Exiting State Fiscal Oversight–After Emerging from Municipal Bankruptcy

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eBlog, 04/28/17

Good Morning! In this a.m.’s eBlog, we consider the consider the unique fiscal challenge confronting Detroit: how does it exit from Michigan state oversight?  

What Is Key to the Windy City’s Future? Detroit Mayor Mike Duggan testifying: “It’s gonna happen!” before a Michigan state House panel, advised legislators that the Motor City could meet requirements to end the state’s financial oversight next year; at the same time, he urged the lawmakers to do something about the city’s high auto insurance costs. He noted that Detroit has paid $7 billion of its $18 billion in debt and obligations after emerging from chapter 9 municipal bankruptcy in 2014, in an effort to demonstrate why such oversight ought no longer to fiscally oversee the city. The state-appointed Financial Review Commission—which oversees all major Detroit operations and labor contracts—was created amid the nation’s largest ever municipal bankruptcy to ensure the city’s recovery was well handled. But now, the Mayor testified, state oversight is interfering, instead of helping, because all major city and labor contracts are delayed 30 days awaiting for approval from the state oversight commission. He and John Walsh, Gov. Rick Snyder’s Director of Strategy, told lawmakers on the House committee that the city’s “grand bargain” agreement to devote hundreds of millions of dollars in state and private philanthropy aid, in part to alleviate some pension cuts to city retirees, has helped with trimming unemployment, slowed population losses, and encouraged development projects. Mr. Walsh, a former state representative from Livonia who played a key role in securing the $195 million in state aid for Detroit, said the city is “well managed,” noting: “It wasn’t just broke. It was broken.” Now, Mr. Walsh said the city is on its way to better times. As evidence of the city’s recovery, Mayor Duggan stressed to lawmakers that thousands of street lights have been installed, blighted houses have been demolished, emergency response times have improved, and buildings revitalized. Nevertheless, the Mayor continued his lobbying of lawmakers to address high auto insurance costs, warning: “If you can’t afford the car insurance, you either drive to work illegally or you lose your job…People are being ripped off,” he said, because of rising health care costs associated with auto insurance—which, he warned, hikes overall rates. Mr. Walsh testified that the economic health of Metro Detroit affects the entire state, because it accounts for 44 percent of Michigan’s total sales and income tax revenue. “All in all, I think it was a very successful effort. There are plenty of challenges ahead to be sure.” Mayor Duggan made the comments just a day after the filing deadline for the mayoral election—an election for which an even dozen challengers have already submitted petitions, while the only other certified candidate on the ballot than the incumbent is Michigan State Senator Coleman Young II, the son of the city’s first black mayor.

As evidence of the city’s recovery, Mayor Duggan noted that Detroit’s ambulance response time dipped below the national average last week for the first time in at least a decade, as he was speaking before a House committee in Lansing with regard to the critical “Grand Bargain” which marked the keystone to the city’s gaining former U.S. Bankruptcy Judge Steven Rhodes’ approval of the city’s plan of debt adjustment to exit chapter 9 bankruptcy. Testifying that the average response time for the city’s emergency medical services was 7 minutes and 58 seconds last week, a response time besting the national EMS average, Mayor Duggan noted: “We did it in a boring way,” telling the panel his administration hired more emergency medical technicians and improved maintenance to make sure ambulances work properly. He did not remind them that at no point during the city’s largest in American history chapter 9 bankruptcy had there been any disruption in 9-1-1 service, but did testify that average EMS response times in Detroit were close to 20 minutes for life-threatening calls subsequently, when he first took office in 2014—a time when the city had six EMS rigs, compared to the 37 which are in service during peak times today. The Mayor added the city is on track to deliver its third balanced budget this June, setting the stage for an exit in early 2018 from state oversight under the Detroit Financial Review Commission—which was adopted to monitor the city’s post-bankruptcy finances. The commission would not dissolve, however, and it could resume oversight in the event the city’s finances worsen.

What Lessons Can State & Local Leaders Learn from Unique Fiscal Challenges?

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eBlog, 04/25/17

Good Morning! In this a.m.’s eBlog, we consider the unique fiscal challenges in Michigan and how the upswing in the state’s economy is—or, in this case, maybe—is not helping the fiscal recovery of the state’s municipalities. Then we remain in Michigan—but straddle to Virginia, to consider state leadership efforts in each state to rethink state roles in dealing with severe fiscal municipal distress. Finally, we zoom to Chicago to glean what wisdom we can from the Godfather of modern municipal bankruptcy, Jim Spiotto: What lessons might be valuable to the nation’s state and local leaders?  

Fiscal & Physical Municipal Balancing I. Nearly a decade after the upswing in Michigan’s economic recovery, the state’s fiscal outlook appears insufficient to help the state’s municipalities weather the next such recession. Notwithstanding continued job growth and record auto sales, Michigan’s per-capita personal income lags the national average; assessed property values are below peak levels in 85% of the state’s municipalities; and state aid is only 80% of what it was 15 years ago.  Thus, interestingly, state business leaders, represented by the Business Leaders for Michigan, a group composed of executives of Michigan’s largest corporations universities, is pressing the Michigan Legislature to assume greater responsibility to address growing public pension liabilities—an issue which municipal leaders in the state fear extend well beyond legacy costs, but also where fiscal stability has been hampered by cuts in state revenue sharing and tax limitations. Michigan’s $10 billion general fund is roughly comparable to what it was nearly two decades ago—notwithstanding the state’s experience in the Great Recession—much less the nation’s largest ever municipal bankruptcy in Detroit, or the ongoing issues in Flint. Moreover, with personal income growth between 2000 and 2013 growing less than half the national average (in the state, the gain was only 31.1%, compared to 66.1% nationally), and now, with public pension obligations outstripping growth in personal income and property values, Michigan’s taxpayers and corporations—and the state’s municipalities—confront hard choices with regard to “legacy costs” for municipal pensions and post-retirement health care obligations—debts which today are consuming nearly 20 percent of some city, township, and school budgets—even as the state’s revenue sharing program has dropped nearly 25 percent for fiscally-stressed municipalities such as Saginaw, Flint, and Detroit just since 2007—rendering the state the only state to realize negative growth rates (8.5%) in municipal revenue in the 2002-2012 decade, according to numbers compiled by the Michigan Municipal League—a decade in which revenue for the state’s cities and towns from state sources realized the sharpest decline of any state in the nation: 56%, a drop so steep that, as the Michigan Municipal League’s COO Tony Minghine put it: “Our system is just broken…We’re not equipped to deal with another recession. If we were to go into another recession right now, we’d see widespread communities failing.” Unsurprisingly, one of the biggest fears is that another wave of chapter 9 filings could trigger the appointment of the state’s ill-fated emergency manager appointments. From the Michigan Municipal League’s perspective, any fiscal resolution would require the state to address what appears to be a faltering revenue base: Michigan’s taxable property is appreciating too slowly to support the cost of government (between 2007 and 2013, the taxable value of property declined by 8 percent in Grand Rapids, 12% in Detroit, 25% in Livonia, 32% in Warren, 22% in Wayne County values, and 24% in Oakland County.) The fiscal threat, as the former U.S. Comptroller General of the General Accounting Office warned: “Most of these numbers will get worse with the mere passage of time.”

Fiscal & Physical Municipal Balancing II. Mayhap Michigan and Virginia state and local leaders need to talk:  Thinking fiscally about a state’s municipal fiscal challenges—and lessons learned—might be underway in Virginia, where, after the state did not move ahead on such an initiative last year, the new state budget has revived the focus on fiscal stress in Virginia cities and counties, with the revived fiscal focus appearing to have been triggered by the ongoing fiscal collapse of one of the state’s oldest cities, Petersburg. Thus, Sen. Emmett Hanger (R-Augusta County), a former Commissioner of the Revenue and member of the state’s House of Delegates, who, today, serves as Senate Finance Co-Chair, and Chair of the Health and Human Services Finance subcommittee, has filed a bill, SJ 278, to study the fiscal stress of local governments: his proposal would create a joint subcommittee to review local and state tax systems, as well as reforms to promote economic assistance and cooperation between regions. Although the legislation was rejected in the Virginia House Finance Committee, where members deferred consideration of tax reform for next year’s longer session, the state’s adopted budget does include two fiscal stress preventive measures originally incorporated in Senator Hanger’s proposed legislation—or, as co-sponsor Sen. Rosalyn Dance (D-Petersburg), noted: “Currently, there is no statutory authority for the Commission on Local Government to intervene in a fiscally stressed locality, and the state does not currently have any authority to assist a locality financially.” To enhance the state’s authority to intervene fiscally, the budget has set guidelines for state officials to identify and help alleviate signs of financial stress to prevent a more severe crisis. Thus, a workgroup, established by the auditor of public accounts, would determine an appropriate fiscal early warning system to identify fiscal stress: the proposed system would consider such criteria as a local government’s expenditure reports and budget information. Local governments which demonstrate fiscal distress would thence be notified and could request a comprehensive review of their finances by the state. After a fiscal review, the commonwealth would then be charged with drafting an “action plan,” which would provide the purpose, duration, and anticipated resources required for such state intervention. The bill would also give the Governor the option to channel up to $500,000 from the general fund toward relief efforts for the fiscally stressed local government.

Virginia’s new budget also provides for the creation of a Joint Subcommittee on Local Government Fiscal Stress, with members drawn from the Senate Finance Committee, the House Appropriations, and the House Finance committees—with the newly created subcommittee charged to study local and state financial practices, such as: regional cooperation and service consolidation, taxing authority, local responsibilities in state programs, and root causes of fiscal stress. Committee member Del. Lashrecse Aird (D-Petersburg) notes: “It is important to have someone who can speak to first-hand experience dealing with issues of local government fiscal stress…This insight will be essential in forming effective solutions that will be sustainable long-term…Prior to now, Virginia had no mechanism to track, measure, or address fiscal stress in localities…Petersburg’s situation is not unique, and it is encouraging that proactive measures are now being taken to guard against future issues. This is essential to ensuring that Virginia’s economy remains strong and that all communities can share in our Commonwealth’s success.”

Municipal Bankruptcy—or Opportunity? The Chicago Civic Federation last week co-hosted a conference, “Chicago’s Fiscal Future: Growth or Insolvency?” with the Federal Reserve Bank of Chicago, where experts, practitioners, and academics from around the nation met to consider best and worst case scenarios for the Windy City’s fiscal future, including lessons learned from recent chapter 9 municipal bankruptcies. Chicago Fed Vice President William Testa opened up by presenting an alternative method of assessing whether a municipality city is currently insolvent or might become so in the future: he proposed that considering real property in a city might offer both an indicator of the resources available to its governments and how property owners view the prospects of the city, adding that, in addition to traditional financial indicators, property values can be used as a powerful—but not perfect—indicators to reflect a municipality’s current situation and the likelihood for insolvency in the future. He noted that there is considerable evidence that fiscal liabilities of a municipality are capitalized into the value of its properties, and that, if a municipality has high liabilities, those are reflected in an adjustment down in the value of its real estate. Based upon examination, he noted using the examples of Chicago, Milwaukee, and Detroit; Detroit’s property market collapse coincided with its political and economic crises: between 2006 and 2009-2010, the selling price of single family homes in Detroit fell by four-fold; during those years and up to the present, the majority of transactions were done with cash, rather than traditional mortgages, indicating, he said, that the property market is severely distressed. In contrast, he noted, property values in Chicago have seen rebounds in both residential and commercial properties; in Milwaukee, he noted there is less property value, but higher municipal bond ratings, due, he noted, to the state’s reputation for fiscal conservatism and very low unfunded public pension liabilities—on a per capita basis, Chicago’s real estate value compares favorably to other big cities: it lags Los Angeles and New York City, but is ahead of Houston (unsurprisingly given that oil city’s severe pension fiscal crisis) and Phoenix. Nevertheless, he concluded, he believes comparisons between Chicago and Detroit are overblown; the property value indicator shows that property owners in Chicago see value despite the city’s fiscal instability. Therefore, adding the property value indicator could provide additional context to otherwise misleading rankings and ratings that underestimate Chicago’s economic strength.

Lessons Learned from Recent Municipal Bankruptcies. The Chicago Fed conference than convened a session featuring our former State & Local Leader of the Week, Jim Spiotto, a veteran of our more than decade-long efforts to gain former President Ronald Reagan’s signature on PL 100-597 to reform the nation’s municipal bankruptcy laws, who discussed finding from his new, prodigious primer on chapter 9 municipal bankruptcy. Mr. Spiotto advised that chapter 9 municipal bankruptcy is expensive, uncertain, and exceptionally rare—adding it is restrictive in that only debt can be adjusted in the process, because U.S. bankruptcy courts do not have the jurisdiction to alter services. Noting that only a minority of states even authorize local governments to file for federal bankruptcy protection, he noted there is no involuntary process whereby a municipality can be pushed into bankruptcy by its creditors—making it profoundly distinct from Chapter 11 corporate bankruptcy, adding that municipal bankruptcy is solely voluntary on the part of the government. Moreover, he said that, in his prodigious labor over decades, he has found that the large municipal governments which have filed for chapter 9 bankruptcy, each has its own fiscal tale, but, as a rule, these filings have generally involved service level insolvency, revenue insolvency, or economic insolvency—adding that if a school system, county, or city does not have these extraordinary fiscal challenges, municipal bankruptcy is probably not the right option. In contrast, he noted, however, if a municipality elects to file for bankruptcy, it would be wise to develop a comprehensive, long-term recovery plan as part of its plan of debt adjustment.

He was followed by Professor Eric Scorsone, Senior Deputy State Treasurer in the Michigan Department of Treasury, who spoke of the fall and rise of Detroit, focusing on the Motor City’s recovery—who noted that by the time Gov. Rick Snyder appointed Emergency Manager Kevyn Orr, Detroit was arguably insolvent by all of the measures Mr. Spiotto had described, noting that it took the chapter 9 bankruptcy process and mediation to bring all of the city’s communities together to develop the “Grand Bargain” involving a federal judge, U.S. Bankruptcy Judge Steven Rhodes, the Kellogg Foundation, and the Detroit Institute of Arts (a bargain outlined on the napkin of a U.S. District Court Judge, no less) which allowed Detroit to complete and approved plan of debt adjustment and exit municipal bankruptcy. He added that said plan, thus, mandated the philanthropic community, the State of Michigan, and the City of Detroit to put up funding to offset significant proposed public pension cuts. The outcome of this plan of adjustment and its requisite flexibility and comprehensive nature, have proven durable: Prof. Scorsone said the City of Detroit’s finances have significantly improved, and the city is on track to have its oversight board, the Financial Review Commission (FRC) become dormant in 2018—adding that Detroit’s economic recovery since chapter 9 bankruptcy has been extraordinary: much better than could have been imagined five years ago. The city sports a budget surplus, basic services are being provided again, and people and businesses are returning to Detroit.

Harrison J. Goldin, the founder of Goldin Associates, focused his remarks on the near-bankruptcy of New York City in the 1970s, which he said is a unique case, but one with good lessons for other municipal and state leaders (Mr. Goldin was CFO of New York City when it teetered on the edge of bankruptcy). He described Gotham’s disarray in managing and tracking its finances and expenditures prior to his appointment as CFO, noting that the fiscal and financial crisis forced New York City to live within its means and become more transparent in its budgeting. At the same time, he noted, the fiscal crisis also forced difficult cuts to services: the city had to close municipal hospitals, reduce pensions, and close firehouses—even as it increased fees, such as requiring tuition at the previously free City University of New York system and raising bus and subway fares. Nevertheless, he noted: there was an upside: a stable financial environment paved the way for the city to prosper. Thus, he advised, the lesson of all of the municipal bankruptcies and near-bankruptcies he has consulted on is that a coalition of public officials, unions, and civic leaders must come together to implement the four steps necessary for financial recovery: “first, documenting definitively the magnitude of the problem; second, developing a credible multi-year remediation plan; third, formulating credible independent mechanisms for monitoring compliance; and finally, establishing service priorities around which consensus can coalesce.”

The Key Lessons Learned after a Decade of Municipal Bankruptcies

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eBlog, 04/07/17

Good Morning! In this a.m.’s eBlog, we consider Detroit’s first steps to address the blight which crisscrossed the city leading to its municipal bankruptcy. Then we look to New Hampshire to assess whether the state legislature will preempt municipalities’ authority to set election dates. Then we slip south to assess fiscal developments in the efforts to recover from insolvency in Puerto Rico. Finally, we assess and consider some of the broader issues related to municipal bankruptcy.

Post Chapter 9 Recovery. One of Detroit’s first tests with regard to whether it can find new use for the vast stretches of land it cleared of blight went into effect this week when development teams announced by  Mayor Mike Duggan, along with partners: The Platform, a Detroit-based firm, and Century Partners announced they would be investing an estimated $100 million to rehab the architectural jewels in the city’s downtown—the Fisher and Albert Kahn buildings, with the two organizations declaring they will take the lead in overhauling 373 parcels of vacant land and houses in the Fitzgerald neighborhood on the northwest side, where they will coordinate with other firms on a $4 million development plan to rehab 115 vacant homes over two years, create a two-acre park, and landscape 192 vacant lots—with the work occurring in neighborhoods wherein the Detroit Land Bank took control of most of the properties and razed some abandoned homes. Mayor Duggan and other officials described the plan as a kind of reverse gentrification—or, as Mayor Duggan framed it: “We are going to keep the families here while improving the neighborhoods,” making his announcement on an empty lot which is scheduled to become a city park and include a greenway path to nearby Marygrove College: the city leaders hope to transform the neighborhood into a “Blight-Free Quarter Square Mile,” and, if the model works, seek to propagate it other neighborhoods.

Granite State Preemption or Cure? House Speaker Shawn Jasper wants to give New Hampshire towns that postponed their municipal elections due to a snowstorm a way out of facing potential lawsuits from voters who may have been disenfranchised. Speaker Jasper had proposed letting towns ratify the results of their elections by holding another vote, offering a bill to give towns which moved Election Day the option of letting townspeople vote to ratify, or confirm, the results on May 23rd. However, in the wake of about five hours of testimony, the House Election Law Committee voted 10-10 on the Jasper plan, so that a tie vote killed the Speaker’s amendment, leaving 73 towns on their own to address potential legal problems resulting from their decisions to hold their elections on days other than March 14th. The fiscal blizzard in the Granite State now depends upon whether state legislators determine whether or not a special election is needed with regard to those results. New Hampshire Deputy Secretary of State David Scanlan noted: “The concept is not entirely new…what is different is that it is applying to an entire class of towns that decided to postpone.”

In the past, the Legislature has voted to “cure” individual election defects. Speaker of the House Shawn Jasper, (R-Hudson, N.H.) noted: “Well, the fact that a bunch of towns moved the day of their town election was unprecedented…And so as a result of doing that, those towns that moved had to start bending other laws to make other issues related to the election work…The Legislature is just granting the authority to allow the towns to correct any defects that may exist,” he added, listing changed time listings, lack of proper notice, and absentee ballot date issues as possible defects in the process. All of those questions, of course, have fiscal consequences—or, as Atkinson Town Administrator Alan Phair put it; “Well, I don’t know the exact cost, what it would be, but I do know that in our case we certainly don’t have the money budgeted to (hold a special election), because we obviously just budgeted for one election…We would certainly go considerably over and have to find the money elsewhere to do it.” Under the proposed amendment, towns and school districts which postponed would hold a hearing, at which the respective governing body would vote on whether to hold a special election with one question: whether or not to ratify results, where a “no” vote would kick out anyone elected in a postponed vote, while nullifying warrant articles, with elected roles to be appointed until the next election. Salem Town Manager (Salem is a town of just under 30,000 in Rockingham County) Leon Goodwin said his elected leaders were of the opinion that its postponement was legal, so that the municipality is moving forward on projects voted on last month, noting: We’re moving on as if the votes were accepted even though there is a cloud hanging over us from Concord,” adding that town counsel advised the town moderator that it was legal to move elections. Yet, even as he remained confident the election issue will be resolved, he cautioned that the town has not budgeted for an additional election; Windham (approximately 14,000) Town Manager David Sullivan said the municipality’s town Counsel would sign off on the town’s fire truck bond, notwithstanding bond counsel elsewhere in the state advising that ratification of the elections would be necessary.

Municipal authority to act has been hampered by different state House and Senate approaches: while the two bodies have been moving on parallel tracks in the wake of state officials’ questioning the authority of town moderators to reschedule the March 14 voting sessions of their town meetings, the Senate this week passed SB 248, a bill introduced to ratify actions taken at the rescheduled meetings; however, the bill passed with a committee amendment which deletes all of the original language and provides instead for the creation of a committee to “study the rescheduling of elections.” Senators acknowledged that the bill was not likely to pass through the House in that form—asserting the intent was simply to get a bill to the House for further work. Subsequently, a floor amendment was introduced to restore the bill’s original language, ratifying all actions taken at the rescheduled meetings; however, that amendment failed on a party-line vote, with all nine Democrats voting in favor and all fourteen Republicans voting against, leaving most unclear how this could have become a partisan issue. The question comes down to what level of control local officials should have over local elections. The Speaker described the outcome thusly: “I think it was a case of 10 people (on the committee) thinking that what happened was legal;” however, he maintained that the postponed votes were not legal, adding: “The sad thing is that for school districts with bond issues that passed in those meetings, I don’t see a path forward for them,” adding: “I think if you’re afraid of snowstorms, you ought to move your meetings, probably to May,” noting that state officials are forbidden by law from moving state primary and general elections, as well as the first-in-the-nation presidential primary. Unsurprisingly, town moderators and attorneys who work with them on municipal bond issues disagreed with the Speaker’s interpretation that the postponed elections were illegal and his belief that the only way to rectify the issue was for them to act to individually ratify them, with many arguing they acted legally under a state law which allows them to postpone and reschedule the “deliberative session or voting day” of a town meeting to another day; however, the Speaker maintains that law applies only to town meetings, while town elections are governed under a different statute, which provides: “All towns shall hold an election annually for the election of town officers on the second Tuesday in March.” He also noted that the state’s official political calendar, which has the force of law, states that town elections must be held on March 14, adding: “Without trying to place blame, laws are sometimes very confusing if you look only at parts of them,” noting: “I don’t believe for one second that moving the election was legal.”

The Speaker added that still another state law provides that at special town meetings, no money may be raised or appropriated unless the number of ballots cast at the meeting is at least half the number of those on the checklist who were eligible to vote in the most recent town meeting, albeit adding that such meetings do not apply to the current situation, because they are not elections. The state’s Secretary of State said that after three weeks of research, he was able to report on voter turnout at town elections for the past 11 years, advising that 210 towns held elections in March, and 137 of them “followed the law” by holding their elections on March 14th, while 73 towns had postponed their elections by several days. Now Speaker Jasper asks: “Why would we give over 300 individual moderators the ability to do that when our Secretary of State doesn’t have the ability to do that for a snowstorm in our general election or our presidential primary?” The Speaker notes: “I think we need to provide a way to ensure that we don’t clog up the courts, and we don’t have people spend a lot of their own money to fight this, and the towns don’t have to spend a lot of money fighting it.”

Un-positive Credit Rating for Puerto Rico. Moody’s Investors Service has lowered the credit ratings on debt of the Government Development Bank and five other Puerto Rico issuers, with a total of approximately $13 billion outstanding, and revised down the Commonwealth’s fiscal outlook, and the outlooks for seven affiliated obligors linked to the central government to negative from developing, with the downgrades reflecting what the agency described as “persistent pressures on Puerto Rico’s economic base that indicate a diminishing perceived capacity to repay,” noting that while it continues to “believe that essentially all of Puerto Rico’s debt will be subject to default and loss in a broad restructuring, the securities being downgraded face more severe losses than we had previously expected, in the light of Puerto Rico’s projected economic pressures. For this reason, we downgraded to C from Ca not only the senior notes issued by the now defunct Government Development Bank, but also bonds issued by the Puerto Rico Infrastructure Financing Authority and backed by federal rum tax transfer payments, the Convention Center District Authority’s hotel occupancy tax-backed bonds, the Employees Retirement System’s bonds backed by government pension contributions, and the 1998 Resolution bonds of the Puerto Rico Highways and Transportation Authority.”

Puerto Rico Governor Rossello late Wednesday said that the U.S. territory’s fiscal plan, approved by the PROMESA Board, does not contemplate any double taxation, adding that, between the increase in the property tax and the reduction of expenses in the municipalities, he favored the latter as a measure to compensate for the absence of the state subsidy of $350 million. He reiterated that, as a substitute for these funds, the properties which are not currently paying taxes to the Centro de Recaution de Ingresos Municipales (CRIM: the Municipal Revenue Collection Center) should be identified, because they are not included in their registry. The Governor also stressed that the economic outcome of these two fiscal initiatives is still being evaluated, albeit he estimated that they could generate about $100 million, noting: “Whatever the differential after that for the municipalities, there are two mechanisms that can be worked: One, a mechanism to seek an additional source of income, or, two, to avail cuts…The central government has taken the cutting position. We are already establishing a protocol to cut in the agencies, to consolidate, to eliminate the expenses that are not necessary, to go from 131 to between 35 to 40 agencies. That has been our action. The municipalities—now we will have a conversation with our technical team—will have several options: ‘either cut as did the central government or seek mechanisms to raise more funds or impose taxes.’” Currently, mayors evaluate to increase the arbitrage of the real property to 11.83% or to 12.83% in all the municipalities; the concept is for members of the Executive to offer assistance to do the modeling. Thus, the president of the board of CRIM, Cidra Mayor Javier Carrasquillo, said CRIM will be “sensitive to the reality of the pockets of Puerto Ricans: We have to be cautious and responsible in the recommendation that we are going to make…There is nothing definitive yet. There are recommendations.” The Governor noted that the PROMESA Board approved fiscal plan approved last month does not contemplate an increase in property taxation, asserting it was “false to imply that our fiscal plan entails an increase in the rate or a double rate on properties,” albeit recalling that the disappearance of $350 million in transfers to municipalities begins on July 1, when the fiscal year begins, promising it will be done progressively, so that in the next budget (2017-2018) $175 million disappear, and the remaining $175 million, the next fiscal year, describing it as a “two-year fade out.” Unsurprisingly, he did not specify when or how the plan would fiscally benefit this island’s municipalities, stating: “We have already been able to have pilot efforts to identify different municipalities where 60% of their properties are not being assessed…We are going to commit ourselves so that all these properties are in the system.”

The End of a Chapter 9 Era? Municipal bankruptcy is a rarity: even notwithstanding the Great Recession which produced a significant number of corporate bankruptcies—and federal bailouts to large for-profit corporations and quasi-federal corporations, such as Fannie Mae; the federal government offered no bailouts to cities or counties. Yet from one of the nation’s smallest cities, Central Falls, to major, iconic cities such as Detroit and Jefferson County, the nation experienced a just-ended spate, before—with San Bernardino’s exit last month, the likely closure of an era—even as we await some resolution of the request by East Cleveland to file for chapter 9 municipal bankruptcy. The lessons learned, compiled by the nation’s leading light of municipal bankruptcy, therefore bear consideration. Jim Spiotto, with whom I had the honor and good fortune over nearly a decade of effort leading to former President Reagan’s signing into law of the municipal bankruptcy amendments of 1988, offers us a critical guide of ten lessons learned:

  1. Do not defer funding of essential services and infrastructure: Detroit is a wake- up call for others that there is never a good reason to defer funding of essential services and infrastructure at an acceptable level. If you do, Detroit’s fate will be yours.
  2. Labor and pension contracts under state constitutional and statutory provisions should not be interpreted as a mutual suicide pact: It appears one of the reasons why resolution of pension and labor costs was not achieved in Detroit prior to filing Chapter 9 was the belief of the workers and retirees that, under the Michigan constitution, those contractual rights could not be impaired or diminished to any degree. This position failed to take into consideration that the municipality can only pay that which it has revenues to pay and, in an eroding declining financial situation, there will never be sufficient funds to pay all obligations, especially those that may be unaffordable and unsustainable.
  3. Don’t question that which should be beyond questioning and is needed for the long-term financial survival of the municipality: A dedicated source of payment, statutory lien or special revenues established under state law must be honored and should not be contested. Capital markets work effectively when credibility and predictability of outcome are clear and unquestioned. Current effort to pass new legislation (California SB222 and Michigan HB5650) to grant statutory first lien on dedicated revenues. Further, as noted in the Senate Report for the 1988 Amendments to the Bankruptcy Code and Chapter 9 “Section 904 [of Chapter 9 limiting the jurisdiction and power of the Bankruptcy Court] and the tenth amendment prohibits the interpretation that pledges of revenues granted pursuant to state statutory or constitutional provisions to bondholders can be terminated by filing a Chapter 9 proceeding”. This follows the precedent from the 1975 financial distress of New York City and the State of New York’s highest court ruling the state imposed moratorium was unconstitutional given the constitutional mandate to pay available revenues to the general obligation bondholders. See Flushing Nat. Bank et. al. v. Mun. Assistance Corp. of New York, 40 N.Y.S.2nd 731, 737-738 (N.Y. 1976). Just as statutory liens and special revenues, there is a strong argument that state statutory and constitutional mandated payments (mandated set asides, priorities, appropriations and dedicated tax revenue payments) should not and cannot be impaired, limited, modified or delayed by a Chapter 9 proceeding given the rulings of the Supreme Court in the Ashton and Bekins cases and the prohibitions of Sections 903 and 904 of Chapter 9 of the Bankruptcy Code.
  4. Debt adjustment is a process, but a recovery plan is a solution: As noted above, while Detroit has proceeded with debt adjustment which provides some additional runway so it can take takeoff in a recovery, such plan is not the cure for the systemic problem. Rather, the plan provides additional breathing room so that the municipality, through its Mayor and its elected officials, may proceed with a recovery plan, reinvest in Detroit, stimulate the economy, create new jobs, clear and develop blighted areas and raise the level of services and infrastructure to that which is acceptable and attract new business and new citizens.
  5. Successful plans of debt adjustment have one common feature: virtually all significant issues have been settled and resolved with major creditors: While the Detroit Plan started with sound and fury between the emergency manager and creditors and what they would receive, in the end, similar to what occurred in Vallejo, Jefferson County and even in Stockton (with one exception), major creditors ultimately reached agreement and supported the Plan of Debt Adjustment that allowed the municipality to move forward, confirm the Plan and begin its journey to recovery.
  6. One size does not fit all: There are many ways to draft a plan of debt adjustment and sometimes the more creative, the better. As noted above, traditionally major cities of size with significant debt did not file Chapter 9. They refinanced their debt with the backing of the state which reduced their future borrowing costs and allowed them to recover by having the liquidity and the reduced costs necessary to deal with their financial difficulties. Detroit chose a different path.
  7. A recovery plan must provide for essential services and infrastructure: “Best interest of creditors” and “feasibility” can only mean an appropriate reinvestment in the municipality through a recovery plan where there is funding of essential services and infrastructure at an acceptable level to stimulate the municipality’s economy to attract new employers and taxpayers thereby increasing tax revenues and addressing the systemic problem. While no plan of debt adjustment is perfect or assured, there should be, as the Bankruptcy Court in Detroit throughout the case pointed out, a plan to show the survivability and future success of the City.
  8. Confirmation of a plan of debt adjustment is only the beginning of the journey to financial recovery, not the end: It is important to recognize, as noted above, that Chapter 9 is a process, not a solution. The recovery plan, which will take dedication and effort by the elected officials of the City along with residents, public workers and other creditors is the only way to achieve success. It is measured not by months, but by years, and by the constant vigilance to ensure that the systemic problem is addressed effectively in a permanent fix.

Addressing Municipal Fiscal Distress

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eBlog, 04/05/17

Good Morning! In this a.m.’s eBlog, we consider some unique efforts to address municipal fiscal distress by the Illinois Legislature, based upon tag team efforts by the irrepressible fiscal tag team of Jim Spiotto and Laurence Msall of the Chicago Civic Federation. The effort matters, especially as the Volker Alliance’s William Glasgall, its Director of State and Local Programs, has raised issues and questions vis-à-vis state roles relating to addressing severe municipal fiscal distress. As we have noted—with only a minority of states even authorizing municipal bankruptcy, there are significant differences in state roles relating to severe municipal fiscal distress and insolvency. Thus, this Illinois initiative could offer a new way to think about state constructive roles. Then we turn to Ferguson, Missouri to assess its municipal election results—and its remarkable, gritty fiscal recovery from the brink of insolvency.

Addressing Municipal Fiscal Distress. The Illinois Legislature is considering House Bill 2575, the Illinois Local Government Protection Authority Act, offered by Rep. David Harris (R-Arlington Heights), which would establish an Authority for the purpose of achieving solutions to financial difficulties faced by units of local government, creating a board of trustees, and defining the Authority’s duties and powers, including the ability to obtain the unit of local government’s records—and to recommend revenue increases. The legislation provides for a petition process, whereby certain entities may petition the Authority to review a unit of local government; it also sets forth participation requirements. The effort comes in the wake of distressed local governments struggling under the weight of pension, healthcare, and other debts: it would propose this new, special authority for fiscal guidance to fiscally strapped local units of government, but without mandating severe budget cuts—or, as Rep. Harris described it: a “cooperative effort between the state and financially unit of local government…(one which) involves local elected officials and local governmental bodies and taxpayers, workers, and business entities developing a plan of financial recovery — is the best way to find a permanent solution to current financial challenges.” According to the Chicago Civic Federation, which asserts the intent is to help the state’s municipalities recover without being forced into chapter 9 municipal bankruptcy, such an authority could be valuable—especially in a state which, like the majority of states, does not generally permit a city, county, or other municipal entity to file for bankruptcy. Under the proposal, nine trustees would oversee the new authority, including four appointed by the Illinois Municipal League; the Governor, Speaker of the House, and Minority Leader, and their state Senate counterparts would each appoint one member: the new authority would rely on the Illinois Comptroller’s office to provide reports and some operational support; the legislation would also set a fee schedule to enable coverage of its administrative costs.

The exceptional leader of the Federation, Laurence Msall, noted: “The LGPA would serve as a resource to assist distressed municipalities in making determinations as to what essential governmental services are sustainable and affordable and what combination of revenue increases and service cuts, and other actions would be necessary to ensure fiscal sustainability and access to critical services.” Under the proposed legislation, a municipality could petition the authority to intervene; but also, the Illinois Comptroller, a public pension fund, or even a large creditor owed a substantial debt could. The proposal would authorize a municipality to petition too—provided it committed to participate—and provided it met specific criteria, including inadequate liquidity, overdue debt, weak pension funding ratios, or signal budget imbalances. If triggered, the suggested new authority would be authorized to recommend budget cuts, tax increases, and/or pension funding actions: as proposed, the authority would be charged with reviewing whether the city, county, or other unit of government should:

  • try to negotiate a debt restructuring,
  • explore public-private partnerships, or
  • asset sales and consolidation.

The authority would be authorized to consider potential pension reforms, such as whether the municipality should offer more corporate-style retirement plans, as well as whether it should establish a trust to fund its OPEB post-retirement healthcare obligations.

The proposed legislation authorizes authority to set fiscal targets; it offers the option for the proposed new authority to serve as a mediator in negotiations between a municipality and debtors, to endorse tax increases—increases which might trigger a public referendum, and issue recommendations to the Illinois state government with regard to the diversion of funds to address specific municipal funding mandates—granting authority too to seek declaratory and injunctive relief with regard to the exercise of its powers and implementation of its findings and recommendations. Finally, as a last resort, the authority could recommend pursuit of chapter 9 municipal bankruptcy. The nation’s architect of the federal municipal chapter 9 municipal bankruptcy law, Jim Spiotto, notes: “This municipal protection authority concept could be the means of providing state and local government cooperation and oversight while allowing the municipality, its elected officials, workers and unions, creditors and bondholders to have a means of participation with a definitive end result.” For his part, Mr. Msall described the rationale as vital to establishing “a systematic means of evaluating and assisting these governments,” instead of taking on municipal fiscal distress on a case-by-case effort, noting that “The Civic Federation is very concerned about the financial condition of many local governments in the state of Illinois, and many of them which will not be able to seek assistance unless there is the creation of this authority.”

& The Winner is: Ferguson, Missouri voters have reelected incumbent Mayor James Knowles III to a third term in the municipality’s first mayoral election since protests erupted there three years ago in the wake of one of the city’s white police officer’s shooting of an unarmed black 18-year-old—a shooting which ignited a national protest and led to a federal Justice Department intervention and harsh fiscal penalties for the nearly insolvent municipality. Mayor Knowles won by a 56%–44% margin against Councilwoman Ella Jones, who is black, in a small municipality which was once an overwhelmingly white “sundown town” where, until the 1960s, African-Americans were banned after dark. Perhaps ironically, the Mayor’s reelection followed just one day in the wake of U.S. Attorney General Gen. Jeff Sessions’ order that the U.S. Justice Department review its existing consent decrees with municipal police departments—the agreement in Ferguson, imposed under the Obama administration, imposed unfunded federal mandates, including demands to levy new taxes. In its report, the Obama Justice Department had alleged that the Ferguson Police Department and the City of Ferguson relied on unconstitutional practices in order to balance the city’s budget through racially motivated excessive fines and punishments, so that former U.S. Attorney General Eric Holder stated the federal government would use its authority to dismantle the Ferguson Police Department—a threat, which at the time, Ferguson’s then-Mayor had warned could mark the first time in the nation’s history that the federal government might force a municipality into municipal bankruptcy, and led credit rating agency Moody’s to place the municipality’s municipal bond rating on review for downgrade because of threats to the city’s solvency—with the downgrade of the city’s general obligation rating reflecting what the credit rating agency described as “the continued pressure on the city’s finances from a persistent structural imbalance and incorporating the recently approved U.S. Department of Justice (DOJ) consent decree, projected to increase annual General Fund expenses over the next several years,” in the wake of Moody’s assessment after the U.S. Justice Department lawsuit against the small city, noting its downgrade then had reflected concerns related to the uncertainty of the potential financial impact of litigation costs from the federal lawsuit and the price tag for implementing the proposed DOJ consent decree, writing: “We believe fiscal ramifications from these items will be significant and could result in insolvency.”

Indeed, the Justice Department’s unfunded federal mandates included federally imposed financial penalties, and the mandate to levy new, municipal taxes: leading to voter approval of a utility tax hike projected to generate $700,000 annually—an increase which Mayor Knowles, at the time, described as a critical vote, because, had the measure failed, the city’s police force’s authorized number would have been cut to 44, and firefighter jobs would also have been cut; he had warned, in addition, that the vote was intended to make clear the city was fiscally viable. So, today, in the wake of resignations and elections, Ferguson features three black council members, a black police chief, and a black city manager—and, in the interim, Mayor Knowles has survived a recall attempt (in 2015), noting in a Facebook post during the campaign that he wanted to follow the example set by former President Abraham Lincoln: “For those familiar with history, during the Civil War, Lincoln was often criticized by people on both sides of the issues of slavery and the war because of his even-handedness and his resistance to the pressures of radicals on both sides. He knew radicalism, even after the war, would further divide us, which it has for generations.”

Mayor Knowles’ challenger, Councilmember Jones, ran, because, she said, it was “time for Ferguson to unite and become one Ferguson, and we cannot move forward under the leadership that we are under at this point,” harshly criticizing the U.S. Attorney General’s move to review the city’s consent decree—one which Mr. Sessions had previously claimed was based on a report that was “anecdotal” and “not so scientifically based,” with Councilmember Jones warning that the Attorney General’s action was “not going to help Ferguson at all,” adding: “We need that consent decree in order to keep Ferguson moving forward.” Nevertheless, the gritty, can-do leadership of the city’s elected officials appears to have defied the odds: City Manager De’Carlon Seewood recently wrote that in the wake of a “drastic decline” in revenue, “the city’s operating budget is beyond lean. It’s emaciated.”

 

Fiscal & Public Service Insolvency

eBlog, 03/03/17

Good Morning! In this a.m.’s eBlog, we consider the ongoing challenges for the historic municipality of Petersburg, Virginia as it seeks to depart from insolvency; we consider, anew, the issues related to “service insolvency,” especially assisted by the exceptional insights of Marc Pfeiffer at Rutgers, then turning to the new fiscal plan by the Puerto Rico Fiscal Agency and Financial Advisory Authority, before racing back to Virginia for a swing on insolvent links. For readers who missed it, we commend the eBlog earlier this week in which we admired the recent wisdom on fiscal disparities by the ever remarkable Bo Zhao of the Federal Reserve Bank of Boston with regard to municipal fiscal disparities.

Selling One’s City. Petersburg, Virginia, the small, historic, and basically insolvent municipality under quasi state control is now trying to get hundreds of properties owned by the city off the books and back on the tax rolls as part of its effort to help resolve its fiscal and trust insolvency. As Michelle Peters, Economic Development Director for Petersburg, notes: “The city owns over 200 properties, but today we had a showcase to feature about 25 properties that we group together based on location, and these properties are already zoned appropriate for commercial development.” Thus the municipality is not only looking to raise revenues from the sale, but also to realize revenues through the conversion of these empty properties into thriving businesses—or as Ms. Peters puts it: “It’s to get the properties back on the tax rolls for the city, because, currently, the city owns them so they are just vacant, there are no taxes being collected,” much less jobs being filled. Ms. Peters notes that while some of the buildings do need work, like an old hotel on Tabb Street, the city stands ready to offer a great deal on great property, and it is ready to make a deal and has incentives to offer:  “We’re ready to sit down at the table and to negotiate, strike a deal and get those properties developed.”

New Jersey & Its Taken-over City. The $72 million tax settlement between Borgata Hotel Casino & Spa and Atlantic City’s state overseers is a “major step forward” in fixing the city’s finances, according to Moody’s Investors Service, which deemed the arrangement as one that has cleared “one of the biggest outstanding items of concern” in the municipality burdened by hundreds of millions of dollars in debt and under state control. Atlantic City owed Borgata $165 million in tax refunds after years of successful tax appeals by the casino, according to the state. The settlement is projected to save the city $93 million in potential debt—savings which amount to a 22 percent reduction of the city’s $424 million total debt, according to Moody’s, albeit, as Moody’s noted: “[W]hile it does not solve the city’s problems, the settlement makes addressing those problems considerably more likely.” The city will bond for the $72 million through New Jersey’s state Municipal Qualified Bond Act, making it a double whammy: because the bonds will be issued via the state MQBA, they will carry an A3 rating, ergo at a much better rate than under the city’s Caa3 junk bond status. Nevertheless, according to the characteristically moody Moody’s, Atlantic City’s finances remain in a “perilous state,” with the credit rating agency citing low cash flow and an economy still heavily dependent upon gambling.

Fiscal & Public Service Insolvency. One of my most admired colleagues in the arena of municipal fiscal distress, Marc Pfeiffer, Senior Policy Fellow and Assistant Director of the Bloustein Local Government Research Center in New Jersey, notes that a new twist on the legal concept of municipal insolvency could change how some financially troubled local governments seek permission to file for federal bankruptcy protection. Writing that municipal insolvency traditionally means a city, county, or other government cannot pay its bills, and can lead in rare instances to a Chapter 9 bankruptcy filing or some other remedy authorized by the state that is not as drastic as a Chapter 9, he notes that, in recent years, the description of “insolvency” has expanded beyond a simple cash shortage to include “service-delivery insolvency,” meaning a municipality is facing a crisis in managing police, fire, ambulance, trash, sewer and other essential safety and health services, adding that service insolvency contributed to Stockton, California, and Detroit filings for Chapter 9 bankruptcy protection in 2012 and 2013, respectively: “Neither city could pay its unsustainable debts, but officials’ failure to curb violent crime, spreading blight and decaying infrastructure was even more compelling to the federal bankruptcy judges who decided that Stockton and Detroit were eligible to file for Chapter 9.”

In fact, in meeting with Kevyn Orr, the emergency manager appointed by Michigan Governor Rick Snyder, at his first meeting in Detroit, Mr. Orr recounted to me that his very first actions had been to email every employee of the city to ensure they reported to work that morning, noting the critical responsibility to ensure that street lights and traffic lights, as well as other essential public services operated. He wanted to ensure there would be no disruption of such essential services—a concern clearly shared by the eventual overseer of the city’s historic chapter 9 municipal bankruptcy, now retired U.S. Bankruptcy Judge Steven Rhodes, who, in his decision affirming the city’s plan of debt adjustment, had written: “It is the city’s service delivery insolvency that the court finds most strikingly disturbing in this case…It is inhumane and intolerable, and it must be fixed.” Similarly, his colleague, U.S. Bankruptcy Judge Christopher Klein, who presided over Stockton’s chapter 9 trial in California, had noted that without the “muscle” of municipal bankruptcy protection, “It is apparent to me the city would not be able to perform its obligations to its citizens on fundamental public safety as well as other basic public services.” Indeed, in an interview, Judge Rhodes said that while Detroit officials had provided ample evidence of cash and budget insolvency, “the concept of service delivery insolvency put a more understanding face on what otherwise was just plain numbers.” It then became clear, he said, that the only solution for Detroit—as well as any insolvent municipality—was “fresh money,” including hundreds of millions of dollars contributed by the state, city, and private foundations: “It is a rare insolvency situation—corporate or municipal—that can be fixed just by a change in management.”

Thus, Mr. Pfeiffer writes that “Demonstrating that services are dysfunctional could strengthen a local government’s ability to convince a [federal bankruptcy] judge that the city is eligible for chapter 9 municipal bankruptcy protection (provided, of course, said municipality is in one the eighteen states which authorize such filings). Or, as Genevieve Nolan, a vice president and senior analyst at Moody’s Investors Service, notes: “With their cases focusing on not just a government’s ability to pay its debts, but also an ability to provide basic services to residents, Stockton and Detroit opened a path for future municipal bankruptcies.”

Mr. Pfeiffer notes that East Cleveland, Ohio, was the first city to invoke service insolvency after Detroit. In its so far patently unsuccessful efforts to obtain authority from the State of Ohio to file for municipal bankruptcy protection—in a city, where, as we have noted on numerous occasions, the city has demonstrated a fiscal inability to sustain basic police, fire, EMS, or trash services. East Cleveland had an approved plan to balance its budget, but then-Mayor Gary Norton told the state the proposed cuts “[would] have the effect of decimating our safety forces.” Ohio state officials initially rejected the municipality’s request for permission to file for municipal bankruptcy, because the request came from the mayor instead of the city council; the city’s status has been frozen since then.

Mr. Pfeiffer then writes:

Of concern.  [Municipal] Bankruptcy was historically seen as the worst case scenario with severe penalties – in theory the threat of it would prevent local officials from doing irresponsible things. [Indeed, when I first began my redoubtable quest with the Dean of chapter 9 municipal bankruptcy Jim Spiotto, while at the National League of Cities, the very idea that the nation’s largest organization representing elected municipal leaders would advocate for amending federal laws so that cities, counties, and other municipal districts could file for such protection drew approbation, to say the least.] Local officials are subject to such political pressures that there needs to be a societal “worst case” that needs to be avoided.  It’s not like a business bankruptcy where assets get sold and equity holders lose investment.  We are dealing with public assets and the public, though charged with for electing responsible representatives, who or which can’t be held fully responsible for what may be foolish, inept, corrupt, or criminal actions by their officials. Thus municipal bankruptcy, rather than dissolution, was a worst case scenario whose impact needed to be avoided at all costs. Lacking a worst case scenario with real meaning, officials may be more prone to take fiscal or political risks if they think the penalty is not that harsh. The current commercial practice of a structured bankruptcy, which is commonly used (and effectively used in Detroit and eventually in San Bernardino and other places) could become common place. If insolvency were extended to “service delivery,” and if it becomes relatively painless, decision-making/political risk is lowered, and political officials can take greater risks with less regard to the consequences. In my view, the impact of bankruptcy needs to be so onerous that elected officials will strive to avoid it and avoid decisions that may look good for short-term but have negative impact in the medium to long-term and could lead to serious consequences. State leaders also need to protect their citizens with controls and oversight to prevent outliers from taking place, and stepping in when signs of fiscal weakness appear.”

Self-Determination. Puerto Rico Gov. Ricardo Rosselló has submitted a 10-year fiscal plan to the PROMESA Oversight Board which would allow for annual debt payments of about 18% to 41% of debt due—a plan which anticipates sufficient cash flow in FY2018 to pay 17.6% of the government’s debt service. In the subsequent eight years, under the plan, the government would pay between 30% and 41% per year. The plan, according to the Governor, is based upon strategic fiscal imperatives, including restoring credibility with all stakeholders through transparent, supportable financial information and honoring the U.S. territory’s obligations in accordance with the Constitution of Puerto Rico; reducing the complexity and inefficiency of government to deliver essential services in a cost-effective manner; implementing reforms to improve Puerto Rico’s competitiveness and reduce the cost of doing business; ensuring that economic development processes are effective and aligned to incentivize the necessary investments to promote economic growth and job creation; protecting the most vulnerable segments of our society and transforming our public pensions system; and consensually renegotiating and restructuring debt obligations through Title VI of PROMESA. The plan he proposed, marvelously on the 100th anniversary of the Jones-Shafroth Act making Puerto Rico a U.S. territory, also proposes monitoring liquidity and managing anticipated shortfalls in current forecast, and achieving fiscal balance by 2019 and maintaining fiscal stability with balanced budgets thereafter (through 2027 and beyond). The Governor notes the Fiscal Plan is intended to achieve its objectives through fiscal reform measures, strategic reform initiatives, and financial control reforms, including fiscal reform measures that would reduce Puerto Rico’s decade-long financing gap by $33.3 billion through:

  • revenue enhancements achieved via tax reform and compliance enhancement strategies;
  • government right-sizing and subsidy reductions;
  • more efficient delivery of healthcare services;
  • public pension reform;
  • structural reform initiatives intended to provide the tools to significantly increase Puerto Rico’s capacity to grow its economy;
  • improving ease of business activity;
  • capital efficiency;
  • energy [utility] reform;
  • financial control reforms focused on enhanced transparency, controls, and accountability of budgeting, procurement, and disbursement processes.

The new Fiscal Plan marks an effort to achieve fiscal solvency and long-term economic growth and to comply with the 14 statutory requirements established by Congress’ PROMESA legislation, as well as the five principles established by the PROMESA Oversight Board, and intended to sets a fiscal path to making available to the public and creditor constituents financial information which has been long overdue, noting that upon the Oversight Board’s certification of those fiscal plans it deems to be compliant with PROMESA, the Puerto Rico government and its advisors will promptly convene meetings with organized bondholder groups, insurers, union, local interest business groups, public advocacy groups and municipality representative leaders to discuss and answer all pertinent questions concerning the fiscal plan and to provide additional and necessary momentum as appropriate, noting the intention and preference of the government is to conduct “good-faith” negotiations with creditors to achieve restructuring “voluntary agreements” in the manner and method provided for under the provisions of Title VI of PROMESA.

Related to the service insolvency issues we discussed [above] this early, snowy a.m., Gov. Rosselló added that these figures are for government debt proper—not the debt of issuers of the public corporations (excepting the Highways and Transportation Authority), Puerto Rico’s 88 municipalities, or the territory’s handful of other semi-autonomous authorities, and that its provisions do not count on Congress to restore Affordable Care Act funding. Rather, Gov. Rosselló said he plans to determine the amount of debt the Commonwealth will pay by first determining the sums needed for (related to what Mr. Pfeiffer raised above] “essential services and contingency reserves.” The Governor noted that Puerto Rico’s debt burden will be based on net cash available, and that, if possible, he hopes to be able to use a consensual process under Title VI of PROMESA to decide on the new debt service schedules. [PROMESA requires the creation of certified five-year fiscal plan which would provide a balanced budget to the Commonwealth, restore access to the capital markets, fund essential public services, and pensions, and achieve a sustainable debt burden—all provisions which the board could accept, modify, or completely redo.]  

Adrift on the Fiscal Links? While this a.m.’s snow flurries likely precludes a golf outing, ACA Financial Guaranty Corp., a municipal bond insurer, appears ready to take a mighty swing for a birdie, as it is pressing for payback on the defaulted debt which was critical to the financing of Buena Vista, Virginia’s unprofitable municipal golf course, this time teeing the proverbial ball up in federal court. Buena Vista, a municipality nestled near the iconic Blue Ridge of some 2,547 households, and where the median income for a household in the city is in the range of $32,410, and the median income for a family was $39,449—and where only about 8.2 percent of families were below the poverty line, including 14.3 percent of those under age 18 and 10 percent of those age 65 or over. Teeing the fiscal issue up is the municipal debt arising from the issuance by the city and its Public Recreational Facilities Authority of some $9.2 million of lease-revenue municipal bonds insured by ACA twelve years ago—debt upon which the municipality had offered City Hall, police and court facilities, as well as its municipal championship golf course as collateral for the debt—that is, in this duffer’s case, municipal debt which the municipality’s leaders voted to stop repaying, as we have previously noted, in late 2015. Ergo, ACA is taking another swing at the city: it is seeking:

  • the appointment of a receiver appointed for the municipal facilities,
  • immediate payment of the debt, and
  • $525,000 in damages in a new in the U.S. District Court for Western Virginia,

Claiming the municipality “fraudulently induced” ACA to enter into the transaction by representing that the city had authority to enter the contracts. In response, the municipality’s attorney reports that Buena Vista city officials are still open to settlement negotiations, and are more than willing to negotiate—but that ACA has refused its offers. In a case where there appear to have been any number of mulligans, since it was first driven last June, teed off, as it were, in Buena Vista Circuit Court, where ACA sought a declaratory judgment against the Buena Vista and the Public Recreational Facilities Authority, seeking judicial determination with regard to the validity of its agreement with Buena Vista, including municipal bond documents detailing any legal authority to foreclose on city hall, the police department, and/or the municipal golf course. The trajectory of the course of the litigation, however, has not been down the center of the fairway: the lower court case took a severe hook into the fiscal rough when court documents filed by the city contended that the underlying municipal bond deal was void, because only four of the Buena Vista’s seven City Council members voted on the bond resolution, not to mention related agreements which included selling the city’s interest in its “public places.” Moreover, pulling out a driver, Buena Vista, in its filing, wrote that Virginia’s constitution filing, requires all seven council members to be present to vote on a matter which involved backing the golf course’s municipal bonds with an interest in facilities owned by the municipality. That drive indeed appeared to earn a birdie, as ACA then withdrew its state suit; however, it then filed in federal court, where, according to its attorney, it is not seeking to foreclose on Buena Vista’s municipal facilities; rather, in its new federal lawsuit, ACA avers that the tainted vote supposedly invalidating the municipality’s deed of trust supporting the municipal bonds and collateral does not make sense, maintaining in its filing that Buena Vista’s elected leaders had adopted a bond resolution and made representations in the deed, the lease, the forbearance agreement, and in legal opinions which supported the validity of the Council’s actions, writing: “Fundamental principles of equity, waiver, estoppel, and good conscience will not allow the city–after receiving the benefits of the [municipal] bonds and its related transactions–to now disavow the validity of the same city deed of trust that it and its counsel repeatedly acknowledged in writing to be fully valid, binding and enforceable.” Thus, the suit requests a judgment against Buena Vista, declaring the financing documents to be valid, appointing a receiver, and an order granting ACA the right to foreclose on the Buena Vista’s government complex in addition to compensatory damages, with a number of the counts seeking rulings determining that Buena Vista and the authority breached deed and forbearance agreements, in addition to an implied covenant of good faith and fair dealing, requiring immediate payback on the outstanding bonds, writing: “Defendants’ false statements and omissions were made recklessly and constituted willful and wanton disregard.” In addition to compensatory damages and pre-and post-judgment interest, ACA has asked the U.S. court to order that Buena Vista pay all of its costs and attorneys’ fees; it is also seeking an order compelling the city to move its courthouse to other facilities and make improvements at the existing courthouse, including bringing it up to standards required by the ADA.

Like a severe hook, the city’s municipal public course appears to have been errant from the get-go: it has never turned a profit for Buena Vista; rather it has required general fund subsidies totaling $5.6 million since opening, according to the city’s CAFR. Worse, Buena Vista notes that the taxpayer subsidies have taken a toll on its budget concurrent with the ravages created by the great recession: in 2010, Buena Vista entered a five-year forbearance agreement in which ACA agreed to make bond payments for five years; however, three years ago, the city council voted in its budget not to appropriate the funds to resume payment on the debt, marking the first default on the municipal golf course bond, per material event notices posted on the MSRB’s EMMA.

Challenges in Rebounding from Insolvency or Municipal Bankruptcy

eBlog, 02/27/17

Good Morning! In this a.m.’s eBlog, we consider new development plans for the insolvent, state-taken over Atlantic City, before turning to the post-chapter 9 municipal bankruptcy electoral challenges in Detroit—where the son of a former Mayor is challenging the current Mayor—and where the post-bankrupt city is seeking to confront its exceptional public pension obligations in a city with an upside down population imbalance of retirees to taxpayers.

Spinning the Fiscal Turnstile in Atlantic City? Since New Jersey’s Casino Reinvestment Development Authority (CRDA) developed its Tourism District master plan for Atlantic City five years ago, five casino have closed—casinos with assessed values of $11 billion. Those closures appeared to be the key fiscal destabilizers which plunged the city into near municipal bankruptcy and a state takeover. Now the Authority, which handles redevelopment projects and zoning in the Tourism District (The rest of Atlantic City is under the city’s zoning jurisdiction—albeit a city today taken over by the state, and where the Development Authority was given authority by the state over the Tourism District in 2011) has approved spending $2 million for refurbishing. Robert Mulcahy, the Chairman of the authority’s board of directors, states: “The master plan is done to streamline zoning, help eliminate red tape, encourage proper development in the appropriate district, and stimulate investment in commercial, entertainment, housing, and mixed-use properties…This provides a vision to what we want to do.” The proposed land-use regulations’ twenty-five objectives include providing a zoning scheme to stimulate development and maintain public confidence in the casino gaming industry as a unique tool of the city’s urban redevelopment. The new zones would allow for mixed use near the waterfront, and retail development around the Atlantic City Expressway and its waterfront under the state agency blueprint intended to make it easier for companies to turn old industrial buildings into commercial and waterfront areas, to build amusement rides off the Boardwalk, maybe even incentivize craft brewers and distillers to open businesses.  

CRDA Director Lance Landgraf noted: “The city last changed the zoning along the Boardwalk when casinos came in.” Similarly, Atlantic City Mayor Don Guardian, who is a CRDA board member, noted: “If we talked 10 years ago about the Southeast Inlet, I think most people saw it as a Miami Beach with a bunch of high-rises that would go from Revel to Brigantine Inlet…Times have changed. People are now looking for mixed-use type of things, which is certainly what is important.” According to the proposed plan, the new tourism district would be intended to maximize recreational and entertainment opportunities, including the growing craft beer trend. Smaller breweries and distilleries have expressed interest in operating in the city, according to the draft plan, which notes it “seeks to reinvigorate the Atlantic City experience by enhancing the Boardwalk, beach and nearby streets through extensive entertainment and event programming; creating an improved street-level experience on major thoroughfares; offering new and dynamic retail offerings and increasing cleanliness and safety.”

Post Chapter 9 Leadership.  Coleman Young II, a state Senator in Michigan representing Detroit, sitting beneath a photograph of his late father and former Detroit Mayor Coleman Young, has officially launched his challenge against current Detroit Mayor Mike Duggan, claiming the Motor City needs a leader who focuses on helping residents who are struggling with unemployment and other hardships, and criticizing Mayor Duggan for what he called a lack of attention to Detroit’s neighborhoods, noting: “We need change, and that is why I am running for mayor: I will do whatever it takes—blood, sweat, tears, and toil—and I will fight to the very end to make sure that justice is done for the City of Detroit…In announcing his challenge, Sen. Young recalled his father’s focus on jobs when he served as Detroit’s first black mayor: “I want to put people back to work just like my father, the honorable Coleman Alexander Young did…He is turning over in his grave right now!”

Interestingly, Sen. Young’s challenge came just days after last week’s formal State of the City address by Mayor Duggan—an address in which he focused on putting Detroiters to work and investing in neighborhoods—announcing a new city program, Detroit at Work, which is focused on training Detroit residents for available jobs—a speech which candidate Young, in his speech, deemed a “joke,” stating: “I think it’s kind of funny he waits for four years and now starts talking about the neighborhoods…As far as I’m concerned, he’s just somebody that’s in the way and needs to go. It’s time for change. It’s time for reform.” (Detroit’s primary will be in August; the election is Nov. 7th.)

Rebound? Whomever is elected next November in Detroit will confront lingering challenges from Detroit’s largest municipal bankruptcy in U.S. history. That July 19th filing in 2013, which then Emergency Manager Kevyn Orr described  as “the Olympics of restructuring,” had been critical to ensuring continuity of essential services and critical to rebuilding an economy for the city—an economy besieged after decades of population decline (dropping from 1,849,568 in 1951 to 713,777 by 2010), leaving the city to confront an estimated 40,000 abandoned lots and structures and the loss of 67 percent of its business establishments and 80 percent of its manufacturing base. The city had spent $100 million more, on average, than its revenues since 2008. According to the census, 36 percent of its citizens were below the poverty level, and, the year prior to the city’s bankruptcy filing, Detroit reported the highest violent crime rate for any U.S. city with a population over 200,000. Thus, as the city’s first post-bankruptcy Mayor, Mayor Duggan has faced a city with vast abandoned properties.

Interestingly, Steve Tobocman, the Director of Global Detroit, an economic-development nonprofit which focuses on maximizing the potential of immigrants and the international community, said that enacting municipal policies which welcome foreign-born residents could be a critical strategy to reverse the population loss: “No American city has been able to rebound from population loss without getting serious about immigration growth…In 1980, 29 of the 50 largest cities lost population. Most of the cities that lost population have since reversed course due to an influx of immigrants. No American city has been able to rebound from population loss without getting serious about immigration growth.” Now that avenue could be closing with President Trump’s efforts to curtail immigration, especially from Mexico and the Middle East, leading Mr. Tobocman to note he had no reason to anticipate any help from Washington, D.C. in helping rebuild Detroit’s population, or energizing its economy, with immigrants. Rather, he warns, he is apprehensive that other policy promises, particularly the proposed border wall with Mexico, actively threaten Michigan’s economy: “Mexico is our second-largest trading partner after Canada…Metro Detroit is the largest metro area trading with Mexico. One hundred thousand jobs are supported by our trade with Mexico.”

Upside Down Fiscal Challenge. A key challenge to Detroit, because of the inverted fiscal pyramid creating by its population decline, is there are far fewer paying into to Detroit’s public pension system, against far more receiving post-retirement pensions, sort of an upside down fiscal dilemma—and one which, increasingly, confronts the city’s fiscal future. Now Mayor (and Candidate) Duggan has announced a plan he believes will help Detroit to city meet its 2024 balloon payment on its public pension obligation, or, as Detroit Chief Financial Officer John Hill puts it, a plan designed to be more than adequate to address the looming future payment of more than $100 million owed beginning in 2024: “What the mayor is proposing is that we take money now and put into a pension protection fund and then use that money in 2024 and beyond to help make some of those payments: So part of the money would come from the budget, and the other would come from the fund,” describing the provisions in Detroit’s plan of debt adjustment for down payments to the city’s pension obligation in Mayor Duggan’s $1 billion general fund budget for the 2017-18 fiscal year the Mayor presented to the Detroit City Council at the end of last week. Mr. Hill said that the payment plan would give the city budget longer to catch up to the $132 million it would have to pay going forward, describing it as “really a way for us to proactively address the future pension obligation payment and not wait to deal with it down the road.”

However, there appears to be a fiscal fly in the ointment: last year, in his 2016 State of the City speech, Mayor Duggan said that consultants who advised the city through its chapter 9 municipal bankruptcy had miscalculated the city’s pension deficit by $490 million—actuarial estimates at the time which projected a payment of $111 million in 2024—a figure subsequently increased by the actuary to $194.4 million—leading Mayor Duggan to assert that the payment had been “concealed” from him by former Detroit emergency manager Kevyn Orr during the city’s bankruptcy, with, according to the Mayor, Mr. Orr’s team using overly optimistic assumptions which made Detroit’s future pension payout obligations appear artificially low. The revised estimates have since forced the city to address the large future payment, beginning in FY2016, when the city set aside $20 million and another $10 million to start its pension trust fund, with the payment coming in addition to the $20 million contribution to the legacy plans the city is mandated to make under Detroit’s plan of debt adjustment. Now Mayor Duggan is proposing Detroit set aside an additional $50 million from a general fund surplus and another $10 million into the trust fund this year: the city projects it will have $90 million in the trust at the end of FY2017. In the following fiscal years, the city is proposing to add another $15 million to the fund, $20 million in FY2019, $45 million in FY2020, $50 million in FY2021, $55 million in FY2022, and $60 million for FY2023. Or, as Detroit Finance Director John Naglick describes it: “All total, we propose that the City would deposit $335 million into the trust fund through the end of FY23, with interest, the fund is projected to grow to $377 million.” Mr. Naglick adds that Detroit expects that the general fund would be required to contribute a total of $143.2 million beginning in FY2024: “We propose to make that payment by pulling $78.5 million out of the trust and appropriating $64.7 million from the general fund that year.” CFO Hill noted that by addressing the 2024 obligation payment with the plan, Detroit would remain on track to exit state oversight as projected, stating: “We believe that after we have executed three balanced budgets and met a number of other requirements that the Detroit Review Commission could vote to waive their oversight…We believe that one of the factors that they are going to want to see to support that waiver is that we have proactively dealt with the pension obligations in 2024.” There could, however, be a flaw in the ointment: Mayor Duggan warned last week that Detroit may decide to sue Mr. Orr’s law firm, Jones Day, if the city finds that Mr. Orr had an obligation to keep the city informed on the pension payments.

The Challenge of Post-Insolvency Governance

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eBlog, 2/21/17

Good Morning! In this a.m.’s eBlog, we consider the role of citizens when a municipality emerges from municipal bankruptcy—and at how little effort seems to have been taken for such cities to share with each other. Then we take a gamble at the roulette wheels in Atlantic City, where the third branch of government, the judiciary, is weighing in even as candidates for next year’s Mayoral election from the City Council are announcing.  

The Challenge of Emerging from Chapter 9 Municipal Bankruptcy. San Bernardino Neighborhood Association Council President Amelia Lopez recently asked if the city’s emergence from municipal bankruptcy might mark the moment to change the city from the ground up, or, as Ms. Lopez put it: “Coming out of bankruptcy is an opportunity…The city is looking for direction. We’re here to have a say in that direction.” No U.S. city has ever been in bankruptcy for as long as San Bernardino, so the question she is raising might singularly impact the city’s future. Yet it comes at a time when citizen activism has altered: of San Bernardino’s 60 neighborhoods, 19 or 20 are active, compared to 30 a decade ago. But the Neighborhood Association Council plans to send representatives to a national convention of neighborhood associations in March and to try to work more closely with elected San Bernardino leaders. It would be interesting were the Council to try to contact comparable neighborhood organizations in Stockton, Jefferson County, and Detroit to both learn what efforts had worked—and which had failed.

Thinking about Tomorrow: A City’s Post Insolvency & State Takeover Future? Notwithstanding Atlantic City’s current status as a ward of the State of New Jersey, there appears to be strong interest in the city’s future elected leadership—albeit, at least to date, an absence of substantive proposals from aspiring candidates. Atlantic City Councilman Frank Gilliam yesterday officially jumped into the mayor’s race, joining previously announced candidate Edward Lea.  Mr. Gilliam, a Democrat, kicked off his campaign with his slate of council running mates—where he spoke about addressing high taxes, unemployment, foreclosures, and other issues, vowing brighter days would come under new leadership: “The Atlantic City that we see right now will not be the Atlantic City we will see in the future…There will be prosperity. There will be equality. There will be fairness from the bottom to the top.” Councilmember Gilliam has served on the City Council since 2010; now he joins a crowded primary: he will face Council President Marty Small and Fareed Abdullah in the June Democratic primary, with the winner set to take on Republican Mayor Don Guardian next November. Councilman Gilliam’s running mates are incumbent Councilmen Moisse “Mo” Delgado, George Tibbitt, and candidate Jeffree Fauntleroy II, who are all seeking at-large seats. Last Friday, candidate Abdullah, a substitute teacher and former City Council candidate, said would also be running for Mayor—meaning a three-way Democratic primary, with the winner to challenge incumbent Republican Mayor Don Guardian.

Councilman Gilliam last year voted against a number of proposals to address the city’s finances, including measures to seek bids for services, dissolve the city’s water authority and approve the administration’s fiscal recovery plan to avoid a state takeover. In some cases, he cited a lack of information about the proposals, or in the case of the fiscal plan, not enough time to review the information. In announcing his bid, he noted: “People elected me to vote on what I think is best for them, not what my other colleagues think is best for them…When you give an individual a document five hours before a vote, that doesn’t give me the proper opportunity to have my fellow folks aware that I’m making the best-informed decision…For too long Atlantic City’s politics and the leaders of this city have sucked the blood out of our town…The time for new leadership is right now.”

Fire in the Hole. Aspiring to be an elected leader in a municipality where the state has preempted such authority comes as the challenge of governing an insolvent city has become more complex and challenging in the wake of Atlantic City Superior Court Judge Julio Mendez restraining order early this month barring the State of New Jersey from cutting Atlantic City’s firefighter workforce or unilaterally altering any of their contracts as part of its state takeover—a judicial decision which caused Moody’s Investors Services to be decidedly moody, deeming Judge Mendez’s decision a credit negative for the cash-strapped city. Or, as the crack credit rating analyst for Moody’s Douglas Goldmacher last week noted: “These developments signal that any actions the state takes to reduce the city’s work force or abrogate labor contracts will prompt a legal challenge, leading to considerable delays in the Atlantic City recovery process, a credit negative for the city…The success or failure of the state to implement broad expenditure cuts for Atlantic City is of tremendous import to the city’s credit quality.” Mr. Goldmacher noted that negotiations with the firefighters and other unions would typically be handled by city officials; however, the Municipal Stabilization and Recovery Act legislation approved by New Jersey lawmakers last year enables the state to alter outstanding municipal contracts, an authority which has now been rendered uncertain. Mr. Goldmacher noted that the firefighters’ court challenge could pave the way for other unions to challenge staffing cuts—effectively handcuffing both municipal and state efforts. He wrote that current city revenues are “insufficient” for debt service and routine expenditures making budget cuts the most likely avenue for permanent financial improvement: “Leaving aside the question of constitutionality, extensive litigation will delay negotiations…Even if other unions refrain from filing suit, the state’s negotiations will be materially impacted by the ongoing lawsuit, delaying or even preventing cost-cutting efforts.”