Getting Out of-and Into Municipal Bankruptcy

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eBlog, 7/27/16

In this morning’s eBlog, we consider the truly extraordinary recovery from the nation’s largest ever municipal bankruptcy in Detroit, where the city appears to be in the forefront of becoming the nation’s newest Silicon Valley: a center of innovation and technology—but one where the future—as with every city and county—will depend upon its ability to educate its next generation. Then we consider the state-local relationships that could constitute the blueprint for shaping Detroit’s emergence to being, once again, the nation’s motor city. Finally, with the Republican convention over in Cleveland, we consider the options under consideration for neighboring East Cleveland, a municipality awaiting  permission to file for chapter 9 municipal bankruptcy, but also whether its importuning of the City of Cleveland might obviate the need to seek federal municipal bankruptcy protection.  

The Motor City’s Kids’ Future. It is difficult to imagine a city or county building its future without addressing its next generation. Yet, in America, the governance and provision of education is a messy complex of state and local revenues—and governance. It has, of course, been further muddied in Detroit by the city’s bankruptcy—and the Detroit Public School system’s insolvency–even as it now appears the city is on the edge of becoming the nation’s new Silicon Valley. That is, even as automotive innovation is emerging in California’s Silicon Valley, where the innovative center of 22 cities and counties, Stanford, and San Jose State universities, and a host of corporations have long-held sway in the world of innovation; Bill Ford, Ford’s Executive Chair, today advises that Detroit now has the opportunity to become the country’s center when it comes to all things involving the movement of goods and people: “The way people move, the way goods move, the way health care is delivered…is going to change in a very short period of time…And I love the fact that Detroit can be and should be ground zero for this change.” Indeed, it seems the pace of partnerships between the automotive industry and Silicon Valley tech companies will continue to accelerate as the two industries work together to develop autonomous cars and reshape the automotive industry—or, as Mr. Ford notes: automakers face a stark choice: either join the game, or face the prospect of being left behind: “In Michigan and Detroit, we have more engineers here than any other state. We have a huge customer base here with (automakers) and tier one suppliers, and this should be mobility central. Not Silicon Valley. Not Austin, Texas. Not Boston.”

If anything, the Indy 500 pace of innovation in Detroit has been eye-snapping: earlier this month:

• GM completed its acquisition of Cruise Automation, a 3-year-old San Francisco start-up, for an estimated $1 billion;
• FCA reached a deal to build 100 Chrysler Pacifica hybrid minivans for Google’s Self-Driving Car Project in May, and
• Mr. Ford announced two weeks ago it has invested $182 million to fund and collaborate on software development with San Francisco-based Pivotal. (Ford, reportedly, has also been in discussions with Google as well, and FCA’s partnership with Google is not exclusive.

Mr. Ford notes that the Motor City is a city where the cost of living is low, and entrepreneurs can make a difference: he describes the people who start new companies here as brave: “You guys want to be trailblazers and you guys want to be brave. You could go to Silicon Valley…and have a great life…But if you are successful here…people are really going to notice and they are going to love you for it and you are going to be part of something special.”

But the future depends upon the rising generation—ergo from whence will the talent critical to Detroit’s future arise? Some, clearly, will be imported from the Silicon Valley, but a vital part—if Detroit is to have a competitive future—will have to emerge from its currently insolvent (physically and fiscally) public school system. Thus, next November’s election of a new Detroit school board will be a key to Detroit’s ability to compete with the Silicon Valley. The race has attracted a, shall we say “huge,” field of candidates: 72 have filed to compete for seven seats—seats on a board in a city where municipal services had been failing, in a metropolitan region ranked 10th worst of 942 metro regions in the U.S.1 in a measure which considers both the number of units administering common services and each government’s related expenditures. As we had noted in our report: “Detroit, nearly encircling two failing municipalities, must redesign and coordinate and share services with other jurisdictions in the metropolitan area to both reduce costs and ensure far more effective delivery of essential services…the city’s 78,000 vacant structures and 60,000 vacant land parcels ‘present an ongoing public safety and public health concern,’ forcing the city, despite the signal loss of population, to provide and maintain services over its 139 square miles—an area that contains 78,000 abandoned and blighted structures, nearly half of which are thought dangerous, and 66,000 blighted and vacant lots which encourage fires and crime.” As we had opined, the exceptional challenge for the City of Detroit was not just to exit the largest municipal bankruptcy in the nation’s history, but also to ensure a post-bankruptcy growth plan. How can a city, after all, create a future without taking into consideration its own public school system? What could be more important not just to a city’s ability to invest in innovation, but also to attracting families to want to live within its boundaries?

Thus, if there is any good news, it is the plethora of candidates vying in November—a number which includes former board members, educators, and parents—with whomever the victors are who emerge responsible to select a superintendent for the new Detroit Public Schools Community District—to relieve the exceptional rhythm guitar playing, former U.S. Bankruptcy Judge Steven Rhodes. Their task will be vastly complicated by the complex navigation required to emerge from state control of the district under a series of emergency managers dating back seven years—and the existing state-approved rescue package, including fiscal oversight by the Detroit Financial Review Commission.

Downsizing to Rightsizing. Michigan’s economic development board this week approved an additional $17 million state investment in a project to transform Willow Run’s one-time World War II bomber plant into a hub for autonomous vehicle testing—where some $20 million of Michigan’s Strategic Fund investment in the American Center for Mobility will be used toward purchasing land at the site of the former General Motors powertrain plant, designing and constructing a high-speed loop test track, or, as John Maddox, president and CEO of the American Center for Mobility, out it: “We’re getting a lot of attention around the nation and really around the world, and that’s really because the state of Michigan is investing in this.” Steve Arwood, president and CEO of the Michigan Economic Development Corp. and Chairman of the Michigan Strategic Fund board, added that the state’s taxpayers’ vital investment in the facility is critical to maintaining Michigan’s stronghold in the development of autonomous vehicles, noting: “Ultimately it’s in the best interest of the state to preserve the future of our automotive industry.” The Center is aiming to complete a 335-acre test site that would include tunnels, bridges, traffic stops, suburban cul-de-sacs and city streets to test the driverless cars of tomorrow: an almost city of innovation where the autonomous vehicle nonprofit organization hopes to attract federal grants and additional private investment for automated driving technology at a site owned by RACER Trust, the entity set up in GM’s own 2009 bankruptcy to sell off land left vacant by closed and abandoned auto plants: Mr. Maddox reports an entity called the Willow Run Arsenal of Democracy, or WRAD, will purchase the land from RACER Trust, adding that Michigan’s risk-based investment in the infrastructure of building and testing autonomous vehicles keeps Michigan competitive with California and foreign countries racing to develop the technology.

Wherefore East Cleveland’s Future? With the RNC convention over in adjacent Cleveland—and still no word back from the State of Ohio with regard to authorizing East Cleveland to file for chapter 9 municipal bankruptcy, the small city may consider adopting an ordinance (#4-16) this week to commence the opening stages of annexation negotiation with Cleveland: Council President Thomas Wheeler said the Council will have a special meeting in the next week to vote on two ordinances: the first would declare East Cleveland’s intent to enter annexation talks with Cleveland and appoint three commissioners who were interviewed by council after an open application process; the second would require Mayor Gary Norton to deliver a letter to the Cleveland Foundation seeking funding for a financial study by the firm Conway MacKenzie, an adviser in Detroit’s bankruptcy. The study for the nearly insolvent municipality would cost approximately $50,000-70,000. Of course, it takes two to party, so any steps towards annexation would require reciprocation from the City of Cleveland—where, as one can imagine, the prospects of annexation might not hold great attraction.

For East Cleveland, the proposed ordinance would lay out some of the guidelines for such commissioners, including the process for requesting information from the city and the requirement that the selected commissioners should report to council every two weeks. Mayor Gary Norton said the appointments would be great progress on the annexation idea which has been discussed for years. 

States of Municipal Limbo

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eBlog, 7/08/16

In this morning’s eBlog, we focus—again—on the ongoing challenges over Detroit’s future, as an ongoing struggle over the city’s insolvent public schools and the governance thereof appears to be diverting scarce state resources and, more importantly, strategic governance to ensure that families can be confident the schools will not only open in the Fall, but also that the state granted resources will focus on the kids and their future. Then we turn to the sudden introduction of Presidential politics in Atlantic City to determine if there might be any light into what a new tenant at the White House might have under consideration for federal urban policy with regard to municipal insolvency.  

Educated in Municipal Bankruptcy? Members of the Detroit Public Schools (DPS) Board of Education announced Wednesday they have filed in the Court of Claims for an injunction against Governor Rick Snyder and the Michigan Legislature to block a $617 million DPS bailout and restructuring package on the grounds the legislation violates Michigan’s constitution. The board believes the legislation will give the city’s schools unfair bond rates and unjustly split DPS into two districts — the old system to pay off hundreds of millions in debt, and a new, debt-free system to educate students. The suit is the second the Board has filed in the past few months—having filed a similar class-action suit last April. This suit comes in the wake of the Board’s rejection, last week, of a $150 million state loan offer (part of the $617 million state rescue package adopted on a partisan vote to erase the old DPS $467 million in debt). The litigation comes as the new debt-free Detroit school district has received all students from the old district; the current school board has been stripped of its responsibilities, and elections are scheduled for a new school board in November. Disputed DPS school board President LaMar Lemmons said the money used to split the district should instead be put into classrooms to reduce class sizes and provide services, noting: “Although we did appreciate the $150 million quote ‘loan,’ that the state was presenting to us at a reasonable rate — the municipal market rate of 1.5 to 2.5 percent — it was the extension of the bond that had a cap up to 18 percent, to which we said, ‘you’re serious?’” Ms. Lemmons added: “We vehemently objected to that as well as the unnecessary, costly bifurcation of the district.” In addition, Ms. Lemmons is requesting that the state perform a forensic audit on the district, adding that the state should take responsibility for the district’s finances, because state-appointed emergency managers have run the district since 2009, largely sidelining the school board and accumulating much of DPS’ debt. According to the board’s attorney, Thomas Bleakley, the district was financially solvent in 1999 when the state began its intervention in the Detroit school system. Note: while Mr. Bleakley is representing the board members for free, he warned that the legal process will still be a costly one—presumably costly not just fiscally, but also to the future for Detroit’s kids with such large resources diverted to litigation instead of education.

State of Limbo. Perhaps no city has been as associated with Donald Trump as Atlantic City—a city, after all, that was once his glorious gambling mecca—that is before he began a string of corporate bankruptcies that had devastating fiscal consequences for the city—a city now facing a state takeover. So it was that Wednesday, candidate Hilary Clinton visited Atlantic City’s iconic boardwalk, where she depicted Mr. Trump as a corporate pirate who reaped millions from the city while leaving behind a legacy of bankruptcies, unpaid bills, layoffs, and lawsuits: “Well, we should believe him – and make sure he never has the chance to bankrupt America the way he bankrupted his businesses,” recalling the ‘80s and ‘90s, when Mr. Trump boasted at his grandiose arrivals and news conferences he would transform the city into an outpost of his burgeoning real estate empire. Mrs. Clinton, however, offered few ideas with regard to her views about Atlantic City’s future, other than a generic call to create jobs “here in Atlantic City and across America.” Mrs. Clinton brought no clarity to her vision of Atlantic City’s future—much less the nation’s cities’ futures. Mr. Trump was able to gamble Atlantic City’s fiscal future, but the closings of four Atlantic City casinos over the past two years have triggered the loss of nearly 8,000 jobs and a steep decline in the city’s tax revenues—and put the city in a deep hole: it has until the end of the year to craft a cost-cutting plan or be taken over by the state. Until then, it is, as one writer put it, in a state of limbo. For Mr. Trump, bankruptcy has perhaps seemed an easy way to walk away from a serious fiscal challenge—but that is not an option for a municipality. It would be a shame if the candidates in the wake of the unprecedented number of post-Great Recession municipal bankruptcies do not address what their respective urban policies would be—and that, despite the visits from both Mrs. Clinton and Mr. Trump, neither addressed the key steps to a sustainable fiscal future for Atlantic City; rather they came and left it in a state of limbo.

Will the Michigan Legislature Push Detroit’s Schools into Municipal Bankruptcy?

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eBlog, 7/05/16

In this morning’s eBlog, we focus—again—on the grave challenge to Detroit’s kids—and the city’s future—in the wake of an S&P downgrade of DPS. Because the quality of schools is so vital to parents’ considerations of where to live, Detroit’s long-term recovery from the nation’s largest municipal bankruptcy is intertwined with the success or failure of DPS.

Getting ready to do the Math at DPS. Standard and Poor’s has downgraded two sets of Detroit Public Schools municipal bonds—and expressed apprehension with regard to the legislature’s rearrangement of the school district in two, an “old” and “new”—effective last Friday—with the old one created by the new state law with its sole role to pay off debt with tax revenues; the new one receives state aid payments to educate students. Expressing doubts the DPS municipal bonds will be paid off, S&P has announced that it would downgrade bonds DPS bonds issued in 2011 and 2012. The downgrade relates to S&P’s apprehension that because the bonds are no longer backed by state aid payments, which go to the new district, it lacks confidence the bondholders will be repaid. As it happens, these are the same bonds the new district is looking to refinance for that very reason. For his part, transition manager Steven Rhodes has asked the Detroit school board to approve up to $235 million in loans to help with that refinancing—a request the board rejected—expressing apprehension about a possible spike in interest rates on the loan. That means Judge Rhodes is likely to turn to the state emergency loan board.

The difficult governing imbroglio signals that S&P might impose still more downgrades, noting: “The CreditWatch on the bonds reflects our view that the complexity of the situation, the looming requirement to redeem, defease, or refund the bonds, and the numerous parties involved—including the split district and Michigan—result in a more than a 50% chance we will lower the rating over the next three months, and could take more than one rating action during that time if warranted.” A key concern is with the lack of information on how bond repayments will work under DPS’ restructuring—with the rating on each series of bonds based on DPS’ pledge of state aid, or, as S&P noted: “It is our understanding that under the new legislation, the state aid bonds will have to be redeemed, refunded, or defeased, because state aid can only flow to school districts that have students, and the Old Co will not have any students…If the actions taken through this [restructuring] process provide bondholders with anything less than the full promise of the original bonds, it is likely to be considered a distressed exchange and therefore a default under our criteria.” S&P noted there is a 50 percent chance that it will lower the ratings again over the next three months if it views the redemption as providing less than the original promise—warning the rating could sink to D. DPS’s debt includes $1.5 billion of unlimited-tax general obligation bonds, $199 million in borrowing from Michigan’s School Loan Revolving Fund, and $259 million in limited-tax GO debt paid by district operating revenues, rather than a dedicated debt service levy. Under the new state legislation, the new Detroit Community District will own assets and operate the schools. DPS survives solely to collect tax millage and service debt outstanding; it is no longer eligible to receive distributable state aid. State aid will remain pledged to the existing bonds and 2015-E notes until the end of September. According to S&P, DPS has been making set aside payments to repay the 2015-E notes in full at their August 2016 maturity. The key arithmetic apprehension, however, is how DPS will repay bondholders once the flow of state aid stops—or, as S&P put it: “Under the new legislation, once the restructuring is effectuated, the series 2011 and 2012 bonds would no longer be supported by a pledge of distributable state aid and the only remaining pledge backing the bonds would be the limited tax general obligation pledge.”

The Detroit Free Press, in a June 22^nd editorial, noted: “In Michigan, it’s not just Detroit schools that are in trouble…Despite a year of pushing for a real reform package for Detroit’s public schools, [Gov.] Snyder and Senate Majority Leader Arlan Meekhof (R-West Olive), caved in the face of Cotter’s mean-spirited partisanship, passing a set of bills that offer little promise that public education in Detroit will improve. Detroit public schools’ doors will stay open, but barely — without the funds to effect real change, or the controls that could require rational geographic placement or consistent academic standards among all of Detroit’s public schools…With bankruptcy looming, and the futures of nearly 100,000 children on the line, Snyder and the Legislature whiffed, sending a remedy to the state’s largest school district that only works on paper.

“And this is what, if you live in this state, you should be asking yourself: If Michigan Republicans won’t send real help to a district on fire, a district so sunk by disinvestment and mismanagement and neglect that it would cease to exist without intervention, do you really believe they’ll act to stop the slow burn in yours?”

The Challenge of Transitions in Governance in the Wake of a Fiscal Crisis

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eBlog, 7/01/16

In this morning’s eBlog, we consider the state commission approval of a budget for the new, debt-free Detroit Public Schools Community District, and the first steps in governance transition in Puerto Rico—and critical steps underway to ensure essential public services. &, of course, we wish readers a great 4^th of July or Julio. 

Getting Ready to Go to School. The Detroit Financial Review Commission yesterday approved the proposed budget for the new, debt-free Detroit school district for FY2017, but not a plan for professional development travel, effectively blessing the $654 million budget proposed for the new Detroit Public Schools Community District by Transition Manager Steven Rhodes, the state-appointed emergency manager and former U.S. Bankruptcy Judge who oversaw Detroit’s municipal bankruptcy. The plan incorporates some of the $150 million in state start-up funding to improve academic programs and better maintain buildings as part of the Michigan legislature’s $617 million bailout package which Gov. Rick Snyder approved last month—the remaining $467 million will be used to retire the debt of the former Detroit Public Schools district. In thanking the members of the Commission, Judge Rhodes noted the Commission “worked expeditiously to approve the budget prior to the first day of the fiscal year for the new Detroit Public Schools Community District. It is a balanced budget based on conservative and realistic assumptions and it reflects enough revenue to pay reasonable expenses,” adding the budget is “a significant milestone” that will help “create a sustainable new school district.” Describing the academic path forward, Judge Rhodes said: “Our focus moving forward will be to support academic innovation, improve student safety and facilities: We have many challenges to overcome as we transition the district from its current governance structure to an elected board. We are on an important mission to ensure the citizens of Detroit have a school system they can trust and in which they can take pride.”

Transition in Governance in a Fiscal Crisis. In the wake of President Obama’s signing the PROMESA legislation to help Puerto Rico restructure its debt, imposing a stay on litigation over payment, Gov. Alejandro Garcia Padilla late yesterday invoked Puerto Rico’s Moratorium Act on the payment of general obligation bonds and obligations of other public entities (Puerto Rico has about $69 billion of public debt outstanding.), opening the door to making partial payments on about $2 billion of debt due today; he also declared a state of emergency at the Puerto Rico Convention Center District Authority, the Employees Retirement System, the Industrial Development Company, and the University of Puerto Rico, to ensure these entities protection from litigation, claiming this protection comes from the Moratorium, Financial Emergency and Rehabilitation Law, which passed in April, and is used by the central government to retain funds necessary for its operation. By invoking the moratorium for these agencies and types of debt, the governor created a mechanism to skip payment on the U.S. territory’s bonds. In an accompanying press release, Gov. Padilla announced the “suspension of payment” on Puerto Rico’s GO debt. The actions had the effect of pushing a record amount of its municipal bonds toward default by declaring a moratorium on debt payments after President Barack Obama signed a law sheltering the island from bondholder lawsuits as it seeks to arrest a financial collapse. The actions mark the first time Puerto Rico has failed to pay on its $13 billion worth of general obligation bonds, bonds which under the Puerto Rico constitution must be covered before other expenses. The territory and its agencies owe about $2 billion on various securities today. The default might effectively mark the governance transition to the financial control board created under the new PROMESA law, albeit it remains uncertain when the White House will make and announce those key appointments. That board of quasi overseers will be involved in the transition as Gov. Padilla seeks to use cash that would otherwise go to investors to avert closing schools, clinics, police and fire stations on an island where nearly half of the 3.5 million residents live in poverty.