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

June 4, 2018

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

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

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

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

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

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

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

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

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

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

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

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

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The Fiscal Challenges of Inequity

May 15, 2018

Good Morning! In this morning’s eBlog, we return to the small municipality of Harvey, Illinois—a city fiscally transfixed between its pension and operating budget constraints in a state which does not provide authority for chapter 9 municipal bankruptcy; then we turn east to assess Connecticut’s fiscal road to adjournment and what it might mean for its capital city of Hartford; before heading south to Puerto Rico where there might be too many fiscal cooks in the kitchen, both exacerbating the costs of restoring fiscal solvency, and exacerbating the outflow of higher income Americans from Puerto Rico to the mainland.

Absence of Fiscal Balance? After, nearly a decade ago, the Land of Lincoln—the State of Illinois—adopted its pension law as a means to ensure smaller municipalities would stop underfunding their public pension contributions—provisions which, as we noted in the case of the small municipality of Harvey, were upheld when a judge affirmed that the Illinois Comptroller was within the state law to withhold revenues due to the city—with the Comptroller’s office noting that whilst it did not “want to see any Harvey employees harmed or any Harvey residents put at risk…the law does not give the Comptroller discretion in this case: The Comptroller’s Office is obligated to follow the law. This dispute is between the retired Harvey police officers’ pension fund and the City of Harvey.” But in one of the nation’s largest metro regions—one derived from the 233 settlements there in 1900, the fiscal interdependency and role of the state may have grave fiscal consequences. As we previously noted, U. of Chicago researcher Amanda Kass found there are 74 police or fire pension funds in Illinois municipalities with unfunded pension liabilities similar to that of Harvey. Unsurprisingly, poverty is not equally distributed: so fiscal disparities within the metro region have consequences not just for municipal operating budgets, but also for meeting state constitutionally mandated public pension obligations.

Now, as fiscal disparities in the region grow, there is increasing pressure for the state to step in—it is, after all, one of the majority of states in the nation which does not authorize a municipality to file for chapter 9 municipal bankruptcy: ergo, the fiscal and human challenge in the wake of the state’s enactment of its new statute which permits public pension funds to intercept local revenues to meet pension obligations; the state faces the governance and fiscal challenge of whether to provide for a state takeover—a governing action taken in the case of neighboring Michigan, where the state takeover had perilous health and fiscal consequences in Flint, but appeared to be the key for the remarkable fiscal turnaround in Detroit from the largest municipal chapter 9 bankruptcy in American history. Absent action by the Governor and state legislature, it would seem Illinois will need to adopt an early fiscal warning system of severe municipal fiscal distress—replete with a fiscal process for some means of state assistance or intervention. In Harvey, where Mayor Eric Kellogg has been banned for life from any role in the issuance of municipal debt because of the misleading of investors, the challenge for a city which has so under-budgeted for its public pension obligations, has defaulted on its municipal bond obligations, and provided virtually no fiscal disclosure; Illinois’ new state law (PL 96-1495), which permits public pension funds to compel Illinois’ Comptroller to withhold state tax revenue which would normally go to the city, which went into effect at the beginning of this calendar year, meant the city reasons did not take effect until January 2018. Now, in the wake of the city’s opting to lay off nearly half its police and fire force, the small municipality with the 7th highest violent crime rate in the state is in a fiscal Twilight Zone—and a zone transfixed in the midst of a hotly contested gubernatorial campaign in which neither candidate has yet to offer a meaningful fiscal option.  

Under Illinois’ Financial Distressed City Law ((65 ILCS 5/) Illinois Municipal Code) there are narrow criteria, including requirements that the municipality rank in the highest 5% of all cities in terms of the aggregate of the property tax levy paid while simultaneously in the lowest percentage of municipalities in terms of the tax collected. Under the provisions, the Illinois General Assembly would then need to pass a resolution declaring the city as fiscally distressed—a law used only once before in the state’s history—thirty-eight years ago for the City of East St. Louis. The statute, as we have previously noted, contains an additional quirk—disqualifying in this case: Illinois’ Local Government Financial Planning and Supervision Act mandates an entity must have a population of less than 25,000—putting Harvey, with its waning population measured at 24,947 as of 2016 somewhere with Rod Serling in the Twilight Zone. Absent state action, Harvey could be the first of a number of smaller Illinois municipalities unable to meet its public pension obligations—in response to which, the state would reduce revenues via intercepting local or municipal revenues—aggravating and accelerating municipal fiscal distress.

Capital for the Capitol. In a rare Saturday session, the Connecticut Senate passed legislation to enable the state to claw back emergency debt assistance for its capital city, Hartford, through aid cuts beginning in mid-2022, with a bipartisan 28-6 vote—forwarding the bill to the House and Gov. Dannel Malloy—as legislators raced to overwhelmingly approve a new state budget shortly before their midnight deadline Wednesday which would:  restore aid for towns; reverse health care cuts for the elderly, poor, and disabled; and defer a transportation crisis. The $20.86 billion package, which now moves to Gov. Dannel P. Malloy’s desk, does not increase taxes; it does raise the maximum tax rate cities and towns can levy on motor vehicles. In addition, the bill would spend rather than save more than $300 million from this April’s $1 billion surge in state income tax revenues. The final fiscal compromise does not include several major changes sought by Republicans to collective bargaining rules affecting state and municipal employees. And, even as the state’s fiscal finances are projected to face multi-billion-dollar deficits after the next election tied in part to legacy debt costs amassed over the last 80 years, the new budget would leave Connecticut with $1.1 billion in its emergency reserves: it will boost General Fund spending about 1.6 percent over the adopted budget for the current fiscal year, and is 1.1 percent higher than the preliminary 2018-19 budget lawmakers adopted last October. The budget also includes provisions intended to protect Connecticut households and businesses which might be confronted with higher federal tax obligations under the new federal tax law changes. Indeed, in the end, the action was remarkably bipartisan: the Senate passed the budget 36-0 after a mere 17 minutes of debate; the House debated only 20 minutes before voting 142-8 for adoption.

In addition to reacting to the new federal tax laws, the final fiscal actions also dealt with the sharp, negative reaction from voters in the wake of tightening  Medicare eligibility requirements for the Medicare Savings Program, which uses Medicaid funds to help low-income elderly and disabled patients cover premiums and medication costs—acting to postpone cutbacks to July 1st, even though it worsened a deficit in the current fiscal year, after learning an estimated 113,000 seniors and disabled residents would lose some or all assistance. As adopted, the new budget reverses all cutbacks, at a cost of approximately $130 million. Legislators also acted to restore some $12 million to reverse new restrictions on the Medicaid-funded health insurance program for poor adults, with advocates claiming this funding would enable approximately 13,500 adults from households earning between 155 and 138 percent of the federal poverty level to retain state-sponsored coverage.

State Aid to Connecticut Cities & Towns. Legislators also took a different approach with this budget regarding aid to cities and towns. After clashing with Gov. Malloy last November, when Gov. Malloy had been mandated by the legislature to achieve unprecedented savings after the budget was in force, including the reduction of $91 million from statutory grants to cities and towns; the new budget gives communities $70.5 million more in 2018-19 than they received this year—and bars the Governor from cutting town grants to achieve savings targets. As adopted, the fiscal package means that some municipalities in the state, cities and towns with the highest local tax rates, could be adversely impacted: the legislation raises the statewide cap on municipal property taxes from a maximum rate of 39 mills to 45 mills. On the other hand, the final legislation provides additional education and other funding for communities with large numbers of evacuees from Puerto Rico—dipping into a portion of last month’s $1.3 billion surge in state income tax receipts tied chiefly to capital gains and other investment income—and notwithstanding the state’s new revenue “volatility” cap which was established last fall to force Connecticut to save such funds. As adopted, the new state budget “carries forward” $299 million in resources earmarked for payments to hospitals this fiscal year—a fiscal action which means the state has an extra $299 million to spend in the next budget while simultaneously enlarging the outgoing fiscal year’s deficit by the same amount. (The new deficit for the outgoing fiscal year would be $686 million, which would be closed entirely with the dollars in the budget reserve—which is filled primarily with this spring’s income tax receipts.) The budget reserve is now projected to have between $700 million and $800 million on hand when the state completes its current fiscal year. That could be a fiscal issue, as it would leave Connecticut with a fiscal cushion of just under 6 percent of annual operating costs, a cushion which, while the state’s largest reserve since 2009, would still be far below the 15 percent level recommended by Comptroller Kevin P. Lembo—and, mayhap of greater fiscal concern, smaller than the projected deficits in the first two fiscal years after the November elections: according to Connecticut’s nonpartisan Office of Fiscal Analysis, the newly adopted budget, absent adjustment, would run $2 billion in deficit in FY2019-20—a deficit that office projects would increase by more than 25 percent by FY2020-21, with the bulk of those deficits attributable both to surging retirement benefit costs stemming from decades of inadequate state savings, as well as the Connecticut economy’s sluggish recovery from the last recession.

As adopted, Connecticut’s new budget also retains and scales back a controversial plan to reinforce new state caps on spending and borrowing and other mechanisms designed to encourage better savings habits; it includes a new provision to transfer an extra $29 million in sales tax receipts next fiscal year to the Special Transportation Fund—designed in an effort to avert planned rail and transit fare increases—ergo, it does not establish tolls on state highways.

Reacting to Federal Tax Changes. The legislature approved a series of tax changes in response to new federal tax laws capping deductions for state and local taxes at $10,000: one provision would establish a new Pass-Through Entity Tax aimed at certain small businesses, such as limited liability corporations; a second provision allows municipalities to provide a property tax credit to taxpayers who make voluntary donations to a “community-supporting organization” approved by the municipality: under this provision, as an example, a household owing $7,000 in state income taxes and $6,000 in local property taxes could, in lieu of paying the property taxes, make a $6,000 contribution to a municipality’s charitable organization.

Impacts on Connecticut’s Municipalities. The bill would enable the state to reduce non-education aid to its capital city of Hartford by an amount equal to the debt deal. It would authorize the legislature to pare non-education grants to Hartford if the city’s deficit exceeds 2% of annual operating costs in a fiscal year, or a 1% gap for two straight year—albeit the legislature would be free to restore other funds—or, as Mayor Luke Bronin put it: “I fully understand respect legislators’ desire to revisit the agreement after five years.” Under the so-called contract assistance agreement, which Gov. Malloy, Connecticut State Treasurer Denise Nappier, and Mayor Luke Bronin signed in late March, the state would pay off the principal on the City of Hartford’s roughly $540 million of general obligation debt over 20 to 30 years. With Connecticut’s new Municipal Accountability Review Board, not dissimilar to the Michigan fiscal review Board for Detroit, having just approved Mayor Bronin’s five-year plan. In the wake of the legislative action, Mayor Bronin had warned that significant fiscal cuts in the out years could imperil the city at that time, albeit adding: “That said, I fully understand and respect legislators’ desire to revisit the agreement after five years, and my commitment is that we will continue to work hard to earn the confidence our the legislature and the state as a whole as we move our capital city in the right direction.”

Dying to Leave. While we have previously explored the departure of many young, college-educated Puerto Ricans to the mainland, depleting both municipio and the Puerto Rico treasuries of vital tax revenues, the Departamento of Salud (Health Department) reports that even though Puerto Rico’s population has declined by nearly 17% over the decade, the U.S. territory’s suicide rate has increased significantly, especially in the months immediately following Hurricane Maria, particularly among older adults, with social workers reporting that elderly people are especially vulnerable when their daily routines are disrupted for long periods. Part of the upsurge is demographically related: As those going have left for New York City, Florida, and other sites on the East Coast, it is older Americans left behind—many who went as long as six months without electricity, who appear to be at risk. Adrian Gonzalez, the COO (Chief Operating Officer at Castañer General Hospital in Castañer, a small town in the central mountains) noted: “We have elderly people who live alone, with no power, no water and very little food.” Dr. Angel Munoz, a clinical psychologist in Ponce, said people who care for older adults need to be trained to identify the warning signs of suicide: “Many of these elderly people either live alone or are being taken care of by neighbors.”

A Hot Potato of Municipal Debt. Under Puerto Rico Gov. Ricardo Rosselló’s proposed FY2019 General Fund budget, the Governor included no request to meet Puerto Rico’s debt, adding he intended not to follow the PROMESA Board’s directives in several parts of his budget—those debt obligations for Puerto Rico and its entities are in excess of $2.5 billion: last month’s projections by the Board certified a much higher amount of $3.84 billion. Matt Fabian of Municipal Market Analytics described it this way: “Bondholders have to wait until the Commonwealth makes a secured or otherwise legally protected provision to pay debt service before they can begin to (dis)count their chickens: The alternative, which is where we are today, is an assumption that debt service will be paid out of surplus funds. ‘Surplus funds’ haven’t happened in a decade and the storm has only made things worse: a better base case assumption is the Commonwealth spending every dollar of cash and credit at its disposal, regardless of what the budget says: That doesn’t leave much room for the payment of debt service and is good reason for bondholders to continue to litigate.” Under the PROMESA Board’s approved fiscal plan, Puerto Rico should have $1.13 billion in surplus funds available for debt service in FY2023—with the Board silent with regard to what percent the Gov. would be expected to dedicate to debt service. The Gov.’s budget request does seek nearly a 10% reduction for the general fund, with a statement from his office noting the proposal for operational expenditures of $7 billion is 6% less than that for the current fiscal year and 22% less than the final budget of former Gov. Alejandro García Padilla. The Governor proposed no reductions in pension benefits—indeed, it goes so far as to explicitly include that his budget does not follow the demands of the PROMESA Oversight Board for the proposed pension cuts, to enact new labor reforms, or to eliminate a long-standing Christmas bonus for government workers.

Nevertheless, PROMESA Board Executive Director Natalie Jaresko, appears optimistic that Gov. Ricardo Rosselló Nevares’s government will correct the “deficiencies” in the recommended budget without having to resort to litigation: while explaining the Board’s reasoning for rejecting the Governor’s proposed budget last week, Director Jaresko stressed that correcting the expenses and collections program, as well as implementing all the reforms contained in the fiscal plan, is necessary to channel the island’s economy and to promote transparency and accountability in the use of public funds, adding that approving a budget in accordance with the new certified fiscal plan is critical to achieve the renegotiation of Puerto Rico’s debt—adding that, should the Rosselló administration not do its part, the Board would proceed with what PROMESA establishes: “The fiscal plan is not a menu you can choose from.”

The Absences of Fiscal Balances

May 4, 2018

Good Morning! In this morning’s eBlog, we note the deepening road towards insolvency of the Harvey, Illinois; then we turn south to consider the potential adverse municipal fiscal impacts were the State of Georgia to enable the de-annexation of the small city of Stockbridge. Finally, we journey back to Puerto Rico, where House Natural Resources Committee Chair Rob Bishop is headed for a first-hand assessment of the ongoing fiscal and physical challenges and federal emergency assistance still needed. 

An Absence of Fiscal Balance? In the Land of Lincoln, Illinois, where the state’s courts have heard requests for municipal bankruptcy relief; but where chapter 9 municipal bankruptcy is not authorized; relief appears only to have been granted when not challenged. Under 65 Illinois Comp. Statute 5/8-5-1, smaller municipalities may, if not home rule jurisdictions, seek judicial relief. Under the state’s Local Government Financial Planning and Supervision Act (50 Ill. Comp. Stat. 3200) a municipality with a population under 25,000 suffering a “fiscal emergency” may, after securing a two-thirds vote of the governing body, petition the state to establish a financial planning and supervision commission to address such “fiscal emergency.” Ironically, Harvey, with a population of 25,282, just exceeds that level—some 1,052 Illinois municipalities have less than 25,000 residents. Now, with the municipality unable to meet its police and fire pensions, Illinois Comptroller Susana Mendoza is holding up more than $1 million in state funds the town is owed—under Illinois statutes which authorize the state to withhold tax revenues a municipality is slated to receive if it does not make the required payments into its police and firefighter pensions: the funds withheld go right into the pension fund instead of town services—which, in the case of Harvey, amount to about $1.4 million, leading to, as we have previously noted, the town’s announcement that it will lay off nearly half of its police and fire department. Making the fiscal situation more dire, the city’s Mayor, Eric Kellogg, has been banned for life from the municipal bond market for misleading investors; the municipality appears to be in a chronic pattern of underfunding its public safety pension funds, even as its operating budget chronically spends more than the revenues it brings in. Ergo, as we have written, under Illinois’ Public Act 96-1495, the Comptroller may be compelled to withhold state tax revenues, which would traditionally be in order to ensure pension payments are made to a municipality which has failed to make full pension payments for years.

In a situation which risks compromising public health and safety, Harvey has laid off nearly half its police and fire force—even as it has warned it might not be able to make payroll—especially with inadequate municipal fiscal resources now being rerouted to oppose the state actions in court.

It being Illinois—and an election year—Gov. Bruce Rauner has been uncharacteristically silent about the brewing fiscal catastrophe. The godfather of chapter 9 municipal bankruptcy, Jim Spiotto, has joined with the exceptional Chicago Civic Federation in drafting legislation, the Local Government Protection Authority, which includes a provision to:

  • establish an oversight board,
  • set up a clear procedure for dealing with a stressed city, and
  • allow filing for Chapter 9 municipal bankruptcy. (Legislation which has, to date, gained no traction in the legislature.)

Harvey Town Attorney Bob Fioretti reports: “We are going to find some solution, if possible,” signaling that the municipality was still negotiating with its police and fire pension funds, but warning that, if those discussions falter:  “Layoffs will occur. But the safety of the population is key, and that will continue.”

Mayhap ironically, Illinois adopted its pension law eight years ago as a way to ensure smaller municipalities would stop shorting their pension fund contributions—provisions upheld the week when a judge affirmed that the Illinois comptroller was within the state law to withhold the revenue. Thus, while the Comptroller’s Office issued a statement that it “does not want to see any Harvey employees harmed or any Harvey residents put at risk…the law does not give the Comptroller discretion in this case: The Comptroller’s Office is obligated to follow the law. This dispute is between the retired Harvey police officers’ pension fund and the city of Harvey.”

Nor does Harvey appear to be an isolated case: According to an analysis by Amanda Kass, a researcher at the University of Chicago, there are 74 police or fire pension funds in Illinois municipalities with similar unfunded pension liabilities—leading Chicago Civic Federation President Laurence Msall to note: “If they ignore the law and don’t make the contribution as Harvey has, then yes, those municipalities all around the state have ability to seek an intercept of state revenues that would otherwise come to the municipality.”

The complicating factor for Harvey is, however, not just that it has had years of decline and corruption in government, but also with declining assessed property values and very high property taxes, the municipality has a shrinking set of fiscal options—or, as Mr. Fioretti puts it: “We have an aging population, a declining population, a fixed-income population, and our revenues aren’t even being collected from the real estate taxes. We’re below 50 percent for the year on those collections,” noting that the delinquent real estate tax money is costing the town $12 million this year.”

Uneasy Fiscal Options. While Mr. Msall notes that the State of Illinois helped create the fiscal mess by setting up the pension funds and setting all of the pension levels; now, he notes, Illinois must either dissolve Harvey’s pension into the state fund, or put together an emergency financial team to sort through the wreckage of this and other distressed towns—adding: “Let’s create a board that could be independent with real financial expertise to guide these local governments, not to push them into [municipal] bankruptcy: The best path forward for Harvey is independent oversight that could sort out why they’re not making their financial reports on a regular basis.”

The Cost of Municipal Annexation. Municipalities across Georgia could face higher borrowing costs if the state government enables the “de-annexation” of about half of one small city, that city being Stockbridge, one settled in 1829 when the Concord Methodist Church was organized near present-day Old Stagecoach Road—and, especially, when Stockbridge was granted a post office on April 5, 1847, named for a traveling professor, Levi Stockbridge, who had passed through the area many times before the post office was built. Albeit that heritage remains a matter of some dispute: others contend that the city was named after Thomas Stock, who was State Surveyor and the Georgia State President in the 1820s. The small municipality was incorporated as a town in 1895 and, subsequently, as a city on August 6, 1920. Now, however, more change might be on the way, especially if Georgia Governor Nathan Deal signs into law Senate bills 262 and 263—bills which, if enacted, would de-annex just over half of Stockbridge’s assessable residential and commercial property. Why? Because proposed SB 263, an Act to incorporate the City of Eagles Landing, provide a charter for the City of Eagles Landing; provide for a referendum; provide for transition of powers and duties; provide for community improvement districts; and repeal conflicting laws would effectively have disconcerting fiscal impacts on City Hall in Stockbridge, which was financed with municipal revenue bonds. Neither of the two bills apportions the revenues involved between the to-be two entities—a requirement which, according to some legal experts, is based upon precedent-setting court cases before the U.S. Supreme Court and Georgia when the boundaries of a governmental entity are changed.

Thus, unsurprisingly, during the Georgia Municipal Association’s Georgia Cities Week last week, Stockbridge officials and representatives of the Eagle’s Landing effort held separate meetings with Gov. Deal.  Stockbridge City Attorney Michael Williams described their session as “very productive: The Governor said he would consider the series of points we made…I’m certainly taking him at his word that he will.” Nevertheless, the municipality is hedging its fiscal bets: it has hired three outside law firms to challenge the laws if Gov. Deal approves them.

Should that happen, however, the much reduced City if Stockbridge would still would be obligated to pay off about $13.02 million of privately placed Urban Redevelopment Agency lease-revenue bonds, and $1.5 million of water and sewer notes issued through the Georgia Environmental Facilities Authority—municipal bonds owned by Capitol One Public Funding LLC. Unsurprisingly, the Romulus and Remus of Eagles Landing have expressed no eagerness to help make those payments: sharing only goes so far. The lease-revenue bonds, issued in 2005 and 2006 for projects including funding to purchase land and build city hall, backed by general fund revenues and the city’s taxing power, if needed, even though the city does not currently impose a property tax.

Also unsurprisingly, Jim Spiotto’s firm, Chapman and Cutler LLP, which represents Capital One, wrote to the city a day after the General Assembly ended its session last month, warning it could face potential litigation: “SB 262 and SB 263 infringe Capital One’s constitutional rights under the contracts clause of the U.S. Constitution and the Georgia Constitution by taking away a significant source of the security and source of repayment for the bonds that was contractually bargained for by the bondholders,” Chapman and Cutler partner Laura Appleby wrote to the City Attorney. Unless the bonds are properly apportioned between Stockbridge and Eagle’s Landing, and the [municipal] bondholders have the benefit of the full security that they were originally promised, Ms. Appleby wrote, “We have serious concerns regarding the ability of [Stockbridge] to continue to pay debt service on the bonds because it will have lost a large portion of its ad valorem tax base.”

Jonathan Lewis, Capital One Public Funding’s president, has written to Gov. Deal also requesting a meeting, writing: “The failure of SB 262 and SB 263 to provide for the apportionment of the [municipal] bonds between the City of Stockbridge and, if formed, the City of Eagle’s Landing, is not only an inequitable result for the City of Stockbridge, it is an infringement on Capital One’s constitutional rights under the contracts clause of the U.S. Constitution and the Georgia Constitution, as it removes a significant portion of the security and source of repayment for the bonds…Capital One has come to trust that the State of Georgia will take those actions required to maintain, preserve, and protect the pledges made by its municipalities to their bondholders…Permitting SB 262 and SB 263 to become law would no longer allow us to rely in the State of Georgia [based] on the bedrock public finance principle of non-impairment,” adding that such a “de-annexation” would impair Capital One’s municipal bonds and “create new, unprecedented risks for existing holders and prospective purchasers of State of Georgia local debt.” Mr. Lewis last week also communicated to Georgia Municipal Association Executive Director Larry Hanson, whose organization is made up of 521 municipalities, that if enacted, the de-annexation would require all lenders to Georgia municipalities to “consider, and price in, the potential loss of security from future de-annexations,” because the legislation does not apportion Stockbridge’s outstanding debt: “GMA’s members would bear the burden of this new, Georgia-specific risk in the form of higher interest costs: “The uncertainty created by such a shift sets a dangerous precedent and could produce additional negative unintended consequences as lenders consider municipal financing opportunities within the state.”

Who’s on First? Chairman Rob Bishop (R-Utah) of the House Natural Resources Committee, the committee of jurisdiction for U.S. territories, yesterday confirmed he would got to Puerto Rico to meet with island leaders to assess the recovery in the wake of Hurricane Maria’s devastation, noting: “This trip will allow me to better understand the ongoing challenges and the emergency assistance that is still needed.” He is scheduled to meet with Puerto Rico’s non-voting Member of Congress, Jenniffer Gonzalez, as well as Chairman Jose Carrion of the PROMESA Board as part of an effort the Chairman described as a “first hand look at recovery efforts,” pointing out that, in his view, it would be irresponsible for Governor Rosselló, who apparently the Chairman had not advised of his visit, not to implement the government reforms ordered by the PROMESA oversight board—making clear the fiscal gulf between the two leaders, with the Governor observing that Chairman Bishop, with his demands in favor of a dialogue with creditors, seems to be supporting the causes of the territory’s municipal bondholders over the U.S. citizens of Puerto Rico.

Unlike chapter 9 municipal bankruptcy, wherein state laws create a process—where permitted—for a municipality; there are many fiscal chefs in the kitchen in Puerto Rico, with growing questions with regard to the limits of their respective legal authority under the PROMESA law. A key issue, the final decision with regard to the implementation of cuts to the pension system and the labor reform may yet take a few months. The fiscal stakes, however, especially on an island where there has been a steady stream of college graduates and young professionals moving to the mainland—leaving behind  disproportionate number of older, retired Puerto Ricans, increasingly creates a greater and greater fiscal imbalance. That is now front and center in the wake of the Board’s proposed 10 percent average reduction in pensions—a proposal Gov. Rosselló has rejected, but, as one commentator noted, it is the Board which holds all the cards. The challenge is in interpreting the PROMESA Board’s authority to use its fiscal plans to provide “adequate funding” to Puerto Rico’s public pension systems: under the proposed fiscal plan, the Board cut in pensions would not begin until FY2020—giving time for the PROMESA Board to submit to U.S. Judge Laura Taylor Swain a quasi-plan of chapter 9 debt plan of debt adjustment by the end of this year.

It is not that the Governor believes pension should be off the table—after all, he had recommended a 6% reduction last year; thus, there remains some chance that the government and the Board could reach an agreement and avoid the heavy costs of fighting the fiscal issues out before Judge Swain. Indeed, as we saw in San Bernardino, those back door negotiations between the government and creditors can save an awful lot in lawyers’ fees—or, as former U.S. Bankruptcy Judge Gerardo Carlo-Altier put it: “The ideal thing would be for the Board, the government, and the groups of creditors to reach an agreement in advance and go together to court.”

A key sticking point appears to be the Board’s insistence of labor reforms: under its proposed plan, the Puerto Rico Legislature should approve the labor reform by the end of this month, so that the seven-day reduction for vacation and sick leave would take effect immediately. The elimination of the protections against unjustified dismissal, the mandatory Christmas bonus, and work requirements for the Nutrition Assistance Program (NAP) are proposed for next January—with the PROMESA Board estimating that, absent the enactment of such labor reforms, including: such as employment at will, reductions in sick and vacation leaves, and non-mandatory Christmas bonus; the government of Puerto Rico would stop receiving $330 million within the next five years. They estimate another $ 185 million to cuts in pensions—all of which has led the PROMESA Board to project that, absent the adoption of the reforms proposed in the five-year fiscal plan, Puerto Rico’s economic growth and capacity to finance its public debt service would fail.

Who Will Govern? Are there too many fiscal cooks in the kitchen? In Central Falls, Rhode Island: there was one individual in charge of steering the small city, aka Chocolateville, out of bankruptcy. Similarly, in Detroit, Governor Snyder named Kevyn Orr as Emergency Manager—effectively suspending the governance authority of the Mayor and Council during the pendency of the city’s chapter 9 proceedings until U.S. Bankruptcy Judge Steven Rhodes approved Detroit’s plan of debt adjustment. Yet, in Puerto Rico—a territory which is neither a state, nor a municipality; there are a multiplicity of actors—including, now, Chairman Bishop, the Governor, the Legislature, and the PROMESA Board—a Board which Constitutionalist Professor Carlos Ramos González of the Inter-American University Law School believes, even given the power conferred upon it by Congress over Puerto Rico’s elected government, is uncertain with regard to its own authority to implement the structural reforms it favors—or, as he has noted: “Nobody wants to be blamed for cutting pensions: in all the chapter 9 municipal bankruptcy cases, there were pension reductions,” adding that, as we saw especially in the case of Detroit, the issue of equity is challenging: how to make those cuts without plunging many retirees into poverty—a problem of even greater resonance on an island experiencing an outflow of its young professionals, so that the demography already risks insufficient revenues to meet a clearly growing demand.  

Then there is a second challenge: while PROMESA appears clear in its grant of authority to the Board to certify the fiscal plan, it appears to lack any authority to implement it on its own. Unlike Central Falls, Detroit, San Bernardino, or other chapter 9 plans of debt adjustment approved by U.S. Bankruptcy Courts; the current PROMESA statute does not authorize a federal court to control Puerto Rico’s legislative process: there is a separation of powers issue.  Nevertheless, in the wake of the approval of the fiscal plan, the PROMESA Board is trying: it has submitted a preliminary labor reform draft to the Puerto Rico Legislature, where Senate President Thomas Rivera Schatz has invited PROMESA President José Carrión III to defend the proposed changes and cuts—an invitation, however, which has not been accepted.  

Former Governor Aníbal Acevedo Vilá, who lectures for a Separation of Powers class at the Law School of the University of Puerto Rico, finds it self-evident that the Legislature will not give way to the Boards proposed labor reforms, noting: “I think the Board has a very weak case in terms of imposing the labor reform. It has a better case in other measures, because they are directly tied to Puerto Rico’s fiscal crisis.” Similarly, Governor Rosselló usually quotes §205 of the PROMESA Act, which refers to the fact that the Board can make “recommendations to the Governor or the Legislature on actions the territorial government may take to ensure compliance with the Fiscal Plan, or to otherwise promote the financial stability, economic growth, management responsibility, and service delivery efficiency of the territorial government.” While Carlo Altieri adds to the debate §108, which, regarding the general powers of the Board, warns that: “Neither the Governor nor the Legislature may— (1) exercise any control, supervision, oversight, or review over the Oversight Board or its activities; or (2) enact, implement, or enforce any statute, resolution, policy, or rule that would impair or defeat the purposes of this Act, as determined by the Oversight Board.”

Indeed, an attorney for the Governor, Richard Cooper of Cleary Gottlieb, noted: “Congress did not grant the Board the power to pass laws or appoint or replace government officials…it left the government of Puerto Rico the capacity and responsibility to make the law (as long as it is consistent with the adopted fiscal plan and adjustment fiscal plan) and manage the government, with all that it entails.” Indeed, in an earlier ‘who’s in charge dispute,’ when the PROMESA Board tried to appoint a trustee to monitor the Puerto Rico Electric Power Authority (PREPA), alleging that PROMESA recognizes it as representative of the “debtor,” Judge Swain stated that no section of the PROMESA law granted the Board power with regard to the “the implementation of those (fiscal) plans and budgets,” instead comparing the statute Congress adopted in the 1990’s creating a fiscal control board over Washington, D.C. with PROMESA. She concluded that the Board has the task of establishing the “rails” for the “territorial government” to move “towards credibility and fiscal responsibility.” Indeed, the Congressional Record appears to make no reference to the power of the Board to impose structural governmental reforms—just as Congress lacks any authority to impose such on a state—especially in a nation where it was the states which created the nation, rather than vice versa. Rather, the Congressional debate on Puerto Rico reflected an emphasis on the power of the PROMESA Board to restructure the debt, which is the main burden of Puerto Rico—and, in Congress, Republicans and Democrats have expressed no interest in amending the act, either to strengthen or soften the powers of the Board.

For his part, Chairman Bishop believes that the act allows the Board to implement structural reforms and that it would be an irresponsible attitude of the Puerto Rican government to block them. That indicates there could well be intriguing fiscal and governmental discussions this weekend—albeit it seems most certain that, as Gov. Rosselló has made clear: “We are not going to allow an imposed Board to dictate the public policy of Puerto Rico.”

Notwithstanding their differences over the extent of the powers of the PROMESA Board, Gov. Rosselló and the Board are not at complete odds: they appear to have made common cause before regarding the case of Aurelius investment group and the Electrical Industry and Irrigation Workers Union, the main union of PREPA, to defend the constitutionality of the appointment of the Board members, because six of the seven were proposed by the Congressional leadership; rather, Gov. Rosselló’s administration has limited itself to challenging actions of the Board, not its existence—even as one of his predecessors, former Governor Acevedo Vilá, noting that, even under the colonial situation and the doctrine of Insular Cases decided a century ago by the U.S. Supreme Court, which has repeatedly validated the so-called “plenary powers” of Congress in Puerto Rico, the government of Puerto Rico must challenge the existence of the Board as a violation of the U.S. Constitution under the theory that “to the extent that Board has executive and legislative powers, even under the Insular Cases, it is unconstitutional,” adding that: “Even when organizing the territories, Congress has to guarantee a minimum system of separation of powers.”

The Puerto Rico Debt Tango. While the PROMESA Oversight Board and Gov. Rosselló are engaged in a complicated dance over future debt payments and policy, their complicated dance steps are not dissimilar: In successive versions of a fiscal plan that the Governor submitted to the Board in January, February, March, and last month; the Governor said the amount of debt Puerto Rico should carry should be determined through a comparison with debt medians in the 50 mainland states—quite similar to the Board’s certified plan.  Like the Governor’s proposed fiscal plans, the board certified plan has a comparison to the medians for the 50 states and to the 10 states with the highest levels of four measures of debt. The Board certified plan stated: “The implied debt capacity and expected growth in debt capacity in debt capacity must be sufficient to cover both the payments due on the restructured debt, and all payments due on future new money borrowings.” Accordingly, the aggregate debt service due on all fixed payment debt issued in the restructuring of the government’s existing tax-supported debt should be capped at a maximum annual debt service level: “The cap would be derived from the U.S. state rating metrics, and specifically what Moody’s [Investors Service] calls the ‘Debt Service Ratio.’” (The debt service ratio is defined as ratio of total debt payments due in a year divided by a state-government’s own source revenues.)

Under such a construct, it would appear that Puerto Rico could pay about $19 billion of the roughly $45 billion that the central government and its closely related lending entities owe, according to the plan’s exhibit 26. In the same exhibit, the PROMESA Board alternately suggests that one should use an average of a set of four measures of debt capacity and not just own-source revenues. Using this composite measure would mean that Puerto Rico should pay back about $10.7 billion in outstanding debt. But the Board plan notes this would be optimistic for a promised level of payments, rather, it reports, the fixed amount committed to should be cut by 10% to 30% to allow for “implementation risk.” It suggest that 20% should be used and the coupon be adjusted to 5%. These would lead to Puerto Rico committing to pay 19% of its debt—adding: “Any additional cash flow above the maximum annual debt service cap applied to the restructured fixed payment debt that is generated over the long-term from successful implementation of the new fiscal plan could be dedicated to a combination of contingent ‘growth bond’ payments to legacy bond creditors, debt service due on future new money borrowings needed to fund Puerto Rico’s infrastructure investments, and additional ‘PayGo’ capital investment to reduce the government’s historically out-size reliance on borrowing to fund its needs, among other purposes.”

The Uneven Challenges to Chapter 9 Recovery from Municipal Bankruptcy

Mayday, 2018

Good Morning! In this morning’s eBlog, we note the uneven recovery in Detroit from the largest chapter 9 municipal bankruptcy in American history.

An Absence of Fiscal Balance? In a new report by 24/7 Wall Street about the nation’s poorest urban regions, Detroit is ranked 5th, raising, the publication notes, the question why so many communities in such good times have been left fiscally behind. . The report — from 24/7 Wall St., a New York-based financial news organization — ranks the Detroit area at No. 5 in a list of impoverished communities. It also raises the question: During such good economic times, why are so many being left behind? While the report notes the seeming good times for the U.S. economy, it also reports that the share of Americans living below the federal poverty level ($25,100 for a family of four) has increased by nearly 10 percent since 2010. But of greater concern for state and local leaders, the concentration of poverty has also risen—or, as the report noted: “This increased concentration of poverty is far more pronounced in certain metropolitan areas: The share of poor residents living in extremely poor neighborhoods—defined as those with a poverty rate of at least 40%—climbed by more than 3.5% in 20 metro areas in the last six years.” That is, in a post-Richard Nixon era where the federal government no longer appears to believe it has a role in providing some fiscal equity, the report writes that the Detroit metro area has “long been the poster child for economic decline in postindustrial America.”

It appears we are in a state of fiscal disequilibrium, where no major municipality is any longer in chapter 9 municipal bankruptcy, and Detroit, emerging from the largest ever municipal bankruptcy and now a center of innovation again for the auto industry, with the city’s poverty rates having declined by more than 10% from 2015 to 2016—to its lowest rate in a decade. Nevertheless, with a poverty rate of 35.7% in 2016, the report found that an increasing share of residents in the metro region are, today, below the federal poverty level: 16.2%, putting the Motor City behind Bakersfield, Fresno, Springfield (Mass.), and Albuquerque, N.M. The report noted: “The share of poor residents living in extremely poor neighborhoods—defined as those with a poverty rate of at least 40%—climbed by more than 3.5% in 20 metro areas in the last six years: Such high-poverty neighborhoods are often characterized by high crime rates, low educational attainment rates, and high unemployment. Partially as a result, those living in these extremely poor neighborhoods are at a greatly reduced likelihood of success and upward economic mobility.”

The 24/7 Wall Street bears out Brooking’s 2016 report which defined the Detroit metro region (including Wayne, Oakland, Macomb, Livingston, St. Clair, and Lapeer) to have the highest rate of concentrated poverty among the most populous metro areas in the U.S. That is, in a nationally growing economy, one can, mayhap, better appreciate some of the appeal of President Trump, as there remains, in a growing economy, a large segment of the population unable to take advantage of the growing economy.

Part of it, of course, is that the issue of fiscal disparities is neither on the agenda of the President nor Congress.

Nevertheless, as our colleagues at Municipal Market Analytics note, Detroit’s exit from state oversight this week after shedding about $7 billion of its fiscal liabilities  “seems a bit fast, given the depths of the city’s challenges, and suggests that the state continues to value a narrative of quick rebound versus evidence that such can be sustained.” While MMA noted Detroit’s relatively conservative budgeting, small resulting surpluses, planning for the upcoming spike in pension payments, and decision to redeem $52M in recovery bonds; it noted the “the rising pension payments are a significant concern (even with funds set aside to temporarily smooth incremental costs) particularly when considered in conjunction with the city’s limited flexibility to address other potential events outside of its control such as reductions in federal or state aid, changes in federal policies that impact the economy in the state and/or nationally, and probably most concerning, an economic recession.”

Interestingly, MMA noted that were the Motor City’s recovery to stumble, the “potential for additional state intervention or aid is remote. Going forward, the city is likely on its own,” adding that, notwithstanding that the city has become an epicenter of the self-driving car industry; nevertheless,  this represents just a portion of the city and: “The rising living costs in these areas risks pushing existing residents out to more challenged neighborhoods, creating a greater income divide and worsening inequality. Notwithstanding the burgeoning economy in some pockets of Detroit, significant challenges remain across the vast city including horribly high poverty, crime, and poor educational outcomes. Detroit’s poverty rate is 39.4%, and only 13.8% have attained at least a bachelor’s degree.”

Phoenix Rises in Detroit!

April 30, 2018

Good Morning! In this morning’s eBlog, we recognize and celebrate Detroit’s emergence from the largest chapter 9 municipal bankruptcy in U.S. history.

More than three years since the Motor City emerged from the largest chapter 9 municipal bankruptcy in U.S. history, the Michigan Financial Review Commission is widely expected to act early this afternoon to vote on a waiver, after its Executive Director, Kevin Kubacki, had, last December, notified Gov. Rick Snyder of the city’s fiscal successes in holding open vacancies and reporting “revenues trending above the city’s adopted budget.” The city’s exit, if approved as expected, would restore local control and end state oversight of the City of Detroit. The expected outcome arrives in the wake of three consecutive municipal budget surpluses—something unanticipated for the federal government any year in the forseeable future. In the case of the Commission, Detroit’s fiscal accomplishment met a crucial threshold required to exit oversight: the Motor City completed FY2017 with a $53.8 million general fund operating surplus and revenues exceeding expenditures by $108.6 million—after recording an FY2016 $63 million surplus, and $71 million for FY2015. Michigan’s statute still requires the Review Commission to meet each year to grant Detroit a waiver to continue local control until the completion of 10 consecutive years.

In acknowledging the historic fiscal recovery, Mayor Mike Duggan noted that the restoration is akin to a suspension, as the oversight commission will not be active—but will remain in a so-called “dormancy period” under which, he said, referring to the Commission: “They do continue to review our finances, and, if we, in the future, run a deficit, they come back to life; and it takes another three years before we can move them out.”

On the morning Detroit went into chapter 9 bankruptcy—a morning I was warned it was too dangerous to walk the less than a mile from my downtown hotel to the Governor’s Detroit offices to meet with Kevyn Orr as he accepted Gov. Snyder’s request that he serve as Emergency Manager; Mr. Orr told me he had ordered every employee to report to work on time—and that the highest priority would be to ensure that all traffic and street lights were operating—and no 9-1-1 call was ignored. We sometimes forget—to our peril—that while the federal government can shut down, that is not an option for a city or county.  From the critical—to the vital everyday services, crews in Detroit have started cleaning 2,000 miles of residential streets, with Mayor Duggan’s office reporting that the first of three city-wide street sweeping operations is underway: each will take 10 weeks to complete.

The state oversight has, unsurprisingly, been prickly, at times: it has added levels of frustration to governance. For example, under the state oversight, all major city and labor contracts are delayed 30 days in order to await approval from the state. Nevertheless, with Detroit a vital component of Michigan’s economy, Detroit Chief Financial Officer John Hill had likened this oversight as a “real constructive process where the city has excelled.” Indeed, under the city’s plan of chapter 9 debt adjustment, Detroit had committed to shed some $7 billion in debt, while at the same time investing some $1.7 billion into restructuring and municipal city service improvements over a decade. In addition, the city had accepted the state fiscal oversight of its municipal finances, including budgets, contracts, and collective bargaining agreements with municipal employees. In return, the carrot, as it were, was that the state would assist by defraying cuts to Detroit retiree pensions and shield the Detroit Institute of Arts collection from bankruptcy creditors. The plan of debt adjustment also provided for relief of most public pension obligations to Detroit’s two pension funds through FY2023—after which Detroit will have to start funding a substantial portion of the pension obligations from its general fund for the General Retirement System and Police and Fire Retirement System.

Follow the Yellow Brick Road? While the Review Commission’s vote of fiscal and governing confidence for Detroit is a recognition of fiscal responsibility and accountability…and pride, the road of bankruptcy is steeper than for other municipalities—and the road is not unencumbered. Detroit is, in many ways, fiscally unique: more than 20 percent of its revenues are derived from a municipal income tax versus 17 percent from property taxes. That means the Motor City cannot fiscally rest: as in Chicago, city leaders need to continue to work with the state and the city’s School Board to improve the city’s public schools in order to attract families to move back into the city—a challenge made more difficult at a time when the current Congress and Administration have demonstrated little interest in addressing fiscal disparities: so Detroit is not competing on a level playing field.

In Michigan, however, the federal disinterest is partially offset by Michigan’s Revenue Sharing program, which, for the current fiscal year, provides that each eligible local unit is eligible to receive 100% of its eligible payment, according to Section 952 of 2016 PA 268. Therefore, if a city’s, village’s, or township’s FY 2010 statutory payment was greater than $4,500, the local unit will be eligible to receive a “Percent Payment” equal to 78.51044% of the local unit’s FY 2010 statutory payment. If a city’s, village’s, or township’s population is greater than 7,500, the local unit will be eligible to receive a “Population Payment” equal to the local unit’s population multiplied by $2.64659. Cities, villages, or townships that had a FY 2010 statutory payment greater than $4,500 and have a population greater than 7,500 will receive the greater of the “Percent Payment” or “Population Payment.

Unfortunately, since the Great Recession, local units of government have been hit with three major blows, all of which involve the state government. The first is the major decline in revenue sharing as the state struggled to balance its budget during the recession of 2007-2009. (Statutory revenue sharing declined from a peak of $684 million in FY 2001 to $210 million in FY 2012 and only recovered to $249 million by FY 2016. Total revenue sharing which fell from a peak of $1.326 billion in FY 2001 had only recovered to $998 million in FY 2016.)

Nevertheless, and, against seemingly all odds, it appears the civic pride created in this extraordinary challenge to recover from the largest chapter 9 in American history has given the Governor, legislature, and Detroit’s leaders—and citizens—a resolute determination to succeed.

Can the “City of Fog” Take the Fiscal Bulls by its Horns?

April 25, 2018

Good Morning! In this morning’s eBlog, we seek to understand the fiscal perspective in Puerto Rice from the municipal perspective, where a group of Mayors from the Popular Democratic Party are seeking to put together collaborative models in order to both achieve fiscal savings, and ensure the provision of essential services. The we jet West out of the rain to sunny San Bernardino, where voters in the post chapter 9 municipality are weighing candidates to lead the city through its plan of debt adjustment.

Taking the Fiscal Bull by the Horns. Cayey, Puerto Rico, is known as “La Ciudad del Torito” (town of the little bull), but also as “La Ciudad de las Brumas,” or the City of Fog. Founded in August of 1773, it is one of our nation’s oldest municipalities: its founder—and first Mayor, was Juan Mata Vázquez. The city’s name is also said to have been derived from the Taino Indian word for “a place of waters.” Located in Puerto Rico’s Central Mountain range, Cavey is surrounded by the Guavate, Jjome, Maton, La Plata, and Grande de Loiza rivers—and the Carite Forest Reserve, which offers more than 6,000 acres of protected parkland. The city is also home to Cayey University College, a branch of the University of Puerto Rico. The surrounding areas produces sugar, tobacco, and poultry—and cigars. Coca-Cola and Procter & Gamble have manufacturing facilities in Cayey. But Cayez’s Mayor—or Alcalde, Rolando Ortiz, is his own optimistic bull: it was, after all, just one year ago that he, together with the Mayors of Coamo (Juan Carlos García Padilla) Villalba (Luis Javier Hernández), and Salinas (Karilyn Bonilla) created what is now known as the Services and Permits Alliance, an innovative initiative through which they have managed to generate an increase of $105,000, and have reduced the approval period for municipal permits by 60 percent. Now, Mayor Ortiz reports: “The Fiscal Supervision Board (JSF) has just certified the different fiscal plans of the government agencies and those final determinations make the country in a position of starting, where Puerto Rico has to continue to seek solutions to the problems of Puerto Rican families,” with his remarks coming exactly one year after he met with his colleagues, the Mayors Juan Carlos García Padilla, of Villalba, Mayor Luis Javier Hernández; and Salinas Mayor Karilyn Bonilla, to create what is now known as the Services and Permits Alliance, an initiative through which they have managed to generate an increase of $105,000, and have reduced the approval period for municipal permits by a whopping 60%.

Their municipio coalition, in addition to the savings and efficiency of services, allows this unique coalition to have direct control over the development of infrastructure in their municipalities and protect those areas designated for agricultural use or the development of parks and public recreational areas. In addition, the agreement makes it easier for them to redirect the development to the areas of the urban centers—or, as Mayor Ortiz put it: “Development experts postulate that 70% of the world’s population has to move to live in cities in the coming decades, and cities have to temper that reality and have to organize their territories, their public spaces, in such a way that this mobilization to the urban centers can occur…This organization aims to organize the territory and have control of what is being built and what is developed from the point of view of planning and organization in each of our municipalities.” Mayor Bonillo added: “We have been able to comply with several of the goals we established when we established the service consortium, including that the services would be more accessible to citizens.” She added that the sharing of services would benefit efficiency, explaining that the consortium has a regional office in Cayey and satellite spaces in the remaining three towns—with a shared workforce of 15 employees—along with a technical staff of engineers, lawyers, planners, and inspectors to collaborate with the four City Councils. Or, as the Mayor put it: “He has given us a tool to all municipalities in the process of monitoring the construction taxes of all the permits that are located in each of our towns,” with a focus on four key objectives: accessibility, maximization of resources streamline the permit process and achieve new revenues. Indeed, it appears the model has been so effective that these municipal executives are already focused on the possibility of integrating the areas of Human Resources, Finance, and the Center for Municipal Revenue Collection, an integration that they hope to have completed in six months. Or, as Mayor Hernández explained: “What started as an alliance of permits…now takes another direction, an extension…today this success story is celebrated, but it is the beginning of many other alliances…the design of a platform that has been successful and that can serve as a model for other municipalities.”

Is There Mayoral Promise from PROMESA? The ambitions of the troika of Mayors comes in the wake of, last week, the PROMESA Board’s approval of a number of fiscal plans to be imposed upon Puerto Rico in efforts to address growth, revenue, expenditure, debt, and government reform—plans which some describe as mayhap “overly (and maybe recklessly) optimistic.” Our colleagues at Municipal Market Analytics, for instance, write that “while it is possible that, as the plan supposes, Hurricane Maria and subsequent aid-fueled rebuilding will leave the Puerto Rico economy stronger and larger than if there had been no storm, this should not be a baseline assumption. We note the island economy’s contraction despite decades of annual billion-dollar stimulus injections via deficit borrowing by Puerto Rico’s public entities. Further, with Maria highlighting the island’s increasing vulnerability to weather-related damage and climate change, MMA expects a material long-term reduction in corporations’ interest in locating facilities in Puerto Rico and a related drag on employment, all else being equal.” Writing that the PROMESA Board’s plans provide little margin for error, MMA worries of a potential slide back into bankruptcy. MMA also noted, as have we, that with so many fiscal cooks in the kitchen, and the Governor having already announced his dedicated opposition to any cuts in pensions or labor reforms, there appears little evidence of an overall change in Puerto Rico’s hunger for hard fiscal steps, such as would be required in a plan of debt adjustment.

A Taxing Imbalance. Perhaps demonstrative of the fiscal challenges of multiple cooks in the kitchen, Governor Ricardo Rosselló’s promised reduction of Puerto Rico’s Sales and Use Tax (IVU) in restaurants now appears to hang in the balance, because, according to the PROMESA plan, his government will be mandated to submit to the PROMESA Board quarterly reports on its budget to determine if the tax changes will remain or will be revoked: the Board’s conditions for approving any proposed tax reform join the list of demands that the Board had imposed on Puerto Rico last week: according to the plan, the tax reform must be revenue “neutral,” that is, it must be most unlike the federal tax reform passed by Congress and signed into law by President Trump. Moreover, under the plan, Puerto Rico will be mandated to carry out an annual so-called “fiscal responsibility test,” and submit an annual report which will be the reference to determine if any tax reduction may continue. According to the proposed fiscal plan, in the first two years of its implementation, incentives and subsidies granted through 17 laws will be eliminated or modified: for example, incentives to the film industry, reimbursements for the rum tax, credits, and incentives tied to affordable housing, the elderly, and the renewal of urban centers will be modified—with the Board plan claiming such changes would result in net savings of $123 million—or less than half the savings target announced by the government. Puerto Rico’s House plans to commence its public hearing process on tax reform next Wednesday.

A Sunny Post Chapter 9 Municipal Future? In San Bernardino, California, six Mayoral candidates on Tuesday offered their qualifications for the position, their plans to improve transparency and participation at City Hall and their vision for downtown before a number of citizens—but also an online audience: Mayor Carey Davis, Councilman John Valdivia, City Clerk Gigi Hanna, businesswoman Karmel Roe, general engineering contractor Rick Avila, and San Bernardino school board member Danny Tillman spoke about the city’s future, with Ms. Roe describing the post-chapter 9 municipality as “one big fix and flip,” describing the city as one which has the resources, money, and energy to cure its ails. Mr. Avila said he would run the city like a business and leave politics out of City Hall; while school board member Tillman explained his plan to increase outside investment by making San Bernardino safer and more visually appealing. Ms. Hanna, who has been twice elected to her current position, stated: “People know me, and people trust me…I have one of the largest Rolodexes in town, and I’m not afraid to use it.” Interestingly, the two veterans of the city’s long ordeal into and out of chapter 9 municipal bankruptcy, Mayor Davis and Councilmember Valdivia kept their distance while sharing their respective accomplishments as city leaders, with Mayor Davis touting his leadership in guiding the city through chapter 9 municipal bankruptcy, implementing a new city charter, hiring reputable city officials, and reducing crime—or, as he sought to frame his candidacy: “I’m a proven leader who delivers results.” Each candidate endorsed more participation in local government. Ms. Roe, a regular at City Council meetings, said she would be a “servant leader,” adding: “We cannot build this city divided.” Mr. Avila and Clerk Hanna noted San Bernardino’s negative reputation among prospective business owners, while School Board Member Tillman said the $30 million surplus Mayor Davis mentioned was not a surplus, but rather “money we haven’t spent on things we need.” Their presentations come as voters head to the primary election on Tuesday, June 5th, to select leaders for the city’s post plan of debt adjustment future.

 

The Fiscal Challenges of Exiting from Fiscal Oversight

April 23, 2018

Good Morning! In this morning’s eBlog, we return to Michigan to assess the unbalanced state of its municipal public pension and post-retirement health care obligations, before turning to the state’s largest city, Detroit, which appears to be on the brink of earning freedom from state oversight—marking the remarkable fiscal exodus from the largest chapter 9 municipal bankruptcy in American history. Then we return to Puerto Rico, a territory plunged once again into darkness and an exorbitant and costly set of fiscal overseers. 

Imbalanced Fiscal Stress. In the Michigan Treasury Department’s first round of assessments under a new state law, the Treasury reported that 110 of 490 local units of government across the state are underfunded for retiree health care benefits, pension obligations‒or both. That number is expected to increase. Nineteen municipalities in Wayne County, including Allen Park, Dearborn and two of the five Grosse Pointes (Farms and Woods), are behind on their retiree health care funding, the state says, as well as six Wayne County jurisdictions, including Redford Township, Trenton, Wayne and Westland are underfunded on both, as are Hazel Park, Oak Park, and Madison Heights in Oakland County. The state fiscal oversight effort to highlight the expanding obligations competing for scarce taxpayer dollars in the state which is home to the largest chapter 9 municipal bankruptcy in American history, the result of the state’s “Protecting Local Government Retirement and Benefits Act,” Act 202, which was enacted last December, marks a pioneering effort to put tighter local data to detect and assess the likelihood of severe fiscal distress—kind of a municipal fiscal radar—or, as Michigan Deputy Treasurer Eric Scorsone, who is the designated head of the State and Local Finance Group,  describes it: “By working together, we can help ensure the benefits promised by communities are delivered to their retirees and help ensure that the fiscal health of communities allows them to be vibrant now and into the future,” Eric Scorsone, deputy state treasurer and head of Treasury’s State and Local Finance Group, put it: “This is just a start. One of the common denominators of the financial crisis has been legacy costs. We know this is a big liability out there”—and it continues to grow for current and retired public employees, as well as their counterparts in public schools, whose districts are not covered by the new state law. In an era featuring longer lifespans, the unfunded liability of the Michigan Public School Employees Retirement System totaled $29.1 billion, or 40.3 percent, at the end of FY2015-16—an aggregate number, the likes of which have not been previously available at the municipal level. Now, under the new statute, a municipality’s post-retirement health care plan is deemed underfunded if its assets are “less than 40 percent” of its obligations, or require annual contributions “greater than 12 percent” of a jurisdiction’s annual operating revenues. A pension plan is deemed underfunded if it is “less than 60 percent funded,” or its annual contributions are “greater than 10 percent” of annual operating revenues. The new state mandates require the state’s panoply of cities, villages, townships, counties, and county commissions to report pension and retiree health care finances by the end of January. (Municipalities whose books close later could be included in future lists.) The aim is to underline the fiscal need to local elected leaders to do something the federal government simply does not do: reconcile reconciling long-term obligations with current contributions and recurring revenue—that is, not only adopt annual balanced budgets, but also longer term. The new state law, an outgrowth of the Responsible Retiree Reform for Local Government Task Force, is intended to enhance transparency and community awareness of local government finance, as well as to emphasize that failure to account for such obligations could negatively impact municipal bond ratings—effectively raising the costs of capital infrastructure. Indeed, as East Lansing City Manager George Lahanas stated last week, “The city’s pension plan was 80 percent funded in 2003 and is 50 percent funded today…The city has implemented numerous cost-controlling measures over the years to address the legacy cost challenges…City officials have identified that more aggressive payments need to be made moving forward to further address the challenges.”

Nevertheless, in one of the very few states which still try to address municipal fiscal disparities, the Michigan Senate General Government subcommittee met last week and reported (Senate Bill 855) its budget recommendations, including for revenue sharing, the subcommittee matched the Governor’s recommendation, which eliminate the 2.5% increase cities, villages, and townships received this year—a cut, ergo, of some $6.2 million for FY2019; the Senate version retained the counties current year 1% increase (which the Governor had also recommended removing) and added another 1% to the county revenue sharing line item—with the accompanying report language noting the increase was intended to ensure “fairness and stability” across local unit types, since counties do not receive Constitutional revenue sharing payments.  Estimates for sales tax growth related to Constitutional payments anticipate an additional 3.1% next year for cities, villages, and townships, distributed on a per capita basis. 

Moving into the Passing Lane? The Legislature’s actions came as the Detroit Financial Review Commission has approved the Motor City’s Four-Year Financial Plan, setting the stage for the city’s exit from direct state supervision as early as this month, enabling the city with the largest chapter 9 municipal bankruptcy in U.S. history to glimpse the possibility of exiting state oversight—or, as Detroit CFO John Hill put it:  “Today’s FRC approval of the City’s 2019 budget and plan for fiscal years 2020-2022, is another key milestone in the city’s financial recovery: It demonstrates the continued commitment of city leaders to prepare and enact budgets that are realistic and balanced now and into the future. It also demonstrates continued progress toward the waiver of active State oversight, which we expect will occur later this month.” The Commission is scheduled to meet at the end of this month for a vote to end state fiscal oversight, albeit the Commission would remain in existence, so that it could be jump started in the event of any reversal in the city’s fiscal comeback. Thus, Mr. Hill said there would likely be a memorandum of understanding between Detroit and the Commission to lay out the kinds of information the city would need to provide to the Commission for review, as he noted: “They still can at any time decide to change the waiver, although we hope and will make sure that doesn’t happen.” Mr. Hill noted that the now approved financial plan includes Mayor Mike Duggan’s budget for FY2019, as well as fiscal years 2020-2022—and that the Motor City now projects ending the current fiscal year with an operating surplus of $33 million: that would mark Detroit’s fourth consecutive municipal budget surplus since exiting from the nation’s largest ever chapter 9 municipal bankruptcy. He also noted that, as provided for under the city’s plan of debt adjustment, Detroit continues to put aside funds to address the city’s higher-than-expected pension payments, payments starting in 2024, when annual payments of at least $143 million begin. Payments of $20 million run through 2019 with no payments then due through 2023.

Unbalanced Budgets & Power–& Justice. Although they are still evaluating the impact that a new reduction of their budget would have, Puerto Rico’s Judicial Branch has expressed apprehension with regard to the PROMESA Board’s imposed cuts, with Sigfredo Steidel Figueroa, Puerto Rico’s Director of the Office of Court Administration, expressing apprehension: “At the moment, we are evaluating the impact that the proposals of the Fiscal Oversight Board, contained in the fiscal plan published yesterday, could have on the Judicial Branch,” referring to the Board certified plan of staggered cuts for the Judiciary—cuts of $31.9 million, rising to a cut of $161.9 million by 2023. He noted: “In the light of the measures already taken, any proposal for additional reduction to our budget is a matter of concern. Therefore, we will remain vigilant to ensure that the Judicial Branch has the resources it needs to ensure its efficiency and that any budgetary measures taken do not affect the quality of judicial services and the access to justice that corresponds to all the citizens and residents of Puerto Rico,” as he stressed that, “At present, even with the budgetary limitations of recent years, the Judicial Branch has managed to draw and execute the work plan defined by the presiding judge, Maite D. Oronoz Rodríguez, for an increasingly more judicial administration—one of efficiency, transparency, and accessibility.” He added:An independent and robust judiciary is essential to guarantee the legal security necessary for the stability and economic development of Puerto Rico.”

PROMESA Board Chair Jose Carrion, at the end of last week, issued a warning: “We hope the government and the legislature will comply. We don’t want to sue the government, but we have to fulfill the duties that we understand the law gives us.” That is to write that in this fiscal governance Rod Serling Twilight Zone, somewhere between chapter 9 municipal bankruptcy and hegemony; there is an ongoing question with regard to sovereignty, autonomy, and, as they would say in Puerto Rico, al fin (in the end): who is ultimately responsible for making decisions in Puerto Rico? We have a federal, quasi U.S. bankruptcy judge, a federal oversight board, a Governor, and a legislature—with only the latter two representing the U.S. citizens of Puerto Rico.

And now, in the midst of a 21st century exodus of the young and educated to Florida and New York, it appears that banks are joining this exodus—threating, potentially, to further not only isolate Puerto Rico’s financial system—a system in which the number of consumer banks has dropped by half over the past decade, and in which two of the largest, Bank of Nova Scotia and Bank of Santander SA, have been quietly shrinking—the challenge of governance and fiscal recovery as Puerto Rico seeks to emerge from recession and rebuild after last year’s Hurricane Maria, a small number of financial institutions could end up in charge of deposits and lending for its 3 million citizens. Poplar, Inc., First Bancorp/Puerto Rico, and OFG Bancorp, are cash rich and have many branches, but these financial institutions appear to have limited ability to facilitate trade beyond the Caribbean and Florida—and, as economist Antonio Fernos of the Interamerican University of Puerto Rico notes: “What would really be negative is if we lose access to the network of international banks.” The U.S. territory, once was an attractive place for banks to invest, with pharmaceutical manufacturing driving growth, meant that financial institutions entered and opened what had been scarce financing for everything from homes and cars to consumer electronics. However, as Congress changed the rules which had incentivized pharmaceutical companies to locate there—and as Congress moved to make it more attractive to provide shipping to other Caribbean nations, rather than the U.S. territory, many drug companies departed. Today, in the wake of a decade-long recession, Puerto Rico’s economy is 14% smaller, and the emigration of college graduates to the mainland appears to have accelerated—leaving behind the elderly and those who could not afford to leave—increasing a crushing public pension burden, while imposing greater fiscal burdens to serve an increasingly elderly and poor population left behind—and left with over $120 billion in debt and pension liabilities, and now, in then wake of Maria’s devastation, a spike in mortgage delinquency.