Emerging from Chapter 9–and the conflict between fiscal and physical safety.

07/07/17

Good Morning! In this a.m.’s eBlog, we consider the final emergence of Orange County, California from chapter 9 municipal bankruptcy; then we consider the ongoing fiscal and fiscal challenges for Flint’s leaders from its fiscal & physical challenges.

Free at Last? Twenty-three years ago, when the former Orange County, California Treasurer, Robert Citron, then managing an investment pool for southern California municipalities, speculated unwisely, the municipal pool he managed lost $1.64 billion—plunging the county into the first chapter 9 municipal bankruptcy of the modern era (California §53760)—a chapter 9 bankruptcy from which the County emerged this week in the wake of its final payment on the $1 billion worth of municipal bonds it had issued. Orange County, however, still owes approximately $20 million to various cities and agencies that have a separate repayment agreement—debt Orange County expects to resolve by late next year. (A subsequent grand jury investigation later found that Mr. Citron, who had earned praise for his investment skills, relied on a mail order astrologer and a psychic for interest rate predictions as Orange County’s Treasurer.)

For this writer, the emergence evokes memories of how controversial the concept of municipal bankruptcy had been—at the time—for the National League of Cities to advocate for the changes in chapter 9: the then Executive Director and the then President of NLC (former New York City Council Chair Carol Bellamy) decried the notion that an association of municipal elected leaders would support facilitating filing for municipal bankruptcy; yet the Orange County case illuminated its importance by demonstrating how important it was to have a mechanism in federal law to ensure continuity in the provision of essential municipal public services.  

In the case of Orange County, the insolvency of an investment pool it ran on behalf of itself and other municipalities in the region would have, absent the kinds of protections provided under chapter 9, risked plunging municipalities in the region into insolvency without a mechanism to ensure vital public services and operations. The County’s insolvency and threat to the other municipalities in the region was its own kind of tremor: a fiscal, rather than physical tremor. In the end, the access to chapter 9 meant the county was able to issue $1 billion in municipal bonds to avoid a critical default and ensure avoidance of any disruption in essential municipal services—bonds the payments on which ($1.5 billion including interest) were finally completed at the beginning of this month when the County made its final payment on that bankruptcy bond debt. While the price to its taxpayers was steep–repayments averaged $68 million a year, and the loss of vital public improvements and services great; the shock it sent to the nation’s cities was key in helping Congress better understand that while an Eastern Airlines could file for federal bankruptcy protection and simply walk away from its services and debts; that could never be the case for a city or county: there had to be a mechanism in federal law to ensure that a city, county, or public school system could continue to operate during insolvency.  

In managing these municipalities’ investment pool, Mr. Citron made unlucky/unwise wagers on interest rates—so unwise that the multi-jurisdiction investment pool suffered a crippling $1.64 billion loss. Now California State Senator John Moorlach, who prior to his Senate service was twice re-elected Orange County Treasurer-Tax Collector after running against Mr. Citron in 1994, has noted: “The bankruptcy dramatically changed my life…I sort of feel like I lived in a movie. I was an officer of the county when those recovery bonds were issued, and I wondered if I’d live long enough to see them paid off. It was a great turn-around opportunity. A lot has changed since then, and the county is better for it. It’s been nearly 23 years, and no one has been able to pull a stunt like this again. It’s a good day.”

While the “day” is not quite over: there are still another $19.7 million which must be settled before all municipal bankruptcy-related bills are resolved; the fiscal lesson appears to have been learned—or as current Supervisor William Steiner put it: “Despite the checks and balances now, and a commitment to strategic planning, there is always the chance that institutional memory will fade as time goes by and as leadership changes…The county has essentially fared well over the years despite the bankruptcy. Still, millions of dollars have been diverted from other important county departments and priorities.” The godfather of modern-day chapter 9 municipal bankruptcy, the incomparable Jim Spiotto, with whom I had the great fortune to work for so many years to achieve enactment of today’s municipal bankruptcy laws, appropriately notes: “Chapter 9 is the most extreme remedy, the last resort, if you can even call it a last resort.” Nevertheless, as he puts it, it creates a powerful tool for a municipality to avoid a potentially devastating “run on the bank.”

Out Like Flint? The State of Michigan, whose former Emergency Manager law played the critical role precipitating the grave physical and fiscal crisis affecting Flint, is now pressing the Flint City Council to vote on a long-term water contract under which Flint would lose rights to a municipal bond financed water pipeline—after the City Council two weeks ago voted to extend the city’s water delivery contract with the Great Lakes Water Authority (GLWA) until September, but delayed a vote on a longer term proposal by Mayor Karen Weaver to extend the contract for 30-years. Unsurprisingly, the state is now ramping up the pressure: in the wake of this week’s City Council vote, the state Department of Environmental Quality (MDEQ) filed suit against the city over the delay on a long-term arrangement, with the state alleging that the City Council’s refusal to approve a long-term water contract is endangering public health in the wake of the city’s lead contamination crisis. The complaint seeks a declaration that the Council’s failure to act is a violation of the federal Safe Drinking Water Act and a mandate that the city must enter into the long-term agreement with the GLWA negotiated by Mayor Weaver. The MDEQ charges that the city would be wasting its resources if it refuses to quit its current Karegnondi water pipeline plan: “The MDEQ has determined that the City Council’s failure to approve the agreement with GLWA and continued consideration of other options that may require operation of the water treatment plant places public health at risk.”

Under the proposed long-term contract, Flint would lose water rights to the Karegnondi Water Authority (KWA) (a new pipeline to Lake Huron, which is currently under construction). Thus, as Flint has awaited completion of the Karegnondi pipeline, it has been drawing its water from the Flint River—withdrawals which contributed to corroding pipes and lead contamination. Flint has been preparing to shift to KWA supplied, un-treated water in two years—with plans to construct vital upgrades to its treatment plant to meet EPA-mandated standards. In April, Mayor Weaver dropped the plan to make the switch to the bond-financed pipeline and recommended the city continue to purchase water from GLWA, believing that the GLWA supplied and treated water is more affordable—and apprehensive about the risk of another supply shift. With the city’s fiscal and physical health scarred by the water contamination crisis which came in the wake of the state-appointed emergency manager’s fateful decision to allow the city’s contract with Detroit for Lake Huron-treated water to expire—Mayor Weaver advised: “The recommendation I put forward months ago is the best option to protect public health and is supported by the public health community…[It] would also allow the City to avoid a projected 40 percent water rate increase and ensure the City of Flint gets millions of dollars to continue replacing lead tainted pipes and make much-needed repairs to our damaged infrastructure so we are able to deliver quality water to residents. The people of Flint have waited long enough for a reliable, permanent water source. Implementing my recommendation will provide that, and will allow us to move forward as a community and focus more on rebuilding our City.” Under her plan, Flint would recoup the roughly $7 million in annual debt service by transferring its KWA water rights to the GLWA.

Nevertheless, as Flint Councilmember Eric Mays described his apprehensions with regard to Flint losing its rights to the KWA pipeline, he recommended the city retain the asset: “My position is that the since the Governor won’t apologize, and the state has the money they can pay the bond; and whether we ever use the KWA asset, I don’t want, at this juncture, to turn over that asset and lose those rights under the deal with GLWA…I would be almost ready to vote for the GLWA deal if we could tweak it and get that bond off to the state and still retain the asset.” He added that he is the only Councilmember to propose an alternative to Mayor Weaver’s plan—a plan, he added, on which the Council “has done nothing.” Rather, he believes the State of Michigan, the precursor of the fiscal and physical crisis, should bear the burden for the municipal bond payments: “Since the MDEQ issued a suspicious administrative consent order for minor repairs and put it into the bond prospectus at the initial bond sale, my position is that Governor has the money and can pay the bond.”

So It Turns Out Chapter 9 Municipal Bankruptcy Can Work!

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eBlog, 4/15/16

In this morning’s eBlog, we continue to follow the unprecedented leadership efforts of House Speaker Paul Ryan—working with U.S. Treasury officials to address the nearing insolvency in Puerto Rico—where the Speaker confronts misinformation and a heavy lobbying campaign to mislead and delay final consideration. The Speaker and Minority Leader Nancy Pelosi are meeting with their respective caucuses in hopes of moving the proposed legislation to the full House by next week. If anything, the leadership by bipartisan House leaders surely contrasts with New Jersey, where Atlantic City is on a timeline to insolvency not very different than Puerto Rico, but where little consensus appears with regard to the most effective resolution. Finally, we look back to where it all began—in a sense—Orange County—the first municipality in the nation to file for chapter 9 municipal bankruptcy after the adoption of the 1988 municipal bankruptcy law, P.L. 100-597. Orange County’s fiscal collapse, moreover, because the County—at the time—was managing a pooled fund for over 200 California municipal school districts, cities, and counties, provided the first test with regard to whether the new federal law would work—or fail. There is nothing like the test of time.

Governing Amid Bankruptcy Misconceptions. House Speaker Paul Ryan has scheduled a policy meeting this morning in an effort to overcome resistance to the bill authored by House Natural Resources Committee Chairman Rob Bishop (R-Utah) as he seeks to gain sufficient support to get the bill reported to the full House, with the Speaker warning the Chairman “did not have votes on the other side of the aisle going into the markup.” Chairman Bishop and other sponsors of the bill will brief House Republicans this morning—emphasizing that—contrary to claims made by some Members and lobbyists for hedge funds—that the bill was specifically designed to prevent any federal bailout, with the Speaker adding that “the direction we’re headed with an oversight board” will help members appreciate and better understand the fiscal commitment. Part of the challenge is coming from Members such as Rep. Tom McClintock (R-Ca.), who warned his colleagues the bill was a bailout and warned it would lead other states to demand the same treatment—demonstrating both a lack of understanding of the outcome of the municipal bankruptcies in Orange County (please see below), Stockton, and San Bernardino in his home state—in no case has there been any bailout—and demonstrating an inability to understand the dual sovereignty of the U.S. Constitution. Indeed, Speaker Ryan has warned that absent swift action to address Puerto Rico’s looming insolvency, the federal government would be forced into a costly federal bailout, noting: “The need for Puerto Rico legislation is to bring order to chaos, and my number one priority as Speaker of the House with respect to this issue is to keep the American taxpayer away from this: there will be no taxpayer-funded bailout down the road.”

On the other side of the aisle, House Minority Leader Nancy Pelosi (D., Ca.) yesterday said Democrats have made “some substantial progress” working with Republicans and the Treasury Department to iron out her party’s remaining concerns with the bill, adding: “At the end of the day, any bill must have restructuring that works, an oversight board that is respectful of the people of Puerto Rico and does not undermine the restructuring part of the bill and does not contain extraneous provisions that harm working people.”

New Jersey & You. Atlantic City, facing insolvency—but less constructive state leadership—has made a $4.25 million payment to its school district in order to ensure its public schools remain open and the teachers paid. The payment came in the wake of a suit filed last week by the New Jersey Department of Education to force the fiscally beleaguered municipality to make all payments due the school district through July, some $34 million, or about $8.5 million per month. The school board did not support the lawsuit, noting that it had been working with the city to resolve their financial problems. A hearing on that suit is scheduled for Tuesday. The added costs and disruption from the state came as New Jersey Senate President Steve Sweeney (D-Gloucester) has proposed an alternative proposal aimed at saving Atlantic City from insolvency—one which proposes additional benchmarks for the city over and above what he had previously proposed. The revised compromise would allow Atlantic City:
• 130 days to address its $102 million deficit; and
• Mandate that the city, which is close to running out of cash flow, cut its current spending per capita from $6,700 to $3,500.

Failure to meet these conditions would trigger House action on the Senate-passed bill which would authorize New Jersey’s Local Finance Board to renegotiate outstanding debt and municipal contracts for as long as five years. In his statement, Senate President Sweeney noted: “This plan gives Atlantic City the opportunity to use all the tools at their disposal to finally reduce spending and reform government operations before the state asserts control over its municipal finances.” Unsurprisingly, Sen. Sweeney not only omitted mention the state role in naming an emergency manager for the city and that individual’s responsibility—nor what constructive suggestions he could contribute—even as the city has implemented a 28-day pay period suspension to allow time for May tax revenue to arrive to fund the next paychecks for city employees. The House Leader’s pressure adds to the increasing pressure from Gov. Chris Christie, who has warned he will not sign a companion bill that provides payments-in-lieu of tax (PILOT) funds from casinos absent this state takeover power.

In contrast, State Assembly Speaker Vincent Prieto (D-Secaucus) has, as we have noted, proposed Christie-opposed legislation which would create a quasi-financial control board, not dissimilar to that being proposed for Puerto Rico—and similar to ones utilized years ago in New York City and Washington, D.C.—under which a five-member committee would assume increased control if certain benchmarks were not met within a year. Speaker Prieto noted that Sen. Sweeney’s proposal was a “step toward compromise,” but still has collective bargaining concerns. For his part, the beleaguered Atlantic City Mayor Don Guardian responded that Speaker Prieto’s bill is “the most pragmatic” approach, adding: “We have enormous problems with legacy costs and debt service from previous tax appeals and other debts that must be addressed over the long-term…I am completely open to compromise and working together to find a solution, but it must be within a reasonable and practical framework.”

The End of the Beginning. With Orange County, Ca., on the verge of making its final payments based upon its plan of debt adjustment from its 1994 municipal bankruptcy—a municipal bankruptcy triggered by a devastating loss of nearly $1.64 billion on derivative investments—those payments will clear its slate and restore the county’s ability to devote its full budget to the county’s future—rather than the devastating financial investments it made more than two decades ago in derivatives that cost it in excess of $1.6 billion—and, because there were also pooled funds from other municipalities in southern California (The investment pool consisted of funds from the county as well as approximately 240 other local agencies, including school districts, cities, and special districts). The insolvency had risked much greater fiscal disasters. Orange County entered municipal bankruptcy after its investment pool reported the losses from highly leveraged positions that unraveled when interest rates rose. The county’s filing for chapter 9—the first filing in the wake of municipal bankruptcy amendments signed into law by former California Governor and U.S. President Ronald Reagan—was met at the time by consternation by the nation’s cities’ leaders. But the chapter 9 ensured there was no interruption of essential public services—and that a lesson was learned: Orange County Executive Frank Kim yesterday said the municipal bankruptcy experience “has made us more conservative in terms of being very careful to not issue debt where we don’t have to.” Orange County currently has plans to issue $68 million for a central utility upgrade at the end of May, according to Suzanne Luster, public finance director. The proceeds will be used to upgrade the heating and cooling infrastructure that supports the civic center campus, the Orange County Jail, and federal and state buildings. County supervisors will vote May 10 on that bond sale, which would be its first long-term debt issuance in 10 years.