The Key Lessons Learned after a Decade of Municipal Bankruptcies

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eBlog, 04/07/17

Good Morning! In this a.m.’s eBlog, we consider Detroit’s first steps to address the blight which crisscrossed the city leading to its municipal bankruptcy. Then we look to New Hampshire to assess whether the state legislature will preempt municipalities’ authority to set election dates. Then we slip south to assess fiscal developments in the efforts to recover from insolvency in Puerto Rico. Finally, we assess and consider some of the broader issues related to municipal bankruptcy.

Post Chapter 9 Recovery. One of Detroit’s first tests with regard to whether it can find new use for the vast stretches of land it cleared of blight went into effect this week when development teams announced by  Mayor Mike Duggan, along with partners: The Platform, a Detroit-based firm, and Century Partners announced they would be investing an estimated $100 million to rehab the architectural jewels in the city’s downtown—the Fisher and Albert Kahn buildings, with the two organizations declaring they will take the lead in overhauling 373 parcels of vacant land and houses in the Fitzgerald neighborhood on the northwest side, where they will coordinate with other firms on a $4 million development plan to rehab 115 vacant homes over two years, create a two-acre park, and landscape 192 vacant lots—with the work occurring in neighborhoods wherein the Detroit Land Bank took control of most of the properties and razed some abandoned homes. Mayor Duggan and other officials described the plan as a kind of reverse gentrification—or, as Mayor Duggan framed it: “We are going to keep the families here while improving the neighborhoods,” making his announcement on an empty lot which is scheduled to become a city park and include a greenway path to nearby Marygrove College: the city leaders hope to transform the neighborhood into a “Blight-Free Quarter Square Mile,” and, if the model works, seek to propagate it other neighborhoods.

Granite State Preemption or Cure? House Speaker Shawn Jasper wants to give New Hampshire towns that postponed their municipal elections due to a snowstorm a way out of facing potential lawsuits from voters who may have been disenfranchised. Speaker Jasper had proposed letting towns ratify the results of their elections by holding another vote, offering a bill to give towns which moved Election Day the option of letting townspeople vote to ratify, or confirm, the results on May 23rd. However, in the wake of about five hours of testimony, the House Election Law Committee voted 10-10 on the Jasper plan, so that a tie vote killed the Speaker’s amendment, leaving 73 towns on their own to address potential legal problems resulting from their decisions to hold their elections on days other than March 14th. The fiscal blizzard in the Granite State now depends upon whether state legislators determine whether or not a special election is needed with regard to those results. New Hampshire Deputy Secretary of State David Scanlan noted: “The concept is not entirely new…what is different is that it is applying to an entire class of towns that decided to postpone.”

In the past, the Legislature has voted to “cure” individual election defects. Speaker of the House Shawn Jasper, (R-Hudson, N.H.) noted: “Well, the fact that a bunch of towns moved the day of their town election was unprecedented…And so as a result of doing that, those towns that moved had to start bending other laws to make other issues related to the election work…The Legislature is just granting the authority to allow the towns to correct any defects that may exist,” he added, listing changed time listings, lack of proper notice, and absentee ballot date issues as possible defects in the process. All of those questions, of course, have fiscal consequences—or, as Atkinson Town Administrator Alan Phair put it; “Well, I don’t know the exact cost, what it would be, but I do know that in our case we certainly don’t have the money budgeted to (hold a special election), because we obviously just budgeted for one election…We would certainly go considerably over and have to find the money elsewhere to do it.” Under the proposed amendment, towns and school districts which postponed would hold a hearing, at which the respective governing body would vote on whether to hold a special election with one question: whether or not to ratify results, where a “no” vote would kick out anyone elected in a postponed vote, while nullifying warrant articles, with elected roles to be appointed until the next election. Salem Town Manager (Salem is a town of just under 30,000 in Rockingham County) Leon Goodwin said his elected leaders were of the opinion that its postponement was legal, so that the municipality is moving forward on projects voted on last month, noting: We’re moving on as if the votes were accepted even though there is a cloud hanging over us from Concord,” adding that town counsel advised the town moderator that it was legal to move elections. Yet, even as he remained confident the election issue will be resolved, he cautioned that the town has not budgeted for an additional election; Windham (approximately 14,000) Town Manager David Sullivan said the municipality’s town Counsel would sign off on the town’s fire truck bond, notwithstanding bond counsel elsewhere in the state advising that ratification of the elections would be necessary.

Municipal authority to act has been hampered by different state House and Senate approaches: while the two bodies have been moving on parallel tracks in the wake of state officials’ questioning the authority of town moderators to reschedule the March 14 voting sessions of their town meetings, the Senate this week passed SB 248, a bill introduced to ratify actions taken at the rescheduled meetings; however, the bill passed with a committee amendment which deletes all of the original language and provides instead for the creation of a committee to “study the rescheduling of elections.” Senators acknowledged that the bill was not likely to pass through the House in that form—asserting the intent was simply to get a bill to the House for further work. Subsequently, a floor amendment was introduced to restore the bill’s original language, ratifying all actions taken at the rescheduled meetings; however, that amendment failed on a party-line vote, with all nine Democrats voting in favor and all fourteen Republicans voting against, leaving most unclear how this could have become a partisan issue. The question comes down to what level of control local officials should have over local elections. The Speaker described the outcome thusly: “I think it was a case of 10 people (on the committee) thinking that what happened was legal;” however, he maintained that the postponed votes were not legal, adding: “The sad thing is that for school districts with bond issues that passed in those meetings, I don’t see a path forward for them,” adding: “I think if you’re afraid of snowstorms, you ought to move your meetings, probably to May,” noting that state officials are forbidden by law from moving state primary and general elections, as well as the first-in-the-nation presidential primary. Unsurprisingly, town moderators and attorneys who work with them on municipal bond issues disagreed with the Speaker’s interpretation that the postponed elections were illegal and his belief that the only way to rectify the issue was for them to act to individually ratify them, with many arguing they acted legally under a state law which allows them to postpone and reschedule the “deliberative session or voting day” of a town meeting to another day; however, the Speaker maintains that law applies only to town meetings, while town elections are governed under a different statute, which provides: “All towns shall hold an election annually for the election of town officers on the second Tuesday in March.” He also noted that the state’s official political calendar, which has the force of law, states that town elections must be held on March 14, adding: “Without trying to place blame, laws are sometimes very confusing if you look only at parts of them,” noting: “I don’t believe for one second that moving the election was legal.”

The Speaker added that still another state law provides that at special town meetings, no money may be raised or appropriated unless the number of ballots cast at the meeting is at least half the number of those on the checklist who were eligible to vote in the most recent town meeting, albeit adding that such meetings do not apply to the current situation, because they are not elections. The state’s Secretary of State said that after three weeks of research, he was able to report on voter turnout at town elections for the past 11 years, advising that 210 towns held elections in March, and 137 of them “followed the law” by holding their elections on March 14th, while 73 towns had postponed their elections by several days. Now Speaker Jasper asks: “Why would we give over 300 individual moderators the ability to do that when our Secretary of State doesn’t have the ability to do that for a snowstorm in our general election or our presidential primary?” The Speaker notes: “I think we need to provide a way to ensure that we don’t clog up the courts, and we don’t have people spend a lot of their own money to fight this, and the towns don’t have to spend a lot of money fighting it.”

Un-positive Credit Rating for Puerto Rico. Moody’s Investors Service has lowered the credit ratings on debt of the Government Development Bank and five other Puerto Rico issuers, with a total of approximately $13 billion outstanding, and revised down the Commonwealth’s fiscal outlook, and the outlooks for seven affiliated obligors linked to the central government to negative from developing, with the downgrades reflecting what the agency described as “persistent pressures on Puerto Rico’s economic base that indicate a diminishing perceived capacity to repay,” noting that while it continues to “believe that essentially all of Puerto Rico’s debt will be subject to default and loss in a broad restructuring, the securities being downgraded face more severe losses than we had previously expected, in the light of Puerto Rico’s projected economic pressures. For this reason, we downgraded to C from Ca not only the senior notes issued by the now defunct Government Development Bank, but also bonds issued by the Puerto Rico Infrastructure Financing Authority and backed by federal rum tax transfer payments, the Convention Center District Authority’s hotel occupancy tax-backed bonds, the Employees Retirement System’s bonds backed by government pension contributions, and the 1998 Resolution bonds of the Puerto Rico Highways and Transportation Authority.”

Puerto Rico Governor Rossello late Wednesday said that the U.S. territory’s fiscal plan, approved by the PROMESA Board, does not contemplate any double taxation, adding that, between the increase in the property tax and the reduction of expenses in the municipalities, he favored the latter as a measure to compensate for the absence of the state subsidy of $350 million. He reiterated that, as a substitute for these funds, the properties which are not currently paying taxes to the Centro de Recaution de Ingresos Municipales (CRIM: the Municipal Revenue Collection Center) should be identified, because they are not included in their registry. The Governor also stressed that the economic outcome of these two fiscal initiatives is still being evaluated, albeit he estimated that they could generate about $100 million, noting: “Whatever the differential after that for the municipalities, there are two mechanisms that can be worked: One, a mechanism to seek an additional source of income, or, two, to avail cuts…The central government has taken the cutting position. We are already establishing a protocol to cut in the agencies, to consolidate, to eliminate the expenses that are not necessary, to go from 131 to between 35 to 40 agencies. That has been our action. The municipalities—now we will have a conversation with our technical team—will have several options: ‘either cut as did the central government or seek mechanisms to raise more funds or impose taxes.’” Currently, mayors evaluate to increase the arbitrage of the real property to 11.83% or to 12.83% in all the municipalities; the concept is for members of the Executive to offer assistance to do the modeling. Thus, the president of the board of CRIM, Cidra Mayor Javier Carrasquillo, said CRIM will be “sensitive to the reality of the pockets of Puerto Ricans: We have to be cautious and responsible in the recommendation that we are going to make…There is nothing definitive yet. There are recommendations.” The Governor noted that the PROMESA Board approved fiscal plan approved last month does not contemplate an increase in property taxation, asserting it was “false to imply that our fiscal plan entails an increase in the rate or a double rate on properties,” albeit recalling that the disappearance of $350 million in transfers to municipalities begins on July 1, when the fiscal year begins, promising it will be done progressively, so that in the next budget (2017-2018) $175 million disappear, and the remaining $175 million, the next fiscal year, describing it as a “two-year fade out.” Unsurprisingly, he did not specify when or how the plan would fiscally benefit this island’s municipalities, stating: “We have already been able to have pilot efforts to identify different municipalities where 60% of their properties are not being assessed…We are going to commit ourselves so that all these properties are in the system.”

The End of a Chapter 9 Era? Municipal bankruptcy is a rarity: even notwithstanding the Great Recession which produced a significant number of corporate bankruptcies—and federal bailouts to large for-profit corporations and quasi-federal corporations, such as Fannie Mae; the federal government offered no bailouts to cities or counties. Yet from one of the nation’s smallest cities, Central Falls, to major, iconic cities such as Detroit and Jefferson County, the nation experienced a just-ended spate, before—with San Bernardino’s exit last month, the likely closure of an era—even as we await some resolution of the request by East Cleveland to file for chapter 9 municipal bankruptcy. The lessons learned, compiled by the nation’s leading light of municipal bankruptcy, therefore bear consideration. Jim Spiotto, with whom I had the honor and good fortune over nearly a decade of effort leading to former President Reagan’s signing into law of the municipal bankruptcy amendments of 1988, offers us a critical guide of ten lessons learned:

  1. Do not defer funding of essential services and infrastructure: Detroit is a wake- up call for others that there is never a good reason to defer funding of essential services and infrastructure at an acceptable level. If you do, Detroit’s fate will be yours.
  2. Labor and pension contracts under state constitutional and statutory provisions should not be interpreted as a mutual suicide pact: It appears one of the reasons why resolution of pension and labor costs was not achieved in Detroit prior to filing Chapter 9 was the belief of the workers and retirees that, under the Michigan constitution, those contractual rights could not be impaired or diminished to any degree. This position failed to take into consideration that the municipality can only pay that which it has revenues to pay and, in an eroding declining financial situation, there will never be sufficient funds to pay all obligations, especially those that may be unaffordable and unsustainable.
  3. Don’t question that which should be beyond questioning and is needed for the long-term financial survival of the municipality: A dedicated source of payment, statutory lien or special revenues established under state law must be honored and should not be contested. Capital markets work effectively when credibility and predictability of outcome are clear and unquestioned. Current effort to pass new legislation (California SB222 and Michigan HB5650) to grant statutory first lien on dedicated revenues. Further, as noted in the Senate Report for the 1988 Amendments to the Bankruptcy Code and Chapter 9 “Section 904 [of Chapter 9 limiting the jurisdiction and power of the Bankruptcy Court] and the tenth amendment prohibits the interpretation that pledges of revenues granted pursuant to state statutory or constitutional provisions to bondholders can be terminated by filing a Chapter 9 proceeding”. This follows the precedent from the 1975 financial distress of New York City and the State of New York’s highest court ruling the state imposed moratorium was unconstitutional given the constitutional mandate to pay available revenues to the general obligation bondholders. See Flushing Nat. Bank et. al. v. Mun. Assistance Corp. of New York, 40 N.Y.S.2nd 731, 737-738 (N.Y. 1976). Just as statutory liens and special revenues, there is a strong argument that state statutory and constitutional mandated payments (mandated set asides, priorities, appropriations and dedicated tax revenue payments) should not and cannot be impaired, limited, modified or delayed by a Chapter 9 proceeding given the rulings of the Supreme Court in the Ashton and Bekins cases and the prohibitions of Sections 903 and 904 of Chapter 9 of the Bankruptcy Code.
  4. Debt adjustment is a process, but a recovery plan is a solution: As noted above, while Detroit has proceeded with debt adjustment which provides some additional runway so it can take takeoff in a recovery, such plan is not the cure for the systemic problem. Rather, the plan provides additional breathing room so that the municipality, through its Mayor and its elected officials, may proceed with a recovery plan, reinvest in Detroit, stimulate the economy, create new jobs, clear and develop blighted areas and raise the level of services and infrastructure to that which is acceptable and attract new business and new citizens.
  5. Successful plans of debt adjustment have one common feature: virtually all significant issues have been settled and resolved with major creditors: While the Detroit Plan started with sound and fury between the emergency manager and creditors and what they would receive, in the end, similar to what occurred in Vallejo, Jefferson County and even in Stockton (with one exception), major creditors ultimately reached agreement and supported the Plan of Debt Adjustment that allowed the municipality to move forward, confirm the Plan and begin its journey to recovery.
  6. One size does not fit all: There are many ways to draft a plan of debt adjustment and sometimes the more creative, the better. As noted above, traditionally major cities of size with significant debt did not file Chapter 9. They refinanced their debt with the backing of the state which reduced their future borrowing costs and allowed them to recover by having the liquidity and the reduced costs necessary to deal with their financial difficulties. Detroit chose a different path.
  7. A recovery plan must provide for essential services and infrastructure: “Best interest of creditors” and “feasibility” can only mean an appropriate reinvestment in the municipality through a recovery plan where there is funding of essential services and infrastructure at an acceptable level to stimulate the municipality’s economy to attract new employers and taxpayers thereby increasing tax revenues and addressing the systemic problem. While no plan of debt adjustment is perfect or assured, there should be, as the Bankruptcy Court in Detroit throughout the case pointed out, a plan to show the survivability and future success of the City.
  8. Confirmation of a plan of debt adjustment is only the beginning of the journey to financial recovery, not the end: It is important to recognize, as noted above, that Chapter 9 is a process, not a solution. The recovery plan, which will take dedication and effort by the elected officials of the City along with residents, public workers and other creditors is the only way to achieve success. It is measured not by months, but by years, and by the constant vigilance to ensure that the systemic problem is addressed effectively in a permanent fix.

Fiscal & Public Service Insolvency

eBlog, 03/03/17

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

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

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

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

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

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

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

Mr. Pfeiffer then writes:

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

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

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

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

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

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

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

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

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

What Could Be the State Role in Averting Municipal Fiscal Distress & Bamkruptcy?

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eBlog, 1/27/17

Good Morning! In this a.m.’s eBlog, we consider the ongoing challenge in Petersburg, Virginia—and the role of the Commonwealth of Virginia. Because, in our federal system, each state has a different blueprint with regard to whether a municipality is even allowed to file for chapter 9 municipal bankruptcy (only 18), and because there is not necessarily rhyme nor reason with regard to fiscal oversight and response mechanisms—as we have observed so wrenchingly in the forlorn case of East Cleveland—the role of states appears to be constantly evolving. So it is this a.m. that we look to Virginia, where the now insolvent municipality of Petersburg had routinely filed financial information with the Virginia auditor of public accounts—but somehow the accumulating fiscal descent into insolvency never triggered alarm bells.   

Virginia Auditor Martha Mavredes this week, testifying before the House Appropriations Committee, told Chairman S. Chris Jones (R-Suffolk) it was “just hard for us to really get our minds around how that was missed,” telling the committee the state currently has no requirement for municipalities to furnish the kind of comprehensive information that would trigger awareness of insolvency; there appears to be no mechanism for the Commonwealth to step in and help. Indeed, that was the very purpose of Chairman Jones to call for the hearing: he wants to better understand options Virginia might consider to not just create some kind of trip wire, but, mayhap more importantly, to act on provisions which could avert future such municipal insolvencies. Auditor Mavredes indicated to the Committee she is scrambling to scrabble together some kind of tripwire or early warning system that would flag financial problems in Virginia’s municipalities at an earlier stage, telling the committee she is using a system devised by the state of Louisiana to help Virginia identify cities and counties in dire fiscal straits. Thus she plans to create a database of all localities in the commonwealth to rate or score their relative fiscal health. Under what she is proposing, her office will approach cities that show warning signs in order to assess more information. Her real issue, she told the committee, is what fiscal assistance tools might be available—or as she put it: the “piece I can’t solve right now is what kind of assistance might be there” once such problems come to light.” Virginia, like a majority of states, has no provision for the state to step in if a locality goes into default. Indeed, it was the thoughtful step of Virginia’s Finance Secretary Ric Brown, who took the unusual step last year to investigate Petersburg’s finances, which led him to discover the city had some $18 million in unpaid bills, an unbalanced budget, and a fiscal practice of papering over deficits with short-term borrowing—a practice that not only jeopardized the city’s bond rating, but also affected the cost of borrowing for the regional public utility. Secretary Brown stressed the need for training local elected officials about budgeting and best practices, and he suggested a program to allow outside management firms to help get cities on a better fiscal foundation. Interestingly, the Committee might want to avail itself of the pioneering work underway by the irrepressibly insightful Don Boyd of the Rockefeller Institute of Government to assess state responses to municipal fiscal distress, seeking to answer the kinds of thoughtful queries Secretary Brown is asking. In a chart for Rockefeller, we tried our own answer:

Understanding Municipal Fiscal Stress

Assessing State Responses to Growing Municipal Fiscal Distress and Insolvency:

  • The Ostriches (head in the sand): Do Nothings/modified harm: e.g. Illinois
  • Denigrators (Alabama is a prime example: when Jefferson County requested authority to raise its own taxes, the Legislature refused, forcing the county into chapter 9 bankruptcy);
  • Learners (Rhode Island is a very good candidate here—in the wake of Central Falls, the state evolved into a much more constructive partnership;
  • Thinkers (I put Colo. & Minn. here—especially because both seem to recognize potential benefits of tax sharing & innovation in intergovernmental fiscal policy);
  • Preemptors (Michigan, because it provides for the usurpation of any local authority through the appointment of an Emergency Manager); New Jersey seems to be fitting in with that category re: Atlantic City;
  • Substitutors: Pa.: Act 47
  • Maybe Do-Nothings: Ohio, even though it authorizes municipal bankruptcy, appears to have been totally non-responsive the petition by East Cleveland to file—and has appeared to play no role in the so-far dysfunctional discussions between Cleveland and East Cleveland).

Fiscal & Physical Health & Safety: What Are the Options?

eBlog, 1/18/17

Good Morning! In this a.m.’s eBlog, we consider the deteriorating fiscal situation in East Cleveland, as epitomized by a seeming breakdown in essential municipal services—combined with an absence of any effective state response to its fiscal insolvency. Then we turn to a seemingly forgotten aspect of the change of administrations in Washington, D.C.: what might that mean to Puerto Rico, where a new study delineates the physical and fiscal impacts on mental health from the disparate treatment the U.S. territory receives—and raises the issue—largely unexplored in the campaign: what will the change in Administrations this Friday mean with regard to the fiscal—and health—situation in Puerto Rico?

Hold Your Nose. As if insolvent East Cleveland did not have enough problems affecting its fiscal dilemmas, Ohio—which in the Urban Institute’s new, incredible, handy-dandy fiscal guide to the states, ranks 45th out of the 50 states with regard to expenditures per capita on corrections and has a high share of its population in state prisons, local jails, or under probation or parole supervision (take-up); EPA Director Craig Butler yesterday ordered mountains of construction and demolition debris removed from an open dump located in a residential neighborhood in East Cleveland, issuing a notice of violation and orders to Arco Recycling to stop accepting construction and demolition debris, and to remove the acres of waste from the site, action taking place in the wake of inspection of the site last week in response to citizen complaints, as well as a determination that the site was an open dump, not a recycling facility as claimed by the company’s owner. The dump was supposed to contain only construction and demolition debris, with the bulk coming from hundreds of abandoned nuisance homes demolished by the Cuyahoga Land Bank. Ohio EPA last June had, in response to citizen complaints, ordered Arco officials to draw down the piles of rubble; however, when the EPA inspectors revisited the site last week, they found four-story piles of rubble and debris which had grown over the past year, not shrunk, triggering the notice of violation and the unilateral EPA order. The mountain of garbage no doubt is part of what appears to have contributed to the 36% population decline in the municipality since 2000. The estimated median income in the city is $20,435—lower than it was in the year 2000, and less than half the statewide median household income.

Is there a Trump Promise for PROMESA? In an epistle to Congressional leaders yesterday, U.S. Treasury Secretary Jack Lew and Health and Human Services Secretary Sylvia Burwell urged Congress to pass legislation to help Puerto Rico before the commonwealth is forced to confront more serious health care and economic challenges—where a new set of findings from the first epidemiological study on the state of mental health in Puerto Ricans since 1985 by the Behavioral Sciences Research Institute for the Puerto Rico Administration of Mental Health and Anti-Addiction Services (PRHIA) found that—as part of an effort to justify the allocation of federal funds—7.3% of Puerto Ricans have serious mental conditions—albeit the level is likely considerably greater, but the study does not include homeless persons, which is a vast population thought to also have a large amount of people with mental illnesses or substance dependence. Of these 165,497 people with serious mental health conditions, 36.1% had not received specialized services in the past year, which would sappear to indicate that there are thousands of undiagnosed or untreated mentally ill people in the streets of the country. The study warns of the danger that the critical fiscal situation Puerto Rico faces could end up affecting the services of mental health patients. The Health Insurance Administration (PRHIA)—which administers the Puerto Rico Government Health Plan, upon which almost two million Puerto Ricans rely—faces a fiscal and physical insufficiency crisis that has forced it to incur millions of dollars of debt with their providers—and which, according to PRHIA, has set off a chain reaction, with longer wait times for clinical and therapeutic procedures, overcrowded emergency rooms, attempts to directly charge patients for services, and an increasing exodus of physicians from Puerto Rico. According to the Puerto Rico College of Physicians and Surgeons, “364 physicians left Puerto Rico in 2014, and 500 in 2015,” so that the “PRHIA debt represents a significant threat to maintaining an operational healthcare system.” The study further cautions that the uncertainty and deterioration of the quality of life in Puerto Rico, due to the fiscal crisis, have the potential of increasing the prevalence of mental health conditions in the years to come: “Since 2008, the Island has been affected by an economic recession. As a consequence, Puerto Rico has been facing greater chronic stressors that might have a negative impact on mental health: high levels of unemployment or underemployment, poverty, a drastic reduction of population, and higher levels of crime.”

Puerto Rico has an unemployment rate of over 10%, and a poverty level of 46%. So it was unsurprising that Secretaries Lew and Burwell had sought to “underscore the need for additional legislation early in this [Congressional] session to address the economic and fiscal crisis in Puerto Rico.” The authors noted that the PROMESA legislation enacted last summer was an example of “important progress achieved to date with bipartisan support.” They wrote, however, that the “the work is not done,” focusing on the critical need to pass legislation to avert what they deemed a “Medicaid Cliff” for Puerto Rico and implement an Earned Income Tax Credit (EITC) to incentivize employment—actions made even more critical because the President-elect’s vows to work with Congress to eliminate the Affordable Care Act will put at early risk significant amounts of Puerto Rico’s Medicaid—putting, according to the two outgoing Cabinet Secretaries, up to 900,000 Americans on the island currently receiving health care under the Affordable Care Act at risk. The two added that while the Congressional Task Force on Economic Growth in Puerto Rico, created under PROMESA to analyze challenges in Puerto Rico and propose federal solutions, had only recommended studying the possibility of an EITC for the territory, they wrote that an EITC would be a “powerful driver to bolster Puerto Rico’s future,” describing it as a “most effective and powerful tool” to address structural challenges like the high unemployment and lesser participation in the formal economy, adding that it will be important for Congress to consider solutions such as an expanded Child Tax Credit, continued authorization for Treasury to provide the Commonwealth with technical assistance, reliance on data in benchmarking economic growth, and initiatives to incentivize small business development.

The Challenges of Fiscal Disparities

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eBlog, 12/29/16

Good Morning! In this a.m.’s eBlog, we consider Detroit’s ongoing challenges to recovery from the nation’s largest ever municipal bankruptcy—a city unbailed out by the federal government, but which, as we noted earlier this week, Detroit News editorial writer Daniel Howes described as “perceptively changing,” especially as we write this rainy morning with regard to its thousands of abandoned homes and buildings. Then we turn to Virginia’s Petersburg, the historic city which danced on the edge of municipal bankruptcy—threatening the solvency of regional public utilities—as it faces challenges to its future. Finally, we look at the newly released census figures to better grasp the scope of fiscal disparities in the State of Ohio—especially with regard to the fiscally depleted municipality of East Cleveland.

Unbuilding & Rebuilding a City’s Future. In the final week of the year, Detroit neared the razing of an industrial building which once covered an entire city block—marking the razing of some 3,130 structures razed this year, bringing the total razed since the city emerged from chapter 9 bankruptcy to around 10,700 over the last three years—with the vast bulk of those owned by Detroit’s Land Bank Authority. Nevertheless, giving some idea of the vast scope of the city’s challenge, its blight task force in 2014 had projected that the city would need to tear down 40,000—and that some 38,000 others were at risk of collapse. Indeed, still today, many blocks in the city have more abandoned houses and empty lots than lived-in homes, a scar reminding us of the exodus of whites and much of the black middle class from the city: an exodus of more than half the city’s population since the 1950’s. In 1950, there were 1,849,568 people in Detroit, but, by 2010, there were 713,777. The city today is home to an estimated 40,000 abandoned lots and structures. Between 1978 and 2007, Detroit lost 67 percent of its business establishments and 80 percent of its manufacturing base. Thus, as Detroit Mayor Mike Duggan has stated, he believes the mass demolitions are necessary for Detroit if it is to attract families to city neighborhoods and staunch the decades of population loss.

Detroit Fire Investigations Division Capt. Winston Farrow adds that the removal of dangerous buildings and empty houses is vital to public safety and the quality of life in Detroit: “It eliminates the opportunities for criminals to set fires in vacant houses…The problem was more just the sheer numbers of dwellings that we had.” In another sign that the strategy is working, the average sale prices of over 100 houses sold in Detroit has increased over the past three years, according to the Land Bank.

Nevertheless, the challenge to the city’s future remains: the Detroit News quoted the owner of 3D Wrecking, Sheila Davenport: “You can tear down a house on one block and go back several months later and where houses were occupied (they) are now abandoned and need to be demolished…It just seems like it never ends.” And, of course, it is a costly process; on average, the city expends $12,616 to knock down a house—a process made fiscally easier through the receipt of more than $128 million in federal funds over the past three years—with another $130 million in the pipeline—along with $40 million from the city’s general fund set aside for further demolitions. (Federal funding had been temporarily halted earlier this year, but resumed after an audit determined demolition costs above a federal cap of $25,000 per house were redistributed to 350 other properties to have those houses appear to meet the cap.)

Syncopating Time. Notwithstanding the cold rain falling in Petersburg this morning, work has finally commenced to restore one of the city’s highest-profile landmarks after months of delay caused by the city’s budget crisis—with the construction to repair a nearly 180-year-old clock tower and roof, a $1.2 million project financed by the Virginia Resource Authority—financed, according to a city spokesperson who stated the VRA municipal bond was “approved prior to the financial crisis.” The work—to properly coordinate the clocks on the clock tower, had been deferred last year when the city discovered its fiscal cupboards were bare—even as city officials had been ordered to close the building two years because of structural problems with the historic edifice—during which time Circuit Court jury trials were temporarily moved to the Dinwiddie County Circuit Courthouse. But it is now in a different courthouse where the U.S. Fourth Circuit Court of Appeals is weighing a lawsuit over a Petersburg Bureau of Police policy concerning social media which could result in a finding that would cost the fiscally challenged municipality millions of dollars after a federal court ruled that a lower court must decide whether the city government can be held liable for damages in the case. In its ruling, the court determined that the police department’s social media policy, put in place in 2013, violated employees’ First Amendment free speech rights. Moreover, the federal judges ordered the case be sent back to U.S. District Court in Richmond to determine whether “the city may also be held liable for the injuries that were caused by the applications of that policy.” The case arose two years ago last March, when two former Petersburg police officers claimed they were unjustly punished for posting comments on Facebook which criticized the department for promoting officers they considered too inexperienced. Their comments were reported to former Police Chief John I. Dixon III. The two officers were found to have violated a policy that Chief Dixon had instituted in April of 2013—a policy which prohibited department employees from giving out information “that would tend to discredit or reflect unfavorably upon the [department] or any other City of Petersburg department or its employees,” according to the appeals court opinion. The two officers were reprimanded and placed on probation—ergo, because they were on probation, they were barred from taking a test to qualify for promotion to sergeant. In addition, the officers had also been investigated over allegations of misconduct, which they claimed were filed in retaliation after the police department learned of their intent to file suit. The appeals court, however, has upheld the district court’s ruling that those investigations were not retaliatory, because “each arose from discrete allegations of misconduct” not related to the Facebook postings or the social media policy. For a municipality on the edge of chapter 9, the stakes on this appeal are high: the two officers are seeking compensatory damages of $2 million, plus punitive damages amounting to $350,000, plus attorney fees.

Ohio Fiscal Disparities. It was a generation ago that Congress eliminated the General Revenue Sharing program signed into law by former President Richard Nixon to address signal fiscal disparities. Today, it is possible to see how significant those disparities are becoming. According to the latest estimates available from the U.S. Census Bureau, median family incomes in Ohio cities range from $221,148 in the Columbus suburb of New Albany to $30,411 in East Cleveland, the city unbalanced between its waiting for Godot efforts to file for chapter 9 municipal bankruptcy or a response to its efforts to become part of the City of Cleveland. The new Census figures make clear the extraordinary fiscal disparities in the state: after New Albany, the rest of the top five in Ohio are: Indian Hill near Cincinnati ($208,158), the Cleveland suburb of Pepper Pike ($162,292), and two Columbus suburbs: Powell at ($147,344) and Dublin ($139,860). The statistics are from surveys conducted from 2011 through 2015 and released this month—the latest estimates available from the U.S. Census Bureau for smaller areas.

The See-Saw of Municipal Fiscal Solvency

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eBlog, 12/27/16

Good Morning! In this a.m.’s eBlog, we consider the remarkable turnaround in fiscal fortunes in Detroit—a city unbailed out by the federal government, but now, as Detroit News editorial writer Daniel Howes writes, is “perceptively changing,” albeit, interestingly in light of the President-elect’s choice to be the new Secretary of Education, the state of Detroit’s public schools “burdens an already difficult financial picture.” Then we turn to the challenge of trying (in the frigid Winter no less!) to describe fiscal contagion from the insolvent East Cleveland, before finally trying to escape the cold by journeying south to Puerto Rico to explore the worsening demographic trends and their implications for the changing administrations both in Washington, D.C. and Puerto Rico.

Winnerville? Daniel Howes, an editor for the Detroit News, in his editorial “Loserville,” wrote that two years “after Detroit emerged from the largest municipal bankruptcy in the nation’s history, the city America gave up for dead is showing that it is anything but,” writing that vacant space downtown is “is growing increasingly hard to find,” a stark contrast from the city’s first day of municipal bankruptcy when I was specifically warned not to walk from my downtown hotel to the Governor’s Detroit offices to meet Kevyn Orr, the then newly named Emergency Manager. Thus, Mr. Howes writes:

He tempered his column by noting that violent crime continues to be an issue in parts of the city—and that neighborhood revitalization “lags the pace set by downtown,” adding that the “exodus from Detroit Public Schools burdens an already difficult financial picture,” albeit writing that Detroit’s makeover is “a process, not a destination with guaranteed arrival,” indeed, comparing it the comparable (and related) comeback of the auto industry—albeit with the profound difference that the latter was bailed out—something Detroit was not, noting: “Detroit’s automakers, effectively a ward of the federal government at the outset of the Obama administration, are closing an eight-year span their leaders used to re-engineer companies that tottered on the edge of collapse on Election Day 2008…Eight years later, at least two of Detroit’s three automakers — as well as many of its suppliers—are emerging as players to be reckoned with in both the traditional car and truck business as well as the emerging mobility space. Loserville? Hardly…The creation of the American Center for Mobility at Willow Run and the Michigan Legislature’s move to enact the most far-reaching autonomous-vehicle laws in the country underscore the state’s bid to become the nation’s epicenter of mobility development and testing.”

Loserville? Fiscal Contagion? Just as the flu can be contagious, so too municipal fiscal distress does not necessarily stop at municipal borders. So it is that a growing number of residents of Forest Hill, a twenty-five acre historic neighborhood spanning parts of Cleveland Heights and East Cleveland, Ohio, founded by John D. Rockefeller and a seeming stark contrast from the virtually bankrupt East Cleveland, are upset by the increasing number of long-abandoned homes in both municipalities: assessed property values are tanking, and there is increasing apprehension at the seeming inability of the municipality to provide even basic services. There is also a sense that East Cleveland’s possible merger with Cleveland will not happen soon enough (if ever) to help Forest Hill’s issues: incorporating as a village would take cooperation from both cities, several voter elections, and the approval of Cuyahoga County. Similarly, there are no answers to the questions of where tax dollars would come from to hire police, firefighters, and provide basic, essential public services. Ironically, the neighborhood hosts municipally influential citizens—or at least formerly so, including East Cleveland’s recalled Mayor Gary Norton, the city’s new mayor Cheryl Stephens, and former Mayor Ed Kelley. The silence of the State of Ohio must weigh heavily on their hopes for the New Year.

Unfeliz Navidad? Puerto Rican demographer Raul Figueroa released information this morning that if the current demographic trends in the U.S. territory continue, by 2020, citizens older than 60 will—for the first time ever—surpass the number of those under 18, writing that between July of 2015 and July of this year, some 60,000 island residents had departed—and that this year marked the first in which the number of deaths exceeded the number of births. He noted increasing apprehensions of an increasing schism for the young generation—whose most productive members have “established themselves outside of the U.S. territory” and are forming families there, while their counterparts who have stayed behind are, increasingly, becoming caught up in criminal activities. Thus, he wrote, “Only a significant reduction in emigration or increase in immigration could reverse this demographic trend…it will be necessary to search for a strategy to permit and facilitate strategies to create employment opportunities.” Indeed, island economists like Elías Gutiérrez and José Alameda have expressed apprehension that the island is converting into a “gueto” of the poor and aged, likening it to a “Greek tragedy.” Mr. Gutiérrez added that the middle class has receded on “every front.” He noted, too, that the increasing demographic imbalance will increase the public pension imbalance: as the young flee, fewer will be paying in, while the number of retirees will continue to grow.

The demographic pressures on the island’s fiscal challenges come as soon-to-depart Puerto Rico Gov. Alejandro García Padilla released more pessimistic figures for the next decade—as he cast increasing doubt with regard to the viability of a negotiated debt solution—explaining that his updated projection of Puerto Rico’s financial shortfall over the next decade would be $8.8 billion worse than its forecast of just two months ago, when he had submitted a 10-year fiscal plan to the PROMESA Puerto Rico Oversight Board—a plan in which the government had projected that if the government stayed on its then current fiscal course—its so-called “Baseline”—it would be short some $58.7 billion, that is, in an ever accelerating state of debt. Moreover, in a revision released yesterday, that figure had increased by nearly $10 billion to $67.5 billion—the deficit reduction target the outgoing administration estimated it would have to achieve in reductions to achieve a balanced budget by 2026. That is, the debt situation has reached such an extreme that even were all its $35 billion in debt service to be magically eliminated, the island would still be overburdened with debt.

The newly released baseline also uncovers a related fiscal challenge which the new one does: what are the fiscal implications on Puerto Rico’s economy? The government’s new baseline projects government spending cuts would lead to a more negative nominal gross national product trajectory over the next decade, with the nominal, annual GNP shrinking by 1.03 percent instead of the previously projected growth from the October plan—even as the revised assumptions about economic growth and inflation added some $3.4 billion to the new baseline compared to the October baseline. The tab? The revised projections over the next decade project $232 billion in government spending, but only $165 billion in revenue—with the difference to be bridged by unspecified budget cuts.

The revised projections come as the PROMESA Oversight Board has commenced its discussions with creditors as part of its mission, similar to a chapter 9 municipal bankruptcy, to achieve a negotiated and consensual debt cut under Title VI of the new PROMESA law. But, to Gov. Padilla, the increasingly deteriorating fiscal and economic projections over the next decade mean that “that a comprehensive restructuring under Title III (the debt restructuring title) of PROMESA is inevitable.” Yet this all comes in the midst of changing administrations in Washington, D.C. and against an encroaching deadline: under the new federal law, creditors’ rights to sue have only been suspended until the middle of February. Ergo, Gov. Padilla’s office notes: “If Puerto Rico does not seek Title III protection before the termination of the claims on February 15, 2017, the government will run out of money and essential services will be severely affected.”

Who’s at Risk of Defaulting?

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eBlog, 12/16/16

Good Morning! In this a.m.’s eBlog, we consider the challenge to state and local leaders arising from both the Federal Reserve’s decision to increase interest rates, apprehensions about growing state budget gaps—and the respective implications for city and county credit ratings—as well, of course, to the incoming Trump administration and next Congress’ proposals on federal tax reform where—as under former President Ronald Reagan, the authority of state and local governments to issue tax exempt municipal bonds is expected to come under challenge—as is the deductibility of state and local taxes. Moreover, with the Federal Reserve’s decision to raise interest rates, those increases could boost mortgage rates—adversely impacting assessed property values—putting cities, counties, and school districts into distinctly uncomfortable territory. Then we turn to the frigid weather in East Cleveland, where the city’s insolvency has let to increasing service insolvency and an inability to clear the city’s roads—threatening the capacity and ability to provide emergency public services. Then we follow the nation’s frigid weather east to Shenandoah, where the fiscally beset municipality of Petersburg, Virginia was hit yesterday by a 4th U.S. Circuit decision, even as S&P Credit granted it a small Yuletide respite. Finally, we venture back west to Chicago, where Municipal Market Analytics helps us to try to untangle the fiscal arithmetic so burdening the Chicago Public Schools.

Nota bene: We wish all readers a well-deserved holiday to you and your loved ones; we will resume the week after next.

Who’s at Risk of Default? Municipal Market Analytics this week, drawing from compiled data, noted that the trend of annually declining defaults is over—breaking a six-year trend—and warning that it “expects that issuer-credit quality has begun to erode,” describing the ominous trend as not only a factor of more “aggressive/permissive” underwriting standards, but also the risk created by growing state budget gaps—gaps which are likely to result in a double fiscal whammy for municipalities, counties, and school districts of reduced local aid—as well as less state public infrastructure investment. MMA suggests “municipal default activity will increase in 2017.”

Brrr! Municipal insolvency, as we have previously noted, often involves service insolvency. Thus it is that many side streets in the insolvent municipality of East Cleveland are complete sheets of ice—and have been so for an entire week, because the city does not have any working snow plows, leading one constituent to liken living in the city to being in the “Ice Age.” With bitter cold from the lake snow, which has been falling in heavy bands, neither of the municipality’s two salt trucks are working, leading some city officials to opine that the money spent on the recent special recall election could have been better used to fix the salt trucks. With one resident noting that “It is very precarious until you get into Cleveland or until you get into Cleveland Heights,” residents can easily make out the boundary where East Cleveland ends and Cleveland Heights begins: on the latter side, the streets are totally cleared. Ice free and this is all “full of ice.” One beleaguered resident noted: “I really hope that we can one day join with Cleveland…That is the only answer.”

Teeter Tottering in Petersburg. The fiscally struggling, historic Virginia municipality of Petersburg was on a teeter totter yesterday, after the 4th U.S. Circuit Court of Appeals yesterday ruled that the city’s police department’s policy barring its employees from criticizing the department on social media was unconstitutional (for further details, please see this morning’s Little Legalities in the eGnus), because its social media policy constituted a “virtual blanket prohibition” on all speech critical of the department and was “unconstitutionally overbroad,” but as the city was removed by S&P Global Ratings from Credit Watch.  In its decision, the court acknowledged a city’s need for discipline, but found that the policy and the disciplinary actions taken pursuant to it would, if upheld, lead to an utter lack of transparency in law enforcement operations that the First Amendment cannot countenance. (The suit had been filed after two of the city’s officers were placed on probation for discussing on Facebook their concerns about inexperienced officers being promoted and leading the department’s training programs: the department’s policy prohibited employees from posting anything that would “tend to discredit or reflect unfavorably” upon the agency—something the court held the police cannot be allowed to do.) In its ratings change, S&P, nevertheless, maintained its junk BB ratings on Petersburg’s general obligation bonds: the city has just over $55 million general obligation, full faith and credit bonds and Qualified Zone Academy bonds outstanding. S&P analyst Timothy Little wrote: “We removed the rating from CreditWatch due to the city securing $6.5 million in cash-flow notes…The negative outlook reflects the extreme uncertainty regarding the city’s ability to return to structural balance and what will likely be persistently very weak liquidity in a difficult budgetary environment,” adding that: “In our opinion, the interest rate is high compared to other non-distressed entities that annually place TANs, further underscoring the fiscal distress of the city.” The continued fiscal distress hinged on the city’s ongoing inability to balance its budget, in the main part because municipal property and other taxes have been less than projected, while expenditures for public safety and health and welfare have exceeded the city’s budget by $2.5 million, according to S&P. (A Virginia technical assistance team reported that general fund expenditures exceeded revenue by at least $5.3 million in FY 2016, and identified a structural imbalance with Petersburg’s FY2017 budget—leading to a state estimate that the city has $18.8 million in unpaid obligations to external entities and internal loans, including repayment of the TANs. S&P further noted that even though the city’s economy is diverse, its 27.5% poverty rate is more than double the statewide level—meaning it bears disproportionate fiscal challenges.

Pixie Dust? Municipal Market Analytics this week inquired into the harsh realities of determining interest rates with regard to municipalities in fiscal straits seeking to go to market (not to buy a fat pig!), focusing on the Chicago Public Schools—suggesting that investors in the school district’s new capital improvement tax bonds should seriously consider the bond-holder settlements in Detroit—and the ongoing legal battles in Puerto Rico—in trying to determine what interest rate would constitute sufficient compensation for the legal and credit uncertainties present in a muni transaction, suggesting: “Basically, rather than use its traditional alternative revenue bond security (which entails a pledge of state aid backstopped by an unlimited property tax), CPS is directly pledging its new limited property tax levy solely for the benefit of bondholders.” Theoretically, MMA notes, the new municipal security (rated A by Fitch and BBB by Kroll) insulates municipal bondholders from CPS’s not very investor friendly credit rating and profile—especially its very high unfunded public pension liability, but then wrote: “However, the real perceived strength here is the durability of the structure, or persistence of regular debt service payments, in a hypothetical (and currently not-permitted) municipal bankruptcy. This durability relies upon legal opinions that conclude that the new bond obligations would be considered backed by special revenues and therefore bond-holders would not see their lien impaired.” However, MMA noted, such reliance might not be something upon which to hang one’s Santa stocking, writing: “The aspiration of the structure is to insulate the bondholders from the fiscal troubles of the district, although the repayment schedule suggests that the district may have taken a more short-term view of the soundness of the transaction given the back-loaded principal. The main trouble with the transaction lies not with the documents but with the assumption—generally implicit, yet quite explicit in the opinions—that the fiscally distressed district will unconditionally continue to abide by, and not challenge the provisions of the indentures or ‘use or claim the right to use’ the capital improvement tax revenues. In other words, to rely on the willingness of CPS not to act exactly like every recent distressed city (and territory) in invading, capturing, and re-purposing every bondholder asset within and beyond easy reach. Even constitutional bond protections have fallen victim to debtor challenges during government disruption. So for this security to function fully as described, CPS would need to experience a Goldilocks bankruptcy the likes of which the municipal market has not seen in decades.” Thus, MMA, in a Yule gifted insight, strongly encourages potential muni investors to carefully unwrap the seasonal gift to determine whether it is really of better credit quality than CPS’ alternative revenue bonds, and “to be avoided by accounts who consider a CPS municipal bankruptcy to be likely or even unavoidable.”