Public Trust, Public Safety, & Municipal Fiscal Sustainability: Has the Nation Experienced the Closing of its Chapter on Municipal Bankruptcies?


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eBlog, 04/20/17

Good Morning! In this a.m.’s eBlog, we consider the unique and ongoing fiscal and physical challenges confronting Flint, Michigan in the wake of the drinking water crisis spawned by a state-appointed Emergency Manager, before heading far west to assess San Bernardino’s nearing formal exit from chapter 9 municipal bankruptcy—marking the last municipality to exit after the surge which came in the wake of the Great Recession.

Public Trust, Public Safety, & Due Diligence. Flint, Michigan Mayor Karen Weaver has recommended Flint continue obtaining its drinking water via the Detroit Great Lakes Water Authority (GLWA), reversing the position she had taken a year ago in the wake of the lead-contaminated drinking water crisis. Flint returned to the Detroit-area authority which sends water to Flint from Lake Huron in October of 2015 after the discovery that Flint River water was not treated with corrosion control chemicals for 18 months. Mayor Weaver said she believed residents would stick with a plan to draw from a pipeline to Lake Huron which is under construction; however, she said she had re-evaluated that decision as a condition of receiving $100 million in federal funding to address the manmade disaster, noting that switching the city’s water source again might prove too great a risk, and that remaining with Detroit’s water supply from Lake Huron would cost her citizens and businesses less. Last year, Mayor Weaver had stated that the city’s nearly 100,000 residents would stay with a plan to draw from a Karegnondi Water Authority pipeline to Lake Huron—a pipeline which remains under construction, noting, then, that switching water sources would be too risky and could cause needless disruptions for the city’s residents—still apprehensive about public health and safety in the wake of the health problems stemming from the decision by a state-imposed Emergency Manager nearly three years ago to switch and draw drinking water from the Flint River, as an interim source after deciding to switch to the fledgling Genesee County regional system and sever its ties to the Detroit system, now known as the regional Great Lakes Water Authority. Even today, federal, state, and local officials continue to advise Flint residents not to drink the water without a filter even though it complies with federal standards, as the city awaits completion of the replacement of its existing lead service lines—or, as Mayor Weaver put it: “At the end of the day, I believe this is the best decision, because one of the things we wanted to make sure we did was put public health first,” at a press conference attended by county, state, federal and Great Lakes authority officials, adding: “We have to put that above money and everything else. That was what we did. And what didn’t take place last time was public health. We’ve done our due diligence.” The 30-year contract with the Great Lakes authority keeps Flint as a member of the Karegnondi authority—a decision supported by the State of Michigan, EPA, and Genesee County officials, albeit the long-term contract still requires the approval of the Flint City Council and Flint Receivership Transition Advisory Board, a panel appointed by Gov. Rick Snyder charged with monitoring Flint’s fiscal conditions in the wake of the city’s emergence from a state-inflicted Emergency Manager two years ago.

City Councilman Eric Mays this week said he will be asking tough questions when he and his eight other colleagues will be briefed on the plan. There is also a town hall tonight in Flint to take public comments. Councilman Mays notes he is concerned the city may be “giving up ownership” in the new Genesee regional authority, something he opposes, adding he would be closely scrutinizing what he deems a “valuable asset to the city.” Mayor Weaver has said she personally wanted to review the earlier decision in the wake of last month’s receipt from the Environmental Protection Agency of $100 million to assist the city to address and recover from the drinking water disaster that took such a human and fiscal toll. (EPA is mandating that Flint provide a 30-day public comment period.) Mayor Weaver notes she anticipates some opposition, making clear any final decision will depend upon “public feedback and public opinion.” Currently, the city remains under contract to make $7 million in annual municipal bond payments over 28 years to the Karegnondi Water Authority (KWA); however, the Great Lakes authority said it would pay a $7 million “credit” for the KWA debt as long as Flint obligates itself to make its debt service payments. There is, at least so far, no indication with regard to how any such agreement would affect water rates. That matters, because, according to the Census Bureau, the city’s median household income is $7,059, significantly lower than the median Michigan-wide household income, and some $11,750 less than U.S. median household income. The GLWA said Flint customers would save a projected $1.8 million over 30 years compared with non-contractual charges they would have paid otherwise; in return, the Flint area authority would become a back-up system for the Detroit area authority, saving it an estimated $600 million over prior estimates and ensuring Metro Detroit communities would still receive water in the event of an interruption in Great Lakes authority service.

Robert Kaplan, the Chicago-based EPA’s acting regional administrator, said he signed off on the deal because the agency believes it protects the health of residents: “What’s best for public health is to stay on the water that’s currently being provided.” Jeff Wright, the KWA’s chief executive and drain commissioner of Genesee County, said the recommended plan not only would allow Flint to remain with the Genesee regional system, but also to be a back-up water supply, which, he noted, “is critically important to the safety of Flint’s residents who have not had a back-up system since the beginning of the Flint water crisis,” adding: “Whether (or not) Flint ultimately chooses high-quality Lake Huron water delivered through the newly constructed KWA pipeline, the highest quality treated water from Genesee County’s Water Treatment Plant or any other EPA-approved alternative, we will continue to assist Flint residents as they strive to recover from the Flint Water Crisis.” 

Keeping the Detroit system. The Great Lakes Water Authority Has embraced Mayor Weaver’s recommendation, with CEO Sue McCormick noting: “Flint residents can be assured that they will continue to receive water of unquestionable quality, at a significant cost savings.” Michigan Senate Minority Leader Jim Ananich (D-Flint) noted: “It provides us a long-term safe water source that we know is reliable. KWA could do the same thing, but this is an answer to help deal with one of the major parts of it,” adding the recommended move to stay on Detroit area water is “another example of the emergency manager sort of making a short-term terrible decision that’s cost us taxpayers half a billion dollars, if not more.” Emergency managers appointed by Snyder decided with the approval of the Flint City Council to switch to the Flint River water in part to save money. Flint officials said they thought Detroit water system price hikes were too high. For more than a year, the EPA has delayed any switch to KWA because of deficiencies including that the Flint treatment plant is not equipped to properly treat water. Staying with the Great Lakes authority may be an initial tough sell because of the city’s history, Mayor Weaver warned, but she is trying to get residents to move on. A town hall is scheduled for this evening at House of Prayer Missionary Baptist Church in Flint for public feedback. “I can’t change what happened,” Mayor Weaver said. “All I can do is move forward.”

Moody Blues in San Bernardino? As San Bernardino awaits its final judicial blessing from U.S. Bankruptcy Judge Meredith Jury of its plan of debt adjustment to formally exit chapter 9 municipal bankruptcy, Moody’s has issued a short report, noting the city will exit bankruptcy with higher revenues and an improved balance sheet; however, the rating agency notes the city will confront significant operational challenges associated with deferred maintenance and potential service shortfalls—even being so glum as to indicate there is a possibility that, together with the pressure of its public pension liabilities, the city faces continued fiscal pressures and that continued financial distress could increase, so that a return to municipal bankruptcy is possible. Moody’s moody report notes the debt adjustment plan is forcing creditors to bear most of the restructuring challenge, especially as Moody’s analyzes the city’s plan to favor its pension obligations over bonded municipal debt and post-retirement OPEB liabilities. Of course, as we noted early on, the city’s pension liabilities are quite distinct from those of other chapter 9 municipalities, such as Detroit, Central Falls, Rhode Island, and Jefferson County. Under the city’s plan, San Bernardino municipal bondholders are scheduled to receive a major buzz cut—some 45%, even as some other creditors whom we have previously described, are scheduled (and still objecting) to receive as little as a 1% recovery on unsecured claims. Thus, Moody’s concludes that the Southern California city will continue to have to confront rising pension costs and public safety needs. Moody’s adjusted net pension liability will remain unchanged at $904 million, a figure which dwarfs the projected bankruptcy savings of approximately $350 million. The California Public Employees’ Retirement System also recently reduced its discount rate, meaning the city’s already increasing pension contributions will rise even faster. Additionally, Moody’s warns, a failure to invest more in public safety or police could exacerbate already-elevated crime levels. That means the city will likely be confronted by higher capital and operating borrowing costs, noting that, even after municipal debt reductions, the city might find itself unable to fund even 50 percent of its deferred maintenance. 

However, as San Bernardino’s Mayor Davis has noted, the city, in wake of the longest municipal bankruptcy in American 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 of adjustment agreement on its $56 million in pension obligation bonds—and in significant part with CalPERS—meant its retirees fared better, as Moody’s has noted, 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 subsequently set up payments to make the public employee pension fund whole.) The city was aided in those efforts in the wake of U.S. Bankruptcy Judge Meredith Jury’s ruling against the argument made by pension bond attorneys: in the wake of the city’s pension bondholders entering into mediation again prior to exit confirmation, substantial agreement was achieved for those bondholders—bondholders whose confidence in the city remains important, especially in the wake of the city’s subsequent issuance of $68 million in water and sewer bonds at competitive interest rates—with the payments to come from the city’s water and sewer revenues, which were not included in the chapter 9 bankruptcy. The proceeds from these municipal bonds were, in fact, issued to provide capital to 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.

What Will the Tides of November Bode for Struggling Cities’ Futures?

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eBlog, 9/09/16

In this morning’s eBlog, we consider the tightening noose around Atlantic City’s fiscal future as a state takeover looms. We consider the grim political and legal complications in post-chapter 9 Stockton, where a criminal trial of the incumbent Mayor who helped steer the city out of municipal bankruptcy looms just weeks before his campaign for re-election. What might it augur for the recovering city’s fiscal fate? Then we head east to Detroit, where elections of a very different sort will be on November’s ballot for a perspective from the Mayor on key ballot issues; finally, we consider the inability to achieve any clarity or resolution with regard to the fiscal fate of nearly fiscally and politically insolvent East Cleveland.  

A City on the Road to Nowhere? The Atlantic City Council has failed to accede to state terms and vote to dissolve its Municipal Utilities Authority, moving the city closer to default—the non-vote occurred after discussion in executive session, where, according to Council President Marty Small, there was insufficient support to reintroduce the requisite authority-related measures. Because the Council did not vote Wednesday evening, the municipality is nearly certain to violate the terms of its $73 million state loan—a loan which made the authority’s assets collateral and required the city to adopt an ordinance by next Thursday—and dissolves the authority if the city does not pay back the loan. The ball now moves to the state, which, under the terms, could then demand immediate repayment of money loaned to date. The city would be unable to repay the loan at this time, putting the authority at risk of monetization by the state, as we had noted from the op-ed Council President Small and Mayor Don Guardian wrote last Monday—or, as Council President Small put it: “It’s sad to say, but whatever the state does, we deserve…People didn’t take it seriously. They missed meetings. They claimed meetings were illegal.”

For the citizens of the beleaguered city, their future is unclear: they packed Council chambers Wednesday: some urged the Council to rescind a July 28 resolution that authorized the loan—a request which Councilman Frank Gilliam so motioned, in the wake of which Council voted 5-3-1 to support; however, Legislative Counsel Robert Tarver later said the measure needed a two-thirds majority to pass since prior notice of the vote had not been given; moreover, he noted that Council cannot rescind the resolution, since the state already performed on the agreement by loaning the city money. As in the old expression “misery loves company,” the actions have also triggered a pending lawsuit against the city, which seeks to void the resolution; the suit asserts a two-thirds majority of the full council was needed to pass the resolution, since it was an “emergency appropriation.” No matter what such future court battles might mean, however, the new reality is that the city’s inability to act means the state can demand it immediately pay back the $73 million loan—a demand the city cannot fiscally meet—but funds the city desperately needs if it is to meet the state-imposed November deadline to develop and submit a five-year fiscal plan to avoid a state takeover.

A Most Uncertain Road out of Municipal Bankruptcy. California Superior Court Judge Leslie Nichols has set an October 18 date for the trial of incumbent Stockton Mayor Anthony Silva—a candidate for re-election in November, where he is being challenged in his bid for a second term by City Councilman Michael Tubbs. The Mayor was arrested last month on charges he participated in and illegally recorded an alcohol-fueled game of strip poker with teenagers in 2015 at his annual summer youth camp in Silver Lake. His attorney reports the Mayor has no intention of dropping out of the race, noting: “That would never happen, for a really good reason…He is the People’s Mayor. He works very hard for the people of Stockton. I don’t think anyone would dispute that he gives every part of himself to being the Mayor of Stockton. He should be re-elected based on the merit that he gives the city.” The Mayor pleaded not guilty at his initial court appearance last month, complaining he is the victim of a political smear campaign being waged because he is a “threat” to Stockton’s establishment; nonetheless, it will be a jury which determines his fate with regard to the felony charge for allegedly making the audio recording without the consent of the strip poker participants and three misdemeanors related to the alleged providing of alcohol to underage drinkers.

A Motown Post Municipal Bankruptcy Future & Community Benefits. While Stockton’s post-chapter 9 recovery appears clouded by the looming criminal trial of the Mayor who was in office throughout his city’s long and arduous adoption of a plan of debt adjustment and emergence from municipal bankruptcy, his counterpart in Detroit, Mayor Mike Duggan, elected in the wake of the Motor City’s emergence from municipal bankruptcy under Michigan’s law, under which—in sharp contrast to California—the Governor had appointed an emergency manager, Kevyn Orr, who barred the city’s former Mayor and Council of any governance authority. Now Mayor Duggan is voting for what he calls the more manageable version of two proposed ordinances requiring “community benefits” be provided by would-be developers. In discussion with reporters and editors from Crain’s, Mayor Duggan warned that if a community benefits ordinance proposed by Rise Together Detroit passes in his city’s November general election, it would “guarantee we never see a (new) auto parts plant in this city again,” because of the requirements it places on developers: “Getting manufacturing jobs in the city will be over if Proposal A passes.” Mayor Duggan made clear he intends to vote for Proposal B, which is the alternative proposed community benefits ordinance.

Proposal A, put together by Rise Together Detroit, would require that projects of $15 million or more which receive $300,000 or more in city actions such as tax abatements or incentives enter into a legally binding community benefits agreement with a group of “representative residents, businesses and nonprofit organizations” within the “host community,” based on U.S. Census tract information. Such agreements would specify what the developer would provide to the community in which the development is located, such as education and land use programs, local small business and resident inclusion, and participation in the project. Environmental protections could also be considered community benefits—albeit, as the mayor noted: “You’d have to send a notice to the city clerk…The clerk and the council somehow contact people in the surrounding Census tract. Those people somehow form a committee, but Proposal A doesn’t say how they form a negotiating committee, doesn’t say how many people are on the negotiating committee. They could be negotiating with 50 or 100 people. It doesn’t say how long the negotiations go on, if they go on months or even years. If the site happens to be near the city border, the neighboring Census tracts would include the suburbs and you could have suburbanites who would get to say no to a development in Detroit.”

In contrast. Proposal B, which was developed by Detroit City Councilmember Scott Benson, appears to offer a less onerous alternative to Proposal A: it would mandate community benefits agreements for developments of $75 million or more and receiving $1 million or more in public incentives or on property with a cumulative market value of $1 million or more that was sold or transferred to a developer. In his conversation with the paper, Mayor Duggan made clear his comments were not a public endorsement of Proposal B; however, he noted there are compelling arguments toward the idea of institutionalizing these agreements for large projects: “Endorsing suggests a level of public campaigning that is different than a personal decision. But right now, I’m going to vote for it.”

In his comments, Mayor Duggan also addressed other pressing issues in his city, including on the pressing issues of the city’s struggling schools. Noting that while enrollment numbers will not be officially disclosed for about a month, Mayor Duggan said he would not discuss any new initiatives between the city and the Detroit Public Schools (DPS) until there is further certainty with regard to how many students the district has—that is, until there is a better sense whether DPS has emerged from its crisis mode, noting the serious “truancy issue in the city that we need to deal with.” With regard to the related Detroit Education Commission, a contentious sticking point in the DPS bailout legislation passed by the GOP-led Legislature and signed by Gov. Rick Snyder this past summer, the Mayor made clear he is not finished with pressing the issue: “To get things through a Republican Legislature, I need allies in addition to the Governor. I’ve learned my lesson and we’ll come back in a different way.”

To Merge or Not to Merge: That Is the Question. The Cuyahoga County, Ohio sheriff’s office is looking into the collection of signatures for a merger petition which was circulated in East Cleveland this summer, according to spokespersons for the sheriff and prosecutor. East Cleveland Mayor Gary Norton and his allies had collected more than 1,600 signatures on petitions to mandate the City Council to begin merger negotiations with neighboring Cleveland—of which the Cuyahoga County Board of Elections determined slightly over half were valid—albeit enough to begin negotiating an annexation agreement (Cleveland willing) that would be decided by voters in November; however, the Council did not appoint any negotiators; instead, Council Members asked the county prosecutor to investigate what they believed to be irregularities in the petitions. Or, as Council President Barbara Thomas reported to Ohio state officials: “East Cleveland City Council has serious questions about annex petitions, related certification, and has declared the petitions to be invalid.” Now the sheriff’s office has received the case from the prosecutor and is investigating, according to the County communications director—albeit she has declined to elaborate on what specifically the probe is examining. Adding to the state of confusion, Mayor Norton’s chief of staff, Michael Smedley, recently filed a lawsuit asking the court to compel East Cleveland’s City Council to move forward with merger talks—merger talks in which the City of Cleveland has expressed no interest. The suit also asks the judge to consider appointing annexation negotiators himself. Even as East Cleveland still awaits a response from the State of Ohio with regard to whether it may file for chapter 9 municipal bankruptcy, the municipality has heard from the State Auditor’s office—the office which last month laid out stark financial options for the struggling municipality, noting the road out of fiscal emergency may require the city to cut between 20 to 40 percent of its staff.

What Is the State Role in Municipal Fiscal Distress?

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eBlog, 8/18/16

 In this morning’s eBlog, we consider the risk of, for the first time in American history, a city reverting back into municipal bankruptcy. Here the fall could come from any combination of governance failures—as well as deeply falling returns on public pension investments. Then we look at an almost comparable inability of governance in Atlantic City—a failure here which risks the city’s own autonomy. Finally, we revisit the historic city of Petersburg, Virginia, a small city in significant fiscal distress—but which appears most unlikely to receive any state aid—meaning it could become the first municipality in the Commonwealth’s history to be forced to seek municipal bankruptcy protection.

The Risk of Re-entry into Municipal Bankruptcy. In an open letter to the citizens and taxpayers of Stockton, the City, on February 25th, last year, wrote: “Over time, the City was facing over $2 billion in labor agreements, long-term debt, and other obligations that would not have been possible to address outside of [municipal] bankruptcy. However, unlike personal bankruptcy, municipal bankruptcy does not erase or ‘wipe out’ debt. Finding solutions required hard work and heavy lifting by everyone involved. Focused by our guiding principles, we have achieved significant, sustainable change. Our employees worked with us to accomplish equitable labor agreements that brought pay and benefits more in line with the average of the labor market. City retirees, represented by a Retirees Committee, recognized that lifetime City-paid healthcare benefits were not sustainable and agreed to a settlement which helped to address the biggest obligation facing the City’s General Fund—a $544 million unfunded liability for retiree medical.” But now, in the midst of a heated election—one which is almost certain to be interrupted and affected by the pending trial of the incumbent mayor who presided during the city’s entry into and exit from chapter 9 municipal bankruptcy—the California Public Employees’ Retirement System (CalPERS) has reported that its rate of return for the year ended June 30 was just 0.61%. What’s more, Ted Eliopoulos, the pension fund’s chief investment officer, said the poor year has pushed CalPERS’ long-term returns below expected levels.

In approving Stockton’s exit from bankruptcy, U.S. Bankruptcy Judge Christopher Klein had opined that public pension obligations can be impaired in California, even though Stockton had not, in its proposed plan of debt adjustment, proposed to impair pensions; nonetheless, Judge Klein made clear that public pensions could be restructured should there be a next time around. In his analysis, Judge Klein said under chapter 9 federal bankruptcy law Stockton could reject its contract with CalPERS, and, he added, the $1.6 billion termination fee that CalPERS said it would charge to break the contract would be voidable in bankruptcy. Now, however, the issue of pensions could be re-opened in the wake of CalPERS’ projections that its pension management system, which had projected a 7.5% return on its investments, investments it uses to defray the cost of public employee pensions to cities such as Stockton, instead gained a return of only 0.61%—an outcome which could force CalPERS to increase its charges to Stockton—an increase for which the current city budget appears ill-equipped to meet—a budget, after all, which is based upon a 7.25% investment return from CalPERS. That is, such a reduction could put Stockton back into chapter 9—making it the first municipality ever to go into chapter 9 a second time. Indeed, the harsh fiscal discipline of the city’s plan of debt adjustment appears to be slipping: the Council gave police an 11% raise; it voted to re-open the Fair Oaks library branch, overruling objections from city staff—a vote which, for the first time, breached the city’s plan of debt adjustment.

Risking Autonomy. The Atlantic City Council this week, in a 4-4-1 vote, failed to adopt an ordinance to dissolve the Municipal Utilities Authority, a failure which puts the city at risk of defaulting on a state loan. (The terms of the $73 million state loan made the Authority collateral and required the city to adopt an ordinance dissolving it by September 15th.) Under the Council’s rules, it may not reconsider a failed ordinance for six months—meaning the city is in breach of the state’s loan terms. Failure to meet the deadline would make loan repayment due immediately and could require the city “to deliver each item of collateral” to the Department of Community Affairs, according to the loan terms. City Council President Marty Small blasted those who voted against the ordinance, saying they just “gift-wrapped the city to the state….So when the city shuts down and people lose their jobs and we owe the state $73 million because we defaulted on a loan, they can look the people in the eye who voted against it and they can thank them.” Council President Frank Gilliam described a lack of transparency leading up to the vote. A statement from Mayor Don Guardian this month said the ordinance’s first reading was needed by Sept. 15, not yesterday; he pointed to the July 28 emergency council meeting, which was announced just earlier that day and only had four members approving the loan terms, adding: “When decisions like these are basically put on the table, I think it’s very important for the public to have an opportunity to chime in.”

SOS! Virginia Delegate Riley Ingram reports he is seeking an appropriation to help Petersburg, a small city of just over 30,000, get through its current financial crisis, after residents of the city spoke with him about the possibility of getting state money for Petersburg, which is facing a cash crunch that state auditors say could hit as early as this month. Del. Ingram made clear he would not support any bailout of the city, which he said would set a bad precedent, adding: “In my opinion it would be a big mistake for the state to get involved: You’ve got to live within your budget and live within your means.” Earlier this month, at a meeting between state auditors and Petersburg city officials, an audit group sent in by the state to review the city’s books, the group informed city leaders that they owe $18.8 million in unpaid bills, making clear the municipality was in a worse financial crisis than they initially thought—by at least $1 million, with debt which includes $14.7 million to external entities, such as contractors and $4.1 million for internal loans, with the auditors making clear the “historic overspending” started in 2012. The growing debt has now reached a point where the city payroll is at risk—a risk made clear last month when the Petersburg City Council agreed to a 10 percent pay cut for its full-time employees, as a method to help balance the budget deficit—a reduction intended to last just six months and projected to save the city about $1.5 million dollars over the six-month period. The deficit was thought to be $17 million at the time of the cuts. Virginia House Majority Leader Kirk Cox (R-66th), a member of the Appropriations Committee, said getting the General Assembly to appropriate funds to help the city shore up its finances “would be a very, very heavy lift” in the legislature, in part because “it would be a very dangerous precedent to set;” moreover, the Majority Leader added that no action could be taken before next year’s General Assembly meets next January—and even then, any such funds would not be available until the start of the next fiscal year on July 1, 2017. State Secretary of Finance Richard D. Brown, who presented the team’s findings, said a high priority for the city is to get control over its finances as quickly as possible so as to be able to assure potential lenders that Petersburg is a safe lending risk. Virginia does not specifically authorize its municipalities to file for chapter 9 municipal bankruptcy; the state does, in certain situations, allow for the appointment of a receiver with respect to municipal revenue bonds.