Addressing Municipal Fiscal Disparities

eBlog, 03/01/17

Good Morning! In this a.m.’s eBlog, we consider the dire stakes for Chicago’s kids if the State of Illinois continues to be unable to get its fiscal act together; then we admire the recent wisdom on fiscal disparities among municipalities in Massachusetts and Connecticut by the ever remarkable Bo Zhao of the Federal Reserve Bank of Boston.

Bad Fiscal Math.  Chicago Public School CEO Forrest Claypool Monday warned the public schools in the city could be forced to close nearly three weeks early and that summer school programs could be cut if the district does not receive a fast-tracked, favorable preliminary ruling from a Cook County judge in the near future, stating: “These possibilities are deeply painful to every school community.” Mr. Claypool, a former Chief of Staff to Mayor Daley, in an epistle to families with children in the city’s school system, warned the school year could end June 1st instead of June 20th without action; moreover, he noted that CPS’s summer school could be eliminated for all elementary and middle-school students, except those in special education programs, as he sought to increase pressure on Gov. Bruce Rauner and the Illinois legislature to help, warning success would depend on the courts or what has been billed as a “grand bargain” in the state capitol of Springfield to resolve Illinois’ record budget impasse. The CEO’s actions were not coordinated with Mayor Rahm Emanuel, who campaigned hard in his first term to extend the year for CPS students—a campaign in which the Mayor sought to reverse what we had termed as a “time bomb,” how to reverse the tide of an exodus of 200,000 citizens and make the city a key demographic destination for the 25-29 age group—i.e., meaning a critical commitment to public schools and safety. Now the state’s inability to act on a budget threatens both: the city’s School Board earlier this month accused the state of employing “separate and unequal systems of funding for public education in Illinois” in its lawsuit filed against both Gov. Rauner and the Illinois State Board of Education, describing its suit as the “last stand” for a cash-strapped district which is “on the brink,” seeking to have Judge Franklin Ulyses Valderrama of the Cook County Chancery Division issue a preliminary injunction which would prevent the state from “continuing to fund two separate but massively unequal systems of education,” noting it intends to present its case for an injunction to the court on Friday. In addition to seeking judicial relief, the System, in its judicial filing, noted that reductions in summer school programs and the academic year could save about $96 million; however, a shortened school year could violate Illinois state requirements with regard to the length of the public school year.

Without any doubt, the threatened disruption is undermining the trust of teachers, students, taxpayers, and parents with regard to the system’s future—brought on here by the awkward math of Gov. Rauner’s veto last December of a measure which would have provided CPS with $215 million in state aid—a measure the Governor argued was contingent on Democratic leaders agreeing to broader state public pension reforms. The ante was upped further at the beginning of the week, when Illinois Secretary of Education Beth Purvis said that instead of threatening cuts to the school year, CPS should focus on pushing legislation to overhaul the state’s education funding formula, stating: “I hope that they would really look seriously at not cutting days from the school year…I think people need to understand that the CPS board adopted a budget with a $215 million hole in it. Why is the governor being held responsible for that instead of the CPS board?” Even as the city sought to pressure the state, however, the Chicago Teachers Union this week issued a statement accusing Mayor Emanuel and the school board of playing politics instead of turning to solutions to help schools such as raising taxes, with union President Karen Lewis stating: “The Mayor is behaving as if he has zero solutions is incredibly irresponsible…Rahm wants us to let him off the hook for under-funding our schools and instead wait for the Bad Bargain to pass the Senate or [Gov.] Rauner’s cold, cold heart to melt and provide fair funds.” For those kids imagining an earlier summer break, CEO Claypool would not say when the district would make a final decision to shorten the school year, noting: “We think it would be wrong to prematurely set a final date for a decision when we still have the opportunity to prevent a shorter school year.”

Revenue Sharing. Bo Zhao, the extraordinary writer for the Boston Federal Reserve who authored the very fine piece: “Walking a Tightrope: Are U.S. State and Local Governments on A Fiscally Sustainable Path?” has now completed another piercing study regarding municipal fiscal disparities: “From Urban Core to Wealthy Towns,” looking at fiscal disparities amongst municipalities in Connecticut, and comparing state policies and practices there with Massachusetts, noting: “Fiscal disparities occur when economic resources and public service needs are not evenly distributed across localities. There are equity concerns associated with fiscal disparities. Using a cost-capacity gap framework and a newly assembled data set, this article is the first study to quantify non-school fiscal disparities across Connecticut municipalities. It finds significant non-school fiscal disparities, driven primarily by the uneven distribution of the property tax base while cost differentials also play an important role. State non-school grants are found to have a relatively small effect in offsetting municipal fiscal disparities.

Unlike previous research focused on a single state, this article also conducts a cross-state comparison. It finds that non-school fiscal disparities in Connecticut are more severe than those in Massachusetts, and non-school grants in Connecticut are less equalizing than those in Massachusetts. This article’s conceptual framework and empirical approach are generalizable to other states and other countries.” Writing that his is the first article to quantify non-school fiscal disparities across the Nutmeg State, he notes they are “driven primarily by the uneven distribution of the property tax base, while cost differentials also play an important role,” as he assesses fiscal disparities amongst the state’s 169 municipalities, writing: “There is recent evidence that this longtime state neglect may have exacerbated non-school fiscal disparities…If state aid formulae are based only on local revenue raising-capacity and ignore cost disparities, they would not fully offset fiscal disparities.” This leads him to note: “Urban core municipalities exhibit the highest average per capita cost, mainly because they have the highest unemployment rate and population density, and the most jobs per capita…This means that nearly one-fifth of Connecticut residents live in the highest cost environments.” In contrast, he notes that “wealthier-property rural towns have the lowest average per capita municipal cost—more than 25 percent lower than the urban core municipal cost.” A key part of the fiscal challenge, he writes, is that in the state, the property tax is the only “tax vehicle authorized for municipal governments and virtually the only own-source revenue available to support the local general fund,” adding that the property tax makes up some 94 percent of own source general fund revenue. All of which led Mr. Zhao to assess or measure what he defines as the “Municipal Gap,” or the difference between municipal cost versus municipal capacity: a measure which he finds demonstrates that “a significant share of Connecticut municipalities and populations face municipal gaps”…with urban core municipalities confronting a gap of as much as $1,000 per capita.

Turning to the state role in addressing fiscal disparities, he notes that non-school grants in the state “do not have an explicit equalization goal.” Such grants are broadly spread, and not “well targeted to fiscally disadvantaged municipalities,” indeed, describing the gap as “very wide,” and noting that a comparison with neighboring Massachusetts would better enable Connecticut law and policy makers to better understand the “relative severity of Connecticut municipal fiscal disparities.” While noting that unlike many other states, neither of these two New England states have active county governments, so that municipalities bear much greater responsibilities for a wide range of public services—and property taxes are almost their sole source of municipal revenues, he distinguishes Connecticut’s greater municipal fiscal disparities in that it has a larger share of its population living in what he terms “smallest-gap” municipalities. Finally, he distinguishes the respective state roles by noting that Massachusetts has a “more explicit equalization goal and its main distribution formula directly considers the differences across municipalities in revenue-raising capacity.”

The Roads out of Municipal Bankruptcy

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eBlog, 2/24/17

Good Morning! In this a.m.’s eBlog, we consider the post-chapter 9 municipal bankruptcy trajectories of the nation’s longest (San Bernardino) and largest (Detroit) municipal bankruptcies.

Exit I. So Long, Farewell…San Bernardino City Manager Mark Scott was given a two-week extension to his expired contract this week—on the very same day the Reno, Nevada City Council selected him as one of two finalists to be Reno’s City Manager—with the extension granted just a little over the turbulent year Mr. Scott had devoted to working with the Mayor, Council, and attorneys to complete and submit to U.S. Bankruptcy Judge Meredith Jury San Bernardino’s proposed plan of debt adjustment—with the city, at the end of January, in the wake of San Bernardino’s “final, final” confirmation hearing, where the city gained authority to issue water and sewer revenue bonds prior to this month’s final bankruptcy confirmation hearing—or, as Urban Futures Chief Executive Officer Michael Busch, whose firm provided the city with financial guidance throughout the four-plus years of bankruptcy, put it: “It has been a lot of work, and the city has made a lot of tough decisions, but I think some of the things the city has done will become best practices for cities in distress.” Judge Jury is expected to make few changes from the redline suggestions made to her preliminary ruling by San Bernardino in its filing at the end of January—marking, as Mayor Carey Davis noted: a “milestone…After today, we have approval of the bankruptcy exit confirmation order.” Indeed, San Bernardino has already acted on much of its plan—and now, Mayor Davis notes the city exiting from the longest municipal bankruptcy in U.S. history is poised for growth in the wake of outsourcing fire services to the county and waste removal services to a private contractor, and reaching agreements with city employees, including police officers and retirees, to substantially reduce healthcare OPEB benefits to lessen pension reductions. Indeed, the city’s plan agreement on its $56 million in pension obligation bonds—and in significant part with CalPERS—meant its retirees fared better than the city’s municipal bondholders to whom San Bernardino committed to pay 40 percent of what they are owed—far more than its early offer of one percent. San Bernardino’s pension bondholders succeeded in wrangling a richer recovery than the city’s opening offer of one percent, but far less than CalPERS, which received a nearly 100 percent recovery. (San Bernardino did not make some $13 million in payments to CalPERS early in the chapter 9 process, but did set up payments to make the public employee pension fund whole; the city was aided in those efforts as we have previously noted after Judge Jury ruled against the argument made by pension bond attorneys two years ago. After the city’s pension bondholders entered into mediation again prior to exit confirmation, substantial agreement was achieved for th0se bondholders, no doubt beneficial at the end of last year to the city’s water department’s issuance of $68 million in water and sewer bonds at competitive interest rates in November and December—with the payments to come from the city’s water and sewer revenues, which were not included in the bankruptcy. The proceeds from these municipal bonds will meet critical needs to facilitate seismic upgrades to San Bernardino’s water reservoirs and funding for the first phase of the Clean Water Factor–Recycled Water Program.

Now, with some eager anticipation of Judge Jury’s final verdict, Assistant San Bernardino City Attorney Jolena Grider advised the Mayor and Council with regard to the requested contract extension: “If you don’t approve this, we have no city manager…We’re in the midst of getting out of bankruptcy. That just sends the wrong message to the bankruptcy court, to our creditors.” Ergo, the City Council voted 8-0, marking the first vote taken under the new city charter, which requires the Mayor to vote, to extend the departing Manager’s contract until March 7th, the day after the Council’s next meeting—and, likely the very same day Mr. Scott will return to Reno for a second interview, after beating out two others to reach the final round of interviews. Reno city officials assert they will make their selection on March 8th—and Mr. Scott will be one of four candidates.

For their part, San Bernardino Councilmembers Henry Nickel, Virginia Marquez, and John Valdivia reported they would not vote to extend Mr. Scott’s contract on a month-to-month basis, although they joined other Councilmembers in praising the city manager who commenced his service almost immediately after the December 2nd terrorist attack, and, of course, played a key role in steering the city through the maze to exit the nation’s longest ever municipal bankruptcy. Nevertheless, Councilmember Nickel noted: “Month-to-month may be more destabilizing than the alternative…Uncertainty is not a friend of investment and the business community, which is what our city needs now.” From his perspective, as hard and stressful as his time in San Bernardino had to be, Mr. Scott, in a radio interview while he was across the border in Reno, noted: “I’ve worked for 74 council members—I counted them one time on a plane…And I’ve liked 72 of them.”

Exit II. Detroit Mayor Mike Duggan says the Motor City is on track to exit Michigan state fiscal oversight by next year , in the wake of a third straight year of balancing its books, during his State of the City address: noting, “When Kevyn Orr (Gov. Rick Snyder’s appointed Emergency Manager who shepherded Detroit through the largest chapter 9 municipal bankruptcy in U.S. history) departed, and we left bankruptcy in December 2014, a lot of people predicted Detroit would be right back in the same financial problems, that we couldn’t manage our own affairs, but instead we finished 2015 with the first balanced budget in 12 years, and we finished 2016 with the second, and this year we are going to finish with the third….I fully expect that by early 2018 we will be out from financial review commission oversight, because we would have made budget and paid our bills three years in a row.”

Nonetheless, the fiscal challenge remains steep: Detroit confronts stiff fiscal challenges, including an unexpected gap in public pensions, and the absence of a long-term economic plan. It faces disproportionate long-term borrowing costs because of its lingering low credit ratings—ratings of B2 and B from Moody’s Investors Service and S&P Global Ratings, respectively, albeit each assigns the city stable outlooks. Nevertheless, the Mayor is eyes forward: “If we want to fulfill the vision of a building a Detroit that includes everybody, we have to do a whole lot more.” By more, he went on, the city has work to do to bring back jobs, referencing his focus on a new job training program which will match citizens to training programs and then to jobs. (Detroit’s unemployment rate has dropped by nearly 50 percent from three years ago, but still is the highest of any Michigan city at just under 10 percent.) The Mayor expressed hope that the potential move of the NBA’s Detroit Pistons to the new Little Caesars Arena in downtown Detroit would create job opportunities for the city: “After the action of the Detroit city council in support of the first step of our next project very shortly, the Pistons will be hiring people from the city of Detroit.” The new arena, to be financed with municipal bonds, is set to open in September as home to the Detroit Red Wings hockey team, which will abandon the Joe Louis Arena on the Detroit riverfront, after the Detroit City Council this week voted to support plans for the Pistons’ move, albeit claiming the vote was not an endorsement of the complex deal involving millions in tax subsidies. Indeed, moving the NBA team will carry a price tag of $34 million to adapt the design of the nearly finished arena: the city has agreed to contribute toward the cost for the redesign which Mayor Duggan said will be funded through savings generated by the refinancing of $250 million of 2014 bonds issued by the Detroit Development Authority.

Mayor Duggan reiterated his commitment to stand with Detroit Public Schools Community District and its new school board President Iris Taylor against the threat of school closures. His statements came in the face of threats by the Michigan School Reform Office, which has identified 38 underperforming schools, the vast bulk of which (25) are in the city, stating: “We aren’t saying schools are where they need to be now…They need to be turned around, but we need 110,000 seats in quality schools and closing schools doesn’t add a single quality seat, all it does is bounce children around.” Mayor Duggan noted that Detroit also remains committed to its demolition program—a program which has, to date, razed some 11,000 abandoned homes, more than half the goal the city has set, in some part assisted by some $42 million in funds from the U.S Department of Treasury’s Hardest Hit Funds program for its blight removal program last October, the first installment of a new $130 million blight allocation for the city which was part of an appropriations bill Congress passed in December of 2015—but where a portion of that amount had been suspended by the Treasury for two months after a review found that internal controls needed improvement. Now, Major Duggan reports: “We have a team of state employees and land bank employees and a new process in place to get the program up and running and this time our goal isn’t only to be fast but to be in federal compliance too.” Of course, with a new Administration in office in Washington, D.C., James Thurber—were he still alive—might be warning the Mayor not to count any chickens before they’re hatched.

Post Chapter 9 Challenges

eBlog, 2/22/17

Good Morning! In this a.m.’s eBlog as we remember the first President of our country,  we consider the accomplishments and challenges ahead for the city recovering from the largest ever municipal bankruptcy; then we visit the historic Civil War city of Petersburg, Virginia—as it struggles on the edge of fiscal and physical insolvency; from thence, we roll the dice to witness a little fiscal Monopoly in the state-taken over City of Atlantic City, before finally succumbing to the Caribbean waters made turbulent by the governance challenges of a federal fiscal takeover of the U.S. territory of Puerto Rico, before considering whether to take a puff of forbidden weed as we assess the governing and fiscal challenges in San Bernardino—a city on the precipice of emerging from the longest municipal bankruptcy in American history.   

State of a Post Chapter 9 City. Pointing to FY2015 and 2016 balanced budgets, Detroit Mayor Mike Duggan, in his fourth State of the City address, pointed to the Motor City’s balanced budgets for FY2015 and 2016 and said the city’s budget will be balanced again at the close of this fiscal year in June—progress he cited which will help the city emerge from state get oversight and back to “self-determination” by 2018. Mayor Duggan cited as priorities: job training, affordable housing, and rebuilding neighborhoods, orating at the nonprofit human rights organization Focus: HOPE on Oakman Boulevard on the city’s northwest side, where residents and others for decades have received critical job training. Mayor Duggan was not just excited about what he called the transformation of city services and finances in a city that exited municipal bankruptcy three years ago, but rather “what comes next,” telling his audience: “We’ve improved the basic services, but if we’re going to fulfill a vision of building a Detroit that includes everybody, then we’ve got to do a whole lot more…You can’t have a recovery that includes everyone if there aren’t jobs available for everyone willing to work.” Ergo, to boost job opportunities, Mayor Duggan announced a new initiative, “Detroit at Work,” which he said would help connect the Motor City’s job seekers with employers, deeming it a portal which would provide a “clear path to jobs.” He also discussed his administration’s program to help city youth secure jobs and the Detroit Skilled Trades Employment Program, a recent partnership with local unions to increase Detroit membership and boost job opportunities.

With regard to neighborhoods, Mayor Duggan touted his Neighborhood Strategic Fund, his initiative to encourage neighborhood development, especially in wake of the exceptional success of Detroit’s new downtown: this fund allocates $30 million from philanthropic organizations toward development, commencing with the engagement of residents in the areas of Livernois/McNicols, West Village, and in southwest Detroit to create revitalized and walkable communities—under the city’s plan to align with the city’s vision for “20-minute neighborhoods” to provide nearby residents with close, walkable access to grocery stores and other amenities—or, as Mayor Duggan noted: “If we can prove that when you invest in these neighborhoods, the neighborhoods start to come back. The first $30 million will only be the beginning. I want everybody to watch…If we prove this works…then we go back for another $30 million and another $30 million as we move across the neighborhoods all through this city.”

In a related issue, the Mayor touted the return of the Department of Public Works’ Street Sweeping Unit, which is preparing to relaunch residential cleanings for the 2017 season, marking the first time in seven years for the program. On the affordable housing front, Mayor Duggan addressed affordable housing, saying that future projects will ensure such housing exists in all parts of the city, referencing a new ordinance, by Councilwoman Mary Sheffield, which seeks to guarantee that 20 percent of the units in new residential projects which receive financial support from the city will be affordable: “We are going to build a city where there is a mix of incomes in every corner and neighborhood and we’re going to be working hard.”

But in his address—no doubt with his re-election lurking somewhere behind his words, Mayor Duggan reflected not just on his successes, but also some missteps, including his administration’s massive federally funded demolition program, now the focus of a federal probe and state and city reviews: that initiative has been successful in the razing of nearly 11,000 abandoned homes since the spring of 2014, but has also triggered federal and state investigations over spiraling costs and bidding practices: an ongoing state review of the program’s billing practices turned up $7.3 million in what the State of Michigan deems “inappropriate” or “inaccurate” costs: the vast majority in connection with a controversial set-price bid pilot in 2014 designed to quickly bring down big bundles of houses—an initiative over which Mayor Duggan has so far rejected the state’s assertion that about $6 million tied to costs of the pilot were inappropriate. Thus, yesterday, he conceded that the federal government’s decision to suspend the demolition program for 60 days beginning last August had been warranted, but noted the city has since overhauled procedures and made improvements to get the program back on track, so that, he said, he is confident the city will raze an additional 10,000 homes in the next two years.

For new initiatives, Mayor Duggan said the Detroit Police Department will hire new officers, and invest in equipment and technology, and he announced the launch of Detroit Health Department’s Sister Friends program, a volunteer program to provide support to pregnant women and their families. On the school front, the Mayor noted what he deemed a “complete alliance” between his office and the new Detroit Public Schools Community District school board, saying the city has joined the Board in its attempt to convince the state’s School Reform Office not to close low-performing schools. (As many as 24 of 119 city schools could potentially be shuttered as soon as this summer.) In a hint of the state-local challenge to come, Mayor Duggan said: “The new school board hasn’t had an opportunity to address the problem…We have 110,000 schoolchildren in this city, which means we need 110,000 seats in quality schools. Closing a school doesn’t add a quality seat. All it does is bounce our children around from place to place. Before you close a school, you need to make sure there’s a better alternative.”

Fiscal & Physical Repair. In a surprising turn of events in Virginia, the Petersburg City Council accepted a motion by Councilman Charlie Cuthbert to postpone the vote on moving forward with the bids for Petersburg’s aging water system, after the Council had been scheduled to vote on whether to move forward with the bids the city had received from Aqua Virginia and Virginia American Water Company to purchase the nearly insolvent city’s water and wastewater system. While the vote, by itself, would not have authorized such a sale, it would have paved the way for formal consideration of such proposals. Under his motion, Councilman Cuthbert outlined a plan to delay the vote, so the Council and the City would have more time to consider options, in part through the formation of a seven person committee, which would be separate from the one the Robert Bobb Group, which is currently overseeing the city in place of the Mayor and Council, has been proposing. Mayhap unsurprisingly, citizens’ reactions to a potential sale has been negative; thus there was approbation when Councilmember Cuthbert’s motion passed—even as it appears many citizen/tax/ratepayers appeared to be hoping for the bids to be scrapped entirely: many had spoken in strong opposition, and there were numerous signs held up in chambers for the Mayor and Council to read: “Listen to us for once, do not sell our water,” or, as one citizen told the elected officials: “We have a choice to make: to make the easy, wrong decision, or the hard, right decision,” as he addressed the Council. The city’s residents and taxpayers appear to want other options to be explored, with many citing reports of Aqua Virginia having trouble with the localities with which it holds contracts.

On the fiscal front, many citizens expressed apprehension that any short-term profit the city would realize by selling its system would be paid back by the citizens in the form of rate-hikes by Aqua Virginia or Virginia American, or as one constituent said: “Never have I seen private industry interested in what the citizens want…They’re going to come in here and raise the rates.” Interim City Manager Tom Tyrell had begun the meeting by giving a presentation outlining the problems with the system. Due to past mismanagement and a lack of investment over decades, the Petersburg water system is in urgent need of upgrades. Tyrell outlined certain deficiencies, such as water pumps that need replacing, and pipes nearly blocked by sediment build up. The water quality has never come into question, but Mr. Tyrell said that the system is very close to needing a complete overhaul: the projected cost needed to get the system completely up to standard is about $97 million. Mr. Tyrell stressed that water rates will need to increase whether or not the city sells the system, going over Petersburg’s water rates, which have been relatively low for many years, ranking near the lowest amongst municipalities across the Commonwealth of Virginia. Even if the rates were to double, he told citizens, the rates still would still not be in the top 15 amongst Virginia localities. The Council had received two unsolicited bids for the system in December, one from Aqua Virginia, a second from the Virginia American Water Company. The Robert Bobb Group recommended to the Council that it move forward to examine the detailed proposals in order to “keep all options open.” The cost of moving forward with the proposals will cost approximately $100,000, which includes the cost of examining each proposal. Thus, the Robert Bobb Group recommended that the Council put together a citizens’ advisory group as an outside adviser group. The council gave no timetable on when they will officially vote to see if the bids will go forward. The people who will make up the seven person committee were not established.

Monopoly Sale. Atlantic City has sold two of its Boardwalk properties and several lots along the Inlet for nearly $6 million, closing on three properties at the end of last week, according to city officials—meaning that a Philadelphia-based developer has gained control of five waterfront properties since 2015. His purchases, he said, reflect his belief in Atlantic City’s revival. Mayor Don Guardian reported the city had received wire transfers for the former Boardwalk volleyball court on New Jersey Avenue ($3.8 million), Garden Pier ($1.5 million) and 12 lots bordered by the Absecon Inlet, Oriental Avenue and Dewey Place ($660,000), according to Atlantic City Planning and Development Director Elizabeth Terenik, all part of a way to raise money for the insolvent municipality – and to spur redevelopment, or, as Ms. Terenik noted: “The effort was part of the Guardian administration’s initiative to leverage underutilized or surplus public lands for economic development and jobs, and to increase the ratable base.” How the new owner intends to develop the properties or use them, however, is unclear—as is the confusing governance issue in a city under state control. The Inlet lots were sold in a city land auction last summer, purchased through an entity called A.C. Main Street Renaissance, according to city officials: the Atlantic City Council approved the auction and voted to name the purchaser, conditional redeveloper of Garden Pier and the volleyball court last year. Unsurprisingly, Council President Marty Small deemed the sales as great news for the city, saying they would bring revenue, jobs, and “new partners to the Inlet area…This instills investor confidence…It lets me know that we made the right decision by going out to auction for land and getting much-needed revenue for the city.”

Paying the Piper. Atlantic City has also announced its intention to issue $72 million in municipal bonds to pay for its tax settlement with the Borgata casino, securing the funds to cover its property tax refunds by borrowing though New Jersey’s Municipal Qualified Bond Act (MQBA), according to Lisa Ryan, a spokeswoman for the New Jersey Department of Community Affairs, which is overseeing the state takeover which took effect last November, with her announcement coming just a week after the state announced it had struck a deal for Atlantic City to pay less than half of the $165 million it owes the Borgata in tax appeals from 2009 to 2015, or, as Ms. Ryan noted: “Qualified bonds will be issued in one or more tranches to achieve the settlement amount…The parties are confident in the City’s ability to access the capital market and raise the necessary amount needed to cover the financing,” albeit adding that the city’s borrowing costs would not be known until the sale. (The Garden State’s MQBA is a state intercept program which diverts a municipality’s qualified state aid to a trustee for debt service payments.) Prior to the New Jersey’s state takeover of Atlantic City, city officials had proposed paying $103 million for a Borgata settlement through MQBA bonding as part of a five-year rescue plan—a plan which the state’s Department of Community Affairs had rejected.

As the state taken over city struggles to adjust, Mayor Don Guardian, in a statement, noted: “I’m glad the state is seeing the wisdom in what we proposed in our fiscal plan back in November…I applaud them for getting the actual amount due upfront lower, even though they have had over two years to do it. It remains to be seen how the other $30 million will be taken care of, but the quicker we can get this issue off the table, the quicker we can move forward tackling the remaining legacy debt.” Atlantic City last utilized New Jersey’s state credit enhancement program in May of 2015 to pay off an emergency $40 million loan and retire $12 million of maturing bond anticipation notes, paying a substantial fiscal penalty for a $41 million taxable full faith and credit general obligation municipal bond sale to address its loan payment with Bank of America Merrill Lynch pricing the bonds to yield at 7.25% in 2028 and 7.75% in 2045. Today, the city, under state control, is seeking to recover from five casino closures since 2014, closures which have bequeathed it with $224 million in outstanding municipal bond debt—debt sufficient according to Moody’s to have saddled the city with some $36.8 million in debt service last year.

Grass Fire? Two separate groups have now filed lawsuits challenging San Bernardino’s Measure O, the initiative citizens approved last November to allow marijuana dispensaries in the city—a measure yet to be implemented by the city—and one which now, according to City Attorney Gary Saenz, will almost surely be further delayed because of the suit. Should Measure O be struck down, the related, quasi-backup Measure N, a second marijuana initiative San Bernardino voters approved last November, but which received fewer votes, would pop up, as it were. The twin suits, one filed by a group of marijuana-related entities, the second by interested property owners in San Bernardino, challenge Measure O on multiple grounds, including the measure’s language determining where dispensaries may operate in the city. One suit charges: “The overlay zones together with the parcel numbers and the location criteria limit the locations within the City of San Bernardino where marijuana businesses may be permitted to only approximately 3 to 5 parcels of land within the entire city, and all of these parcels of land are either owned or controlled by the proponents of Measure O…The locations of these 3 to 5 parcels of land, furthermore, are incompatible for a medical marijuana business by virtue of the locations and surrounding land uses and for this reason are in conflict with the City of San Bernardino General Plan.” Unsurprisingly, Roger Jon Diamond, the attorney for the proponents of Measure O, disputes that number and predicts the challenge will fail, noting that thirteen marijuana dispensaries and related groups that describe themselves as non-profits are operating in San Bernardino or which have invested substantial sums of money in plans to operate in San Bernardino. The soon to be out of chapter 9 municipal bankruptcy city, prior to citizen adoption of Measure O, means, according to Counselor Diamond, that the dispensaries have been operating illegally, or as he put it: “There’s a concept in the law called clean hands: If you don’t have clean hands, you can’t maintain a lawsuit…Here we have people who don’t qualify (to operate a dispensary in their current location), complaining that they would not become legal under the new law. It sounds like sour grapes.”

The second, related suit, filed earlier this month, calculates a somewhat higher (not a pun) number of eligible locations—between three to twelve, but makes the same observation regarding physical location: “We think there is a financial interest in the people who wrote it up,” said Stephen Levine of Milligan, Beswick Levine & Knox: “We don’t think that is fair, because it was so narrowly constricted. Zoning by parcel numbers is a highly unusual practice in California. Let’s include Colorado and Washington State in there, too; they don’t use parcel numbers for this.” (Measure O restricts marijuana businesses to marijuana business overlay districts, which are identified by parcel number, and further prohibits the businesses from being within 600 feet of schools or residentially zoned property.) In this case, Mr. Levine is representing a consortium of property owners calling themselves AMF as well as Wendy McCammack, a business owner and former San Bernardino Councilmember. According to Mr. Levine, the plaintiffs’ interest is in possible changes in assessed property values due to the location of the dispensaries.

Getting High on the City Agenda. The City Council last week, in a closed session, discussed the lawsuit in closed session; however, City Attorney Saenz reported he was unaware aware of the lawsuit and had yet to decide upon a response to either, noting: “We haven’t totally assessed the merits of the lawsuit, nor how we’ll respond.” Nevertheless, the lawsuits’ arguments appear likely to interfere with the city’s process of incorporating Measure O into the development code and beginning to issue permits, or, as Mr. Saenz notes: “It (the AMF lawsuit) very much calls into question the validity of Measure O…Being a city of very limited resources, we don’t want to expend resources on an implementation that’s never going to occur. That would be a waste of resources.” The suits will also complicate governance: last month the city, on its website, and in a letter to interested parties, said it would provide an update in March on when the marijuana measure would be implemented: “City departments are in the process of integrating the provisions of Measure O into the City’s existing Development Code, developing procedures for receiving applications, and identifying provisions that may require interpretation and clarification prior to implementation…The San Bernardino Development Code and Measure O are both complex legal regulatory frameworks and it will require time to properly implement this new law.”

Governance & Challenges. Puerto Rico Gov. Ricardo Rosselló has arrived in Washington, D.C., where he will meet with his colleagues at the National Governors Association and join them at the White House tomorrow; he will also dine with Vice President Mike Pence this week. Last week, in Puerto Rico, he had hosted Chairman Sean Duffy (R-Wisc.), of the House Financial Services Subcommittee on Housing & Insurance, and an author of the Puerto Rico Oversight, Management and Economic Stability Act – in San Juan.  Chairman Duffy told the Governor he is available to amend PROMESA to ensure that the PROMESA oversight board treats Puerto Rico fairly, according to an office press statement. The lunch this week might occasion an interesting discussion in the wake of the Governor’s claim that the PROMESA Oversight Board’s plans for austerity may violate federal law: the Governor’s Chief of Staff, William Villafañe, this week stated: “The Fiscal Supervision Board officials cannot act outside of the law that created the body. If the board were to force the implementation of a fiscal plan that affects people’s essential services, it would be acting contrary to the PROMESA law.” His complaints appear to signify an escalation of tensions between the U.S. territory and the PROMESA Board: Mr. Villafañe added: “The [PROMESA] board is warned that it must act in conformance with the law…The commitment of Governor Ricardo Rosselló is to achieve economies that allow government efficiency, doing more with fewer expenses, without affecting essential services to the people and without laying off public employees.” If anything, Mr. Villafañe added fuel to his fire by criticizing the Board’s new interim executive director, Ramón Ruiz Comas, in the wake of Mr. Ruiz’ radio statement this week that if Gov. Rosselló did not present an acceptable fiscal plan by the end of February, the PROMESA Board would provide its own—and the plan would be deemed the legally, binding plan—in reaction to which, Mr. Villafañe had responded: “To make expressions prejudging a fiscal plan proposal that the board has not yet seen demonstrates on the part of the board improvisation and lack of a collaborative attitude for the benefit of the Puerto Rican people,” adding that “The board must be aware that the federal Congress will supervise the board.” He went on to say that when the Governor presents a fiscal plan, Congress will be aware of the way the board evaluates it.

Mr. Villafañe’s complaints and warnings extend tensions between the board and the U.S. territory: even before the Governor took office in January, a Rosselló official complained that the board was seeking a $2 billion cut in spending. On Feb. 13 the governor rejected the board’s claimed right to review bills before they are submitted to the Puerto Rico legislature. On Jan. 18 the board sent a letter to Gov. Rosselló stating that spending cuts and/or tax raises equaling 44% of the general fund would have to be made in the next 18 months. At its Jan. 28 meeting, board chairman José Carrion, for emphasis, said twice that some governor-proposed changes to the board’s Jan. 18 proposals may be OK, “as long as the ultimate fiscal plan is based on solid savings and revenue projections, a once and done approach, and not simply on hope or predictions that various changes will generate more revenues in the future.”

A Midwestern Tale of Two Cities

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eBlog, 2/14/17

Good Morning! In this a.m.’s eBlog, we consider the tale of two cities in Detroit: is a city set to displace Chicago as the capitol of the Midwest—or is a city with its fiscal future in re-jeopardy, because of its inability and conflicts with the state over how to educate its children in a way that will create incentives for families to want to move back into the city?

Post Chapter 9 Reinvention? In opting to relocate its regional headquarters to downtown Detroit, Microsoft has sent a message that the city’s emergence from the largest chapter 9 municipal bankruptcy in American history is a success: the city is even threatening to displace Chicago as a regional headquarters of choice for the Midwest. That’s an honor long owned by Chicago. The extraordinary changes in the city—fashioned through the path-breaking efforts not just of former emergency manager Kevyn Orr and now retired U.S. Bankruptcy Judge Steven Rhodes, but also the fiscal rebuilding blueprint, the city’s court-approved plan of debt adjustment, a plan aptly described by the Detroit News an “arc of change, the redemptive power of reinvention, and critical facts on the ground say a bid by Detroit and southeast Michigan to be part of that conversation could be real for those with the courage to take a real, hard look.”  The paper, continuing its own comparison of Detroit to the Windy City—two cities which appear to be fiscally headed in opposite directions, aptly notes the respective state roles, contentious as they are, but noting that while the Michigan government is “aggressively attacking its unfunded liabilities,” instead of being (in Illinois) a state legislature “deaf to the fiscal ticking time bomb of its state pensions.” An iconic city’s recovery from bankruptcy is, after all, not just designing and implementing an architectural and fiscal turnaround, but also reversing the fiscal and economic momentum; thus, unsurprisingly, in a reminder of the old aphorism: “Go West, young man;” today it is civic leader, Quicken Loans Inc. Chairman Dan Gilbert who actively recruits young talent to the Motor City, telling potential new Detroiters: anyone can go work in Chicago and most will change nothing, but you could make a difference working and living in Detroit. Or, as the News describes it: “So could companies looking to reduce costs, find a vibrant food, arts and culture scene, and join an enthusiastic business community with global connections. They could find both in Detroit. Or in Ann Arbor, with the University of Michigan.”  

Might There Be a Fly in the State Ointment? Yet for a city one-third its former size, the more pressing challenge to its fiscal future is likely to rest on the perceived quality of its public schools—schools in a city where the Detroit Public School system became physically and fiscally insolvent—and where the state intervened to not just appoint an emergency manager, but also where the legislature created and imposed what some deem the nation’s most economically disparate school system—or, as the New Jersey nonprofit EdBuild, in its report “Fault Lines: America’s Most Segregating School District Borders,” described it: nearly half of the households in Detroit Public Schools—49.2%—live in poverty, compared with 6.5% in Grosse Pointe Public Schools—with the non-profit noting to the Detroit News: “Fault Lines shows how school finance systems have led to school segregation along class lines within communities around the country, and how judicial and legislative actions have actually served to strengthen these borders that divide our children and our communities:” its report traces the economic gap between Detroit and Grosse Pointe schools to a 1974 U.S. Supreme Court ruling, Milliken v. Bradley, which blocked busing between districts to achieve racial integration, writing: “Income segregation in the Detroit metropolitan area parallels the racial segregation that inspired the Milliken case and has worsened since the case was first argued.” Today, there are some 97 traditional public schools in Detroit, 98 charter schools, and 14 schools in the Education Achievement Authority, a controversial state-run district created in 2012—that is, there are an estimated 30,000 more seats than students in the city in the wake of the state’s 2015 “rescue” of the Detroit Public Schools—a rescue of a public school district which had been under state control, and a rescue which pledged some $617 million to address the debt, but also invoked a number of unorthodox “reforms” which state legislators argued would promise a brighter future: the reforms included provisions which permit the hiring uncertified teachers, penalization of striking employees, and the outsourcing of academic roles, like the superintendent position, to surrounding districts, and the state closure of all schools that fall in the bottom 5 percent of academic performance for three years in a row: a category into which dozens of Detroit public schools fall. The state also authorized charter schools for Detroit.

Now, a new Michigan School Reform Office school closing plan has reignited debate in Detroit over how to fix the Motor City’s fractured system of public schools, less than seven months after the Michigan Legislature spent $617 million relieving Detroit Public Schools of crushing debt which had hovered on the brink of its own chapter 9 municipal bankruptcy. Indeed, the perceived fiscal threat to the city’s future has led Mayor Mike Duggan to deem the state school closing plan “irrational,” because many of the other nearby public schools in Detroit are on the brink of being deemed failing schools—or, as Mayor Duggan noted: “You don’t throw people out of the boat without looking out to see if there’s a life raft.” Moreover, the Mayor and the newly elected Board of Education for the Detroit Public Schools Community District have threatened to sue Gov. Rick Snyder’s administration to stop the proposed closures—closures which the state is evaluating to determine whether such closures would create unreasonable hardships for students, such as distance to other schools with capacity, if the buildings are closed. Ergo, unsurprisingly, Governor Snyder is confronting pressure from school leaders, parents, businesses and civic groups to consider the impact that another round of school closings might have on Detroit’s ongoing recovery—and on its neighborhoods and commercial corridors hard hit by decades of abandonment and disinvestment—or, as Veronica Conforme, Chancellor of the Education Achievement Authority, notes: such closures would “cause disruption in the neighborhoods.”

The state-municipal tussle relates to the tug-of-rope state-local challenge about how to address Detroit’s worst-performing schools under a 7-year-old state statute which has never been fully enforced—and comes as the Michigan School Reform Office has announced that twenty-five Detroit schools may be closed in June due to persistently low student test scores—creating apprehension that these closures, coming at a time when then city’s focus on fuller implementation of its approved plan of debt adjustment envisions revitalization shifting from downtown and Midtown to Detroit’s vast neighborhoods and commercial corridors. Unsurprisingly, some business and community leaders are concerned that the impact mass school closings could undercut the city’s efforts to turn around pockets of the city which have been showing signs of rebirth, or, as Sandy Baruah, President and CEO of the Detroit Regional Chamber, who worries that abruptly closing two dozen schools could “create other crises” in city neighborhoods, puts it: “I don’t want to see neighborhoods that are on the early path to recovery be dealt a setback.” That is, in the post chapter 9 city, rebuilding neighborhoods must go hand in hand with schools: the presence of a school, after all, affects the assessed values of properties, residential and commercial, in a neighborhood.

The Different Roads out of Municipal Bankruptcy

eBlog, 1/25/17

Good Morning! In this a.m.’s eBlog, we consider yesterday’s guilty plea from the former Mayor of Pennsylvania’s capitol, Harrisburg, for actions he had taken as Mayor which plunged the city to the brink of chapter 9 bankruptcy; then we consider Detroit Mayor Mike Duggan’s announcement that a majority of Detroiters will see a reduction in their property tax obligations—a sign of the signal fiscal turnaround. Then we head into the icy blast of Winter in Pennsylvania, where the former Mayor of Harrisburg has pleaded guilty to stealing city-purchased artifacts, before veering south to note Puerto Rico Gov. Ricardo Rosselló has signed into law an extension of Act 154’s tax on foreign corporations.  

Public Mistrust. Former Harrisburg, Pa., Mayor Stephen Reed pleaded guilty Monday to 20 counts of theft  for stealing artifacts purchased by the city in Dauphin County court Monday, with the outcome coming in the wake of negotiations with the state Attorney General’s office. The 20 counts reflects a dramatic reduction of criminal counts from the original more than 470, including many tied to fiscal decisions during his service as Mayor, a period which had propelled the city to the verge of chapter 9 municipal bankruptcy—and a leftover severe set of fiscal challenges still bedeviling the state capitol. The former mayor, in his comments to the press after the proceeding, described it as “gut-wrenchingly humiliating.” The Patriot-News of Harrisburg reported that Mr. Reed, who served as mayor from 1982 to 2009, admitted to taking 20 historic artifacts, but said he had no criminal intent. Judge Kevin Hess scheduled a sentencing hearing for Friday in the Dauphin County Court of Common Pleas in Harrisburg. The trial commenced in the wake of then Pennsylvania Attorney General Kathleen Kane in July of 2015 announcing the indictment of the former Mayor: prosecutors asserted he had diverted municipal bond proceeds, notably related to an incinerator retrofit project, to a special projects fund he allegedly used to purchase as many as 10,000 Wild West artifacts and other “curiosities” for himself—including a $6,500 vampire hunting kit—a series of disclosures which contributed to the city’s descent into receivership due to municipal bond financing overruns related to an incinerator retrofit project; the Harrisburg City Council filed for chapter 9 municipal bankruptcy in October of 2011, notwithstanding the objection of then-Mayor Linda Thompson; however, a federal judge two months later negated the filing, and a state-appointed receivership team pulled together a recovery plan approved by the Commonwealth Court of Pennsylvania in September of 2013. Yesterday, Christopher Papst, author of the book Capital Murder an Investigative Reporter’s Hunt for Answers in a Collapsing City, noted: “Stephen Reed’s guilty plea concerning his stealing of city artifacts is a good start for the people of Harrisburg who deserve answers and justice. But far more needs to be done and more people need to be held accountable for the city’s financial collapse…A strong message must be sent that any impropriety concerning municipal financial dealings will not be tolerated.”

Rebalancing Motor City’s Tax Wheel Alignments. Detroit Mayor Mike Duggan has announced that about 55% of residential property owners in the city will see a reduction in their property tax obligations later this year. His announcement came in the wake of the city’s completion of a three-year reappraisal project, as required under Detroit’s plan of debt adjustment approved by the U.S. Bankruptcy Court. According to Mayor Duggan, about 140,000 residents will realize an average reduction of $263 on their tax bills, while 112,000 will see an average increase of $80. The reappraisal process, unlike past years, assessed each property individually. Tax assessments were mailed Monday. The city, despite boasting one of the broadest tax bases of any city in the U.S., (its municipal income taxes constitute the city’s largest single source of revenues), nevertheless have been constrained by the state: only Chrysler and DTE Energy pay business taxes; moreover, state law bars cities from increasing revenues by adding a sales tax or raising residential property tax rates more than inflation. Moreover, in the years leading up to the city’s fiscal collapse into chapter 9 bankruptcy, homeowners had complained that their property taxes did not compare to the market value of their homes. Ergo, now Mayor Duggan is hopeful that the new assessment will improve property tax collections—or as he put it yesterday: “It turns out, when people feel they’re being assessed fairly, they pay their taxes….For years, we basically have taken entire neighborhoods or sections of the city and taken averages, which is the best that could be done with the data available.” But the new assessments are based upon house-by-house reassessments using aerial and street-level photography as well as field visits. In addition, the city digitized field cards for every single residential property, allowing employees to inspect the condition of homes based on the historical information and new ground and aerial photos, according to City Assessor Alvin Horhn—or, as Mr. Horn notes: “Where everything matched up, fine. Whenever there was a difference, we sent people out to look…For the most part, this was done at a desktop (computer) review.” Next up: a citywide reassessment of all commercial and industrial properties will be completed for the winter 2018 tax bills. According to city data, collections have increased steadily from about 68% in 2012-14 during the city’s municipal bankruptcy to 79% in 2015 and a projected 82% last year: from 2015 to 2016, the city reported that property tax collections increased approximately $8 million.

Act 54 Where Are You? Puerto Rico Gov. Ricardo Rosselló has signed into law an extension of Act 154’s tax on foreign corporations (mainly corporations manufacturing pharmaceuticals and other high-tech products), a key action to preserve revenues which provide a quarter of the U.S. Territory’s general fund revenues; the action came as Public Affairs Secretary Ramon Rosario Cortés submitted a measure to replace Puerto Rico’s Moratorium Law, an action which he said could mean Puerto Rico could dedicate some of the savings from which to provide “payment of interest or some part of the principal” in negotiations with the island’s creditors: “The obligations of the government of Puerto Rico will be fulfilled in an orderly process. The government is going to commit itself to the policy that what it is directed is to pay the obligations of the government of Puerto Rico. The first thing is essential services.” The discussion occurs at a pivotal point, as, since before the administration of newly elected Governor Ricardo Rosselló Nevares taking office, Senate President Thomas Rivera Schatz had announced that they were in tune to extend the expiration of the moratorium scheduled for the end of this month. If the government does not extend the litigation deadlock, it will face $1.3 billion in February, leaving it with no cash for operations, according to a liquidity report by Conway Mackenzie. Secretary Cortés, in response to a query yesterday with regard to interest payments, did note that would be possible “with the savings that are achieved, guaranteeing priority, which are essential services…The government of Puerto Rico will be making savings with this measure and the savings that will be made will be part of the renegotiation process, which could include the payment of interest or some part of principal, but in negotiation with creditors.” The revenues, as reported over the most recent half fiscal year, accounted for 25% of all General Fund revenues—more even than the $713 million in individual income taxes. The Act, adopted in 2010 to help address the dire fiscal imbalance, was set to impose a continually declining levy rate on foreign corporations until it would phase out this year, based on Treasury regulations promulgated six years ago which allow corporations to take tax credits against temporary excise taxes. Now a tricky shoal to navigate in the midst of the major transition in power in Washington, D.C. The issue involves whether the IRS will grant an extension of Act 154 past its current scheduled expiration at the end of this calendar year. According to Puerto Rico, 10 corporations and partnerships paid some 90 percent of all Act 154 taxes in FY2016. The law mainly affects corporations manufacturing pharmaceuticals and other high-tech products on the island.

Fighting for Cities’ Futures

eBlog, 1/23/17

Good Morning! In this a.m.’s eBlog, we consider the ongoing fiscal and governing challenge to Detroit’s future—especially with regard to the quality of education for the city’s future leaders; then we learn from one of the unsung heroes, retired U.S. Judge Gerald Rosen, about his reflections and role in Detroit’s exit from the largest municipal bankruptcy in American history. Then we return to the historic Virginia municipality of Petersburg, where, in its struggle to exit insolvency, a citizen effort is underway to recall its elected leaders. Finally, in the category of ‘when it rains it pours,’ we consider the city hall relocation underway in San Bernardino—one month before it hopes to gain U.S. Bankruptcy Judge Meredith Jury’s approval of the city’s plan of debt adjustment, permitting the city to egress from the longest municipal bankruptcy in American history.

Fighting for Detroit’s Fiscal Future. The City of Detroit is siding with seven Detroit public schoolchildren suing Gov. Rick Snyder and Michigan state education officials over their right to access literacy. (See Jessie v. Snyder, #16-CV-13292, U.S. District Court), having filed an amicus brief in a proposed class action lawsuit against Gov. Snyder and Michigan education officials in a legal challenge seeking to establish that literacy is a U.S. constitutional right. The suit, which was filed last September by a California public interest law firm, claims the state has functionally excluded Detroit children from the state’s educational system; the suit seeks class-action status and several guarantees of equal access to literacy, screening, intervention, a statewide accountability system, as well as other measures. Detroit’s amicus brief urged the court to hold access to literacy as being fundamental, arguing the plaintiffs have alleged sufficient facts to show they are being denied that right: “Denying children access to literacy today inevitably impedes tomorrow’s job seekers and taxpayers; fathers and mothers; citizens and voters…That is why the Supreme Court has stressed the ‘significant social costs borne by our nation’ when children suffer the ‘stigma of illiteracy’—and are thereby denied ‘the basic tools by which (to) lead economically productive lives to the benefit of us all…The City of Detroit (though it does not control Detroit’s schools) is all too familiar with illiteracy’s far-reaching effects.”

A critical fiscal issue for every city and county is the perceived quality of its public schools—a perception critical to encouraging families with children to move into the city—thereby positively affecting assessed property values. The challenge has been greater in Detroit, where the schools’ fiscal and educational insolvencies led to the appointment of former U.S. Bankruptcy Judge Steven Rhodes to serve as DPS’s Emergency Manager. In Detroit, politics at the state level imposing a disproportionate number of charter schools has meant that today Detroit has a greater share of students in charters than any U.S. city except New Orleans; however, half the charters perform only as well, or worse than, Detroit’s traditional public schools—mayhap a challenge of having a state attempt to substitute itself over local control. Perhaps former state representative Thomas F. Stallworth III, who helped navigate the passage of the 2014 legislation that paved Detroit’s way out of bankruptcy, put it more succinctly: “We’ll either invest in our own children and prepare them to fill these jobs, or I suppose maybe people will migrate from other places in the country to fill them…If that’s the case, we are still left with this underbelly of generational poverty with no clear path out.”

But, in Michigan, it appears that it has been for-profit companies that expressed the greatest interest: they now operate about 80 percent of charters in Michigan, far more than in any other state. In the wake of the state action, and even as Michigan and Detroit continued to preside over an exodus of families, the number of charter schools grew: Michigan today has nearly 220,000 fewer students than it did in 2003, but more than 100 new charter schools. The number not only grew, but the legislature made sure accountability did not: the legislature in 2012 repealed in the Revised School Code Act 451 the state’s longstanding requirement that the Michigan Department of Education issue annual reports monitoring charter school performance; and the state even created a state-run school district, with new charters, in an effort to try to turn around Detroit’s lowest performing schools. Indeed, 24 charter schools have opened in Detroit since the legislature removed the cap 2011: eighteen charters whose existing schools were at or below Detroit’s dismal performance expanded or opened new schools—that despite increasing evidence students in one company’s schools grew less academically than students in the neighboring traditional public schools. By 2015, the Education Trust-Midwest Michigan noted that charter school authorizers’ performance overall had improved marginally over the previous year, but remained terribly low compared to leading states’ charter sectors, in its report, Accountability for All: 2016, The Broken Promise of Michigan’s Charter Sector. The report celebrates high-performing authorizers and sheds light on the devastatingly low performance of other authorizers, adding that roughly one-quarter of one group’s eligible schools ranked among the worst performing 10 percent of schools statewide. Similarly, according to the Trust, a federal review of a grant application for Michigan charter schools found an “unreasonably high” number of charters among the worst-performing 5 percent of public schools statewide, even as the number of charters on the list had doubled from 2010 to 2014.

The great press to create charter schools has led to another challenge: today Detroit has roughly 30,000 more seats, charter and traditional public, than students. For a system desperate for investment in quality education, instead it has badly failed in elementary math; and there is great risk of a discriminatory system: Detroit Public Schools today bears the human and fiscal burden of trying to educate most of Detroit’s special education students. In contrast, charter schools are concentrated downtown, with its boom in renovation and wealthier residents. With only 1,894 high school age students, there are 11 high schools. Meanwhile, northwest Detroit — where it seems every other house is boarded up, burned or abandoned — has nearly twice the number of high school age students, 3,742, and just three high schools. The northeastern part of the city is even more of an education desert: 6,018 high school age students and two high schools.

Like others elsewhere, charter schools receive roughly the same per-pupil state dollars as public schools; however, in Detroit, it is about $7,300 a year — roughly half what New York or Boston schools get, and about $3,500 less than charters in Denver or Milwaukee.

With the significant fiscal challenges to the Detroit Public Schools, Mayor Mike Duggan had proposed an appointed Detroit Education Commission to determine which neighborhoods most needed new schools and to set standards to close failing schools and ensure that only high performing or promising ones could replicate. Backed by a coalition of philanthropies and civic leaders, the teachers’ union and some charter school operators, Mayor Duggan has succeeded in restoring local control of majority-black Detroit Public Schools, and supported the proposal. In the waning days of the legislative session, House Republicans offered a deal: $617 million to pay off the debt of the Detroit Public Schools, but no commission. Lawmakers were forced to take it to prevent the city school system from going bankrupt.

An Interview with Gerald Rosen. U.S. District Court Judge Gerald Rosen, who, as we have written, played an invaluable role in the so-called “Grand Bargain,” which paved the way for Detroit to exit the largest chapter 9 municipal bankruptcy in U.S. history—and who will now join retired U.S. Bankruptcy Judge Steven Rhodes, who presided over Detroit’s municipal bankruptcy, in an interview with the Detroit Free Press, said, in response to the query how well Detroit was doing in adhering to its court approved plan of debt adjustment:  “We are hitting the marks, exceeding them in most areas — certainly revenue, I think the last report I saw was about 2 percent above the projected revenue. On budget. Expenditures are below — not much — but slightly below what was projected. Those are two important things…Certainly, investment and growth in the downtown area, certainly Midtown, and with the Ilitch development coming to fruition, the Red Wings, Pistons, some of the entertainment venues becoming a reality now, I expect the area between Midtown and downtown will become very vibrant over the next two-three years.”

Asked what the most difficult part of that case was, aside from the Grand Bargain, Judge Rosen responded: “You have to go back and see what the case was when we found it, which was an assetless bankruptcy. That was the most difficult part, for me. Certainly, there were a lot of first-impression legal issues. Certainly there were issues that could have gone all the way up to the U.S. Supreme Court, whether it was the collision between the federal bankruptcy code and the federal constitutional supremacy clause and the Michigan Constitution’s provisions to protect pensions. But there were also a lot of other really important issues: The tenor of the security instruments, of the finance instruments, the level and tenor of their security, were all major issues in the bankruptcy, whether they could be crammed down all across the rope line on the financial creditors’ side were really first-impression issues.” He added: “Overwhelmingly, the most challenging issue for me was an assetless bankruptcy—other than the art. I’ll never forget when I was reading Kevyn Orr’s proposal for creditors, coming to the asset section and realizing that there really weren’t any assets other than the art…It was devastating. Kevyn, he had just hired Christie’s to appraise the art, so he was clearly serious about it. I remember thinking, ‘What the hell have I gotten myself into?’ My job is to get deals. To get deals, you have to have revenue or assets that can be monetized into revenue, and the cupboard was pretty much bare. There didn’t seem to be much to work with for deals, other than the art.

There were other aspects to the DIA that I was concerned about. This was a time when Detroit was cannibalizing its heritage to mortgage its future, consistently over the decades. In terms of Detroit’s future, it didn’t make sense to me to do that again, but I was realistic.

Time was Detroit’s enemy. The only way to get through the bankruptcy in any sort of expeditious way was through consensual agreements, and the only asset that could be monetized was the art. So that’s basically what led to the idea of the Grand Bargain—trying to figure out a way to monetize the art without liquidating it, and giving the proceeds to the retirees. Neat trick.

I’ll never forget sitting in this little condo (in Florida) thinking, “What the hell have I gotten myself into? Is my legacy going to be that we liquidated one of the great art collections in the world for sheikhs in Dubai and oligarchs in Russia?” I wasn’t very excited about that.

There was another aspect too. One of the few nascently growing areas in Detroit was Midtown. I went on the DIA website and I saw that the DIA attracted over 600,000 people a year to Midtown. I thought, “Gee whiz, liquidating the DIA would be like dropping a hydrogen bomb in Midtown.” It would suck the life out of it. So there was that part of it.”

What would be the theme song for Detroit’s bankruptcy case?

“Don’t Stop Thinking About Tomorrow.”

We might be having some new City Council members a year from now. What would you suggest to the new ones potentially coming on board?

“I’m not in politics. I’m not a political person in the sense of being involved in the political maw, but my observation is that Mayor (Mike) Duggan is working very positively with President (Brenda) Jones and other members of the council in a way that has not been done by any mayor in years and years.

“At the same time, my word of caution is that we have to be careful to continue to provide the fertile ground that Detroit is for investment for people coming in. Part of that is not placing onerous regulation on people coming in, with artificial employment requirements. I understand the social need for that and I applaud it. I think if Detroit is going to continue the comeback that we are on, the neighborhoods have to be part of it and the African-American population has to be part of it. But you can’t disincentivize people coming in.”

You think that’s been done recently?

“I’m a little bit concerned about the community benefits ordinance. The one that was passed was certainly better than the alternative, but I’m still leery of it because it’s creating entry barriers.”

What was the most surprising individual (Kwame Kilpatrick text) message you saw?

“A lot of that is sealed. I would just refer to it generically by saying there was very little public business conducted by the Mayor and his associates. I’m sure they conducted business by communication means other than texts, but these were city-provided pagers. I assume that the city provided the pagers for people to be able to conduct city business on them, and I saw very little. I learned a lot of new text language that I hadn’t known before, and I appreciate urbandictionary.com.”

Twenty-four hours left in the Obama administration. It’s pardon and commutation time. Does the former mayor deserve one?

No. Absolutely not. I have to be a little cautious, but I presided over that grand jury for 2 ½ years.

Political Leadership & Municipal Insolvency. In Virginia, Petersburg residents who blame their elected municipal leaders for their city’s collapse into insolvency have filed dual petitions to oust both the incumbent and former mayor from their City Council seats—after, over months, gathering the legally required number of signatures from registered voters of Wards 3 and 5 to ask for the removal of Mayor Samuel Parham and W. Howard Myers, whose term as mayor ended this month; both are up for re-election next year. According to the petition, Mayor Parham “has conducted himself in the office of City Councilman, Vice Mayor and Mayor in such a way to govern the City of Petersburg chaotically, unpredictably, secretly and wastefully.” The two-page cover sheet to the petition has garnered 276 certified signatures. (Virginia law requires the petitioners to gather signatures equal to 10 percent of the voter turnout in the contest that resulted in an official’s initial election. For Parham, the number is 160.) The petitions were filed on January 20th in Petersburg Circuit Court under a provision in Virginia law which allows the court to remove officials for specific reasons, which includes certain criminal convictions. Here, in this instance, petitioners cited “neglect of duty, misuse of office, or incompetence in the performance of duties,” faulting the current and former mayor with failing to heed warnings of Petersburg’s impending insolvency, but also alleging ethical breaches and violations of open government law. “Nothing has happened in the new year, with the installation of new council officers, to demonstrate that Myers or Parham are any more capable of providing effective oversight of city government than they have over the past two years,” according to Ms. Barb Rudolph, a local activist and organizer of the good government group Clean Sweep Petersburg. The effort came as Petersburg’s mounting legal claims have now exceeded nearly $19 million in past-due invoices and the city’s budget which was $12 million over budget: the municipality has experienced a stretch of structurally imbalanced budgets dating back to 2009. The City Council fired former City Manager William E. Johnson II last March. For his part, Mayor Parham defended his decisions since taking office, reporting he has done the best he could with the guidance he has received, and noting: “I serve at the pleasure of the people of Petersburg and, with God as my witness, I have tried my best.”

The ouster filings came as former Richmond City Manager, now consultant Robert Bobb, has been hired by the City Council to try to put the city back into solvency. Mr. Bobb has issued a request for a forensic audit of spending over the past three fiscal years—notwithstanding reservations expressed by City Attorney Joseph Preston, who noted that the city’s finances are included in a special grand jury investigation which began as a probe of the Petersburg Police Department. Petersburg obtained short-term financing last month to help meet payroll and other ongoing expenses, with Mr. Bobb reporting the cost of Petersburg’s outstanding invoices has been cut from nearly $19 million to about $6 million. Next comes a session to meet with about 400 of the city’s vendors to try to begin to sort out what they are owed, with a city spokesperson Thursday stating the Petersburg has entered into a payment plan to make good on Petersburg’s share of employee and school worker pensions overdue to the Virginia Retirement System: Petersburg and the city school division collectively owed just over $4.2 million to the system as of last week; however, current payments have resumed, and plans are in place to pay down the balance by $100,000 each month, officials said.

The citizen petitions focus largely on events from last year, but reference years of mounting trouble. The issue for the courts is sufficiency, as a judge in Bath County last week demonstrated when the judge dismissed a similar petition to remove three members of the county’s Board of Supervisors, finding the complaints raised by residents there were insufficient to require a judicial reversal of election results. However, Ms. Rudolph said the Petersburg petitions contain more serious charges, noting: “We believe that, on its merits, it’s far more substantive than the Bath County removal action that was recently rejected by the circuit court there.” Included among the two-page list of grievances documenting reasons for Mayor Myers’ removal were allegations he had “flagrantly and repeatedly acted in contravention of the City of Petersburg’s Code of Ethics” by attempting to “intimidate and silence a critic,” who remains unnamed, by “attempting to harm the citizen’s good standing with her employer.” Petitioners also criticized the Myers-led council for possibly violating the Council’s own rules and the city charter in holding a re-do of a vote to bring in the Bobb Group two days after an initial measure to hire the firm failed. City Attorney Preston has said that the Council did nothing wrong.

Quake & Shake. San Bernardino, on track to end the longest chapter 9 municipal bankruptcy in U.S. history next month, now faces a physical and fiscal challenge not listed in its plan of debt adjustment: a substantial earthquake risk. San Bernardino has two independent engineering evaluations — from 2007 and 2016 — saying City Hall would be unsafe in an earthquake. Specifically, the February 2016 study concludes a magnitude 6.0 earthquake would lead to “a likelihood of building failure” for City Hall, which was designed before code updates following the 1971 Sylmar and 1994 Northridge earthquakes. The building sits along two fault lines. That means the City has plans for vacating City Hall by April, as all employees move out of a building determined to be a substantial earthquake risk, with the approximately 200 municipal employees set to relocate to several leased sites set by a unanimous Council vote. A public information counter will direct members of the public to whatever service they’re seeking, as will signs.

Governing Challenges of Federalism & Severe Fiscal Distress

eBlog, 1/20/17

Good Morning! In this a.m.’s eBlog, we consider the deteriorating municipal fiscal conditions in Connecticut’s central cities, a new twist in New Jersey’s usurpation of municipal governance in Atlantic City, and the ongoing challenges in Puerto Rico where the PROMESA Board has provided new Governor Ricardo Rosselló Nevares additional time to submit a new fiscal plan—albeit a plan potentially complicated by a court ruling, as well as uncertainty with regard to potential changes in direction from Washington where, later this morning, a new Trump Administration takes the reins of power in Washington, D.C.  

Can Connecticut Help to Avert Municipal Bankruptcies? Gov. Daniel Malloy, in his State of the State address this month, stated he wanted to “ensure that no Connecticut city or town will need to explore the avoidable path of [municipal] bankruptcy,” indicating he would be working on an initiative involving statewide restructuring of local aid, especially for schools. His remarks seemed to parallel a new report, “Connecticut’s Broken Cities,” by Stephen Eide of the Manhattan Institute, in which he wrote: “State government is almost certainly going to have to get involved in the case of Hartford…Hartford may need a bailout to restore solvency.” However, the new report also examined the fiscal challenge of three other of the state’s central cities: Bridgeport, New Haven, and Waterbury—cities confronted by nearly $5 billion in OPEB and public pension obligations, estimating their combined annual OPEB liabilities at $120 million, and their unfunded pension liability to be $2.7 billion. The report paints a fiscal picture of municipalities which have the highest property taxes in the state—and the highest per capita municipal debt. Indeed, the rating agencies awarded Hartford two four-notch downgrades last year: Moody’s reduced the city’s rating to junk-level, putting it in the lowest one percent credit rating of all municipalities—even as it cited the city as at risk of further downgrades “over the medium term,” with its analysts noting that: “For the time being, Waterbury, and Bridgeport, and most likely also New Haven, can continue to muddle through without the need for extraordinary support from the state…[but] the same cannot be said for Hartford.” Hartford faces a $48 million gap on a $270 million budget, notwithstanding the steep budget cuts and layoffs the city undertook last year. The city appears to be on the wrong fiscal end of a teeter-totter: its reserves sagged 34% from FY2006 to FY2015; while its debt per capita escalated 78% over the same period, according to the report. Or, as Mayor Luke Bronin describes it: “The city used every trick up its sleeve to try to keep the lights on…I think all of those were mistakes, but in a big sense they’re a symptom of the problem, not the problem itself.” Gov. Malloy attributes the city’s property tax as the key fiscal contributor, whilst Mayor Bronin, the Governor’s former Chief Counsel, has pressed, as we have previously noted, for a regional solution—one that might, for instance, mirror some of the innovative fiscal, regional efforts in the St. Paul-Minneapolis and Denver metro areas. Mayor Bronin believes that a municipal fiscal partnership could include shared services or revising state formulas for education and health funding—a proposal that in some ways fits Connecticut Superior Court Judge Thomas Moukawsher’s order last fall directing the state to revise its state aid to education formula to better serve students in low-income municipalities—an order which Connecticut Attorney General George Jepsen is currently appealing. For his part, Gov. Malloy said a fairer distribution of Connecticut’s state aid to local governments could provide an important lifeline to avert chapter 9 bankruptcies—but that any such aid would mean the state would “play a more active role in helping less-affluent communities – in helping higher-taxed communities – part of that role will be holding local political leadership and stakeholders to substantially higher standards and greater accountability than they’ve been held to in the past: We should do it so that increased aid doesn’t simply mean more spending on local government.”

A Bridge to Local Experience. The New Jersey Department of Community Affairs has hired Atlantic City business administrator Jason Holt to assist in its state takeover of the distressed city, in this case adding a key individual who has worked under Mayor Donald Guardian for the last two years: Mr. Holt is charged with assisting the Department’s Division of Local Government Services in taking on the virtually insolvent city’s fiscal. He seems very well equipped, having served previously as Mayor Guardian’s solicitor, before serving as the city’s business administrator. Indeed, Mayor Guardian yesterday noted: “Over the past three years, Jason Holt has been an integral part of my team…When I originally selected him as my solicitor and then as my business administrator, I did so because of his extreme intellect and professionalism. Obviously, the State sees the same thing in Mr. Holt.” The transition is likely enhanced, because Mr. Holt has worked closely over the last two months with Local Government Services Director Tim Cunningham and Jeffrey Chiesa, the state’s designee in charge of Atlantic City financial matters. Department of Community Affairs spokesperson Lisa Ryan noted: “Mr. Holt’s hire by DLGS formalizes the work he has been doing in practice for the last two months…Mr. Holt will leave the City’s business administrator position, although the work he will do for DLGS will largely be the same as what he is doing now.” She added that Mr. Holt will continue working out of City Hall with his official first day with the DLGS set for next Monday. The state decision, however, has not been met with uniform approval: Assemblyman Chris Brown (R-Atlantic), who has been critical of the state for not producing its own fiscal recovery plan after rejecting the city’s, noted the lack of state transparency: “Without a transparent plan, even if they laid all the state’s experts end to end, they’d still never reach a solution.” In contrast, Mayor Don Guardian, who, in a statement said Mr. Holt has been an integral part of his team, added: “When I originally selected him as my solicitor, and then again as my business administrator, I did so because of his extreme intellect and professionalism. Obviously, the state sees the same thing in Mr. Holt…I look forward to working with him in his new capacity.” Indeed, Mr. Holt brings considerable experience, having previously served as corporation counsel for East Orange, Essex County, where, he provided legal counsel to both the Mayor and City Council, oversaw the complete spectrum of that city’s legal affairs, and played a key role in revamping its public-safety initiatives.

Is There Promise in PROMESA? Just as Puerto Rico enters its 12th year of economic depression, the PROMESA Oversight Board has informed new Governor Ricardo Rosselló Nevares that the Board is willing to grant additional time for the submission of a new fiscal plan—provided the Governor is willing to lay off public employees, reduce the pensions of thousands of retirees, make budget cuts for the University of Puerto Rico and Mi Salud, and extract an additional $1.5 billion from the pockets of corporations and individuals. In addition, the Board indicated it would be willing to extend the stay on litigation provided by PROMESA until May 1st, if Gov. Rosselló Nevares’s administration presents a plan to renegotiate Puerto Rico’ public debt. According to the calculations provided by the Board, this could mean an adjustment of $3 billion to the debt service, with the proposals gleaned from a 14-page letter, which appeared to be a warning to the new Governor that he must balance the budget in the next two fiscal years, and that the proposals for adjustments in public expenditures are “prerequisites” for the Board to certify any plan submitted. In response, Puerto Rico’s representative to the Board, Elías Sánchez Sifonte, immediately stated that Gov. Rosselló Nevares’s administration will seek to meet the Board’s conditions. He also assured that there are other mechanisms to balance the budget and close the fiscal gap—a gap the Oversight Board estimates at nearly $7.6 billion. In its letter, the Board advised the new Governor that his team could submit a new fiscal plan by the end of February, and that the document should be approved by March 15th—all subject to the Governor agreeing to balance the budget with a “one and done” approach, with “no discussion or consideration of short-term liquidity loans or near-term financings,” despite the contention by Gov. Rosselló Nevares and his team that such financing are a prerequisite in order to avoid a government shutdown. The stiff challenges, which the new Governor’s administration agreed were not so different from its own preliminary forecasts, were, nevertheless, perceived as “dramatic,” albeit key to avoid “the total collapse” of the government, blaming the previous Gov. Alejandro García Padilla’s administration’s “unwillingness to cooperate, [and] wasting time in presenting a fiscal plan that did not meet the requirements.”

The Board’s orders will affect not only Puerto Rico’s public employees, government pensioners, and foreign corporations and their tax liabilities, but also holders of Puerto Rican municipal bonds: those bondholders, in every state, could realize a reduction of as much as 80% of the annual payments that Puerto Rico must make—through different issuers—over the next two years. Sacrifices, it appears, will be widespread: the Board also proposed that Gov. Rosselló cut 23% in payroll expenses (about $900 million), which would imply a reduction in the number of public sector employees, an indicator that is already at a historical low; reduced public pensions by 10 percent—in a “progressive manner,” eliminated 100 percent of the subsidies to municipalities (about $400 million), which would be offset by a revision to property taxes, and higher payments by beneficiaries of Puerto Rico’s healthcare plan, all as part of Board recommendations that could, if implemented, save the U.S. territory as much as $1 billion. The Board added it believed the University of Puerto Rico could cut $300 million (27%) from its budget if it hiked tuitions. if it increased the amount of services among students and faculty members, raised the tuition to those who could afford it, and promoted the arrival of international and continental students to take courses in the institution.

The Board noted that to close Puerto Rico’s budget gap, Gov. Rosselló Nevares’s administration would have to meet with Puerto Rico’s municipal bondholders to make voluntary debt renegotiations through Title VI of PROMESA; albeit negotiations with the creditors would not necessarily take place in good terms: according to the numbers the Board released yesterday, the series of cutbacks and changes in the government would, on their own, be insufficient; ergo bondholders—including thousands of Puerto Rican individuals—will have to accept a cut in the debt service, which could amount to $3 billion.

But Here Come da Judge. Yet even as the PROMESA Board and the new Governor were seeking to come to terms with steps critical to fiscal recovery, the third branch of government stepped into the fiscal fray when U.S. District Judge Francisco Besosa handed a victory to holders of Puerto Rico Employment Retirement System (ERS) bonds, marking one of municipal bondholders’ first legal victories since Puerto Rico began defaulting on municipal bond interest payments about a year ago. Judge Besosa has ordered ERS to shift incoming employers’ contributions from its operating account to a segregated account at Banco Popular de Puerto Rico, directing that such funds remain in the segregated account until all parties agree on a different approach or the court orders the money to be moved out of the account. ERS had $3.1 billion in municipal bond debt outstanding as of July 2, 2016, according to the Puerto Rico government—none of it insured; all of it taxable. Normally, Puerto Rico government employers make employer contributions to support the payment of senior pension funding bonds; last year, as part of Puerto Rico’s emergency order 2016-31 in which it declared the ERS was in an emergency, the obligation of the ERS to transfer employer contributions to the bond trustee was suspended. Last November, Judge Besosa ruled against the plaintiffs in the case concerning the ERS bonds. Simultaneously, he had ruled against several other bondholder plaintiffs in other cases—leading some of the municipal bondholders to appeal to the United States Court of Appeals for the First Circuit—which, last week, generally concurred with Judge Besosa’s opinion (see Peaje Investments, LLC v. Alejandro Garcia-Padilla et al, 4th U.S. Court of Appeals, #16-2431, January 11, 2017), affirming the continued stay on bondholder litigation stemming from the Puerto Rico Oversight, Management, and Economic Stability Act in several cases, albeit ordering Judge Besosa to hold a hearing for the arguments of the lead plaintiff, Altair Global Credit Opportunities Fund, and its co-plaintiffs, with the court writing: “We note that the Altair movants’ request for adequate protection here appears to be quite modest. They ask only that the employer contributions collected during the PROMESA stay be placed ‘in an account established for the benefit of movants.’ In light of ERS’s representation that it is not currently spending the funds, but instead simply holding them in an operating account, this solution seems to be a sensible one.” Thus, this week, Judge Besosa ordered such a segregated account to be set up and that all funds not transferred since the start of the PROMESA litigation stay be deposited in the account within five business days; Judge Besosa also ordered that in the future the ERS should transfer the employer contributions to the segregated account no later than the end of each month, noting that the segregated account will be “for the benefit of the holders of the ERS bonds,” adding, moreover, that said funds will simply sit in the account until a court orders otherwise, although he noted it would not preclude the ERS from transferring the employer contributions to the bond trustee for payment of the bonds, as would normally be the case.