Is There a “Right” Structure to Resolve Fiscal Insolvency?

06/19/17

Good Morning! In this a.m.’s eBlog, we consider the ongoing challenges to restoring fiscal solvency in the U.S. territory of Puerto Rico, so that chapter 9 does not apply—nor does that process provide a mechanism to address the territory’s municipalities, much less the existing federal discrimination against Puerto Rico vis-à-vis other Caribbean nations The challenge, if anything, has been heightened by the absence of mixed messages from Congress-where the PROMESA Oversight Board has sent a letter to Puerto Rico’s leaders warning of what the Board described as a waning resolve to deal with a dire financial situation.

Trying to Shock? House Natural Resources Committee Chairman Rob Bishop R-Utah) has notified PROMESA’s oversight board that its failure to approve the Puerto Rico Electric Power Authority’s restructuring support agreement is seen as “very problematic” by some federal legislators: “It appears there is no consensus from the oversight board in favor of certifying the PREPA [RSA] under…PROMESA…This is troubling, as the decision to implement the RSA had already been made by Congress with the passage of PROMESA. The oversight board’s dilatory tactics run counter to the plain language of PROMESA.” At the same time, PROMESA Board Chair José Carrión III stated that Puerto Rico needs to create implementation plans to reduce government spending and ensure adequate liquidity—writing last  Friday at a key time as the Puerto Rico legislature worked to try to reach consensus on a balanced FY2018 budget, in compliance with a board-approved 10-year fiscal plan. Chairman Carrión wrote: “I write to you out of a concern that some of the progress we appeared to have made in the past few weeks as a result of the close and positive collaboration between the board and the administration–and their respective teams of advisors–may be receding and that the necessary resolve to attain the goals set forth in the certified fiscal plan may be waning…It is equally of concern that some of the narrative taking hold in the public discourse fails to characterize adequately the truly dire fiscal situation the Commonwealth is facing.”  Chairman Carrión, in his epistle to Gov. Ricardo Rosselló, Senate President Thomas Rivera Schatz, and House of Representatives Speaker Carlos Méndez Núñez, noted it was an incorrect “narrative” for Puerto Rico’s government to say that if the government generates $200 million in additional cash reserves by June 30th, the PROMESA Board would not mandate a government furlough program and reduction or elimination of the Christmas bonus; rather, to avoid these measures, the Board is mandating a spending-reduction implementation plan in addition to the cash reserve intended to ensure ongoing liquidity—with Chairman Carrión warning that if the plan is inadequate or poorly executed, “Puerto Rico is all but certain to run out of money to fund the central government’s payroll come November or December of this year.” The PROMESA Board also called on Governor Rosselló to explain which public services are essential.

The stern warning—to a government where some of the most essential services are lacking—produced a response from Governor Rosselló’s non-voting representative to the PROMESA Board, Elías Sánchez Sifonte: “This administration has demonstrated an unwavering commitment to face this inherited crisis with the seriousness it deserves,” adding that: “We have also been demonstrating implementation plans to ensure we provide resources to cover essential services as required by PROMESA and in accordance with our Certified Tax Plan,” including progress in the Puerto Rico legislature on the budget proposed by the Governor based upon consultation with the PROMESA Board—a budget the Puerto Rican Senate expects to consider later this week.

The discussions came as U.S. District Judge Laura Taylor Swain, who is overseeing Puerto Rico’s Title III municipal bankruptcy process, taking a page from Detroit’s chapter 9 bankruptcy, named U. S. District Court Judges, including the remarkable Judge Christopher Klein, who presided over Stockton’s municipal bankruptcy trial, to help address critical issues. She also named Judge Barbara Houser of the U.S. Bankruptcy Court of the Northern District of Texas, designating her to lead the mediation team; Judge Thomas Ambro, of the U.S. Court of Appeals for the 3rd Circuit; U.S. District Court Judge Nancy Atlas of U.S. District Court for the Southern District of Texas; and Judge Victor Marrero of U.S. District Court for the Southern District of New York. Judge Swain made clear that participation in any mediation will be voluntary and confidential—and that she will not participate in mediation sessions, and mediators will not disclose information about the parties’ positions or the substance of the mediation process to her—with this process—as was the case in Stockton and Detroit’s chapter 9 cases—ongoing concurrently with trial in her courtroom. Judge Swain added that she plans to make final appointments prior to the June 28th Title III hearing in San Juan, where she will further explain the mediation process.

Who’s in Charge? The PROMESA Oversight Board has warned Puerto Rico’s leaders that the Board is apprehensive of a waning resolve to address the U.S. territory’s dire fiscal situation, with Chairman José Carrión III warning that Puerto Rico needs to create implementation plans for reducing government spending and assuring adequate liquidity at all times. The letter—coming between the emerging quasi-bankruptcy proceedings under Judge Taylor and as the Puerto Rico legislature is attempting to put together a balanced FY2018 budget, in compliance with a board-approved 10-year fiscal plan—came as PROMESA Board Chair José Carrión III urged greater resolve, writing: “I write to you out of a concern that some of the progress we appeared to have made in the past few weeks as a result of the close and positive collaboration between the Board and the administration–and their respective teams of advisors–may be receding and that the necessary resolve to attain the goals set forth in the certified fiscal plan may be waning…It is equally of concern that some of the narrative taking hold in the public discourse fails to characterize adequately the truly dire fiscal situation the Commonwealth is facing.” Chairman Carrión, in his epistle to Gov. Ricardo Rosselló, Senate President Thomas Rivera Schatz, and House of Representatives Speaker Carlos Méndez Núñez, added that there is an incorrect “narrative” that says that if the Puerto Rican government generates $200 million in additional cash reserves by the end of this month, the PROMESA Board would not mandate a government furlough program, nor a cut or elimination of the Christmas bonus. To avoid such a mandate, he added that the PROMESA Board is mandating a spending-reduction implementation plan in addition to a cash reserve plan intended to assure government liquidity, with the Chairman adding that if the plan is inadequate or poorly executed, “Puerto Rico is all but certain to run out of money to fund the central government’s payroll come November or December of this year.” Noting that: “Now we are at a critical juncture that requires that we collectively strengthen…,” the Board demanded that Gov. Rosselló explain which public services are essential.

Does Accountability Work Both Ways? Unlike chapter 9 bankruptcy cases in Detroit, San Bernardino, Central Falls, Jefferson County, and Stockton—Puerto Rico is unique in that the issue here does not involve municipalities, but rather a quasi-state. There have been no public hearings. PROMESA Chair José B. Carrion has not testified before the legislature. Now Puerto Rico Rep. Luis Raúl Torres has asked the Puerto Rico Finance Committee to invite Chair Carrión to appear to explain to Puerto Rico’s elected leaders the demands the PROMESA Board is seeking to mandate—and to justify the $60 million that the Fiscal Supervision Board is scheduled to receive as part of the resolution of special assignments. That Board, headed by Natalie Jaresko, the former Finance Minister of the Ukraine, is, according to PROMESA Chair Jose Carrión, to be in charge of the implementation of the plan, or, failing that, to achieve the fiscal balance of Puerto Rico and its return to the capital markets. (Ms. Jaresko has agreed to work for a four-year term: she is expected to earn an annual salary of $ 625,000 without additional compensation or bonuses, except for reimbursement of travel and accommodation expenses related to the position he will hold, according to PROMESA Board Chair Carrión, who has previously noted: “I know it’s going to be a controversial issue…We have a world-class problem, and we have a world-class person. This is what the rooms cost.”)

The Indelicate Challenge of Restoring Political Authority in the Wake of Municipal Insolvency

Good Morning! In this a.m.’s eBlog, we consider the historic Civil War municipality of Petersburg’s, Virginia’s steps back to solvency and restoration of municipal control, and then to the indelicate imbalance of fiscal power in Puerto Rico—and whether the federal preemption might be causing more fiscal damage to its fiscal future.

Returning to Solvency. The Petersburg, Virginia City Council last night approved its FY2018 budget, a budget which includes outsourcing jobs—with more than a dozen city employees slated to lose their jobs as a result. The new municipal budget includes an increase in water rates—an increase of nearly 15%–an increase the city’s elected officials deemed necessary in order to finance needed repairs, as well as to update its systems for billing and collections—and to cover its past due arrears of $1.9 million. The session came as the Council began discussions with regard to hiring a new city manager and police chief—and whether to beef up is personal property tax enforcement: the city estimates it could be losing as much as $7 million annually from inadequate collection efforts. The actions by the Mayor and Council reflect a restoration of municipal authority in the wake of state intervention.

The Unpromise of PROMESA? Neither the government of Puerto Rico, nor the PROMESA Oversight Board has been able to state how much in municipal bond interest payments will be made for the next fiscal year—even as the gates of the University of Puerto Rico have been locked, depriving the U.S. territory of the jewel in its crown. The University, which has relied upon 30% of its financing from the government—financing critical to Puerto Rico’s hopes to keep its most promising future generation on the island, rather than incentivized to leave for New York City or Miami—increasingly threatening to leave behind an older and less educated population, more dependent on governmental services, but less able to pay taxes. However, as the PROMESA Board struggles over its preemptive decision with regard to what percent of Puerto Rico’s debt obligations to its municipal bondholders should be mandated, (according to the Board’s March approved fiscal plan, the bonds most closely associated with Puerto Rico’s government would pay $404 million in debt service in the coming fiscal year—approximately one-eighth of the $3.28 billion debt service due), the question with regard to investing in Puerto Rico’s fiscal and physical future remains murky—indeed, murky enough that the balance between Puerto Rico’s $404 million in debt service costs versus investments in its future has been left hanging.

Part of the challenge of preemptive governance is, as we perceived in the first instance of the Michigan takeover of Flint, that there can be signal human and fiscal damage to life, property, and fiscal solvency. Thus, the imbalance where the federal takeover under PROMESA, the Act intended to serve as the fiscal guide through FY2026, is to what extent disinvestment in Puerto Rico’s physical infrastructure and its municipalities might aggravate, rather than restore the territory’s solvency and create a fiscal foundation for its future. And that future is at stake—a future where the gates of its premier university are locked, and where demographers report the loss of population of 61,874 in one year—and where last Sunday’s plebiscite witnessed a drop of more than 50% in voter participation, with markedly reduced percentages in Puerto Rico’s 78 municipalities—where participation was 23%, less than a third the level of 1998. Demographer Raúl Figueroa noted: “The population is declining…To give people an idea, from 2015 to 2016, the loss of population was 61, 874,” adding that every year between 1% and 2% of the population is lost. The Mayors of Yauco (a municipality which lost nearly 10% of its population over the last decade) and Ponce, Puerto Rico’s second largest city, known as the City of Lions (population of 194,636), founded in 1692, an important trading and distribution center, as well as a key port of entry—indeed, one of the busiest ports in the Caribbean, which has seen a 9.36% decline in its population—a decline which Mayor Maria Mayita Meléndez, attribute to emigration: Mayor Meléndez notes that since 2006, more than 25,000 Puerto Ricans have left Ponce.

Elections, Federalism, & Inequitable Fiscal Outcomes

Good Morning! In this a.m.’s eBlog, we consider yesterday’s overwhelming vote in Puerto Rico for statehood—and why that will likely be ignored with less equitable fiscal implications.

Federally Sanctioned Fiscal Inequity? In the fifth such vote on a non-binding referendum, Puerto Ricans, yesterday, overwhelmingly, voted for statehood—sending the issue back again to Congress—which, last time, in 2012, opted not to act.  In order for Puerto Rico to become the nation’s 51st state, Congress would have to act. 502,616 voted for statehood, against 7,779, who voted in favor of independence, and 6,821 to retain the current territorial status 6,821. Gov. Ricardo Rosselló, in the wake of the vote, noted: “Today Puerto Ricans are sending a strong and clear message to the world, claiming equal rights as American citizens…It is now up to us to bring those results to Washington with the strength of democratic exercise, supervised by a Mission of National and International observers: this mission will be reporting to Congress and the federal government on this historic election.”  

Since Puerto Rico became a U.S. territory after the Senate, on February 20, 1917, voted in support of H.R. 9533, to “provide a civil government for Puerto Rico.” The Act, falling between statehood and colonial status, has meant that Puerto Rico has remained in quasi-colonial status, with less favorable shipping laws than neighboring nations and less equitable treatment under Medicaid for its citizens—notwithstanding their U.S. citizenship. Moreover, it has meant Puerto Rico is entitled to no representation in the U.S. Senate—and has only a non-voting delegate in the U.S. House of Representatives. Similarly, because it is not defined as a state, Puerto Rico does not receive entitlement funding for Medicare—as do the fifty states.

The outcome is almost certain to be ignored by the White House and Congress. It leaves Puerto Rico’s efforts to restructure its nearly $120 billion in debt—some six times what Detroit faced in the largest municipal bankruptcy in. U.S. history—in a quasi-colonial status, where current federal laws provide competing Caribbean nations with more favorable trade status, but less favorable costs for shipping, as well far less in Medicaid assistance compared to states.

The British Broadcasting Service, the Beeb, posits that a GOP-led Congress is wary of acting on the vote, because it would likely mean adding two Democratic votes in the closely-divided U.S. Senate—as well as opening the fiscal gates for equitable treatment on a par with the other 50 states.  

Are There non-Judicial Avenues to Solvency?

Good Morning! In this a.m.’s eBlog, we consider the increasing threat to Hartford, Connecticut’s capitol, of insolvency; then we look at the nearing referendum in Puerto Rico to address the U.S. Territory’s legal status.

Can Chapter 9 Be Avoided? As the Connecticut legislature nears ending its session, House Majority Leader Matthew Ritter (D-Hartford) has been taking the lead in efforts to commit tens of millions of state dollars to rescue the city—but, as the Leader noted: “There are going to be strings;” the price to the municipality will be greater state control—however, what that control will be and how implemented remains unclear. One key issue will be the city’s looming pension challenge: the city’s current $33 million in annual obligations is projected to increase to $52.6 million by FY2023—ergo, one option for the state would be to utilize an oversight board to re-negotiate union contracts, a move used before by the state for Waterbury—and a step Mayor Luke Bronin had proposed last year—only to see it rejected. His efforts to seek a commitment for $15 million in givebacks by the unions this year succeeded in getting only one tenth that amount, $1.5 million—and came as the local AFSCME Council recently rejected a contract which could have saved the city $4 million.

The inability to agree upon voluntary steps to address the nearing insolvency has pushed state leaders, increasingly, to discuss the creation of a state financial control board as a linchpin to any state bailout of the city—with leaders discussing a board composed evenly of state, local, and union representatives. Connecticut’s law (§7-566) requires the express prior written consent of the Governor—obligating him to submit a report to the Treasurer and General Assembly—actions taken twice before in the cases of Bridgeport (1991) and the Westport Transit District; however, each case was resolved without going through the legal process and submission of a plan off debt adjustment. Indeed, there is, as yet, little consensus in the state legislature with regard to what oversight governance would include: one option under consideration would impose a spending cap, while another would provide for state preemption of the city’s authority to negotiate with its unions: the Majority Leader notes: “I think that if we could get these concessions agreed to and reach the savings that have been targeted…it would go a long way to limiting the amount of oversight in the city of Hartford.” Whatever route to restoring solvency, tempus fugit as the Romans used to say: time is fleeing: the city’s deficit is just under $50 million, even as the departure of one of its biggest employers, Aetna, looms—and, as we had reported in Providence, the city has a disproportionate hole in its property tax base: state and local government agencies, hospitals, and universities occupy 50% of the city’s property. Add to that, the city’s current authority to levy property tax limits such collections to an assessed value of 70 percent.

Mayor Bronin, recognizing that state help is critical, notes his “goal and hope is that legislators from around the state of Connecticut will recognize that Hartford cannot responsibly solve a crisis of this magnitude at the local level alone.” State aid will be critical for an additional reason: absent such assistance, the city’s credit rating is almost certain to deteriorate, thereby driving up its costs for capital borrowing.  Adding to the urgency of fiscal action is the pending departure of Aetna from the city: even though city leaders believe the giant health care corporation will keep many of its 6,000 employees in Connecticut, notwithstanding its negotiations with several states to relocate its corporate headquarters from Hartford, Aetna has stated it remains committed to its Connecticut employees and its Hartford campus. (Aetna and Hartford’s other four biggest taxpayers contribute nearly 20% of the city’s $280 million of property-tax revenues which make up nearly half the city’s general fund revenues.) The companies have imposed a fiscal price, however: Aetna, together with Hartford Financial Services and Travelers have offered to contribute a voluntary payment of $10 million annually over the next five years to help the city avoid chapter 9 municipal avoid bankruptcy, but only on the condition there are comprehensive governing and fiscal changes. But the companies have said they want to see comprehensive changes in how Hartford is run—including vastly reducing reliance on the property tax—a tax rate which the city has raised seven times in the past decade and a half to rates 50% greater than they were in 1998. Thus, with time fleeing, the city confronts coming up with the fiscal resources to finance nearly $180 million in debt service, health care, pensions, and other fixed costs for its upcoming fiscal budget—an amount equal to more than half of the city’s budget, excluding education; that is, the city’s options are increasingly limited—and the Mayor has made clear that he will not reduce essential public safety. As the Majority Leader describes it, it is in the state’s best interest to make sure the city has a sustainable future, noting that a municipal bankruptcy would not “just affect Hartford: It would affect neighboring communities, it would affect the state, it would probably affect our credit ratings.”

Eliminating local power? Hartford City Council President Thomas Clark is apprehensive with regard to state preemption of local authority, noting hisconcern has always been if this bill is passed–in whatever form it gets passed–what does that do to the elected leadership at the local level?…And I think until we see what that actually includes, we’re just going to be uncomfortable with this concept.” From the Mayor’s perspective, he notes: “Understandably, Connecticut residents do not want their hard-earned tax dollars being used wastefully, or simply funding an increase in the cost of city government…I don’t mind anybody looking over my shoulder…and I don’t mind having the books open. I’m confident in the decisions that we’ve made.” That contrasts with his colleagues on the City Council—and the city’s unions, who have previously charged: “The Governor and this mayor are clutching at their last chance at unconditional and overreaching power.” The unions have claimed there are measures which could be taken without resorting to negating collective bargaining rights and municipal bankruptcy; yet, as we have seen in Detroit, San Bernardino, etc., those efforts were ineffective compared to the pressure of a U.S. bankruptcy judge.

Chartering a Post Insolvency Future? Voters and taxpayers in the U.S. Territory of Puerto Rice go to the polls this Sunday to vote on a referendum on Puerto Rico’s political status—the fifth such referendum since it became an unincorporated territory of the United States. Although, originally, this referendum would only have the options of statehood versus independence, a letter from the Trump administration had recommended adding “Commonwealth,” the current status, in the plebiscite; however, that recommendation was scotched in response to the results of the plebiscite in 2012 which asked whether to remain in the current status—which the voters rejected. Subsequently, the administration cited changes in demographics during the past 5 years as a reason to add the option once again, leading to amendments incorporating ballot wording changes requested by the Department of Justice, as well as adding a “current territorial status” as provided under the original Jones-Shafroth Act as an option. Notwithstanding what the voters decide, however, it remains uncertain what might happen—much less how a Trump Administration or how Congress would react. The referendum was approved last January by the Puerto Rico Senate—and then by the House, and signed by Gov. Rossello last February.

The Thin Line Between Fiscal & Physical Recovery Versus Unsustainability.

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

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

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

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

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

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

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

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

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

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

The Hard Road to Fiscal Sustainability

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

The Road to Recovery from Municipal Bankruptcy.  Detroit, which has roared back from the largest municipal bankruptcy ever, but, in doing so paid an average 81% of what it owed to its municipal bondholders as part of its plan of debt adjustment, nearly 25% more than either San Bernardino or Stockton, now, in the wake of its decades of its more than 50% population decline  (In 1950, there were 1,849,568 people in Detroit; in 2010, there were 713,777.), is ready to tackle its housing dilemma. Post-chapter 9 Detroit inherited an estimated 40,000 abandoned lots and structures and an 80% erosion of its manufacturing base—that in a municipality where 36 percent of its citizens were below the federal poverty level, and, the year it filed for chapter 9, had reported the highest violent crime rate for any U.S. city with a population over 200,000.

Thus, Mayor Mike Duggan now vows that his administration plans to launch a street-by-street initiative effective August 1st to board up abandoned homes in the city while demolition crews continue razing blighted houses. That will be a painstaking challenge: in a city of 142 square miles, the city reports some 25,000 unsecured houses, the bulk of which have been scheduled to be razed—but, up to now, the pace of demolitions has been limited to 4,000-5,000 annually, according to the Mayor. Thus, he posits: “We’re going to go through and board up every house we can’t get to so we’re not just saying to people, ‘It’s going to be five years before we get to everything. Wait!’”

Mayor Duggan, speaking at the Mackinac Policy Conference, vowed the city will begin deploying six crews beginning at the end of next month, with the teams slated to go through each neighborhood and close off vacant and abandoned homes—homes that are susceptible to crime, to being scrapped for metal and finishings, and becoming uninhabitable safety hazards. Mayor Duggan made the announcement, as the city’s plan of adjustment and the city’s actions in implementing it appear certain to be fodder for the upcoming mayoral primary election set for August 8th—with whichever candidate is chosen slated to confront Michigan state Sen. Coleman Young II (D) in the November 7th general election. Indeed, unsurprisingly, Sen. Young (1st District), who previously served two terms in the Michigan House prior to being elected to the State Senate, is the son of former Detroit Mayor Coleman Young—who served as the Motor City’s Mayor from 1973-1994, this week blasted Mayor Duggan for waiting until his fourth year in office to address the safety hazard of unsecured houses: he accused his upcoming opponent of “playing games with the people and the public, because it’s election time,” adding he was “just amazed now all of sudden that he cares about the neighborhoods and he wants to do this…Where was he for the last 3.5 years in office? They just should have addressed that first.”

Currently the Duggan administration estimates city crews can board up 100-200 homes each week and that the effort will take two years to complete, so that, as Mayor Duggan notes: “By the end of two years, we’ll have every house in the city either demolished, reoccupied, or boarded…So at least it will be secure. Kids won’t be wandering in and out.” In making the statement, Mayor Duggan acknowledged the city has fallen well short of its avowed initial goal of razing 10,000 blighted homes annually, describing that as “not a practical goal.” Since Mayor Duggan took office in 2014, Detroit has razed some 11,593 blighted structures; there are 331 more contracted for demolitions, and then another 2,141 in the pipeline.

In making his responses, Mayor Duggan acknowledged that his initial commitment to raze more than 5,000 homes per year had gotten him into “trouble,” noting: “I feel bad for the people who took the grief for it, because I pushed them;” he said the city will post notices on unsecured privately owned homes for which city crews will be covering the windows and doors with plywood, noting: “We’ll go down and board up every house that’s not scheduled to come down in the next six to 12 months,” adding that the city’s budget is bearing the burden more often than not, because the cost of going after the home owners of such abandoned homes has proved impractical and costly: “You’ve got a lot of people in this town (who say), ‘My uncle died, left me the house, the house is in a bad neighborhood,’ they don’t even live here…To send them bills is not practical.” To date, for the most part, Mayor Duggan said the city has been delivering plywood to some neighborhood groups and relying on volunteers to board up houses on their streets; however, he added that there are a lot of neighborhoods with mostly senior citizens who “just physically can’t put these huge sheets of wood onto these houses…We finally said, ‘You know the most efficient way to do it just roll through the city.’”

On the Road to Fiscal Recovery. As we reported earlier this week, Detroit completed its most recent fiscal year with a $63 million surplus according to its Comprehensive Annual Financial Report, which the city filed with the Michigan Treasury Department on Tuesday, with Detroit CFO John Hill noting the FY2016 surplus was some $22 million higher than the city had projected, an outcome  to which he attributed the city’s improved financial controls, stronger-than-anticipated revenues, and lower costs due to unfilled vacancies—something, he told the Detroit News, the city believes “will have a lot of positive implications on the future.” In the near future, it offers the potential for Detroit to exit from state oversight by the Financial Review Commission under terms of Detroit’s plan of debt adjustment. Or, as Mayor Mike Duggan noted: “This audit confirms that the administration is making good on its promise to manage Detroit’s finances responsibly…With deficit-free budgets two years in a row, we have put the city on the path to exit Financial Review Commission oversight.” In fact, the city now projects an FY2017 $51 million surplus.

All this is increasing optimism that the 2017 audit of the Motor City’s finances could trigger a vote by the Commission to suspend its direct financial oversight, obviating the current required state oversight and requisite approvals on all the city’s budgets and contracts. Of the city’s reported $143 million in accumulated unassigned fund balances, including this year’s surplus, the city has allocated $50 million from its FY2016 balance as a down payment to help set up the city’s Retiree Protection Fund to help it address pension obligations scheduled to come due in 2024 under the terms of the city’s plan of debt adjustment. In addition, the city has set aside $50 million in its FY2018 budget for blight remediation and capital improvements—an amount which would leave a cushion of about $43 million in an unassigned fund balance—but which account could only be drawn from with the approval of Mayor Duggan, the City Council, or the state review commission. The city primarily draws from this account for one-time costs, such as to address blight and for its capital budget. CFO Hill has expressed hope the ongoing, positive cash flow and budget balances will enhance the city’s credit rating—and, thereby reduce its borrowing or capital costs.

What Constitutes Economic Sustainability? Puerto Rico Gov. Ricardo Rosselló has proposed an austere Fy2018 General Fund budget which, he reports, would reduce the territory’s operating expenses by 9.1%, describing his plan as comparable to “those we had established in the fiscal plan.” As proposed, the Governor would allocate at least $2.04 billion for pensions—an amount that would leave naught to meet Puerto Rico’s debt obligations: he noted that funding pensions was vital to protect Puerto Rico’s most vulnerable citizens—and that the “measures implemented in this budget are those that we had established in the fiscal plan.” Nevertheless, Gov. Rosselló said his budget was different from past budgets, because it was balanced: it projects that the central government would have sufficient balance to remit $404 million of $3.283 billion in scheduled debt service, or 12.3%, in FY2018. The budget does not include the debt from semi-autonomous and autonomous public sector entities, but shows near balance: $9.1 billion in revenue and $8.987 billion in spending, according to the Puerto Rico Office of Management and Budget, with an increase of nearly 6% in spending. In the Governor’s proposed budget, all General Fund payments for debt would be eliminated—guaranteeing a battle with the PROMESA Board, which, in its plan, had projected there would be $404 million available cash flow “post-measures” for FY2018, with the Board seemingly pressing to ensure funds were included in the budget to address Puerto Rico’s debt services to municipal bond holders—even as the Governor appears focused on protecting the territory’s most vulnerable citizens. In contrast, the PROMESA board certified decade-long quasi plan of debt adjustment incorporated the amount of municipal bond debt service to be paid each year—providing that amount be $3.28 billion.

The challenge is complex: with apprehension that the territory’s young professionals are increasingly leaving to New York and Miami, leaving behind an increasingly elderly and impoverished population—less able to remit taxes, but in greater and greater need for public services, and for promised pension payments, the critical planned increase by the Governor in public pension funding is imperiled: each of Puerto Rico’s three government pension systems is projected to run out of liquid assets in FY2018, unsurprisingly leading the Governor to propose allocating at least $2.04 billion in his budget to cover pension funding—marking a stark change from his previous budget, when the line item to cover “pay-as-you-go” pension funding was absent. (Puerto Rico has three public pension systems: the Employee Retirement System, the Teacher’s Retirement System, and the Judiciary Retirement System.) In contrast, the PROMESA Board, last March, in its decade-long oversight fiscal plan, ordered a cut in public pension obligations effective in FY2020, projecting fiscal savings for the subsequent six years in the range of $83 million. It is unclear whether those projections incorporated the potential fiscal impacts on either sales tax revenues, or the increased costs of aid to those falling below the poverty level.

In his proposed budget, Gov. Rosselló has recommended to the legislature a $9.56 billion FY2018 General Fund budget, seeking a 6.4% increase—but, after compensating for public pension obligations, actually providing 21.8% less for spending. Within his proposed budget, the Governor is asking for $583 million more for “other operating expenses,” but $555 million less for salaries and related costs, and retaining $195 million as a reserve. (In the wake of the final action by the Puerto Rico legislature, the PROMESA Board is authorized to reject any final budget and substitute its own.)

However, there is now a third party to this increasingly complex fiscal process, in the form of U.S. Judge Laura Swain, who, under PROMESA’s Title III municipal bankruptcy process, has some discretion of her own to consider changes in the amounts of debt paid in the next fiscal year—albeit, as we have learned from the chapter 9 proceedings in Detroit, San Bernardino, etc., the judicial system in these exceptionally complex chapter 9 cases acts with  considerable deliberation—not haste; moreover, unlike a normal chapter 9 process, PROMESA section 106(e) prohibits Judge Swain from deviating from the PROMESA Board’s certified fiscal plan and budgets.

Gov. Rosselló’s budget, unlike previous proposals, includes a $2 billion payment for Puerto Rico’s three public pension systems, noting: “One of the most important differences, he said, as mandated by the PROMESA Board, in this budget is that, contrary to the previous ones, it really is balanced,” adding that, as proposed, Puerto Rico had created a $200 million reserve. In addition, the Governor reported he would soon propose measures to simplify Puerto Rico’s tax system. Overall, his proposed plan contains some $924 million in revenue increases versus $851 million expense cuts for FY2018: among the key fiscal plan measures to increase FY2018 revenues is $519 million by extending the Act 154 foreign corporation tax and $150 million through improving tax compliance.

What Might it Mean to Puerto’s Rico’s Fiscal Future? The PROMESA Oversight Board, which had requested a structurally balanced budget, seeking a “once and done” approach to the Puerto Rico government’s fiscal crisis, had focused on immediate large spending cuts and revenue increases in the budget. Indeed, as proposed by the Governor, there are significant changes, including reductions in support for the University of Puerto Rico ($411 million) and $250 million to the island’s municipalities or muncipios. The plan encompasses freezing payroll increases and eliminating vacation and sick day liquidations—all with the aim to reduce Puerto Rico’s debt service costs by 76% through FY2026. San Juan Mayor Carmen Yulín Cruz said, “The governor’s public policy has been to act as the messenger of the junta [i.e. the Oversight Board] and, in this way, has hidden behind it to become the executioner of Puerto Rico,” according to the El Vocero news web site. “The budget message will be another sign that the governor turns his back on the people.”

The Roads Out of and into Insolvency

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

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

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

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

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

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