Restoring Power–and Recovering Governing Authority

July 10, 2018

Good Morning! In this morning’s eBlog, we consider the challenges of restoration of electric power (as opposed to political power) in Puerto Rico, and then try to explore the risks of powers of appointments of emergency managers by a state—here as the City of Flint, Michigan is still seeking to fiscally and physically recover from the human and fiscal devastation caused by the State of Michigan.

Adios. Walter Higgins, the CEO Puerto Rico’s bankrupt PREPA Electric power authority resigned yesterday, just months after he was chosen to oversee its privatization, an appointment made in an effort to fully restore power some ten months after the human, fiscal, and physical devastation wrought by Hurricane Maria. Now his resignation adds to PREPA’s uphill climb to not only fully restore power, but also to address its $9 billion in debt. Gov. Ricardo Rosselló said in a statement that Mr. Higgins had resigned for personal reasons, while Mr. Higgins, in his resignation letter, wrote that the compensation details outlined in his contract could not be fulfilled—with his written statement coming just one month after the Commonwealth’s Justice Secretary said it would be illegal for him to receive bonuses. According to a PREPA spokesperson, Mr. Higgins will remain as a member of the PREPA Board. Nevertheless, his appointment was stormy itself, after, last month, Puerto Rican officials had questioned how and why he had been awarded a $315,000 contract without authorization from certain government agencies—in response to which PREPA’s Board advised the government as a consultant, rather than filling the vacancy for an executive sub-director of administration and finance. Unsurprisingly, his departure will not be mourned by many Puerto Ricans in view of his generous compensation package of $450,000 annual salary compared to the average income for Puerto Ricans of $19,518.  

Nevertheless, PREPA officials, announced that current Board member Rafael Diaz Granados will become the new CEO—with nearly double the compensation: he will assume the position on Sunday and receive $750,000 a year—a level which Puerto Rico Senate President Thomas Rivera Schatz described as the “kind of insult that to Puerto Ricans is unacceptable,” as the government and PROMESA Oversight Board continue to struggle to address and restructure Puerto Rico’s $70 billion in public debt. Nevertheless, as PREPA crews continue restoring power to the last 1,000 or so customers who have been without power since Maria hit nearly a year ago and destroyed up to 75% of transmission lines across the territory, the federal government is still operating 175 generators across the island.

Indeed, U.S. House Natural Resources Committee Chair Rob Bishop (R-Utah) has scheduled a hearing for July 25th to assess and inquire about the status of the Electric Power Authority and to examine the functioning and plans for the privatization of PREPA assets, an issue which the territory’s non-voting Congressional Representative Jenniffer Gonzalez noted “has been under the Committee’s jurisdiction for the past two years.” Rep. Gonzalez added: “I’m surprised with the salary: I did not expect that amount. I do not know the elements which affected Mr. Higgin’s resignation, and I believe that these changes affect the process of recovery on the island.”

Meanwhile, Chairman Bishop had announced a second potential hearing—this one to assess the operation of the PROMESA statute and how the PROMESA Oversight Board is working, after, last week, postponing an official trip with a dozen Members of Congress to assess the physical and fiscal recovery on the island, after meeting, early last month in San Juan with the now former PREPA Director Higgins, and after, in the spring, Chair Bishop, Chair Doug LaMalfa (R-Ca.), of the Subcommittee on Island Affairs, and Chairman Bruce Westerman (R-Ark.) had announced a probe into “multiple allegations of corruption and serious allegations of maladministration” during the restoration of the electric service after the storm.

Out Like Flint? Meanwhile, in a criminal and fiscal case arising out of Michigan’s Flint water crisis in the wake of fatal decisions by a gubernatorially appointed Emergency Manager, closing arguments in the involuntary manslaughter case against state Health and Human Services Director Nick Lyon began yesterday before Genesee District Court Judge David Goggins, who will determine whether Director Lyon will go on trial in the Flint water crisis prosecution on charges of involuntary manslaughter and misconduct in office connected to the 2014-2015 Legionnaires’ disease outbreak in the Flint region which killed at least 12 people and sickened another 79 people. A misdemeanor charge of “willful neglect” to protect the health of Genesee County residents was added last week. Director Lyon is receiving assistance in his defense from John Bursch, a former Michigan Solicitor General, who was hired for that position by Michigan Attorney General Bill Schuette—who has brought criminal charges related to the Flint water crisis against Director Lyon and 14 other current and former city and state government employees. Flint still faces financial questions after years of emergency management.

The criminal trial comes as questions still remain with regard to Flint’s long-term financial health, despite six years of state oversight that overhauled the city’s finances, after a 2011 state-ordered preliminary review showed problems with Flint’s finances and ultimately recommended an emergency manager for the city. Last April, State Treasurer Nick Khouri repealed all remaining Emergency Manager orders, with state officials claiming the city’s financial emergency has been addressed to a point where receivership was no longer needed, and, as the Treasurer wrote to Mayor Karen Weaver: “Moreover, it appears that financial conditions have been corrected in a sustainable fashion,” and Flint CFO Hughey Newsome said that while emergency managers had helped Flint get its financial house in order; nevertheless, Flint’s fiscal and physical future remains uncertain: “The after-effects of the water crisis, including the dark cloud of the financials, will be here for some time to come: We’re not out of the woods yet, but I don’t think emergency management can help us moving forward.” In the city’s case, the fateful water crisis with its devastating human and fiscal impacts, hit the city as it was still working to recover from massive job and population losses following years of disinvestment by General Motors. CFO Newsome said the crisis affected the city’s economic development efforts and may have left potential businesses wanting to come to Flint wary because of the water.

Flint’s spending became more in line with its revenues, changes were made to its budgeting procedures, and retiree healthcare costs and pension liabilities were reduced while under emergency management. Nevertheless, past financial overseers have warned the city about what would happen if Flint allows its fiscal responsibilities to slip. Three years ago, former Emergency Manager Jerry Ambrose, in a letter to Gov. Snyder, wrote: “If, however, the new policies, practices and organizational changes are ignored in favor of returning to the historic ways of doing business, it is not likely the city will succeed over the long term: The focus of city leaders will then likely once again return to confronting financial insolvency.”

Today, there are still signs of potential fiscal distress, notwithstanding  the city’s recovery; indeed, Mayor Weaver’s FY2019 budget plans for a more than $276,000 general fund surplus—even as the municipal budget is projected to grow to more than $8 million by FY2023, with that growth attributed by CFO Newsome to ongoing legacy costs and a lack of revenue—or, as he put it: “My last two predecessors have really delivered realistic budgets: I definitely don’t see this administration being irresponsible in that regard, and I don’t see this Council rubberstamping such a budget either.”

And, today, questions about criminal and fiscal accountability are issues for the state’s third branch of government: the judiciary, in District Court Judge William Crawford’s courtroom, where the issues with regard to criminal charges relating to the governmental actions of defendants charged for their actions during the Flint Water Crisis include former Emergency Manager Darnell Early and former City of Flint Public Works Director Howard Croft, and former state-appointed Flint Emergency Manager Jerry Ambrose, who, prosecutors  allege, knew the Flint water treatment plant was not ready to produce clean and safe water, but did nothing to stop it. The trial involves multiple charges, including willful neglect of duty and misconduct in office. (Mr.  Ambrose was the state appointed Emergency Manager from January until April of 2015; he also held the title of Finance Director under former state appointed emergency managers Mike Brown and Darnell Early. To date, four others have entered into a plea agreement in their cases.)

Bequeathing a Legacy of healthcare and retirees benefit costs: When Mr. Ambrose left in 2015 and turned things over the to the Receivership Transition Advisory Board, he stated that Flint’s other OPEB costs had been reduced from $850 million to $240 million, adding that a new hybrid pension plan put in place by state appointed emergency managers had reduced Flint’s long-term liability; however, he warned, on-going legacy costs are still one of the most pressing issues for Flint’s fiscal future: “Remember, the reality we’re facing: we have a $561 million liability to (Municipal Employees’ Retirement System), and the fund is only at $220 million; we also have an obligation to our 1,800 retirees to make sure that we’re paying our MERS obligation.” (A three percent raise for Flint police officers approved earlier this year added to those liabilities, with those increases attributable to two different contracts, which were imposed on officers by former state-appointed Emergency Managers Michael Brown and Darnell Earley in 2012 and 2014, respectively.)

The RTAB asked CFO Huey Newsome in January how the city would pay the additional $264,000 annually in wages and benefits along with a projected $3.4 million in additional retirement costs over the life of the contract—a question he was unable to specify an answer to at the time: “To tell you exactly where those‒where those dollars will come from right at this point in time, I can’t say…I think the ‘so what’ of this is that, you know, the incremental impact from this pay raise is not going to be that large when you think about the three and a half million. The city still needs to figure out where that three and a half million is coming from.” Moreover, he added, because police negotiated the raise, it also could be an issue with other unions wanting a similar increase during their future negotiations, adding that the city is making increased payments to MERS to avoid balloon payments in the future. For example, Mr. Newsome said, Flint will pay an additional $21.5 million this year, adding that all the city’s funds currently have a positive balance. However, Flint’s budget projections show the water fund will have a $2.1 million deficit in FY2018-19, a deficit projected to increase to $3.3 million by FY2022-23; Flint’s fiscal projections eventually put the water fund balance in the red by 2022-23; however, CFO Newsome warned: “The water fund is probably the most tepid one, because it is expected to be below the reserve balance by the end of the year,” noting the city can only account for 60% of the water that goes through its system, adding that the city has an 80% collection rate on its water bills, which is about $28 million this fiscal year, telling the Mayor and Council: “One of our top priorities is better metering.”

The city’s most-recent budget for 2018-19 calls for a combined revenue increase of $1.09 million more than previous budget projections because of increased assessed property values, more income taxes coming in, and additional state revenue sharing. Nevertheless, one Board member, notwithstanding projections for increased revenue, is apprehensive that Flint’s “tax base is likely going to continue to shrink, and the city currently has limited resources to reverse this trend,” or, as CFO Newsome put it: “Right now, revenue is not there: The income tax is relatively flat. The property tax is flat. That’s reality.” The city’s current proposed FY2019 budget calls for an increase of $120,000 from property taxes, $339,000 increase in income tax revenue, and an additional $631,000 in revenue from the state of Michigan. 

 

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Motor City Rising

June 1, 2018

Good Morning! In this morning’s eBlog, we consider the remarkable turnaround of Detroit—a city which, when I inquired on its very first day in chapter 9 municipal bankruptcy, for walking directions from my hotel to the Governor’s Detroit office—in response to which I was told the one mile route was not doable—not because I would be too physically challenged,  but rather because I would be slain. Yet now, as the  fine editorial writers for the Detroit News, Daniel Howes and Nolan Finley, wrote: “A regional divide that appeared to be healing since Detroit’s historic bankruptcy is busting wide open over a plan for regional transit, exposing anxiety that the city is prospering at the expense of the suburbs,” noting that the trigger is a is a proposed millage to fund expansion of the Regional Transit Authority of Southeast Michigan, a $5.4 billion plan that would seem to promise an exceptional reshaping of the metro region—indeed: a reversal a what had been a decades-long shift of the economy from downtown Detroit to is suburbs: an exodus that contributed to a wasteland and the nation’s largest ever chapter 9 municipal bankruptcy.” Or, as they wrote: “That battle reveals growing suburban resentments over the region’s shifting economic fortunes: decades-long capital flow is reversing directions as more jobs and tax revenue flee the ‘burbs for a rejuvenated downtown.”

Mr. Finley noted that Mayor Mike Duggan, this week, told him: “I can’t explain why Oakland and Macomb (suburban counties) are doing what they’re doing” three weeks ago Microsoft brought 400 employees from Southfield into the city of Detroit. And last week, Tata Technologies said they were moving 200 people from Novi and into Detroit. Google is in the process of moving people from Birmingham into the city of Detroit.” What the Mayor was alluding to was a u-turn from a decade of moderate and upper income families leaving Detroit for its suburban counties in the days when former Mayor Coleman Young had advised criminals to “hit Eight Mile” has the relationship between the Metro Motor City’s regional leaders become so difficult in the wake of the unexpected reverse exodus: this time from Detroit’s suburbs back into the city. Billions in private sector investment, spearheaded by Dan Gilbert’s Quicken Loans Inc., the Ilitch family, and growing enthusiasm among other business leaders to be part of the city’s post-chapter 9 municipal bankruptcy have been changing demographic and economic patterns.

As the city continues under decreasing state oversight to carry out its judicially approved plan of debt adjustment, Mayor Duggan notes: “Expectations are rising.” This, after all, is not a City Hall bound mayor, but rather what the editors described as a “short, stocky, balding white guy who is no stranger to block after block of dilapidated houses—and who was reelected to a second term with an amazing 72% of the vote in a city where slightly more than 82% of the voters are black—and where, when he took office, there were about 40,000 abandoned homes. He is not a stay at City Hall type fellow either—rather an inveterate inspector of this mammoth rebuilding of an iconic city, who listens—and with his cell phone—takes action immediately in response to constituents concerns. After all, as the Mayor notes: “Expectations are rising…People are putting more demands on me and more demands on the administration, and I think that’s a really good thing and that will keep us motivated to work hard.”

Already, the urban wasteland is changing—almost on a daily basis: already, under a city program which supports renovation over demolition to try to preserve the mid-century architectural character of neighborhoods, that number of abandoned homes has been halved—with many of the units set aside for affordable housing. In his State of the City address this year, Mayor Duggan said he wants 8,000 more homes demolished, 2,000 sold, another 1,000 renovated and 11,000 more boarded up by the end of next year.

On that first day of the nation’s largest ever municipal bankruptcy, Kevin Orr, whom the Governor had tapped to become the Emergency Manager for Detroit, had flown out from the Washington, D.C. region, and told me his first actions were to email every employee of Detroit that he would be filing that morning in the U.S. Bankruptcy Court, but that he expected every employee to report to work—and that the most critical priorities were that every traffic and street light work—and that there be a professional, courteous, and prompt response to every 911 call.  

That was a challenge—especially for a municipality in bankruptcy, but, by 2016, the city had completed a $185 million streetlight repair project; 911 response times have been reduced from 50 minutes in 2013 to 14.5 minutes last year, and ambulance response times fell from 20 minutes in 2014 to the national average of 8 minutes this year.

As we have previously noted, two months ago, just three and a half years after Detroit emerged from chapter 9, the city has exited from state oversight; its homeless population has, for the third consecutive year, declined—and, its unemployment rate, which had peaked during the fiscal crisis at 28%, is now below 8%. No wonder the suburbs are becoming fiscally jealous. And the downtown, which was unsafe for pedestrians when the National League of Cities hosted its annual meeting there in the 1980’s and on the city’s first day in bankruptcy, has been transformed into a modern, walkable metropolis.

Nevertheless, the seeming bulldog, relentless leader has refused to sugarcoat the fiscal and physical challenge—or, as he puts it: “I don’t spend a lot of time promising. I just say, here’s what we’re doing next and here’s why we’re doing it and then we do what we say…Over time, you don’t restore trust by making more promises; you restore trust by actually doing what you said you were going to do.”

Mr. Finley wrote that the Mayor, deemed a “truth teller” by Detroit Housing Director Arthur Jemison, has been direct in confronting the city’s harsh legacy of racist policies after the Great Depression lured thousands upon thousands of African-Americans north in the early decades of the 20th century to work in auto factories—luring them to a city at a time when Federal Housing Administration guidelines barred blacks in the city from obtaining home mortgages and even led to the construction in 1941 of a wall bordering the heavily African-American 8 Mile neighborhood to segregate it from a new housing development for whites.

Aaron Foley — the 33-year-old author of How to Live in Detroit Without Being a Jackass, noted: “When you deliver that kind of message about this is why black people are on this side of the wall in 8 Mile versus the other side of the wall, that gets people talking: This is a history that we all know in Detroit, and for the city government to acknowledge that in the way that it did on that platform, it did resonate.”

Mayor Duggan’s concern for Detroit’s people—and not forcing low-income families out, is evidenced too by his words: “Every single time that we had a building where the federal [housing] credits were expiring and people were going to get forced out of their affordable units, I had to sit down for hours with the building owner to convince them why those who stayed were entitled to be there, and I thought: I need to do just one speech and explain that this is the right thing to do…Since then there’s been just great support for the direction we’re going in the city. We have very little pushback now from our developers over making sure that what they’re doing is equitable.”

Charting a Municipal Rovery Budget

April 5, 2018

Good Morning! In this morning’s eBlog, we shiver on the Appomattox River at first light in the historic Civil War municipality of Petersburg, a municipality which is on the rebound from virtual insolvency—in Virginia, where the state does not specifically authorize its municipalities to file a chapter 9 petition, but does impose a debt limitation barring any municipality from incurring debt in excess of 10% of the assessed valuation of taxable properties. It is a city, which has been, since the dawn of the republic, a strategic center for transportation and commercial activities, and it is a city, which came closest of any in the Commonwealth to filing for insolvency. But, in the wake of the appointment of a former city manager—as well as a state commission to provide assessment and evaluation of municipal fiscal well-being, it is, today, a city of 32,420 that is returning to fiscal health.

Setting the Path for a Strategic Recovery. In her first budget proposal for the historic Virginia municipality of Petersburg in the wake of its insolvency and near first-ever Virginia chapter 9 municipal bankruptcy, City Manager Aretha Ferrell-Benavides, who was hired last June just as consultants charged with turning around the city’s finances told the City Council that it needed a $20 million cash infusion to make up a deficit and comply with its own reserve policies, Manager Ferrell-Benavides proposed a rebuilding budget–even as she  expressed cautious optimism to the Mayor and Council that Petersburg can overcome the challenges it faces and continue to restore its financial standing. Thus, she presented a $73 million proposed operating budget–one which focuses on public safety, more funding for the city’s chronically underperforming schools, but cuts to city departments.

In presenting her proposed FY2019 $102.6 million budget, she told the Mayor and Council the spending plan reflects five “strategic priorities,” led by a focus on establishing the city “as a structurally stable organization with a greater focus on customer service, efficiency, accountability, and transparency.” In addition, she added, she is proposing a budget, which aims to “strengthen our fundamental policy and process to achieve long-term fiscal stabilization.”

She cited other priorities, including boosting economic development, encouraging neighborhood revitalization, promoting community engagement, and neighborhood support. Noting that Petersburg confronts some uncertainty with regard to the levels of funding which will be available from the state and federal governments, Manager Ferrell-Benavides outlined revenue and spending plans, plans which, she advised, were based on “conservatism” in their projections, as she proposed an operating budget slightly under this year’s level–a reduction of about $305,000, or about 0.3 % from the amended budget for the current fiscal year–of which approximately 72% or $73 million would be for the operating budget–a 1.5% drop from the current level, while proposing a 6.4% increase in the capital budget for the city’s Utilities Fund, noting that public safety would remain the largest funding category, at about $18.9 million, or about 26% of the total, comparable to the current level. She proposed $13.6 million for the city’s second largest budget category, Social Services, unchanged from the current level services funding, but recommended an increase of about 3% for the city’s public schools, as part of what she asserted was a continuing effort to restore cuts which had been made during the city’s financial crisis in FY2016. For next year, she proposed that the budget allocate about $9.7 million to the school system, an increase of up about $271,000 from $9.5 million this year.

In a post General Revenue Sharing era, Petersburg, with a nearly 80% black population and where more than a quarter of its families are headed by a female householder with no husband present—and more than 11% of its households headed by a single person over the age of 65—has a median family income of $33,927, with nearly a quarter of its residents below the federal poverty level. It is a city, too, living with fear: on Wednesday, more than 100 guns were taken off the streets and destroyed by the order of Petersburg Police Chief Kenneth Miller, who described these as “illegal guns that were taken off streets.” Indeed, some nine months on the job, Chief Miller has been adamant about his decision to have the guns destroyed and not sold “to put these weapons back on the street for gain…We’re not going to take weapons of destruction and try to make a profit off of that.”

But, fiscally, the city appears to be on a strong road to recovery. Manager Ferrell-Benavides noted that the challenges that the Petersburg still faces include rising health care costs for city employees, aging water and sewer infrastructure, antiquated technology, the need to recruit and retain employees, and ongoing issues with billing and collections. Nevertheless, she said the city’s efforts to date have produced results, notably an improvement in Petersburg’s municipal bond rating from junk status to investment-grade, adding that her fiscal goal is  to wean the city off its use of revenue anticipation notes. Indeed, with her proposed five-year plan in place to build Petersburg’s cash reserve fund to $6 million, a remarkable turnaround from the city’s negative balance in place at the time of the financial crisis, she testified that her proposed budget was intended to help provide stability to city government by seeing the plan through, noting: “I am committed…and our team is committed, to be here for the next five years.” Her proposed $77 million operating budget would boost spending on public safety and restore 10 percent cuts to municipal workers’ pay, while shrinking a workforce that consultants had charged was bloated and structurally inefficient. 

In the wake of her predecessor, William Johnson’s firing for his role in dipping into the city’s rainy day fund two years ago, Ms. Ferrell-Benavides said big goals within her proposal include building up the reserve, reducing reliance on grant funding, and being conservative with estimates. She testified that her proposed budget, overall, represents a $1.1 million decrease from the FY2018 amended budget, and proposes increasing the reserve to $950,000, adding that the city’s reserve funds are out of the red–and, in good gnus, that Petersburg’s bond rating has been upgraded from junk bond status. She noted that Department heads had been instructed to trim their expenses by 10%, but that cutting salaries was not an option. Her proposed budget includes $18.93 million for public safety, a $3 million increase from two years ago–with the increase part of an effort to stem the exodus of public safety workers to surrounding counties. For the city’s kids, she proposed a budget increase of $300,000 over the current $9.7 million level, telling the Mayor and Council: “This is a big step for us. And that was part of the priorities. Our goal is to annually increase our investment in the school system.” 

The consultants are scheduled to be back in Petersburg later this week and will submit an updated report in the coming weeks. Their perspective will help, as the City Council begins the process drill down into the details over the next two months through work sessions and a round of community meetings—meetings scheduled to begin at the end of this month and finish by the end of May: the Council is scheduled to make its recommended changes to the city manager on May 22nd, after which the city has scheduled a public hearing on June 5, with the Mayor Council scheduled to act on final adoption on June 12th.  

Petersburg, a city still not completely free from the grips of financial crisis, has rolled out a $73 million proposed operating budget that emphasizes public safety, more money for chronically under performing schools, and cuts to city departments.

April 3, 2018

Good Morning! In this morning’s eBlog, we consider the challenges of governance in insolvency. Who is in charge of steering a municipality, county, or U.S. territory out of insolvency? How? How do we understand and assess the status of the ongoing quasi chapter 9 municipal bankruptcy PROMESA deliberations in the U.S. territory of Puerto Rico. Then we head north to assess the difficult fiscal balancing challenges in Connecticut.

Governance in Insolvency.  Because, in our country, it was the states which created the federal government, making the U.S. unique in the world; chapter 9 municipal bankruptcy is only, in this country, an option in states which have enacted state legislation to authorize municipal bankruptcy. Thus, unsurprisingly, the process is quite different in the minority of states which have authorized municipal bankruptcy. In some states, such as Rhode Island and Michigan, for instance, the Governor has a vital role in which she or he is granted authority to name an emergency manager–a quasi-dictator to assume governmental and fiscal authority, usurping that of the respective city or county’s elected officials. That is what happened in the cases of Detroit and Central Falls, Rhode Island, where, in each instance, all authority was stripped from the respective Mayors and Councils pending a U.S. Bankruptcy Court’s approval of respective plans of debt adjustment, allowing the respective jurisdictions to emerge from municipal bankruptcy. Thus, in the case of those two municipalities, the state law preempted the governing authority of the respective Mayors and Councils.

That was not the case, however, in Jefferson County, Alabama–a municipal bankruptcy precipitated by the state’s refusal to allow the County to raise its own taxes. Nor was it the case in the instances of Stockton or San Bernardino, California: two chapter 9 cases where the State of California played virtually no role. 

Thus, the question with regard to governance in the event of a default or municipal bankruptcy is a product of our country’s unique form of federalism.

In the case of Puerto Rico, the U.S. territory created under the Jones-Shafroth Act, however, the issue falls under Rod Sterling’s Twilight Zone–as Puerto Rico is neither a municipality, nor a state: a legal status which has perplexed Congress, and now appears to plague the author of the PROMESA law, House Natural Resources Committee Chair Rob Bishop (R-Utah) with regard to who, exactly, has governing or governance authority in Puerto Rico during its quasi-chapter 9 bankruptcy process: is it Puerto Rico’s elected Governor and legislature? Is it the PROMESA Board imposed by the U.S. Congress? Is it U.S. Judge Laura Swain, presiding over the quasi-chapter 9 bankruptcy trial in New York City? 

Chairman Bishop has defended the PROMESA’s Board’s authority to preempt the Governor and Legislature’s ruling and governance authority, stressing that the federal statute gave the Board the power to promote “structural reforms” and fiscal authority, writing to Board Chair Jose Carrion: “It has been delegated a statutory duty to order any reforms–fiscal or structural–to the government of Puerto Rico to ensure compliance with the purpose of PROMESA, as he demanded the federally named Board use its power to make a transparent assessment of the economic impact of Hurricanes Irma and Maria on Puerto Rico’s fiscal conditions–and to ensure that the relative legal priorities and liens of Puerto Rico’s public debt are respected–leaving murky whether he intended that to mean municipal bonholders and other lien holders living far away from Puerto Rico ought to have a priority over U.S. citizens of Puerto Rico still trying to recover from violent hurricanes which received far less in federal response aid than the City of Houston–even appearing to link his demands for reforms to the continuity of that more limited federal storm recovery assistance to compliance with his insistence that there be greater “accountability, goodwill, and cooperation from the government of Puerto Rico…” Indeed, it seems ironic that a key Chairman of the U.S. Congress, which has voted to create the greatest national debt in the history of the United States, would insist upon a quite different standard of accountability for Puerto Rico than for his own colleagues.

It seems that the federal appeals court, which may soon consider an appeal of Judge Swain’s opinion with regard to Puerto Rico’s Highway and Transportation Authority not to be mandated to make payments on its special revenue debt during said authority’s own insolvency, could help Puerto Rico: a positive decision would give Puerto Rico access to special revenues during the pendency of its proceedings in the quasi-chapter 9 case before Judge Swain.

Stabilizing the Ship of State. Farther north in Connecticut, progressive Democrats at the end of last week pressed in the General Assembly against Connecticut’s new fiscal stability panel, charging its recommendations shortchange key priorities, such as poorer municipalities, education and social services—even as the leaders of the Commission on Fiscal Stability and Economic Growth conceded they were limited by severe time constraints. Nevertheless, Co-Chairs Robert Patricelli and Jim Smith asserted the best way to invest in all of these priorities would be to end the cycle of state budget deficits and jump-start a lagging state economy. The co-chairs aired their perspectives at a marathon public hearing in the Hall of the House, answering questions from members of four legislative committees: Appropriations; Commerce; Finance, Revenue and Bonding; and Planning and Development—where Rep. Robyn Porter (D-New Haven) charged: “I’m only seeing sacrifice from the same people over and over again,” stating she was increasingly concerned about growing income inequality, asking: “When do we strike a balance?” Indeed, New York and Connecticut, with the wealthiest 1 percent of households in those states earning more than 40 times the average annual income of the bottom 99 percent, demonstrate the governance and fiscal challenge of that trend. In its report, the 14-member Commission made a wide array of recommendations centered on a major redistribution of state taxes—primarily reducing income tax rates across the board, while boosting the sales and corporation levies. Ironically, however, because the wealthy pay the majority of state income taxes, the proposed changes would disproportionately accrue to the benefit of the state’s highest income residents—in effect mirroring the federal tax reform, leading Rep. Porter to question why the Commission made such recommendations, including another to do away immediately with the estate tax on estates valued at more than $2 million, but gradually phase in an increase to the minimum wage over the next four years.  From a municipal perspective, Rep. James Albis (D-East Haven), cited a 2014 state tax incidence report showing that Connecticut’s heavy reliance on property taxes to fund municipal government “is incredibly regressive,” noting it has the effect of shifting a huge burden onto lower-middle- and low-income households—even as the report found that households earning less than $48,000 per year effectively pay nearly one-quarter of their annual income to cover state and local taxes. Rep. Brandon McGee (D-Hartford), the Vice Chair of the legislature’s Black and Puerto Rican Caucus, said the Committee’s recommendations lack bold ideas on how to revitalize Connecticut’s poor urban centers—with his concerns mirrored by Rep. Toni E. Walker (D-New Haven), Chair of the House Appropriations Committee, who warned she fears a commission proposal to cut $1 billion from the state’s nearly $20 billion annual operating budget would inevitably reduce municipal aid, especially to the state’s cities. Co-Chair Patricelli appeared to concur, noting: “Candidly, I would agree we came up a little short on the cities,” adding that the high property tax rates in Hartford and other urban centers hinder economic growth: “They really are fighting with one or more hands tied behind their backs.”

The ongoing discussion comes amidst the state’s fiscal commitment to assume responsibility to pay for Hartford’s general obligation debt service payments, more than $50 million annually—a fiscal commitment which understandably is creating equity questions for other municipalities in the state confronted by fiscal challenges. Like a teeter-totter, balancing fiscal needs in a state where the state itself has a ways to go to balance its own budget creates a test of fiscal and moral courage.

The Steep & Winding Road Out of Municipal Bankruptcy and State Oversight

February 26, 2018

Good Morning! In this morning’s eBlog, we consider the hard road out of chapter 9 municipal bankruptcy and state oversight.

Motor City Races to Earn the Checkered Flag. Detroit Mayor Mike Duggan last Friday presented his proposed annual budget to the City Council, informing Councilmembers that, if approved, his $2 billion budget would be the keystone for formal exit from Michigan state oversight: that is, he advised he believed it would lay the ground work for ending the Financial Review Commission created in the wake of the city’s chapter 9 municipal bankruptcy: “Once we get this budget passed, we have the opportunity to get out from active state oversight…I don’t have enough good things to say about how the administration and Council has worked together.” As we had noted last month, Michigan Treasurer Nick Khouri, the Chair of the state oversight commission, made clear that the trigger to such an exit would be for the city to post its third straight budget surplus—with the Treasurer noting: “I think everyone, including me, has just been impressed with the progress that’s been made in the city of Detroit, both financially and operationally.”

For Detroit to fully emerge from the nation’s largest ever municipal bankruptcy, it must both comply with the provisions of the federal chapter 9 bankruptcy code, which provides that the debtor must file a plan (11 U.S.C. §941); neither creditors nor the U.S. Bankruptcy Court may control the affairs of a municipality indirectly through the mechanism of proposing a plan of adjustment of a municipality’s debts that would in effect determine the municipality’s future tax and/or spending decisions: the standards for plan confirmation in municipal bankruptcy cases are a combination of the statutory requirements of 11 U.S.C. §943(b) and portions of 11 U.S.C. §129. Key confirmation standards provide that the federal bankruptcy court must confirm a plan if the following conditions are met: the plan complies with the provisions of title 11 made applicable by sections 103(e) and 901;the plan complies with the provisions of chapter 9; all amounts to be paid by the debtor or by any person for services or expenses in the case or incident to the plan have been fully disclosed and are reasonable; the debtor is not prohibited by law from taking any action necessary to carry out the plan; except to the extent that the holder of a particular claim has agreed to a different treatment of such claim, the plan provides that on the effective date of the plan, each holder of a claim of a kind specified in section 507(a)(1) will receive on account of such claim cash equal to the allowed amount of such claim; any regulatory or electoral approval necessary under applicable non-bankruptcy law in order to carry out any provision of the plan has been obtained, or such provision is expressly conditioned on such approval; and the plan is in the best interests of creditors and is feasible.

Unlike in a non-municipal corporate bankruptcy (chapter 11), where the requirement that the plan be in the “best interests of creditors,” means in the “best interest of creditors” if creditors would receive as much under the plan as they would if the debtor were liquidated; under chapter 9, because, as one can appreciate, the option of Detroit to sell its streets, ambulances, and other publicly owned municipal assets is simply not an option, in municipal bankruptcy, the “best interests of creditors” test has generally been interpreted to mean that the plan must be better than other alternatives available to the creditors. It is not, in a sense, different from a Solomon’s Choice (Kings 3:16-28): that is, in lieu of the alternative to municipal chapter 9 bankruptcy of permitting each and every creditor to fend for itself, the federal bankruptcy court instead seeks to interpret what is in the “best interests of creditors” as a means to balance a reasonable effort by the municipality against the obligations it has to its retirees, municipal duties, service obligations, and its creditors—albeit, of course, leaving the door open for unhappy parties to object to confirmation, (see, viz. 11 U.S.C. §§ 901(a), 943, 1109, 1128(b)). The statute provides that a city or municipality may exit after a municipal debtor receives a discharge in a chapter 9 case after: (1) confirmation of the plan; (2) deposit by the debtor of any consideration to be distributed under the plan with the disbursing agent appointed by the court; and (3) a determination by the court that securities deposited with the disbursing agent will constitute valid legal obligations of the debtor and that any provision made to pay or secure payment of such obligations is valid. (11 U.S.C. §944(b)). Thus, the discharge is conditioned not only upon confirmation, but also upon deposit of the consideration to be distributed under the plan and a court determination of the validity of securities to be issued. (The Financial Review Commission is responsible for oversight of the City of Detroit and the Detroit Public Schools Community District, pursuant to the Michigan Financial Review Commission Act (Public Act 181 of 2014); it ensures both are meeting statutory requirements, reviews and approves their budgets, and establishes programs and requirements for prudent fiscal management, among other roles and responsibilities.)

As part of Detroit’s approved plan of debt adjustment, the State of Michigan mandated the appointment of a financial review commission to oversee the Motor City’s finances, including budgets, contracts, and collective bargaining agreements with municipal employees—a commission, ergo, which Mayor Duggan, last Friday, made clear would not simply disappear in a puff of smoke, but rather go into a “dormancy period: They do continue to review our finances, and if we in the future run a deficit, they come back to life, and it takes another three years before we can move them out.”

Mayor Duggan’s proposed budget includes an $8 million boost to Detroit’s Police Department budget—enough to hire 141 new full-time positions. With the increase, the Mayor noted, the city will be able to expand its Project Greenlight and Ceasefire programs—adding that the Motor City had struggled to fill police department vacancies until about two years ago when the City Council passed a new contract. Detroit had improved from its last place ranking in violent crime in 2014, moving up to second worst in 2015, vis-à-vis rates per resident in cities with 50,000 or more people: in 2014, Detroit had recorded 13,616 violent crimes, for a rate of about 994 incidents per 50,000 people, declining to 11,846 violent crimes in 2015, and to a violent crime rate of about 880. Since then, the city has been able to hire 500 new officers, albeit, as the Mayor noted: “This city is not nearly where it needs to be for safety.”  Additionally, Mayor Duggan said his budget allows Detroit to double the rate of commercial demolitions with a goal of having all “unsalvageable” buildings on major streets razed by 2019. That would put the city on track for cleaning up its commercial corridors, he added. The budget allocates $100 million of the unassigned fund balance to blight remediation and capital projects, which is double the resources allocated last fiscal year. Other budget plans include more funding for summer jobs programs and Detroit At Work; neighborhood redevelopment plans for areas such as Delray, Osborn, Cody Rouge, and East English Village; and boosting animal control so it can operate seven days a week.

The $2 billion budget dedicates $1 billion to the city’s general fund. Chief Financial Officer John Hill said it is able to maintain its $62.3 million budget reserve, which exceeds the $53.6 million requirementCouncilman Scott Benson said the Mayor presented a “conservative fiscal budget” which allows Detroit to live within its means. The Councilmember said prior to the meeting that he had hoped the budget would address funding for poverty and neighborhood revitalization. However, council members received the budget 20 minutes before the meeting and Councilmember Benson said he needed more time to review it. “We’re seeing some good things,” he said of Mayor Duggan’s proposals, “But I want to dig into the numbers and actually go through it with a fine-tooth comb.” Officials say city council has until March 9 to approve the budget.

That early checkered flag for the Motor City ought to help salve the city’s reputational wounds in the wake of the KO administered to the city’s bid to host Amazon. Indeed, as Quicken Loans Chairman Dan Gilbert wrote, it was Detroit’s negative reputation, not a lack of talent which knocked it out of the running for an Amazon headquarters, as he tweeted to the 60-plus member bid committee who crafted Detroit’s bid: “We are all disappointed,” referring to the city’s failed bid to make the cut for the top 20 finalists. Nevertheless, Mr. Gilbert urged members not to accept the “conventional belief” that Detroit had fallen short because of its challenges with regional transportation and attracting talent; rather, he wrote, the “elephant in the room” was the nasty reputation associated with the post-bankruptcy city’s 50-plus years of decline: “Old, negative reputations do not die easily. I believe this is the single largest obstacle that we face…Outstanding state-of-the-art videos, well-packaged and eye-catching proposals, complex and generous tax incentives, and highly compelling and improving metrics cannot, nor will not overcome the strong negative connotations that the Detroit brand still needs to conquer.” Regional leaders had been informed that Detroit’s bid had failed to move on because of inadequate mass transit and questionable ability to attract talent.

As part of Detroit’s approved plan of debt adjustment, the State of Michigan mandated the appointment of a financial review commission to oversee the Motor City’s finances, including budgets, contracts, and collective bargaining agreements with municipal employees—a commission, ergo, which Mayor Duggan, last Friday, made clear would not simply disappear in a puff of smoke, but rather go into a “dormancy period: They do continue to review our finances, and if we in the future run a deficit, they come back to life, and it takes another three years before we can move them out.”

Mayor Duggan’s proposed budget includes an $8 million boost to Detroit’s Police Department budget—enough to hire 141 new full-time positions. With the increase, the Mayor noted, the city will be able to expand its Project Greenlight and Ceasefire programs—adding that the Motor City had struggled to fill police department vacancies until about two years ago when the City Council passed a new contract. Detroit had improved for its last place raking in violent crime in 2014, moving up to second worst in 2015, vis-à-vis rates per resident in cities with 50,000 or more people: in 2014, Detroit had recorded 13,616 violent crimes, for a rate of about 994 incidents per 50,000 people, declining 11,846 violent crimes in 2015, and to a violent crime rate of about 880. Since then, the city has been able to hire 500 new officers, albeit, as the Mayor noted: “This city is not nearly where it needs to be for safety.”  Additionally, Mayor Duggan said his budget allows Detroit to double the rate of commercial demolitions with a goal of having all “unsalvageable” buildings on major streets razed by 2019. That would put the city on track for cleaning up its commercial corridors, he said. The budget allocates $100 million of the unassigned fund balance to blight remediation and capital projects, which is double the money allocated last fiscal year. Other budget plans include more funding for summer jobs programs and Detroit At Work; neighborhood redevelopment plans for areas such as Delray, Osborn, Cody Rouge and East English Village, and boosting animal control so it can operate seven days a week. 

The $2 billion budget dedicates $1 billion to the city’s general fund. Chief Financial Officer John Hill said Detroit is able to maintain its $62.3 million budget reserve, which exceeds the $53.6 million requirementCouncilman Scott Benson said the mayor presented a “conservative fiscal budget” that allows Detroit to live within its means, having said, prior to the meeting, that he hoped the budget would address funding for poverty and neighborhood revitalization. However, council members received the budget 20 minutes before the meeting and Councilmember Benson said he needed more time to review it. “We’re seeing some good things,” he said of Mayor Duggan’s proposals. “But I want to dig into the numbers and actually go through it with a fine-tooth comb.” Officials say city council has until March 9 to approve the budget.

Returning from Municipal Bankruptcy

February 7, 2017

Good Morning! In today’s Blog, we consider the remarkable signs of fiscal recovery from the largest municipal bankruptcy in U.S. history, before returning to consider the ongoing fiscal recovery of Atlantic City, where the chips had been down, but where the city’s elected leaders are demonstrating resiliency.

Taking the Checkered Flag. John Hill, Detroit’s Chief Financial Officer, this week reported the Motor City had realized its first net increase in residential property values in more than 15 years. Although property taxes, unlike in most cities and counties, in Detroit only account for 17.1% of municipal revenues (income taxes bring in 20.4%), the increase marked the first such increase in 16 years—demonstrating not just the fiscal turnaround, but also indicating the city’s revitalization is spreading to more of its neighborhoods. Mr. Hill described it as a “positive sign of the recovery that’s occurring in the city,” and another key step to its emergence from strict state fiscal oversight under the city’s chapter 9 plan of debt adjustment. As Mr. Hill put it: “We do believe that we’ve hit bottom, and we’re now on the way up.” Nevertheless, Mr. Hill was careful to note he does not anticipate significant gains in property tax revenues in the immediate future, rather, as he put it: “[O]ver time, it will certainly have a very positive impact on the city’s revenue.” According to the city, nearly 60 percent of residents will experience a rise of 10 percent or less in assessments this year: the average assessed home value in Detroit is between $20,000 and $50,000. The owner of a home within that range could see an increase in their taxes this year of $22 to $34, according to Alvin Horhn, the city’s chief assessor. Detroit has the seventh highest rate among Michigan municipalities, with a 70.1 mills rate for owner-occupied home in city of Detroit/Detroit school district. Mr. Hill noted that for Detroit properties which show an increase in value this year, the rate will be capped; therefore he projects residents will not experience significant increases except for certain circumstances, such as a property changing hands.

Nevertheless, in the wake of years in which the city’s assessing office had reduced assessments across Detroit to reflect the loss in property values, the valuation or assessment turnaround comes as, in the past decade, the cumulative assessed value of all residential property was $8.4 billion, officials noted Monday: and now it is on the rise: last year, that number was $2.8 billion; this year, the assessed value of Detroit’s 263,000 residential properties rose slightly to $3 billion—or, as Mr. Horhn noted: “For the last 12 to 17 years, we’ve been making massive cuts in the residential (property) class to bring the values in line with the market…It’s been a long ride, but for the first time in a very long time, we see increases in the residential class of property in the city of Detroit.” This year’s assessments come in the wake of a systemic, citywide reassessment of its properties to bring them in line with market value—a reassessment initiated four years ago as part of a state overhaul to bring Detroit’s assessment role into compliance with the General Property Tax Act to ensure all assessments are at one half of the market value and that like properties are uniform. That overhaul imposed a deadline of this August for Detroit to comply with state oversight directives imposed in 2014 in the wake of mismanagement in Detroit’s Assessment Division, widespread over-assessments, and rampant tax delinquencies in the wake of an investigation finding that Detroit was over assessing homes by an average of 65%, based upon an analysis of more than 4,000 appeal decisions by a state tax board. Mr. Hill asserts now that he is confident Detroit’s assessments are fair; better yet, he reports the fixes have led to more residents paying property taxes. Indeed, city officials note that property tax collections increased from an average rate of 69% in 2012-14 to 79 percent in 2015, and 80 percent in 2016; the collection rate for 2017 is projected to be 82%. Mayor Mike Duggan, in a statement at the beginning of the week, noted: “We still have a long way to go to in rebuilding our property values, but the fact that we have halted such a long, steep decline is a significant milestone…This also corresponds with the significant increase in home sale prices we have seen in neighborhoods across the city.”

At the same time, Mr. Horhn notes that Detroit’s commercial properties have increased in value to nearly $3 billion, while industrial properties recovered from a drop last year, rising from $314 million to $513 million. He added that the demolition of blighted homes, as well as improving city services, had contributed to the rise in assessed property values: “It’s perception to a large extent: If people believe things are improving, they’ll invest, and I think that’s what we’re seeing.”

Raking in the Chips? In the wake of a state takeover, and the loss—since 2014, of 11,000 jobs in the region, Atlantic City marked a new step in its fiscal recovery with interviews commencing for the former bankrupt Trump Taj Mahal casino to reopen this summer as a Hard Rock casino resort. Indeed, 1,400 former Taj Mahal employees applied after an invitational event, marking what Hard Rock president Matt Harkness described as the “first brush stroke of the renaissance.” The casino is projected to create more than 3,000 jobs—and to be followed by the re-opening Ocean Resort Casino, which will add thousands of additional jobs. The rising revenues come after, last year, gambling revenue increased for the second consecutive year, marking a remarkable turnaround in the wake of a decade in which five of the city’s 12 casinos shut down, eliminating 11,000 jobs—and, from the fiscal perspective, sharply hurt assessed property values and property tax revenues. New Jersey Casino Control Commission Chair James Plousis noted: “Every single casino won more, and every internet operation reported increased win last year…Total internet win had its fourth straight year of double-digit increases. It shows an industry that is getting stronger and healthier and well-positioned for the future.” In fact, recent figures by the New Jersey Division of Gaming Enforcement show the seven casinos won $2.66 billion in 2017, an increase of 2.2 percent over 2016. Christopher Glaum, Deputy Chief of Financial Investigations for the gaming enforcement division, noted that 2017 was the first year since 2006 when a year-over-year increase in gambling revenue at brick-and-mortar casinos occurred. Moreover, many are betting on the recovery to gain momentum: two of the five casinos which were shuttered in recent years are due to reopen this summer: the Taj—as reported above—under its new ownership, and the Revel, which closed in 2014, will reopen as the Ocean Resort Casino. The fiscal bookies are, however, uncertain about the odds of the reintroduction of two new casinos, apprehensive that that could over saturate the market; however, the rapid increase in internet gaming, which, last year, increased earnings for the casinos by 25 percent appear to demonstrate momentum.  

Now, the fiscal challenge might rest more at the state level, where the new administration of Gov. Phil Murphy, who promised major spending initiatives during his campaign, had been counting on revenue increases from restoring the income tax surcharge on millionaires and legalizing and taxing marijuana. The latter, however, could go up in a proverbial puff of weed—and, in any event, would arrive too late for this year’s Garden State budget. Similarly, the new federal “tax reform” act’s capping on the deduction for state and local taxes will mean increased federal income taxes most for well-off residents of high-tax states such as New Jersey—raising apprehension that a new state surcharge might encourage higher income residents to leave. That effort, however, has been panned by the New Jersey Policy Perspective, which notes: “Policy changes to avoid the new $10,000 cap on state and local tax deductions would mostly benefit New Jersey’s wealthiest families.” New Jersey Senate President Steve Sweeney (D-West Depford) notes: “We don’t have a tax problem in New Jersey. New Jersey collects plenty in taxes. We have a government problem in New Jersey, and it’s called too much of it,” noting he has tasked a panel of fellow state Senators and tax experts to “looking at everything,” including the deduction issue. In addition, he is seriously considering shifting to countywide school districts, where possible, in an effort to reduce costs. Or, as he put it: “There is a lot of money to be saved when you do things differently.” Turning to efforts to restore Atlantic City’s finances, the state Senate President said the city is “doing great;” nevertheless, noting that talk about ending the state takeover is unrealistic: “We can adjust certain things there” and Governor Murphy will select someone new to be in charge. But end the state takeover?  “Absolutely not and it’s legislated for five years.”

It seems ironic that in the city where Donald Trump’s company filed for bankruptcy protection five times for the casinos he owned or operated in the city, he was able to simply walk away from his debts: he argued that he had simply used federal bankruptcy laws to his advantage—demonstrating, starkly, the difference between personal and municipal bankruptcy.

Balancing Fiscal & Public Safety

January 9, 2017

Good Morning! In today’s Blog, we consider the potential fiscal impact of the expiration of the State of New Jersey’s public safety arbitration cap—with the expiration coming as Governor-elect Phil Murphy has been reviewing a report examining the implications for property taxes, state spending, collective bargaining agreements, and public safety. Then we journey south to witness the denouement of the fiscal siege of the historic municipality of Petersburg, Virginia.

Uncapping & Fiscal Impacts. The State of New Jersey’s statute capping public safety arbitration awards at 2% has been in effect for seven years—it was last extended in 2014. Now, with a new Governor taking office, Moody’s has warned that its expiration on the last day of 2017 is a credit negative for the Garden State—and for its municipalities and counties. Indeed, the New Jersey League of Municipalities has been joined by the New Jersey Association of Counties, the New Jersey Conference of Mayors, the New Jersey Chamber of Commerce, New Jersey Business and Industry Association, and the New Jersey Realtors Association to urge the new Governor and Legislature to support permanently extending the 2% cap Interest Arbitration Cap, noting that an expired cap would have a negative impact on property taxes and jeopardize the continued delivery of critical services, as well as adversely impact residential and commercial property taxpayers, working class families, and those on fixed incomes. The League’s President, Mayor James Cassella of East Rutherford, noted that the 2% Interest Arbitration Cap has controlled costs: without the cap, municipalities could see costly arbitration awards that would force local officials to reduce services or lay off employees to satisfy the arbitrator’s award and stay within the 2% levy cap. Similarly, New Jersey Association of Counties President Heather Simmons, a Gloucester County Freeholder, noted that failure to permanently extend the 2% cap on binding interest arbitration awards would inequitably alter the collective bargaining process in favor of labor at the expense of taxpayers, and lead to awards by arbitrators with no fiduciary duty to deliver essential services in a cost-effective manner.

Now Moody’s has moodily weighed in, deeming the expiration a credit negative for the state’s cities and  counties, as has Fitch Ratings.

In New Jersey, interest arbitration is a process open only to police and fire employee unions: it is a mechanism to resolve collective bargaining disputes between local governments and unions: when a public employer is unable to reach a contract agreement with a police or fire union, an arbitrator is called in to decide the terms of the contract. When the state adopted the 2 percent property tax levy cap, a separate 2 percent cap on interest arbitration awards was also imposed: that mandates arbitrators to take property taxes into account when issuing awards and providing local officials with a now proven and effective tool to contain property tax increases. The arbitration cap expired on Dec. 31; however, the property tax levy cap is permanent. The New Jersey League noted: “For nearly a decade, the 2 percent cap on binding interest arbitration awards has kept public safety employee salaries and wages under control simply because parties have been closer to reaching an agreement from the onset of negotiations. Moreover, the 2 percent cap on binding interest arbitration awards has established clear parameters for negotiating reasonable successor contracts that preserve the collective bargaining process and take into consideration the separate 2 percent tax levy cap on overall local government spending. And, importantly, the 2 percent cap on binding interest arbitration awards has not negatively impacted public safety services or recruitment.

In the wake of the expiration of the arbitration cap, it appears likely that arbitrator contract awards would exceed 2 percent. That would likely force cities and counties in the Garden State to reduce or eliminate municipal services—or go to the voters to seek approval to exceed the 2 percent property tax cap in order to fund an arbitration award.

Moody’s analyst Douglas Goldmacher moodily noted: “Given that salary costs are among the largest of municipal expenditures, the cost implications are obvious and considerable. The effect of this is, in most cases, unlikely to be rapid, but ultimately, the loss of the arbitration cap is likely to cause the sector’s credit quality to deteriorate…Although the cap has expired, and it may not be finished. Numerous local governments and local government advocacy groups support the arbitration cap. It is possible that the new governor and New Jersey state Legislature will revisit the matter. Until and unless that occurs, there will be a potentially dangerous mismatch between revenue and expenditures.” The statute, which caps public safety arbitration awards at 2%, came into force on January 1, 2011; it was extended for a three-year period in 2014 when it was last up for renewal. Mr. Goldmacher noted: “The cap played a major role in helping local governments manage public safety costs by instituting a limit on increases in police and fire salaries in arbitration and effectively tying the salary increases to the municipality’s or county’s revenue-raising capabilities…The cap’s expiration, should it prove permanent, is a credit negative for all local governments.” Mr. Goldmacher noted the cap’s existence has been a “valuable tool” in contract negotiations when police and firefighter unions with negotiators often forced to consider small salary increases. A September report by former Gov. Chris Christie’s appointees to the Police and Fire Public Interest Arbitration Impact Task Force stated that municipal property taxes jumped at an annual average of 7.19% for the five years prior to the cap compared to 2.41% since 2011. The report also estimated that the cap has saved taxpayers a collective $429 million. Thus, Mr. Goldmacher notes: “Given that salary costs are among the largest of municipal expenditures, the cost implications are obvious and considerable: Police and fire contracts often serve as a benchmark contract for other negotiations, which had the effect of making a 2% annual increase something of a standard target for most contracts, even for non-public safety collective bargaining units.” While it is possible the cap may be reinstated, Mr. Goldmacher added that as long as no action is taken to address the lapse, New Jersey’s cities and counties confront “a potentially dangerous mismatch” aligning revenue and expenditures, because of how much a 2% property tax cap law would limit their budgetary flexibility, writing: “The effect of this is, in most cases, unlikely to be rapid, but ultimately, the loss of the arbitration cap is likely to cause the sector’s credit quality to deteriorate,” he said. “The degree of deterioration will depend on the idiosyncratic qualities of the given community.”

For its part, Fitch wrote: “…the arbitration cap is beneficial to local government credit quality as it helps to align revenue and spending measures and supports structural balance in the context of statutory caps on property tax growth…bargaining groups may become more emboldened to pursue arbitration as opposed to voluntary settlement if the arbitration cap expires. Arbitration awards were significantly higher prior to the cap, ranging from 2.50% to 5.65% from 1993-2010, according to a report of the New Jersey Public Employment Relations Commission (PERC.)” Fitch also noted that the elimination of the arbitration cap “could force local governments to reduce governmental services and/or rely on one-time resources to accommodate higher wage expenses.”

The Fiscal Siege of Petersburg. Jack Berry, Robert Bobb, and Nelsie Birch, writing in a piece, “Overcoming the latest siege of Petersburg, referenced the city’s then vital role in the Civil War, where, as they wrote: “The series of battles known as the Siege of Petersburg lasted nine months and consisted of devastating trench warfare. It featured the largest concentration of African-American troops in the war, who suffered enormous casualties at the Battle of the Crater.” They went on to write: “Some would say that Petersburg has been under siege ever since the Civil War, that there is a siege mentality in the city. Petersburg even has a Siege Museum…But Petersburg has not always been under siege; it is not today, and it will not be tomorrow. Noting that Petersburg was once the second largest city in Virginia—and home to the largest number of free blacks in Virginia, they noted that it was once “a wealthy city, a major industrial center, and one of the largest rail hubs in the nation,” where, in the wake of the Civil War, a “coalition of Africa-American and white, populist Republicans, controlled the state legislature, which led to the creation of two large public institutions in the region: Virginia State University and Central State Hospital. Later, Fort Lee became another major economic engine for the area.” The authors noted, however, that “Jim Crow laws and Massive Resistance devastated the hopes and dreams of black citizens and fueled racial tensions. In 1985, one of the city’s largest employers, Brown & Williamson Tobacco, shut down its Petersburg factory. Later, Southpark Mall was located north of the city, sucking retail sales out of Petersburg.” These events adversely affected assessed property values—in turn reducing investment in public schools. The historic city seemed on a route to chapter 9 municipal bankruptcy—or being, as they wrote: “relinquishing city status—and being subsumed by neighboring jurisdictions,” all because of what they described as a “self-inflicted, mismanaged city government” which “ran itself into a ditch: In July of 2016, the city faced $18 million in unpaid bills. The budget was $12 million out of balance. Petersburg had nearly run out of cash and was dipping into every available pot of money, regardless of restrictions, to pay bills. A botched water meter conversion project impacted utility billings, which made the cash situation even worse.”

Because the Commonwealth of Virginia was apprehensive that a default by Petersburg would have had severe fiscal repercussions for municipalities across the state, the Commonwealth, as we have previously written, provided a consulting team to diagnose the fiscal issues and recommend fiscal measures—including, in its recommendations, pay cuts of 10 percent pay cuts for the entire city workforce. Even as the state-imposed overseer was acting, an aroused citizenry, via a grassroots group called “Clean Sweep,” attended every City Council session, demanding greater fiscal accountability. A year ago last October, former Mayor Howard Meyers and the City Council brought in a fiscal posse in an effort to restructure, hiring former Richmond City Manager Robert Bobb and his team, who set up a temporary war room in the City Hall building where General Robert E. Lee had met with his senior Confederate officers during the Siege of Petersburg. Mr. Bobb wrote of the fiscal war room: “We dug in for the long haul, with Nelsie Birch leading efforts to peel back layers of the financial onion. We got a handle on cash flow, figured out the extent of the unpaid bills, found checks stashed in drawers, arranged short-term financing, crafted a new budget, dramatically cut spending, put pressure on the city treasurer to collect taxes, and revamped the decrepit utility system…New financial policies were put in place; debt was restructured; water and sewer rates were increased to comply with debt covenants; the organization was right-sized; new managers were hired.”

Mr. Bobb described this war room process as one in which—at the same time—his team teamed with Mayor Sam Parham and the members of the Petersburg City Council “every step of the way,” to make the tough decisions, adding that, during this process, “Our strongest ally was the Governor’s Office, in particular, Virginia Secretary of Finance Ric Brown.” Indeed, by last November, external auditors reported a signal fiscal turnaround: Petersburg reported a year-end surplus of $7.2 million—and the report was on time; the auditor’s opinion was clean.