The Challenges of Intergovernmental Relations in Insolvency

Share on Twitter

eBlog, 8/04/16

In this morning’s eBlog, we consider the harsh and stark terms of a loan imposed by the Governor of New Jersey on Atlantic City, the prospects of getting high in San Bernardino—a city nearing exit from the longest municipal bankruptcy in American history, and the growing challenges of insolvency and financing of essential public services in Puerto Rico as the U.S. territory awaits the appointment of a fiscal oversight board.

State Holdup? New Jersey Gov. Chris Christie, in imposing a harsh loan agreement on Atlantic City, took exception to the city sending back the original agreement marked up with changes, making clear this was not an agreement between the state and the city, but rather a state imposed mandate, and saying: “You should just say, where do I sign? Thank you sir,” adding that with regard to the imposition and referring to the city’s elected leaders: “You are in no position to dictate terms to me when I’m giving you $74 [sic] million to stay alive.” Indeed, making clear the scorched earth nature of the one-sided agreement, last week, Gov. Christie made clear he wanted the loan “secured by every asset they have…So that if they don’t pay it, I get to take the assets, sell them and pay you (the taxpayer) back…My job is to protect the interest of the people who are giving them that ($73 million), and that’s all the people in the rest of the state.” The state-imposed loan agreement is unprecedented; prior short-term cash flow loans never had this type of requirement.

The $73M loan agreement between the state and Atlantic City is of an unprecedented kind in the state’s history, imposing conditions, including dissolving its water authority, barring or preempting municipal authority to sell or lease any asset without state permission, and ordering the city to provide a weekly report on its finances to the state—terms Mayor Donald Guardian described as “extremely overreaching.” The state loan carries a fixed 1.75 percent interest rate. The loan terms have been signed, but the funds have yet to be made available according to the Mayor, who added the city made its $3.5 million debt payment Monday. Other conditions for the city include dropping its claims in a lawsuit against the state education commissioner, submitting a draft FY2016 budget by a week from Monday, and issuing third-quarter tax bills that include school and county tax-rate increases.

The Mayor added that the loan would not have been necessary at all if about $78 million in non-taxpayer redirected casino funds due the city by virtue of recent rescue legislation were made available by the state: “We have been creative and steadfast in our resolve to maintain the City’s fiscal integrity…More recently, we had to work with the State to attempt to lessen the restrictions on a proposed loan agreement that the City regarded as extremely overreaching.” Indeed, Atlantic City officials reported the original terms offered by the state were “much, much worse” than what the city and state ultimately agreed upon, but declined to elaborate. In fact, the redirected casino funds have been long promised to the city by the state; however, in the final rescue package approved by the state legislature and signed by the governor, the city is held hostage until it approves a fiscal plan acceptable to the state—with a state-imposed deadline of November 3rd. Moreover, notwithstanding the withholding of funds to the city, the city, which, under the unprecedented loan agreement executed with the New Jersey Department of Community Affairs, acknowledges is the first collateral for the loan, the agreement sets out an even harsher demand under which the state will also seize the proceeds of assets such as the city’s airport (Bader Field—on which sealed bids are due Thursday for the now defunct municipal airstrip once valued at $850 million.) and the city’s Municipal Utilities Authority—or, as the Mayor characterized the nature of the taking: “Ironically, restrictions in the Act prevented the City from accessing non taxpayer funding…If this redirected casino revenue were available today, a bridge loan with interest from the State would not be necessary.” Adding fiscal insult to injury, the loan agreement also mandates Atlantic City to include in its 3rd quarter property tax bills any hikes to the school and county tax rate that each “appropriately accounts for the entire amount” of their respective levies. (Atlantic City does not set the school and county tax rate), and it mandates weekly reporting by the city of cash flow, proposed and actual spending, and all known accounts payable.

But that is not all (any reader wishing a copy of the agreement should contact me directly): other stipulations or mandates impose:

* The city has to initiate an ordinance by Sept. 15th to dissolve its water authority and allow the assets to be used as additional collateral should the city default on the loan; however, the ordinance can include a revocation clause, letting the city cancel the dissolution if it successfully pays back the state. The city must make a deposit account for proceeds from a Bader Field sale. Sealed bids for the former airport are due Thursday. The city initially set a minimum bid of $155 million, but later decided to accept sealed bids instead.

* The state loan agreement also stipulates that state aid might be used as collateral; however, it mandates Atlantic City to dismiss a lawsuit against the state that sought to gain access to the redirected casino funds, and putting proceeds from a sale of Bader Field into escrow as additional collateral. (The redirected casino funds are the last two years of a casino-funded marketing plan signed into law by Gov. Christie, which allocated $30 million a year to develop a city-wide promotional strategy that resulted in the DoAC campaign, free beach concerts, and a widely mocked art park. In addition, about $18 million in casino tax money that previously went to the state Casino Reinvestment Development Authority was targeted in the recent legislation to be sent to the city.)

The harsh terms—terms which threaten the city’s solvency perhaps more than its already difficult circumstances—came even as Mayor Guardian reported that Atlantic City was able to make a $3.475 million debt payment earlier this week, despite not receiving the loan by that date. Nevertheless, the Mayor said: “Moving forward, we will continue to work diligently to ensure the City continues to run efficiently while also concurrently putting together a viable 150-day Atlantic City rescue plan.”

It was unclear whether the county tax-rate hike referred to a previously announced increase. Asked about it, a frustrated Atlantic County Executive Dennis Levinson said: “I don’t know what it means…It means whatever they want it to mean in Trenton,” adding it depends on how “the smartest, most expensive lawyers” will interpret it. He also said that county taxpayers should not be on the hook anymore for an “over-assessment of the casinos” by Atlantic City. Meanwhile, a tea party group led by former city Councilman Seth Grossman is suing to block council’s action on the loan agreement: the lawsuit, filed by Liberty and Prosperity, claims the Council excluded the public in its July 28 emergency meeting when it authorized the city to strike the loan agreement. Councilmember Grossman said council went into executive session for “confidential” matters involving “attorney-client” privilege, but said the Council’s attorney, Robert Tarver, did not attend the meeting. City Solicitor Anthony Swan was at the meeting. Thus, in his statement, Councilman Grossman added: “They instead discussed a complicated 18-page document loaning money that can’t possibly be paid back so that the state can seize every valuable asset the city owns.” (A hearing has been scheduled for Monday before Judge Julio Mendez with the court assessing Councilmember Grossman’s claim that Atlantic City violated state budget law by not adopting a balanced budget and by refusing to specify how the loan will be spent—or, as he put it: “While under state supervision, Atlantic City broke almost every law on the books written to protect taxpayers.”)

The abrupt actions by Governor Christie appear to signal a sea change in the state’s oversight of local governments—this in a state with, heretofore, an extraordinary reputation for working with—as opposed to against—them. Some believe the Governor’s key motive is to try to usurp Atlantic City’s vital and potentially valuable resources as a means of coercing increased resources for a faltering state budget: in return for the emergency loan, the state has basically put a lien on everything important that Atlantic City could, after all, sell to realize fiscal resources critical to its recovery. One commentator advises, referring to this stark change in the state’s policy towards municipalities: “This administration is just evil.  They care not about local democracy – they are inventing a new language and process on the fly.”

Getting High to Exit Municipal Bankruptcy? The City of San Bernardino is now set not only to emerge from the nation’s longest ever municipal bankruptcy, but also to have votes by its citizens on not one, not two, but three initiatives to replace the city’s long-standing ban on medical marijuana dispensaries—with one of the options prepared by the city attorney’s office. The latter was drafted by an unusual coalition—one including city officials who have said they want to continue the ban, but would rather regulate it on the city’s terms, rather than risk someone else’s regulatory framework. Were the municipally drafted option to receive more than 50 percent of the vote and more “yes” votes than either of the citizen-submitted initiatives, the city-written measure would become law. Moreover, unlike those initiatives, the city version could be modified as state law regarding marijuana changes, which led the City Council to put the medical marijuana regulation on the ballot in a 5-2 vote Monday, albeit reluctantly, in some cases. Nevertheless, as Councilmember Henry Nickel noted: “(The vote) is to put this question to the voters…It will still be our policy to enforce the ban unless and until voters say otherwise.” The most vocal advocate of the ban was Mayor Carey Davis, who offered extensive evidence that marijuana legalization has been harmful in Colorado and suggested it would stretch thin an already understaffed police department. (The mayor does not have a vote: he may vote, however, to break a tie or to veto.) Under its charter, the city lacks any legal alternative to putting the two citizen initiatives on the ballot — other than immediately adopting the framework they suggest, and Deputy City Attorney Steven Graham advised councilmembers that was not an option either with regard to the measure that imposed a tax on marijuana: California law bars municipalities from passing a tax without a vote of the public; it is unclear, legally, whether a voter-originated tax can pass in an election at which council members are not up for a vote, which is the case in November, according to Councilmember Graham. The city-drafted measure would require separate licenses for marijuana cultivation, marketing, testing, distribution and dispensaries; application fees and enforcement fees would be set yearly to match the cost of providing the service. Under the proposal, dispensaries could only be within industrial zones, and could not be within 600 feet of a school, park, library or recreation center, nor within 100 feet of a residential zone or religious center. No two dispensaries could be within 1,000 feet of each other, amounting to a significant limitation on the number of dispensaries, according to the Councilmember, the primary author of the initiative.

Waiting for Godot. Puerto Rico Gov. Alejandro Garcia Padilla on yesterday approved a voluntary reduction of working hours for government employees after signing several laws to help reduce spending and generate revenue amid a severe economic crisis. The Governor’s action came in the wake of another multimillion-dollar default this week by the U.S. territory, which is struggling to stay afloat as it prepares to restructure a portion of its nearly $70 billion public debt with help from a federal oversight or control board, and as it awaits the naming or appointment of such by the White House. One of the new laws allows government agencies to reduce an employee’s workweek if there is a voluntary agreement to do so: public employees would be allowed to work four days a week in exchange for receiving only 80 percent of their salary. A second new law aims to boost revenue for a severely depleted public pension system in danger of running out of money in upcoming years: the law pushes public agencies to prioritize revenues for the retirement system over any other payments, expenses or disbursements. The island has underfunded public pension obligations by more than $40 billion. The new law comes as citizens have already been forced to accept new taxes and ongoing increases in utility bills amid a decade-long economic slump and an unemployment rate that hovers at 11 percent. The U.S. territory’s fiscal plight has been exacerbated, moreover, by the loss of some 200,000 citizens who have left for the U.S. mainland in recent years in search of jobs and a more affordable cost of living, leaving behind a disproportionate number of retirees depending upon an ever declining workforce to make contributions into the public pension system. Thus, Camuy NPP Mayor Edwin García Feliciano warned the measure aimed at boosting the public retirement system only postpones the inevitable: “Eventually, there’ll be a debt restructuring, and it will probably include cuts to the current retirees: There’s a conflict between retirees and bondholders for the same pot of money.” His comments came in the wake of comments earlier this week by Gov. Alejandro Garcia Padilla after vetoing a bill that sought to create a special fund so the government could make minimum payments on the island’s debt. Gov. Garcia said the government needs the limited liquidity it has to keep providing essential services; he added Puerto Rico should allow the as-yet unnamed federal control board ought to decide how much in resources should be set aside for debt payments.

The growing conflict between bondholders and retirees came in the wake of Puerto Rico’s payments Monday from funds previously placed in escrow accounts. Gov. Alejandro García Padilla earlier this week had vetoed a House bill to allocate $450 million for debt payments due in this fiscal year, according to his office. The approved budget has no money approved for paying the government’s debt. Instead debt service or debt service reserve accounts appear to be dedicated to pay the Puerto Rico Sales Tax Financing Corp. (COFINA), Employees Retirement System, Puerto Rico Highways and Transportation Authority, and Puerto Rico Industrial Development Company debt. But with fiscal resources running out, the choices of whom to pay—and who not is becoming increasingly difficult: the Bond Buyer notes that the Puerto Rico Infrastructure Finance Authority, Public Finance Corp., and Puerto Rico (general obligation), did not make their payments. According to Moody’s, the GDB owed $28.5 million, Puerto Rico owed $1.3 million for its general obligation debt, and PRIFA owed $700,000. Moreover, at the beginning of the week, Gov. Padilla’s office announced his veto of House Bill 2959 for the Commonwealth government’s payment of debt: the requisite funds for the payments were to come primarily from resources normally allocated to the PRHTA, but the Governor said this diversion was inconsistent with his policy of ensuring essential public services—and that it would be premature to allocate particular resources to paying debts before the control board set up under the Puerto Rico Oversight, Management, and Economic Stability Act is in place.

The Hard Balancing Choices in Public School Finance

 

eBlog

Share on Twitter

eBlog, 6/13/16

In this morning’s eBlog, we consider the unique state perspective on the challenges of public school finance—something which has bedeviled Kansas, but here we look at the unique political challenges for Michigan legislators to act to avoid letting the Detroit Public School System go into municipal bankruptcy: the challenge for Michigan Governor Ric Snyder is to somehow convince members of the state’s House and Senate to appropriate funds that might otherwise have gone to their own Districts to, instead, go to DPS. Then we turn to the fate of the House-passed bipartisan legislation to address Puerto Rico’s looming insolvency—and how and when the Senate will act with time running out. 

Learning about the Importance of Getting it Right. Daniel Howes, the very insightful editor from the Detroit News, in his column on Friday, “Bankruptcy for DPS threatens cascading risks,” wrote that “All it took was a few texts from Kevyn Orr…to confirm Gov. Rick Snyder’s worst fears: A chapter 9 bankruptcy of Detroit Public Schools risked establishing a precedent, the city’s former emergency manager told the Governor, that could expose taxpayers to billions of dollars in creditor and pension liabilities — and the possibility that a federal court could order the state to raise taxes to pay them.” The result, Gov. Snyder therefore warned state legislators, would be a financial and political cataclysm: absent sufficient votes to pass the $617 million rescue package for DPS, the Governor would, once again, have been forced – as he had years ago when he first appointed Mr. Orr to put Detroit into bankruptcy and then steer the city through the largest municipal bankruptcy in U.S. history. Moreover, the Governor warned legislators that the fiscal carnage or failure would not necessarily stop at Detroit’s city limits: “School districts across the state would be tempted to follow DPS’ path in an effort to shed liabilities on their books, effectively dumping them on Michigan taxpayers and creating a civic firestorm that would be difficult to control.”

The hard issue, after all, for state legislators, was to agree to spend more than $600 million in state revenues to go to Detroit’s schools—that is: a challenge more difficult, politically, because it meant asking House and Senate members to find a way to take state funds from their own districts to send to Detroit. Thus, the warning from Gov. Snyder that a failure to appropriate a significant aid package could risk putting the state on the hook for as much as $2 billion to $3.5 billion in liabilities—or the equivalent of a cut of $3,000 in state aid for every public school student. In addition, the Governor reminded his colleagues in the House and Senate that a new municipal bankruptcy in Detroit for its school system could hurt the state retirement system, because it includes Detroit teachers. He added, finally, that failure to act would jeopardize Michigan’s credit ratings. That is, such a filing would likely risk fiscal contagion: it could raise the cost of capital borrowing for virtually every city, county, and public school district in the state. Mr. Howes noted: “More precisely, Orr advised the governor that bankruptcy lawyers likely would advance a go-for-broke argument seeking to establish that states could be ordered to raise revenue to pay creditors and satisfy unfunded liabilities.”

Finally, Mr. Howes wrote what I found the most profound: “The city’s bankruptcy was neither easy nor free of confrontation. Memories dim. Chapter 9 was disruptive; it required sacrifice; it challenged labor and the municipal bureaucracy in ways they had never been challenged before; and it cost the city something in the neighborhood of $180 million in fees to shed $7 billion in liabilities, refinance another $3 billion more and renegotiate all of its union contracts.”

Oye! The U.S. Senate expects to take up the PROMESA Puerto Rico bill passed by the House and vote by the end of this month or in early July—an effort facilitated by House action last week to provide a procedure for Senate Majority Leader Mitch McConnell (R-Ky.) to bring the measure, S. 2328, up before the full Senate without having to go through committees. Moreover, with Senate Majority Whip Sen. John Cornyn (R-Tx.) advising his colleagues that the House-passed bill is the only alternative to what otherwise would become a large, taxpayer-funded bailout. Senate Finance Committee Chairman Orrin Hatch (R-Utah) said the Senate would have to support the bill if the House passed it, even though he said he does not “think it’s a very good bill in many ways.” Moreover, no Senator seems to have been able to come up with an alternative proposal which has garnered any interest or support: and all appear acutely aware that, as they use to say in Rome, tempus fugit: the Senate has quite simply run out of time to consider any significant alternatives between today and the July 1 deadline when Puerto Rico faces a nearly $2 billion debt payment deadline. If there is one fly in the ointment, it is Vermont’s Sen. Bernie Sanders (I-Vt.), who has threatened to filibuster the bill. Sen. Sanders introduced an alternate bill, The Puerto Rico Humanitarian Relief Act last Thursday in which he proposes to create a seven-member Reconstruction Finance Corporation of Puerto Rico and provide that U.S. territories be included under the Chapter 9 municipal bankruptcy title. The public corporation would be a restructuring agency with authority to lend to Puerto Rico and facilitate debt restructuring for the commonwealth. His bill would also appropriate $10.8 billion to the commonwealth over five years to help modernize infrastructure as well as extend Chapter 9 bankruptcy protections to the island. In introducing his bill and opposition to the House-passed bill, Sen. Sanders said: “The more we learn about the disastrous House bill to address the crisis in Puerto Rico, the worse it becomes. It is bad enough for Republicans in Congress (and apparently the Treasury, White House, and House Democrats) to take away the democratic rights of U.S. citizens living in Puerto Rico by setting up a neocolonial control board empowered with the authority to slash pensions, fire teachers, and close hospitals. But to ask Puerto Rican taxpayers to pay $370 million to create an unelected control board stacked with right-wing Republicans is beyond insulting. Mexico is not going to pay for Donald Trump’s unnecessary wall and, if I have anything to say about it, the people of Puerto Rico will not pay for this outrageous control board. This is just one more reason why I will do everything I can to defeat this legislation in the Senate and fight for an alternative bill that will allow Puerto Rico to grow its economy, create good jobs, expand its tax base and pay back its debt in a way that is fair and just.” Nonetheless, it seems most unlikely Sen. Sanders would be able to gain the requisite 41 votes he would need to block cloture in the Senate. And it comes in the wake of overwhelming, bipartisan action in the House. Puerto Rico’s own nonvoting Member of Congress, Commissioner Pedro Pierluisi noted to his colleagues that the House-passed bill accomplished the first step in dealing with an emergency: to stabilize the solution: “Without PROMESA, the Puerto Rico government is likely to collapse, participants in public pension plans will be terribly harmed, and many bondholders could lose their investments: PROMESA is in the interest of all stakeholders.”

The Governing Challenge in Averting Insolvency

Share on Twitter
eBlog, 6/10/16
In this morning’s eBlog, we consider the bipartisan legislation overwhelming passed by the U.S. House of Representatives last night to address Puerto Rico’s looming insolvency—and a related U.S. Supreme Court decision; then we look at the almost Detroit Public Schools filing for chapter 9 municipal bankruptcy. It almost seems as if these events and actions were staged just for my fine graduate class on public policy process.

 

Oye! The House last evening passed and forwarded to the Senate legislation to address Puerto Rico’s looming insolvency on a bipartisan 297-127 vote: Speaker Paul Ryan (R-Wi.) and Minority Leader Nancy Pelosi (D-Ca.) took to the House floor to urge support for the legislation, with Speaker Ryan noting: “The Puerto Rican people are our fellow Americans. They pay our taxes. They fight in our wars…We cannot allow this to happen.” The bill now heads to the Senate, where there is little evidence Senators are eager to remake the bill wholesale, particularly as conditions on the island continue to worsen. The only amendment to fail was one offered by Democrats that would have struck a provision of the bill permitting Puerto Rican employers to pay workers under 25 years old less than the minimum wage. The legislation is critical as Puerto Rico—being neither a municipality, nor a state, falls into a Twilight Zone in terms of authority to address an insolvency. Puerto Rico has defaulted on three classes of municipal bonds, including last month when it missed most of a $422 million payment, and faces $2 billion in payments on July 1 that the island’s governor said cannot be paid. That final vote on the amendment was 196 in favor to 225 against. Puerto Rico’s government has begun defaulting on $70 billion in debts, and has warned it could run out of cash this summer.

In pressing for the vote, the Speaker warned that pressure would mount on Congress to spend money rescuing the territory if it could not arrest its economic decline, telling his colleagues: “This bill prevents a bailout. That’s the entire point…if we do not pass this bill…there will be no other choice.” Anne Krueger, a former IMF economist who led a detailed review of Puerto Rico’s economy, has warned: “Come July 1, if nothing is done, Puerto Rico will technically be bankrupt…Assets will be tied up in courts. It is very likely that essential services will have to be suspended.”

As drafted, the House-passed legislation does not commit a single federal dollar to Puerto Rico. The legislation creates a federal oversight board—whose members will be appointed by Congress and President Obama, and not the governor—to determine whether and when to initiate court-supervised debt restructuring: it charges the board with the responsibility to determine the hierarchy of municipal debt obligations and encourages it to respect the existing legal framework, which places constitutionally backed general obligation debt above pension liabilities. The board terminates after Puerto Rico regains the ability to borrow at reasonable interest rates and balances its budget for four consecutive years. Congressional leaders and the Treasury hope the bill will avert a long, expensive courtroom battle between hedge funds and the federal government—a battle that could harm investment in the U.S. territory’s economic future and undercut its ability to provide essential public services (servicing Puerto Rico’s current debt burden today absorbs approximately 30 percent of the Commonwealth’s revenues)—especially as Puerto Rico is now at the forefront of the Zika virus. While critics have falsely warned the bill could set a precedent for distressed states to seek similar relief, the dual sovereignty created by the founding fathers—or statesmen—in the U.S. Constitution clearly undercuts such claims: Congress granted U.S. citizenship in 1917 under the Jones-Shafroth Act to residents of Puerto Rico, which was seized in the Spanish-American War of 1898. The U.S. gave the territory the right to elect its own governor in 1947.

 Republicans have been concerned that the language would allow the to-be appointed oversight board to elevate pensions above the island’s full faith and credit general obligation municipal bond debt: Rep. John Fleming (R-La.) submitted an unsuccessful amendment to require compliance with the legal hierarchy, calling the statutory use of the word “respect” a “weasel word.”

Hear Ye! By coincidence, the U.S. Supreme Court chimed in almost simultaneously in a 6-2 decision (Commonwealth of Puerto Rico v. Sanchez Valle et al., (2016), No. 15-108, involving a simple criminal prosecution for firearms sales, but also the related governance issue of the Commonwealth’s autonomy—a case in which attorneys for Puerto Rico argued that it should be able to try two men who already had pleaded guilty in federal court. Justice Elena Kagan, writing for the majority, said that would amount to double jeopardy, writing: “There is no getting away from the past…Because the ultimate source of Puerto Rico’s prosecutorial power is the federal government…the Commonwealth and the United States are not separate sovereigns.” Reasoning that even though Congress, in 1950, gave Puerto Rico the authority to establish its own government under its own constitution, that did not, in and of itself, break the chain of command that originates with Congress. As a result, the majority determined, the Commonwealth should be treated the same as other U.S. territories. While the 50 states and even Indian tribes enjoy sovereign powers that preceded the union or were enshrined in the U.S. Constitution, Justice Kagan wrote, Puerto Rico in 1952 “became a new kind of political entity, still closely associated with the United States, but governed in accordance with, and exercising self-rule through, a popularly ratified constitution,” adding that Puerto Rico’s Constitution, significant though it is, does not break the chain.” Justice Ruth Bader Ginsburg went further in her concurrence, suggesting that the high court should hear a case that tests whether states and the federal government should remain able to try defendants for the same crime.

During oral argument last January, a majority of Justices appeared to side with the Obama administration, which argued that, as a territory of the United States, Puerto Rico cannot try the gun dealers after federal courts have acted, with Asst. Solicitor General Nicole Saharsky arguing: “Congress is the one who makes the rules.” The majority appeared to agree: Justice Kagan, writing for the majority, noted: “If you go back, the ultimate source of authority is Congress.” Nevertheless, in their dissent, Justices Stephen Breyer and Sonia Sotomayor stood by Puerto Rico — with Justice Breyer writing that if the court ruled against it, “that has enormous implications” for setting back the U.S. territory’s legal status: “Longstanding customs, actions and attitudes, both in Puerto Rico and on the mainland, uniformly favor Puerto Rico’s position — that it is sovereign, and has been since 1952, for purposes of the double jeopardy clause.” Justice Sotomayor, whose parents were born in Puerto Rico, said during oral argument that the island is an “estado libre asociado” Ironically the case was the first of two involving Puerto Rico to come before the high court this term. The Court is also re weighing the Commonwealth’s effort to restructure part of its $70 billion public debt, an issue addressed last evening by the House: a federal appeals court blocked the restructuring because of conflicts with U.S. bankruptcy laws.

Schooling for What If & Municipal Bankruptcy. With uncertainty whether the Michigan legislature would be able to pass and send legislation to him before the Detroit Public Schools exhausted all its cash—and before the legislature completed its session, Gov. Rick Snyder’s administration had commenced discussion with regard to drafting a chapter 9 municipal bankruptcy filing for DPS—in some apprehension of a wave of vendors’ and employees’ suits against DPS—the city’s public school system foundering in more than $515 million in outstanding operating debt: key staff worked with attorneys on a possible DPS chapter 9 bankruptcy, and Gov. Snyder had exchanged text messages with his former law school colleague and appointee as Detroit’s Emergency Manager, Kevyn Orr, who had, as we have catalogued, served as Emergency Manager in charge of both taking Detroit into municipal bankruptcy, and then piloting it through its successful emergence and approval of its plan of debt adjustment. Michigan State Treasurer Nick Khouri recently estimated the DPS would need $65 million for capital costs, including deferred maintenance and upgraded security equipment; $125 million for cash flow needs due to the timing of school aid payments and other startup expenses; and $10 million for academic programming. Now, in the wake of partisan action on which we reported yesterday, DPS will be able to make payroll, pay vendors, and purchase supplies this summer to prepare for school this fall. Logistically, the new school district will be created by July 1: retired U.S. Judge Steven Rhodes, DPS’s emergency manager appointed by Gov. Snyder and now serving as DPS’ transition manager, is working with state administrators to implement the new agreement.

How States Can Threaten a Municipality’s Fiscal Future

March 17, 2016. Share on Twitter

Because the federal government–and, increasingly, states no longer address fiscal disparities within states, that has provoked or invoked greater challenges for states–and increased fiscal despair for municipalities. Congressional elimination of general revenue sharing and countercyclical fiscal assistance has meant that states, such as New jersey and Michigan, for instance, now bear a burden and challenge. Will they opt for a constructive, passive, or destructive state fiscal policy?

Shutting Down a Municipality. Atlantic City Mayor Don Guardian yesterday reported that because of his city’s near insolvency (city officials have warned the city will run out of cash on April Fools’ Day), the city would be forced to halt all nonessential government services beginning in early April absent urgent state assistance: Mayor Guardian said the shutdown would start on April 8th and was likely to last until at least May 2nd, the date when quarterly tax revenues are due. During the shutdown, police, fire, and sanitation workers would perform their jobs—but without pay, which would be deferred pending receipt of taxes due; health care benefits would continue uninterrupted. Moreover, Mayor Guardian warned this was unlikely to be a one-time event, especially if the State of New Jersey does not step up with some kind of fiscal assistance, noting: “The city is in discussions with the state to avoid and forestall what may be an imminent financial predicament…Unfortunately, due to financial circumstances beyond our control, we will be forced to close City Hall.” The increasingly dire fiscal standoff comes as New Jersey Governor Chris Christie has warned he will not sign legislation to provide fiscal assistance to Atlantic City unless the New Jersey Legislature approves a state takeover of the city government. Atlantic City police union President Thomas Moynihan yesterday reported that Atlantic City’s police officers would report to work even if they “miss a paycheck or two in the meantime.”

Even though Gov. Christie claimed he had reached an agreement with New Jersey Senate President Steve Sweeney (D-West Deptford) to give the state control over the finances of Atlantic City for five years, that agreement has not secured House support, and has drawn criticism from New Jersey Assembly Speaker Vincent Prieto (D-N.J), who has made clear he would not ask the House to consider state legislation to alter or terminate union contracts unless and until local and state officials reach a compromise, noting: “The governor already has authority to help Atlantic City avoid financial disaster…It’s time for Gov. Christie to do his job and use his existing authority to resolve this once and for all.” In addition, Speaker Prieto’s spokesman notes that the New Jersey Local Government Supervision Act of 1947 already allows the state to control Atlantic City’s finances and government. For his part, Gov. Christie has made clear he will not sign any bill into state law that changes even a word of the Senate version.

Atlantic City, which has seen its tax base contract 64% since 2010, is deep in debt and not only unable to issue debt through the municipal bond market because of its low credit rating, but also faces a severe contraction of its tax base in the wake of the closure of four of its twelve casinos. It now faces worse odds of avoiding a state takeover. Even though Mayor Guardian yesterday said “We are making every effort to find solutions” prior to April 1st, his plan would mean that no employees would be paid until at least May 2nd, the date the city will receive its next installment of taxes. While essential services such as public safety and revenue collections will continue, other functions will cease and City Hall will close 4:30 pm local time on April 8. Moody’s Investors Service has warned that the city could default on debt as early as next month without state action, meaning its cost of borrowing is increasing—as are the possibilities the city could file for chapter 9 municipal bankruptcy.

Unbalancing. The Michigan Municipal League yesterday reported Michigan is the only state in the country in which there was an overall revenue decline for cities, townships, and counties over the decade from 2002 to 2012, due in large measure to state cuts in revenue sharing with cities, townships, villages, and counties by $7.5 billion over the decade—assistance vital to finance essential public services and to address fiscal disparities. The League, in its report, noted that U.S. Census Bureau data finds that Michigan’s municipalities experienced an 8 percent drop in revenues from what it has experienced from failed state fiscal policies toward cities and towns, noting that, according to the U.S. Census Bureau, Michigan is the only state in the country providing fewer economic resources to its cities in 2012 than it did a decade ago in 2002, adding that the tragic outcome in Flint reflects in many ways what should have been anticipated in a state which has adopted a state fiscal policy which incentivizes new building at the expense of what currently exists: “Our system attempts to balance budgets by only addressing the cost side of the equation. We have no mechanism to invest in our cities as a way of improving the financial well-being of a community.” The League’s report further points to the extraordinary state powers under Michigan law for Emergency Managers—powers the League warns which “virtually all relate in one way or another to cutting costs,” rather than taking into consideration the provision of essential services, such as drinking water, public safety, etc.: “Cost-cutting measures, with few very exceptions, result in a reduction in the services that the community will receive. Usually those reductions do not have tragic consequences, but make no mistake: the decision to switch from the Detroit Water and Sewer Department to the Flint River was an economic one driven by state laws and policies that significantly impact and restrain local government…This decision was not about improved service, water quality, infrastructure investment, or any other altruistic goal. This was an opportunity to save money and nothing more.”

A System Designed for Failing a Municipality: The special report notes that the state law and practice of appointing Emergency Managers has proven contrary to the long-term fiscal and human sustainability of the state’s communities, noting: “By design, emergency managers are outsiders with a single mission to reduce costs. I am in no way suggesting that this decision was made with malice or without forethought, but the emergency manager and, by extension, the state has only one objective during a financial emergency. That goal is to reduce costs until the budget is balanced. It is this approach that has brought us to where we are today. Emergency managers do not have to live, long-term, with service reductions and the diminishment to the community that they bring. When they have completed the mission, they move on. They have one focus: to balance the budget by cutting expenses until they equal revenues. But this approach fails to recognize, and in fact is in direct conflict with one of the fundamental tenants of Michigan’s municipal finance model, which is that the value of a community directly impacts the revenue that a community can generate to sustain services. It’s a system designed for failure.”

Think for a moment about how cities (& counties) generate revenue. Property taxes are a function of two variables: millage rates and taxable value. What makes taxable value higher in one community versus another, is, in essence, what makes one city or village more desirable than another. Great places can command higher prices, which translate into greater taxable value. This in turn generates more revenue. It is simple math. When an emergency manager balances the books by closing parks, eliminating programs and services and forgoing investments in infrastructure, he or she) makes it a less desirable place. This, of course, diminishes the value of the city and its revenue generating power. Consequently, the city offers even fewer services, which further diminishes it as a place where people want to live, which diminishes value, and so on. It’s a death spiral — a fundamentally flawed process that will never work given Michigan’s current municipal finance model. The system is broken.

Now think of that approach in the context of Flint. What have we bought with our cost-reduction approach to balancing budgets? A significantly damaged community in both a social and economic sense. If taxes are a function of value and millage, how have property values been impacted in Flint as a result of this cost-cutting decision? I think it is fair to suggest that the property values in Flint have been severely impacted as a result of the current crisis. Which will mean deep reductions in local tax revenue, which of course will mean reductions in service, which means a diminishment of value. The death spiral continues. Sadly, our only existing mechanism to address this will be through more cuts. We need a new way forward.

Our first priority must be to address the social and health impacts Flint is experiencing. Beyond that, we must address the policy that brought us here. We must invest in our local communities. Cuts beget more cuts. It is a race to the bottom, and in this case a tragic illustration of flawed public policy. Creating vibrant, desirable communities is proven to have positive economic impact as well as social value that we have lost sight of with our current approach. We must recognize that by investing to create great places we can improve both the quality of life and the economy of a city at the same time. A cut-only approach can only diminish the strength of a community and in extreme instances like this have a devastating human impact. We must learn from this disaster and redefine how we invest in Michigan cities.

“If you were going to put something in a population to keep them down for generations to come, it would be lead.”

eBlog
February 1, 2016. Share on Twitter

Flint’s Future. “If you were going to put something in a population to keep them down for generations to come, it would be lead,” Dr. Mona Hanna-Attisha, MD, MPH program director for the pediatric residency at the Hurley Children’s Hospital at the Hurley Medical Center in Flint, Michigan warned, as the complex fiscal and human challenge confronting the city’s future—and the relative responsibilities of the federal and state governments are being debated. Dr. Hanna-Attisha is developing a new database of children under 6 who may have been exposed to lead in Flint’s water, a group she said she believed could number 8,000—in effect the guts of a tale about the failure of Michigan and the federal government to promptly address the crisis after it began nearly two years ago—a fateful delay, because of the threat that the youngest children in this city may have suffered irreversible damage to their developing brains and nervous systems from exposure to lead in their drinking water. According to the U.S. Public Health Service, 26 water samples, out of nearly 4,000 collected, contained lead at levels higher than 150 parts per billion—ten times higher than federally recommended limits.

A report four years ago by the Centers for Disease Control (“Low Level Lead Exposure Harms Children: A Renewed Call for Primary Prevention Report of the Advisory Committee on Childhood Lead Poisoning Prevention”) found that exposure to even low levels of lead can profoundly affect children’s growth, behavior, and intelligence over time: combined state, local, and federal failures might well now have so tainted and imperiled the city’s fiscal and human future, because studies have linked elevated lead levels in blood to learning disabilities, problems with attention and fine motor coordination, and even violent behavior—with younger children and fetuses the most vulnerable. To date, Gov. Rick Snyder and the Michigan legislature have appropriated $28 million in emergency appropriations for the city—funds to provide initial services, such as health assessments and home visits from nurses.

State testing of four water samples from three Flint schools last year found lead levels significantly exceeding federal drinking water safety standards in what should have been a federal-state wake-up call: Flint Community Schools Superintendent Bilal Tawwab notes that no one can accurately report how many of the city’s children have been affected at this point, but he notes: “we can’t write off a generation of kids.” If anything, children in Flint are likely more dependent on the city’s schools for water and public health than most cities: more than 80 percent of Flint’s school children qualify for free or reduced meals.

Re-Balancing Motor City Taxes. Detroit Mayor Mike Duggan is set this afternoon to announce details of the city’s annual proposed property assessment changes: the good news for most owners is that most can anticipate a reduction in assessments for nearly all city residential property owners. In addition, joined by Detroit’s CFO John Hill, chief assessor Gary Evanko and a Detroit City Council representative, Mayor Duggan will also discuss how property owners can challenge her or his proposed assessments. Today’s announcement will mark the second consecutive year Mayor Duggan has proposed reducing property assessments—reductions which, in total, are projected to save Detroit’s property owners some $10-$15 million—and begin to address a gap we had noted in our MacArthur report with regard to the significant discrepancies between assessments and actual property values—over assessments by an average of 65 percent, according to a review of state tax appeals—so high that the administrative court reduced Detroit property values at a far higher rate than neighboring communities and nearly 50 percent more than the surrounding Wayne County average. The Mayor’s proposal is consistent with recommendations from a report last year by the Lincoln Institute of Land Policy which had recommended reductions in the city’s property tax rates–the highest of any major U.S. city and more than double the average rate for neighboring cities (the home-owners rate is 69 mills, or $69 for every $1,000 of assessed value).

San Bernardino Election Day. You might be glued on elections tonight in Iowa, but there is an important election tomorrow in the bankrupt city of San Bernardino, where two seats on the City Council—that is enough seats to change the balance of political power in a municipal government in bankruptcy—at a time when critical political decisions will have to be made if the city is to finalize its plan of debt adjustment and obtain U.S. Bankruptcy Judge Meredith Jury’s green light to exit bankruptcy. The election comes because no candidate received more than the requisite 50 percent threshold in the race for the 6th Ward or 7th Wards last November—effectively leading to tomorrow’s Ground Hog Day runoff, where, to fill a vacancy in the 6th Ward, Bessine Littlefield Richard is running against Roxanne Williams. Ms. Littlefield Richard is a supervisor at San Bernardino County’s Workforce Development Department at the America’s Job Center training facility; Ms. Williams works in the central office of the San Bernardino Unified School District. In the 7th Ward, representing parts of the northern and central portions of the city, incumbent Councilman Jim Mulvihill will be challenged by businessman Scott Beard. Councilman Mulvihill is an urban planning professor at Cal State San Bernardino who was first elected in the 2013 recall election—a recall largely financed by Mr. Beard, the president of Rialto-based Gerald W. Beard Realty Inc.

Ms. Williams, who would be a newcomer to elected office, frames the race as her experience and specificity against what she has described as Ms. Littlefield Richard’s less-formed plans, noting that she has—on her website—a plan for the first 100 days and beyond, a plan which she unsurprisingly notes begins with public safety—especially in the wake of the events last December: she is proposing an increase in police and police patrols—and body cameras. For her part, challenger Littlefield Richard has also stressed public safety in her campaign—a campaign in which she has been endorsed by the unions representing police and firefighters, as well as by her predecessor and the two candidates she and Ms. Williams trounced in the November primary. Ms. Littlefield Richard has repeatedly emphasized her lifelong residence on the Westside and contrasted that with Ms. Williams, who moved to the 6th Ward shortly before the election—after running for the 3rd Ward City Council seat in 2013. Despite running to serve in the city now in municipal bankruptcy longer than any other city, neither runoff candidate appears to have devoted much time or focus on the city’s fiscal future.

Restructuring Puerto Rico’s Debts. The Puerto Rico government moved at the end of last week to try to restructure some $70 billion of public bonds: the U.S. territory offered a voluntary debt exchange to bondholders last Friday in a meeting in New York City, following up on what Government Development Bank President Melba Acosta Febo had said in December when he committed that Puerto Rico would propose a restructuring of its debt to its creditors before the end of January—leading to Puerto Rico Gov. Alejandro García Padilla’s confirmation last Thursday night that his government would propose a debt exchange on Friday to its creditors in a closed door meeting. The Wall Street Journal reported that Puerto Rico was seeking to exchange its debt for two new types of securities: one in which all interest and principal payments would be suspended for five years, at the end of which interest would rev up to 5% in 2021; in the other, payments would commence in 2021, but would be dependent on government revenues doing better than current projections. In the second security type, the island’s bondholders would receive up to 25% annually of revenues that exceed current projections. All municipal bondholders would receive both forms of bonds, with the value of the second type equal to the amount of impairment on the first type, and, according to local press reports, haircuts for Puerto Rico’s municipal bondholders would depend on what type of bond they held: those with general obligation bonds would experience smaller haircuts than those holding other sorts of municipal bonds: their bonds would be less impaired. The payments would come from a wide variety of revenue sources pooled together to enable payments of about $3 billion a year in interest and principal starting in 2018, according to El Vocero. The proposal, however, has yet to weather Puerto Rico’s legislature, according to the island’s House of Representatives President or the Chair of the Treasury and Finance Committee Rafael “Tatito” Hernández Montañez: Chair Montañez wryly noted: “The devil is in the details,” adding he was unfamiliar with the proposal Puerto Rico made to creditors in New York City.

The Steep Road of Recovery

eBlog
December 2, 2015. Share on Twitter

The Steep Road to Recovery. The route out of municipal bankruptcy is long and steep, and requires everyone to pitch in—so it is that the city is filing 185 suits against some of its vendors in an effort to recover as much as $50 million paid to various firms in the months preceding its filing for chapter 9 municipal bankruptcy. According to Chuck Raimi, deputy corporation counsel, Detroit plans to file the suits for what he termed “preferential payments” which were made on account of past-due debts within 90 days prior to the city’s July 18, 2013, bankruptcy filing. The issue? Mr. Raimi argues fairness: the city paid those vendors more than other similarly situated creditors, so that, as he noted in his statement: “The city’s position is that the payments are recoverable as ‘preferences’ under the Bankruptcy Code…The firms in total received about $50 million in the 90 days before the bankruptcy filing.” The Motor City, whose plan of debt adjustment and thereby exit from municipal bankruptcy U.S. Bankruptcy Judge (now retired) Steven Rhodes approved a year ago, says it will attempt to settle the cases prior to a trial. In the nonce, Detroit has asked the federal bankruptcy court to temporarily suspend the vendors’ obligation to formally answer the complaints—the key is the stipulation in chapter 9 municipal bankruptcy of time limitations—so that Detroit was required to file any actions prior to this Saturday.

In a sense, the issue is about equity: trying to ensure that each and every creditor is dealt with fairly and to prevent certain of a municipality’s creditors from receiving a greater share of such municipality’s resources than others that are similarly situated—or that there is as much equity as possible in distribution of a municipality’s proceeds among similarly situated creditors, so that, typically, a portion of a city’s recovered resources would go toward funding payment of the unsecured creditors under the plan.

Striving to Climb Out of Debt. In testimony before the Senate Judiciary Committee, Puerto Rico Gov. Alejandro García Padilla yesterday testified the U.S. territory would give some of its debts priority over others, because, without recourse to municipal bankruptcy, Puerto Rico has reached a debt precipice where it has no choice remaining but to give some of its debts priority over others. Thus, the government has commenced clawing back revenue from certain non-general obligation full faith and credit bonds as a means of avoiding default on $355 million of Government Development Bank notes—or, as the governor testified: “Starting today, the commonwealth will have to claw back revenues pledged to certain bond issues in order to maintain essential public services…In light of the rapidly deteriorating revenue situation, in accordance with Article 6, Section 8 of the constitution of the Commonwealth of Puerto Rico, I ordered the ‘claw back’ of revenues assigned to certain instrumentalities of the commonwealth for the repayment of their debts. Together these instrumentalities have approximately $7 billion in bonds outstanding. In simple terms, we have begun to default on our debt in an effort to attempt to repay bonds issued with the full faith and credit of the commonwealth and secure sufficient resources to protect the life, health, safety and welfare of the people of Puerto Rico.”

Indeed, shortly after Gov. Padilla testified, the Government Development Bank for Puerto Rico reported it had paid all $355 million in debt service due on its notes. Thus, the testimony came at a pivotal moment as Puerto Rico is seeking to restructure about $70 billion of public sector bond debt—debt which the Governor testified is unpayable unless the economy improves. It also means that in the face of looming default, revenues have been diverted from the Puerto Rico Highways and Transportation Authority, the Infrastructure and Finance Authority, the Metropolitan Bus Authority, the Integrated Transportation Authority, and the Convention District Authority. Gov. Padilla, according to a statement from his office, had tried to negotiate with the insurers of some of Puerto Rico’s debt maturing yesterday, but no agreement was reached—or, as his Chief of Staff explained: “The administration’s priority has always been and will always be the welfare of Puerto Ricans, so while we tried to negotiate with the insurers of our bonds to refinance the payment that was due today, the terms and conditions that they wanted to impose on us were unacceptable to the government.”

In his testimony, Gov. Padilla noted that the “magnitude of the fiscal and economic problems bearing down on Puerto Rico are simply too large,” and that, with default imminent, the government had no choice but to choose between paying back creditors versus providing essential public services: “Commencing today, the Commonwealth will have to claw back other income sources in order to maintain essential public services. We have taken this step in the trust that Congress will act…But do not be misled. We have no resources left. Puerto Rico cannot keep this up longer.” Neither the Chair, nor other members of the Senate Committee asked any questions—nor provided any indication in Congress’ waning days of this session whether the Gov. could expect any response or action, notwithstanding the looming $945 million of total Puerto Rican municipal bond payments coming due on Jan. 1st.

The Senate Committee heard testimony from a second panel of five experts with remarkably different perspectives Puerto Rico’s fiscal sustainability, ranging from Professor Carlos Colón de Armas, of the University of Puerto Rico, who testified that Puerto Rico has the money to honor its debt commitment as originally contracted to Stephen Spencer, who represents funds such as OppenheimerFunds and Franklin Advisors in negotiations over the Puerto Rico Electric Power Authority debt, who strongly opposed providing Puerto Rico with recourse to municipal bankruptcy, claiming it would be harmful to the many retail investors both in Puerto Rico and the mainland U.S. that have holdings in Puerto Rico debt—adding that Detroit could be considered as proof that municipal bankruptcy can harm a city’s future access to the capital markets—adding: Detroit “wasn’t a bankruptcy, it was a stickup.”

Alternatives to Chapter 9. Given the apparent unwillingness to consider amending federal bankruptcy law to give Puerto Rico access to bankruptcy, other witnesses suggested alternatives: Alex Pollack, a resident fellow with the American Enterprise Institute, testified the best option would be an emergency federal control board, such as were successfully used for Washington, D.C. and New York City—indeed, Mr. Pollack was speaking on a panel with a former such control board overseer, former New York Lieutenant Governor and a member of the current Michigan oversight panel for Detroit, Richard Ravitch. Mr. Ravitch told the committee the best solution would be a municipal bankruptcy rubric which would modify the current federal 9 municipal bankruptcy law so that it could apply to the Commonwealth. Finally, Richard Carrión, executive chairman of Banco Popular in San Juan, recommended a three-part solution plan which would provide for bankruptcy, a control board, and some type of stimulus for the economy.

Gov. García Padilla and Rep. Pedro Pierluisi (Puerto Rico) urged the Committee to act on legislation which would offer the commonwealth a structured process through which it could resolve its debts, such as municipal bankruptcy, for Puerto Rico’s public authorities, noting that were Congress to act swiftly to pass a package of legislation to permit the U.S. territory to restructure its debt and provide improved healthcare and tax credit practices, he would agree to greater federal oversight – a concept which heretofore has been met with contempt from Puerto Rico officials.

The committee did not invite the administration to testify. The Obama administration has proposed a plan under which indebted governmental agencies, such as the island’s public power company, would be eligible to file for bankruptcy—just as any U.S. corporation may, and would provide for a restructuring of other debts and pension obligations. Under the proposed plan, the federal government would also oversee the territory’s future public spending, and residents of the territory, all U.S. citizens, would gain full access to various anti-poverty programs—programs currently which are less generous there than on the mainland.

The Alternative? With time running out both for Puerto Rico and for this session of Congress, continued inaction by Congress could well accelerate the withering of Puerto Rico’s economy and the exodus of those of its U.S. citizens who can find a way to move to the mainland. It seems, in some ways, almost reminiscent of East Berlin: economic opportunity is shrinking, in part because of federal policy, thus, more than 200 Puerto Ricans are moving to the mainland every day—adding to an economic whirlpool, because it appears to be that those most able to leave and most able to find a job on the mainland are departing—leaving those least able to relocate behind: today there are more Puerto Ricans on the mainland than in Puerto Rico. The exodus also creates a separate fiscal sustainability issue: public pension liabilities: the island’s pension program has sufficient funds to cover just 0.7 percent of its future obligations. The departure of those most able to find employment elsewhere risks widening that fiscal chasm.

Turning a Deaf Ear. If Congress refuses to act, it seems likely Puerto Rico’s leaders will have little option but to raise taxes—even as those most able to pay are seeking to leave—and the territory’s crippling 40 percent poverty level increase—so that there would be greater pressure for essential services, but a growing erosion of revenues. One can imagine a whirlpool now brought on by a shrinking tax base triggering ever higher taxes and reduced essential services, prompting still further emigration—likely triggering a humanitarian crisis. As American citizens, Puerto Ricans, whether on the island or newly moving to the mainland, will be eligible for public support, so that there can be little question but that the federal government will end up bearing much of the cost of Puerto Rico’s past profligacy. The question thus becomes when and how might be the most critical and effective way to provide such assistance.

Scouts’ Honor. Two former JPMorgan bankers have agreed not to violate securities laws and to repay money they made while working on transactions that ultimately thrust Jefferson County, Ala., into bankruptcy, according to documents filed by the Securities and Exchange Commission: The SEC entered consent agreements that Douglas MacFaddin and Charles LeCroy approved into court records in Birmingham, along with a motion requesting that federal Judge Abdul K. Kallon approve the judgments that will end the five-year-old case. Both men agreed, without admitting or denying charges, to injunctions against future violations of all five counts sought in the SEC lawsuit, which centers around sewer warrant transactions and swaps. Mr. MacFaddin agreed to pay a disgorgement of $201,224, including interest; Mr. LeCroy agreed to pay a disgorgement of $125,149, including interest, with both men having agreed to made payments within a year. The decision comes in the wake of the SEC’s November 2009 civil suit alleging that Messieurs LeCroy and MacFaddin improperly arranged payments to local broker-dealers in Alabama to assure that certain Jefferson County commissioners would award $5 billion in county sewer bond and swap deals to JPMorgan. The SEC suit charged that the two men “privately agreed with certain county commissioners to pay more than $8.2 million in 2002 and 2003 to close friends of the commissioners who either owned or worked at local broker-dealers.” The lawsuit sought declaratory and permanent injunctions against the two for federal securities law violations, as well as disgorgement of all profits they received as a result of the violations, plus interest.

Emerging from or Entering Municipal Bankruptcy

December 1, 2015. Share on Twitter

Rebuilding Detroit. The Detroit Financial Review Commission, the nine-member commission created in the wake of the largest municipal bankruptcy in U.S. history, yesterday concluded that the Motor City, in its first post-bankruptcy year, has been in compliance with its plan of adjustment as approved by now retired U.S. Bankruptcy Judge Steven Rhodes. The good news came in the wake of the Commission’s review and in the wake of receipt of updated financial plans. In its first year, the Commission has reviewed and approved 237 city contracts and one collective bargaining agreement between the city’s transportation department and a transit union; but also a period during which Detroit has amended its budget and issued new debt with the review and consent of the Commission.

The Commission is made up of appointees by Governor Rick Snyder, Mayor Mike Duggan, and the City Council; it has authority to review and approve the city’s budget, major contracts, and labor agreements for a number of years to try to keep the city on a sound fiscal course. In its biannual report to Gov. Snyder, the commission found that the City of Detroit has been in compliance with the plan in its first year by providing commission members with updated financial plans—a period during which the Commission has reviewed and approved 237 city contracts and one collective bargaining agreement between the city’s transportation department and a transit union; but also a period during which Detroit has amended its budget and issued new debt with the review and consent of the Commission. Detroit Mayor Mike Duggan, yesterday, in an interview with the Detroit Free Press, described the relationship between his administration and the Financial Review Commission as a positive one, noting: “As long as we balance our budgets and pay our bills, we’re going to get along with the Financial Review Commission just fine,” adding that Detroit remains on track to post balanced budgets for FY16 as well as the current fiscal year. By early 2018, Mayor Duggan responded he anticipates that “We will be out of the control period,” effectively restoring full fiscal authority to the city from the oversight committee—absent some significant fiscal misstep.

According to the report, Detroit expects it will record a larger-than-expected surplus for the year ending June 30, 2015: based on first-quarter fiscal year 2016, which ended in September of this year, the city projected a $35-million budget surplus for the current year. Nevertheless, Detroit officials and their pension funds are still wrestling with looming public pension liabilities—liabilities that have recently grown, as the recovering city faces an upside down pyramid of retirees from a time when the city’s population and workforce was far larger than today—and retirees who are projected to live far longer than originally projected, based on new actuarial calculations based on updated mortality tables use to determine how long retirees are expected to live. Commission Executive Director Ronal Rose, in his biannual letter to Gov. Snyder, wrote that Detroit has formulated a strategy to address the pension balloon payments starting in 2024 by hiring a consultant to examine the numbers by the end of the year. Nevertheless, these financial forecasts could change, according to commission staff, or, as Mr. Rose put it: “It is important to understand that many changes in the projections will occur over the next few years and these changes may be positive or negative.” The key apprehension is long-term: Detroit faces a pension balloon payment in 2024 of $195 million for its two pension funds—or nearly 71 percent higher than the $114 million incorporated in its plan of adjustment. In his report, Mr. Rose did note that “in years after 2024, the annual amount payable decreases by about $2 million per year.”

Over the next six months, commission officials said they are looking for the city to make progress on a number of fronts, including:
• Major changes and consolidations in city departments to improve the effectiveness and efficiency of finance, human resources, information technology, planning, and housing;
• A new ability for Detroit tax filers to submit returns electronically after Michigan’s Treasury begins to process individual income tax returns for the city, commencing in January;
• The formal separation of the city’s water and sewerage department into two systems — one to manage the city and another to manage its suburbs — also expected in January; and,
• A new city planning system expected to launch by April to run municipal financial management and human resources.

Tempus Fugit. With time running out on debts due (please note Bloomberg’s chart below), Puerto Rico Gov. Alejandro García Padilla, joined by Pedro Pierluisi, Puerto Rico’s representative in Congress, will testify today before the Senate Judiciary Committee with regard to their most current fiscal sustainability issues and positions—including whether Puerto Rico might default—its first ever default—on a debt service payment. Today’s hearing is the same day on which Moody’s Investors Service is projecting Puerto Rico’s Government Development Bank (GDB) to default on debt service payments for $355 million of notes—of which two-thirds, or $273.3 million, is backed by Puerto’s Rico’s full faith and credit or general obligation guarantee.

Moody’s projects that Puerto Rico is more likely to default on the non-GO portion of the debt, adding, however, that given the U.S. territory’s severe liquidity challenges, Puerto Rico could default on the entire payment. Gov. Padilla, at a press conference yesterday, said he would decide either late yesterday or this morning whether the Commonwealth will make the GDB bond payment, noting: “There are creditors of the Government Development Bank that continue to negotiate with the bank today,” so that the timing of his decision would depend on the status of those negotiations.

This morning’s hearings, according to Chairman Charles Grassley (R-Iowa), are “to help committee members and the public identify and gain a better understanding of the root cause of Puerto Rico’s fiscal problems.” Mr. Pierluisi and Gov. Padilla have repeatedly urged Congress to amend the Chapter 9 municipal bankruptcy law to provide the same rights as other municipalities, as provided in pending bills offered by Mr. Pierluisi and Sens. Richard Blumenthal (D-Conn.), and Chuck Schumer (D-N.Y.)—bills which the Chairs of the respective House and Senate Judiciary Committees have made clear they have no intention of marking up. In addition to the two Puerto Rican elected leaders, former New York Lt. Governor Richard Ravitch, who is also not only a member of the a public finance veteran, but also the Detroit Financial Review Commission, and a former member of a Washington, D.C. fiscal oversight board, will also testify—on a panel with Carlos Colón de Armas, a professor of finance at the University of Puerto Rico; Alex Pollack, a resident fellow at the DC-based American Enterprise Institute; Stephen Spencer, managing director at Houlihan Lokey in Minneapolis; and Richard Carrión, executive chairman of Banco Popular in San Juan.

The chances of Senate constructive input is dim. Senate Finance Committee Chairman Orrin Hatch (R-Utah), yesterday said the Senate should be cautious about any municipal bankruptcy proposal and that Congress needs precise estimates of how much aid is needed before it can decide whether to help: “Right now, too many people are willing to throw out demands and vague proposals – with a price tag as high as thirty to forty billion dollars – accompanied by a lot of political rhetoric.” It is not clear to what the Senator is referring, of course, because, unlike the bankruptcies of General Motors and other financial institutions in the wake of the Great Recession, the federal government has made no payments to Detroit or any other municipality which has gone through chapter 9 municipal bankruptcy.

For his part, Chairman Grassley, whose panel oversees bankruptcy law, has expressed doubt about whether such a step alone would solve Puerto Rico’s financial strains, noting: “Restructuring debt and throwing taxpayer money at the island, without ensuring the creation and implementation of structural and fiscal reform, fails to resolve the underlying problems in Puerto Rico.” Again, Chairman Grassley seems to have a signal misperception of municipal bankruptcy. Nevertheless, Senate Republicans, including Chairman Hatch, have said they are working on a legislative proposal to address the concepts of a control board and bankruptcy, albeit, with Congress scheduled to adjourn in less than two weeks, the chances of affirmative action appear unlikely.