayhap such an obligation that it could force the municipality into chapter 9 municipal bankruptcy, albeit stating that Dallas is not legally responsible for the $4 billion pension liability, even though he said that the city wants to help. The fund has an estimated $6 billion in future liabilities under its current structure. In testimony to the Texas State Pension Review Board, Mayor Rawlings said the pension crisis has made recruitment of police officers more difficult just as the city faces a flood of retirements.

 

What Is the State Role in Municipal Solvency/Recovery?

 

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eBlog, 11/21/16

Good Morning! In this a.m.’s eBlog, we consider the state role in addressing municipal fiscal distress and bankruptcy: what are the different models—and how are they working? Then we consider one especially dysfunctional model: Ohio, where the City of East Cleveland could find its two Mayoral candidates in municipal jail before the voters go to the polls early next month. From thence, we strike east to consider this month’s elections in Massachusetts on charter schools—examining an issue that goes to the heart not only of state local relations and authority, but also to the potential impact on municipal assessed property values. What may be learned? Finally, we wish readers a Happy Thanksgiving!

What Is the State Role in Municipal Solvency/Recovery? Under our country’s system of dual federalism created by the founding fathers, while federal law authorizes municipalities to file for chapter 9 bankruptcy, a city, county, or school district may only do so if authorized by a state. Today, only 18 of the 50 states provide such authority. Ergo, one of the issues we have sought to consider through this eBlog has been the evolving State role in municipal distress in a field of seeming constant flux. This month, for instance, we experienced the uncertain governance situation in New Jersey in the wake of the state takeover of the City of Atlantic City—a state takeover in which the process and how it will play out could be further impacted by the potential selection by President-elect Trump of New Jersey Governor Chris Christie, who might be a potential Cabinet or other senior advisor to the President-elect.

Actual governance has shifted from local accountability to the state’s Division of Local Government Services—but with the state already having imposed a state emergency manager in the city, what the new state takeover means continues to be uncertain. In Ohio, which authorizes chapter 9 municipal bankruptcy, the City of East Cleveland’s request to do so appears to be on the desk of Rod Serling in the Twilight Zone: there has simply been no response of any kind. Similarly, in California, state policies have clearly contributed to some of the fiscal distress that led Stockton and San Bernardino into chapter 9 municipal bankruptcy, but the state played absolutely no role in helping either Stockton or San Bernardino to emerge. Michigan, a state which has been deeply enmeshed in municipal fiscal distress—albeit not necessarily in a constructive manner—has acted in different ways—going from its imposition of an emergency manager—a process with deadly consequences in Flint, but seemingly key to Detroit’s turnaround. Alabama, by refusing to allow Jefferson County to raise its own taxes, directly aided and abetted the County’s chapter 9 municipal bankruptcy. Rhode Island, on the day of Central Falls’ chapter 9 filing—the very day Providence, the state’s capitol city, was itself poised on the rim of filing, but opted not to—and the state, thanks to the exceptional ingenuity of its then Treasurer (now Governor), created an ingenious model of creating teams of city managers and retired state legislators to act in teams to offer assistance to cities in danger of insolvency—so that there was a team effort before—instead of after such a precipitous event.

Part of what has made this effort to assess what is happening in the arena of severe municipal fiscal challenges and bankruptcy so much more difficult is the surprise that, in the wake of recovery from the Great Recession, one would have assumed severe municipal fiscal distress and insolvency would have dissipated. It has not. What has changed? Why are States not reacting more uniformly? With only 18 states permitting municipal bankruptcy, what state models exist which offer a clearly defined legal or legislated route to address not just insolvency, but also to avoid the spread of fiscal contagion? What is a state’s role in recovery from a chapter 9 municipal bankruptcy? What is a state’s role in addressing increasing fiscal disparities?

Ungoverning in a Fiscal Twilight Zone. In East Cleveland, Ohio, the mall city which is seeking authority from the State of Ohio to file for chapter 9 bankruptcy—a plea to which it remains unclear whether there will ever be a response, and where there have been on and off discussions with adjacent Cleveland about a consolidation of the two municipalities; the city’s election day activities provide a sense of the increasing dysfunctional nature of the small city: it was, after all, on election day this month at Mayfair Elementary School where both candidate Devin Branch and current Mayor Gary Norton were working the polls trying to convince registered voters to go with their respective causes. Mayor Norton was pressing potential voters not to recall him at the city’s upcoming election on December 8th; Devin Branch was going door-to-door to obtain the 550 requisite signatures to ensure the recall would officially be on the ballot. Their respective efforts, however, came up against each other when they encountered each other going after the same person and their battle became an event where they pressed their respective clip boards in front of registered voters—leading to a confrontation so that Mayor Norton decided to order the Chief of Police and a squad of police to arrest Mr. Branch. Moreover, dissatisfied with the police response, Mayor Norton then ordered his personal lawyer, Willa Hemmons, to issue a warrant for the arrest of Mr. Branch. Thus, in an insolvent municipality, several squads of police and detectives were directed to make the arrest of Devin Branch last Thursday. Mr. Branch was arrested and placed in East Cleveland’s jail; last Friday, Judge William Dawson opened the door for his release after posting bond. This morning, Judge Dawson will hear from both men, albeit, what the voters and city’s taxpayers will hear seems unlikely to be enlightening for the city’s fiscal future.

Schooled in Fiscal Solvency? Massachusetts voters this month overwhelmingly rejected a major expansion of charter schools, rejecting Question 2 by nearly a 2-1 margin, in what was perceived as a significant setback for Governor Charlie Baker, who had aggressively campaigned for the referendum, saying it would provide a vital alternative for families trapped in failing urban schools. As proposed, the measure would have allowed for 12 new or expanded charters per year, adding significantly to the existing stock of 78 charters statewide. Had the measure been approved, it would have—as state-imposed charter schools in Detroit are, shifted thousands of dollars in state aid from public to charter schools—shifting as much as an estimated $451 million statewide this year. During the campaign, opponents such as Juan Cofield, president of the New England Area Council of the NAACP, warned that charters were creating a two-tiered system, draining money from the traditional schools that serve the bulk of black and Latino students, telling voters “a dual school system is inherently unequal.” Worcester Mayor Joseph Petty, an opponent, noted: “Here in Worcester we will spend $24.5 million dollars on charter schools in our city…that is money that could be used to hire more teachers, improve our facilities, and invest in our students,” in effect underscoring the reason municipal leaders in the Bay State opposed the measure: their apprehension with regard to the fiscal impact on cities, towns, and school districts when more children attend charter schools. Had the measure been adopted, district schools would have received less money: the money to educate a child would have followed the child: over time, expanding access to charter schools could cost local property taxpayers more, since district schools will need more funding, forcing local elected leaders to either raise property taxes more, or cut public services. Indeed, opponents of charter school expansion claimed, based on state data, that school districts would have lost some $450 million this year to charter school tuition, even after accounting for state reimbursements.

Unsurprisingly, ergo, municipal officials generally opposed expanding charter schools, with the mayors of Springfield, Boston, Chicopee, Holyoke, Northampton, Pittsfield, Westfield, and West Springfield all coming out publicly opposed. Geoff Beckwith, the Executive Director of the Massachusetts Municipal Association, said the current funding system is already difficult for cities and towns to deal with, noting that, for one, the formula transferring money from district to charter schools does not take into account the fact that many of a school’s costs are fixed and do not vary by child, noting that with regard to the fiscal impact on cities, towns and school districts: “You have to a have a classroom, you have to heat the building, you still have principals…It’s extremely hard for communities to actually cut costs…The only thing they can do is cut back on the overall quality of the programming they’re offering the vast majority of kids who stay behind in the regular public school system.” Ergo, he noted: “Until the financing system is fixed, the ballot question providing for the expansion of charter schools would exacerbate and deepen the financial trouble that these local school systems are dealing with…And the communities that are most impacted by charter school expansion are in most cases the most financially challenged communities.” (Unsurprisingly, the Massachusetts Municipal Association board voted unanimously to oppose the ballot question.) Indeed, Moody’s reported the rejection to be a credit positive for the Commonwealth’s urban local governments: “It will allow those cities and towns to maintain current financial operations without having to adjust to increased financial pressure from charter school funding.” According to Moody’s, since the last charter school expansion in 2010, cities such as Boston, Fall River, Lawrence, and Springfield have experienced significant growth in charter school assessments, averaging 83% due to increasing charter school enrollment. To which, Moody’s notes: “So far, the growing cost of charter schools on municipalities has not been a direct credit challenge; rather the effect is more indirect because Massachusetts school districts are integrated within cities and towns with relatively healthy credit profiles.” The agency went on to write: “Education in the commonwealth is a primary budget item within a municipality’s overall budget, which allows city budgets to absorb some of the education financial stress with other municipal sources….This integration is a key distinction from school districts in other states that operate separately from the communities they serve.”