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.”

Getting Out of Insolvency & Back on Fiscal Track

eBlog, 04/14/17

Good Morning! In this a.m.’s eBlog, we consider the ongoing recovery of Atlantic City, New Jersey—where the Mayor this week proposed, in his first post-state takeover budget, the first tax cuts in a decade. Then we head west to the Motor City, where the city, as part of its fiscal recovery from the largest municipal bankruptcy in American history is seeking to ensure all its taxpayers pay what they owe, before then veering south to assess the first 100 days of the PROMESA oversight of the U.S. Territory of Puerto Rico.

Getting Back on the Fiscal Track. Atlantic City Mayor Don Guardian this week presented his proposed $206 million budget to the City Council, which unanimously voted 7-0 to introduce it at a special meeting, and the City has scheduled a public budget hearing for May 17th. In a taste of the fiscal turnaround for the city, the proposed budget includes the first municipal tax decrease in a decade. It also marks the first budget for the city since the State of New Jersey usurped control over Atlantic City’s finances last November. As proposed, it is more than $35 million or 21% less than last year’s and would reduce the municipal tax rate by 5 percent, according to both city and state officials. The city has scheduled a public budget hearing for May 17th.

As proposed, the steepest cut is in public safety—some $8 million, but the draft proposal also seeks cuts in administration costs ($5 million), as well as proposing savings via the privatization of trash pickup, payroll, and vehicle towing services. The smaller budget request is projected to reduce the city’s costs of debt service by $6 million. Unsurprisingly, the proposed tax cuts—the first in nearly a decade, drew the strongest applause: Atlantic City’s municipal tax rate has skyrocketed 96 percent since 2010, a period during which the city’s tax base dropped by nearly 66%. The $206.3 million budget Mayor Guardian presented features $6 million of cuts to debt service at $30.8 million and proposes to allocate $8 million less for public safety.

Mayor Guardian, who is running for his second term as Mayor this fall, said in a statement before presenting the budget that state overseers have played an instrumental role in crafting the new spending plan which features the proposed 5% property tax cut. It could mark a key point in the city’s efforts to regain governance control back from the State of New Jersey—a takeover the Republican mayor had bitterly contested, which took effect last November after New Jersey’s Local Finance Board rejected the city’s five-year recovery plan, or, as the Mayor put it: “From the beginning, I have said that we need to work with the State of New Jersey to stabilize Atlantic City and to reduce the outrageous property taxes that we inherited from years of reckless spending…Even though the entire state takeover was both excessive and unnecessary, the state did play an important role in helping us turn things around.”

For his part, New Jersey Gov. Chris Christie praised former U.S. Sen. Jeffrey Chiesa for his role as the state’s designee leading the financial recovery and his contributions in helping to achieve the city’s first property tax cut in a decade. Gov. Christie credited Mr. Chiesa with withstanding union challenges to make firefighter and police cuts, as well as reaching a $72 million settlement with the Borgata casino which is projected to save the city $93 million on $165 million of owed property tax refunds from 2009 to 2015, noting: “As promised, we quickly put Atlantic City on the path to financial stability, with taxpayers and employers reaping the benefits of unprecedented property tax relief with no reduction in services by a more accountable government…I commend Senator Chiesa for leading Atlantic City to turn the corner, holding the line on expenses and making responsible choices to revitalize the city.”

Atlantic City is planning to issue $72 million in municipal bonds to finance the Borgata settlement though New Jersey’s Municipal Qualified Bond Act: the savings from the settlement, brokered by the state, were a key factor in S&P Global Ratings’ upgrade of Atlantic City’s junk-level general obligation bond debt: Atlantic City, which is weighed down by some $224 million in bonded debt, is rated Caa3 by Moody’s Investors Service. State overseer Chiesa noted: “Over the past five months, I have met so many smart, talented, tenacious people who want to see the city succeed. This inspires me every day to tackle the challenges facing the city to ensure that the progress we’ve made continues.”

A key contributor to the improved fiscal outlook appears to come from some of the unilateral contract changes to public safety officials, imposed by Mr. Chiesa, which led to reduced salaries and benefits for police and firefighters, albeit the courts will have the final say so: the unions have sued to block the cuts, arguing the takeover law is unconstitutional. In addition, the state also reach agreement on a $72 million tax settlement with Borgata Hotel Casino & Spa which is projected to save Atlantic City $93 million and essentially put Borgata back on its tax rolls. The casino had withheld property tax payments, but is now paying its part of casino payments in lieu of property taxes, or, as Mr. Chiesa put it: “Real progress is being made in the city, which is great news for the people who live, work and visit Atlantic City.”

Gov. Chris Christie, in his final term in office, praised Mr. Chiesa and jabbed at his political opponents in a statement issued before the City Council meeting, noting: “It took us merely a few months to lower property taxes for the first time in the past decade, when local leaders shamelessly spent beyond their means to satisfy their special political interests,” he said, even as Atlantic City officials described the budget as a collaborative effort with the state. Or, as Mayor Guardian put it: “He’s the governor. He makes those comments…What I think is [that] it’s clear the city moves ahead with the state.” Council President Marty Small, who chairs the Revenue and Finance Committee, said he was “intimately involved” in the budget process, describing it as a “win-win-win for everybody, particularly the taxpayers.”

Don’t Tax Me: Get the Feller behind the Tree! Getting citizens to pay their taxes is a problem everywhere, of course, but Detroit had a particularly hard time going after scofflaws because budget cuts decimated its ability to enforce the law. Even the citizens and businesses who paid up created logistical havoc for beleaguered city bureaucrats. Part of the reason, it seems, is that in Detroit, the only way to file taxes has been on paper. While that might be merely an irritation for taxpayers, it has been a nightmare for the city’s revenuers, who must devote endless hours typing data into computer systems. It appears also to have led to some innovation: last year the Motor City opted to send out more than 7,000 mailings to deadbeat tax filers, that is taxpayers who were still delinquent on their 2014 taxes; the city suspected each delinquent owed at least $350; ergo it randomly selected some taxpayers to receive one of six different letters, each with a different message in a black box on the mailing: One such message appealed to residents’ civic pride: “Detroit’s rising is at hand. The collection of taxes is essential to our success.” Another simply made clear that Detroit’s revenue department had detailed information on the deadbeats: “Our records indicate you had a federal income of $X for tax year 2014.” (Detroit is somewhat unique in that it has an income tax under which residents owe 2.4 percent of their incomes to the city, after a $600 exemption. Nonresidents who work in Detroit pay a rate of 1.2 percent.) Another message made a bold declaration: “Failure to file a tax return is a misdemeanor punishable by a fine of $500 and 90 days in jail.”

It seems that threats have proven more effective than cajoling: More than 10 percent of taxpayers responded to the letter mentioning a fine and jail time, some 300% greater than the response rate to the city’s basic control letter. This revenue experiment was overseen by Ben Meiselman, a graduate student at the University of Michigan’s economics department, who manned a desk in Detroit’s tax office to run the experiment. He wrote the messages included in the mailings to reflect behavioral economics research, noting: “I find that a single sentence, strategically placed in mailings to attract attention, can have an economically meaningful impact on tax filing behavior,” in his working paper, “Ghostbusting in Detroit: Evidence on Non-filers from a Controlled Field Experiment,” which he intends to eventually become a chapter in his doctoral dissertation. And it turns out that providing details of a taxpayer’s income boosted the response rate by 63 percent, even as a letter from the city which combined a threat with income information was less effective than a threat by itself. Or, as one city official noted: “Keeping it simple seems to be the key,” especially as city officials learned that appeals to civic pride fell flat: the response rate was just 0.8 percentage points higher than that of a basic letter. Nevertheless, the city still confronts a long uphill fiscal cliff, even if it manages to apply the results of the experiment and triple the response rate from tax delinquents: according to the IRS, approximately six percent of U.S. taxpayers break the law by not filing with the Service each year, but, in Detroit, Mr. Meiselman estimated that some 46 percent of taxpayers had not submitted their 2014 returns by the due date in the following year—and that the return rate was getting worse.

Thus, Detroit’s next step was to back up threats with action—mayhap especially because there appears to have been little enforcement for the past decade: Detroit had not undertaken an audit or tax investigation in more than a decade. One outcome of insolvency and municipal bankruptcy, it appears, can hit hard: Detroit’s tax office, which once had a staff of about 70, is today about half that: it is a department which was recently reorganized, in the wake of last year’s takeover by the state of Michigan, a takeover intended to free up city employees to collect unpaid income taxes. The city also eased such filings by permitting them to be submitted electronically for the first time. And, wow!: 77 percent of filers took advantage. Detroit has sent out 15,000 letters since July 2016 and has collected $5.3 million through letters, audits, and investigations. And some of the amounts collected are significant, particularly for those who have juked, dodged, and evaded paying taxes for years: in one instance, a taxpayer agreed to pay $400,000. Detroit also began filing misdemeanor charges and lawsuits in small claims court to get its tax revenues, especially after learning that only one in five residents in several high-end apartments buildings had filed income taxes, helping to persuade a judge to issue an order requiring landlords to turn over tenant information.

These various steps appears to be helping: The number of residents filing tax returns more than doubled last year from the previous year; filings by non-residents increased by more than a third. City returns from 2016 are due, along with state and federal returns, by next Tuesday—the same deadline as applies to all readers of this eBlog, and, this year, Detroit officials are optimistic—or, as one wag put it: In the past, “people knew we weren’t coming after them…Now we are following up on those threats.”

The Promise or PROMESA of the First 100 Days. The PROMESA oversight board, provided by the Congress with authority over the U.S. territory of Puerto Rico, has now surpassed its first one hundred days, created a juxtaposed governance challenge, especially for Governor Rosselló: how can he make sure that the framework set up during this period of quasi dual governance provides for the change Puerto Rico needs? How can he gain the approval of the Board for a long-term fiscal plan as the main achievement of his incipient administration? To prevail, it appears, he will have to convince the Oversight Board that his proposed budgets are based on real possibilities of revenues and that such estimates are free of dependence on loans and that he will conduct the restructuring of Puerto Rico’s public debt on favorable terms, and that he will take the key role in the reconstruction of the government apparatus to higher levels of service, efficiency, participation, and transparency. And, now, there appears to be some evidence that he is achieving progress. Puerto Rico’s statute on permits is intended address a serial inefficiency with regard to the “absurd and abusive terms” to obtain permits, delays which have hindered and discouraged the generation of new economic activity. The effort to provide for the progressive elimination of the costly redundancy in programs and services via the consolidation of agencies, with security first, appear to be key steps in achieving changes to restore financial health. Moreover, the creation of a spending budget 10 per cent below the current one appears to mark an important step in the goal of reasserting self-governance.

Nevertheless, the fiscal and governance challenges of recovering from fiscal insolvency can be beset from any angle: note, for instance, Judge Lauracelis Roques Arroyo has revived an “audit” of Puerto Rico’s debt and reversed Gov. Ricardo Rosselló’s attempt to dismantle the debt audit commission. (Judge Roques Arroyo is a member of the Carolina Region of the Puerto Rico Superior Court.) And, thus, he has ruled that Puerto Rico Gov. Ricardo Rosselló’s attempt to dismantle a commission auditing Puerto Rico’s debt was illegal. The statute in question, law 97 of 2015, created the Puerto Rico Commission for the Comprehensive Audit of the Public Credit. The commission aimed to find Puerto Rico debt which was legally invalid. The commission’s first report in June of last year had reviewed documents connected with the Commonwealth’s $3.5 billion general obligation bond and $1.2 billion tax and revenue anticipation note, both sold in 2014. In this report, the Commission had raised doubts with regard to the legality of much of Puerto Rico’s bond debt. Late last September, the commission questioned the legality of the series 2013A power revenue bonds from the Puerto Rico Electric Power Authority (PREPA), raising concerns with regard to the behavior of Morgan Stanley, Ernst &Young, and URS Corp. in the municipal bond sale and the period leading up to it. In early October, possibly in response to the commission’s work, the SEC commenced an investigation of PREPA’s 2012 and 2013 bonds. Ergo, Judge Arroyo’s order late last week returned three public interest members to the board, according to attorney Manuel Rodriguez Banchs; the order provided that the Governor has no authority to intervene with the commission: it said that the dismissal of the public interest members was illegal. The board has $650,000 in its account right now, according to board member Roberto Pagán, e.g. adequate to do a substantial amount of additional work. Gov. Rosselló, thus, is considering how to react to the judge’s order, according to the El Vocero news website.

The Art & Commitment of Municipal Fiscal Recovery

eBlog, 04/11/17

Good Morning! In this a.m.’s eBlog, we consider the ongoing recovery of the city of Flint, Michigan, before heading east to one of the smallest municipalities in America, Central Falls, Rhode Island, as it maintains its epic recovery from chapter 9 municipal bankruptcy, before finally turning south to assess recent developments in Puerto Rico. We note the terrible shooting yesterday at North Park Elementary School in San Bernardino; however, as former San Bernardino School Board Member Judi Penman noted, referring to the police department: “It is one of the most organized and well-prepared police departments around, and they are well prepared for this type of situation.” Indeed, even if sadly, the experience the city’s school police department gained from coordinating with the city’s police department in the wake of the December 2, 2015 terrorist attack appeared to enhance the swift and coordinated response—even as calls came in yesterday from the White House and California Gov. Jerry Brown to offer condolences and aid, according to San Bernardino Mayor Carey Davis.

Could this be a Jewel in the Crown on Flint’s Road to Fiscal Recovery? In most instances of severe municipal fiscal distress or bankruptcy, the situation has been endemic to the municipality; however, as we have noted in Jefferson County, the state can be a proximate cause. Certainly that appears to have been the case in Flint, where the Governor’s appointment of an emergency manager proved to be the proverbial straw that broke the camel’s back at an exceptional cost and risk to human health and safety. The fiscal challenge is, as always, what does it take to recover? In the case of Flint, the city’s hopes appear to depend upon the restoration of one of the small city’s iconic jewels: the historic, downtown Capitol Theatre—where the goal is to restore it to its original glory, dating back to 1928, when it opened as a vaudeville house: it was listed on the National Register of Historic Places in 1985, but has been empty now for more than a decade—indeed, not just empty, but rather scheduled to become still another parking lot. Instead, however, the property will undergo a $37 million renovation to become a 1,600-seat movie palace and performance venue, which will provide 28,000 square feet of ground-floor retail and second-floor office space; an additional performance space will be created in the basement for small-scale workshops, experimental theater, and other performances. Jeremy Piper, chairman of the Cultural Center Corp., a Flint lawyer, will manage the new performing arts venue in the cultural center; he will also serve as co-chair of a committee that is raising the last $4 million of the $37 million needed to bring the theater back to life. The goal and hope is that the renovated theater will, as has been the experience in other cities, such as New York City’s Lincoln Center for the Performing Arts, help serve as a foundation for Flint’s fiscal and physical recovery. The new theater is intended to become the focal point of 12,000, 13,000, or 14,000 people coming into downtown Flint for a performance and then going out for dinner—that is, to benefit and revive a downtown economy. Indeed, already, the venture firm SkyPoint is planning to open a large fine-dining restaurant on the ground floor and mezzanine timed to the rejuvenated theater’s reopening—SkyPoint Ventures being the company co-founded by Phil Hagerman, the CEO of Flint-based Diplomat Pharmacy Inc., and his wife, Jocelyn, whose Hagerman Foundation (the author, here, notes his middle name, derived from his great grandfather, is Hagerman) donated $4 million toward the Capitol’s renovation. In 2016, the Flint-based C.S. Mott Foundation announced a grant of $15 million for the Capitol Theatre project as part of $100 million it pledged to the city in the wake of the water crisis. The project also received $5.5 million from the Michigan Strategic Fund.

The ambitious effort comes as Michigan has paid $12 million to outside attorneys for work related to the Flint drinking water crisis, but out of which nearly 30% has gone to pay criminal and civil defense attorneys hired by Gov. Rick Snyder—an amount expected to climb as the lead poisoning of Flint’s drinking water has proven to be devastating for Flint and its children, but enriching for the state’s legal industry: Jeffrey Swartz, an associate professor at Western Michigan University-Cooley Law School, notes: “It’s a lot of money…I can see $10 million to $15 million being eaten up very quickly.” He added, moreover, that the state is still “on your way up the slope” in terms of mounting legal costs. The approved value of outside legal contracts, not all of which has been spent, is at least $16.6 million, adding that the Michigan Legislature may want to appoint a commission to review the appropriateness of all outside legal bills before they are approved for payment: already, Gov. Rick Snyder’s office has spent a combined $3.35 million for outside criminal and civil defense lawyers; the Michigan Department of Environmental Quality has spent $3.65 million; the Department of Health and Human Services has spent $956,000; and the Treasury Department has spent $35,555, according to figures released to the Free Press. In addition, the state has paid $340,000 to reimburse the City of Flint for some of its civil and criminal legal defense costs related to the drinking water crisis, which a task force appointed by Gov. Snyder has said was mainly brought on by mistakes made at the state level. Yet to be equitably addressed are some $1.3 million in Flint legal costs. Michigan Attorney General Bill Schuette, whose investigation is still ongoing, has charged 13 current or former state and municipal officials, including five from the Dept. of Environmental Quality, the Dept. of Health and Human Safety, the City of Flint, and two former state-appointed emergency managers who ran the city and reported to the state’s Treasury Department; no one, however, from Gov. Snyder’s office has been charged.

The Remarkable Recovery of Chocolateville. Central Falls, Rhode Island Mayor James A. Diossa, the remarkable elected leader who has piloted the fiscal recovery of one of the nation’s smallest cities from chapter 9 municipal bankruptcy, this week noted: “Our efforts and dedication to following fiscally sound budgeting practices are clearly paying off, leaving the City in a strong position. I would like to personally thank the Council and Administrative Financial Officer Len Morganis for their efforts in helping to lead the comeback of this great City.” The Mayor’s ebullient comments came in the wake of credit rating agency Standard and Poor’s rating upgrade for one of the nation’s smallest cities from “BB” to “BBB,” with S&P noting: “Central Falls is operating under a much stronger economic and management environment since emerging from bankruptcy in 2012. The City of Central Falls now has an investment grade credit rating from S&P due to diligently following the post-bankruptcy plan in conjunction with surpassing budgetary projections.”

One of the nation’s smallest municipalities (population of 19,000, city land size of one-square-mile), Central Falls is Rhode Island’s smallest and poorest city—and the site of a George Mason University class project on municipal fiscal distress—and guidebook for municipal leaders. Its post-bankruptcy recovery under Mayor Diossa has demonstrated several years of strong budgetary performance, and has “fully adhered to the established post-bankruptcy plan,” or, as Mayor Diossa put it: “S&P’s latest ratings report is yet another sign of Central Falls’ turnaround from bankruptcy.” Mr. Morganis noted: “The City of Central Falls now has an investment grade credit rating from S&P due to diligently following the post-bankruptcy plan in conjunction with surpassing budgetary projections,” adding that the credit rating agency’s statement expressed confidence that strong budgetary performance will continue post Rhode Island State oversight. S&P, in its upgrade, credited Mayor Diossa’s commitment to sound and transparent fiscal practices, noting the small city has an adequate management environment with improved financial policies and practices under their Financial Management Assessment (FMA) methodology—and that Central Falls exhibited a strong budgetary performance, with an operating surplus in the general fund and break-even operating results at the total governmental fund level in FY2016. Moreover, S&P reported, the former mill town and manufacturer of scrumptious chocolate bars has strong liquidity, with total government available cash at 28.7% of total governmental fund expenditures and 1.9 times governmental debt service, along with a strong institutional framework score. Similarly, Maureen Gurghigian, Managing Director of Hilltop Securities, noted: “A multi-step upgrade of this magnitude is uncommon: this is a tribute to the hard work of the City’s and the Administrative Finance Officer’s adherence to their plan and excellent relationship with State Government.” The remarkable recovery comes as one of the nation’s smallest cities heads towards a formal exit from chapter 9 municipal bankruptcy at the end of FY2017. S&P, in its upgrade, noted the city is operating under a “much stronger economic and management environment,” in the wake of its 2012 exit from municipal bankruptcy, or, as Mayor Diossa, put it: “Obviously we’ve had a lot of conversations with the rating agencies, and I was hoping we’d get an upgrade of at least one notch…When we got the triple upgrade, first, I was surprised and second, it reaffirmed the work that we’re doing. Our bonds are no longer junk. We’re investment level. It’s like getting good news at a health checkup.”  S&P, in its report, noted several years of sound budgeting and full adherence to a six-year post-bankruptcy plan which state-appointed receiver and former Rhode Island Supreme Court Justice Robert Flanders crafted. The hardest part of that recovery, as Judge Flanders noted to us so many years ago in City Hall,was his swift decision to curtail the city’s pension payments—cuts of as much as 55 percent—a statement he made with obvious emotion, recognizing the human costs. (Central Falls is among the approximately one-quarter of Rhode Island municipalities with locally administered pension plans.) Unsurprisingly, Mayor Diossa, maintains he is “fully committed” to the fiscal discipline first imposed by Judge Flanders, noting the municipality had a general fund surplus of 11% of expenditures in FY2016, and adding: “That reserve fund is very important.” He noted Central Falls also expects a surplus for this fiscal year, adding that the city’s expenses are 3% below budget, and that even as the city has reduced the residential property tax rate for the first time in a decade, even as it has earmarked 107% of its annual required contribution to the pension plan and contributed $100,000 toward its future OPEB liability.

The End of an Era? Mayor Diossa, recounting the era of chapter 9 bankruptcies, noted Pennsylvania’s capital, Harrisburg, in 2011; Jefferson County, Alabama; Stockton, Mammoth Lakes and San Bernardino, California; and Detroit: “I think Central Falls is a microcosm of all of them…I followed Detroit and heard all the discussions. They had the same issues that we had…sky-high costs, not budgeting appropriately,” adding his credit and appreciation—most distinctly from California—of the State of Rhode Island’s longstanding involvement: “The state’s been very involved,” commending Governors Lincoln Chafee and Gina Raimondo. Nevertheless, he warns: fiscal challenges remain; indeed, S&P adds: “The city’s debt and contingent liability profile is very weak…We view the pension and other post-employment benefit [OPEB] liabilities as a credit concern given the very low funded ratio and high fixed costs…They are still a concern with wealth metrics and resources that are probably below average for Rhode Island, so that’s a bit of a disadvantage…That adds more importance to the fact that they achieved an investment-grade rating through what I think is pretty good financial management and getting their house in order.” The city’s location, said Diossa, is another means to trumpet the city.

The Uncertainties of Fiscal Challenges. Natalie Jaresko is the newly named Executive Director of the PROMESA federal control board overseeing Puerto Rico’s finances, who previously served during a critical time in Ukraine’s history from 2014 to 2016 as it faced a deep recession, and about whom PROMESA Board Chair Jose Carrion noted: “Ukraine’s situation three years ago, like Puerto Rico’s today, was near catastrophic, but she worked with stakeholders to bring needed reforms that restored confidence, economic vitality and reinvestment in the country and its citizens. That’s exactly what Puerto Rico needs today;” came as Ms. Jaresko yesterday told the Board that with the tools at its disposal, Puerto Rico urgently needs to reduce the fiscal deficit and restructure the public debt, “all at once,” while acknowledging that the austerity measures may cause “things to get worse before they get better.” Her dire warnings came as the U.S. territory’s recovery prospects for the commonwealth’s general obligation and COFINA bonds continued to weaken, and, in the wake of last week’s moody Moody’s dropping of the Commonwealth’s debt ratings to its lowest rating, C, which equates with a less than 35% recovery on defaulted debt. Or, as our respected colleagues at Municipal Market Analytics put it: “[T]he ranges of potential bondholder outcomes are much wider than those, with a materially deeper low-end. For some (or many) of the commonwealth’s most lightly secured bonds (e.g., GDB, PFC, etc.) recoveries could hypothetically dip into the single digits. Further, any low end becomes more likely the longer Puerto Rico’s restructuring takes to achieve as time:

1) Allows progressively more negative economic data to materialize, forcing all parties to adopt more conservative and sustainable projections for future commonwealth revenues;

2) Allows local stakeholder groups—in particular students and workers—to organize and expand nascent protest efforts, further affecting the political center of gravity on the island;

3) Worsens potential entropy in commonwealth legislative outcomes;

4) Frustrates even pro-bondholder policymakers in the US Congress, which has little interest in, or ability to, re-think PROMESA and/or Federal aid compacts with the commonwealth.”

On the other hand, the longer the restructuring process ultimately takes, the more investable will be the security that the island borrows against in the future (whatever that is). So while the industry in general would likely benefit from a faster resolution that removes Puerto Rico from the headlines, the traditional investors who will consider lending to a “fixed” commonwealth should prefer that all parties take their time. Finally, if bleakly, MMA notes: “In our view, reliable projections of bondholder recovery impossible, and we fail to understand how any rating agency with an expected loss methodology can rate Puerto Rico’s bonds at all…Remember that the Governor’s Fiscal Plan, accepted by the Oversight Board, makes available about a quarter of the debt service to be paid on tax-backed debt through 2027, down from about 35% that was in the prior plan that the Board rejected. As we’ve noted before, the severity of the proposal greatly reduces the likelihood that an agreement will be reached with creditors by May 1 (when the stay on litigation ends), not only increasing the prospect of a Title III restructuring (cram down) un-der PROMESA, but also a host of related creditor litigation against the plan itself and board decisions both large and small. The outcomes of even normal litigation risks are inherently unpredictable, but the prospects here for multi-layered, multi-dimensional lawsuits create a problem several orders of magnitude worse than normal.

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.”

 

State and Local Insolvency & Governance Challenges

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eBlog, 03/29/17

Good Morning! In this a.m.’s eBlog, we consider the efforts to recover from the brink of insolvency in the small municipality of Petersburg, Virginia, before considering the legal settlement between the State of Michigan and City of Flint to resolve the city’s state-contaminated water which nearly forced it into municipal insolvency.

On the Precipice of Governing & Municipal Insolvency. Consultants hired to pull the historic Virginia municipality of Petersburg from the brink of municipal bankruptcy this week unveiled an FY2018 fiscal plan they claim would put the city on the path to fiscal stability—addressing what interim City Manager Tom Tyrrell described as: “It’s bad, it’s bad, it’s bad.” With the city’s credit ratings at risk, and uncertainty with regard to whether to sell the city’s utility infrastructure for a cash infusion, former Richmond city manager Robert Bobb’s organization presented the Petersburg City Council with the city’s first structurally balanced spending plan in nearly a decade: the proposed $77 million operating budget would increase spending on public safety and restore 10 percent cuts to municipal employees’ pay, even as it proposes cutting the city’s workforce, deeming it to be bloated and structurally inefficient. The recommendations also propose: restructuring municipal departments, the outsourcing of services that could eliminate up to 12 positions, and the reduction through attrition of more than 70 vacancies.

As offered, the plan also recommends about a 13 percent increase in the city’s current operating budget of $68.4 million, which was amended twice this fiscal year: the $77 million total assumes a $6 million cash infusion labeled on a public presentation as a “revenue event,” referring to a controversial issue dividing the elected leaders versus the consultants: Council members and the Washington, D.C. based firm have been at loggerheads over unsolicited proposals from private companies offering to purchase Petersburg’s public city’s utility system—a challenge, especially because of citizen/taxpayer apprehension about private companies increasing rates for consumers at a time when double-digit rate increases already are on the horizon. That, in turn, has raised governance challenges: Mr. Bobb, for instance, has expressed frustration with the city’s elected leaders’ decision to stall negotiations and study the prospect by committee, noting: “The city is out of time…They’re out of time with what’s needed with respect to the long-term financial health of the city. Time’s up.” Mr. Bobb believes the city cannot cut its way to financial health, or raise tax rates for city residents who themselves are struggling to get by, noting that at $1.35 per $100 of assessed value, the city’s real estate tax rate is currently the highest in the region—and at a potential tipping point, as, according to Census data, nearly half the city’s children live below the poverty line, which is set at $24,600 for a family of four. Moreover, Petersburg’s assessed property values have stagnated for the past five years, according to the credit rating agency Standard & Poor’s, which rated the city with a negative outlook at the end of last year: the lowest of any municipality in the state. (The city ended FY2016 with $18.8 million in unpaid bills and began the new fiscal year $12.5 million over budget. The budget since has been balanced, but debts remain.)

Under Mr. Bobb’s proposed plan, in a city where public safety is already the largest expense in the operating budget, he has proposed increasing police pay, addressing salary compression in the department, and providing for a force of 111 full-time and seven part-time employees. He suggests that should Petersburg not reap a $6 million “revenue event” in FY2018, the operating budget would be about 5 percent above this year’s, and a few million below revenues for fiscal years 2016 and 2015. Mr. Bobb’s consultant, Nelsie Birch, who is serving as Petersburg’s CFO, reports the city’s budget process and the development of the upcoming year’s budget have been thwarted by a lack of administrative infrastructure, noting that in the wake of starting work last October, he walked into a city finance department that had two part-time workers out of seven allocated positions—and a municipality with only $75,000 in its checking account. (Last week, there was approximately $700,000.) Today, Mr. Birch holds one of more than a half-dozen high-profile positions now filled by interim workers and consultants; Petersburg is paying about $80,000 for a Florida-based head hunter to help fill some of the city’s key vacancies, including those for city manager, deputy city manager, police chief, and finance director—with the City Council having voted last week to extend the Bobb Group’s contract through the end of September—at a cost to Petersburg’s city taxpayers of about $520,000.

Nevertheless, the eventual governance decisions remain with the Petersburg City Council, which secured its first opportunity to study the plan this week—a plan which will be explored during more than a half-dozen public meetings planned for the coming weeks: explorations which will define the city’s fiscal future—or address the challenge with regard to whether the city continues on its road to chapter 9 municipal bankruptcy.

The fiscal and governance challenges in this pivotal Civil War city, however, extend beyond its borders—or, as the ever so insightful Neal Menkes, the Director of Fiscal Policy for the Virginia Municipal League notes:  

“Perhaps the unstated theme is that the push for ‘regionalism’ is related not just to changing economic realities but to the state’s outmoded governance and taxation models. Local finances are driven primarily by growth in real estate and local sales, revenues that are not sensitive to a service economy. Sharing service costs with the Commonwealth is another downer. K-12 funding formulae are more focused on limiting the state’s liability than meeting the true costs of education.  That’s why locals overmatch by over $3.0 billion a year the amounts required by the state to access state basic aid funding.”

State Preemption of Municipal Authority & Ensuing Physical, Governing, and Fiscal Distress. U.S. District Judge David Lawson yesterday approved a settlement under which Michigan and the City of Flint have agreed to replace water lines at 18,000 homes under a sweeping agreement to settle a lawsuit over lead-contaminated water in the troubled city—where the lead contamination ensued under the aegis of a state-appointed emergency manager. The agreement sets a 2020 deadline to replace lead or galvanized-steel lines serving Flint homes, and provides that the state and the federal government are mandated to finance the resolution, which could cost nearly $100 million; in addition, it provides for the state to spend another $47 million to replace lead pipes and provide free bottled water—with those funds in addition to $40 million budgeted to address the lead-contamination crisis; Michigan will also set aside $10 million to cover unexpected costs, bringing the total to $97 million.

The lawsuit, filed last year by a coalition of religious, environmental, and civil rights activists, alleged state and city officials were violating the Safe Drinking Water Act—with Flint’s water tainted with lead for at least 18 months, as the city, at the time under a state-imposed emergency manager, tapped the Flint River, but did not treat the water to reduce corrosion. Consequently, lead leached from old pipes and fixtures. Judge Lawson, in approving the settlement, called it “fair and reasonable” and “in the best interests of the citizens of Flint and the state,” adding the federal court would maintain jurisdiction over the case and enforce any disputes with residents. Under the agreement, Michigan will spend an additional $47 million to help ensure safe drinking water in Flint by replacing lead pipes and providing free bottled water, with the state aid in addition to $40 million previously budgeted to address Flint’s widespread lead-contamination crisis and another $10 million to cover unexpected costs, bringing the total to $97 million. The suit, brought last year by a coalition of religious, environmental, and civil rights activists, alleged Flint water was unsafe to drink because state and city officials were violating the Safe Drinking Water Act; the settlement covers a litany of work in Flint, including replacing 18,000 lead and other pipes as well as providing continued bottled water distribution and funding of health care programs for affected residents in the city of nearly 100,000 residents. It targets spending $87 million, with the remaining $10 million saved in reserve. Ergo, if more pipes need to be replaced, the state will make “reasonable efforts” to “secure more money in the legislature,” Judge Lawson wrote, adding that the final resolution would not have been possible but for the involvement of Michigan Governor Rick Snyder. Judge Lawson also wrote that the agreement addresses short and long-term concerns over water issues in Flint.

The settlement comes in the wake of last December’s announcement by Michigan Attorney General Bill Scheutte of charges against two former state-appointed emergency managers of Flint, Mich., and two other former city officials, with the charges linked to the disastrous decision by a former state-appointed emergency manager to switch water sources, ultimately resulting in widespread and dangerous lead contamination. Indeed, the events in Flint played a key role in the revocation of state authority to preempt local control—or Public Act 72, known as the Local Government Fiscal Responsibility Act, which was enacted in 1990, but revised to become the Emergency Manager law under current Gov. Rick Snyder. Michigan State University economist Eric Scorsone described the origin of this state preemption law as one based on the legal precedent that local government is a branch of Michigan’s state government; he noted that Public Act 72 was rarely used in the approximately two decades it was in effect through the administrations of Gov. John Engler and Gov. Jennifer Granholm; however, when current Gov. Rick Snyder took office, one of the first bills that he signed in 2011 was Public Act 4, which Mr. Scorsone described as a “beefed-up” emergency manager law—one which Michigan voters rejected by referendum in 2012, only to see a new bill enacted one month later (PA 436), with the revised version providing that the state, rather than the affected local government paying the salary of the emergency manager. The new law also authorized the local government the authority to vote out the state appointed emergency manager after 18 months; albeit the most controversial change made to PA 436 was that it stipulated that the public could not repeal it. The new version also provided that local Michigan governments be provided four choices with regard to how to proceed once the Governor has declared an “emergency” situation: a municipality can choose between a consent agreement, which keeps local officials in charge–but with constraints, neutral evaluation (somewhat akin to a pre-bankruptcy process), filing for chapter 9 municipal bankruptcy, or suffering the state appointment of an emergency manager. As Mr. Scorsone noted, however, the replacement version did not provide Michigan municipalities with a “true” choice; rather “what you actually find is that a local government can choose a consent agreement, for example, but actually the state Treasurer has to agree that that is the right approach. If they don’t agree, they can force them to go back to one of the other options. So it is a choice, but perhaps a bit of a constrained choice.”

Thus, the liability of the emergency managers and the decisions they made became a major issue in the Flint water crisis—and it undercut the claim that the state could do better than elected local leaders—or, as Mr. Scorsone put it: “The state can take over the local government and run it better and provide the expertise, and that clearly didn’t work in the Flint case. The situation is epically wrong, perhaps, but this is clearly a case of where we have to ask the question: why did it go wrong, and I think it’s a complex answer, but one of the things that needs to be done…we need a better relationship between state and local government.” That has proven to be especially the case in the wake felony charges levied against former state appointed Emergency Managers in Flint of Darnell Earley and Gerald Ambrose, who were each charged with two felonies that carry penalties of up to 20 years—false pretenses and conspiracy to commit false pretenses, in addition to misconduct in office (also a felony) and willful neglect of duty in office, a misdemeanor.

Today, Michigan local governments have four choices in the wake of a gubernatorial declaration of an “emergency” situation: a municipality or county  can choose between a consent agreement, which keeps local officials in charge but with constraints; neutral evaluation, which is like a pre-municipal bankruptcy process;  filing for chapter 9 municipal bankruptcy directly; or suffering the appointment of an emergency manager—albeit, as Mr. Scorsone writes: “The choice is a little constrained, to be truthful about it…If you really carefully read PA 436, what you actually find is that a local government can choose consent agreement, for example, but actually the state Treasurer has to agree that that is the right approach. If they don’t agree, they can force them to go back to one of the other options. So it is a choice, but perhaps a bit of a constrained choice…The law is pretty clear that the emergency manager is acting in a way that does provide some governmental immunity…The emergency manager, if there’s a claim against her or him, has to be defended by the Attorney General. That was fairly new to these new emergency manager laws. The city actually has to pay the legal bills of what the Attorney General incurs, and it’s certainly true that there is a degree of immunity provided to that emergency manager, and I suppose the rationale would be that they want some kind of protection because they are making these difficult decisions. But I think this issue is going to be tested in the Flint case to see how that really plays out.” Then, he noted: “The theory is that the state can do it better…The state can take over the local government and run it better and provide the expertise, and that clearly didn’t work in the Flint case. The situation is especially wrong, perhaps, but this is clearly a case of where we have to ask the question why did it go wrong, and I think it’s a complex answer, but one of the things that needs to be done…we need a better relationship between state and local government.”

The Challenge of Recovering from or Averting Municipal Bankrupty

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eBlog, 03/28/17

Good Morning! In this a.m.’s eBlog, we consider the ongoing recovery in Detroit from the largest municipal bankruptcy in U.S. history, before spinning the tables in Atlantic City, where the state takeover of the city has been expensive—and where the state’s own credit rating has been found wanting.

Home Team? A Detroit developer, an organization, Dominic Rand, has initiated a project “Home Team,” seeking to purchase up to up 25 square miles of property on the Motor City’s northwest side with a goal of keeping neighborhoods occupied by avoiding foreclosures and offering renters a path to homeownership. Nearly four years after the city’s chapter 9 filing for what former Emergency Manager Kevyn Orr deemed “the Olympics of restructuring,” to ensure continuity of essential services while developing a plan of debt adjustment to restructure the city’s finances—and to try to address the nearly 40 percent population decline and related abandonment of an estimated 40,000 abandoned lots and structures, as well as the loss of 67 percent of its business establishments and 80 percent of its manufacturing base, Mr. Rand reports he is excited about this initiative by an organization for purchases of homes slated for this year’s annual county tax foreclosure auction. His effort is intended to rehabilitate the homes and help tenants become homeowners. The effort seeks to end the cycle of home foreclosures due to unpaid property taxes. 

This is not the first such effort, however, so whether it will succeed or not is open to question. Officials at the United Community Housing Coalition note that previous such initiatives have failed, remembering Paramount Mortgage’s comparable effort, when the company purchased 2,000 properties, in part financed through $10 million from the Detroit police and fire pension fund—an effort which failed and, in its wake, left 90 percent of those in demolition status. Fox 2 reported that the City “does not support this proposal,” questioning its “ability to deliver on such a massive scale with no particular track record to indicate they would be successful,” adding the organization, if it wants to “start out by becoming a community partner through Detroit Land Bank and show what they can do with up to nine properties, they are welcome to do so.”

At first, the Home Team Detroit development group considered purchasing every property in Detroit subject to this year’s annual county tax foreclosure auction; instead, however, the group focused on the northwest quadrant covering 25 square miles and 24 neighborhoods—an area larger than Manhattan—with founder David Prentice noting: our “game plan is pretty simple: You are going to have a quadrant of (Detroit) with properties that are primarily occupied.” Mr. Prentice believes this initiative would address what he believes is one of Detroit’s biggest problems: halting the hemorrhaging of home foreclosures due to unpaid property taxes—an initiative one Detroit City Council member told the Detroit News was “unique and comprehensive.” Thus, city officials are reviewing the entity’s proposal—even as it reminds us of the Motor City’s ongoing home ownership challenge—a city where, still, more than 11,000 homes a year have ended in foreclosure over each of the last four years. Under the city’s process, the city warns property owners in January if their properties are at risk of tax foreclosure: as of last January, the Home Team group reports its targeted area has 11,073 properties headed for foreclosure.

Home Team is seeking approval from Detroit to purchase the properties via a “right of first refusal,” under which Mayor Mike Duggan and the Detroit City Council would have to approve the sale—and Wayne County and the State of Michigan would at least have to agree to not buy them as well, since both also have the option to buy the properties prior to such public auctions. Home Team claims it has the resources and expertise to buy the properties, rehab the homes, find new residents, and allow it to work with people traditional lenders would not consider due to poor credit ratings or because of the locations of the properties. The group claims its land contract system, or contracts for deeds, under which tenants make payments directly to the property owner and often have no ownership stake until the entire debt is paid, would work as an alternative to traditional mortgages—even as housing advocate groups such as the United Community Housing Coalition warn that land contracts are financial traps, and the nonprofit Michigan Legal Services told the Detroit News that many land contract deals are “gaming the system,” referencing a recent Detroit News story about many residents with land contracts losing out on actually getting a home—and others warning that those families sign contracts may end up owing significantly more than they would by renting, yet, at the end of such transactions, “have nothing to show for it.” (In recent years, the News reports, land contracts have outnumbered traditional mortgages in Detroit.) Mr. Prentice, while agreeing that “most land contracts are designed for the tenants to fail,” suggested his company’s land contracts would come without the high penalties, high monthly payments—payments which increase in time, and rising interest rates which have trapped unwary families in the past—and, he has vowed the company would fix up every property before putting it back on the market.

Detroit City Councilman George Cushingberry, who represents a major portion of the targeted area, told the News: “I like that it’s comprehensive and takes into account that one of the issues that prevents home ownership is financial literacy.” Yet, the ambitious proposal has also encountered neighborhood opposition: the Northwest Detroit Neighborhood Coalition has launched a petition drive to block the plan—and drawn support from eight neighborhood groups, with the Coalition issuing a statement: “We the people of northwest Detroit hereby declare our strong opposition to high-volume purchases of tax-foreclosed properties (10+ parcels) and other high-volume transfers of properties to real estate investors…Proposals like the one currently being circulated by (Home Team Detroit) do not serve the needs or interests of Detroit neighborhood residents. These bulk purchases only accelerate vacancy, blight, and further erosion of our community.” However, Melvin “Butch” Hollowell, Detroit’s Corporation Counsel, said the city opposes the effort, which would require the city to authorize a purchase agreement for the properties, noting: “The city does not support this proposal: We have a number of serious concerns, especially Home Team Detroit’s ability to deliver on such a massive scale with no particular track record to suggest they would be successful. If they want to start out by becoming a community partner through the Detroit Land Bank (Authority) and show what they can do with up to nine properties, they are welcome to do so and go from there.”

Robbery or the Cost of Municipal Fiscal Distress? The law firm of Jeffrey Chiesa, whom New Jersey Governor Chris Christie named to oversee the state takeover of Atlantic City, has billed the State of New Jersey about $287,000 for its work so far, according to multiple reports, including some $80,000 alone for Mr. Chiesa. The fiscal information came in the wake of the release by the state of invoices that showed the law firm submitted more than $207,000 in bills for the first three months of work, November through January—with some twenty-two members of the firm billing the state. In addition, Mr. Chiesa, who bills the State $400-an-hour for his time, reports he himself has billed $80,000 over that same period, noting to the Press those invoices were not included in the state’s data released last Friday, because they have yet to be fully reviewed. He added that the state has imposed “no cap” on the fees his firm may charge—leading State Assemblyman Chris A. Brown (R-Atlantic), who has been critical of the takeover, to note: “The governor handing over the city to a political insider without a transparent plan is like leaving your home without locking the door, and it looks like we just got robbed.”  The release of the data could not have come with more awkward timing, with the figures aired approximately a week after Mr. Chiesa wrote to Atlantic City police officers announcing the state was seeking to cut salaries, change benefits, and introduce longer shifts to save the city money—and as the state is calling for similar cuts and 100 layoffs in the city’s fire department—efforts in response to which Atlantic City’s police and fire unions have filed suit to prevent, with a judge last week ruling the state cannot yet move forward with the fire layoffs until he determines whether the state proposal is constitutional—even as Mr. Chiesa has defended the cuts, calling negotiations with the unions “money grabs.” For his part, at the end of last week, Mr. Chiesa defended his bills, claiming his firm helped negotiate a $72 million settlement with the Borgata casino in a long-running tax dispute with the city, gaining more than a 50 percent savings to the city from the refund it owed in the wake of tax appeals, deeming that an “important success on behalf of the city.”

Nevertheless, as S&P Global Ratings noted last week in upgrading Atlantic City’s credit rating from “CC” to “CCC,” despite assistance from the state, there is still the distinct possibility the city could still default on its debt over the next year and that filing for chapter 9 municipal bankruptcy remains an option down the line.  Nevertheless, S&P analyst Timothy Little wrote that the upgrade reflected S&P’s opinion that “the near-term likelihood” of Atlantic City defaulting on its debt has “diminished” because of the state takeover and the state’s role in brokering the Borgata Casino agreement—an upgrade which a spokesperson for the Governor described as “early signs our efforts are working, that we will successfully revitalize the Atlantic City and restore the luster of this jewel in the crown.”  However, despite the upgrade, Atlantic City still remains junk-rate, and S&P reported the city’s recovery remains “tenuous:” It has a debt payment of $675,000 due on April Fool’s Day, $1.6 million on May Day, $1.5 million on June 1st, and another $3.5 million on August 1st—all payments which S&P believes will be made on time and in full, albeit warning that more substantial debts will come due later in the year, meaning, according to S&P, that the city’s recovery remains “tenuous,” and that Atlantic City is unlikely “to have the capacity to meet its financial commitment…and that there is at least a one-in-two likelihood” of a default in the next year.” Or, as Mr. Little wrote: “Despite the state’s increased intervention, [municipal] bankruptcy remains an option for the city and, in our opinion, a consideration if timely and adequate gains are not made to improve the city’s structural imbalance.”