Stop & Start Federal Governance, and Abandoning Puerto Rico

eBlog

February 9, 2017

Good Morning! In today’s Blog, we consider the outcome of last night’s deliberations to avoid another federal government shutdown and the nexus between New Jersey’s public pension system and Puerto Rico’s growing foreclosure crisis, and we consider the growing frustration of the Executive Director of the PROMESA Oversight Board with regard to the absence of any real commitment by the Congress.

Dysfunctional Governing & Creating Record Federal Debt. In the wake of still another shutdown of the federal government last night, he U.S. House of Representatives, earlier this morning, voted to approve Senate-passed legislation (71-28), including a sweeping budget deal to increase the national debt, increase federal deficits, and fund the federal government through March 23rd, voting 240-186 to forward the bill to President Trump for his signature. The new, temporary patch for the federal budget will come at a signal cost: it will boost federal spending for both defense and non defense programs by $325 billion over the next two years; it will suspend the debt ceiling for one year; it will give the White House, House, and Senate until March 23rd to write an omnibus spending bill for the remainder of the federal fiscal year and break the pattern of gridlock that has led to five temporary funding patches since last September. As passed, the legislation includes a number of other priorities for both parties, including nearly $90 billion for disaster relief, $6 billion to address the opioid crisis, a four-year extension of the Children’s Health Insurance Program, and more than $7 billion for community health centers. As passed, the agreement includes a massive defense spending increase, and a smaller domestic discretionary increase. The legislation to reopen the federal government—temporarily—is estimated to add as much as $2 trillion to the national debt over the next decade. As passed, the legislation includes $15 billion in tax extenders, restoring nearly three dozen federal tax expenditures which expired at the end of last year, subsidizing owners of racehorses, NASCAR tracks, filmmakers, and railroads—that is, a Congress with the greatest debt and deficits of any in U.S. history already running a $1 trillion-plus annual deficit voted to subsidize businesses and individuals for activities they took in 2017.

Fiscal Imbalances. Meanwhile, in Puerto Rico, PROMESA Board Executive Director Natalie Jaresko stated the Board is making progress towards its goal of restoring the U.S. territory’s fiscal balance and renegotiating its public debt; the just adopted spending agreement this morning by Congress could help: it would allow full Medicaid access to Puerto Rico, laying a foundation to revive the territory’s health system for two years, and lay the foundations for rebuilding its power grid: the provisions, announced by the U.S. Senate leadership, could represent about $ 15 billion in direct allocations, according to Sen. Marco Rubio (R-Fla.); the package which went to the White House this morning Florida), include $ 4.8 billion in Medicaid funds for the island, as an allocation that would represent full access to the program, based on the emergency caused by Hurricane Maria. The bill includes $2 billion for the Puerto Rico Electric Power Authority (PREPA) to rebuild its infrastructure, a critical provision for the island, where, 141 days after Hurricane Maria, 28% of the territory’s citizens remain without power.

In an interview with El Nuevo Día, Director Jaresko stated there had been “measurable” fiscal progress, albeit “small, but important,” as she answered each of the questions regarding performance reported this week by this newspaper, assuring that there are “measurable progresses” that, although “small, are important.” She added, however, that the process of transformation driven by the oversight Board has not moved at the pace she would like; moreover, she said, the role of the Congressionally created entity is not understood either in Puerto Rico or by the Congress or White House; nevertheless, she added, the Board expects to resume the correct course that Puerto Rico needs: “Those who expected the Board to come to govern are disappointed. Those who expected the Board to be in favor of the creditors are not happy; and those who expected the Board to be against the creditors: the reality between what  the enabling law dictates, the powers of the Board and the relationship with the government is, by far, more complex than expectations.” She added: “I wish there was more support from Congress for Puerto Rico: More clarity is needed. The second round of the supplementary aid package to address the disaster is still pending; CHIP and Medicaid funds are still pending. We need more confidence and clarity,” noting fiscal quandary for the Board to be forced to make fiscal decisions without knowing clearly what federal resources Puerto Rico can realistically anticipate.

Her comments came as, this week, the Board advised Ricardo Rosselló that Puerto Rico’s fiscal plans do not comply with PROMESA, giving the government seven days to correct them. Among the requested or demanded changes: an update on the information with regard to the federal funds that Puerto Rico would receive for its recovery. She also made clear she was “disappointed,” because, in the newly enacted federal tax reform, the law does not include provisions to exempt U.S. multinational businesses operating in Puerto Rico from the new taxes on U.S.; nor did the law grant a transition period to counterbalance the impact of that decision on the local economy. She noted the PROMESA Board expects concrete actions by Congress, noting that, last month, the Board had invoked §103 of the PROMESA Law, requesting the transfer of federal employees to address the situation in Puerto Rico, with the request made to the departments of Energy, Agriculture, Commerce, Transportation, Health, Housing, the U.S. Treasury, the General Services Administration, and the Environmental Protection Agency.

Her comments came as the Board’s 18-month anniversary of service nears next month—marking their halfway point. Next month, the members of the Board will have served 18 months in office, that is, half of their term since they accepted the task of restoring the fiscal balance and access of Puerto Rico to the capital markets—a period during which the only voluntary agreement with bondholders of Puerto Rico municipal debt (in the Puerto Rico Electric Power Authority [PREPA]) was rejected, while the liquidation of the Government Development Bank (GDB) was approved. During her tenure, PREPA has exhausted its funding: it could cease operating as early as this month; bondholders this week have returned to Court for the Title III cases, determined to litigate their debts. Thus, to Director Jaresko, the progress of the Board must be measured in light of its dual federal partially funded mandate: fiscal balance and access to the capital market: a charge which she noted, to achieve, would require time and a series of reforms which the Board has just put on the table, in no small part by, this week, sending the Governor the first notices of violations to the PROMESA Law in the fiscal plans—and giving Puerto Rico until Monday, President Lincoln’s birthday, to respond.

Asked whether seven days were enough for the government to make all the changes that the Board has requested, Director Jaresko responded that “Most of the information being requested must be supporting information for the estimates in the plan. I understand the information is available, because, if they are talking about the savings they will achieve, the details of that policy have to be there,” adding that it is the Board’s intent to certify the fiscal plans on February 23rd. She added that the creation of the office of the government’s Chief Financial Officer will allow staff to engage in financial disclosure tasks without being at the mercy of a change of government. Finally, she noted that with the new fiscal plan, Gov. Rosselló had demonstrated a greater commitment towards the structural reforms needed—with those comments coming just as Gov. Rosselló reported that the negotiations to review the fiscal plans are still in place and that he will comply with the submission date imposed by the PROMESA Board.

Nevertheless, while the Director appears upbeat, that confidence is not felt in New Jersey, where members of the state investment council have made clear they would not be comfortable if the pension fund profited from the hardships of Puerto Ricans, warning that in the wake of Hurricane Maria, Puerto Rico is bracing for a mortgage crisis, with many residents now way behind on their payments. Thus, policymakers for New Jersey’s public-employee pension system are trying to make sure investments that were launched here years ago do not aggravate that fiscal and fiscal crisis: members of the New Jersey State Investment Council were recently notified that two private equity funds which the pension system owns have significant stakes in corporations which are pursuing foreclosures on Puerto Rico: the private equity funds are part of the $77.5 billion pension system’s substantial alternative-investment portfolio—and, private equity was a top performer for the system during the 2017 calendar year, according to the latest returns reviewed during the investment council’s public meeting this week: in all, the pension system enjoyed returns totaling nearly 15 percent last year, which more than doubled the 7 percent assumed rate of return. Currently, the federal government has placed a moratorium on most foreclosure proceedings in the wake of the hurricane; however, the moratorium is due to expire next month, creating uncertainty about what that might mean; however, the council members made it clear during a public meeting that they are not comfortable seeing the pension fund profit from the hardships being faced in Puerto Rico, with Chair Tom Byrne noting: “I don’t think any of us are looking to make three extra basis points on this fund by throwing people out of their homes in Puerto Rico.” said Tom Byrne, the panel’s chairman. The issue involves pension system’s ties to the companies pursuing foreclosures in Puerto Rico, ties related to a diversification strategy that the investment council launched more than a decade ago as it sought to protect against major losses that can occur during a market crash. The diversification strategy relies in part on alternative investments, such as hedge funds, venture capital, and private equity—investments which, however, wrest control from state pension decisions compared to some of the more conventional investments that are managed in-house by the Division of Investment, an agency within the New Jersey Department of Treasury. For example, three years ago, the Council was pressed to eliminate a stake in another private-equity firm, JLL Partners, in the wake of information the firm had ties to a Texas-based payday lending firm that was fined after being accused of heavy-handed lending practices—especially as the practice of payday lending is prohibited in New Jersey. Now, with an estimated 90,000 borrowers in Puerto Rico behind on their mortgages as a result of Hurricane Maria, memories of the Hurricane Sandy impact on New Jersey has resurrected memories of the many state citizens who were forced to pay rent for temporary housing and also cover the mortgages on their damaged homes. Jim Baker, from the Private Equity Stakeholder Project, told the council this week that some of the foreclosures were not just conventional mortgages, but also reverse mortgages that have been set up with senior citizens who are required to make property tax and homeowners insurance payments in order to receive payouts, as he urged the panel to get involved in the issue, saying the federal moratorium on foreclosures is “fast approaching” and it’s still not clear what is going to happen once it passes. Mr. Baker said he would like to see the moratorium extended for another year, which is something four U.S. senators, including New Jersey’s Robert Menendez, have asked the federal government to do.

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Returning from Municipal Bankruptcy

February 7, 2017

Good Morning! In today’s Blog, we consider the remarkable signs of fiscal recovery from the largest municipal bankruptcy in U.S. history, before returning to consider the ongoing fiscal recovery of Atlantic City, where the chips had been down, but where the city’s elected leaders are demonstrating resiliency.

Taking the Checkered Flag. John Hill, Detroit’s Chief Financial Officer, this week reported the Motor City had realized its first net increase in residential property values in more than 15 years. Although property taxes, unlike in most cities and counties, in Detroit only account for 17.1% of municipal revenues (income taxes bring in 20.4%), the increase marked the first such increase in 16 years—demonstrating not just the fiscal turnaround, but also indicating the city’s revitalization is spreading to more of its neighborhoods. Mr. Hill described it as a “positive sign of the recovery that’s occurring in the city,” and another key step to its emergence from strict state fiscal oversight under the city’s chapter 9 plan of debt adjustment. As Mr. Hill put it: “We do believe that we’ve hit bottom, and we’re now on the way up.” Nevertheless, Mr. Hill was careful to note he does not anticipate significant gains in property tax revenues in the immediate future, rather, as he put it: “[O]ver time, it will certainly have a very positive impact on the city’s revenue.” According to the city, nearly 60 percent of residents will experience a rise of 10 percent or less in assessments this year: the average assessed home value in Detroit is between $20,000 and $50,000. The owner of a home within that range could see an increase in their taxes this year of $22 to $34, according to Alvin Horhn, the city’s chief assessor. Detroit has the seventh highest rate among Michigan municipalities, with a 70.1 mills rate for owner-occupied home in city of Detroit/Detroit school district. Mr. Hill noted that for Detroit properties which show an increase in value this year, the rate will be capped; therefore he projects residents will not experience significant increases except for certain circumstances, such as a property changing hands.

Nevertheless, in the wake of years in which the city’s assessing office had reduced assessments across Detroit to reflect the loss in property values, the valuation or assessment turnaround comes as, in the past decade, the cumulative assessed value of all residential property was $8.4 billion, officials noted Monday: and now it is on the rise: last year, that number was $2.8 billion; this year, the assessed value of Detroit’s 263,000 residential properties rose slightly to $3 billion—or, as Mr. Horhn noted: “For the last 12 to 17 years, we’ve been making massive cuts in the residential (property) class to bring the values in line with the market…It’s been a long ride, but for the first time in a very long time, we see increases in the residential class of property in the city of Detroit.” This year’s assessments come in the wake of a systemic, citywide reassessment of its properties to bring them in line with market value—a reassessment initiated four years ago as part of a state overhaul to bring Detroit’s assessment role into compliance with the General Property Tax Act to ensure all assessments are at one half of the market value and that like properties are uniform. That overhaul imposed a deadline of this August for Detroit to comply with state oversight directives imposed in 2014 in the wake of mismanagement in Detroit’s Assessment Division, widespread over-assessments, and rampant tax delinquencies in the wake of an investigation finding that Detroit was over assessing homes by an average of 65%, based upon an analysis of more than 4,000 appeal decisions by a state tax board. Mr. Hill asserts now that he is confident Detroit’s assessments are fair; better yet, he reports the fixes have led to more residents paying property taxes. Indeed, city officials note that property tax collections increased from an average rate of 69% in 2012-14 to 79 percent in 2015, and 80 percent in 2016; the collection rate for 2017 is projected to be 82%. Mayor Mike Duggan, in a statement at the beginning of the week, noted: “We still have a long way to go to in rebuilding our property values, but the fact that we have halted such a long, steep decline is a significant milestone…This also corresponds with the significant increase in home sale prices we have seen in neighborhoods across the city.”

At the same time, Mr. Horhn notes that Detroit’s commercial properties have increased in value to nearly $3 billion, while industrial properties recovered from a drop last year, rising from $314 million to $513 million. He added that the demolition of blighted homes, as well as improving city services, had contributed to the rise in assessed property values: “It’s perception to a large extent: If people believe things are improving, they’ll invest, and I think that’s what we’re seeing.”

Raking in the Chips? In the wake of a state takeover, and the loss—since 2014, of 11,000 jobs in the region, Atlantic City marked a new step in its fiscal recovery with interviews commencing for the former bankrupt Trump Taj Mahal casino to reopen this summer as a Hard Rock casino resort. Indeed, 1,400 former Taj Mahal employees applied after an invitational event, marking what Hard Rock president Matt Harkness described as the “first brush stroke of the renaissance.” The casino is projected to create more than 3,000 jobs—and to be followed by the re-opening Ocean Resort Casino, which will add thousands of additional jobs. The rising revenues come after, last year, gambling revenue increased for the second consecutive year, marking a remarkable turnaround in the wake of a decade in which five of the city’s 12 casinos shut down, eliminating 11,000 jobs—and, from the fiscal perspective, sharply hurt assessed property values and property tax revenues. New Jersey Casino Control Commission Chair James Plousis noted: “Every single casino won more, and every internet operation reported increased win last year…Total internet win had its fourth straight year of double-digit increases. It shows an industry that is getting stronger and healthier and well-positioned for the future.” In fact, recent figures by the New Jersey Division of Gaming Enforcement show the seven casinos won $2.66 billion in 2017, an increase of 2.2 percent over 2016. Christopher Glaum, Deputy Chief of Financial Investigations for the gaming enforcement division, noted that 2017 was the first year since 2006 when a year-over-year increase in gambling revenue at brick-and-mortar casinos occurred. Moreover, many are betting on the recovery to gain momentum: two of the five casinos which were shuttered in recent years are due to reopen this summer: the Taj—as reported above—under its new ownership, and the Revel, which closed in 2014, will reopen as the Ocean Resort Casino. The fiscal bookies are, however, uncertain about the odds of the reintroduction of two new casinos, apprehensive that that could over saturate the market; however, the rapid increase in internet gaming, which, last year, increased earnings for the casinos by 25 percent appear to demonstrate momentum.  

Now, the fiscal challenge might rest more at the state level, where the new administration of Gov. Phil Murphy, who promised major spending initiatives during his campaign, had been counting on revenue increases from restoring the income tax surcharge on millionaires and legalizing and taxing marijuana. The latter, however, could go up in a proverbial puff of weed—and, in any event, would arrive too late for this year’s Garden State budget. Similarly, the new federal “tax reform” act’s capping on the deduction for state and local taxes will mean increased federal income taxes most for well-off residents of high-tax states such as New Jersey—raising apprehension that a new state surcharge might encourage higher income residents to leave. That effort, however, has been panned by the New Jersey Policy Perspective, which notes: “Policy changes to avoid the new $10,000 cap on state and local tax deductions would mostly benefit New Jersey’s wealthiest families.” New Jersey Senate President Steve Sweeney (D-West Depford) notes: “We don’t have a tax problem in New Jersey. New Jersey collects plenty in taxes. We have a government problem in New Jersey, and it’s called too much of it,” noting he has tasked a panel of fellow state Senators and tax experts to “looking at everything,” including the deduction issue. In addition, he is seriously considering shifting to countywide school districts, where possible, in an effort to reduce costs. Or, as he put it: “There is a lot of money to be saved when you do things differently.” Turning to efforts to restore Atlantic City’s finances, the state Senate President said the city is “doing great;” nevertheless, noting that talk about ending the state takeover is unrealistic: “We can adjust certain things there” and Governor Murphy will select someone new to be in charge. But end the state takeover?  “Absolutely not and it’s legislated for five years.”

It seems ironic that in the city where Donald Trump’s company filed for bankruptcy protection five times for the casinos he owned or operated in the city, he was able to simply walk away from his debts: he argued that he had simply used federal bankruptcy laws to his advantage—demonstrating, starkly, the difference between personal and municipal bankruptcy.

Balancing Fiscal & Public Safety

January 9, 2017

Good Morning! In today’s Blog, we consider the potential fiscal impact of the expiration of the State of New Jersey’s public safety arbitration cap—with the expiration coming as Governor-elect Phil Murphy has been reviewing a report examining the implications for property taxes, state spending, collective bargaining agreements, and public safety. Then we journey south to witness the denouement of the fiscal siege of the historic municipality of Petersburg, Virginia.

Uncapping & Fiscal Impacts. The State of New Jersey’s statute capping public safety arbitration awards at 2% has been in effect for seven years—it was last extended in 2014. Now, with a new Governor taking office, Moody’s has warned that its expiration on the last day of 2017 is a credit negative for the Garden State—and for its municipalities and counties. Indeed, the New Jersey League of Municipalities has been joined by the New Jersey Association of Counties, the New Jersey Conference of Mayors, the New Jersey Chamber of Commerce, New Jersey Business and Industry Association, and the New Jersey Realtors Association to urge the new Governor and Legislature to support permanently extending the 2% cap Interest Arbitration Cap, noting that an expired cap would have a negative impact on property taxes and jeopardize the continued delivery of critical services, as well as adversely impact residential and commercial property taxpayers, working class families, and those on fixed incomes. The League’s President, Mayor James Cassella of East Rutherford, noted that the 2% Interest Arbitration Cap has controlled costs: without the cap, municipalities could see costly arbitration awards that would force local officials to reduce services or lay off employees to satisfy the arbitrator’s award and stay within the 2% levy cap. Similarly, New Jersey Association of Counties President Heather Simmons, a Gloucester County Freeholder, noted that failure to permanently extend the 2% cap on binding interest arbitration awards would inequitably alter the collective bargaining process in favor of labor at the expense of taxpayers, and lead to awards by arbitrators with no fiduciary duty to deliver essential services in a cost-effective manner.

Now Moody’s has moodily weighed in, deeming the expiration a credit negative for the state’s cities and  counties, as has Fitch Ratings.

In New Jersey, interest arbitration is a process open only to police and fire employee unions: it is a mechanism to resolve collective bargaining disputes between local governments and unions: when a public employer is unable to reach a contract agreement with a police or fire union, an arbitrator is called in to decide the terms of the contract. When the state adopted the 2 percent property tax levy cap, a separate 2 percent cap on interest arbitration awards was also imposed: that mandates arbitrators to take property taxes into account when issuing awards and providing local officials with a now proven and effective tool to contain property tax increases. The arbitration cap expired on Dec. 31; however, the property tax levy cap is permanent. The New Jersey League noted: “For nearly a decade, the 2 percent cap on binding interest arbitration awards has kept public safety employee salaries and wages under control simply because parties have been closer to reaching an agreement from the onset of negotiations. Moreover, the 2 percent cap on binding interest arbitration awards has established clear parameters for negotiating reasonable successor contracts that preserve the collective bargaining process and take into consideration the separate 2 percent tax levy cap on overall local government spending. And, importantly, the 2 percent cap on binding interest arbitration awards has not negatively impacted public safety services or recruitment.

In the wake of the expiration of the arbitration cap, it appears likely that arbitrator contract awards would exceed 2 percent. That would likely force cities and counties in the Garden State to reduce or eliminate municipal services—or go to the voters to seek approval to exceed the 2 percent property tax cap in order to fund an arbitration award.

Moody’s analyst Douglas Goldmacher moodily noted: “Given that salary costs are among the largest of municipal expenditures, the cost implications are obvious and considerable. The effect of this is, in most cases, unlikely to be rapid, but ultimately, the loss of the arbitration cap is likely to cause the sector’s credit quality to deteriorate…Although the cap has expired, and it may not be finished. Numerous local governments and local government advocacy groups support the arbitration cap. It is possible that the new governor and New Jersey state Legislature will revisit the matter. Until and unless that occurs, there will be a potentially dangerous mismatch between revenue and expenditures.” The statute, which caps public safety arbitration awards at 2%, came into force on January 1, 2011; it was extended for a three-year period in 2014 when it was last up for renewal. Mr. Goldmacher noted: “The cap played a major role in helping local governments manage public safety costs by instituting a limit on increases in police and fire salaries in arbitration and effectively tying the salary increases to the municipality’s or county’s revenue-raising capabilities…The cap’s expiration, should it prove permanent, is a credit negative for all local governments.” Mr. Goldmacher noted the cap’s existence has been a “valuable tool” in contract negotiations when police and firefighter unions with negotiators often forced to consider small salary increases. A September report by former Gov. Chris Christie’s appointees to the Police and Fire Public Interest Arbitration Impact Task Force stated that municipal property taxes jumped at an annual average of 7.19% for the five years prior to the cap compared to 2.41% since 2011. The report also estimated that the cap has saved taxpayers a collective $429 million. Thus, Mr. Goldmacher notes: “Given that salary costs are among the largest of municipal expenditures, the cost implications are obvious and considerable: Police and fire contracts often serve as a benchmark contract for other negotiations, which had the effect of making a 2% annual increase something of a standard target for most contracts, even for non-public safety collective bargaining units.” While it is possible the cap may be reinstated, Mr. Goldmacher added that as long as no action is taken to address the lapse, New Jersey’s cities and counties confront “a potentially dangerous mismatch” aligning revenue and expenditures, because of how much a 2% property tax cap law would limit their budgetary flexibility, writing: “The effect of this is, in most cases, unlikely to be rapid, but ultimately, the loss of the arbitration cap is likely to cause the sector’s credit quality to deteriorate,” he said. “The degree of deterioration will depend on the idiosyncratic qualities of the given community.”

For its part, Fitch wrote: “…the arbitration cap is beneficial to local government credit quality as it helps to align revenue and spending measures and supports structural balance in the context of statutory caps on property tax growth…bargaining groups may become more emboldened to pursue arbitration as opposed to voluntary settlement if the arbitration cap expires. Arbitration awards were significantly higher prior to the cap, ranging from 2.50% to 5.65% from 1993-2010, according to a report of the New Jersey Public Employment Relations Commission (PERC.)” Fitch also noted that the elimination of the arbitration cap “could force local governments to reduce governmental services and/or rely on one-time resources to accommodate higher wage expenses.”

The Fiscal Siege of Petersburg. Jack Berry, Robert Bobb, and Nelsie Birch, writing in a piece, “Overcoming the latest siege of Petersburg, referenced the city’s then vital role in the Civil War, where, as they wrote: “The series of battles known as the Siege of Petersburg lasted nine months and consisted of devastating trench warfare. It featured the largest concentration of African-American troops in the war, who suffered enormous casualties at the Battle of the Crater.” They went on to write: “Some would say that Petersburg has been under siege ever since the Civil War, that there is a siege mentality in the city. Petersburg even has a Siege Museum…But Petersburg has not always been under siege; it is not today, and it will not be tomorrow. Noting that Petersburg was once the second largest city in Virginia—and home to the largest number of free blacks in Virginia, they noted that it was once “a wealthy city, a major industrial center, and one of the largest rail hubs in the nation,” where, in the wake of the Civil War, a “coalition of Africa-American and white, populist Republicans, controlled the state legislature, which led to the creation of two large public institutions in the region: Virginia State University and Central State Hospital. Later, Fort Lee became another major economic engine for the area.” The authors noted, however, that “Jim Crow laws and Massive Resistance devastated the hopes and dreams of black citizens and fueled racial tensions. In 1985, one of the city’s largest employers, Brown & Williamson Tobacco, shut down its Petersburg factory. Later, Southpark Mall was located north of the city, sucking retail sales out of Petersburg.” These events adversely affected assessed property values—in turn reducing investment in public schools. The historic city seemed on a route to chapter 9 municipal bankruptcy—or being, as they wrote: “relinquishing city status—and being subsumed by neighboring jurisdictions,” all because of what they described as a “self-inflicted, mismanaged city government” which “ran itself into a ditch: In July of 2016, the city faced $18 million in unpaid bills. The budget was $12 million out of balance. Petersburg had nearly run out of cash and was dipping into every available pot of money, regardless of restrictions, to pay bills. A botched water meter conversion project impacted utility billings, which made the cash situation even worse.”

Because the Commonwealth of Virginia was apprehensive that a default by Petersburg would have had severe fiscal repercussions for municipalities across the state, the Commonwealth, as we have previously written, provided a consulting team to diagnose the fiscal issues and recommend fiscal measures—including, in its recommendations, pay cuts of 10 percent pay cuts for the entire city workforce. Even as the state-imposed overseer was acting, an aroused citizenry, via a grassroots group called “Clean Sweep,” attended every City Council session, demanding greater fiscal accountability. A year ago last October, former Mayor Howard Meyers and the City Council brought in a fiscal posse in an effort to restructure, hiring former Richmond City Manager Robert Bobb and his team, who set up a temporary war room in the City Hall building where General Robert E. Lee had met with his senior Confederate officers during the Siege of Petersburg. Mr. Bobb wrote of the fiscal war room: “We dug in for the long haul, with Nelsie Birch leading efforts to peel back layers of the financial onion. We got a handle on cash flow, figured out the extent of the unpaid bills, found checks stashed in drawers, arranged short-term financing, crafted a new budget, dramatically cut spending, put pressure on the city treasurer to collect taxes, and revamped the decrepit utility system…New financial policies were put in place; debt was restructured; water and sewer rates were increased to comply with debt covenants; the organization was right-sized; new managers were hired.”

Mr. Bobb described this war room process as one in which—at the same time—his team teamed with Mayor Sam Parham and the members of the Petersburg City Council “every step of the way,” to make the tough decisions, adding that, during this process, “Our strongest ally was the Governor’s Office, in particular, Virginia Secretary of Finance Ric Brown.” Indeed, by last November, external auditors reported a signal fiscal turnaround: Petersburg reported a year-end surplus of $7.2 million—and the report was on time; the auditor’s opinion was clean.

Fiscal Challenges Under Federal or State Takeovers

December 6, 2017

Good Morning! In this a.m.’s Blog, we consider the fiscal and governing challenges of a city still under a state takeover, before heading south to assess the governing and fiscal challenges in a dissimilar, quasi-takeover of the U.S. territory of Puerto Rico.  

Visit the project blog: The Municipal Sustainability Project 

Fiscal, Intergovernmental, & Branches of Government Challenges under a State Takeover. Atlantic City’s Fire Department, which, like the City, remains under the control, as part of the ongoing state takeover, of the state Department of Community Affairs, faces another round of salary cuts as the state continues to cut spending in the municipality: the firefighters are anticipated to realize an 11.3 percent reduction in their salaries effective this Sunday, according to union officials, with the cuts coming just two months after Superior Court Judge Julio Mendez ruled the state had the authority to cut the Department by 15 members, to 180, after next February 15th. Moreover, in the wake of the state’s fiscal action, the state warned further salary cuts were possible, because Atlantic City only had sufficient fiscal resources to fund the department through November 30: Lisa Ryan, a spokesperson for the New Jersey Department of Community Affairs, noted: “While we have made considerable progress in stabilizing Atlantic City, significant work remains in restraining the city’s unsustainable finances…Judge Mendez’s decision requiring 180 firefighters instead of the 148 the state and city believe is sufficient to maintain public safety in Atlantic City resulted in $3.8 million in additional costs.” Over the past couple of years, the size of the city’s Fire Department has continued to shrink: in January, the department had 225 members; currently there are 195. Indeed, over the last seven years, the department has been reduced by 82 members—leading Fire Chief Scott Evans to note that in what would have to be an understatement, the year has been tough on the department, or, as he put it, the cuts and ongoing litigation have been a “distraction” to the firefighters: “It’s tough to keep the focus on your job…What the guys have faced all year have been the toughest challenges.” Ms. Ryan noted: “The state and city refuse to have taxpayers and other city stakeholders shoulder the burden of these costs caused by the fire union, thereby resulting in the salary reduction of firefighters, who are still highly compensated when compared to other city employees…Notably, the police have chosen to mediate and find compromise, and we encourage firefighters to do the same.”

Siguiendo en Disarollo. Puerto Rico currently expects its central government revenues to come in 25% short of budget in this fiscal year. Geraldo Portelo Franco, the Executive Director of the Puerto Rico Fiscal Advisory and Financial Information Authority, advised the PROMESA Oversight Board yesterday, meaning Gov. Ricardo Rosselló and the PROMESA Board will have to address the shortfall as the island government struggles to address not just recovery from the devastation from Hurricane Maria, devastation which received far less of a U.S. response than Houston or Florida, but also left the island with a substantial loss of those who could afford to leave—and who may not return. Now Mr. Portelo Franco is warning that public corporations will be without cash this month, while the General Fund will see a 25 percent drop in revenues this fiscal year: while he did not specify how the central government would help PREPA and PRASA if the disaster loan under FEMA, a loan the final terms of which are still undefined—even as the full restoration of electricity and water services is urgent; Puerto Rico’s two main public corporations on the island, those which provide essential public services, appear to be without fiscal resources with which to cover their operations this month, according to Mr. Portela, when he spoke at the eleventh public meeting of the PROMESA Oversight Board in New York City. He noted that in the case of PREPA (the Puerto Rico Electric Power Authority), which has not yet restored electricity service to most of its customers, the corporation will deplete what is left in its coffers by the end of the week of December 22nd; he anticipates PREPA will finish the calendar year with a cash deficit of $ 224 million. Meanwhile, the Puerto Rico Aqueducts and Sewers Authority (PRASA) is anticipated to end this month with a cash overdraft of about $ 1 million. The twin fiscal perils could, according to Mr. Portela, push Puerto Rico’s general fund into negative territory, because there might be no choice but to assist PREPA and PRASA if Washington does not allocate fiscal resources to Puerto Rico as soon as possible: in total, according to PAFAA, PREPA, and PRASA need $ 883 million of liquidity. Thus, Mr. Portela noted: “Our efforts are focus on obtaining liquidity for PREPA and PRASA through the CDL (Community Disaster Loan).”

If anything, the governance and fiscal challenge has been exacerbated, because the FEMA disaster loan, which was authorized about a month ago, but for which terms have yet to be negotiated, has yet to arrive. While Puerto Rico, as part of governing for contingencies, maintains reserves in case it needs to give liquidity to these quasi-public corporations, or, as he put it: “They (PREPA) have tried to preserve cash by managing the time of payment to suppliers,” in responding to PROMESA Board executive Arthur González, the liquidity crisis in PREPA and PRASA has complicated the governance and fiscal options facing the PROMESA Board as it confronts the challenge of approving a new fiscal plan which, among other things, seeks profound reforms of Puerto Rico’s economic framework and, in turn, will be key to the renegotiation of the debt through the cases of Title III of PROMESA. For one, if Puerto Rico uses General Fund resources, it would likely face further court challenges by Puerto Rico’s creditors—similar to a challenge already underway in the case of the bondholders of the Puerto Rico Sales Tax Financing Corporation (Cofina). (Recently, the insurer Ambac Assurance Corporation and several investment funds have asked U.S. Judge Laura Taylor Swain to investigate how Puerto Rico’s decisions to suspend the collection of the Sales and Use Tax (IVU) will affect that debt. But, with some $700 million owed to its suppliers, Puerto Rico’s central government has no cash options. Notwithstanding the gloomy fiscal portents, Mr. Portela reported better collections in items such as the 4 percent tax, FEMA assistance, and a less severe migration than had been feared; notwithstanding, however, he noted that if the predicted drop of 25 percent in revenues materializes, the General Fund would fall short in this fiscal year by about $ 2.4 billion—ensnaring the government in delaying payments to its suppliers and contractors, as he admitted that, apart from the estimate of accounts payable already recorded (around $ 500 million), there could be up to $ 250 million in additional payments to suppliers which are pending, noting that because “certain systems were inoperative in the immediate aftermath of the hurricane, there was a delay in payments and processing.”

Catch 22. With the PROMESA Board, the most likely bridge to gaining any additional fiscal help from the White House and Congress, thus a critical potential ally to Puerto Rico; the evident frustration by members of the PROMESA Board, combined with the speed with which Congress is moving on federal tax reform—but with virtually no analysis of the potential fiscal impact on Puerto Rico, albeit with a debt dwarfing Puerto Rico’s, the Board appears increasingly caught between a rock and hard place—a place Director Ana Matosantos described as “unacceptable,” adding that, for at least four times, PROMESA Board executives have asked for information on what is owed to government suppliers and contractors, stating: “This issue of not having clear things about accounts payable and the ongoing issue of late payments, at the same time that we are trying to look at what is happening economically in Puerto Rico while you have outstanding balances, is frustrating.” PRMOMESA Executive Andrew Biggs noted: “I have mostly dealt with governments at the state and federal level, but I’ve never seen a government that is so dependent on external consultants.”

The fiscal challenges, indeed, go both ways: as the exchange between the Board and officials of Gov. Ricardo Rosselló Nevares’ administration, the officials sought information and analysis of the potential fiscal impacts on Puerto Rico of the rapidly moving federal tax reform legislation in Congress—legislation, after all, which Congress’ Joint Committee on Taxation has warned will add close to $1.4 trillion to the federal debt.

Putting Humpty-Dumpty Back Together Again

November 13, 2017

Good Morning! In today’s Blog, we consider the election results in Atlantic City, where incumbent Mayor Don Guardian was defeated by two-term Democratic City Councilman Frank Gilliam, in a municipality which has been under state intervention since last November.

Visit the project blog: The Municipal Sustainability Project 

Emerging from State Oversight? In New Jersey, voters elected a new Governor, Phil Murphy—and a new Mayor in Atlantic City, potentially paving the way for Atlantic City to emerge from its state takeover. Indeed, prior to his election, candidate Phil Murphy, who was elected over Republican candidate Lt. Gov. Kim Guadagno, had said he would end the state takeover of the city and instead work together with city officials as partners. The election came almost a year after the state takeover of the city—so that in his victory statement, Mayor-elect Frank Gilliam Jr., noted: “This is the beginning of a new era in Atlantic City: For the past 30-40 years Atlantic City has been taking the back seat, and now it is time for us to actually take the front seat.” How this new era will transform the municipality as it emerges from state intervention—and under a new Governor will be a challenge: the former Governor Chris Christie, under whom the state took over Atlantic City; has been replaced by the voters, who elected Philip Murphy, a former Wall Street banker with no experience in office, as the Garden State’s 56th governor—with Gov.-elect Murphy prevailing in a decisive victory to end the two-term reign of Gov. Chris Christie. The twin changes in governance could play a critical role as the city is emerging from its state takeover. The Governor-elect has proposed instituting a millionaire’s tax; he has also called for boosting public pension funding; he has not publicly discussed what he might propose with regard to the state’s current relationship with Atlantic City. Meanwhile, in Atlantic City, where voters turned Mayor Don Guardian out of office after a single, turbulent term, during which five of the city’s famed dozen casinos shut down, and the State of New Jersey seized control of the city’s assets and governing authority—voters selected Atlantic City Councilman and city native Frank Gilliam, who has served as a member of the City Council since 2009 to replace Mayor Guardian, with the Mayor-elect noting: “This is the beginning of a new era in Atlantic City.” Mayor Gilliam, in his first discussion, surrounded by his colleagues selected to fill the three open council-at-large seats, noted: “It’s going to always be about the people: We love Atlantic City: Now it’s time for us to actually take the front seat.” But the challenges ahead for the newly elected Mayor who, during his campaign, had promised the city’s voters would reverse the previous four years of debt and state takeover will not be easy. The Mayor-elect said he wants to focus on shaping up the city’s finances, improving tax rates, and bringing in more development for the city to appeal to people of all ages. In addition, he said he would like to clean up the beach blocks to raise the value of housing—a slight contrast from Mayor Guardian’s platform of taking credit for stabilizing the city’s finances and more interest from investors on new projects coming to the city, such as South Jersey Gas and Stockton University’s city campus: promises and promises which could not be converted to victory. Rounding out the City Council were victories by incumbent council-at-large candidates George Tibbitt and Moisse “Mo” Delgado, and the third at-large seat was won by Jeffrey Fauntleroy II. The Mayor-elect noted he was looking forward to having a “prosperous” relationship with the governor—describing it as it “is going to be a true partnership.”

Mayhap ironically the shuttered Trump Taj Mahal casino will reopen as a Hard Rock casino resort, bringing new life, and potentially new gaming, hotel revenue, and assessed property values; Stockton University is expected to open its Atlantic City satellite campus as part of a project which could also lead to the construction of a new corporate headquarters for South Jersey Gas in a section of the city starved for economic activity. As Brigid Harrison, a political science professor at Montclair State University put it: most people in the region believe Atlantic City has put its worst problems behind it, and are optimistic about a coming wave of development: “Part of Don Guardian’s greatest legacy will be the fact that he believed in and worked for a diversification of the city’s economic base, and, as Mayor, Frank Gilliam certainly will be able to reap some of the credit and benefits for projects initiated in the Guardian administration…Hopefully Mayor Gilliam will take a page from Mayor Guardian and continue the process of attracting a wide variety of businesses and enterprises to Atlantic City, which will only serve to strengthen the city and the region.”

But the new Mayor will also inherit unresolved challenges and problems, including the state’s takeover of Atlantic City, hundreds of millions in debt, the stalled development of a former airport property, and a city economy, which, albeit less dependent on casinos, is still disproportionately affected by their success or failure. And it is the unwinding of the state takeover which could prove the most challenging: The Mayor-elect, in his campaign, said he would commence with an audit of Atlantic City; he vowed to work closely with the incoming administration of Gov.-elect Murphy in what will be a key challenge with regard to how to unwind the state takeover of Atlantic City—a challenge to work across bureaucratic boundaries in a city where numerous state agencies held vast power even before the state takeover—or, as the Mayor-elect put it: “Atlantic City has been working in silos for 30 years: We have to talk to one another.”

S&P Global Ratings analyst David Hitchcock, in the wake of the election results, wrote that while Gov.-elect Murphy will have the support of a Democratic-controlled legislature, he will, nevertheless, be confronted by signal fiscal challenges due to decades of poor budgetary decisions. Mr. Hitchcock wrote that public pension-funding shortfalls under both Republican and Democratic administrations the last two decades have left the Garden State with a heavy pension liability shortfall along with high debt and consistent structural budget deficits, noting: “These impediments will likely constrain the state’s ability to increase funding for local aid or avoid deficits during an economic downturn, regardless of any near-term tax increases or spending cuts…The magnitude of the credit risks facing Governor-Elect Phil Murphy and the newly elected legislature means the state’s long-term credit conditions will remain challenging for the foreseeable future, no matter what policy direction they choose.”

Can Congress Uninflict Federally Caused Fiscal & Economic Disparities & Distress?

October 13, 2017

Good Morning! In today’s Blog, we consider the ongoing fiscal, legal, physical, and human challenges to Puerto Rico, before heading north to New Jersey where the fiscal and governing strains between Atlantic City and the Garden State continue to fester.

Visit the project blog: The Municipal Sustainability Project 

Physical, Oratorical, & Fiscal Storms. President Trump served notice yesterday that he may pull back federal relief workers from Puerto Rico, effectively threatening to abandon the U.S. territory amid a staggering humanitarian crisis in the aftermath of Hurricane Maria–even as House Speaker Paul Ryan (R-Wis.) goes to Puerto Rico this morning to assess not only the damage, but also how to more effectively respond to a staggering humanitarian crisis in the aftermath of Hurricane Maria. The Speaker will also bear some good news: the House yesterday approved 353-69, a $36.5 billion disaster aid package to help victims struggling to recover from a string of devastating hurricanes and wildfires, sending the aid package to the Senate, which returns from a weeklong recess next week. While the Trump administration requested $29 billion in supplemental spending last week, it asked for additional resources Tuesday night, including $4.9 billion to fund a loan program that Puerto Rico can use to address basic functions such as infrastructure needs. Speaker Ryan noted: “‎We think it’s critical that we pass this legislation this week to get the people the help they need, to support the victims, and also to help the communities still recovering and dealing with the problems with the hurricanes Harvey, Irma, and Maria.” Puerto Rico Governor Ricardo Rosselló had warned Congressional leaders that the U.S. territory is “on the brink of a massive liquidity crisis that will intensify in the immediate future.”

President Trump yesterday claimed that it will be up to Congress how much federal money to appropriate for Puerto Rico, but that relief workers will not stay “forever,” even as, three weeks after Hurricane Maria struck, much of Puerto Rico remains without power, with limited access to clean water, hospitals are running short on medicine, and many businesses remain  closed. The President added:  “We cannot keep FEMA, the Military & the First Responders, who have been amazing (under the most difficult circumstances) in P.R. forever!”

The White House late yesterday issued a statement committing for now “the full force of the U.S. government” to the Puerto Rico recovery, seemingly contradicting the President, who has sought to portray Puerto Rico as in full recovery mode and has voiced frustration with what he considers mismanagement by local leaders. The Governor had warned earlier in the week that the U.S. territory is “on the brink of a massive liquidity crisis that will intensify in the immediate future.” The legislation the House adopted last night allows up to $4.9 billion in direct loans to local governments in a bid to ease Puerto Rico’s fiscal crunch—a vital lifeline, as, absent Congressional action, the territory may not be able to make its payroll or pay vendors by the end of this month.

In contrast, Speaker Ryan said that Puerto Rico must eventually “stand on its own two feet,” but that the federal government needs to continue to respond to the humanitarian crisis: “We’re in the midst of a humanitarian crisis…Yes, we need to make sure that Puerto Rico can begin to stand on its own two feet…But at the moment, there is a humanitarian crisis which has to be attended to, and this is an area where the federal government has a responsibility, and we’re acting on it.”

Rep. Nydia M. Velázquez (D-NY), who was born in Puerto Rico, said in a statement that the President’s “most solemn duty is to protect the safety and the security of the American people. By suggesting he might abdicate this responsibility for our fellow citizens in Puerto Rico, Mr. Trump has called into question his ability to lead. We will not allow the federal government to abandon Puerto Rico in its time of need.” Similarly, Jennifer Hing, a spokeswoman for House Appropriations Committee Chairman Rodney Frelinghuysen (R-N.J.), who will accompany Speaker Ryan today, said that those who live on the island “are American citizens and they deserve the federal assistance they need to recover and rebuild. The Chairman and the Committee fully stand by them in these efforts, and will continue to be at the ready to provide the victims of these devastating hurricanes with the necessary federal resources both now and in the future.” Without Congressional action, the territory may not be able to make its payroll or pay vendors by the end of the month. Unmentioned is whether such contemplated assistance might entail repealing the Jones Act—an act which means the price of goods in Puerto Rico is at least double that in neighboring islands—including the U.S. Virgin Islands. The New York Federal Reserve  found that the Act hurts the Puerto Rican economy—Sen. John McCain (R-Az.) and Rep. Gary Palmer (R-Ala.) have offered legislation to repeal or suspend the law.

President Trump yesterday warned that his administration’s response to hurricane-ravaged Puerto Rico cannot last “forever,” tweeting: “We cannot keep FEMA, the Military & the First Responders, who have been amazing (under the most difficult circumstances) in P.R. forever!” He added that the U.S. territory’s existing debt and infrastructure issues compounded problems. His tweeting came as the House is preparing to consider legislation under which Puerto Rico would receive a $4.9 billion low-interest federal loan to pay its bills through the end of October, as part of a $36.5 billion package. The temporary assistance comes as Moody’s Investors Service has downgraded the Commonwealth of Puerto Rico’s general obligation bonds to Ca from Caa3, in view of the protracted economic and revenue disruptions caused by Hurricane Maria. The President also threatened he may pull back federal relief workers from Puerto Rico, effectively threatening to abandon the U.S. territory amid a staggering humanitarian crisis in the aftermath of Hurricane Maria: he said that relief workers will not stay “forever.” Three weeks after Hurricane Maria made landfall, much of Puerto Rico, an island of 3.4 million Americans, remains without power. Residents struggle to find clean water, hospitals are running short on medicine, and commerce is slow, with many businesses closed.

The lower ratings are aligned with estimates of Puerto Rico’s reduced debt servicing capacity given extensive damage from Hurricane Maria. Puerto Rico faces almost total economic and revenue disruption in the near term and diminished output and revenue probably through the end of the current fiscal year and maybe well into the next. The weaker trajectory will undercut the government’s ability to repay its debt, a matter now being weighed in a bankruptcy-like proceeding authorized by the Puerto Rico Oversight, Management, and Economic Stability Act (PROMESA). For the University of Puerto Rico, the downgrade factors in expected pressure on enrollment-linked revenue and on funding from the Puerto Rican government.

With 155 mile-an-hour winds and a path that cut diagonally across the island, Hurricane Maria was the most destructive storm to hit Puerto Rico in almost 90 years. It knocked out all electric power, destroyed more than 100,000 homes, and ruptured bridges and other public infrastructure. Beyond the disruption of the immediate aftermath, the potential long-term repercussions may be somewhat mixed, however. On one hand, a massive exodus of residents relocating to the mainland, rather than rebuilding on the island, could further erode Puerto Rico’s economic base. Moody’s opined that an infusion of federal relief and rebuilding funds could spur the economic growth and infrastructure replacement that, under normal conditions, has eluded Puerto Rico: “We, nevertheless ,view the economic impact overall as a substantial negative that has weakened the commonwealth’s ability to repay creditors: The negative outlook is consistent with ongoing economic pressures, which will weigh on the commonwealth’s capacity to meet debt and other funding obligations, potentially driving bondholder recovery rates lower as restructuring of the commonwealth’s debt burden unfolds.”

Tens of thousands of islanders left for the U.S. mainland to escape the immediate aftermath of the storm. With conditions back home still grim—approximately 85 percent of residents still lack electricity and 40 percent are without running water, and neither is expected to be fully restored for months—many find themselves scrambling to build new lives away from the island. Particularly in states with large Puerto Rican populations, such as New York, Illinois, Florida, and Connecticut, people are bunking with relatives while trying to find longer-term housing, jobs and schools for their kids.

There have been several major migratory exoduses from Puerto Rico to the mainland over the years, most recently during the past decade when the island’s population shrank by about 10 percent because of a long economic slide that shows no sign of easing anytime soon. Hurricane Maria struck Sept. 20th, and, according to the latest figures from the Puerto Rican government, killed at least 45 people. It also created a new surge that could have lasting demographic effects on Puerto Rico and on the mainland. “I think that we could expect that people who did not plan to stay permanently might do so now,” said Jorge Duany, a professor of anthropology at Florida International University who has long studied migration from the island. Many of those who left are elderly or sick people who fled or were evacuated because of the dangers posed by living on a tropical island with no power or air conditioning and limited water for an indefinite period of time.  It is too early to know exactly how many have departed Puerto Rico for the mainland, but Florida reports more than 20,000 have come to the Seminole state since Oct. 3rd. There were already about 1 million Puerto Ricans in the Sunshine State, second only to New York.

Addressing the urgency of fiscal assistance, House Appropriations Committee Chairman Rodney Frelinghuysen (R-N.J.) stated: “These funds are vital right now, in the near term, to get the aid where it is needed most.” Puerto Rico faces a government shutdown at the end of the month without an infusion of cash, according to Puerto Rico Treasury Secretary Raul Maldonado: the proposed loan provides flexibility for repayment: it allows the Secretary of Homeland Security, in consultation with Treasury Secretary Mnuchin to “determine the terms, conditions, eligible uses, and timing and amount of federal disbursements of loans issued to a territory or possession, and instrumentalities and local governments.”

Gov. Ricardo Rossello Nevares, in his letter at the end of last week to the President, cited “independent damage assessments in the range of $95 billion–approximately 150% of Puerto Rico’s” economy, writing that “financial damages of this magnitude will subject Puerto Rico’s central government, its instrumentalities, and municipal governments to unsustainable cash shortfalls: As a result, in addition to the immediate humanitarian crisis, Puerto Rico is on the brink of a massive liquidity crisis that will intensify in the immediate future.”

Saving Atlantic City. New Jersey Superior Court Judge Julio Mendez has ruled that Atlantic City can cut its Fire Department by 15 members early next year as a cost-saving measure under the Garden State’s Municipal Stabilization and Recovery Act, with his ruling lifting the restriction that any reduction in force must occur through retirements or attrition. Judge Mendez, who in late August had ruled against a state proposal for 50 layoffs, ruled no cuts may take place before February 1st—marking the first legal showdown under New Jersey’s Recovery Act takeover powers under designee Jeffrey Chiesa, which enables the state to alter outstanding municipal contracts. In his decision, Judge Mendez wrote: “Upon careful consideration of the facts and legal arguments, the court is of the view that the plan and timeline for immediate reductions is problematic but it’s not impermissible by the Recovery Act…The court will not restrict the Designee from establishing a plan to reduce the size of the ACFD from the current level of 195 to 180.”  Judge  Mendez ruled the state may exercise its authority; however, the cuts are not allowed until after Feb. 1, according to the ruling: “Upon careful consideration of the facts and legal arguments, the court is of the view that the plan and timeline for immediate reductions is problematic, but it’s not impermissible by the Recovery Act…The court will not restrict the Designee from establishing a plan to reduce the size of the ACFD from the current level of 195 to 180.” In his August ruling, the Judge had written that any reduction in force below 180 members would compromise public safety, and any further reduction would have to come through attrition and retirements. Under this week’s ruling, before the state makes cuts, however, officials must explore other funding to cover lost SAFER Grant funding, allow for additional attrition to take place, and provide fair notice to those who may lose their jobs.

Atlantic City Mayor Don Guardian said he had hoped the state would offer an early retirement incentive—especially after, last August, Gov. Chris Christie had signed a bill allowing the state to offer such an incentive to the city’s police officers, firefighters, and first responders facing layoffs. However, the state has said the offer would not be financially beneficial, leading Mayor Guardian to note: “I am disappointed that the state has pushed forward this motion knowing that the state Senate, Assembly, and the Governor all passed an early retirement bill for just this reason: We could have easily gotten to 180 fighters through these incentives.”

New Jersey Community Affairs spokeswoman Lisa Ryan noted: “We remain disappointed by the court’s insistence on requiring an artificially and unnecessarily high number of firefighters…While the decision to allow a modest reduction in firefighters on Feb. 1, 2018, will provide some budget relief, the city will still be forced to make additional and significant reductions to fire salaries in order to afford paying for 180 firefighters.” (Last January, the Fire Department had 225 members; now there are 195, or, as Judge Mendez wrote: “The plans to reduce the size of the ACFD have evolved from a request to approve a force of 125, resulting in a loss of 100 positions, to the current request to reduce the force to 180, resulting in a loss of 15 positions.” 

Measuring Municipal Fiscal Distress

August 29, 2017

Good Morning! In this a.m.’s Blog, we consider the new Local Government Fiscal Distress bi-cameral body in Virginia and its early actions; then we veer north to Atlantic City, where both the Governor and the courts are weighing in on the city’s fiscal future; before scrambling west to Scranton, Pennsylvania—as it seeks to respond to a fiscally adverse judicial ruling, then back west to the very small municipality of East Cleveland, Ohio—as it awaits authority to file for chapter 9 municipal bankruptcy—and municipal elections—then to Detroit’s ongoing efforts to recover revenues as part of its recovery from the nation’s largest municipal bankruptcy, before finally ending up in the Windy City, where the incomparable Lawrence Msall has proposed a Local Government Protection Authority—a quasi-judicial body—to serve as a resource for the Chicago Public School System.  

Visit the project blog: The Municipal Sustainability Project 

Measuring Municipal Fiscal Distress. When Virginia Auditor of Public Accounts Martha S. Mavredes last week testified before the Commonwealth’s new Joint House-Senate Subcommittee on Local Government Fiscal Stress, she named Bristol as one of the state’s four financially distressed localities—a naming which Bristol City Manager Randy Eads confirmed Monday. Bristol is an independent city in the Commonwealth of Virginia with a population just under 18,000: it is the twin city of Bristol, Tennessee, just across the state line: a line which bisects middle of its main street, State Street. According to the auditor, the cities of Petersburg and Bristol scored below 5 on a financial assessment model that uses 16 as the minimum threshold for indicating financial stress, with Bristol scoring lower than Petersburg. One other city and two counties scored below 16. For his part, City Manager Eads said he and the municipality’s CFO “will be working with the APA to determine how the scores were reached,” adding: “The city will also be open to working with the APA to address any issues.” (Bristol scored below the threshold the past three years, dropping to 4.25 in 2016. Petersburg had a score of 4.48 in 2016, when its financial woes became public.) Even though the State of Virginia has no authority to directly involve itself in a municipality’s finances (Virginia does not specifically authorize its municipal entities to file for chapter 9 municipal bankruptcy, certain provisions of the state’s laws [§15.2-4910] do allow for a trust indenture to contain provisions for protecting and enforcing rights and remedies of municipal bondholders—including the appointment of a receiver.), its new system examines the Comprehensive Annual Financial Reports submitted annually and scores them on 10 financial ratios—including four that measure the health of the locality’s general fund used to finance its budget. Manager Eads testified: “At the moment, the city does not have all of the necessary information from the APA to fully address any questions…We have been informed, by the APA, that we will receive more information from them the first week of September.” He added that the city leaders have taken steps to bolster cash flow and reserves, while reducing their reliance on borrowing short-term tax anticipation notes. In addition, the city has recently began implementing a series of budgetary and financial policies prior to the APA scores being released—steps seemingly recognized earlier this summer when Moody’s upgraded the city’s outlook to stable and its municipal bond rating to Baa2 with an underlying A3 enhanced rating, after a downgrade in 2016. Nevertheless, the road back is steep: the city still maintains more than $100 million in long-term general obligation bond debt with about half of it tied to The Falls commercial center in the Exit 5 area, which has yet to attract significant numbers of tenants.

Fiscal Fire? The State of New Jersey’s plan to slash Atlantic City’s fire department by 50 members was blocked by Superior court Judge Julio Mendez, preempting the state’s efforts to reduce the number of firefighters in the city from 198 to 148. The state, which preempted local authority last November, has sought to sharply reduce the city’s expenditures: state officials had last February proposed to move the Fire Department to a less expensive health plan and reduce staffing in the department from 225 firefighters to 125. In his ruling, however, Judge Mendez wrote: “The court holds that the (fire department’s union) have established by clear and convincing evidence that Defendants’ proposal to reduce the size of the Atlantic City Fire Department to 148 firefighters will cause irreparable harm in that it compromises the public safety of Atlantic City’s residents and visitors.” Judge Mendez had previously granted the union’s request to block the state’s actions, ruling last March that any reduction below 180 firefighters “compromises public safety,” and that any reduction should happen “through attrition and retirements.”

Gov. Christie Friday signed into law an alternative fiscal measure for the city, S. 3311, which requires the state to offer an early-retirement incentive program to the city’s police officers, firefighters, and first responders facing layoffs, noting at the bill signing what he deemed the Garden State’s success in its stewardship of the city since November under the Municipal Stabilization and Recovery Act, citing Atlantic City’s “great strides to secure its finances and its future.” The Governor noted a drop of 11.4 percent in the city’s overall property-tax rate, the resolution of casino property-tax appeals, and recent investments in the city. For their parts, Senate President Steve Sweeney and Assemblyman Vince Mazzeo, sponsors of the legislation, said the new law would let the city “reduce the size of its police and fire departments without jeopardizing public safety,” adding that the incentive plan, which became effective with the Governor’s signature, would not affect existing contracts or collective bargaining rights—or, as Sen. Sweeney stated: “We don’t want to see any layoffs occur, but if a reduction in workers is required, early retirement should be offered first to the men and women who have served the city.” For his part, Atlantic City Mayor Don Guardian said, “I’m glad that the Governor and the State continue to follow the plan that we gave them 10 months ago. As all the pieces that we originally proposed continue to come together, Atlantic City will continue to move further in the right direction.”

For its part, the New Jersey Department of Community Affairs, which has been the fiscal overseer of the state takeover of Atlantic City, has touted the fiscal progress achieved this year from state intervention, including the adoption of a $206.3 million budget that is 20 percent lower than the city’s FY2015 budget, due to even $56 million less than 2015 due to savings from staff adjustments and outsourcing certain municipal services. Nevertheless, Atlantic City, has yet to see the dial spin from red to black: the city, with some $224 million in bonded debt, has deep junk-level credit ratings of CC by S&P Global Ratings and Caa3 by Moody’s Investors Service; it confronts looming debt service payments, including $6.1 million owed on Nov. 1, according to S&P.

Scrambling in Scranton. Moody’s is also characteristically moody about the fiscal ills of Scranton, Pennsylvania, especially in the wake of a court decision barring the city from  collecting certain taxes under a state law—a decision Moody’s noted  “may reduce tax revenue, which is a vital funding source for the city’s operations.” Lackawanna County Court of Common Pleas Judge James Gibbons, at the beginning of the month, in a preliminary ruling against the city, in response to a challenge by a group of eight taxpayers, led by Mayoral candidate Gary St. Fleur, had challenged Scranton’s ability to levy and collect certain taxes under Pennsylvania’s Act 511, a state local tax enabling act. His preliminary ruling against the city affects whether the Home Rule Charter law supersedes the statutory cap contained in Act 511. Unsurprisingly, the City of Scranton has filed a motion for reconsideration and requested the court to enable it to appeal to the Commonwealth Court of Pennsylvania. The city, the state’s sixth-largest city (77,000), and the County seat for Lackawanna County is the geographic and cultural center of the Lackawanna River valley, was incorporated on St. Valentine’s Day 161 years ago—going on to become a major industrial city, a center of mining and railroads, and attracted thousands of new immigrants. It was a city, which acted to earn the moniker of the “Electric City” when electric lights were first introduced in 1880 at Dickson Locomotive Works. Today, the city is striving to exit state oversight under the state’s Act 47—oversight the municipality has been under for a quarter century.

Currently, Moody’s does not provide a credit rating for the city; however, Standard and Poor’s last month upgraded the city’s general obligation bonds to a still-junk BB-plus, citing revenue from a sewer-system sale, whilst Standard and Poor’s cited the city’s improved budget flexibility and liquidity, stemming largely from a sewer-system sale which enabled the municipality to retire more than $40 million of high-coupon debt. Moreover, Scranton suspended its cost-of-living-adjustments, and manifested its intent to apply a portion of sewer system sale proceeds to meet its public pension liabilities. Ergo, Moody’s writes: “These positive steps have been important for paying off high interest debt and funding the city’s distressed pension plans…While these one-off revenue infusions have been positive, Scranton faces an elevated fixed cost burden of over 40% of general fund revenues…Act 511 tax revenues are an important revenue source for achieving ongoing, balanced operations, particularly as double-digit property tax increases have been met with significant discontent from city residents. The potential loss of Act 511 tax revenues comes at a time when revenues for the city are projected to be stagnant through 2020.”

The road to municipal fiscal insolvency is easier, mayhap, because it is downhill: Scranton fiscal challenges commenced five years ago, when its City Council skipped a $1 million municipal bond payment in the wake if a political spat; Scranton has since repaid the debt. Nevertheless, as Moody’s notes: “If the city cannot balance its budget without illegally taxing the Scranton people, it is absolute proof that the budget is not sustainable…Scranton has sold off all its public assets and raised taxes excessively with the result being a declining tax base and unfriendly business environment…The city needs to come to terms with present economic realities by cutting spending and lowering taxes. This is the only option for the city.”

Scranton Mayoral candidate Gary St. Fleur has said the city should file for Chapter 9 municipal bankruptcy and has pushed for a related ballot measure. Combined taxes collected under Act 511, including a local services tax that Scranton recently tripled, cannot exceed 1.2% of Scranton’s total market value.  Based on 2015 market values, according to Moody’s, Scranton’s “511 cap” totals $27.3 million. In fiscal 2015 and 2016, the city collected $34.5 million and $36.8 million, respectively, and for 2018, the city has budgeted to receive $38 million.  The city, said Moody’s, relied on those revenues for 37.7% of fiscal 2015 and 35.9% of fiscal 2016 total governmental revenues. “A significant reduction in these tax revenues would leave the city a significant revenue gap if total Act 511 tax revenues were decline by nearly 25%,” Moody’s said.

Heavy Municipal Fiscal Lifting. Being mayor of battered East Cleveland is one of those difficult jobs that many people (and readers) would decline. If you were to motor along Euclid Avenue, the city’s main street, you would witness why: it is riddled with potholes and flanked by abandoned, decayed buildings. Unsurprisingly, in a city still awaiting authorization from the State of Ohio to file for chapter 9 municipal bankruptcy, blight, rising crime, and poor schools, have created the pretext for East Clevelanders to leave: The city boasted 33,000 people in 1990; today it has just 17,843, according to the latest U.S. Census figures. Nevertheless, hope can spring eternal: four candidates, including current Mayor Brandon L. King, are seeking the Democratic nomination in next month’s Mayoral primary (Mayor King replaced former Mayor Gary Norton last year after Norton was recalled by voters.)

Motor City Taxing. Detroit hopes to file some 700 lawsuits by Thursday against landlords and housing investors in a renewed effort to collect unpaid property taxes on abandoned homes that have already been forfeited; indeed, by the end of November, the city hopes to double the filings, going after as many as 1,500 corporations and investors whose abandonment of Detroit homes has been blamed for contributing to the Motor City’s blight epidemic: Motor City Law PLC, working on behalf of the city, has filed more than 60 lawsuits since last week in Wayne County Circuit Court; the remainder are expected to be filed before a Thursday statute of limitations deadline: the suits target banks, land speculators, limited liability corporations, and individuals with three or more rental properties in Detroit: investors who typically purchase homes at bargain prices at a Wayne County auction and then eventually stop paying property tax bills and lose the home in foreclosure: the concern is that unscrupulous landlords have been abusing the auction system. The city expects to file an additional 800 lawsuits over the next quarter—with the recovery effort coming in the wake of last year’s suits by the city against more than 500 banks and LLCs which had an ownership stake in houses that sold at auction for less than what was owed to the city in property taxes. Eli Savit, senior adviser and counsel to Mayor Mike Duggan, noted that those suits netted Detroit more than $5 million in judgments, even as, he reports: “Many cases are still being litigated.” To date, the 69 lawsuits filed since Aug. 18 in circuit court were for tax bills exceeding $25,000 each; unpaid tax bills for less than $25,000 will be filed in district court. (The unpaid taxes date back years as the properties were auctioned off by the Wayne County Treasurer’s Office between 2013 and 2016 or sent to the Detroit Land Bank Authority, which oversees demolitions if homes cannot be rehabilitated or sold.) The suits here indicate that former property owners have no recourse for lowering their unpaid tax debt, because they are now “time barred from filing an appeal” with Detroit’s Board of Review or the Michigan Tax Tribunal; Detroit officials have noted that individual homeowners would not be targeted by the lawsuits for unpaid taxes; rather the suits seek to establish a legal means for going after investors who purchase cheap homes at auction, and then either rent them out and opt not to not pay the taxes, or walk away from the house, because it is damaged beyond repair—behavior which is now something the city is seeking to turn around.

Local Government Fiscal Protection? Just as the Commonwealth of Virginia has created a fiscal or financial assessment model to serve as an early warning system so that the State could act before a chapter 9 municipal bankruptcy occurred, the fiscal wizard of Illinois, the incomparable Chicago Civic Federation’s Laurence Msall has proposed a Local Government Protection Authority—a quasi-judicial body—to serve as a resource for the Chicago Public School System (CPS): it would be responsible to assist the CPS board and administration in finding solutions to stabilize the school district’s finances. The $5.75 billion CPS proposed budget for this school year comes with two significant asterisks: 1) There is an expectation of $269 million from the City of Chicago, and 2) There is an expectation of $300 million from the State of Illinois, especially if the state’s school funding crisis is resolved in the Democrats’ favor.

Nevertheless, in the end, CPS’s fiscal fate will depend upon Windy City Mayor Rahm Emanuel: he, after all, not only names the school board, but also is accountable to voters if the city’s schools falter: he has had six years in office to get CPS on a stable financial course, even as CPS is viewed by many in the city as seeking to file for bankruptcy (for which there is no specific authority under Illinois law). Worse, it appears that just the discussion of a chapter 9 option is contributing to the emigration of parents and students to flee to suburban or private schools.

Thus, Mr. Msall is suggesting once again putting CPS finances under state oversight, as it was in the 1980s and early 1990s, recommending consideration of a Local Government Protection Authority, which would “be a quasi-judicial body…to assist the CPS board and administration in finding solutions to stabilize the district’s finances.” Fiscal options could include spending cuts, tax hikes, employee benefit changes, labor contract negotiations, and debt adjustment. Alternatively, as Mr. Msall writes: “If the stakeholders could not find a solution, the LGPA would be empowered to enforce a binding resolution of outstanding issues.” As we noted, a signal fiscal challenge Mayor Emanuel described was to attack crime in order to bring young families back into the city—and to upgrade its schools—schools where today some 380,000 students appear caught in a school system cracking under a massive and rising debt load.  

Far East of Eden. East Cleveland Mayor Gary Norton Jr. and City Council President Thomas Wheeler have both been narrowly recalled from their positions in a special election, setting the stage for the small Ohio municipality waiting for the state to—in some year—respond to its request to file for chapter 9 municipal bankruptcy to elect a new leader. Interestingly, one challenger for the job who is passionate about the city, is Una H. R. Keenon, 83, who now heads the city school board, and campaigning on a platform of seeking a blue-ribbon panel to examine the city’s finances. Mansell Baker, 33, a former East Cleveland Councilmember, wants to focus on eliminating the city’s debt, while Dana Hawkins Jr., 34, leader of a foundation, vows to get residents to come together and save the city. The key decisions are likely to emerge next month in the September 12 Democratic primary—where the winner will face Devin Branch of the Green Party in November. Early voting has begun.