The Thin Line Between Fiscal & Physical Recovery Versus Unsustainability.

eBlog

Good Morning! In this a.m.’s eBlog, we consider, Detroit’s remarkable route to fiscal recovery; then we turn to challenges to a municipality’s authority to deal with distress—or be forced into chapter 9 municipal bankruptcy in Pennsylvania, before returning to the stark fiscal challenges to Puerto Rico’s economic sustainability, and then the taxing challenge to Scranton’s efforts for a sustainable fiscal recovery.

Campaigning & Turning around the Motor City’s Fiscal Future. Detroit Mayor Mike Duggan, last week, at the annual Mackinac Policy Conference spoke about the racially divisive public policies of the first half of 20th century which, he said, had helped contribute to Detroit’s long slide into municipal bankruptcy—indeed, the largest municipal bankruptcy in U.S. history—but one which he said had helped lay the foundation for a conversation about how Detroit could grow for the first time in half a century without making the mistakes of the past that had, inexorably, led to an exodus of nearly 1.2 million from 1956 to its chapter 9 bankruptcy—noting: “If we fail again, I don’t know if the city can come back.” His remarks, mayhap ironically, came nearly a half century from the 1976 Detroit riot, a riot which  began downtown and was only curtailed after former U.S. President Lyndon Johnson ordered the 82nd and 101st Airborne Divisions to intervene, along with then Michigan Gov. George Romney ordering in the Michigan Army National Guard. The toll from the riot: 43 dead, 1,189 injured, 2,000 of the city’s buildings destroyed, and 7,200 arrests.  

But, rather than discussing or issuing a progress report on the city’s remarkable turnaround, Mayor Duggan instead spoke of the city’s racial tensions that had sparked that riot, in many ways, according to the Mayor, coming from the housing policies of former President Franklin Roosevelt—a policy which placed or zoned blacks in the city into so-called “red zones,” thereby creating the kind of racial tensions central to the 1943 and 1967 riots—a federal policy adopted in 1934 which steered federally backed mortgages away from neighborhoods with blacks and other racial minorities. Indeed, the Mayor quoted from a 1934 Federal Housing Administration manual that instructed mortgage bankers that “incompatible racial groups should not be permitted to live in the same communities;” the manual also instructed housing appraisers to “predict the probability of the location being invaded by…incompatible racial and social groups…, so that, as the Mayor added: “If you were adjacent to a minority area, your appraisal got downgraded.”

Thus, federal housing policies were a critical component contributing to the historic white and middle class flight from Detroit to its suburbs—suburbs where federal housing policies through the Federal Housing Administration subsidized more than half of the mortgages for new construction—or, as Mayor Duggan described the federal policies: “There was a conscious federal policy that discarded what was left behind and subsidized the move to the suburbs: This is our history, and it’s something we still have to overcome.” His blunt Mayoral message to the business community was that the city’s hisgtory of race and class segregation had to be acknowledged—or, as he put it: “I just wanted to deliver a message to the broader community to say, ‘Look, there’s a place for you to come invest in Detroit. Here are the ground rules, here is the reasoning behind the ground rules… and if you want to come in and invest in the city, move into the city and be part of it with the understanding that the recovery includes everybody, we’d love to have you: The African-American community voted for me, and I can’t tell you what an enormous responsibility that feels like.” Thus, the Mayor made clear that he and the Detroit City Council have been focused on governing mechanisms that ensure longtime Detroiters are not displaced by downtown and Midtown revitalization—enacting an ordinance mandating that housing developments in receipt of city tax subsidies have at least 20 percent of the units classified as affordable housing for lower-income residents, and mandating that 51% of the person-hours for construction of the new Little Caesars Arena be performed by Detroiters: “We’re going to fight economic segregation…It would be so easy in this city to have one area be all wealthy people and one area all poor people.”

The Challenge of Municipal Fiscal Recovery. Judge James Gibbons of the Lackawanna, Pennsylvania County Court of Common Pleas last week heard the City of Scranton’s preliminary arguments in response to a lawsuit by eight taxpayers seeking to bar the municipality from tripling its local services tax. The suit, filed March 2nd, contends that Scranton has been collecting taxes which exceed the legal issuance; it calls for the issuance of a mandamus against the city. In response, city attorneys, note that, as a home rule charter city, Scranton is not subject to the cap that Pennsylvania’s Act 511 stipulates. (The taxing legal and political regime, as we have previously noted, in one of the nation’s oldest cities, comes in the wake of its action to raise the levy from $52 to $156 for every person working within the city limits who earns at least $15,600, with the city justifying the action under Pennsylvania Act 47 and municipal planning code.) The taxpayer group, led by independent Mayoral candidate Gary St. Fleur, in seeking a mandamus action, has charged that lowering taxes across the board is the only way for the city to be able to fiscally recover.

Mr. St. Fleur, an independent candidate for mayor, has initiated a ballot measure to force 76,000-population county seat Scranton into chapter 9 municipal bankruptcy, citing a Wells Fargo report from October 2016, which found that a 2014 audit of Scranton revealed $375 million in liabilities and $184 million in unfunded non-pension post-retirement public pension benefits to government employees. (Mr. St. Fleur’s group, last February, had also objected to the city’s annual petition to the court to raise the tax—an objection rejected by visiting Judge John Braxton—a decision which, unsurprisingly, prompted the taxpayer group to initiate its own suit, notwithstanding that Scranton is a home-rule community, so that, in Pennsylvania, it has the authority to levy taxes.) Unsurprisingly, the anti-tax challengers’ attorney, John McGovern, counters that Act 511, which, when enacted 52 years ago, authorized the local Earned Income Tax, which authorizes municipalities and school districts the legal authority to levy a tax on individual gross earned income/compensation and net profits (the tax is based on the taxpayer’s place of residence or domicile, not place of employment) is separate from the Pennsylvania personal income tax. He charges that the Act has two “very specific” sections which cap how much the City of Scranton can tax, charging: “Call it a duck or a goose, call it a rate or a cap, but for the city to say it can tax whatever it wants, that alone is dangerous and absurd,” adding: “At this point, we’re dealing with 2017, and the city is spending like a drunken sailor…State law clearly states there is a cap to taxation through the Act 511 law…If we do not win, that would allow any city to raise taxes in any amount it wants.”

In contrast, David Fiorenza, a Villanova School of Business finance Professor and former CFO of Radnor Township, noted: “Scranton has made progress from three years ago, in part due to the renegotiating of some city union contracts and the low-interest rates on debt…The challenges this city will face will be the uncertainty of the state and federal budget as it relates to school funding and other funds that have been relied on for some many years.” Kevin Conaboy, whose firm is representing the city, told the court the city may raise its taxes under the state’s home-rule provisions, and he noted that Pennsylvania’s home rule provisions supersede a cap in the state’s Act 511 local tax enabling act. Moreover, Scranton city leaders have deemed the revenue increase essential for Scranton’s recovery under the state-sponsored Act 47 workout for distressed communities, to which Scranton has been subject since 1992.

Is the Bell Tolling for Act 47? The case is re-raising questions with regard to the effectiveness of the state’s municipal fiscal distress law, Act 47, a program which some critics charge has become an addiction rather than a cure. Villanova School of Business Professor David Fiorenza, referring to a 2014 change to the state enabling law, believes municipalities stay in the program for too long: “Act 47 is effective, but continues to present a problem as cities are able to request an extension after the five-year time period has expired…A five-year time frame is sufficient for a municipality to assess their financial situation and implement any changes. However, if the economy enters a recession during this time period, it will impede their financial progress.”

Physical & Fiscal Atrophy. Puerto Rico has lost two percent of its people in each of the past three years—but a two percent which in fiscal terms is far more grave from a fiscal perspective: the two percent, according to the insightful fiscal wizards at Federal Reserve Bank of New York, means that “If people continue to leave the island at the pace that has been set in recent years, the economic potential of Puerto Rico will only continue to deteriorate.” That outflow is comparable to 18 million Americans emigrating from the 50 states: it marks nearly a 12% drop: some 400,000 fewer Puerto Ricans today compared to 2007—meaning, increasingly, a U.S. territory entrapped in a fiscal tornado: unemployment is at 11.5%, so, unsurprisingly, the young and mobile are leaving the island behind. With unemployment at 11.5%, Puerto Rico in a quasi-chapter 9 municipal bankruptcy, federal law discriminating against the territory’s economy, and its municipalities unable to access chapter 9—the $74 billion accumulated debt and quasi-federal takeover has created incentives for more and more Puerto Ricans, from all economic levels, to leave—creating a vicious fiscal cycle of reduced government revenue, but ever-increasing debt: Puerto Rico’s municipal bond debt has grown 87 percent just since 2006—making the increasing obligations a further incentive to emigrate.

The PROMESA Board’s proposed plan to revert to fiscal sustainability does not appear to address the physical demographic realities: it assumes the population will shrink just 0.2 percent each year over the next decade, relying on that projection as the basis for its projections of tax receipts and economic growth—projections which Sergio Marxuach, Public Policy Director at the Center for the New Economy in San Juan, generously describes as: “[R]eally, really optimistic.” The harsh reality appears to be that the growing earnings disparity between Puerto Rico and the continental U.S. is so stark that any family focused on its health, safety, and financially viable future—in a situation of today where the Puerto Rican government has closed schools to save money—means that teachers can double or triple their earnings if they move to the mainland: doing that math adds up to younger generations of child-bearing age being increasingly likely to leave Puerto Rico for the mainland. Coming on top of Puerto Rico’s more than a decade-long population decline, it seems that, more and more, for those who can afford it, the option of leaving is the only choice—meaning, for those who cannot afford to—the Puerto Rico left behind could become increasingly older and less fiscally able to construct a fiscal future.

The Roads Out of and into Insolvency

Good Morning! In this a.m.’s eBlog, we consider Detroit’s remarkable route to fiscal recovery, before returning to the stark fiscal challenges to Puerto Rico’s economic sustainability.

The Road to Recovery from Municipal Bankruptcy. The Motor City, Detroit, ended its FY2016 fiscal year with a $63 million surplus, etching into the books the city’s second consecutive balanced budget out of  the nation’s largest ever chapter 9 municipal bankruptcy, an achievement officials hope will earn it better standing in the bond markets and a path out of financial oversight. Its new Comprehensive Annual Financial Report also discloses that, for the first time in more than a decade, the city did not have any costs scrutinized for its federal grant use. Nevertheless, despite hopes of a turnaround in a decades-long population decline, the most recent census data finds that Detroit lost population—0.5% or 3,541 persons in the latest U.S. Census estimates, the same number as last year, a year which marked the slowest rate of exodus in decades. While Mayor Mike Duggan has given special emphasis to the importance of population regrowth as a means of measuring the city’s economic recovery, his Chief of Staff, Alexis Wiley, notes: “We are pleased in the direction that we are heading…The data are a year behind.”

Indeed, measures of building permits, home prices, and 3,000 more occupied residences reported by DTE Energy in the city in March versus the same time a year earlier all appear to affirm that recovery is sustained, even though, based on data from July 1, 2016, Detroit has dropped down from 21st to 23rd in terms of size ranking amongst the country’s largest cities. (Last year, for the first time since before the Civil War, Detroit fell out of the top 20.) The City’s CFO, John Hill, reported Detroit’s FY2016 fiscal surplus was about $22 million higher than the city projected—a figure he attributed to improved financial controls, stronger-than-anticipated revenues, and lower costs due to unfilled vacancies—or, as he told the Detroit News: “We are operating in a very fiscally responsible way that we believe will have a lot of positive implications on the future.”

That fiscal upward trajectory matters, because, under the city’s plan of debt adjustment, Detroit must achieve three consecutive years of balanced budgets to exit oversight by the Financial Review Commission. Unsurprisingly, Mayor Mike Duggan noted: “This audit confirms that the administration is making good on its promise to manage Detroit’s finances responsibly…With deficit-free budgets two years in a row, we have put the city on the path to exit Financial Review Commission oversight.” Indeed, Detroit now projects a $51 million surplus in the 2017 fiscal year, which closes on the last day of June, according to CFO Hill—potentially paving the way for a vote by the review commission early next year to lift its direct fiscal oversight—freeing Detroit from the mandate of state approval of its budgets and contracts. The CAFR also notes $143 million in accumulated unassigned fund balances, including this year’s surplus—out of which the city has allocated $50 million to help set up the Retiree Protection Fund to help it deal with pension obligations, which will come due in 2024, as well as a matching $50 million for FY2018 for blight remediation and capital improvements. Even with that, $43 million remains in an unassigned fund balance, which city officials noted would carry over to the next fiscal year—with restrictions that none may be allocated without approvals from Mayor Duggan, the City Council, or the state review commission. Mr. Hill hopes the strong fiscal news will enhance the city’s credit rating and thereby reduce the cost of servicing its debt and capital budget.

What Constitutes Economic Sustainability? University of Puerto Rico interim President Nivia Fernandez, just hours before her arrest for failing to reopen an institution closed in the wake of a two-month student strike, has resigned, along with three members of the University’s Board of Governors in the wake of a judicial threat for her arrest if she failed to present a plan to end the student strike—a strike which commenced last March in protest of the $450 million in budget cuts sought by the PROMESA oversight board. Now there are apprehensions that strike could spread to other sectors—especially with Puerto Rico Gov. Ricardo Rosselló expected to release his proposed budget with deep cuts to programs today—a budget constructed in response to demands by the PROMESA Board for a structurally balanced budget. Those proposed cuts have provoked students to go on strike, leading to the closure at several of the university’s campuses since late March. Likely, the rate of civilian unrest will grow, or, as University of Puerto Rico sociology Professor Emilio Pantojas García has noted, the student strike may foreshadow a wave of demonstrations in coming months as Gov. Rosselló’s budget will almost certainly call for reductions in public pensions and health care—with the PROMESA Board calling for spending cuts and revenue increases in the coming fiscal year equal to nearly 11 percent of projected revenues for all central government activities—a proportion projected to increase to 28.8% by FY2022. Moreover, because the bulk of the revenue increases and spending cuts would impact the General Fund, the human and fiscal impact is expected to be much greater. University of Puerto Rico political science Professor José Garriga Pico notes: “In some, the opposition to the austerity measures will lead them to frustration and fear, as well as real suffering, and an intensification of the militancy against the Financial Oversight Board, its policies, Gov. Rosselló, and his budget proposal. These could engage in protest that may turn confrontation and violence.”

In the face of the Oversight Board’s demands for cuts at the University, Gov. Rosselló, last February, proposed a $300 million cut—leading to the resignations by the President of the University and 10 of its 11 rectors; subsequently, the PROMESA Board upped the ante, ordering the annual cut to be $411 million for the upcoming fiscal year, which starts next month—a cut of 44% compared to FY2015 appropriations—with the Board noting that out-year cuts will have to be deeper.  Yet the Board orders have put governance between a rock and a hard place: this spring a judge ordered then interim university President Nivia Fernández to submit a plan to reopen the main Rio Piedras campus; however, the Puerto Rico police department, claiming it would not act out of respect for the traditional autonomy of the University, provoked a judicial threat for Ms. Fernández’s imprisonment if she failed to comply—a threat obviated by her resignation, along with several members of the university board. Nevertheless, the judge, even after excusing Ms. Fernández from her prison sentence, maintained a $1,000 per day fine on the university until it opened operations—this, as the University, as of last February, had some $496 million in outstanding debt outstanding, according to the PROMESA board certified fiscal plan—and as Moody’s senior credit officer Diane Viacava, earlier this year, wrote that the government’s planned cuts for Puerto Rico were a “credit negative because they will be difficult for the university to absorb,” predicting that the university was likely to default on subsequent payments “absent a resumption of fund transfers to the trustees.”

How Does A City Turn Around Its Fiscal Future?

Good Morning! In this a.m.’s eBlog, we consider a state’s response to a municipal fiscal insolvency, before turning to the challenge the Windy City is facing in the virtually politically insolvent State of Illinois, before finally turning to the uncertain political, governing, and fiscal future of East Cleveland, Ohio.  

Addressing Disparate Municipal Fiscal Distress. More than a century ago, Petersburg, Virginia, was a highly industrialized city of 18,000 people—and the hub and supply center for the Confederacy: supplies arrived from all over the South via one of the five railroads or the various plank roads; it was also the last outpost. Today, it is one of the last fiscal outposts, but, mayhap, because of its fiscal distress, set to be a model for the nation and federalism with regard to how the Commonwealth of Virginia—unlike, for instance, Ohio, is responding. More than 53 percent of Virginia’s counties and cities have reported above-average or high fiscal stress, according to a report by the Commission on Local Government. Petersburg, a city grappling with a severe financial crisis, placed third on the state fiscal stress index behind the cities of Emporia and Buena Vista. Del. Lashrecse Aird (D-Petersburg) noted: “Petersburg does have some financial challenges, but they’re actually not unique. There are a lot of counties and localities within the commonwealth right now that are facing similar fiscal distressers.”  

The Virginia Legislature has dropped a proposed study of local government finances in its just completed legislative session, a legislative initiative which co-sponsor Rosalyn Dance (D-Petersburg) had described to her colleagues as necessary, because:  “Currently, there is no statutory authority for the Commission on Local Government to intervene in a fiscally stressed locality, and the state does not currently have any authority to assist a locality financially;” nevertheless, Virginia’s new fiscal year state budget did revive a focus on fiscal stress in Virginia cities and counties. Motivated by the City of Petersburg’s financial crisis, Sen. Emmett Hanger (R-Augusta County), who co-Chairs the Virginia Senate Finance Committee, had filed a bill (SJ 278) to study the fiscal stress of local governments: his bill proposed the creation of a joint subcommittee to review local and state tax systems, as well as reforms to promote economic assistance and cooperation between regions. Under SJ 278, a 15-member joint subcommittee would have reviewed local government and state tax systems, local responsibilities for delivery of state programs, and causes of fiscal stress among local governments. In addition, the study would have been focused on creating financial incentives and reforms to promote increased cooperation among Virginia’s regions. We will have to, however, await developments, as his proposal was rejected in the House Finance Committee, as members deferred consideration of tax reform for next year’s longer session; however, the adopted state budget did incorporate two fiscal stress preventive measures originally introduced in Sen. Hanger’s bill.

Del. Aird had identified the study as a top priority for this session, identifying: “what we as a Commonwealth need to do to put protections into place and allow localities to have tools and resources to prevent this type of challenge from occurring into the future,” noting: “I believe that this legislation will help address fiscal issues that localities are experiencing: ‘Currently, there is no statutory authority for the Commission on Local Government to intervene in a fiscally stressed locality, and the state does not currently have any authority to assist a locality financially.’” In the case of Petersburg, the city received technical assistance from state officials, including cataloging liabilities and obligations, researching problems, and reviewing city funds; however, state intervention could only be triggered by a request from the municipality: the state’s statutes forbid the Commonwealth from imposing reactive measures to an insolvent municipality.

To modify the conditions to enhance the ability of the state to intervene, the proposal set guidelines for state officials to identify and help alleviate signs of financial stress to prevent a more severe fiscal crisis, proposing the creation of a workgroup established by the Auditor of Public Accounts, who would have been responsible to create an early warning system for identifying fiscal stress, taking into consideration such criteria as a local government’s expenditure reports and budget information. In the event such distress was determined, such a local government would be notified and entitled to request a comprehensive review of its finances by the state. After such a review, the state would be responsible to draft an ‘action plan’ detailing: purpose, duration, and the requisite state resources for such intervention; in addition, the governor would be offered the option to channel up to $500,000 from the general fund toward relief efforts for the local government in need. As Del. Aird noted: “It is important to have someone who can speak to first-hand experience dealing with issues of local government fiscal stress: This insight will be essential in forming effective solutions that will be sustainable long-term, adding: “Prior to now, Virginia had no mechanism to track, measure, or address fiscal stress in localities…Petersburg’s situation is not unique, and it is encouraging that proactive measures are now being taken to guard against future issues. This is essential to ensuring that Virginia’s economy remains strong and that all communities can share in our commonwealth’s success.”

What Might Be a City’s Weakest Link? The state initiative comes as the city intends to write off $9 million in uncollected internal debt Petersburg has accumulated over the past 17 years: debt representing loans from Petersburg’s general fund to other city enterprises since 2000 which its leaders now concede they will never collect—or, as former Richmond City Manager—and now consultant for the city Robert Bobb notes: “This is something that the leadership should have addressed between 2000 and last year, but the issue was not being addressed.” As a result, when Petersburg officials receive the city’s financial audit for FY2017, it will show a negative fund balance that will make it even harder to secure financing for capital projects, albeit, it is expected to clear the uncollected debt from the books for the current fiscal year and the upcoming fiscal year—or, as Virginia Finance Director Ric Brown notes: “They’re taking it on the chin in FY2016 by clearing it all out of the books: To me, the most important thing is not how bad ‘16 is—it’s going forward whether FY2017 and FY2018 improve.” With its bond rating downgraded last year to BB with a negative outlook, Petersburg already faces a stiff fiscal challenge in raising capital—the municipality recently experienced an inability to raise capital to purchase police cars and fire equipment—making manifest the connection between public safety and assessed property values.

Nevertheless, Mr. Bobb has promised that this fiscal year will end without an operating deficit and the next one will begin with the first structurally balanced budget in nearly a decade—to which Secretary Brown notes: “It’s going to take some time, but I believe the sense of everyone is he’s making progress.” The Secretary noted that when the Commonwealth acted to come to Petersburg’s assistance last summer, he discovered the municipality had ended the fiscal year with $18.8 million in unpaid bills and $12 million over its operating budget; ergo, he testified the bottom line was “not going to be good” in the city’s FY2016 CAFR; however, Petersburg has worked in phases to pay its bills, reduce its costs, and rebuild its underpersonned, overwhelmed bureaucracy: The city has reduced its unpaid bills to $5.5 million, with the largest remaining obligation a $1.49 million payment to the Virginia Retirement System—a payment the city has agreed to pay by the end of December. The city’s school system has some $1.3 million in debt to its public retirement system due next month for teacher pensions. Nevertheless, in the school of lost and found, Mr. Bobb reports that city employees have scoured “every desk drawer” and discovered an additional $300,000 in unpaid bills, some of them dating back to 2015—unsurprisingly describing it as “[A] mess to clean up things from the past to where we are today.” Petersburg also has a gaping $1.9 million hole in the school system budget, in no small part by making payments this year to last year’s budget, a practice Mr. Bobb notes to be a [mal]practice the city has followed for 10 years—putting the city’s school budget near the minimum required by the Virginia Standards of Quality.

Nevertheless, Petersburg completed the first phase of recovery, focusing on short-term financing concerns, at the end of March. That has allowed it to focus on long-term financing and a fiscal plan, including developing policies for capital improvements, debt, and reserves to ensure financial stability. In the final stage, from July 1 until Mr. Bobb’s contract ends on September 30th, the city will develop five-year financial and capital improvement plans, as well as a budget transition plan, for ongoing financial performance and monitoring—as well as refilling the fiscal architecture via filling critical positions, including a finance director, which Mr. Brown notes, will be critical to filling middle management positions, such as accountants, which are vital to maintain the city’s financial stability: “If they don’t get that in place, there’s a real risk they’ll slide back.”

Petersburg wasn’t even at the top of the list of the most fiscally stressed localities ranked by the Virginia Commission on Local Government in 2014. It was third, behind Emporia and Buena Vista, and just ahead of Martinsville and Covington. “We’re only as strong as our weakest link,” said Sen. Rosalyn R. Dance, D-Petersburg, who served as the city’s mayor from 1992 to 2004. “We’re not the only ones there.”

Whither Chicago? The Windy City, nearly 350 years old, named “Chicago,” based upon a French rendering of the Native American word “shikaakwa,” from the Miami-Illinois language, is today defined by the Census Bureau as the city and suburbs extending into Wisconsin and Indiana; however, it is, today, a city experiencing population decline: last year it lost just under 20,000 residents—and its surrounding state, Illinois, saw its population decline more than any other state: 37,508 people, according to census data released last December. During the Great Recession, families chose to stay in or move to core urban areas, and migration to the suburbs decelerated; however, in the recovery, there is a reverse trend: families are deciding it is time to move back to the suburbs.

Thus, by most estimates, Chicago’s population will continue to decline, with the Chicago Tribune, from a survey of dozens of former residents, reporting the depopulation stems from reactions to: high taxes, the state budget stalemate, crime, the unemployment rate, and weather—with black residents among those leaving in search of safe neighborhoods and prosperity: it seems many are heading to the suburbs and warm-weather states: Chicago lost 181,000 black residents between 2000 and 2010, according to census data. Just under 90,000 Chicagoans left the city and its immediately surrounding suburbs for other states last year, according to an analysis of census data released in March, marking the greatest outflow since at least 1990. It appears that, more than any other city, Chicago has relied upon the increase in Mexican immigrants to offset the decline of its native-born population: during the 1990s, that immigration accounted for most of Chicago’s growth. After 2007, when Mexican-born populations began to fall across the nation’s major metropolitan areas, most cities managed to make up for the loss with the growth of their native populations, but that has not been the case for Chicago (nor Detroit, which, according to census data, realized a decline of 3,541 residents from 2015 to 2016). While Chicago’s changes may be small in context, they could be a harbinger of more losses to come.

As we had noted in our fiscal report on Chicago, Mayor Rahm Emanuel focused on drawing in new businesses, concerned that any perception that assessed property taxes might have to increase—or that schools and crime rates would not improve—would adversely affect companies’ willingness to come to Chicago—meaning an intense focus on confronting fiscal challenges: such as credit quality threats: e.g. avoiding having a disproportionate percent of the city’s budget devoted to long-term pension borrowing obligations instead of critical future investments: the more of its budget the city had to divert to meeting unsustainable pension obligations, the less it would have to address its goal of investments in the city’s infrastructure, schools, and public safety—investments the Mayor believed fundamental to the city’s economic and fiscal future.  We noted a critical change: Investing in the Future: Mayor Emanuel created enterprise funds so that a greater portion of municipal services were not financed through property taxes and the operating budget: some 83 percent of its budget was focused on schools and public safety, in an effort to draw back young families. Nevertheless, amid growing perceptions that Chicago’s cost of living has become too high, rising property taxes, and perceived growth in crime; some are apprehensive Chicago could be at a tipping point: the period in a city’s time when an increasing number of residents believe it is time to leave—or, as one leaver noted: “It’s just sad to see that people have to leave the city to protect their own future cost of living.”

Does East Cleveland Have a Fiscal Future? In the small Ohio municipality of East Cleveland, a city waiting on the State of Ohio for nearly a year to obtain permission to file for chapter 9 municipal bankruptcy, there is an upcoming Mayoral election—an election which could decide whether the city has a fiscal future—and where voters will have to decide among an array of candidates: who might they elect as most likely to turn the fortunes of the City around, and avert its continuing slide towards insolvency? One candidate, who previously served as Chairman of the East Cleveland Audit Committee, noted a report to the Council detailing twenty-four budget appropriations totaling approximately $2,440,076 in unauthorized and questionable expenditures—and that his committee had provided documentation to the Auditor of State’s Office of Local Government Services regarding the hiring of 10 individuals in violation of a Council-mandated hiring freeze, costing the City approximately $408,475 in unauthorized payroll costs, adding: “All told, the Audit Committee uncovered approximately $3,055,351 in illegal and suspicious spending by the Norton Administration…The truth is, as I stated in the beginning, the municipal government of East Cleveland is afflicted with the cancer of corruption that has been allowed to grow because of two main reasons: The first being, the indifference displayed by Ohio and Cuyahoga County government officials who failed in their respective responsibility when confronted with documented facts.  They collectively have turned a blind eye to what was, and is, happening in East Cleveland.  No one wants to get their hands dirty with so-called ‘black politics,’ even if the legal and financial evidence is given to them on a ‘silver platter.’  Personally, I smell the stench of secret political deals which produced a ‘hands off policy.’”

He added that a symptom of what he described as “this cancer” included some “$41, 857, 430 in unwarranted expenses and debt that was generated during the first 3 years of Mayor Norton’s first term as Mayor. I anticipate that whenever an audit is conducted for 2013 thru 2016, the $41 million figure will grow by an additional $25 million to $35 million.” Addressing the unresponsiveness of the State of Ohio, he described the Governor’s Financial Planning and Supervision Commission as a “joke:  It has been wholly unimpressive and has not provided the necessary oversight and forced accountability one would have expected from the Commission at the beginning.  Furthermore, The Commission became tainted when Governor Kasich appointed Helen Forbes Fields to the Commission.  She has a number of personal conflicts of interests that prevent her from being an impartial member of the Commission.  I can recall a conversation I had with the former Commission Chair, Sharon Hanrahan when she admitted to me that the State Government did not have the ‘political will’ to clean up the mess we were trying to get them to address.” He added, that, if elected, in order to bring accountability for the mismanagement of public funds, he would seek assistance from Ohio and federal law enforcement agencies to ensure those responsible for the mismanagement of East Cleveland’s financial resources would be held accountable, estimating that between $5 million and $15 million dollars could be recovered. 

A Hole in Puerto Rico’s Fiscal Safety Net: Should Congress Amend Chapter 9 Municipal Bankruptcy?

eBlog

Good Morning! In this a.m.’s eBlog, we consider the growing physical and fiscal breakdown in the U.S. Territory of Puerto Rico as it seeks, along with the oversight PROMESA Board, an alternative to municipal bankruptcy—but we especially focus on the fiscal plight of the territory’s many, many municipalities—or muncipios, which, because Puerto Rico is not a state, do not have access to chapter 9 municipal bankruptcy .   

Tropical Fiscal Typhoon. When former President Ronald Reagan signed Public Law 100-597, legislation authorizing municipal into law 29 years ago, no one was contemplating a U.S. territory, such as Puerto Rico—so that the federal statute, in coherence and compliance with the concepts of dual sovereignty, which served as the unique foundation of the nation, provided that a city, county, or other municipality could only file for chapter 9 if authorized by state law—something a majority of states have not authorized. Unsurprisingly, none of us contemplated or thought about U.S. territories, such as Puerto Rico, Guam, etc.: Puerto Rico is to be considered a state for purposes of the bankruptcy code, except that, unlike a state, it may not authorize its municipalities (and by extension, its utilities) to resolve debts under Chapter 9 of the code. Ergo, no municipio in Puerto Rico has access to a U.S. bankruptcy court, even as 36 of the island’s 78 muncipios have negative budget balances; 46% are experiencing fiscal distress. Their combined total debt is $3.8 billion. In total, the combined debt borne by Puerto Rico’s municipalities is about 5.5% of Puerto Rico’s outstanding debt.  

The fiscal plight of Puerto Rico’s municipalities has also been affected by the territory’s dismal fiscal condition: From 2000 to 2010, the population of Puerto Rico decreased, the first such decrease in census history for Puerto Rico, declining by 2.2%; but that seemingly small percentage obscures a harsher reality: it is the young and talented who are emigrating to Miami, New York City, and other parts on the mainland, leaving behind a declining and aging population—e.g. a population less able to pay taxes, but far more dependent on governmental assistance. At the same time, Puerto Rico’s investment in its human infrastructure has contributed to the economy’s decline: especially the disinvestment in its human infrastructure: a public teacher’s base salary starts at $24,000—even as the salary for a legislative advisor for Puerto Rico starts at $74,000. That is, if Puerto Rico’s youngest generation is to be its foundation for its future—and if its leaders are critical to local fiscal and governing leadership in a quasi-state where 36 of the island’s 78 municipalities, or just under half, are in fiscal distress—but, combined, have outstanding debt of about $3.8 billion; something will have to give. These municipalities, moreover, unlike Detroit, or San Bernardino, or Central Falls, have no recourse to municipal bankruptcy: they are in a fiscal Twilight Zone. (Puerto Rico has a negative real growth rate; per capita income in 2010 was estimated at $16,300; 46.1% of the territory’s population is in poverty, according to the most recent 2106 estimate; but that poverty is harsher outside of San Juan.) A declining and aging population adversely affects economic output—indeed, as former Detroit Emergency Manager Kevyn Orr who steered the city out of the largest municipal bankruptcy in U.S. history recognized, the key to its plan of debt adjustment was restoring its economic viability.

U.S. Supreme Court Justice Sonia Sotomayor, who is of Puerto Rican descent, has indicated there should be a more favorable interpretation of the law to make the system fairer to Puerto Rico: to allow the Commonwealth of Puerto Rico to create its own emergency municipal bankruptcy measures—something, however, which only Congress and the Trump administration could facilitate. It seems clear that Justice Sotomayor does believe Puerto Rico ought to be considered the equivalent of a state, i.e. empowered to create its own bankruptcy laws. However, as the First Circuit Court of Appeals has interpreted, Puerto Rico is barred from enacting its own bankruptcy laws: it is treated as a state—in a country of dual federalism wherein the federal government, consequently, has no authority to authorize state access to bankruptcy protection.

The Knife Edges of Municipal Bankruptcy

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Good Morning! In this a.m.’s eBlog, we consider the ongoing fiscal pipeline to the recovery for the City of Flint, the outcome of a Pennsylvania grand jury investigation of the near municipally bankrupt Pennsylvania capital city of Harrisburg, before addressing the .growing physical and fiscal breakdown in the U.S. Territory of Puerto Rico.

In Like Flint? The Michigan legislature has finally agreed to appropriate $20 million to make the requisite match in order for some $100 million in federal aid to go to the city, with the funds to be used to replace corroded pipes which leached lead into the city’s drinking water system, creating not just grave health repercussions, but also devastating the city’s assessed property values and public safety budgets. The city’s near insolvency, which had come in the wake of the decisions which lead to the water contamination by a gubernatorially appointed Emergency Manager, may mark one of the final chapters to the city’s physical and fiscal recovery.

A State Capital’s Near Bankruptcy. Pennsylvania’s capital city, Harrisburg, chartered as a city the year the Civil War commenced, which came close to filing for chapter 9 municipal bankruptcy, will, in its proposed budget for the upcoming fiscal year, follow a court-approved bankruptcy plan, with slightly more revenues than expenditures, except that the city does not expect to be able to hire police as fast as called for in its budget. At a workshop this week, the first of several planned before the City Council votes on the budget for FY2017-2018, the proposed plan proposes minimal increases in most departments, as total revenue is expected to climb to $119.86 million, an increase of about $7 million from last year. City Manager Mark Scott, in a memo to the Council prior to its consideration of the budget, wrote: “In developing our budget recommendations, it is obvious we do not have anywhere near the money we would like to have…Nor is that likely to change any time soon. We cannot expect to address our future by replicating our past. We will have different staffing than in the past and different service delivery expectation. Right now, we are budgeting to establish a solid base—meaning staff skill sets and new, efficient systems/processes.”

In the city, where taxpayers and residents, as well as city officials, consistently list public safety as a top priority, Harrisburg’s five-year plan to increase spending on police was a keystone of the city’s plan of debt adjustment, which was officially confirmed in February. Nevertheless, while the Police Department budget, at $72 million, meaning it is more than 60 percent of the total general fund budget, calls for a significant increase in hiring, and recruiting. City Manager Mark Scott, however, warned that the issue involves more than the budget: “We’re getting people into the academy as fast as we can,” as he advised he hopes the city to realize “a net increase of 18 officers by the end of the year.” Following a trend that began before the 2012 bankruptcy filing, the city again plans to have fewer employees than the year before. This year, however, that is primarily due to the new voter-approved city charter, which transfers sewer workers from the city to the independent Water Department: the new budget authorizes 746 positions, compared to 763 one year earlier.

Tropical Fiscal Typhoon. Puerto Rico, the insolvent U.S. territory, is trapped in a vicious fiscal and physical whirlpool where the austerity measures it has taken to meet its fiscal obligations to its creditors all across the U.S. have come at a steep fiscal and physical cost: some 30,000 public sector employees have lost their jobs, even as the nearly 75% increase in its sales and use tax has backfired: it has served to curtail shopping, adding to the vicious cycle of increasingly drastic fiscal steps in an effort to make payments to bondholders on the mainland—enough so that nearly 33% of the territory’s revenue is currently going to creditors and bondholders, even as its economy has shrunk 10% since 2006. Over this period, the poverty rate has grown to 45%, while the demographic imbalance has deteriorated with the exit of some 300,000 Puerto Ricans—mostly the young and better educated—leaving for Miami and New York. Puerto Rico and its public agencies owe $73 billion to its creditors, nearly five times greater than the nearly $18 billion in debts accumulated by Detroit when it filed for chapter 9 municipal bankruptcy four years ago in what was then the largest municipal bankruptcy in U.S. history. Now, with U.S. District Court Judge Laura Taylor Swain set to preside next Wednesday (Financial Oversight and Management Board of Puerto Rico, 17-cv-01578), we will witness a unique trial, comparable to those in Jefferson County, Detroit, Stockton, San Bernardino, etc.; however, here there will be differences compared to chapter 9, as there will be roles for both Puerto’s Rico, but also the PROMESA oversight board—with, presumably, both seeking a fiscal recovery, but unlikely to have comparable proposals with regard to the most appropriate and effective plan of debt adjustment. Perhaps the greatest challenge will be economic recovery: for Detroit, whose bankruptcy pales in comparison to Puerto Rico’s; Detroit was able to benefit from a constructive state role and an economy vastly boosted by the federal bailout of its gigantic auto industry. That contrasts with current federal laws discriminating against Puerto Rico’s economy vis-à-vis competitor Caribbean nations, and caught in a Twilight Zone between a state and municipality, with a stream of its young talent streaming to Miami and New York, leaving behind a demographic map of poverty, empty classrooms, and aging people—and dependent on sales taxes, but with sharp reductions in pensions almost certain to sharply and adversely affect sales tax revenues. Judge Taylor will require the wisdom and strength of Job.

Solomon’s Choices: Who Will Define Puerto Rico’s Fiscal Future–and How?

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Good Morning! In this a.m.’s eBlog, we consider the growing physical and fiscal breakdown in the U.S. Territory of Puerto Rico as it seeks, along with the oversight PROMESA Board, an alternative to municipal bankruptcy. 

Tropical Fiscal Typhoon. U.S. Supreme Court Chief Justice John Roberts has selected Southern District of New York Judge Laura Taylor Swain, who previously served as a federal bankruptcy Judge for the Eastern District of New York from 1996 until 2000 to preside over Puerto Rico’s PROMESA Title III bankruptcy proceedings—presiding, thus, over a municipal bankruptcy nearly 500% larger than that of Detroit’s–one which will grapple with creating a human and fiscal blueprint for the future of some 3.5 million Americans—and force Judge Swain to grapple with the battle between the citizens of the country and the holders of its debt spread throughout the U.S. (Title III of PROMESA, which is modeled after Chapter 9 of the Municipal Bankruptcy Code and nearly a century of legal precedent, provides a framework for protecting Puerto Rico’s citizens while also respecting the legitimate rights and priorities of creditors.) For example, the recent Chapter 9 restructuring in Detroit sought reasonable accommodations for vulnerable pensioners and respected secured creditors’ rights.

The action came in the wake of Puerto Rico’s announcement last week that it was restructuring a portion of its nearly $73 billion in debt—an action which it was clear almost from the get-go that the requisite two-thirds majority of Puerto Rico’s municipal bondholders would not have supported. (Puerto Rico’s constitution provides that payments to holders of so-called “general obligation” bonds have priority over all other expenditures—even as another group of creditors has first access to revenues from the territory’s sales tax.) More critically, Judge Swain will be presiding over a process affecting the lives and futures of some 3.5 million Americans—nearly 500% greater than the population of Detroit. And while the poverty rate in Detroit was 40%, the surrounding region, especially after the federal bailout of the auto industry, differs signally from Puerto Rico, where the poverty rate is 46.1%–and where there is no surrounding state to address or help finance schools, health care, etc. Indeed, Puerto Rico, in its efforts to address its debt, has cut its health care and public transportation fiscal support; closed schools; and increased sales taxes. With the Bureau of Labor Statistics reporting an unemployment rate of at 12.2%, and, in the wake of last year’s Zika virus, when thousands of workers who were fighting the epidemic were let go from their jobs; the U.S. territory’s fiscal conditions have been exacerbated by the emigration of some of its most able talent—or, as the Pew Research Center has noted:  “More recent Puerto Rican arrivals from the island are also less well off than earlier migrants, with lower household incomes and a greater likelihood of living in poverty.”

For Judge Swain—as was the case in Detroit, Central Falls, San Bernardino, Stockton, etc., a grave challenge in seeking to fashion a plan of debt adjustment will resolve around public pensions. While the state constitutional issues, which complicated—and nearly led to a U.S. Supreme Court federalism challenge—do not appear to be at issue here; nevertheless the human aspect is. Just as former Rhode Island Supreme Court Judge Robert G. Flanders, Jr., who served as Central Falls’ Receiver during that city’s chapter 9 bankruptcy—and told us, with his voice breaking—of the deep pension cuts which he had summarily imposed of as much as 50%—so too Puerto Rico’s public pension funds have been depleted. Thus, it will fall to Judge Swain to seek to balance the desperate human needs on one side versus the demands of municipal bondholders on the other. Finally, the trial over which Judge Swain will preside has an element somewhat distinct from the others we have traced: can she press, as part of this process to fashion a plan of debt adjustment, for measures—likely ones which would have to emanate from Congress—to address the current drain of some of Puerto Rico’s most valuable human resources: taxpayers fleeing to the mainland. Today, Puerto Rico’s population is more than 8% smaller than seven years ago; the territory has been in recession almost continuously for a decade—and Puerto Rico is in the midst of political turmoil: should it change its form of governance: a poll two months’ ago found that 57% support statehood. Indeed, even were Puerto Rico’s voters to vote that way, and even though the 2016 GOP platform backed statehood; it seems most unlikely that in the nation’s increasingly polarized status the majority in the U.S. Congress would agree to any provision which would change the balance of political power in the U.S. Senate.

Is There a PROMESA of Recovery?

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Good Morning! In this a.m.’s eBlog, we consider the growing physical and fiscal breakdown in the U.S. Territory of Puerto Rico as it seeks, along with the oversight PROMESA Board, an alternative to municipal bankruptcy, after which we journey north to review the remarkable fiscal recovery from chapter 9 municipal bankruptcy of one of the nation’s smallest municipalities.

Tropical Fiscal Typhoon. Puerto Rico is trapped in a vicious fiscal whirlpool where the austerity measures it has taken to meet short-term obligations to its creditors all across the U.S., including laying off some 30,000 public sector employees and increasing its sales tax by nearly 75% have seemingly backfired—doing more fiscal harm than good: it has devastated its economy, depleted revenue sources, and put the government on a vicious cycle of increasingly drastic fiscal steps in an effort to make payments—enough so that nearly 33% of the territory’s revenue is currently going to creditors and bondholders, even as its economy has shrunk 10% since 2006, while its poverty rate has grown to 45%. At the same time, a demographic imbalance has continued to accelerate with the exit of some 300,000 Puerto Ricans—mostly the young and better educated—leaving for Miami and New York. Puerto Rico and its public agencies owe $73 billion to its creditors, nearly 500% greater than the nearly $18 billion in debts accumulated by Detroit when it filed for chapter 9 municipal bankruptcy four years ago in what was then the largest municipal bankruptcy in U.S. history. Thus, with the island’s hedge-fund creditors holding defaulted municipal general obligation bonds on the verge of completing a consensual agreement earlier this week, the PROMESA oversight board intervened to halt negotiations and place Puerto Rico under the Title III quasi municipal bankruptcy protection. That will set up courtroom confrontations between an impoverished population, wealthy municipal bondholders in every state in the domestic U.S., and hedge funds—pitted against some of the poorest U.S. citizens and their future. Nevertheless, as Congress contemplated, the quasi-municipal bankruptcy process enacted as part of the PROMESA statute provides the best hope for Puerto Rico’s future.

Thus the PROMESA Board has invoked these provisions of the PROMESA statute before a federal judge in San Juan, in what promises to be a long process—as we have seen in Detroit, San Bernardino, and other cities, but with one critical distinction: each of the previous municipal bankruptcies has involved a city or county—the quasi municipal bankruptcy here is more akin to a filing by a state. (Because of the dual federalism of our founding fathers, Congress may not enact legislation to permit states to file for bankruptcy protection.) Unsurprisingly, when Puerto Rico was made a U.S. territory under the Jones-Shafroth Act, no one contemplated the possibility of bankruptcy. Moreover, as chapter 9, as authorized by Congress, only provides that a city or county may file for chapter 9 bankruptcy if authorized by its respective state; Puerto Rico inconveniently falls into a Twilight Zone—to write nothing with regard to access to such protections for Puerto Rico’s 87 municipalities or muncipios.

Moreover, while from Central Falls, Rhode Island to Detroit, the role of public pension obligations has played a critical role in those chapter 9 resolutions; the challenge could be far greater here: in Puerto Rico, retired teachers and police officers do not participate in Social Security. Adopting deep cuts to their pensions would be a virtual impossibility. So now it is that Puerto Rico will be in a courtroom to confront hedge funds, mutual funds, and bond insurers, after the negotiations between Puerto Rico and its creditors over a PROMESA Board-approved fiscal plan that allocates about $787 million a year to creditors for the next decade, less than a quarter of what they are owed, was deemed by said creditors to be a slap in the face—with the Board having pressed for a combination of debt restructuring spending cuts in its efforts to revive an economy trapped by a 45% poverty rate—and where the Board had proposed upping water rates on consumers, liquidating its decades-old industrial development bank, and seeking concessions from creditors of other government agencies. Moreover, amid all this, Gov. Ricardo Rosselló, who has recently renegotiated to mitigate politically unpopular fee increases on residents, now finds himself nearly transfixed between desperate efforts to sort out governance, meet demands of his constituents and taxpayers, and negotiate with a federally imposed oversight board, even as he is in the midst of a campaign for U.S. statehood ahead of a plebiscite on Puerto Rico’s political status—and in the wake of being named a defendant in a lawsuit by hedge funds after the expiration of a stay on such suits expired this week. Hedge funds holding general obligation and sales-tax bonds filed the suit on Tuesday, naming Gov. Rosselló as a defendant—albeit, the suit, and others, are nearly certain to be frozen, as the main judicial arena now will fall into a quasi-chapter 9 courtroom epic battle. And that battle will not necessarily be able to fully look to prior chapter 9 judicial precedents: while Title III incorporates features of chapter 9, the section of the U.S. bankruptcy code covering insolvent municipal entities, courts have never interpreted key provisions of Title III—a title, moreover, which protections for creditors which chapter 9 does not.

The Rich Chocolatey Road to Recovery! Moody’s has awarded one of the nation’s smallest municipalities, Central Falls, aka Chocolate City, Rhode Island, its second general obligation bond upgrade in two months, a sign of the former mill city’s ongoing recovery from municipal bankruptcy—an upgrade which Mayor James Diossa unsurprisingly noted to be “very important.” Moody’s noted that its upgrade “reflects a multi-year trend of stable operating results and continued positive performance relative to the post-bankruptcy plan since the city’s emergence from Chapter 9 bankruptcy in 2012,” adding that it expects the city will enhance its flexibility when its plan of debt adjustment period ends at the end of next month—at which time one of the nation’s smallest cities (one square mile and 19,000 citizens) will implement a policy of requiring maintenance of unassigned general fund reserves of at least 10% of prior year expenditures. In its upgrade, Moody’s reported the upgrade reflected Central Falls’ high fixed costs, referring to its public pension obligations, OPEB, and debt service–costs which add up to nearly 30% of its budget—and what it termed a high sensitivity to adverse economic trends compared with other municipalities, with the rating agency noting that a sustained increase in fund balance and maintenance of structural balance could lead to a further upgrade, as could a reduction in long-term liabilities and fixed costs and material tax-base and growth.