The Challenging Transition in the Wake of a State Takeover

September 25, 2018

Good Morning! In this morning’s eBlog, we report on the likely extension of the Garden State takeover of Atlantic City, because, as one of our most respected and insightful fiscal experts there, Marc Pfeiffer, the Assistant Director of Rutgers University’s Bloustein Local Government Research Center, put it: it is important for New Jersey and Atlantic City to focus on long-term challenges beyond the state takeover period. That is, Mr. Pfeiffer believes continued state oversight will be a positive for Atlantic City municipal bondholders, because it assures more fiscal discipline will be in place—or, in his own words: “You are going to have ongoing stability while the state is involved…The city will have to show that it can stand on its own.”

The Steep Road to Municipal Fiscal Recovery. In the wake of a release of a new state report, “Atlantic City, Building a Foundation for a Shared Prosperity,” [64-page report]  released by New Jersey Gov. Phil Murphy’s administration, a report recommending continuation of the almost two-year-old state takeover of Atlantic City’s finances, that state governance now appears likely to last a full five years, due to “longstanding challenges” to New Jersey officials, as recommended by the Governor’s office. While the Governor, in his campaign, had, as part of his platform, a commitment to terminate the state takeover of Atlantic City, now, three-quarters of a year after taking office, the Governor appears likely to leave the state takeover in place—indeed, possibly for an additional three years.

The Murphy Administration has released a plan to assist the city to get back on its fiscal feet, a plan which benefited from input from numerous study groups, task forces, and committees, as well as a redirection of some state government funds to youth programs, and a training program for municipal department heads; that plan does not end the takeover; rather the report recommends keeping the takeover in place for the full five years called for under the 2016 law, unless signal fiscal and financial improvement is put in place before then, including the significant reduction or total elimination of Atlantic City’s reliance on state aid—or, as Gov. Murphy put it: “We had a pretty clear-eyed sense of what the challenge was…That doesn’t mean Atlantic City doesn’t need the state, that the state won’t continue to stay the course and be a partner. We’re not going away; we’re going to go out and executive this plan.”

Under New Jersey’s state takeover law gave the state broad powers, including the right to overturn decisions of the city council, override or even abolish city agencies and seize and sell assets, including Atlantic City’s much-coveted water utility. The statue empowers state overseers, in addition, to hire or fire workers, break union contracts, and restructure Atlantic City’s debt, most of which was done to varying degrees, although no major assets have been sold off.

What Is the City’s Perspective? Atlantic City Mayor Frank Gilliam has conceded the uncomfortable governance challenge under the takeover, which was initiated in November of 2016 by former Governor Chris Christie, but he notes that Gov. Murphy’s administration has been willing to listen to concerns and work with city officials, even as it has retained the final governing say-so.

How Can a State Transition Governance Back to a City? Unlike under a chapter 9 municipal bankruptcy, where a federal bankruptcy court has the final say in approving (or not) a plan of debt adjustment under which governance authority reverts back to a municipality’s elected leaders, a state takeover lacks a Betty Crocker cookbook set of instructions. Gov. Murphy’s quasi-emergency manager, Jim Johnson, whom the Governor named to review Atlantic City’s transition back to local control, said the state administration should remain in place for an additional three years, unless Atlantic City’s reliance on state aid has been “substantially reduced or eliminated” and that its municipal workforce is on “solid footing.”  Under the provisions of the state takeover, enacted shortly after Atlantic City nearly defaulted on its municipal bond debt, the state was empowered to alter outstanding debt and municipal contracts—or, as Mr. Johnson wrote: “Atlantic City has a set of fiscal, operational, economic and social challenges that will only be resolved with significant direction from, and partnership with the State.”

Focus on the Fiscal Future. Mr. Pfeiffer said it is important for New Jersey and Atlantic City to focus on long-term challenges beyond the state takeover period, adding that the continued state oversight will be a positive for Atlantic City municipal bondholders, because it will assure greater fiscal discipline will be in place, or, as he put it: “You are going to have ongoing stability while the state is involved: The city will have to show that it can stand on its own.”

The report outlines a series of recommendations such, as:

  • the importance of diversifying Atlantic City’s economy beyond casinos,
  • providing increased training for senior municipal workers, and
  • purchasing data that can better track city services.

Mr. Johnson also urged Atlantic City to redirect Casino Reinvestment Development Authority funds into new development projects and toward providing increased financial support for youth programming.

Transitioning Back to Local Control. Atlantic City Mayor Frank Gilliam noted: “The citizens of Atlantic City deserve to have their local elected officials control their destiny…I am very optimistic that this is a huge step in the right direction for Atlantic City and its future.” Mr. Johnson, who was a primary challenger to the Gov. two years ago, was named after that election as a special counsel to review the state’s oversight of Atlantic City—and he came somewhat prepared thanks to his previous service as a U.S. Treasury Undersecretary for enforcement under former President Bill Clinton.

Gov. Murphy, who had been critical of the state takeover during his gubernatorial campaign, and who had criticized former Gov. Chris Christie’s administration for implementing it without support from former Mayor Donald Guardian, noted: “This is a community that needs the state’s help as a partner, not as a big-footing jamming down, taking away—you know, taxation without representation,” adding: “That doesn’t mean that Atlantic City doesn’t need the state, that the state isn’t going to stay the course and be a partner.” The Governor, soon after assuming office, had removed former Gov. Christie’s designated takeover manager Jeffrey Chiesa as the state designee to oversee the state role in Atlantic City. It should be noted, as we have previously, that Mr. Chiesa forged a number of settlements on owed casino property tax appeals and effected a $56 million reduction in Atlantic City’s FY2017 budget. All of which brings us back to the wary fiscal trepidation of Mr. Pfeiffer, because Atlantic City’s debt is still in the high risk range so favored by some casino players in the city: a CCC-plus from S&P Global Ratings and Caa3 from Moody’s Investors Service.

Post Municipal Bankruptcy Election, and How Does a City, County, State, or Territory Balance Schools versus Debt?

June 4, 2018

Good Morning! In this morning’s eBlog, we consider tomorrow’s primary in post-chapter 9 municipally bankrupt Stockton, and the harsh challenges of getting schooled in Puerto Rico.

Taking New Stock in Stockton? It was Trick or Treat Day in Stockton, in 2014, when Chris McKenzie, the former Executive Director of the California League of Cities described to us, from the U.S. Bankruptcy Court courtroom, Judge Christopher Klein’s rejection of the claims of the remaining holdout creditor, Franklin Templeton Investments, and approved the City of Stockton’s proposed Chapter 9 Bankruptcy Plan of Adjustment. Judge Klein had, earlier, ruled that the federal chapter 9 municipal bankruptcy law preempted California state law and made the city’s contract with the state’s public retirement system, CalPERS, subject to impairment by the city in the Chapter 9 proceeding. Judge Klein determined that that contract was inextricably tied to Stockton’s collective bargaining agreements with various employee groups. The Judge also had stressed that, because the city’s employees were third party beneficiaries of Stockton’s contract with CalPERS, that, contrary to Franklin’s assertion that CalPERS was the city’s largest creditor; rather it was the city’s employees—employees who had experienced substantial reductions in both salaries and pension benefits—effectively rejecting Franklin’s assertion that the employees’ pensions were given favorable treatment in the Plan of Adjustment. Judge Klein, in his opinion, had detailed all the reductions since 2008 (not just since the filing of the case in 2012) which had collectively ended the prior tradition of paying above market salaries and benefits to Stockton employees. Moreover, his decision included the loss of retiree health care,  reductions in positions, salaries and employer pension contributions, and approval of a new pension plan for new hires—a combination which Judge Klein noted meant that any further reductions, as called for by Franklin, would have made city employees “the real victims” of the proceeding. We had also noted that Judge Klein, citing an earlier disclosure by the city of over $13 million in professional services and other costs, had also commented that the high cost of Chapter 9 municipal bankruptcy proceedings should be an object lesson for everyone about why Chapter 9 bankruptcy should not be entered into lightly.

One key to the city’s approved plan of debt adjustment was the provision for a $5.1 million contribution for canceling retiree health benefits; however a second was the plan’s focus on the city’s fiscal future: voter approval to increase the city’s sales and use tax to 9 percent, a level expected to generate about $28 million annually, with the proceeds to be devoted to restoring city services and paying for law enforcement.

Moody’s, in its reading of the potential implications of that decision opined that Judge Klein’s ruling could set up future challenges from California cities burdened by their retiree obligations to CalPERS, with Gregory Lipitz, a vice president and senior credit officer at Moody’s, noting: “Local governments will now have more negotiating leverage with labor unions, who cannot count on pensions as ironclad obligations, even in bankruptcy.” A larger question, however, for city and county leaders across the nation was with regard to the potential implications of Judge Klein’s affirmation of Stockton’s plan to pay its municipal bond investors pennies on the dollar while shielding public pensions.

Currently, the city derives its revenues for its general fund from a business tax, fees for services, its property tax, sales tax, and utility user tax. Stockton’s General Fund reserve policy calls for the City to maintain a 17% operating reserve (approximately two months of expenditures) and establishes additional reserves for known contingencies, unforeseen revenue changes, infrastructure failures, and catastrophic events.  The known contingencies include amounts to address staff recruitment and retention, future CalPERS costs and City facilities. The policy establishes an automatic process to deposit one-time revenue increases and expenditure savings into the reserves.  

So now, four years in the wake of its exit from chapter 9 municipal bankruptcy, Republican businessman  and gubernatorial candidate John Cox has delivered one-liners and a vow to take back California in a campaign stop in Stockton before tomorrow’s primary election, asking prospective voters: “Are you ready for a Republican governor in 2018?”

According to the polls, this could be an unexpectedly tight race for the No. 2 spot against former Los Angeles Mayor Antonio Villaraigosa, a Democrat. (In the primary, the two top vote recipients will determine which two candidates will face off in the November election.) Currently, Democratic Lt. Gov. Gavin Newsom is ahead. Republicans have the opportunity to “take back the state of California,” however, candidate Cox said to a group of more than 130 men and women at Brookside Country Club—telling his audience that California deserves and needs an honest and efficient government, which has been missing, focusing most of his speech on what he said is California’s issue with corruption and cronyism worse than his former home state of Illinois. He vowed that, if elected, he would end “the sanctuary protections in the state’s cities.”

Seemingly absent from the debate leading up to this election are vital issues to the city’s fiscal future, especially Forbes’s 2012 ranking Stockton as the nation’s “eighth most miserable city,” and because of its steep drop in home values and high unemployment, and the National Insurance Crime Bureau’s ranking of the city as seventh in auto theft—and its ranking in that same year as the tenth most dangerous city in the U.S., and second only to Oakland as the most dangerous city in the state.

President Trump, a week ago last Friday, endorsed candidate Cox, tweeting: “California finally deserves a great Governor, one who understands borders, crime, and lowering taxes. John Cox is the man‒he’ll be the best Governor you’ve ever had. I fully endorse John Cox for Governor and look forward to working with him to Make California Great Again.” He followed that up with a message that California is in trouble and needs a manager, which is why Trump endorsed him, tweeting: “We will truly make California great again.”

Puerto Rico’s Future? Judge Santiago Cordero Osorio of the Commonwealth of Puerto Rico Superior Court last Friday issued a provisional injunction order for the Department of Education to halt the closure of six schools located in the Arecibo educational region—with his decision coming in response to a May 24th complaint by Xiomara Meléndez León, mother of two students from one of the affected schools, and with support in her efforts by the legal team of the Association of Teachers of Puerto Rico. The cease and desist order applies to all administrative proceedings intended to close schools in the muncipios of Laurentino Estrella Colon, Camuy; Hatillo; Molinari, Quebradillas; Vega Baja; Arecibo; and Lares—with Judge Cordero Osorio writing: “What this court has to determine is that according to the administrative regulations and circular letters of the Department of Education, there is and has been applied a formula that establishes a just line for the closure without passion and without prejudice to those schools that thus understand merit close.”  

With so many leaving Puerto Rico for the mainland, the issue with regard to education becomes both increasingly vital, while at the same time, increasingly hard to finance—but also difficult to ascertain fiscal equity—or as one of the litigants put it to the court: “The plaintiff in this case has clearly established on this day that there is much more than doubt as to whether the Department of Education is in effect applying this line in a fair and impartial manner.” Judge Osorio responded that “this court appreciates the evidence presented so far that the action of the Department of Education regarding the closure of schools borders on arbitrary, capricious, and disrespectful;” he also ruled that the uncertainty he saw in the testimonies of the case had created “irreparable emotional damage worse than the closing of schools,” as he ordered Puerto Rico Education Secretary Julia Keleher to appear before him a week from today at a hearing wherein Secretary Keleher must present evidence of the procedures and arguments that the Department took into consideration for the closures.  

Meléndez León, the mother who appears as a plaintiff in the case, stated she had resorted to this legal path because the Department of Education had never provided her with concrete explanations with regard to why Laurentino Estrella School in Camuy, which her children attend, had been closed—or, as she put it: “The process that the Department of Education used to select closure schools has never been clarified to the parents: we were never notified.” At the time of the closure, the school had 186 students—of which 62 belonged to Puerto Rico’s Special Education program—and another six were enrolled in the Autism Program. Now, she faces what might be an unequal challenge: one mother versus a huge bureaucracy—where the outcome could have far-reaching impacts. The Education Department, after all, last April proposed the consolidation of some 265 schools throughout the island.

Motor City Rising

June 1, 2018

Good Morning! In this morning’s eBlog, we consider the remarkable turnaround of Detroit—a city which, when I inquired on its very first day in chapter 9 municipal bankruptcy, for walking directions from my hotel to the Governor’s Detroit office—in response to which I was told the one mile route was not doable—not because I would be too physically challenged,  but rather because I would be slain. Yet now, as the  fine editorial writers for the Detroit News, Daniel Howes and Nolan Finley, wrote: “A regional divide that appeared to be healing since Detroit’s historic bankruptcy is busting wide open over a plan for regional transit, exposing anxiety that the city is prospering at the expense of the suburbs,” noting that the trigger is a is a proposed millage to fund expansion of the Regional Transit Authority of Southeast Michigan, a $5.4 billion plan that would seem to promise an exceptional reshaping of the metro region—indeed: a reversal a what had been a decades-long shift of the economy from downtown Detroit to is suburbs: an exodus that contributed to a wasteland and the nation’s largest ever chapter 9 municipal bankruptcy.” Or, as they wrote: “That battle reveals growing suburban resentments over the region’s shifting economic fortunes: decades-long capital flow is reversing directions as more jobs and tax revenue flee the ‘burbs for a rejuvenated downtown.”

Mr. Finley noted that Mayor Mike Duggan, this week, told him: “I can’t explain why Oakland and Macomb (suburban counties) are doing what they’re doing” three weeks ago Microsoft brought 400 employees from Southfield into the city of Detroit. And last week, Tata Technologies said they were moving 200 people from Novi and into Detroit. Google is in the process of moving people from Birmingham into the city of Detroit.” What the Mayor was alluding to was a u-turn from a decade of moderate and upper income families leaving Detroit for its suburban counties in the days when former Mayor Coleman Young had advised criminals to “hit Eight Mile” has the relationship between the Metro Motor City’s regional leaders become so difficult in the wake of the unexpected reverse exodus: this time from Detroit’s suburbs back into the city. Billions in private sector investment, spearheaded by Dan Gilbert’s Quicken Loans Inc., the Ilitch family, and growing enthusiasm among other business leaders to be part of the city’s post-chapter 9 municipal bankruptcy have been changing demographic and economic patterns.

As the city continues under decreasing state oversight to carry out its judicially approved plan of debt adjustment, Mayor Duggan notes: “Expectations are rising.” This, after all, is not a City Hall bound mayor, but rather what the editors described as a “short, stocky, balding white guy who is no stranger to block after block of dilapidated houses—and who was reelected to a second term with an amazing 72% of the vote in a city where slightly more than 82% of the voters are black—and where, when he took office, there were about 40,000 abandoned homes. He is not a stay at City Hall type fellow either—rather an inveterate inspector of this mammoth rebuilding of an iconic city, who listens—and with his cell phone—takes action immediately in response to constituents concerns. After all, as the Mayor notes: “Expectations are rising…People are putting more demands on me and more demands on the administration, and I think that’s a really good thing and that will keep us motivated to work hard.”

Already, the urban wasteland is changing—almost on a daily basis: already, under a city program which supports renovation over demolition to try to preserve the mid-century architectural character of neighborhoods, that number of abandoned homes has been halved—with many of the units set aside for affordable housing. In his State of the City address this year, Mayor Duggan said he wants 8,000 more homes demolished, 2,000 sold, another 1,000 renovated and 11,000 more boarded up by the end of next year.

On that first day of the nation’s largest ever municipal bankruptcy, Kevin Orr, whom the Governor had tapped to become the Emergency Manager for Detroit, had flown out from the Washington, D.C. region, and told me his first actions were to email every employee of Detroit that he would be filing that morning in the U.S. Bankruptcy Court, but that he expected every employee to report to work—and that the most critical priorities were that every traffic and street light work—and that there be a professional, courteous, and prompt response to every 911 call.  

That was a challenge—especially for a municipality in bankruptcy, but, by 2016, the city had completed a $185 million streetlight repair project; 911 response times have been reduced from 50 minutes in 2013 to 14.5 minutes last year, and ambulance response times fell from 20 minutes in 2014 to the national average of 8 minutes this year.

As we have previously noted, two months ago, just three and a half years after Detroit emerged from chapter 9, the city has exited from state oversight; its homeless population has, for the third consecutive year, declined—and, its unemployment rate, which had peaked during the fiscal crisis at 28%, is now below 8%. No wonder the suburbs are becoming fiscally jealous. And the downtown, which was unsafe for pedestrians when the National League of Cities hosted its annual meeting there in the 1980’s and on the city’s first day in bankruptcy, has been transformed into a modern, walkable metropolis.

Nevertheless, the seeming bulldog, relentless leader has refused to sugarcoat the fiscal and physical challenge—or, as he puts it: “I don’t spend a lot of time promising. I just say, here’s what we’re doing next and here’s why we’re doing it and then we do what we say…Over time, you don’t restore trust by making more promises; you restore trust by actually doing what you said you were going to do.”

Mr. Finley wrote that the Mayor, deemed a “truth teller” by Detroit Housing Director Arthur Jemison, has been direct in confronting the city’s harsh legacy of racist policies after the Great Depression lured thousands upon thousands of African-Americans north in the early decades of the 20th century to work in auto factories—luring them to a city at a time when Federal Housing Administration guidelines barred blacks in the city from obtaining home mortgages and even led to the construction in 1941 of a wall bordering the heavily African-American 8 Mile neighborhood to segregate it from a new housing development for whites.

Aaron Foley — the 33-year-old author of How to Live in Detroit Without Being a Jackass, noted: “When you deliver that kind of message about this is why black people are on this side of the wall in 8 Mile versus the other side of the wall, that gets people talking: This is a history that we all know in Detroit, and for the city government to acknowledge that in the way that it did on that platform, it did resonate.”

Mayor Duggan’s concern for Detroit’s people—and not forcing low-income families out, is evidenced too by his words: “Every single time that we had a building where the federal [housing] credits were expiring and people were going to get forced out of their affordable units, I had to sit down for hours with the building owner to convince them why those who stayed were entitled to be there, and I thought: I need to do just one speech and explain that this is the right thing to do…Since then there’s been just great support for the direction we’re going in the city. We have very little pushback now from our developers over making sure that what they’re doing is equitable.”

Human, Fiscal, & Physical Challenges

April 20, 2018

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

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

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

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

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

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

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

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

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

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

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

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

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

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

 

Motoring Back from Chapter 9 Bankruptcy

March 9, 2018

Good Morning! In this morning’s eBlog, we consider the state of the City of Detroit, the state of the post-state takeover Atlantic City, and the hard to explain delay by the U.S. Treasury of a loan to the U.S. Territory of Puerto Rico.

An Extraordinary Chapter 9 Exit. Detroit Mayor Mike Duggan yesterday described the Motor City as one becoming a “world-class place to put down your roots” and make an impact: “We’re at a time where I think the trajectory is going the right way…We all know what the issues are. We’re no longer talking about streetlights out, getting grass cut in the parks. We’re making progress. We’re not talking all that much about balancing the budget.” His remarks, coming nearly five years after I met with Kevin Orr on the day he had arrived in Detroit at the request of the Governor Rick Snyder to serve as the Emergency Manager and steer the city into and out of chapter 9 municipal bankruptcy, denote how well his plan of debt adjustment as approved by U.S. Bankruptcy Judge Steven Rhodes has worked.

Thus, yesterday, the Mayor touted the Detroit Promise, a city scholarship program which covers college tuition fees for graduates of the city’s school district, as well as boosting a bus “loop” connecting local charter schools, city schools and after-school programs. Maybe of greater import, the Mayor reported that his administration intends to have every vacant, abandoned house demolished, boarded up, or remodeled by next year—adding that last year foreclosures had declined to their lowest level since 2008. Over the last six months, the city has boarded up 5,000 houses, sold 3,000 vacant houses for rehab, razed nearly 14,000 abandoned houses, and sold an estimated 9,000 side lots. The overall architecture of the Motor City’s housing future envisions the preservation of 10,000 affordable housing units and creation of 2,000 new ones over the next five years.

The Mayor touted the success of the city’s Project Green Light program, noting that some 300 businesses have joined the effort, which has realized, over the last three years a 40% in carjackings, a 30% decline in homicides since 2012, and 37% fewer fires, adding that the city intends to expand the Operation Ceasefire program, which has decreased shootings and other crimes, to other police precincts. On the economic front, the Mayor stated that Lear, Microsoft, Adient, and other major enterprises are moving or planning to open sites: over the last four years, more than 25 companies of 100-500 jobs relocated to Detroit. On the public infrastructure radar screen, Mayor Duggan noted plans for $90 million in road improvements are scheduled this year, including plans to expand the Strategic Neighborhood Fund to target seven more areas across the city, add stores, and renovate properties. Nearly two years after Michigan Senate Majority Leader Arlan Meekhof (R-West Olive) shepherded through the legislature a plan to pay off the Detroit School District’s debt, describing it to his colleagues as a “realistic compromise for a path to the future…At the end of the day, our responsibility is to solve the problem: Without legislative action, the Detroit Public Schools would head toward bankruptcy, which would cost billions of dollars and cost every student in every district in Michigan,” the Mayor yesterday noted that a bigger city focus on public schools is the next front in Detroit’s post-bankruptcy turnaround as part of the city’s path to exiting state oversight. He also unveiled a plan to partner with the Detroit Public Schools Community District, describing the recovery of the district as vital to encourage young families to move back into the city, proposing the formation of an education commission on which he would serve, as well as other stakeholders to take on coordinating some city-wide educational initiatives, such as putting out a universal report card on school quality (which he noted would require state support) and coordinating bus routes and extracurricular programs to serve the city’s kids regardless of what schools they attend.

The Mayor, who at the end of last month unveiled a $2 billion balanced budget, noted that once the Council acts upon it, the city would have the opportunity to exit active state oversight: “I expect in April or May, we’re going to see the financial review commission vote to end oversight and return self-determination to the City of Detroit,” adding: “As everybody here knows, the financial review commission doesn’t entirely go away: they go into a dormancy period. If we in the future run a deficit, they come back.”

His proposed budget relies on the use of $100 million of an unassigned fund balance to help increase spending on capital projects, including increased focus on blight remediation, stating he hopes to double the rate of commercial demolition and get rid of every vacant, “unsalvageable” commercial property on major streets by the end of next year—a key goal from the plan he unveiled last October to devote $125 million of bond funds towards the revitalization of Detroit neighborhood commercial corridors, part of the city’s planned $317 million improvements to some 300 miles of roads and thousands of damaged sidewalks—adding that these investments have been made possible from the city’s $ billion general fund thanks to increasing income tax revenues—revenues projected to rise 2.7% for the coming fiscal year and add another $6million to $7 million to the city’s coffers. Indeed, CFO John Hill reported that the budget maintains more than a 5% reserve, and that the city continues to put aside fiscal resources to address the  higher-than-expected pension payments commencing in 2024, the fiscal year in which Detroit officials project they will face annual payments of at least $143 million under the city’s plan of debt adjustment, adding that the retiree protection fund has performed well: “What we believe is that we will not have to make major changes to the fund in order for us to have the money that we need in 2024 to begin payments; In 2016 those returns weren’t so good and have since improved in 2017 and 2018, when they will be higher than the 6.75% return that we expected.” He noted that Detroit is also looking at ways to restructure its debt, because, with its limited tax general obligation bonds scheduled to mature in the next decade, Detroit could be in a position to return to the municipal market and finance its capital projects. Finally, on the public safety front, the Mayor’s budget proposes to provide the Detroit Police Department an $8 million boost, allowing the police department to make an additional 141 new hires.

Taking Bets on Atlantic City. The Atlantic City Council Wednesday approved its FY2019 budget, increasing the tax levy by just under 3%, creating sort of a seesaw pattern to the levy, which three years ago had reached an all-time high of $18.00 per one thousand dollars of valuation, before dropping in each of the last two years. Now Atlantic City’s FY2019 budget proposal shows an increase of $439,754 or 3.06%, with Administrator Lund outlining some of the highlights at this week’s Council session. He reported that over the years, the city’s landfill has been user fee-based ($1 per occupant per month) to be self-sufficient; however, some unforeseen expenses had been incurred which imposed a strain on the landfill’s $900,000 budget. Based on a county population of 14,000, the money generated from the assessment amounts to roughly $168,000 per year, allowing the Cass County Landfill to remain open. However, the financing leaves up to each individual city the decision of fee assessments. Thus, he told the Council: “The Per Capita payment to the landfill accounted for about .35 to .40 cents of the increase.”  Meanwhile, two General Department heads requested budget increases this year and five Department Heads including; the Police Department and Library submitted budgets smaller than the previous year. Noting that he “never advocate(s) for a tax increase,” Mr. Lund stated: “But it is what it is. It was supposed to go up to $16.98 last year and now we are at $16.86, so it’s still less,” adding that the city’s continuous debt remains an anchor to Atlantic City’s credit rating—but that his proposed budget includes a complete debt assumption and plan to deleverage the City over the next ten years.

Unshelter from the Storm. New York Federal Reserve Bank President, the very insightful William Dudley, warns that Puerto Rico should not misinterpret the economic boost from reconstruction following hurricanes that hit it hard last year as a sign of underlying strength: “It’s really important not to be seduced by that strong recovery in the immediate aftermath of the disaster,” as he met with Puerto Rican leaders in San Juan: “We would expect there to be a bounce in 2018 as the construction activity gets underway in earnest,” warning, however, he expects economic growth to slow again in 2019 or 2020: “It’s “important not to misinterpret what it means, because a lot still needs to be done on the fiscal side and the long-term economic development side.”

President Dudley and his team toured densely populated, lower-income, hard hit  San Juan neighborhoods, noting the prevalence of “blue roofs”—temporary roofs overlaid with blue tarps which had been used as temporary cover for the more permanent structures devastated by the hurricanes, leading him to recognize that lots of “construction needs to take place before the next storm season,” a season which starts in just two more months—and a season certain to be complicated by ongoing, persistent, and discriminatory delays in federal aid—delays which U.S. Treasury Secretary Steven Mnuchin blamed on Puerto Rico, stating: “We are not holding this up…We have documents in front of them that [spell out the terms under which] we are prepared to lend,” adding that the Trump Administration has yet to determine whether any of the Treasury loans would ultimately be forgiven in testimony in Washington, D.C. before the House Appropriations Subcommittee on Financial Services and General Government.

Here, the loan in question, a $4.7 billion Community Disaster Loan Congress and the President approved last November to benefit the U.S. territory’s government, public corporations, and municipalities—but where the principal still has not been made available, appears to stem from disagreements with regard to how Puerto Rico would use these funds—questions which the Treasury had not raised with the City of Houston or the State of Florida.  It appears that some of the Treasury’s apprehensions, ironically, relate to Gov. Ricardo Rosselló’s proposed tax cuts in his State of the Commonwealth Speech, in which the Governor announced tax cuts to stimulate growth, pay increases for the police and public school teachers, and where he added his administration would reduce the size of government through consolidation and attrition, with no layoffs, e.g. a stimulus policy not unlike the massive federal tax cuts enacted by President Trump and the U.S. Congress. It seems, for the Treasury, that what is good for the goose is not for the gander.

At the end of last month, Gov. Rosselló sent a letter to Congress concerned that the Treasury was now offering only $2.065 billion, writing that the proposal “imposed restrictions seemingly designed to make it extremely difficult for Puerto Rico to access these funds when it needs federal assistance the most.” This week, Secretary Mnuchin stated: “We are monitoring their cash flows to make sure that they have the necessary funds.” Puerto Rico reports it is asking for changes to the Treasury loan documents; however, Sec. Mnuchin, addressing the possibility of potential loans, noted: “We’re not making any decision today whether they will be forgiven or…won’t be forgiven.” Eric LeCompte, executive director of Jubilee USA, a non-profit devoted to the forgiveness of debt on humanitarian grounds, believes the priority should be to provide assistance for rebuilding as rapidly as possible, noting: “Almost six months after Hurricane Maria, we are still dealing with real human and economic suffering…It seems everyone is trying to work together to get the first installment of financing sent and it needs to be urgently sent.”

Part of the problem—and certainly part of the hope—is that President Dudley might be able to lend his acumen and experience to help. While the Treasury appears to be most concerned about greater Puerto Rico public budget transparency, Mr. Dudley, on the ground there, is more concerned that Puerto Rican leaders not misinterpret the economic boost from reconstruction following the devastating hurricanes as a sign of underlying strength, noting: “It’s really important not to be seduced by that strong recovery in the immediate aftermath of the disaster: We would expect there to be a bounce in 2018 as the construction activity gets underway in earnest,” before the economic growth slows again in 2019 or 2020, adding, ergo, that it was “important not to misinterpret what it means, because a lot still needs to be done on the fiscal side and the long-term economic development side.”

The Steep & Winding Road Out of Municipal Bankruptcy and State Oversight

February 26, 2018

Good Morning! In this morning’s eBlog, we consider the hard road out of chapter 9 municipal bankruptcy and state oversight.

Motor City Races to Earn the Checkered Flag. Detroit Mayor Mike Duggan last Friday presented his proposed annual budget to the City Council, informing Councilmembers that, if approved, his $2 billion budget would be the keystone for formal exit from Michigan state oversight: that is, he advised he believed it would lay the ground work for ending the Financial Review Commission created in the wake of the city’s chapter 9 municipal bankruptcy: “Once we get this budget passed, we have the opportunity to get out from active state oversight…I don’t have enough good things to say about how the administration and Council has worked together.” As we had noted last month, Michigan Treasurer Nick Khouri, the Chair of the state oversight commission, made clear that the trigger to such an exit would be for the city to post its third straight budget surplus—with the Treasurer noting: “I think everyone, including me, has just been impressed with the progress that’s been made in the city of Detroit, both financially and operationally.”

For Detroit to fully emerge from the nation’s largest ever municipal bankruptcy, it must both comply with the provisions of the federal chapter 9 bankruptcy code, which provides that the debtor must file a plan (11 U.S.C. §941); neither creditors nor the U.S. Bankruptcy Court may control the affairs of a municipality indirectly through the mechanism of proposing a plan of adjustment of a municipality’s debts that would in effect determine the municipality’s future tax and/or spending decisions: the standards for plan confirmation in municipal bankruptcy cases are a combination of the statutory requirements of 11 U.S.C. §943(b) and portions of 11 U.S.C. §129. Key confirmation standards provide that the federal bankruptcy court must confirm a plan if the following conditions are met: the plan complies with the provisions of title 11 made applicable by sections 103(e) and 901;the plan complies with the provisions of chapter 9; all amounts to be paid by the debtor or by any person for services or expenses in the case or incident to the plan have been fully disclosed and are reasonable; the debtor is not prohibited by law from taking any action necessary to carry out the plan; except to the extent that the holder of a particular claim has agreed to a different treatment of such claim, the plan provides that on the effective date of the plan, each holder of a claim of a kind specified in section 507(a)(1) will receive on account of such claim cash equal to the allowed amount of such claim; any regulatory or electoral approval necessary under applicable non-bankruptcy law in order to carry out any provision of the plan has been obtained, or such provision is expressly conditioned on such approval; and the plan is in the best interests of creditors and is feasible.

Unlike in a non-municipal corporate bankruptcy (chapter 11), where the requirement that the plan be in the “best interests of creditors,” means in the “best interest of creditors” if creditors would receive as much under the plan as they would if the debtor were liquidated; under chapter 9, because, as one can appreciate, the option of Detroit to sell its streets, ambulances, and other publicly owned municipal assets is simply not an option, in municipal bankruptcy, the “best interests of creditors” test has generally been interpreted to mean that the plan must be better than other alternatives available to the creditors. It is not, in a sense, different from a Solomon’s Choice (Kings 3:16-28): that is, in lieu of the alternative to municipal chapter 9 bankruptcy of permitting each and every creditor to fend for itself, the federal bankruptcy court instead seeks to interpret what is in the “best interests of creditors” as a means to balance a reasonable effort by the municipality against the obligations it has to its retirees, municipal duties, service obligations, and its creditors—albeit, of course, leaving the door open for unhappy parties to object to confirmation, (see, viz. 11 U.S.C. §§ 901(a), 943, 1109, 1128(b)). The statute provides that a city or municipality may exit after a municipal debtor receives a discharge in a chapter 9 case after: (1) confirmation of the plan; (2) deposit by the debtor of any consideration to be distributed under the plan with the disbursing agent appointed by the court; and (3) a determination by the court that securities deposited with the disbursing agent will constitute valid legal obligations of the debtor and that any provision made to pay or secure payment of such obligations is valid. (11 U.S.C. §944(b)). Thus, the discharge is conditioned not only upon confirmation, but also upon deposit of the consideration to be distributed under the plan and a court determination of the validity of securities to be issued. (The Financial Review Commission is responsible for oversight of the City of Detroit and the Detroit Public Schools Community District, pursuant to the Michigan Financial Review Commission Act (Public Act 181 of 2014); it ensures both are meeting statutory requirements, reviews and approves their budgets, and establishes programs and requirements for prudent fiscal management, among other roles and responsibilities.)

As part of Detroit’s approved plan of debt adjustment, the State of Michigan mandated the appointment of a financial review commission to oversee the Motor City’s finances, including budgets, contracts, and collective bargaining agreements with municipal employees—a commission, ergo, which Mayor Duggan, last Friday, made clear would not simply disappear in a puff of smoke, but rather go into a “dormancy period: They do continue to review our finances, and if we in the future run a deficit, they come back to life, and it takes another three years before we can move them out.”

Mayor Duggan’s proposed budget includes an $8 million boost to Detroit’s Police Department budget—enough to hire 141 new full-time positions. With the increase, the Mayor noted, the city will be able to expand its Project Greenlight and Ceasefire programs—adding that the Motor City had struggled to fill police department vacancies until about two years ago when the City Council passed a new contract. Detroit had improved from its last place ranking in violent crime in 2014, moving up to second worst in 2015, vis-à-vis rates per resident in cities with 50,000 or more people: in 2014, Detroit had recorded 13,616 violent crimes, for a rate of about 994 incidents per 50,000 people, declining to 11,846 violent crimes in 2015, and to a violent crime rate of about 880. Since then, the city has been able to hire 500 new officers, albeit, as the Mayor noted: “This city is not nearly where it needs to be for safety.”  Additionally, Mayor Duggan said his budget allows Detroit to double the rate of commercial demolitions with a goal of having all “unsalvageable” buildings on major streets razed by 2019. That would put the city on track for cleaning up its commercial corridors, he added. The budget allocates $100 million of the unassigned fund balance to blight remediation and capital projects, which is double the resources allocated last fiscal year. Other budget plans include more funding for summer jobs programs and Detroit At Work; neighborhood redevelopment plans for areas such as Delray, Osborn, Cody Rouge, and East English Village; and boosting animal control so it can operate seven days a week.

The $2 billion budget dedicates $1 billion to the city’s general fund. Chief Financial Officer John Hill said it is able to maintain its $62.3 million budget reserve, which exceeds the $53.6 million requirementCouncilman Scott Benson said the Mayor presented a “conservative fiscal budget” which allows Detroit to live within its means. The Councilmember said prior to the meeting that he had hoped the budget would address funding for poverty and neighborhood revitalization. However, council members received the budget 20 minutes before the meeting and Councilmember Benson said he needed more time to review it. “We’re seeing some good things,” he said of Mayor Duggan’s proposals, “But I want to dig into the numbers and actually go through it with a fine-tooth comb.” Officials say city council has until March 9 to approve the budget.

That early checkered flag for the Motor City ought to help salve the city’s reputational wounds in the wake of the KO administered to the city’s bid to host Amazon. Indeed, as Quicken Loans Chairman Dan Gilbert wrote, it was Detroit’s negative reputation, not a lack of talent which knocked it out of the running for an Amazon headquarters, as he tweeted to the 60-plus member bid committee who crafted Detroit’s bid: “We are all disappointed,” referring to the city’s failed bid to make the cut for the top 20 finalists. Nevertheless, Mr. Gilbert urged members not to accept the “conventional belief” that Detroit had fallen short because of its challenges with regional transportation and attracting talent; rather, he wrote, the “elephant in the room” was the nasty reputation associated with the post-bankruptcy city’s 50-plus years of decline: “Old, negative reputations do not die easily. I believe this is the single largest obstacle that we face…Outstanding state-of-the-art videos, well-packaged and eye-catching proposals, complex and generous tax incentives, and highly compelling and improving metrics cannot, nor will not overcome the strong negative connotations that the Detroit brand still needs to conquer.” Regional leaders had been informed that Detroit’s bid had failed to move on because of inadequate mass transit and questionable ability to attract talent.

As part of Detroit’s approved plan of debt adjustment, the State of Michigan mandated the appointment of a financial review commission to oversee the Motor City’s finances, including budgets, contracts, and collective bargaining agreements with municipal employees—a commission, ergo, which Mayor Duggan, last Friday, made clear would not simply disappear in a puff of smoke, but rather go into a “dormancy period: They do continue to review our finances, and if we in the future run a deficit, they come back to life, and it takes another three years before we can move them out.”

Mayor Duggan’s proposed budget includes an $8 million boost to Detroit’s Police Department budget—enough to hire 141 new full-time positions. With the increase, the Mayor noted, the city will be able to expand its Project Greenlight and Ceasefire programs—adding that the Motor City had struggled to fill police department vacancies until about two years ago when the City Council passed a new contract. Detroit had improved for its last place raking in violent crime in 2014, moving up to second worst in 2015, vis-à-vis rates per resident in cities with 50,000 or more people: in 2014, Detroit had recorded 13,616 violent crimes, for a rate of about 994 incidents per 50,000 people, declining 11,846 violent crimes in 2015, and to a violent crime rate of about 880. Since then, the city has been able to hire 500 new officers, albeit, as the Mayor noted: “This city is not nearly where it needs to be for safety.”  Additionally, Mayor Duggan said his budget allows Detroit to double the rate of commercial demolitions with a goal of having all “unsalvageable” buildings on major streets razed by 2019. That would put the city on track for cleaning up its commercial corridors, he said. The budget allocates $100 million of the unassigned fund balance to blight remediation and capital projects, which is double the money allocated last fiscal year. Other budget plans include more funding for summer jobs programs and Detroit At Work; neighborhood redevelopment plans for areas such as Delray, Osborn, Cody Rouge and East English Village, and boosting animal control so it can operate seven days a week. 

The $2 billion budget dedicates $1 billion to the city’s general fund. Chief Financial Officer John Hill said Detroit is able to maintain its $62.3 million budget reserve, which exceeds the $53.6 million requirementCouncilman Scott Benson said the mayor presented a “conservative fiscal budget” that allows Detroit to live within its means, having said, prior to the meeting, that he hoped the budget would address funding for poverty and neighborhood revitalization. However, council members received the budget 20 minutes before the meeting and Councilmember Benson said he needed more time to review it. “We’re seeing some good things,” he said of Mayor Duggan’s proposals. “But I want to dig into the numbers and actually go through it with a fine-tooth comb.” Officials say city council has until March 9 to approve the budget.

The Precipitous Chapter 9 Road to Recovery

January 3, 2018

Good Morning! In this a.m.’s Blog, we consider the fiscal, scholastic, and governing challenges of the city emerging from the largest chapter 9 municipal bankruptcy in U.S. history.

Visit the project blog: The Municipal Sustainability Project 

The Steep Fiscal Road to Recovery.  After years of failed leadership, financial mismanagement, quasi-chapter 9 municipal bankruptcy which led to a state takeover; the state of Detroit’s Public Schools Community District remains vital to encouraging young families to move back into the city—especially in the wake, last month, of DPS failing to meet critical deadlines necessary to be eligible for vital state aid.  (In 2016, Michigan enacted a $617 million DPS bailout, as we have previously noted.) That action separated the district’s debt from a new district that could start fresh. Now, renewed state intervention would be a critical fiscal step backwards; thus it is fortunate that Superintendent Nikolai Vitti appears to be on top of the situation: he warns that disciplinary action will follow in the wake of DPS’ failure to meet these deadlines, making it critical the Superintendent can trust his staff. It is especially vital now in the wake of a second credit rating upgrade—with the report card having recorded, last month, that DPS that Detroit Public Schools had lost out on $6.5 million in fiscal assistance to whittle down its old debt, because DPS officials had failed to turn in paperwork homework on time, according to Superindent Vitti (Michigan reimburses its public school districts for debt loss under Public Act 86 if they met the Aug. 15 deadline; thus, Superindent Vitte, on Monday, reported: “At this point, Detroit Public Schools is not eligible for the $6.5 million-dollar reimbursement from the state…After speaking with state officials, the available funds have already been disbursed to other qualifying entities. However, we will continue to petition the state to receive the reimbursement.”

Under the agreement, Detroit’s old district is still obligated to pay down its past operating debt; thus, the system’s failure to meet two deadlines last year cost not $6.5 million in aid from the state to help pay down its debt, but also a loss of public trust and confidence. As Superintendent Vitte noted last month: “At this point, Detroit Public Schools is not eligible for the $6.5 million-dollar reimbursement from the state: After speaking with state officials, the available funds have already been disbursed to other qualifying entities.” According to Superintendent Vitti, former CFO Marios Demetriou received the documents, but never completed them or sent them to the state. Even though the missed payout from the state is not expected to harm the day-to-day operations of the new district, it appears to curry a D grade; more importantly, it delays repayment of DPS’ legacy debt—or, as Superintendent Vitti notes: it is “unacceptable….The inability to submit the reimbursement form on time is a vestige of the past that continues to haunt the district…This is directly associated with the need for stronger leaders, systems, and processes. The individuals who were closest to the responsibility to submit the form will no longer be with the district.”

The unscholarly missteps appear to have contributed to ongoing doubts about the city’s fiscal acumen: The Motor City’s credit ratings remain deep in junk-bond territory, even after S&P Global Ratings last month upgraded Detroit’s credit rating from B to B+, while Moody’s last October had lifted its to B1 in the wake of the city’s launch of a new web portal to improve investor access to its financial data and bond offerings, Stephen Winterstein, a Managing Director and chief municipal fixed income strategist at Wilmington Trust Investment Advisors, Inc. to note he was “really optimistic about what they have been doing in terms of disclosure and the investor website is definitely a move in the right direction: The road to recovery is a long one, and I think that Detroit is doing the right things.”

Since exiting from the largest chapter 9 municipal bankruptcy in American history just three years ago last month, Detroit has issued debt twice: in August 2015 with $245 million of local government loan program revenue bonds, and in August 2016 with a $615 million general obligation/distributable state aid backed bond sale—albeit both issuances were via the Michigan Finance Authority, with the first enhanced with a statutory lien and intercept feature on the city’s income taxes. CFO John Naglick said that Detroit is also close to deciding on the underwriting team for a request for proposals it launched in October to find banks to lead a tender offer and refunding of its unsecured financial recovery municipal bonds with the aim of lowering its costs and easing a future escalation of debt service. For its part, S&P, in its upgrade, cited positive momentum the city is building with regard to stabilizing its operations and being better prepared to address future significant increases in pension contributions—or, as the agency noted: “We believe the city’s financial position is now more transparent compared with recent years, as is Detroit’s long-term financial strategy, which relies on fairly conservative growth assumptions…We also believe that the city has a stronger capacity to service its debt obligations than in years past.” Indeed, Detroit’s credit ratings are the highest since March of 2012, just over a year before Kevin Orr filed for chapter 9 bankruptcy in July of 2013. Nevertheless, Detroit’s credit rating remains deep in junk territory and vulnerable to another recession, say market participants. Or, as Michigan Attorney General and gubernatorial Bill Scheutte notes: “We still believe Detroit faces a long path that will require years of prudent decision-making from management and the avoidance of major economic shocks before its debt makes sense for investors looking for high-quality municipal exposure…The city still has an abundance of extremely high-risk characteristics and speculative-grade qualities that investors should be very cognizant of and understand what they are taking on.” Notwithstanding, Detroit appears to be on course to exit state oversight this year: it has presented deficit-free budgets for two consecutive years, enabling it to exit from oversight by the Financial Review Commission oversight; it ended FY2016 with a $63 million surplus; Detroit’s four-year forecast predicts an anemic annual growth rate of only about 1%; thus, any adverse public school news could have repercussions.