The Fiscal, Balancing Challenges of Federalism

eBlog, 2/16/17

Good Morning! In this a.m.’s eBlog, we consider the fiscal, balancing challenges of federalism, as Connecticut Governor Daniel Malloy’s proposed budget goes to the state legislature; then we return to the small municipality of Petersburg, Virginia—the insolvent city which now confronts not just fiscal issues, but, increasingly, trust issues—including how an insolvent city should bear the costs of litigation against its current and former mayor—including their respective ethical governing responsibilities. Finally, we seek the warming waters of the Caribbean to witness a fiscal electrical storm—all while wishing readers to think about the President who would never tell a lie…

The Challenge of Revenue Sharing—or Passing the Buck? S&P Global Ratings yesterday warned that Connecticut Governor Daniel Malloy’s proposed budget could negatively affect smaller towns while benefiting the cities, noting that from a municipal credit perspective, “S&P Global Ratings believes that communities lacking the reserves or budgetary flexibility to cushion outsized budget gaps will feel the greatest effects of the proposed budget.” S&P, as an example, cited Groton, a town of under 30,000, which has an AA+ credit rating, which could find its $12.1 million reserve balance depleted by a proposed $8.2 million reduction in state aid and a $3.9 million increase to its public pension obligations. Meanwhile, state capitol Hartford, once the richest city in the United States, today is one of the poorest cities in the nation with 3 out of every 10 families living below the poverty line—which is to write that 83% of Hartford’s jobs are filled by commuters from neighboring towns who earn over $80,000, while 75% of Hartford residents who commute to work in other towns earn just $40,000. Thus, under Gov. Rowland’s proposed budget, Hartford would receive sufficient state aid under the Governor’s proposal to likely erase its projected FY2018 nearly $41 million fiscal year 2018 budget gap, according to S&P, leading the rating agency to find that shifting of costs from the state to municipal governments would be a credit positive for Connecticut, but credit negative for many of the affected towns: “Those [municipal] governments lacking the budgetary flexibility to make revenue and expenditure adjustments will be the most vulnerable to immediate downgrades.” With the Connecticut legislature expected to act by the end of April, S&P noted that the state itself—caught between fixed costs and declining revenues, will confront both Gov. Malloy and the legislature with hard choices, or, as S&P analyst David Hitchcock put it: “Bringing the [budget] into balance will involve painful adjustments,” especially as the state is seeking to close a projected $1.7 billion annual deficit. Thus, S&P calculated that general fund debt service, pension, and other OPEB payments will amount to just under 30 percent of revised forecast revenues plus proposed revenue enhancements for FY2018, assuming the legislature agrees to Gov. Malloy’s plan to “share” some one-third, or about $408 million of annual employer teacher pension contributions with cities and towns, effectively reducing state contributions.

As Mr. Hitchcock penned: “Rising state pension and other post-employment benefit payments are colliding with weak revenue growth because of poor economic performance in the state’s financial sector…Although other states are also reporting weak revenue growth and rising pension costs, Connecticut remains especially vulnerable to an unexpected economic downturn due to its particularly volatile revenue structure.” Unsurprisingly, especially given the perfect party split in the state Senate and near balance in the House, acting on the budget promises a heavy lift to confront accumulated debt: Deputy Senate Republican Majority Leader Scott Frantz (R-Greenwich) said the state’s—whose state motto is Qui transtulit sustinet (He who transplanted sustains)—financial struggles have been predictable for more than a decade, “with a completely unsustainable rate of growth in spending on structural costs and far too much borrowing that further adds to the state’s fixed costs, especially as interest rates rise….” adding: “The proposed budget is an admission that the state can no longer afford to pay for many of its obligations and will rely on the municipalities to pick up the slack, which means that local property tax rates will rise.” The Governor’s proposals to modify the state’s school-aid formula could, according to Mr. Hitchcock, be a means by which Connecticut could comply with state Superior Court Judge Thomas Moukawsher’s order for the state to revise its revenue sharing formula to better assist its poorest municipalities: “It could benefit poor cities at the expense of the rich and lower overall local aid;” however, he added that “[c]ombined with other local aid cuts, municipalities’ credit quality could be subject to greater uncertainty.” With regard to Governor Malloy’s proposed pension obligation “sharing,” our esteemed colleagues at Municipal Market Analytics described the shift in teacher pension costs to be “a more positive credit development for the state,” notwithstanding what MMA described as “quite high” challenges. Under the proposal, the municipalities of Hartford and Waterbury would receive about $40 million apiece in incremental aid, while 145 municipalities would lose aid after the netting of pension costs. Several middle-class towns, according to MMA’s analysis, could realize reductions in pension aid of more than $10 million—some of which might be offset by the Governor’s proposal to permit towns to begin assessing property taxes on hospitals, which in turn would be eligible for some state reimbursement.

Hear Ye—or Hear Ye Not. Petersburg residents who say their elected leaders are to blame for the historic city’s fiscal challenges and insolvency yesterday withdrew their efforts to oust Mayor Samuel Parham and Councilman W. Howard Myers (and former mayor) from office in court over procedural issues, notwithstanding that good-government advocates had collected the requisite number of signatures to lodge their complaints against the duo. An attorney representing the pair testified before Petersburg Circuit Court Judge Joseph Teefey that the cover letters accompanying those petitions were drafted after the signatures were gathered. Thus, according to the attorney, even if the petition signers knew why they were endorsing efforts to unseat the elected officials, they were not aware of the specific reasoning later presented to the court.

Not unsurprisingly, Barb Rudolph, a citizen activist who had helped spearhead the attempt, said she felt discouraged but not defeated, noting: “We began collecting these signatures last March, and in all that time we’ve been trying to learn about this process…We will take the information we have learned today and use that to increase our chances of success moving forward.” The petition cited “neglect of duty, misuse of office, or incompetence in the performance of duties,” charging the two elected officials for failing to heed warnings of Petersburg’s impending fiscal insolvency; they alleged ethical breaches and violations of open government law.

But now a different fiscal and ethical challenge for the insolvent municipality ensues: who will foot the tab? Last week the Council had voted to suspend its own rules, so that members could consider whether Petersburg’s taxpayers should pick up the cost of the litigation, with the Council voting 5-2 to have the city’s taxpayers foot the tab for Sands Anderson lawyer James E. Cornwell Jr., who had previously, successfully defended elected officials against similar suits. Unsurprisingly, the current and former Mayor—with neither offering to recuse himself—voted in favor of the measure. Even that vote, it appears, was only taken in the wake of a residents’ questions about whether Council had voted to approve hiring a lawyer for the case.

A Day Late & a Dollar Short? Mayor Parham and Councilmember Myers signed a written statement acknowledging their interest in the vote with the city clerk’s office the following day. The Mayor in a subsequent interview, claimed that the attorney hired by the city told him after that vote that the action was legal and supported by an opinion issued by the Virginia Attorney General’s Office, noting: “Who would want to run for elected office if they knew they could bear the full cost of going to court over actions they took?” To date, the two elected officials have not disclosed the contract or specific terms within it detailing what the pair’s litigation has cost the city budget and the city’s taxpayers. Nor has there been a full disclosure in response to Petersburg Commonwealth’s Attorney Cassandra Conover’s determination last week with regard to whether the Mayor and former Mayor’s votes to have Petersburg’s taxpayers cover their legal fees presented a conflict of interest.

Electric Storm in Puerto Rico. Yesterday, Puerto Rico Governor Ricardo Rosselló stated that the reorganization of the Puerto Rico Electric Power Authority (PREPA) Governing Board’s composition and member benefits will not affect the fiscal recovery process that is currently underway, noting: “I remind you that we announced a week or week and a half ago that we had reached an agreement with the bondholders to extend and reevaluate the Restructuring Support Agreement (RSA) terms. Everything is on the table,” referring to the extension for which he had secured municipal bondholders’ approval—until March 31. His statement came in the wake of the Puerto Rican House of Representatives Monday voting to approve a bill altering the Board’s composition and member benefits—despite PREPA Executive Director Javier Quintana’s warning that the governance model should remain unaltered, since its structure was designed to comply with their creditors’ demands. However, Gov. Rosselló argued that, according to PROMESA, the Governor of Puerto Rico and his administration are the ones responsible for executing plans and public policies: “Therefore, the Governor and the Executive branch should feel confident that the Board and the executive directors will in fact execute our administration’s strategies and public policies. We believe we should have the power to appoint people who will carry out the changes proposed by this administration.” The Governor emphasized: “We have taken steps to have a Board that responds not to the Governor or partisan interests, but to the strategy outlined by this administration, which was validated by the Puerto Rican people.”

Indeed, at the beginning of the week, the Puerto Rican government had approved what will be the Board’s new composition, which would include the executive director of the Fiscal Agency and Financial Advisory Authority (FAFAA), the Secretary of the Department of Economic Development and Commerce, and the executive director of the Public-Private Partnerships Authority among its members: “We campaigned with a platform, the people of Puerto Rico validated it, and the Oversight Board expects all of these entities to respond to what will be a larger plan,” he insisted. Gov. Rosselló added that adjustments are essential, due to the Government’s current fiscal situation, specifically referring to the compensation paid to the members of the Board, which can reach $60,000. If this measure becomes law, the compensation would be limited to an allowance of no more than $200 per day for regular or special sessions. (The measure, pending the Senate’s approval, would establish that no member may receive more than $30,000 per year in diet allowances.) Currently, the Governing Board’s annual expenses—including salaries and other benefits—are approximately $995,000 per year. Meanwhile, PREPA has a debt of almost $9 billion, including a $700-million credit line to purchase fuel and no access to the capital markets.

Lone Star Blues

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eBlog, 2/16/17

Good Morning! In this a.m.’s eBlog, we consider the dwindling timeline confronting the city of Dallas to take action to avert a potential municipal bankruptcy; then we return to the small municipality of Petersburg, Virginia—an insolvent city with what appears to be an increasingly insolvent governing model, enmeshing the small city in litigation it can ill afford. Finally, we return to the trying governing and fiscal challenges in the U.S. territory of Puerto Rico—caught between changing administrations, a federal oversight board, a disparate Medicaid regime than for other states and counties, and trying to adjust to a new Administration and Congress.

Dallas, Humpty-Dumpty, & Chapter 9? In a state where, as one state and local government expert yesterday described it, that state has created a governance structure which allows everyone to avoid accountability, the City of Dallas is confronting a public pension problem that could force the city into municipal bankruptcy [Texas Local Government Code §101.006—seven Texas towns and cities have filed for such protection.]. Should the city lose its current case against its firefighters—a case with some $4 billion at stake—municipal bankruptcy could ensue. Another Texan, noting the challenge of putting “Humpty Dumpty back together again,” said failure of the city to emulate Houston and come to terms with its employees, retirees, and taxpayers would be “cataclysmic.” With about two weeks remaining to file bills in the Longhorn legislature and negotiations over the city’s mismanaged and underfunded police and fire pension at a standstill, state lawmakers note they will likely be forced to step into the crisis, if the city is to avoid chapter 9 municipal bankruptcy—or, as Rep. Jason Villalba (R-Dallas) noted: “I think we’re forced to step in. We’re [17] days away from the deadline, and there is yet to be an agreement between the city and the pension board…I think at this point we have to have a summit or some form of intervention, get everyone to the table and hammer those final issues down. If they don’t do that, it’s going to be a plan that’s drawn by the legislators, and we don’t have a stake interest like the other groups do to understand the nuances.” His statement came in the wake of a stoppage in negotiations over the last couple weeks—negotiations originally set up by the state, and negotiations with a short fuse: the last chance for the Texas Legislature to file bills to address the issue is looming: March 1st.

The severity of the crisis could be partially alleviated by a settlement reached late yesterday by the failing Dallas Police and Fire Pension System in its litigation against its former real estate advisers, whom pension officials had accused of leading the retirement fund astray. CDK Realty Advisors and the Dallas pension system both agreed to drop all claims and counterclaims with prejudice, according to court records filed late yesterday—and came as the city’s pension system and its attorneys have also been battling litigation from four City Council members, Mayor Mike Rawlings, a former contract auditor, and active and retired police and firefighters. The stakes are the city’s fiscal future: its retirement fund is now set to become insolvent within the next decade because of major losses and overvaluations—mostly from real estate—and generous benefits guaranteed by the system. Advising me that the “stigma or consequences for a city with the pride and stature of Dallas to fail would be cataclysmic,” one of the nation’s most insightful state and local pension wizards described the city’s pension challenge as “about as bad as any I have ever seen.”  

Hear Ye—or Hear Ye Not. A hearing for the civil case brought against Petersburg Mayor Samuel Parham and Councilman and former Mayor W. Howard Myers is set for this morning: Both men are defendants in a civil court case brought about by members of registered voters from the fifth and third wards of Petersburg: members of the third and fifth wards signed petitions to have both men removed from their positions. The civil case calls for both Parham and Myers to be removed from office due to “neglect, misuse of office, and incompetence in the performance of their duties.” The purpose of hearing is to determine a trial date, to hear any motions, to determine whether Messieurs Parham and Myers will be tried separately, and if they want to be tried by judge or jury. James E. Cornwell of Sands Anderson Law Firm will be representing Myers and Parham. The City Council voted 5-2 on Tuesday night to have the representation of Mr. Myers and Mayor Parham be paid for by the city. Mayor Parham, Vice Mayor Joe Hart, Councilman Charlie Cuthbert, former Mayor Myers, and Councilman Darrin Hill all voted yes to the proposition, while Councilwoman Treska Wilson-Smith and Councilwoman Annette Smith-Lee voted no. Mayor Parham and Councilmember Hill stated that the Council’s decision to pay for the representation was necessary to “protect the integrity of the Council,” noting: “It may not be a popular decision, but it’s [Myers and Parham] today, and it could be another council tomorrow.” Messieurs Hill and Parham argued that the recall petition could happen to any member of council: “[The petitions] are a total attack on our current leadership…We expect to get the truth told and these accusations against us laid to rest.” The legal confrontation is further muddied by City Attorney Joseph Preston’s inability to represent the current and former Mayors, because he was also named in the recall petition, and could be called as a witness during a trial.

Municipal Governance Bankruptcy? Virginia Commonwealth’s Attorney Cassandra Conover has felt forced to write a complaint, suggesting a conflict of interest in the virtually insolvent municipality of Petersburg, Virginia, in the wake of a city council vote to have the city pay for the legal expenses of Mayor Samuel Parham and Councilman Howard Myers. Ms. Conover, in an advisory opinion, described the vote to approve those expenses as a conflict of interest for the current and former mayors: “It is my advisory opinion that the undeclared conflict of interest disqualified both councilmen from voting on this motion and renders the vote invalid.” (The vote in question, as we have previously noted, was to hire a private attorney to represent Mayor Sam Parham and Councilman Howard Myers after more than 400 neighbors signed a petition to oust two Councilmembers from office.) Ms. Conover cited Virginia Code §2.2-3112, which says an employee of a state or local government entity “shall disqualify himself from participating in the transaction where the transaction involves a property or business or governmental agency in which he has a personal interest,” noting that Code §2.2-3115(F) mandates that in such a situation, there must be oral or written statements that show the transaction involved; the nature of the employee’s personal interest: that he (or she) is a member of a business, profession, occupation or group of members which are affected by the transaction: and that he is able to participate fairly, objectively and in the public interest. In this case, Ms. Conover stated that there was “no evidence that all four of these requirements were met in this case: concluding that the undeclared conflict of interest disqualified both men from voting and renders the vote invalid. 

The governance issue was not just the concept of an insolvent city’s Council voting to use public municipal funds to hire the private attorney, but also that neither Mayor Parham, nor Councilmember Myers recused himself from voting. Nevertheless, Petersburg City Attorney Joseph Preston responded that there was no conflict of interest and that the pair of elected officials had acted legally. Mayor Parham said the city likely will pay the bill for the personal attorney he and Councilmember Myers retained, albeit noting: “We’ve had to make cuts to schools and public safety, and we’re just starting to get back on our feet. It is a shame that we have to pump funds into something like this.” City Attorney Preston noted that Ms. Conover’s advisory opinion “adequately represents what occurred at their council meeting,” but he said he believes the pair of elected officials were legally allowed to take part in the vote, citing Virginia Code §2.2-3112 which provides that persons who have a conflict of interest can submit a disclosure statement on the issue—filings which the two elected officials filed with the Clerk of Court’s office the day after the vote. In addition, City Attorney Preston cited a decision from the Virginia Attorney General’s Office from 2009 which had ruled in favor of the Gloucester County Board of Supervisors, who were seeking compensation for their legal expenses; Ms. Conover, however, responded that the Attorney General’s 2009 decision did not apply to this case, because the charges against the Gloucester Board of Supervisors had been dismissed, and the court ordered the locality to pay for the majority of the legal fees which the board members had accrued, adding that the insolvent city had offered no estimate with regard to how much their legal fees could be. Notwithstanding the Commonwealth Attorney’s opinion, it appears unlikely that the Council will vote on the issue again: Mayor Parham yesterday noted: “I don’t feel like there was any conflict, and we did as we were advised by our attorney…We’ve had to make cuts to schools and public safety, and we’re just starting to get back on our feet. It is a shame that we have to pump funds into something like this.”  

Federalism, Governance, & Hegemony. With the enactment of the PROMESA legislation, Congress created governance and fiscal oversight responsibilities in the hands of seven non-elected officials to make critical fiscal reforms and restructuring of Puerto Rico—either through federal courts or via voluntary negotiations—for a debt that adds up to about $69 billion, but the new law also tasked a Congressional Task Force with analyzing initiatives which could help the island’s economy to grow; however, this bipartisan and bicameral committee ceased to exist upon submitting its report; ergo, unsurprisingly, both Governor Ricardo Rosselló and Jenniffer González, the new Resident Commissioner for Puerto Rico, have demanded that the PROMESA board members support their claims. But now a key area of concern has arisen: if the U.S. territory is unable to comply with the implementation of an information system which methodically integrates the management of important data for Medicaid claims—as mandated for federal eligibility as part of an integrated system to process claims and recover information, which is a Medicaid program requirement for federal fund eligibility which Puerto Rico should have long ago met, the island faces a more stark January 1 deadline by which it must comply with 60% of this system or be confronted with a fine of $147 million—a threat so dire that, according to the Health Secretary, Dr. Rafael Rodríguez Mercado, failing to comply with this requirement would mean the end of the Puerto Rico Government Health Plan. Puerto Rico is the only jurisdiction lacking such a platform, a platform intended to protect against medical fraud and establish eligibility, compliance, and service quality controls.

It was revealed in December, during the new government’s transition hearings for the Department of Health that the development of this platform began in 2011, but that it was not until 2014 that the project was resumed in its planning stage. The necessary funds to begin the implementation phase were finally matched during this fiscal year. The last administration predicted that the basic modules would begin working in a year and a half, and that the entire system would be operating in five years: it was expected that the window for the disbursement of Medicare and Medicaid funds would open in a year and a half. However, under threat of a fine, the government now expects to reach this goal before the date predicted by the last administration. Dr. Rodríguez Mercado stressed that there are currently 470,000 Puerto Ricans without health care insurance, many of whom cannot afford private insurance or are ineligible for the Government Health Plan, thus, many of these people seek out services in Centro Médico, an institution with a multi-million dollar deficit, when they become sick or are injured. Dr. Mercado further noted the disproportionate percentage of Medicare and Medicaid fraud cases, further undermining the territory’s credibility with the federal government—and, adding that local governments have complied  with the implementation of a Medicaid Fraud Control Unit (MFCU), which he says falls under the purview of the Department of Justice. Nevertheless, despite differing points of emphasis, both the leadership of the PROMESA Oversight Board and Resident Commissioner Jenifer González yesterday restated the importance of preventing Puerto Rico’s healthcare system from falling into a fiscal abyss, given the depletion of the $1.2 billion in Medicaid funds which has been provided on an annual basis under the Affordable Care Act.

Yesterday, in the wake of separate meetings with Commissioner González, with one of Speaker Paul Ryan’s advisors, and with Congresswoman Elise Stefanik (R-NY), PROMESA Oversight Board Chair José Carrión claimed that “we always try to include healthcare and economic development issues” in the meetings held in Congress, describing meetings in which he had been joined by Board member Carlos García and interim executive director, Ramón Ruiz Comas, as sessions to provide updates, while trying to deal with the issue which most concerns the Board: health care—emphasizing that especially in the wake of the end of the Congressional Task Force on Economic Growth in Puerto Rico.  

Federalism, Governance, & Bankruptcy

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eBlog, 2/15/17

Good Morning! In this a.m.’s eBlog, we consider the evolving governance challenge in New Jersey and the state takeover of fiscally troubled Atlantic City—a breach into which it appears the third branch of government—the judiciary—might step. Next, we turn to whether governmental trust by citizens, taxpayers, and voters can be exhausted–or bankrupted–as the third branch of government, the judiciary–as in the case of New Jersey–could determine the fate of the former and current mayors of the fiscally insolvent municipality of Petersburg, Virginia. Finally, we try to get warm again by visiting Puerto Rico—where the territorial status puts Puerto Rico between a state and a municipality—what Rod Serling likely would have deemed a fiscal Twilight Zone—further complicated by language barriers—and, in a country where the federal government may not authorize states to file for bankruptcy protection, in a governance challenge with a new Governor. No doubt, one can imagine if Congress appointed an oversight board to take over New Jersey or Illinois or Kansas, the ruckus would lead to a Constitutional crisis.

We Await the Third Branch. The first legal action challenging the State of New Jersey’s takeover of Atlantic City finances will be decided at the local level in the wake of U.S. District Court Judge Renee Marie Bumb’s decision to remand the case back to Atlantic County Superior Court. The case involves a lawsuit from the union representing Atlantic City firefighters which alleges state officials are unlawfully seeking to lay off 100 firefighters and alter the union’s contract; Judge Bumb held that the federal court lacks jurisdiction, since the complaint does not assert any federal claims, thereby granting International Association of Firefighters Local 198’s “emergency motion” to remand the lawsuit to New Jersey state court, saying it was inappropriate for the defendants to remove the action to federal court. Thus, the case will revert to New Jersey Superior Court Judge Julio Mendez, who temporarily blocked the state-ordered firefighter cuts at the beginning of the month. The case involves the suit filed by the International Association of Fire Fighters, Local 198, and the AFL-CIO challenging the state’s action to proceed with 100 layoffs and other unilateral contract changes under New Jersey’s Municipal Stabilization and Recovery Act—the legislation enacted last November in the wake of the New Jersey Local Finance Board’s rejection of Atlantic City’s rescue plan. The suit claims the act violates New Jersey’s constitution. This legislation, which was implemented last November after the New Jersey’s Local Finance Board rejected an Atlantic City rescue plan, empowers the state alter outstanding Atlantic City debt and municipal contracts. Prior to Judge Mendez’s Ground Hog Day ruling, the state was planning to set up changes to the firefighters’ work schedule, salaries, and benefits commencing by cutting the 225-member staff roughly in half beginning in September.

Hear Ye—or Hear Ye Not. A hearing for the civil case brought against Petersburg Mayor Samuel Parham and Councilman and former Mayor W. Howard Myers is set for tomorrow morning. Both men are defendants in a civil court case brought about by members of registered voters from the fifth and third wards of Petersburg. Members of the third and fifth wards signed petitions to have both men removed from their positions. The civil case calls for both Parham and Myers to be removed from office due to “neglect, misuse of office, and incompetence in the performance of their duties.” The purpose of hearing is to determine trial date, to hear any motions, to determine whether Mayors Parham and Myers will be tried separately, and if they want to be tried by judge or jury. James E. Cornwell of Sands Anderson Law Firm will be representing messieurs Myers and Parham. (Mr. Cornwell recently represented the Board of Supervisors in Bath County, Virginia, where the board was brought to court over a closed-doors decision to cut the county budget by $75,000 and eliminate the county tourism office.) The City Council voted 5-2 on Tuesday night to have the representation of Mr. Myers and Mayor Parham be paid for by the city. Mayor Parham, Vice Mayor Joe Hart, Councilman Charlie Cuthbert, former Mayor Myers, and Councilman Darrin Hill all voted yes to the proposition, while Councilwoman Treska Wilson-Smith and Councilwoman Annette Smith-Lee voted no. Mayor Parham and Councilmember Hill stated that the Council’s decision to pay for the representation was necessary to “protect the integrity of the Council,” noting: “It may not be a popular decision, but it’s [Myers and Parham] today, and it could be another council tomorrow.” Messieurs Hill and Parham argued that the recall petition could happen to any member of council: “[The petitions] are a total attack on our current leadership…We expect to get the truth told and these accusations against us laid to rest.” The legal confrontation is further muddied by City Attorney Joseph Preston’s inability to represent the current and former Mayors, because he was also named in the recall petition, and could be called as a witness during a trial.

Federalism, Governance, & Hegemony. Puerto Rico Gov. Ricardo Rosselló has said that he is setting aside $146 million for the payment of interest due on general obligation municipal bonds, noting, in an address to the Association of Puerto Rico Industrialists, that he plans to pay off GO holders owed $1.3 million, because the Commonwealth defaulted on its payment at the beginning of this month, so, instead, he said the interest would be drawn from “claw back” funds, a term the government uses to describe the diversion of revenue streams which had supported other municipal bonds. Now the Governor has reported the $146 million would be held in an account at Banco Popular, ready to be used to meet subsequent general obligation payments to bondholders—noting that the funds to be used had not been “destined” to be used for essential services for Puerto Rico’s people; the Governor did not answer a question as to which bond revenues were being clawed back; however, his announcement creates the potential to partially address the nearly 9 month default on a $779 million payment.

But mayhap the harder, evolving governance issue is the scope of the PROMESA Board to “govern” in Puerto Rico: the statute Congress enacted and former President Obama signed does not vest authority in the PROMESA Oversight Board to review all legislation introduced by the current administration before its approval—thus, the growing perception or apprehension is the implication that Congress has created an entity which is violating the autonomy of the Government of Puerto Rico. It is, for instance, understood that Congress and the President lack the legal or Constitutional authority to take over the State of Illinois—a state which, arguably—has its own serious fiscal disabilities. Thus, it should come as no surprise that Gov. Rosselló’s administration is feeling besieged by disparate treatment at the receipt of a letter sent by the PROMESA Board at the beginning of this month—an epistle in which Board Chair José B. Carrión requested that the Puerto Rican Government discuss with the Board the implications of any new legislation before submission, citing §§204, 207, and 303 of PROMESA as part of the “many tools that can be deployed in terms of legislation.” Unsurprisingly, Elías Sánchez Sifonte, Gov. Rosselló’s representative to the Board, wrote that the Board’s “request to preliminarily review all legislation, as a right they can exercise, is not considered in PROMESA, and it violates the autonomy of the Government of Puerto Rico,” noting that Governor Rosselló’s administration “is working and will continue to work in cooperation with the Oversight Board on all issues” considered under PROMESA. Nevertheless, in the epistle, Mr. Sifonte wrote that “nowhere” in §204 is there any mention that the Government of Puerto Rico must submit its legislation for revision, rather: “It only requires that the legislation be submitted to the Board after it has been properly approved,” even as Mr. Sifonte acknowledged in the letter that after the Fiscal Plan has been certified, the Commonwealth must forward any adopted legislation to the PROMESA Board, accompanied by a cost estimate and a certification stating if it is consistent with the fiscal plan. Moreover, Mr. Sifonte added, because there is currently no fiscal plan, such a certification is not applicable, although a cost estimate is—the deadline for the fiscal plan is February 28th at the latest.

Moreover, according to Mr. Sifonte, “[o]nce the Plan is certified, every piece of legislation to be submitted will be consistent with the Fiscal Plan and will be accompanied by the proper certification, which, in his view, means that it should be protected from Board review, according to the Congressional report that gave way to PROMESA, adding that his purpose in communicating was to “help” both Puerto Rico and the PROMESA Board understand and respect each other’s authority—or, as he noted: “PROMESA’s broad powers are recognized, and we recognize all of the Board’s powers contained within the law. What shouldn’t happen is for them to want to go further, despite those extensive powers, and occupy a space that belongs to the officials elected by the people, because then that would in fact infringe upon the full democracy of our country,” adding that “the administration’s intention is not to interfere with the Oversight Board while the members carry out their mission under the federal statute, but the letter seeks to clarify “the autonomy of Puerto Rico’s Government, which is safeguarded under PROMESA.” The letter also states that the Government’s interpretation of PROMESA is based on Section 204(a)(6), which establishes that the Oversight Board may review legislation before it is approved “only by request of the Legislature.” Finally, Mr. Sifonte addressed a fundamental federalism apprehension: referencing §207 of PROMESA, which establishes that “the territory” cannot issue, acquire, or modify debt, he wrote that Puerto Rico has not issued, nor does it intend to issue any debt, referencing the Puerto Rico Financial Emergency & Fiscal Responsibility Act, and emphasizing this statute marks a change in public policy, with the intention of paying the creditors, just as Governor Rosselló this month had announced. Finally, he noted: the “inappropriateness” of the Chairman’s proposition, where—under the protection of §303 of PROMESA—he tells the Government that “the compliance measures under PROMESA should be a last resort and hopefully won’t be necessary,” noting that that provision “expressly says that the Government of Puerto Rico retains the duty to exercise political power or the territory’s governmental powers.”

Federalism & Fiscal Challenges

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eBlog, 2/07/17

Good Morning! In this a.m.’s eBlog, we consider some of the implications of New Jersey’s constitution with regard to the state’s takeover of Atlantic City: does the state takeover violate parts of the Garden State’s constitution? Then we head south to the Caribbean to try to understand the extraordinary fiscal challenges to the neighboring U.S. territories of Puerto Rico and the U.S. Virgin Islands.

New Jersey Federalism? New Jersey Superior Court Judge Julio Mendez has issued an order temporarily blocking the state’s effort to eliminate one hundred Atlantic City firefighter positions—all part of an order which momentarily halts the state from imposing any layoffs or unilateral contract changes to Atlantic City’s 225-member fire department. The issue and legal challenge here arose in the wake of the International Association of Fire Fighters, Local 198, and the AFL-CIO filing a lawsuit arguing that the State of New Jersey’s action under the Municipal Stabilization and Recovery Act—which empowered the state takeover of the City, and authorized New Jersey’s Local Finance Board to take over the city, violates New Jersey’s constitution. The suit comes even as the state’s Department of Community Affairs claims the state had already decided before the ruling to push back implementing the firefighter cuts until next September—with the changes to pay structure, hours, and overtime postponed until the end of next week; however, the state made clear the “temporary restraining order signed by Judge Mendez does not change the State’s timetable for advancing reforms of Atlantic City firefighters’ contracts…We decided to delay implementing the proposed contract reforms until February 19th as a good faith gesture to give the fire department more time to prepare.”

Judge Mendez had initially scheduled a hearing for next Monday; however, the state successfully fought to get the case removed to federal court at an undetermined date. Judge Mendez issued the restraining order despite the state, in a court filing, advising the court it would hold off implementing the proposed 100 layoffs until September, and would delay changes to pay structure, hours, overtime, and benefits until February 19th. However, Judge Mendez’s order bars the state from taking any action under the Municipal Stabilization and Recovery Act that is “in violation of the Due Process and Equal Protection, Contracts, Takings, Collective Negotiation, and Civil Service clauses of the New Jersey Constitution.” The case marks the first legal challenge to the broad state preemption and takeover of Atlantic City imposed by the state last November: the subsequent court case could shape up to be a significant test of the takeover’s constitutionality against criticisms that it violates residents’ civil rights and the collective bargaining rights of the city’s unions.

The state’s strategy in responding by seeking removal to the federal court seems exceptional—and in stark contrast to the unique concept of dual federalism in this country, especially so in this case, because the New Jersey constitution includes a comparable provision with regard to voiding contracts—or, as a colleague late last night noted: “It’s odd for a state law to be appealed to the federal court when there are state constitutional issues at stake.” Nevertheless, the filing raises two issues: 1) would a federal court even consent? It is, after all, a matter of New Jersey law, and 2) it would seem, especially in a New Jersey court, that the state constitution issue should supersede a federal action.  

At the same time, in a separate fiscal arena, Moody’s Investor Service’s affirmed  Atlantic City’s deep-junk level Caa3 bond rating and retained the city’s negative outlook, citing an ongoing “liquidity crisis” and likely default in the next year notwithstanding the state’s takeover—the city, after all, is confronting a structural deficit of more than $100 million and has suffered five casino closures since 2014; it has $240 million in municipal bond debt and more than $500 million in total debt when factoring in casino tax refunds and other obligations. It would seem Moody’s is seeking to ensure investors are aware of what is transpiring—and needed to remind the city’s municipal bondholders that there will be a new Governor who will have to reassess what actions—and relationship with Atlantic City—they ought to consider.

Statehood I? Puerto Rico Gov. Ricardo Rosselló has signed into law a bill for a June referendum on Puerto Rico’s political status. The law provides for a non-binding referendum that would allow the U.S. territory to vote on statehood. The referendum, to be held this June, will allow the voters to choose between statehood and independence/free association. Those in support of Puerto Rican statehood believe approving statehood could help the country restructure its $70 billion in public debt and stave off further federal austerity measures. Functionally, if approved, Puerto Rican statehood would allow the state to receive $10 billion in federal funds per year, as well as allowing government agencies and municipalities to file for chapter 9 municipal bankruptcy. In signing the legislation, Gov. Rosselló called the vote “a civil rights issue;” he said the U.S. will have to “respond to the demands of 3.5 million citizens seeking an absolute democracy.” Importantly, if granted statehood, the U.S. citizens of Puerto Rico would, at long last, no longer be denied many of the benefits provided to citizens in U.S. mainland and Hawaii, including equal access to Social Security and Medicare, despite paying taxes for these services. In addition, Puerto Rico’s representatives in Congress would be granted the same voting rights as all other Members of Congress—except for the Delegate from the District of Colombia. Under the referendum, voters would, in effect, determine whether to alter Puerto Rico’s status as a territory granted under the Jones-Shafroth Act: they will be asked if they support Puerto Rico becoming a state or a country independent of the United States of America. Should voters opt for independence, a subsequent referendum next October would be held to determine whether citizens wish to maintain some sort of association with the U.S., or become independent. In a written statement from Gov. Rosselló, Puerto Rico House of Representatives President Carlos Méndez said, “The colonial situation that currently defines Puerto Rico has deprived Puerto Ricans of participating fully in the federal government, of voting for the president of the United States, of electing representatives with a say and vote in the federal congress, and of receiving equal treatment in opportunities that strengthen socio-economic development and quality of life.”

Statehood or Independence? Even as Gov. Rosselló has signed into law a provision to allow Puerto Rico’s citizens to vote on their own governing destiny, Congressman Luis Gutiérrez (D-Puerto Rico) today plans to offer legislation in Congress to promote a federal plebiscite in which Puerto Ricans can select between independence and a free association pact between Puerto Rico and the United States, with a draft of his proposal, as reported by El Nuevo Día, stating: “The annexation of Puerto Rico as a state of the Union would be detrimental both to the United States and to Puerto Rico. It is time to return sovereignty to Puerto Rico…Statehood and full assimilation—in which Puerto Rico delivers its nationality, culture, Olympic team, language, and ability to determine its future—is not the only option and is not the best option for Puerto Ricans.” Under the proposed legislation, all Puerto Ricans or a father or mother born in Puerto Rico, would be granted the right to vote; rights granted via federal programs, such as veterans, pensions, and benefits from military service would be recognized. The proposal suggests a process to restructure public debt as well as an agreement to keep the current total of federal transfers, as a bloc, during a transitional period. The bill provides that citizenship of Puerto Rico would be recognized; however, Puerto Ricans would be eligible to retain U.S. citizenship.

Caribbean Fiscal Contagion? Fitch Ratings has lowered its credit ratings for the U.S. Virgin Islands, just seventeen miles from Puerto Rico, downgrading its ratings on about $216 million of the U.S. territory’s water and power authority municipal bonds—acting in the wake of the island government’s rescission of a utility rate increase which had been approved last month. Fitch’s action put the island’s ratings eight levels below investment grade—and near default, and came in the wake, last month, of its downgrade of the Virgin Islands’ public finance authority, which borrows on behalf of the government, writing: “The rating downgrade reflects the heightened credit risk as a consequence of the island’s Water & Power Authority’s continued inability to gain regulatory approval of rate relief needed to address its exceptionally weak cash flow and liquidity.” The downgrade came in the wake of the U.S. territory’s increasing inability to issue municipal debt: the government has been unable to issue municipal debt since December, twice delaying a planned $219 million municipal bond sale. The U.S. territory, confronted by budget shortfalls, had intended to use the bond proceeds to help cover the government’s bills. Virgin Islands Governor Kenneth Mapp has proposed a series of tax increases intended to bolster the territory’s finances and restoring its access to the financial markets. However, as the Romans used to say: tempus fugit: Last week, Gov. Mapp warned the government may not be able to make payroll by the middle of this month if nothing is done.

Are American Cities at a Financial Brink?

eBlog, 1/13/17

Good Morning! In this a.m.’s eBlog, we consider the ongoing fiscal and physical challenges to the City of Flint, Michigan in the wake of the disastrous state appointment of an Emergency Manager with the subsequent devastating health and fiscal subsequent crises, before turning to a new report, When Cities Are at the Financial Brink” which would have us understand that the risk of insolvency for large cities is now higher than at any point since the federal government first passed a municipal bankruptcy law in the 1930’s,” before briefly considering the potential impact on every state, local government, and public school system in the country were Congress to adopt the President-elect’s proposed infrastructure plan; then we consider the challenge of aging: what do longer lifespans of city, county, and state employees augur for state and local public pension obligations and credit ratings?

Not In Like Flint. Residents of the City of Flint received less than a vote of confidence Wednesday about the state of and safety of their long-contaminated drinking water, precipitated in significant part by the appointment of an Emergency Manager by Governor Rick Snyder. Nevertheless, at this week’s town hall, citizens heard from state officials that city water reaching homes continues to improve in terms of proper lead, copper, alkaline, and bacteria levels—seeking to describe Flint as very much like other American cities. The statements, however, appeared to fall far short of bridging the trust gap between Flint residents and the ability to trust their water and those in charge of it appears wide—or, as one Flint resident described it: “I’m hoping for a lot…But I’ve been hoping for three years.” Indeed, residents received less than encouraging words. They were informed that they should, more than 30 months into Flint’s water crisis, continue to use filters at home; that it will take roughly three years for Flint to replace lead water service lines throughout the city; that the funds to finance that replacement have not been secured, and that Flint’s municipal treatment plants needs well over $100 million in upgrades: it appears unlikely the city will be ready to handle water from the new Karegnondi Water Authority until late-2019-early 2020. The state-federal presentation led to a searing statement from one citizen: “I’ve got kids that are sick…My teeth are falling out…You have no solution to this problem.”

Nevertheless, progress is happening: in the last six months of water sampling in Flint, lead readings averaged 12 parts per billion, below the federal action level of 15 ppb, and down from 20 ppb in the first six months of last year. Marc Edwards, a Virginia Tech researcher who helped identify the city’s contamination problems, said: “Levels of bacteria we’re seeing are at dramatically lower levels than we saw a year ago.” However, the physical, fiscal, public trust, and health damage to the citizens of Flint during the year-and-a-half of using the Flint River as prescribed by the state-appointed Emergency Manager has had a two-fold impact: the recovery has been slow and residents have little faith in the safety of the water. Mayor Karen Weaver has sought to spearhead a program of quick pipeline replacement, but that process has been hindered by a lack of funding.

State Intervention in Municipal Bankruptcy. In a new report yesterday, “When Cities Are at the Financial Brink,” Manhattan Institute authors Daniel DiSalvo and Stephen Eide wrote the “risk of insolvency for large cities in now higher than at any point since the federal government first passed a municipal bankruptcy law in the 1930’s,” adding that “states…should intervene at the outset and appoint a receiver before allowing a city or other local government entity to petition for bankruptcy in federal court—and writing, contrary to recent history: “Recent experiences with municipal bankruptcies indicates that when local officials manage the process, they often fail to propose the changes necessary to stabilize their city’s future finances.” Instead, they opine in writing about connections between chapter 9, and the role of the states, there should be what they term “intervention bankruptcy,” which could be an ‘attractive alternative’ to the current Chapter 9. They noted, however, that Congress is unlikely to amend the current municipal bankruptcy chapter 9, adding, moreover, that further empowering federal judges in municipal affairs “is sure to raise federalism concerns.” It might be that they overlook that chapter 9, reflecting the dual sovereignty created by the founding fathers, incorporates that same federalism, so that a municipality may only file for chapter 9 federal bankruptcy if authorized by state law—something only 18 states do—and that in doing so, each state has the prerogative to determine, as we have often noted, the process—so that, as we have also written, there are states which:

  • Precipitate municipal bankruptcy (Alabama);
  • Contribute to municipal insolvency (California);
  • Opt, through enactment of enabling legislation, significant state roles—including the power and authority to appoint emergency managers (Michigan and Rhode Island, for instance);
  • Have authority to preempt local authority and take over a municipality (New Jersey and Atlantic City.).

The authors added: “The recent experience of some bankrupt cities, as well as much legal scholarship casts doubt on the effectiveness of municipal bankruptcy.” It is doubtful the citizens in Stockton, Central Falls, Detroit, Jefferson County, or San Bernardino would agree—albeit, of course, all would have preferred the federal bailouts received in the wake of the Great Recession by Detroit’s automobile manufacturers, and Fannie Mae and Freddie Mac. Similarly, it sees increasingly clear that the State of Michigan was a significant contributor to the near insolvency of Flint—by the very same appointment of an Emergency Manager by the Governor to preempt any local control.

Despite the current chapter 9 waning of cases as San Bernardino awaits U.S. Bankruptcy Judge Meredith Jury’s approval of its exit from the nation’s longest municipal bankruptcy, the two authors noted: “Cities’ debt-levels are near all-time highs. And the risk of municipal insolvency is greater than at any time since the Great Depression.” While municipal debt levels are far better off than the federal government’s, and the post-Great Recession collapse of the housing market has improved significantly, they also wrote that pension debt is increasingly a problem. The two authors cited a 2014 report by Moody’s Investors Service which wrote that rising public pension obligations would challenge post-bankruptcy recoveries in Vallejo and Stockton—perhaps not fully understanding the fine distinctions between state constitutions and laws and how they vary from state to state, thereby—as we noted in the near challenges in the Detroit case between Michigan’s constitution with regard to contracts versus chapter 9. Thus, they claim that “A more promising approach would be for state-appointed receivers to manage municipal bankruptcy plans – subject, of course, to federal court approval.” Congress, of course, as would seem appropriate under our Constitutional system of dual sovereignty, specifically left it to each of the states to determine whether such a state wanted to allow a municipality to even file for municipal bankruptcy (18 do), and, if so, to specifically set out the legal process and authority to do so. The authors, however, wrote that anything was preferable to leaving local officials in charge—mayhap conveniently overlooking the role of the State of Alabama in precipitating Jefferson County’s insolvency.  

American Infrastructure FirstIn his campaign, the President-elect vowed he would transform “America’s crumbling infrastructure into a golden opportunity for accelerated economic growth and more rapid productivity gains with a deficit-neutral plan targeting substantial new infrastructure investments,” a plan the campaign said which would provide maximum flexibility to the states—a plan, “American Infrastructure First” plan composed of $137 billion in federal tax credits which would, however, only be available investors in revenue-producing projects—such as toll roads and airports—meaning the proposed infrastructure plan would not address capital investment in the nation’s public schools, libraries, etc. Left unclear is how such a plan would impact the nation’s public infrastructure, the financing of which is, currently, primarily financed by state and local governments through the use of tax-exempt municipal bonds—where the financing is accomplished by means of local or state property, sales, and/or income taxes—and some user fees. According to the Boston Federal Reserve, annual capital spending by state and local governments over the last decade represented about 2.3% of GDP and about 12% of state and local spending: in FY2012 alone, these governments provided more than $331 billion in capital spending. Of that, local governments accounted for nearly two-thirds of those capital investments—accounting for 14.4 percent of all outstanding state and local tax-exempt debt. Indeed, the average real per capita capital expenditure by local governments, over the 2000-2012 time period, according to the Boston Federal Reserve was $724—nearly double state capital spending. Similarly, according to Census data, state governments are responsible for about one-third of state and local capital financing. Under the President-elect’s proposed “American Infrastructure First” plan composed of $137 billion in federal tax credits—such credit would only be available to investors in revenue-producing projects—such as toll roads and airports—meaning the proposed infrastructure plan would not address capital investment in the nation’s public schools, libraries, etc. Similarly, because less than 2 percent of the nation’s 70,000 bridges in need of rebuilding or repairs are tolled, the proposed plan would be of no value to those respective states, local governments, or users. Perhaps, to state and local leaders, more worrisome is that according to a Congressional Budget Office 2015 report, of public infrastructure projects which have relied upon some form of private financing, more than half of the eight which have been open for more than five years have either filed for bankruptcy or been taken over by state or local governments.

Moody Southern Pension Blues. S&P Global Ratings Wednesday lowered Dallas’s credit rating one notch to AA-minus while keeping its outlook negative, with the action following in the wake of Moody’s downgrade last month—with, in each case, the agencies citing increased fiscal risk related to Dallas’ struggling Police and Fire Pension Fund, currently seeking to stem and address from a recent run on the bank from retirees amid efforts to keep the fund from failing, or, as S&P put it: “The downgrade reflects our view that despite the city’s broad and diverse economy, which continues to grow, stable financial performance, and very strong management practices, expected continued deterioration in the funded status of the city’s police and fire pension system coupled with growing carrying costs for debt, pension, and other post-employment benefit obligations is significant and negatively affects Dallas’ creditworthiness.” S&P lowered its rating on Dallas’ moral obligation bonds to A-minus from A, retaining a negative outlook, with its analysis noting: “Deterioration over the next two years in the city’s budget flexibility, performance, or liquidity could result in a downgrade…Similarly, uncertainty regarding future fixed cost expenditures could make budgeting and forecasting more difficult…If the city’s debt service, pension, and OPEB carrying charge elevate to a level we view as very high and the city is not successful in implementing an affordable plan to address the large pension liabilities, we could lower the rating multiple notches.” For its part, Fitch Ratings this week reported that a downgrade is likely if the Texas Legislature fails to provide a structural solution to the city’s pension fund problem. The twin ratings calls come in the wake of Dallas Mayor Mike Rawlings report to the Texas Pension Review Board last November that the combined impact of the pension fund and a court case involving back pay for Dallas Police officers could come to $8 billion—mayhap such an obligation that it could force the municipality into chapter 9 municipal bankruptcy, albeit stating that Dallas is not legally responsible for the $4 billion pension liability, even though he said that the city wants to help. The fund has an estimated $6 billion in future liabilities under its current structure. In testimony to the Texas State Pension Review Board, Mayor Rawlings said the pension crisis has made recruitment of police officers more difficult just as the city faces a flood of retirements.

 

Who’s in Charge of a Municipality’s Future?

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eBlog, 9/29/16

Good Morning! In this a.m.’s eBlog, we consider, the always difficult state-local governance challenges for cities in fiscal stress: first, we look at yesterday’s editorial from the Detroit Free Press raising serious concerns with regard to Michigan’s emergency manager law—a state law which authorizes the state to appoint an emergency law with dictatorial type authority and without accountability to citizens, voters, or taxpayers in a city, county, or public school district. The issue relates to the kinds of challenges we have been following in New Jersey, Connecticut, Virginia, and other states where the hard questions relate to what the role of a state might be for a municipality in severe fiscal distress—especially where such distress might risk municipal fiscal contagion. Then, mayhap appropriately, we journey back to Atlantic City, which is nearing its own state-imposed deadline to avert a state takeover. Finally, we examine the ongoing plight of East Cleveland —a small, poor municipality in some state of negotiation with the adjacent City of Cleveland with regard to the possibility of a merger—while awaiting a response from the State of Ohio with regard to its specific request for authority to file for chapter 9 bankruptcy. It remains unclear if the State of Ohio will ever even notify the city it has received said request, much less act. Thus, in a week, we have watched the States of Virginia, Connecticut, Michigan, and New Jersey struggle with what the role of a state might be—and how the fiscal ills of a city might adversely impact the credit ratings of said state.

Who’s in Charge of a Municipality’s Future? The Detroit Free Press in an editorial this a.m. wrote that, “[F]our years on, it’s hard to argue that Gov. Rick Snyder’s retooled emergency manager law, [Gov.] Snyder’s second revision of Michigan’s long-standing law, is working,” referring to Michigan’s Emergency Manager Law (Act 436), a state law unique to the state of Michigan: one which authorizes authority to the governor to appoint emergency managers with near-absolute power in cash-strapped cities, towns, and school districts; it authorizes such emergency managers to supersede local ordinances, sell city assets, and break union contracts; it leaves local elected officials without real authority. It provides that an Emergency Manager may be appointed by the Local Emergency Financial Assistance Loan Board. In the case of Detroit, it served as the mechanism by which Governor Rick Snyder appointed Kevyn Orr as Detroit’s emergency financial manager. The law, the Local Financial Stability and Choice Act reads: “The financial and operating plan shall provide for all of the following: The payment in full of the scheduled debt service requirement on all bonds and notes, and municipal securities of the local government, contract obligations in anticipation of which bonds, notes, and municipal securities are issued, and all other uncontested legal obligations (See §141.155§11(1)(B)). The editorial went on: “The crux of the problem lies in the limited impact accounting can have on the myriad factors that affect quality of life or efficient service delivery within a city:

“Sure, an emergency manager (in theory) can balance a city or school district’s books. But no amount of budget slashing or service cuts can make a city somewhere people want to live, or a school district the kind of place that offers quality education. In fact, it’s often the reverse: When residents leave, the tax base slims, meaning cities or school districts stretch to provide the requisite level of service with significantly less money. Cuts exacerbate the population decline, which depletes revenue more, which means more service cuts. And so on and so on and so on.

Nowhere is this object lesson in sharper contrast than Flint, where the city — under a success {I suspect the editors meant “excess’} of emergency managers — started pumping drinking water from the Flint River in 2014, pending the start-up of a new regional water system, a cost-saving switch prompted by the city’s ongoing budget woes. Almost immediately, botched water treatment caused bacterial contamination that altered the color, taste and odor of the city’s drinking water, and 18 months later, the state would acknowledge that improper treatment of which had caused lead to leach from aging service lines, contaminating the city’s drinking supply, and exposing nearly 9,000 children under age 6 to the neurotoxin, which can cause behavioral and developmental problems.

Why play games with something as important as drinking water? When the mandate is to cut, cut, cut, everything is on the table.

But it shouldn’t be.

A task force appointed by [Gov.] Snyder to review the Flint water crisis recommended a slate of changes to the state’s emergency manager law, like a mechanism for local appeal of emergency manager decisions, outside review, and other controls that Flint residents, alarmed by the smell, taste and color of their drinking water, could have employed to halt Flint’s water disaster before it reached crisis proportions.

Snyder says he’s waiting for the completion of a legislative report into the task force’s recommendation.

Why?

Snyder took office in 2011 knowing the bill was about to come due for a wave of municipal crises that threatened to cascade across the state.

There was the City of Detroit, where systemic budget troubles had been building for decades; Pontiac, Flint, and Benton Harbor, Allen Park, Ecorse, and Highland Park, where emergency managers were already waging uphill battles with incremental results, or whose substantial financial challenges put them firmly in emergency management’s crosshairs. And Detroit Public Schools, under state control for most of the last decade, with no fix in sight.

Inexplicably, in this climate, [Gov.] Snyder chose to cut state revenue sharing, continuing a trend of bolstering the state’s fiscal health at the expense of its cities to the tune of about $6 billion in cuts to cities over a decade.

Snyder and then-Treasurer Andy Dillon believed that the state’s long-standing emergency manager act was insufficient to truly remedy cities’ and school districts’ fiscal woes. An emergency manager, Snyder and Dillon believed, should have clear authority over operations, not just finances, and have greater power to impact labor agreements. Through two revisions (the first emergency manager law passed in Snyder’s tenure was repealed by voters; its replacement carries a budget appropriation and is thus repeal-proof), Snyder crafted a law that granted his emergency managers the authority to make the broad fixes he believed necessary.

There’s no question that a temporary usurpation of local elected control, as happens during an emergency manager’s appointment, is a serious matter. But Snyder seemed to understand that ensuring the health and well-being of Michigan residents — by ensuring that Michigan cities and school districts could provide the services necessary to create those conditions — was properly a governor’s job. It still is.

In the meantime, there’s promising news out of Lansing: Michigan State University professor Eric Scorsone, long a champion of funding cities properly and sustainably, has been appointed state deputy treasurer for finance. Scorsone has been a strong advocate for municipal governments and school districts, and we hope, deeply, that his appointment indicates that Snyder has come around to a point of view we’ve advanced for years: Fund cities properly, and whether or not to appoint an emergency manager may become a question that never needs answering.

Tempus Fugit? In ancient Rome, the query was ‘Is time running out,’ now an increasingly anxious question for Atlantic City’s leaders, where, having already missed one state-imposed deadline to initiate dissolution of its authority, the state has given the city until Monday to cure the violation. New Jersey Senate President Steve Sweeney (D-Salem) said Atlantic City must make a “realistic plan” to dig out of its fiscal hole; however, he declined to weigh in on the city’s most recent proposal. Noting that “Atlantic City has roughly 30-something days” left, Sen. Sweeney noted: “It’s incumbent upon them to put a realistic plan forward. You know, we’ve been at this for a while, and they really need to put a plan forward that’s going to make sense and work.” With the state-imposed deadline just six days before election day, Sen. Sweeney said he would “reserve judgment” on the city’s proposal to avail itself of its public water utility to purchase its airport, Bader Field, for at least $100 million. His comments came in the wake of the city’s unveiling earlier this week the first of seven parts to its plan in which city officials announced the Municipal Utilities Authority has agreed to purchase as part of an effort to raise revenues for the city, yet retain the water system in public hands, with the proceeds to go toward paying down the city’s roughly $500 million debt. The deadline comes as Moody’s has warned that the city not only risks defaulting on terms of a $73 million state loan agreement, but could also miss a $9.4 million municipal bond interest payment due on November 1. Analyst Douglas Goldmacher noted Atlantic City “does not have sufficient funds to immediately repay the $62 million already received from the state…Furthermore, unless the state continues to disburse additional funds from the bridge loan, or releases the Atlantic City Alliance and investment alternative tax funds owed to the city, it is highly improbable that the city will be able to make its (Nov. 1) $9.4 million balloon payment.” Mr. Goldmacher wrote, however, that the city’s repayment challenges would be addressed if the proposed Bader Field sale goes through—even as he again said the plan raises questions, such as whether the authority can afford to borrow $100 million and whether the state would even approve the plan—a plan to which the New Jersey Department of Community Affairs has yet to comment—perhaps confirming Mr. Goldmacher’s apprehension that: “Atlantic City’s impending technical default is credit negative for it, and indicates a disconnect between the city council, mayor, and state: “The impending default was caused by political gridlock.”

What Kind of City Do the Voters Want? The Cuyahoga County, Ohio Board of Elections and the East Cleveland City Council Clerk’s office this week certified more than 600 petition signatures to force a recall vote of East Cleveland Mayor Gary Norton and City Council President Tom Wheeler, so that the two highest ranking elected officials in this virtually insolvent municipality will face a recall election this fall, albeit not on the November ballot: the election likely will occur on December 6th—appropriately one day before Pearl Harbor Day. The election, however, will not be without cost to the virtually insolvent city: it could cost the city between $25,000 and $30,000—and will be a run-up just 10 months before the next mayoral primary election, even as the city is locked in so far seemingly non-existent merger negotiations with the City of Cleveland and awaiting a non-existent response from the Ohio State Treasurer with regard to its request for authorization to file for chapter 9 municipal bankruptcy. Nevertheless, the citizens of East Cleveland gathered more than twice the requisite number of signatures necessary to force a special recall election, triggering the City Clerk to send a letter to Mayor Norton informing him of the election. Under the East Cleveland charter, if he does not resign, he will face a recall election within 60-90 days. Unsurprisingly, Mayor Norton does not plan to resign. In a phone interview last Saturday, he characterized the election a waste of money in a city that cannot afford it: “East Cleveland will select it’s next mayor 10 months after this needless recall election…This is a horrible expenditure of funds given the city’s current financial provision, and beyond that, switching a single mayor or single councilman will have no impact on the city’s financial situation and the city’s economy.” Mayor Norton said the money the election will cost will have to be cut from other city services, noting that would include possible cuts in police and fire, because, he added: “There’s little to nothing left to cut in the city.” In East Cleveland, violent crime, on a scale from 1 (low crime) to 100, is 91. Violent crime is composed of four offenses: murder and non-negligent manslaughter, forcible rape, robbery, and aggravated assault. The US average is 41.4. In the city, property crime, on a scale from 1 (low) to 100, is 75. The U.S. average is 43.5. A recall election, if it happens, would be the third for the Mayor.

Mayor Norton’s success rate in overcoming recall votes could change, however, as voters in November—before the next scheduled recall election, will consider an amendment to the city’s charter intended to curtail the ease with which residents can trigger a recall, although it is currently being reviewed by the Board of Elections and has not been finalized for the November ballot. For his part, the beleaguered Mayor Norton has so far refused to say whether he was going to run for re-election next year, and declined to answer why voters should vote to keep him as mayor in December.

What Is a State’s Role When a Municipality Can No Longer Provide Essential Public Services?

eBlog, 9/27/16

Good Morning! In this a.m.’s eBlog, we consider the risk of municipal fiscal contagion—and what the critical role of a state might be as the small municipality of Petersburg, Virginia’s fiscal plight appears to be spreading to neighboring municipalities and utilities: Virginia currently lacks a clearly defined legal or legislated route to address not just insolvency, but also to avoid the spread of fiscal contagion. Then we journey to Atlantic City, where a comparable fiscal challenge—but in a state with a much longer history of state-local consideration—appears on the verge of a total state takeover: we ask whether the city’s end is nigh: will the state, in fact, take it over? Then we turn to the school yards in Chicago, where a threatened teacher strike augurs fiscal downgrades and worse fiscal math for Chicago Public Schools—a city beleaguered by this year’s terrible increase in murders and now unsettling math.

When It Rains, It Pours. The small Virginia municipality of Petersburg, near insolvency–or its tipping point, uncertain of what role the Commonwealth of Virginia will take in a state where, were the city to file a chapter 9 municipal bankruptcy petition, its municipal bondholders holding bonds to which statutory liens have attached would continue to receive payments on those bonds, [§15.2-5358], now is confronted by the filing of two similar lawsuits, accusing the city of repeated failures to meet payment due dates. The fiscal crisis is finally forcing the State of Virginia to contemplate what role it might have to take—a role which would set a precedent in a state which does not specifically authorize its municipal entities to file for municipal bankruptcy—and where the only such petition filed—by an economic development authority—was dismissed. The likely mechanism that will leave the state little alternative but to act is likely to be the filing of two lawsuits against the city over past-due payments—suits alleging similar accusations of repeated failures to meet payment due dates even before Petersburg’s fiscal problems evolved into a crisis: the South Central Wastewater Authority last week filed a lawsuit against the city, seeking more than $1 million and the appointment of a receiver to make sure the money the authority says it is owed is not spent by the city on other things, with the suit alleging: “Since 2011, city officials have failed to regularly and timely bill and collect monies for wastewater services and have failed to make payments due and owing to South Central.”

The second suit, filed last month by a road paving company, alleges that Petersburg failed to make payments on time for the company’s work repaving U.S. Route 460 East—a contract which specified that the company would receive payment within 30 days of the work being billed. In its filing, however, the company noted that its bills were paid late and that many times “those checks bore dates that made it appear they had been issued on time pursuant to the contract terms, even though delivery did not occur until weeks or months later.” The company’s corporate credit manager and chief financial officer met in July 2015 with Petersburg’s then Finance Director to discuss the problems—in the wake of which the city proposed a very delayed schedule—late enough that the company halted work on the project. The suit charges it has been left with an unpaid balance of about $214,000, so that it is seeking payment of that balance plus interest of 1 percent per month. For its part, the South Central Wastewater Authority alleges a similar pattern of late payments stretching back to mid-2011: “Since 2011, city officials have failed to regularly and timely bill and collect monies for wastewater services and have failed to make payments due and owing to South Central…This failure by Petersburg became sustained and serious beginning in the middle of 2012 and has become chronic and severe since…Despite continuous communication and extraordinary forbearance by [South Central] regarding Petersburg’s payment practices, which only resulted in repeated assurances of payment followed by more broken commitments, Petersburg has now altogether ceased making payments.” The suit charges the city is delinquent by $1.2 million, excluding penalty fees. Another $410,000 came due on the first of this month, according to the lawsuit. Because the Authority, moreover, provides wastewater treatment for the municipalities of Petersburg and Colonial Heights, and the counties of Chesterfield, Dinwiddie, and Prince George; and because Petersburg uses about half of the wastewater plant’s capacity, South Central’s complaint notes that  if Petersburg continues to fail to make payments, the authority will have to ask the other municipalities to pay higher rates, or it may be forced to shut down the treatment plant—a shutdown which, the utility notes, “would endanger public health and require an alternate means of treatment to prevent the flow of untreated wastewater directly into the Appomattox River…Planning, permitting, financing and construction of new facilities would take years. The scale and seriousness of this crisis cannot be overstated.” Indeed, the scale and complexity of the growing list of creditors of the municipality unearthed by auditors last summer determined Petersburg owed a total of about $3.4 million to six regional organizations: South Central, the Appomattox River Water Authority, the Central Virginia Waste Management Authority and Riverside Regional Jail, Crater Youth Care and the District 19 Community Services Board. It has become increasingly apparent that Petersburg’s fiscal problems have become contagious to adjacent municipalities and essential public services, so that, increasingly, the Commonwealth of Virginia will be forced to act.

Indeed, Virginia Secretary of Finance Richard D. Brown last week briefed members of the General Assembly’s Finance Committees on his department’s effort to help Petersburg figure out how to close its $12 million budget gap and generate enough cash flow to both keep the city government operating and to begin to pay down a debt that has ballooned to nearly $19 million. But, as it has become apparent the city likely will simply be unable to get out by itself, its fiscal collapse risks spreading—as can be noted from the impact of its non-payment to a regional facility—adjacent municipalities, it would appear the Governor and Virginia legislature will have little choice but to both act on measures to protect the state’s AAA credit rating, but also to prevent the fiscal distress from spreading. The Virginian Commission on Local Government, which has measured local fiscal distress in the state for three decades: notes in its stress index measures cities’ and counties’ revenue capacity, revenue effort, and median household income: it ranks Petersburg as the third-most fiscally stressed locality in Virginia—behind Emporia and Buena Vista.

The increasing apprehension in Richmond has led the Chairman of the House Appropriations Committee, Del. S. Chris Jones (R-Suffolk) to ask: “How did this get this bad without anyone knowing about it?” It also triggered his appointment last week of Del. R. Steven Landes (R-Augusta) to head a subcommittee to study states dealing with fiscally stressed localities and come up with solutions if a situation similar to that in Petersburg were to occur elsewhere in Virginia—or, as the Chairman put it: “We want to do our due diligence to see if there is legislation we might have to put in place to give authority to the state in certain circumstances to potentially take action…Right now, we don’t have the authority to do this, which is why I thought it is important to have this subcommittee between now and January and then begin the process to come up with some legislation.” In doing so, the Chairman emphasized that the state legislature will look primarily for proposals aimed at protecting the state’s interests—not those of the troubled localities, stating: “We are elected to represent our citizens at the state level, and we have our AAA bond rating to consider.” For his part, Chairman Landes said his committee will also examine the state’s options with regard to steps it could take to shorten its response time when a locality is heading toward the fiscal cliff, noting: “We want to make sure that audit information is getting to the money committees and the administration, because we would much rather be kept abreast sooner rather than later,” even as he vowed that a “bailout” for Petersburg is out of the question, noting: “I’m not aware where the state has ever stepped in to provide a locality a bailout…I don’t see that happening.”

Balancing on the Prick of the NeedleWhile it seems clear that neither the Governor nor the Legislature have much willingness to either grant municipal bankruptcy or provide significant fiscal assistance; nevertheless, there appears to be recognition that should Petersburg default, it would have implications for other municipalities in the state, especially if there were a default—such a default—increasingly possible in Petersburg’s case, because it is unclear how Petersburg, by Saturday, will come up with a $1.4 million principal-and-interest payment owed to the Virginia Resources Authority, a premier funding source for local government infrastructure financing through bond and loan programs. Under Virginia’s intercept provision, the Commonwealth is authorized to seize dollars it directs to localities for services, such as for schools, police and welfare, and use them, instead, to make scheduled payments on bonds to avoid default.

Interim City Manager Dironna Moore Belton acknowledged in an email last week that in order to secure short-term financing and bring long-term stability to the city, it cannot default on its loan payments. But Ms. Belton did not provide any specifics about from where she would take these dollars: “The city regularly collects revenues which go toward paying obligations…(and) has set aside dollars from incoming revenue to make the VRA payment;” however, in light of the $1.2 million lawsuit filed last week by the South Central Wastewater Authority, calls for the city to file for chapter 9 municipal bankruptcy have grown louder at public meetings and on internet message boards. However, as one expert commentator warns: “The state’s position is that Petersburg has dug themselves into a very unusual hole, and that they are going to have to take some very stringent and even draconian steps to get their house in order.” It is no longer certain, however, that the municipality has the capacity to get out by itself—indeed, it seems that, more likely than not, its fiscal tribulations will, increasingly, adversely affect neighboring public utilities and jurisdictions. According to Secretary Brown, the possibility of the city defaulting on bond payments is very real—a default which would leave the municipality with few alternatives—to which the Secretary remarked: “Some say that if it’s gotten to the point where they can’t operate, they should look at their charter and un-incorporate.” Such incorporation, however, would be a version of passing the buck—after all: which government would then be responsible for not only providing essential public services, but also paying off the growing mountain of municipal debts?

Thirsty City. Just as the provision of drinking water was a difficult issue in Detroit’s chapter 9 municipal bankruptcy, and has become so in Petersburg, so too the issue has arisen in San Bernardino, where the city’s municipal water department has announced water bills will increase by an average of $3.50 starting in October—with some of the increased  costs triggered by a state mandated water reduction goal of 28% this past summer—even as the utility notes the importance of conserving water during winter months: the Board of Water Commissioners, which is responsible for water rates in the city, voted unanimously to impose the higher rates, the first increase in four years; the city has approved further increases to go into effect next July 1st and in the subsequent July 1st of 2018. Again, just as in Detroit, virtually all who attended the session and vote came away angry—as the city water department’s General Manager put it: “For all of us, the last thing we want to do is cause economic distress to people…But we need to take care of what we’ve got, or we’re going to end up spending more in the future.” Since the city’s last rate increase, the water department has had to deal with California’s historic drought; the rising cost of imported water; new water quality regulations; and other expenses. Cost-cutting efforts include operating with fewer employees than in 2007, requiring employees to pay for a larger portion of their benefits, and securing as much as $350,000 in rebates from Southern California Edison, according to the water department. According to the water department website, the average water bill in San Bernardino, will be just under $50 per month, higher than average in adjacent Riverside and Redlands, but less than in Colton, Rialto, the East Valley Water District, the Cucamonga Valley Water District, the West Valley Water District and Fontana. Unlike Detroit, where one of the most difficult issues for then U.S. Bankruptcy Judge Steven Rhodes was how to balance the critical public health and safety issues related to water versus affordability; that question appears not to have arisen in San Bernardino.

Can a City Maintain its Sovereignty? Just as the question of sovereignty for a municipality in Virginia has become an issue, so too the question of whether the State of New Jersey will take over Atlantic  City and dissolve its sovereignty, after the New Jersey Division of Local Government Services notified Atlantic City that it has until Monday to comply with the terms of a $73 million state loan or face the possibility of default, warning that, because the city is in violation of its loan terms, it must act swiftly to “cure the breach.” As part of its effortsd to cure that “breach,” Atlantic City has reached an agreement with its water utility to purchase its old municipal airport property in a deal that officials of the city hope will help it avoid a state takeover. The Municipal Utilities Authority, which provides Atlantic City’s drinking water and is financially independent from the city, plans to purchase the 143-acres of the former Bader Field airport for at least $100 million through bonding, officials announced at a press conference yesterday, with Mayor Donald Guardian touting the partnership as a way of maintaining both the city and utility’s “sovereignty” while also helping the city dig its way out of more than $500 million of total debt. Mayor Guardian said he hopes the agreement, one which still needs city council and state approval, prevents New Jersey’s Local Finance Board from taking action after it violated the terms of a $73 million bridge loan that called for dissolving the MUA. Nevertheless, the New Jersey Department of Community Affairs declined to comment on whether the Local Finance Board would accept the Atlantic City MUA plan—a key apprehension after that Board last Thursday had imposed a deadline of next Monday to fix a breach of a condition on its $73 million bridge loan or face a possible default where the state could seek full repayment and withhold state aid—indeed, under the terms of last July’s loan agreement mandating the city needed to dissolve the MUA by September 15th, the state could demand full repayment of the $73 million loan and withhold state aid if the city were unable to avert a default by the October 3 deadline. For his part, MUA Executive Director Bruce Ward said the authority will get an agreement with the city before deciding how to proceed with the property. Mr. Ward added that floating a bond for the Bader Field purchase is attainable and that the MUA has advisors who will help strategize the borrowing. The MUA has $15.7 million in annual revenues with $16.6 million of net water revenue debt outstanding, according to Moody’s Investors Service.

Learning about Debt—or Failing Grades? Moody’s yesterday awarded a failing credit grade to Chicago Public Schools, downgrading CPS’ bond rating further into junk status, lowering its view of the school system’s debt one notch to a B3 rating, citing a variety of factors, including CPS’ reliance on short-term borrowing, a “deepening structural deficit,” and a budget “built on unrealistic expectations” of help from a state government with money woes of its own. If there could be fiscal insult to financial injury, it arrived yesterday when CPS announced budgets at about 300 schools would lose a total of $45 million because of enrollment declines, and the Chicago Teachers Union said its members authorized a strike if contract talks break down. Unsurprisingly, that led the ever so moody Moody’s to warn that its debt rating could decline even further—a downgrade that would make the school district’s borrowing more expensive, even as CPS’ Board is set to vote Wednesday on the system’s $338 million capital budget—a budget projected to swell amid plans to borrow up to $945 million in long-term debt for a variety of other school infrastructure projects. For its part, the union yesterday announced that more than 95% of members who submitted a ballot last week voted in favor of authorizing a strike, easily crossing the requisite 75% threshold: CTU’s House of Delegates will meet Wednesday to discuss a possible strike date which could come as soon as October 11th—a strike, were it to occur, which added to Moody’s fiscal moodiness, as it noted CPS’ “increasingly precarious liquidity position and acute need for cash flow borrowing to support ongoing operations…The downgrade is also based on CPS’s deepening structural deficit, with budgets that are built on unrealistic expectations of assistance from the State of Illinois, which faces its own financial challenges. The rating also incorporates escalating pension contribution requirements, strong employee bargaining groups that impede cost cutting efforts, and elevated debt service expenses.” (CPS is offering raises in a new multi-year contract offer but it wants to phase out the $130 million annual tab for covering 7% of teachers’ 9% pension contribution. The union argues that the contract offer results in a pay cut and is strike-worthy.)