Returning from Municipal Bankruptcy

February 7, 2017

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

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

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

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

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

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

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

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The Raceway to Recovery

Taking the Checkered Flag. Detroit, on the verge of posting its third consecutive balanced budget, appears on course to exit state oversight as early as next year in the wake of yesterday’s Comprehensive Annual Financial Report (CAFR) demonstrating the Motor City has steadied its finances after emerging more than three years ago from the largest municipal bankruptcy in U.S. history. The state’s Detroit Financial Review Board could vote to waive its authority over the city as early as next month, according to Detroit Chief Financial Officer John Hill, who noted: “We believe we have met all the criteria for the waiver…I believe this will be the last budget that will be done under the FRC’s authority.” The CAFR, officially released Wednesday, appears to support the city’s hopes to soon regain full authority over its own finances: The report notes that Detroit ended its FY2017 with a $53.8 million general fund operating surplus and revenues exceeding expenditures by $108.6 million—even better than the city had originally projected: it ended its most recent fiscal year with a $63 million surplus—as well as a general fund unassigned fund balance of $169 million, better than 15% increase from the previous fiscal year, leading CFO Hill, as he prepares to present the results to the commission at a meeting later this month, to note: “It allows us to have a really good base of information as we are going into our budget process…It also gives us a chance to address some of the items that are identified as things we need to work on.” Mr. Hill added that Detroit has demonstrated vast improvements in its financial health, citing credit rating agency upgrades from rating agencies, a higher employment rate, and enhanced assessed property values: “I have to say that certainly there has been a positive impact from the financial review commission oversight: It’s been a real constructive process where the city has excelled.”

For his part, Mayor Mike Duggan noted that a third straight balanced budget proves his administration, in partnership with the City Council can “effectively manage the city’s finances: “This is another big step forward and helps set the stage for the end of the active state financial oversight,” as the Mayor preps to present the new budget later this month. Detroit Financial Review Commission member “Ike” McKinnon also credited the leadership role Mayor Duggan deserved for with getting the city’s finances back on track: “I remember when Mike Duggan took over as Mayor, we certainly had some hope and thoughts that things would happen…I did not know that it would happen this quickly. This says a lot about what he’s doing and certainly working with the state.”

The state’s financial review commission could vote to waive its authority over the city as early as next month, according to Mr. Hill. Zin any event, even if it does not, Detroit would no longer require the state board’s approval on budgeting or contracts, as it has since exiting chapter 9 municipal bankruptcy. As Mr. Hill put it: “We believe we have met all the criteria for the waiver…I believe this will be the last budget that will be done under the FRC’s authority.”

Key highlights of Detroit’s CAFR include the Motor City ending FY2017 fiscal year with a $53.8 million general fund operating surplus and revenues exceeding expenditures by $108.6 million. (The City had projected a $51 million surplus for FY2017). Detroit’s general fund unassigned fund balance will be $169 million, a $26 million increase from the previous fiscal year, according to the report. 

Detroit has also reported improvements in its management of $100 million in federal grants with no questioned costs resulting from audits, for the second consecutive year—after, two years ago, the city had federal funding for blight demolition funding suspended for two months due to procedural errors. Thus, hopes are high for the release from state oversight, albeit, concerns remain with regard to the looming 2024 pension payment and subsequent debt restructuring the following year. Mr. Hill notes: “I am sure that the FRC, as well as the city–because we are dealing with those issues, will be looking at those two items to make sure that plans are in place, money has been put aside, and the budget is able to absorb the additional costs that will come in those years.” Detroit is confronted by challenges to amortize debt payments on roughly $630 million of B notes that would see payments jump from $60 million to $120 million by 2025—notes issued as part of the implementation of Detroit’s chapter 9 municipal bankruptcy plan of debt adjustment—notes which are unsecured. Indeed, pending before the City Council is a proposal pending to dedicate $50 million from the city coffers to pay begin paying off the debt. Going forward, according to Mr. Hill, the strategy would be to dedicate a combination of restructuring some of the debt as well as paying it off, with the effort to address pension obligations a critical component to shoring up Detroit’s long-term fiscal health. The Motor City’s  long-term funding model approved by the City Council to modify its pension provisions which established the Retiree Protection Trust Fund, and deposited $105 million–$90 million from amounts reserved in FY2016 and 2017, plus $15 million appropriated in Fiscal 2018—and, for FY2018-2021 including the addition of an additional $115 million, contemplates another $115 million from FY2022–FY2023.

eBlog

February 2, 2017

Good Morning! In today’s Blog, we consider U.S. Judge Laura Taylor Swain’s decision to dismiss a number of claims from bondholders of Puerto Rican debt–a challenge pitting bondholders versus Puerto Rico’s ability to finance its utilities.

Judge Laura Taylor Swain yesterday dismissed a claim that several General Obligations (GOs) bondholders in Puerto Rico filed last year in the absence of payment from the government of Puerto Rico, setting back municipal bond insurers Assured Guaranty and National Public Finance Guarantee, which had sought to protect the collections that serve as a source of repayment to the debt of the Highway and Transportation Authority (ACT), dismissing suits filed by ACP Master, Aurelius Opportunities and others, as well as the claims of Assured and NPFG, ruling their claims were insufficiently ripe to be resolved. Judge Swain held that Puerto Rico’s special revenue bonds did not have to make payments to municipal bondholders during the quasi-chapter 9 municipal bankruptcy, in a Title III adversary proceeding filed by three bond insurers, holding that while the bonds may have liens on revenue, that was not the same thing as the right to receive payments during the Title III bankruptcy. Her decision came in relation to municipal bonds issued by the Puerto Rico Highways and Transportation Authority, the Convention Center District Authority, and Puerto Rico’s Infrastructure Finance Authority—a decision which Assured Guaranty, has said it will appeal to the U.S. Court of Appeals for the First District in Boston.

In each case, Judge Swain’s dismissal rulings occurred in relation to PROMESA’s §305, a section which appears to grant the government of Puerto Rico a shield exempting it from paying off the debt for the time being. Judge Swain wrote: “The federal courts do not have the power to issue advisory opinions when there is no dispute.” In this case, Aurelius and others had sued in the wake of the Board of Fiscal Oversight (JSF)’s invoking PROMESA’s Title III, the party of general obligation bondholders seeking a declaratory judgment and injunction remedy to, among other things, declare that the resources available from the U.S. territory’s Treasury should be devoted primarily to the service of the municipal debt, especially those subject to retention through the so-called “claw back” clause; the plaintiffs also alleged that the actions of the government and those of the JSF were contrary to the U.S. Constitution, particularly the confiscation clause. In her decision, Judge Swain wrote: “Decisions on abstract or isolated points that will primarily be useful in formulating or litigating other future elections that may or may not be are beyond the authorized scope of the declaratory (sentencing) relief,” adding that  Swain explained the government has not yet taken definitive action regarding the property rights that its creditors would have, the controversy is not mature to determine if it is a confiscation of goods. Further, Judge Swain noted that PROMESA Title III cases are barely in an initial stage, noting that “at this point, even, the content of the fiscal plan is subject to constant change after the devastating hurricane of September 2017.” Judge Swain added that she could not grant a remedy of declaratory judgment or interdict the creditors with regard to the use that the government gives to its collections, because since §305 forbids it, providing that “unless the Board consents,” or the debt adjustment plan “provides” it, the court may not by any order, decree or suspension, “interfere” with the political powers or powers of government of the debtor, nor with “any of the property or collections” of the debtor or with “the use and enjoyment of any property” which leaves income to the government, noting: “The Board has not consented to any of those remedies. 

Unequal and/or Inequitable Fiscal & Physical Responses

January 29, 2017

Good Morning! In today’s Blog, we consider the seemingly unending physical and fiscal challenges to Puerto Rico’s fiscal and   physical recovery.

Post Storm Fiscal & Physical Misery. Puerto Rico Gov. Ricardo Rosselló’s proposed privatization of the Puerto Rico Electric Power Authority faces opposition from local political leaders; thus, it may prove to be a tough sell to potential investors: the proposal, which the Governor has presented to privatize PREPA, the public utility burdened with some $8.2 billion of municipal bond debt—and the utility which the PROMESA Oversight Board has put into a Title III bankruptcy process, creating potential hurdles for any plan to alter its ownership, notwithstanding that Board members have expressed support for the idea. For his part, Puerto Rico House Minority Leader Rafael Hernández Montañez said he thought Governor Rosselló was seeking to distract people from his problems with his PREPA privatization proposal: “It’s a way of taking off the heat, on the re-energization of the houses and stores.” That is to write that the Gov. understands that neither the Puerto Rico House nor Senate will approve his proposal—so, Minority Leader Montañez asserts he is just posturing for public support, he said. Members of Gov. Rosselló’s own party in the legislature; moreover, appear to be opposed. Nevertheless, as part of the Title III PROMESA quasi-chapter 9 bankruptcy, parts of the utility appear certain candidates for sale–albeit, this would be a decision made by Judge Laura Taylor Swain—not Governor Rosselló.  

Moreover, there is apprehension that the Governor’s governance proposal would be unlikely to generate any support from investors, either: Tom Sanzillo, Director of Finance at the Institute for Energy Economics and Financial Analysis, noted: “We fail to see how any investor would put money into Puerto Rico with a regulatory system like that proposed by Gov. Rosselló: “He appoints and can fire board members at will. Under the current system, board members have staggered, fixed terms, and can only be fired for cause…This means the whim of every new Governor sets rules and contracts. This makes energy investing highly risky, contracts uncertain, and a politicized investment environment.” Indeed, Tomás Torres, Project Director at the Institute for Competitiveness and Sustainable Economy, believes the Puerto Rico Energy Commission’s oversight should be strengthened, and it should implement any transformation of PREPA.

Jose Rossi Coughlin, Chairman of the Institute for Competitiveness and Sustainable Economy has expressed apprehension about any interruption of key regulatory processes, much less permitting each new Governor to select all commission members when she or he assumes elected office—noting that is not only contrary to widely prevailing mainland U.S. practice, but also likely legally incompatible with Title V of PROMESA. For his part, Mr. Torres notes that with the Governor’s submission, last week, of a bill to eliminate the Energy Commission and substitute in its place a Public Service Commission (which would merge Telecom, Transportation & Public Services, and the Energy Commission), the “The three commissions/boards that are to be merged in this new body add to 15 commissioners, but the new boards will only be of three members…“The recently proposed Energy Commission reorganization and consolidation with other public service regulation would be a huge step backward.”

Moody’s Investor Service was not quite as pessimistic, writing: “The [proposed] privatization itself is positive, because it is another source of capital to help solve PREPA’s fiscal problems; however, there are still challenges; including negotiating a price in an environment of declining Puerto Rico population, investing in rebuilding aging infrastructure, and how PREPA’s pension liability will be handled. The 18-month timeline appears quite aggressive.” For its part, the PREPA Bondholders Group said they would support a “private operator” to “immediately” take over operations, subject to the Puerto Rico Energy Commission oversight. Indeed, in statement sent out by Gov. Rosselló’s office, some representatives of Puerto Rico’s business community indicated their support for the proposal, with Nelson Ramírez of the United Center of Retailers, noting: “The announced changes will allow Puerto Rico to become a competitive jurisdiction, ending a monopoly that discourages investment and the creation of jobs,” albeit, as Puerto Rico Senate Minority Leader Eduardo Bhatia Gautier said, the proposal was a step in the right direction but that “the devil is in the details.”  Leader Bhatia-Gautier, a co-founder and former editor of the Stanford Journal of Law and Policy, with previous service as a law clerk at the U.S. Court of Appeals for the First Circuit in Boston, as well as Chief of Staff for the resident Commissioner of Puerto Rico in the U.S. Congress, is the 15th president of the Senate of Puerto Rico, where he has focused on the U.S. Territory’s fiscal system and authored a comprehensive energy reform law. Now, he asserts that Puerto Rico’s electrical system should be decentralized into 20 to 25 micro grids, and believes that, with federal assistance, Puerto Rico should try for widespread installation of solar panels on rooftops. Nevertheless, as he notes: even though the Governor and the Puerto Rico legislature will privatize PREPA, the reality is that Judge Swain will have to be involved.

Power to the Muncipio? Jayuya Mayor Jorge L. González Otero, a muncipio founded in 1911, at a time it featured a population of around 9,000, was certain that power would be restored to close to 10,000 residents of his northwest coast municipality of around 88,000, on Saturday. Some 35% of residents in Arecibo do not currently have electricity, he reported, albeit, he said he had received word from PREPA that one of the region’s substations, Charco Hondo, would receive a generator from the U.S. Army Corps of Engineers to power a temporary micro grid while repairs on the substation continue. The muncipio, which, at its founding, was separated from the larger cities of the coasts with little to no communication: it was the site of the Jayuya uprising in 1950, in which the Nationalists commenced a revolt against the U.S. Government, when a social worker, Doris Torresola, and her cousins led the group into the town square and gave a speech, declaring Puerto Rico an independent republic. Subsequently, the police station was attacked, telephone lines cut, and the post office burned to the ground. The Nationalists held the town for three days, until it was bombed by U.S. planes, which were supporting a ground attack by the Puerto Rican National Guard. Even though an extensive part of the town was destroyed, however, news of the bombing was not reported outside of Puerto Rico. Today, unsurprisingly, the Mayor notes: “Four months is way too much time for people in Puerto Rico to not have energy. All of us, the representatives, the mayors, the people, the senators, have to raise our voices to get things done.”

In fact, last month, he had reached an agreement with PREPA to temporarily restore power by means of the micro grid: last Saturday, the Mayor planned to tour the substation with PREPA’s interim director, Justo González, as the generator was being installed. However, in another example of the dysfunction which has plagued Puerto Rico’s recovery, there was no sign of the generator, nor even PREPA’s interim director at the Charco Hondo substation—meaning thousands of Arecibo’s residents remained in darkness, just like nearly one-third of all Puerto Ricans: more than one million U.S. citizens—darkness wherein there is no remote contemplation of when power might be restored: a spokesperson for PREPA told BuzzFeed News that the U.S. Army Corps of Engineers was overseeing the project and providing the generator. A Corps spokesperson indicated that after a second inspection of the site, the Corps had determined there was too much damage to the nearby power lines to allow the generator to be safely switched on as planned; rather, he said contractors will “begin installing” the generator over the weekend, but that it will not become operational, albeit the Corps is unable to provide “definitive time” when it will.

Renogiaciones. The Fiscal Agency and Financial Advisory Authority reports that Puerto Rico’s decision to renegotiate its public debt will cost at least $ 800 million over five years, with FAFAA, relying on an expensive cadre of attorneys, consultants, and financial advisors who have been recruited as part of an effort to cobble together a quasi-plan of debt adjustment which would reduce more than $ 70 billion owed to  Puerto Rico’s bondholders—now the cadre has to translate its fiscal algorithms before Judge Swain’s courtroom. The document, however, fails to specify whether the plan incorporates the budget for either FAFAA or the PROMESA Oversight Board, much less the vast array of advisors and lawyers who have participated in voluntary negotiations, as in the case of the Government Development Bank (GDB)—not exactly as propitious beginning as, for the first time, there is to be an assessment of the actual costs of reducing or cancelling bondholders’ debts, albeit, already, some early estimates are that such costs could exceed $1 billion—the portion of which would redound to U.S. citizens of Puerto Rico, where, in comparison to the different mainland states, Puerto Rico falls far below the poorest mainland state, with 45% of its population living below the poverty line, would be most limited. Nevertheless, despite the seemingly endless process, and despite the PROMESA oversight, or quasi-chapter 9 plan of debt adjustment, there has been as yet, no agreement with any key creditor. Rather, in what many in Puerto Rico would deem noticias falsas, President Trump, last November, reported Puerto Rico was “doing well” and “it’s healing, and it’s getting better, and we’re getting them power, and all of the things that they have to have.” That was in sharp contrast with reality—or, as District Representative José “Memo” González Mercado, of Arecibo put it: “The reality is that we are U.S. citizens, but Donald Trump treats us as second-class citizens.”

Post-Chapter 9 Elections–and Post Physical & Fiscal Storms

November 6, 2017

Good Morning! In today’s Blog, we consider yesterday’s election results in municipalities we have followed through their fiscal stress or chapter 9 municipal bankruptcy, including: Flint, and Detroit, in its first Mayoral election since emerging from chapter 9, Then we turn to the historic municipality of Petersburg, Virginia—a municipality which avoided chapter 9 thanks to state intervention. Finally, we consider U.S. District Court Judge Laura Swain’s approval yesterday of an urgent motion from the government of Puerto Rico and the Fiscal Oversight Board (JSF) that requires all federal funds to be allocated for the tasks of assistance and recovery in the wake of Hurricane Maria, removing said funds from possible use in restructuring the U.S. territory’s restructuring of its public debt.

Visit the project blog: The Municipal Sustainability Project 

In Like Flint. Flint Mayor Karen Weaver yesterday prevailed over City Council member Scott Kincaid in a recall election involving 18 candidates, retaining the city’s proposed 30-year agreement with the Detroit water system, with Mayor Weaver prevailing by a 53-32 percent margin, according to the unofficial results. The recall had arisen from a controversy related to the Genesee County’s garbage contract: Mayor Weaver had pressed for an emergency trash collection contract with the former Rizzo Environmental Services in Macomb County over City Council opposition. The controversy arose because a former trash provider, Chuck Rizzo, and his father have reached plea deals with federal prosecutors and are expected to plead guilty this month for their roles in a wide-ranging public corruption scandal in Macomb County—a scandal which has, so far, led to criminal charges against 17 persons. The recall also came amid Mayor Weaver’s ongoing struggle with the Flint City Council with regard to the approval of a 30-year agreement with the Detroit area Great Lakes Water Authority—with City Council opposition arising from apprehension about increased water rates—and in response to last month’s decision by U.S. District Court Judge David Lawson taking the small city to task for failing to act on an April agreement supported by Mayor Weaver, the State of Michigan, and EPA which would have Flint remain on the Detroit area water system. Flint had been supposed to switch to the regional Karegnondi Water Authority; however, Mayor Weaver’s administration rejected that option, because updating of the Flint water treatment facility had been projected to cost more than $68 million and to consume more than three years to complete. The Flint Council had disregarded Judge Lawson’s decision, and approved a two-year extension of service with the Great Lakes Water Authority. Thus, while the prior agreement with the Detroit area water authority had lapsed, Mayor Weaver, the State of Michigan, the Great Lakes Authority, and other supporters have revived the agreement. Last week, the Michigan Department of Environmental Quality had filed an emergency motion asking Judge Lawson to approve giving Mayor Weaver the authority to sign the renewed contract by Election Day, because of the inability of the City Council to act—a request from the state which the Judge rejected; however, he has scheduled a hearing on the motion later this month.

Motor City Victory Lap. Detroit Mayor Duggan was re-elected yesterday by more than a 2-1 margin over challenger State Sen. Coleman A. Young II, son of a former Detroit Mayor. In remarks after the decision, Mayor Duggan  noted: “I have been treated with nothing but warmth and kindness from Detroiters in every neighborhood in the city…I hope that this is the year where we put us-versus-them politics behind us forever because we believe in a one Detroit for all of us.” His opponent, in conceding, claimed he had commenced a movement to help the politically dispossessed: “The campaign might be over, but the passion and values are eternal…We are the voice for the voiceless. We are the hope for the hopeless.” Mayor Duggan, who won a write-in primary campaign in 2013 and then defeated Wayne County Sheriff Benny Napoleon in the general election, thus became the Motor City’s first mayor to serve two terms since Dennis Archer in the 1990’s.  In his campaign, the former CEO of the Detroit Medical Center gained prominent endorsements from city labor unions, clergy, and business groups—he overwhelmed his opponent in fundraising: he secured about $2.2 million; whereas Mr. Young raised just under $39,000. Mayor Duggan, in his victory remarks, noted his campaign had focused on spending “time talking about the vision of what we are going to do in the next four years,” adding: “I thought one of the most profound things President Obama ever said was ‘If you have to divide people in order to get elected, you’ll never be able to govern.’”

In his campaign, Mayor Duggan touted public service improvements under his administration in the wake of the nation’s largest-ever municipal bankruptcy, including new streetlights, improved public safety response, and more dependable bus lines. He said he intends to continue work on building a more unified Detroit—focusing now on a series of efforts to fix up neighborhood corridors, roads, and sidewalks—and stating: “There are haves and have-nots in every city in America. We’re building a city here that it doesn’t matter where you start, you have the opportunity to be successful,” adding that he believe the greatest challenge now confronting Motor City residents will be over automobile insurance reform legislation—referring to legislation rejected by the Michigan House last week, but making clear he does not intend to give up: “We were a lot closer this time than we were two years ago, and we have a plan to get it through the next time: It’s going to be one relationship at a time, one vote at a time, but we’ve already had several meetings with both the medical and the legal community, and I think they realize we were three votes away.” 

The Road Out of State Oversight. The re-election comes at a critical time, as the City expects to have its full municipal fiscal authority restored next spring for the first time since it exited the nation’s largest ever chapter 9 municipal bankruptcy three years ago—challenging the city’s appointed and elected leaders with the task of resuming governance after the end of state oversight—and as the Mayor and Council resume authority over budgets and contracts. With two balanced budgets and an audit of a third expected next May, city leaders anticipate Detroit will be released early next year from the strict financial controls required under the city’s approved plan of debt adjustment—a key issue during the just completed campaign, where both the Mayor and his challenger had proposed plans with regard to how they would fiscally guide the recovering city—and as Michigan Governor Rick Snyder expressed optimism about the city’s ability to manage its finances, telling the Detroit News: “They’ve been hitting those milestones, and I hope they continue to hit them—that’s a good thing for all of us.”

Indeed, the Motor City’s credit rating has been upgraded; its employment rate is up; assessed property values are climbing. In its financial update last month, the city noted economic development in some neighborhoods and Detroit’s downtown, job creation efforts, and growth in multifamily home construction. Nonetheless, the road to recovery will remain not just steep, but also pot-holed: it confronts very large future payments for past borrowing and public pension obligations under the plan of debt adjustment—or, as our colleague Lisa Washburn of Municipal Market Analytics noted: “It really takes the economic environment to cooperate, as well as some very good and focused financial management. Right now, that seems to be all there…Eventually, I suspect there will be another economic downturn and how that affects that region, that’s something outside of their control. But it can’t be outside of their field of vision.”

Petersburg. In one of the most closely watched municipal elections in Virginia, last night, Gloria Person-Brown, the wife of the current embattled City Treasurer Kevin Brown of Petersburg, was trounced by former City Council member Kenneth Pritchett, with Mr. Pritchett winning by a large margin: he captured more than 70 percent of the vote. In his campaign, stating he had been frustrated by the city’s low credit rating, and by the city’s struggles with collecting revenue and timely payment of bills, Mr. Pritchett vowed he would implement policies and standardize internal controls to improve the office’s operations. Likely, in the wake of a Virginia state fiscal report last September—a report which scrutinized eight specific aspects of city governance and fiscal responsibilities—and contained allegations of theft involving Ms. Person-Brown’s husband, City Treasurer Kevin Brown. Some Council members then had called for his resignation, and even Ms. Person-Brown had distanced herself from her husband’s actions during the election, albeit she did not say he had done anything wrong. Rather she ran on a platform of improving the Treasurer’s services, including instituting more checks and balances, and calling for more accountability.

Stepping in to Help Puerto Rico. U.S. District Court Judge Laura Taylor Swain has approved, with various changes, an urgent motion from the government of Puerto Rico and the PROMESA Fiscal Oversight Board which mandates that all federal funds to be allocated to the country for the tasks of assistance and recovery due to the passage of Hurricane Maria may not be claimed in the process of restructuring the public debt, accepting to the request of the Authority for Financial Supervision and Tax Agency and the JSF during the general hearing held in New York City‒in which it emerged that, in part, the order would restrict the use of disaster assistance funds as a condition of the federal government, so that Puerto Rico can receive assistance: the order will establish that the Federal Emergency Management Agency (FEMA) funds for Puerto Rico following in the wake of Hurricane Maria, as well as funds granted by other federal agencies, will be maintained. Judge Swain granted the order after listening to the arguments of Suzanne Uhland, legal representative of AAFAF, as well as lawyers from municipal insurers and the organized group of General Obligations bondholders (GOs), who underscored the need to incorporate into the order transparency criteria and mechanisms to ensure that some entity such as the JSF has influence in how federal funds granted by the government will be used. Matthew J. Troy, the federal government’s representative in the case, told Judge Swain that to include specific language which would give the Puerto Rican government priority in claiming funds that had been misused by state agencies or public corporations in the Island was indispensable for Puerto Rico to receive funds from the federal government: as part of the order, it would be established that, in the event federal funds were misused, it will be up to the central government to claim these funds from the agency or public corporation which received them from the federal government. Judge Swain has scheduled a follow-up hearing for next Wednesday.

During the hearing, an attorney, Marcia Goldstein, pointed out that it is urgent to know what role if any the Junta de Supervisión y Administración Financiera for Puerto Rico (the JSF) will have with regard to the approval of the contracts for the recovery tasks. The PROMESA law establishes, among other things, that the federal agency has the power to review the contracts granted by the Puerto Rican government or the dependencies subject to the control of the JSF. To date, however, it is uncertain whether the JSF has examined or had influence in the process of hiring dozens of companies which would be responsible for multiple tasks, from infrastructure repair to the audit of federal funds. In an interview with the Puerto Rican El Nuevo Día a little over a week ago, House Speaker Paul Ryan (R-Wis.), in the wake of his visit to Puerto Rico, pointed out that the JSF will have a key role in defining the scope of the aid package that Puerto Rico would need and how such resources would be allocated.

Three Different Roads to Fiscal Recovery

November 6, 2017

Good Morning! In today’s Blog, we consider the next critical step in Detroit’s emergence from the largest chapter 9 municipal bankruptcy in U.S. history; then we consider the ongoing legal and fiscal recovery of Ferguson, Missouri, before, finally, trying to go to school in Puerto Rico.

Visit the project blog: The Municipal Sustainability Project 

The Road Out of State Oversight. The city of Detroit expects to get the keys back to its financial house this spring for the first time since it exited bankruptcy in 2014. The question is whether it can keep the house in order once state oversight ends — and local elected officials regain control over budgets and contracts. With two balanced budgets and an audit of a third expected in May, city officials anticipate they will be released early next year from the strict financial controls required under Chapter 9 restructuring. The shift is especially important as voters cast ballots Tuesday for the Detroit leaders who will chart the city’s direction. Both Mayor Mike Duggan and challenger Coleman Young II have offered plans on how they would guide the city financially. Gov. Rick Snyder said he is optimistic about the city’s ability to manage finances on its own. “They’ve been hitting those milestones, and I hope they continue to hit them — that’s a good thing for all of us,” Snyder told The Detroit News.

There is evidence that the oversight is no longer warranted: Detroit’s credit has been upgraded among rating agencies, its employment rate is up and property values are climbing. The city, in a financial update last month, noted economic development in some neighborhoods and Detroit’s downtown, job creation efforts and growth in multifamily home construction. Experts say bankruptcy allowed Detroit to drop billions in debt, setting it on a solid financial path. But the city faces massive future payments for past borrowing and pension obligations that are difficult to plan for. “It really takes the economic environment to cooperate, as well as some very good and focused financial management. Right now, that seems to be all there,” said Lisa Washburn, managing director of the Concord, Massachusetts-based firm Municipal Market Analytics. “Eventually, I suspect there will be another economic downturn and how that affects that region, that’s something outside of their control. But it can’t be outside of their field of vision.”

Post-oversight protections. The landmark municipal bankruptcy set forth strict conditions to help Detroit avoid falling back into debt. A nine-member commission, which under the law includes Duggan and City Council President Brenda Jones, currently signs off on the city’s four-year budget plan, certain contracts and transactions. It has also empowered to review, modify and approve operational budgets. The commission was established as a condition of a financial aid package approved by the state Legislature to defray cuts to Detroit retiree pensions and shield the Detroit Institute of Arts collection from bankruptcy creditors. There are still protections even if the city is released from oversight, Detroit officials note. The state-mandated commission would continue to meet monthly and could step back in if necessary, the city’s Chief Financial Officer John Hill said. The city would continue to hold revenue estimation conferences in February and September to set budgeting limits for each fiscal year, as well as develop a four-year financial plan. Detroit’s numbers are headed in the right direction when it comes to property values, income tax collection, median income and employment. Among the positives:

■The city’s taxable value is projected to climb by about $100 million, from $6.4 billion based on the taxable values from the end of the 2016 calendar year to $6.5 billion at the end of this year, according to data from the CFO’s office.

■The city projects an increase of about $30 million in its residential real estate — the first boost in the property class in almost two decades. Detroit’s level of owner-occupied homes went from a low of 59 percent in 2010 to a projected 74 percent in 2018, based on findings from the reappraisal, officials say.

■City figures show income tax collection has gone from $263.2 million in the 2016 fiscal year to a forecast of $285 million for 2017, based on unaudited figures.

■The city’s employment has gone up from 206,568 in January 2014 to 233,068 this July, according to labor statistics.

■Detroiters’ median household income was $28,099 in 2016, a 7.5 percent hike from the previous year, according to U.S. Census estimates released in September.

Not as encouraging are poverty and crime rates. The poverty rate has dipped 4 percentage points to 35.7 percent, Detroit’s lowest since 2008. But the rate is still the highest among large U.S. cities, as is the city’s violent crime rate. “You can’t ignore what’s happening in the downtown and Midtown, but Detroit is obviously so much bigger than that,” said Matt Butler, a vice president at Moody’s Investors Service and lead analyst for Detroit. “The real story here going forward is how is Detroit able to re-create that development in other areas of the city.”

The city filed for bankruptcy in the summer of 2013 and officially exited on Dec. 10, 2014, with a plan to shed $7 billion in debt and pump $1.7 billion into restructuring and city service improvements over a decade. Last month, Moody’s Investors Service upgraded Detroit’s credit outlook and praised the city for its gains. Detroit’s economy “remains vulnerable,” the report noted, but adds it “is showing real progress.” Detroit recorded a general fund surplus of just over $63 million in fiscal year 2016 and expects an additional surplus for 2017 of about $38.5 million. For 2015, the surplus was about $71 million. But Moody’s warns of economic unknowns that could pose future problems, namely the massive contributions that loom for its two pension funds.

A funding plan forged through Detroit’s bankruptcy coined the “grand bargain” relieved the city of much of those payments through 2023. But in 2024, the city 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. The initial payment was first contemplated at $113.9 million, but city officials later said estimates had been off, in part because of outdated mortality tables. If earnings meet the plan of debt adjustment’s assumed return rate of 6.75 percent, the city’s contribution in 2024 would be $167 million. If there are no earnings, it could soar to $344 million or more. Contributions to the pensions would be annual and could continue for 20-30 years. Investment returns have varied greatly. To minimize a shortfall, the city’s administration established a dedicated Retiree Protection Fund that’s expected to pull together $335 million in the coming years to help meet the required contributions. The City Council would contribute a dedicated amount from its general fund each year. So far, $105 million has been set aside. Moody’s has called the fund a “credit positive action,” noting, however, that once it’s depleted in 2033 the city will be required to fund annual pension payments directly from its budget.

Retooling debt structure. CFO Hill notes that today his greatest concern is restructuring the city’s debt, so, last month, the city solicited requests for proposals from investment banks which could help address debt tied to past capital borrowing and millages—or, as Mr. Hill put it: “We think revenues should increase, but if we can also deal with the structure of the debt and lower those payments then the city will be much better off,” said Hill, adding a plan, he said, would “set the city on the course to have dealt with two of its major challenges.” Indeed, the issue of the city’s debt and finance has been, unsurprisingly, an issue in the mayoral campaign, where Mayor Duggan, during a debate, said Detroit’s City Council has been rigorous in making sure that we “watch every dollar that we have,” and he expects the city will be released from state fiscal oversight this spring—adding that, under his administration, “We won’t ever lose self-determination again.” In response, his opponent, Coleman Young, counters that Detroit will not fully regain budget and contract authority back from the state; moreover, he vowed he would, if elected, find efficiencies and reduce costs—and cut what he deemed the “top heavy” staff to manager ratio, adding: “These are some of the things I am willing to do to make sure we have a balanced budget and our finances get back in order.”  “In theory, it would be great to have as much money plowed into redevelopment as possible, but that comes at a cost,” she said. “With less than seven years away from having to start making pension payments again, you don’t want to find yourself in a budgetary hole at a time when you can see it coming.”

Ferguson’s Steep Road to Recovery. Ferguson, Missouri, a small city of about 21,000, which in 2010 was 67.4% black, and 29.3% white, with 8,192 households of which 39.1% had children under the age of 18 living with them, and 31.5% had a female householder with no husband present—and where 32.9% were non-families, is a relatively young municipality: the median age in the city was 33.1 years, while 10.3% were 65 years of age or older. The gender makeup of the city was 44.8% male and 55.2% female. It is a city where the Mayor is directly elected (Mayor James Knowles ran unopposed in 2014 in an election where voter turnout was approximately 12%.) Ferguson is one of 89 municipalities in St. Louis County, where the county police have jurisdiction throughout. It is a city where the fatal police shooting of Michael Brown still weighs.

Last Friday, in Ferguson, as part of a street theater protest, activists set fire to a model depicting the Ferguson Commission report in front of City Hall: it was a demonstration intended to mock political leaders and the city police department’s response to crime and protests in the city. The demonstration came just two weeks after St. Louis police, using a technique called “kettling,” in which exits are blocked in and people are arrested en masse, arrested dozens of protesters, residents, journalists, and legal observers as people protested, for a third day, after former police officer Jason Stockley was found not guilty in the 2011 fatal shooting of Mr. Lamar–and after Mayor Lyda Krewson challenged the city to recommit itself to reforms laid out in the Ferguson Commission report—the nearly 200-page report which had proposed 189 “calls to action,” and marked the culmination of nearly 10 months of work for a commission established by former Gov. Jay Nixon in 2015, in response to the shooting death of Michael Brown, a black teenager, by a white Ferguson police officer—a report in which Commissioners grouped their post-Ferguson calls for action into three categories: Justice for All, involving urgent police and court reforms; Youth at the Center, exploring policies to promote better lives for children; and Opportunity to Thrive, laying out changes to address economic inequalities.

Regional leaders have largely focused on the “Justice for All” component of the report, overhauling municipal court practices such as jailing defendants who could not pay their fines, even as discussion has commenced on strengthening the Civilian Oversight Board, equipping police with body cameras, and developing police policies for using force and for handling public demonstrations. The report also called for improving the public’s relationship with law enforcement through community policing, by encouraging police departments to facilitate better interactions between officers and those they serve, and allowing the public to weigh in on programs and policies through forums. Starsky Wilson, the former co-chair of the Ferguson Commission, in a recent interview with the St. Louis Post-Dispatch, noted that while police accountability and reform has clearly been the starting point for those revisiting the Commission’s findings, he hoped elected leaders would not forget the aspects of the report devoted to building a better St. Louis for the city’s children: “It can’t just be about police. That’s just one piece of the puzzle.”

Nevertheless, the Ferguson protests appear to have produced changes, particularly in Ferguson itself, where new city and police leaders came into power. The state Legislature also passed a municipal reform statute, the most significant element of which lowered the cap on revenue from traffic tickets: It can now only make up 12.5 percent of a city’s general operating revenue in St. Louis County, and 20 percent elsewhere, down from 30 percent. Moreover, municipalities which fail to submit a timely and accurate report on their finances to the state auditor will immediately lose jurisdiction over their courts. (The previous law did little to punish the many courts that ignored the limits.) The impact was swift: Ferguson’s Municipal Court revenue plummeted from $2.7 million in 2014 to roughly $500,000 in 2016.

In St. Louis, Mr. Wilson cites several achievements, including the creation of a Civilian Oversight Board and the decision to raise the city’s minimum wage, both in 2015, though state lawmakers negated the wage effort this year. Meanwhile, other bills have been introduced to address some of the Ferguson Commission’s findings, including a measure being considered by the St. Louis Board of Aldermen limiting when St. Louis police could use pepper spray and tear gas. Sponsoring Alderman Megan Green, 15th Ward, reports she hopes it will serve as a starting point for officials to discuss revising the city’s vague ordinance against unlawful assembly. Asked what changes were made in the city police department in response to the Ferguson report, spokeswoman Schron Jackson said the St. Louis Police Department has begun training officers in de-escalation tactics and how implicit bias may affect their work, as well as how to work with victims of violence who are gay, transgender, and bisexual. These kinds of higher training standards were among recommendations laid out by the Ferguson Commission. Additionally, Ms. Jackson said, the department has launched its Community Engagement and Organizational Development Division, which carries out community outreach programs.

But Mr. Wilson questions these early efforts: “When we see police arrest more than 300 people over 18 days, then we have to ask how seriously the increased training requirements were implemented…and how much culture change is actually happening, around use of force: What were the lessons that were learned surrounding de-escalation?” Allegations that police have improperly used force in recent weeks have already prompted the ACLU to challenge St. Louis police tactics in federal court. They have also sparked conversations at the St. Louis Board of Aldermen about when force should be used—and who should investigate afterward. The aldermanic public safety committee has already interviewed Maj. Mary Warnecke, deputy Commander of the department’s Bureau of Professional Standards, and Circuit Attorney Kim Gardner. Attorney Gardner has pitched the formation of a new unit in her office to investigate use-of-force incidents and officer-involved shootings, arguing that it is no longer acceptable for police to be investigating themselves.

In the long-term, the Ferguson Commission recommended shifting deadly force investigations to the Missouri Highway Patrol and the state attorney general—a recommendation in response to which Gov. Eric Greitens said he was open to considering. City lawmakers, too, are exploring Attorney Gardner’s idea, crafting legislation expanding the circuit attorney’s prosecutorial powers and giving the office the ability to open investigations into police officers’ use of force, according to Board of Aldermen President Lewis Reed, who notes that events such as the Stockley verdict can be catalysts for change, if legislators work quickly enough: noting that the creation of a Civilian Oversight Board is proof of that. The Aldermen had attempted to institute an oversight board in 2006, but the bill, which included subpoena power, was vetoed by former Mayor Francis Slay. Ferguson finally opened the door for its creation, President Reed said, but subpoena power did not have the requisite support to make it into the final product. With the continued unrest, a new mayor and a more open-minded board, Mr. Reed sees a window of opportunity to revisit subpoena power: “I see a readiness for people now to step outside of what I would call their normal comfort zone and support efforts that probably in a normal state they would be a little more hesitant to support.” Mayor Krewson supports providing subpoena power to the city’s Civilian Oversight Board, which investigates complaints against police, and has said she agrees with community leaders who have demanded local police change how they handle use-of-force investigations and prosecutions. She also has committed to establishing a Racial Equity Fund, a proposed 25-year city fund dedicated to promoting racial equity in the region. “I know I don’t have the decision-making power across all of these things, but I am committed to adding my political will to the push to find the right way to get those things done,” Mayor Krewson said after the first week of protests over Stockley. One thing the Mayor says she has the power to do immediately is oust interim Police Chief Lawrence O’Toole, who declared police “owned the night” after law enforcement used a technique called “kettling” to surround and arrest more than 100 people on a single evening. She has shown no indication that she will act before the chief hiring process plays out.  “We have all the answers we need in the report. The road map exists. The longer (Krewson) chooses not to act, the longer our city hurts,” said Charli Cooksey, a catalyst with the Forward Through Ferguson advocacy group. ‘Not a short-term endeavor.’ There may be a long road ahead in making changes laid out in the report a reality, but leaders have pointed to some encouraging signs. Wilson says he has noticed a more diverse group of people engaging in disruption this time, suggesting that people understand the problems don’t amount to “black people’s issues” alone. “These are justice issues. Racial inequity harms the entire region and all people,” he said.

Forward Through Ferguson, the advocacy group that grew out of the Ferguson Commission, plans to knock on as many as 4,000 doors to get feedback before kicking off a series of policy campaigns next spring. “It’s not a short-term endeavor,” Ms. Cooksey said: “Diverse stakeholders in the region have to be committed to this for years to come.” But those inspired to run for office after the events of Ferguson, such as Rasheen Aldridge, a former Ferguson commissioner and now 5th Ward Democratic Committeeman, contend that new leaders have emerged at the state and local levels who have a better understanding of why young people have been protesting in recent weeks. “We have new people at the table, folks who are for the people, who haven’t been bought out and who haven’t been around for a while,” Aldridge said: “They’re willing to do the work.”

Learning about Fiscal & Physical Recovery. The Department of Education of Puerto Rico expects to open 80 percent of the 1,113 public schools on the island next Monday after having relaxed the criteria to enable the schools by the pressure of parents, mothers and students who demand a return to normalcy. Through twitter, the Department of Education published the list of schools that will open. The slowness in the process of resumption of classes on the island has been criticized by parents, educators, and even legislators who complain that six weeks after the passage of hurricane Maria on the island, only 152 schools have been opened (13 percent of the total) in the educational regions of San Juan, Ponce, Mayagüez and Bayamón. Groups of parents and teachers have held protests; the Federation of Teachers of Puerto Rico (FMPR) has called for a massive demonstration for November 9th to press for the opening of closed schools.  Members of the school community claim that many of the schools are able to operate, with water, no debris, or damage that poses a danger to students, but have not been opened. Even a mother of a special education student started a hunger strike against the DE in Hato Rey to demand that classes be resumed at the Urban Elementary School in Guaynabo, because the prolonged closure is having adverse effects on her child’s health: “Children of special education, when you take away their world, when you take away their school, you take away their therapies, you are leaving them unarmed. It is another hurricane that is reaching them: “I am seeing my daughter break down day by day, I am seeing my daughter who has started to attack herself, something that five years ago she did not do.”

The criticism focuses on the slowness of the work of the US Army Corps of Engineers and a company that contracted to inspect the schools and certify that they do not represent a danger to students and that they have water service, they are free of debris and fumigated. Most the the re-opened schools are without electricity: even the education unions FMPR and National Union of Educators and Education Workers (Unete) maintain that the limited opening of schools could be part of a supposed plan to close schools and eliminate teacher positions, something which had been happening before the impacts of hurricanes Irma and Maria, when Puerto Rico’s public education system had, after severe budget cuts, closed 167 schools—and suffered a decline of some 44,000 students. To date, some 800 schools which have been inspected, but there are still another 300—leaving Education Secretary Keleher to describe her frustration with the “slowness of the inspection process,” and that the Department will not use the Corps of Engineers or the CSA private firm for these works. The Secretary added that there are about 44 schools which will not open because of structural damage; she noted that for schools that will not open, “We are going to relocate that population or to bring them a temporary school, which is like a wagon.”

The Steep & Ethical Challenges in Roads to Fiscal Recovery

October 17, 2017

Good Morning! In today’s Blog, we consider the ongoing recovery in Detroit from the largest municipal bankruptcy in American history; then we turn to the Constitution State, Connecticut, as the Governor and State Legislature struggle to reach consensus on a budget, before, finally, returning to Petersburg, Virginia to try to reflect on the ethical dimensions of fiscal challenges.

Visit the project blog: The Municipal Sustainability Project 

The Motor City Road to Recovery.  The City of Detroit has issued a request seeking proposals to lead a tender offer and refunding of its financial recovery municipal bonds with the goal of reducing the costs of its debt service, with bids due by the end of next week, all as a continuing part of its chapter 9 plan of debt adjustment. The city has issued $631 million of unsecured B1 and B2 notes and $88 million of unsecured C notes. The bulk of the issuance is intended to secure the requisite capital to pay off various creditors, via so-called term bonds, 30-year municipal debt at a gradually sliding interest rate of 4% for the first two decades, and then 6% over the final decade, as the debt is structured to be interest-only for the first 10 years, before amortizing principal over the remainder of the term, with the city noting: “It is the city’s goal to alleviate the significant escalation of debt service during the period when principal on the B Notes begins to amortize, and that any transaction resulting from this RFP process be executed as early as possible in the first quarter of 2018.” According to Detroit Finance Director John Naglick, “Those bonds are traded very close to par, because people view them as very secure…Those bondholders feel really comfortable because they see the intercept doing what it was designed to do.” The new borrowing is the city’s third since its exit from chapter 9 municipal bankruptcy, with the prior two issued via the Michigan Finance Authority. Last week the city announced plans to utilize the private placement of $125 million in municipal bonds, also through the Michigan Finance Authority, provided the issuance is approved by both the Detroit City Council and the Detroit Financial Review commission, with the bonds proposed to be secured by increased revenues the Motor City is receiving from its share of state gas taxes and vehicle registration fees.

Fiscal TurmoilConnecticut Gov. Dannel Malloy yesterday released his fourth fiscal budget proposal—with the issuance coming as he awaits ongoing efforts by leaders in the state legislature attempting to reach consensus on a two-year state budget, declaring: “This is a lean, no-frills, no-nonsense budget…Our goals were simple in putting this plan together: eliminate unpopular tax increases, incorporate ideas from both parties, and shrink the budget and its accompanying legislation down to their essential parts. It is my sincere hope this document will aid the General Assembly in passing a budget that I can sign into law.” The release came as bipartisan leaders from the state legislature were meeting for the 11th day behind closed doors in a so far unrewarding effort to agree on a budget to bring to the Governor—whose most recent budget offer had removed some of the last-minute revenue ideas included in the Democratic budget proposal. Nevertheless, that offer gained no traction with Republican legislators: it had proposed cuts in social services, security, and clean energy—or, as the Governor described it: “This is a stripped down budget.” Specifically, the Governor had proposed an additional $144 million in spending cuts from the most recent Democratic budget proposal, including: nearly $5 million from tax relief for elderly renters; $5.4 million for statewide marketing through the Department of Economic and Community Development; $292,000 in grants for mental health services; $11.8 million from the Connecticut Home Care Program over two years, and; about $1.8 million from other safety net services. His proposed budget would eliminate the state cellphone tax and a statewide property tax on second homes in Connecticut, as proposed by the Democrats; it also proposes the elimination of the 25 cent fee on ridesharing services, such as Uber and Lyft, and it reduces the amount of money Democrats wanted to take from the Green Bank, which helps fund renewable energy projects. His proposal also recommends cutting about $3.3 million each year from the state legislature’s own budget and eliminates the legislative Commissions for women, children, seniors, and minority communities—commissions which had already been reduced from six to two over the past two years. The Governor’s revised budget proposal would cut the number of security staff at the capitol complex to what it was before the metal detectors were implemented—proposed to achieve savings of about $325,000 annually, and the elimination of the Contracting Standards Board, which the state created a decade ago in response to two government scandals—here for a savings of $257,000.

For the state’s municipalities, the Governor’s offer proposes phasing in an unfunded state mandate that municipalities start picking up the normal cost of the teachers’ pension fund: Connecticut municipalities would be mandated to contribute a total of about $91 million in the first year, and $189 million in the second year of the budget—contributions which would be counted as savings for the state—and would be less steep than Gov. Malloy had initially proposed, but still considerably higher than many municipalities may have expected. Indeed, Betsy Gara, the Executive Director of the Council for Small Towns, described the latest gubernatorial budget proposal as a “Swing and a miss: The revised budget proposal continues to shift teachers’ pension costs to towns in a way that will overwhelm property taxpayers,” adding that if the state decides to go in this direction, they will be forced to take legal action, because requiring towns to pick up millions of dollars in teachers’ pension costs without any ability to manage those costs going forward is ‘simply unfair.’” Moreover, she noted, it violates the 2008 bond covenant.

In his revised new budget changes, Gov. Malloy has proposed cutting the Education Cost Sharing grant, reducing magnet school funding by about $15 million a year, and eliminating ECS funding immediately for 36 communities. The proposal to eliminate the ECS funding would likely encounter not just legislative challenges, but also judicial: it was just a year ago that a Connecticut judge’s sweeping ruling had declared vast portions of the state’s educational system as unconstitutional, when Superior Court Judge Thomas Moukawsher ruled that Connecticut’s state funding mechanism for public schools violated the state’s constitution and ordered the state to come up with a new funding formula—and mandated the state to set up a mandatory standard for high school graduation, overhaul evaluations for public-school teachers, and create new standards for special education in the wake of a lawsuit filed against the state in 2005 by a coalition of cities, local school boards, parents and their children, who had claimed Connecticut did not give all students a minimally adequate and equal education. The plaintiffs had sought to address funding disparities between wealthy and poor school districts.

Nevertheless, in the wake of a week where the state’s Democratic and Republican legislative leaders have been holed up in the state Capitol, without Gov. Malloy, combing, line-by-line, through budget documents; they report they have been discussing ways to not only cover a projected $3.5 billion deficit in a roughly $40 billion two-year budget, but also to make lasting fiscal changes in hopes of stopping what has become a cycle of budget crises in one of the nation’s wealthiest states—or, as House Speaker Joe Aresimowicz, (D-Berlin) put it: “I think what we’ve done over the last few days has been a really good step forward, and I think we’re moving in the right direction,” even as Senate Republican Leader Len Fasano said what the Governor put forward Monday will not pass the legislature: “It is obvious that the governor’s proposal, including his devastating cuts to certain core services and shifting of state expenses onto towns and cities, would not pass the legislature in its current form. Therefore, legislative leaders will continue our efforts to work on a bipartisan budget that can actually pass.”

Getting Schooled on Budgeting & Debt. Even as the Governor and legislature appear to be achieving some progress, the Connecticut Education Association (CEA) is suing the state over Gov. Dannel Malloy’s executive order which cuts $557 million in school funding from 139 municipalities: Connecticut’s largest teachers union has filed an injunction request in Hartford Superior Court, alleging the order violates state law. (The order eliminates education funding in 85 cities and towns and severely cuts funding in another 54 communities.) The suit contends that without a state budget, Gov. Malloy lacks the authority to cut education funding. The municipalities of Torrington, Plainfield, and Brooklyn joined the initial filing. Association President Sheila Cohen noted: “We can’t sit by and watch our public schools dismantled and students and teachers stripped of essential resources…This injunction is the first step toward ensuring that our state lives up to its commitment and constitutional obligations to adequately fund public education.”

Governance in Fiscal Straits? Connecticut Attorney General George Jepsen has questioned the legality of Governor Malloy’s executive order, and Connecticut Senate Republican Leader Len Fasano (R-North Haven) noted: “I think the Governor’s order is in very serious legal trouble.” Nevertheless, the Governor, speaking to reporters at the state capitol, accused the CEA of acting prematurely: “Under normal circumstances, those checks don’t go out until the end of October…Secondarily, they’ll have to handle the issue of the fact that we have a lot less money to spend without a budget than we do with a budget…Their stronger argument might be that we can’t make any payments to communities in the absence of a budget. That one I would be afraid of.”

Municipal Fiscal Ethics? Forensic auditors from PBMares, LLP publicly went over their findings from the forensic audit they conducted into the City of Petersburg, Virginia’s financial books during a special City Council meeting. Even though the audit and its findings were released last week, John Hanson and Mike Garber, who were in charge of the audit for PBMares, provided their report to Council and answered their questions, focusing especially on what they deemed the “ethical tone” of the city government, saying they found much evidence of abuse of city money and city resources: “The perception that employees had was that the ethical tone had not been good for quite some time…The culture led employees to do things they might not otherwise do.” They noted misappropriations of fuel for city vehicles, falsification of overtime hours, vacation/sick leave abuse, use of city property for personal gain including lawn mowers and vehicles for travel, excessive or lavish gifts from vendors, and questionable hiring practices. In response, several Council Members asked whether if some of the employees who admitted to misconduct could be named. Messieurs Garber and Hanson, however, declined to reveal names in public, but said they could discuss it in private with City Manager Aretha Ferrell-Benavides, albeit advising the City Council that the ethical problems seemed to be more “systemic,” rather than individual, adding: “For instance, we looked at fuel data usage…And we could tell just looking at it that it was misused, though it would’ve cost tens of thousands of more dollars to find out who exactly took what.”

In response to apprehensions that the audit was insufficient, the auditors noted that because of the city’s limited budget, the scope of PBMares’ work could only go so far. Former Finance Director Nelsie Birch noted that the audit was tasked with focusing on several “troubling areas,” and that a full forensic audit could have cost much more for a city which had hovered on the brink of chapter 9 municipal bankruptcy. However, Mr. Hanson noted that while the transgressions would have normally fallen under a conflict of interest policy, such was the culture in Petersburg that the city’s employees either did not know, or were allowed to ignore those policies: “When I asked employees what their conflict of interest or gifts and gratuity policy is, people couldn’t answer that question because they didn’t know.”