Human Needs & Fiscal Imbalances

Good Morning! In this a.m.’s eBlog, we consider the ongoing fiscal challenges to the City of Detroit—especially in ensuring equitable tax collections; then we look north to assess the ongoing, serious physical and fiscal challenges to Flint’s long-term recovery, before considering the fiscal plight in Puerto Rico.

Motor City Revenue Uncollections. Unlike most cities, Detroit has a broad tax base in which municipal income taxes constitute the city’s largest single source, and that notwithstanding that the city has the highest rate of concentrated poverty among the top 25 metro areas in the U.S. by population. (Detroit’s revenues, from taxes and state-shared revenues are higher than those of any other large Michigan municipality on a per capita basis: these revenues consist of property taxes, income taxes, utility taxes, casino wagering taxes, and state-shared revenues.) Therefore, it is unsurprising that the city is cracking down on those who owe back income taxes: Detroit has launched an aggressive litigation effort, an effort targeted at thousands of tax evaders living or working at thirty-three properties in the downtown and Midtown areas. The city’s Corporation Counsel, Melvin Butch Hollowell, notes the city has identified at least 7,000 such taxpayers at these properties as potential tax evaders. Collecting those owed taxes is an especially sensitive issue in the wake of the city’s chapter 9 experiences when the decline in revenues of 22 percent over the decade of its most important source of revenues was a key trigger of the nation’s largest municipal bankruptcy.

Out Like Flint? Just as in Detroit’s chapter 9 bankruptcy, where now-retired U.S. Bankruptcy Judge Steven Rhodes had to address water cut-offs to families who had not paid their utility bills, so too the issue is confronting Flint—where the current penalty for non-payment under the city’s ordinance is tax foreclosure: something which has put at risk some 8,000 homeowners in the municipality, until, last week, the City Council approved a one-year moratorium on such tax liens: the moratorium covers residents with two years of unpaid water and sewer bills dating back to June of 2014. After the moratorium vote, City Council President Kerry Nelson said: “The people are suffering enough” for being forced to pay for water they cannot drink and are reluctant to use…The calls that I received were numerous. Everywhere I go, people were saying: Do something,” he said: “I did what the charter authorized me to do” with a temporary moratorium “until we look at the ordinance and get it corrected. It needs work. It’s 53 years old. We must start doing something for our community.” The council president insisted the Snyder administration needs to step up “and help us: They created this…the government doesn’t get a free pass.”

Indeed, the question of risk to life and health had been one which now retired U.S. Bankruptcy Judge Rhodes had to deal with in Detroit’s chapter 9 bankruptcy: how does one balance a city’s fiscal solvency versus human lives; and how does one balance or assess a family’s needs versus the civic duty to pay for vital municipal serves and ensure respect for the law? Now the situation has been further conflicted by the Michigan state-appointed Receivership Transition Advisory Board, which oversees and monitors Flint’s finances in the wake of its emergence from state oversight two years ago. That board has scheduled a vote for next month on the moratorium—as this Friday’s deadline for the thousands of homeowners to pay up under a 1964 ordinance nears—albeit a deadline which has been modified to provide a one-year partial reprieve, in part to give time to amend the ordinance. Perhaps unsurprisingly, the apprehension has had municipal political impacts: a recall effort against Mayor Karen Weaver, who a year ago was in Washington, D.C., for meetings at the White House with President Barack Obama to lobby for more federal aid and to obtain other attention for the city. The Mayor, understandably, notes Flint is now between a rock and a hard place: there is understandable residential anger over access to water critical to everyday life; however, unpaid bills could cause irreparable fiscal harm to the city—leading the Mayor to affirm that she will honor the moratorium and “follow the law: It’s not like something new has been put in place…We’re doing what has always been done. This was something that Council did. This is the legislative body. My role is to execute the law. So I’m carrying out the law that’s put in place.” Nevertheless, after a year in which the city did not enforce its ordinance, due in no small part to credits its was able to offer to its citizens courtesy of state financing, those credits expired at the end of February, a time when lead levels finally recovered to 12 parts per billion, which is under the federal action standard—and after Gov. Rick Snyder last February rejected Mayor Weaver’s request for an extension.  

The fiscal challenge is complicated too as illustrated by the case of former City Councilmember Edward Taylor, who noted that he had received a $1,053 bill from a home he had rented out to a woman whom he recently evicted. The problem? Mr. Taylor said the woman illegally turned on the water, so the city is holding him responsible for paying up. Now he is threatening to sue the City of Flint if he is unable to gain fiscal relief: i.e., he wants the city to erase his debt—but have the city’s grow.  “The calls that I received were numerous. Everywhere I go, people were saying: Do something,” Coincilman Nelson said. “I did what the charter authorized me to do” with a temporary moratorium “until we look at the ordinance and get it corrected. It needs work. It’s 53 years old. We must start doing something for our community.” The council president insisted the Snyder administration needs to step up “and help us: They created this…the government doesn’t get a free pass.”

Tropical Fiscal Typhoon. The administration of Governor Ricardo Rosselló Nevares declined yesterday to publish the recommended budget for the next fiscal year despite the fact that two days ago the deadline for completing the version of the document to be assessed by the PROMESA Board expired; initially, the Governor’s administration was supposed to turn over the budget to the Board on May 8th; however, the Board had granted a two-week extension—one which expired at the beginning of this week—time in which the Governor’s office could improve and correct some of the issues contained in its draft document—a document which has yet to have been made public, but one which the Governor is expected to make public as part of his budget message to the Legislative Assembly: according to Press Secretary Yennifer Álvarez Jaimes, the budget is currently in the draft phase, so it cannot be published, including the version which is to be provided to the PROMESA Board—even as, today, the Governor is due in the nation’s capital on an official trip, meaning the formal presentation of his budget before the legislature will almost surely be deferred until next week. The delay comes as PROMESA Chair José B. Carrión has indicated the Board will await the document prior to beginning its assessment and evaluation.

The Governor’s representative to the PROMESA Board, Elías Sánchez Sifonte, said the budget process is well advanced and that it is only necessary to complete the legal analysis and align some aspects with the provisions contained in the Fiscal Plan—even as a spokesperson for the Puerto Rico Peoples Democratic Party (PPD) minority in the Senate, Eduardo Bhatia, insisted on his claim to know the content of the document: he stated: “I think the people should know what was proposed in the budget…Yesterday (Monday) was the date to deliver the budget and we know nothing.” Sen. Bhatia, who sued at the beginning of this month to force publication of the budget, had his suit rejected by the San Juan Court of First Instance, because it was preempted under Title III of PROMESA—meaning the case was then brought before U.S. District Judge Laura Taylor Swain, who issued an order giving Puerto Rico until this Friday to present its position in this controversy. 

State Agency BankruptciesPuerto Rico has filed cases in the U.S. District Court in San Juan, according to Puerto Rico’s Fiscal Agency and Financial Advisory Authority, to place its Highways and Transportation Authority and Employees Retirement System into Title III bankruptcy—a move affecting some $9.5 billion in debt, with Governor Rosselló asserting he was seeking to protect pensioners and the transportation system by putting both agencies into municipal bankruptcy; he added he had asked the PROMESA Oversight Board to put the two entities into Title III’s chapter 9-like process, because, according to his statement, the island’s creditors had “categorically rejected” the Puerto Rico fiscal plan as a basis for negotiations and have recently started legal actions to undermine the public corporation’s stability. In the board-approved HTA fiscal plan, there would be no debt service paid through at least fiscal year 2026. Gov. Rosselló added that he had filed for Title III, because Puerto Rico faces insolvency in the coming months, and because his government has been unable to reach a consensual deal with its creditors, adding that pensioners will continue to receive their pensions from the General Fund after the territory’s pension fund, ERS, runs out of money. (As of February the ERS had $3.2 billion in debt, of which $2.7 billion was bond principal and $500 million was capital appreciation bonds.)

As Puerto Rico attempts to sort out its tangled financial web, retirees may face bigger cuts than those in past U.S. municipal insolvencies, due in part to an unconventional debt structure which pits pensioners against the very lenders whose money was supposed to sustain them—but also because this is an unbalancing teeter-totter, where the young and upwardly mobile are moving from Puerto Rico to New York City and Florida—leaving behind the impoverished and elderly, so that contributions into the Puerto Rico’s pension system are ebbing, even as demands upon it are increasing, and as the benefit structures are widely perceived as unsustainable. There is recognition that radical cuts to pensioners could deepen the population’s reliance on government subsidies and compound rampant emigration, for, as Gov. Rosselló has noted, most retirees “are already under the poverty line,” so that any pension cuts “would cast them out and challenge their livelihood.” Indeed, Puerto Rico’s Public pensions, which as of June last year had total pension liabilities of $49.6 billion, and which are projected to be insolvent sometime in the second half of this calendar year, today have almost no cash; rather pension benefits are coming out of the territory’s general fund, on a pay-as-you-go basis—imposing a cost to Puerto Rico of as much as $1.5 billion a year: $1.5 billion the territory does not have.

Governance in the Face of Fiscal Insolvency

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eBlog, 1/05/17

Good Morning! In this a.m.’s eBlog, we consider the political challenges encumbering the virtually insolvent, historic municipality of Petersburg, Virginia, before turning to the growing judicial disputes with regard to the respective rights and authority of municipal bondholders in Puerto Rico, even as the new administration of Governor Ricardo Rosselló has taken office and the PROMESA oversight board is attempting to get its arms around a long-term fiscal path to resolution.

The Right Fiscal & Governance Direction. Petersburg, Virginia’s City Council Tuesday voted 4-3 to elevate current Vice Mayor Samuel Parham to the position of Mayor—with the action coming amidst critics who have called for the criminal prosecution of the ousted incumbent W. Howard Myers, who had said last week he planned to run for another term—a declaration which appeared to accelerate maneuvering among his colleagues who are seeking to avoid more unrest from citizens unhappy with the city’s decline into near municipal bankruptcy last year. Nevertheless, when the clerk called the question, Mayor Myers nominated Vice Mayor Parham, later describing his action as a step towards much-needed continuity for the city at a critical time, adding that the dissent from his fellow Council members Treska Wilson-Smith, John Hart, and Annette Smith Lee was “horrific” at a time when the city needs to come together to address critical fiscal challenges. He noted: “This reflects poorly on all of us and hurts future opportunities.” The Council selected John Hart to be vice mayor. Both roles are largely ceremonial, but symbolic at a time when Petersburg has been battered by financial challenges. Indeed, good government advocates with the group Clean Sweep Petersburg have been targeting incumbents for removal from office, actively petitioning for their ouster. Nevertheless, new Mayor Parham pledged more transparency during his two-year tenure as mayor and fewer of the type of last-minute special meetings that had evoked such condemnation last November from the American Civil Liberties Union of Virginia. In addition, an organization spokesman has also criticized the city for holding the meeting at noon on a workday at a time when its governance has come under increased scrutiny. In response, council members voted to change the timing of organizational meetings to the half-hour preceding the first city council meeting in odd-numbered years.

Former Mayor Myers told his colleagues that the new designee, Mayor Parham, who is in his first four-year term on the council, has all the experience he needs to take the city to the next level: “He was my right-hand man for the last two years…I have every confidence in his ability to lead the city forward.” Nevertheless, the governance challenge looms: the city began its current fiscal year some $19 million in arrears and $12 million over budget, voting to slash employees’ pay, strip millions from the budget of the struggling public schools, and eliminate a youth summer program in order to try to balance the budget; meanwhile, the city’s credit rating tanked, and municipal workers fled to find other work, or, as new Mayor Parham put it: “Our locality was the first in the state to go through financial issues like we have.” In addition, late last year, the council voted to hire a turnaround team for $350,000 to take a short-term contract to try to bring the budget back above water and stabilize municipal operations. The contract expires in some eight weeks, but appears to have been instrumental in disentangling the layers of structural financial and fiscal problems that forced the city into insolvency—as well as helping to secure much-needed short-term financing for the city last month, or, as Mayor Parham described it: “In 2016, the government of Petersburg was supposed to be shut down, but we avoided that…We are moving in the right direction.”

Trying to Unpromise PROMESA? Meanwhile, in a letter to the PROMESA board, on behalf of Governor Ricardo Rosselló, the U.S. territory of Puerto Rico requested an extension of the January 15th deadline to prepare and submit its revised fiscal plan to the PROMESA board, seeking a 45 day extension—in order to ensure a credible plan which could return Puerto Rico to “fiscal responsibility within a decade.”  

Puerto Rico creditors presented arguments in federal court in Boston in an effort to lift a stay related to litigation over the U.S. territory’s debt. The courtroom request, in effect, seeks to challenge the provisions in the newly enacted federal legislation which imposed a stay on such suits in order to provide both Puerto Rico and the PROMESA oversight board with more time to put together a broad debt restructuring plan. The current stay is scheduled to expire next month on the Ides of February, with the possibility of an extension of 60 or 75 days or until the Oversight Board opts to file a petition to commence debt-adjustment proceedings, if that date is earlier. But complicating the promise of PROMESA has been this parallel process by some municipal bondholders and bond insurers in suing Puerto Rico—where a new Governor is just getting his administration underway. The new effort comes after last year’s U.S. District court ruling in two decisions concerning several cases that the stay should continue. That decision is now subject of an appeal in the U.S. First Circuit Court of Appeals, with the challenge asserting the burden of proof should be imposed upon Puerto Rico that any stay would not cause harm to bondholders, and arguing that the lower court’s decision should be overturned, because it had failed to hold an evidentiary hearing. For its part, the PROMESA Oversight Board has filed an amicus brief arguing in favor of continuing the stay, writing: “There can be no dispute that the amounts due will be paid during the pendency of the PROMESA stay, and the appellants will, therefore, suffer no material harm during the pendency of the stay.” Meanwhile, in its brief, the Commonwealth of Puerto Rico wrote: “It is not even clear how the stay is causing appellants any concrete injury, let alone the kind of substantial injury that would justify lifting a stay designed to help abate an unprecedented fiscal crisis affecting the health, safety, and welfare of millions of individuals.”

The Critical Role of State Leaders if Distressed Cities and Public Schools Are to Get Back on their Feet

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eBlog, 6/02/16

In this morning’s eBlog, we consider, again, the challenges the City of Detroit confronts in addressing the future of its public schools—an issue debated at some length yesterday at an annual retreat on Mackinaw Island of state legislative leaders—who have less than two weeks to act, and we consider the significant fiscal challenges that Atlantic City confronts in the wake of Gov. Chris Christie’s signing into state law legislation to provide the city a bridge loan to its fiscal future—a law which leaves in place not only significant constitutional challenges, but also shortcoming in the state law which could severely limit Atlantic City’s ability to recover. We would also like to note that feedback from the likes of retired U.S. Bankruptcy Judge Thomas Bennett; Marc Pfeifer of the Bloustein Local Government Research Center; Bob Deis, a former Stockton City Manager, the ever invaluable Jim Spiotto, Richard Ravitch, and others are invaluable to our efforts to try to provide not only emerging municipal fiscal distress information, but, more critically, analysis which might be valuable to other state and local leaders.

Atlantic City Surfs. Marc Pfeifer, ‎the remarkable Assistant Director at the Bloustein Local Government Research Center, and perhaps the most insightful expert about the precipitous fiscal future of Atlantic City, notes “It’s not over yet,” warning that notwithstanding the compromise between Gov. Chris Christie and the legislature to grant a time extension for Atlantic City to get back on its fiscal feet, the city, nevertheless, confronts significant challenges to address in order to come up with a balanced budget (under the terms of the law) for FY2017, not to mention assumptions it will make for its five-year plan. He adds, moreover, that because there are no standards for the New Jersey Department of Community Affairs (DCA)—the State agency created to provide administrative guidance, financial support and technical assistance to local governments, and community development organizations—the DCA Commissioner will have a great challenge in assessing and determining whether to approve or deny any budget and recovery plan put together by Atlantic City Mayor Don Guardian and his City Council, noting: to apply, “The only additional tool the law gave the city is authority for early retirement incentives (ERI) for employees. Lacking any of the tools the state gave itself under the takeover part of the law, this makes the city’s problem more challenging. The law did not give the city any new authority to negotiate or impose changes to labor contracts – which are some of the most expensive in the state. Unless the unions feel the need to cooperate (a potential state takeover did not faze them prior to this), the ERI will allow individuals with already lucrative retirement benefits to experience them early, with future city taxpayers paying the bill. This is further complicated by the ‘brain drain’ of losing experienced individuals and bringing in new, inexperienced ones.” He recognizes that other solutions (and tools) to address these issues should have been explored.

Mr. Pfeifer also points out that the new statute leaves in place substantial constitutional challenges were the State of New Jersey to seek to take over Atlantic City, noting such a takeover could be challenged on “constitutional principles of home rule, due process, and sanctity of contracts.” He added that even if the Garden State were to prevail on some of these issues, if the state wound up imposing this form of takeover, the court challenges would consume additional time.

Finally, he notes that the fact that this state last-minute action was needed pointed to the state’s failure to act sooner: “In the fall of 2010, the state gave itself, but did not use the full authority under pre-existing law, to oversee and manage the city’s finances. While Atlantic City now has problems which exceed ones faced by other cities in the past, we lost a good deal of time that could have been used to prevent the high-profile, politically bombastic process that we wound up with. We should have learned from our history and not try to invent solutions until the existing solutions fail.”

What makes this all so remarkable is New Jersey’s long and successful record at constructive intercession before a fiscal crisis arises. The state, under the Local Government Supervision Act, has authority, if the Local Finance Board determines that a triggering event has occurred, to not just monitor such a municipality’s financial affairs, but also to act to limit its debts and other financial obligations. It is clear the state’s past leaders recognized the constructive role the state could play to avert a municipal fiscal crisis. The state failure to act in a constructive way here appears to have imposed significant long-term costs not just on Atlantic City, but also on municipalities across the state. The question will be whether there are lessons learned.

R-O-L-A-I-D-S. Detroit will receive an additional $88 million in Troubled Asset Relief Program funding from funds provides to Michigan to raze blighted homes, allowing the city to clear thousands more houses in the next few years. Those funds could be essential to Mayor Mike Duggan commitment made last week to assist the city to meet its goal of demolishing 5,000 houses this year and 6,000 next year.

Focusing on Not Leaving a City’s Children Behind. The fate of Detroit’s children’s futures might hinge on the ability of Mayor Mike Duggan to convince Michigan’s business and civic leaders to oppose a proposed, compromise $617 million bailout of the Detroit Public Schools bailout which does not include a citywide commission to oversee where schools can open in the city. At the Mackinac Policy Conference, Mayor Duggan yesterday said Michigan’s largest school district would be set up for failure without such a Detroit Education Commission to oversee what would otherwise be a “chaos” of rapid school turnover in parts of the city where his administration is focused on rebuilding blight-ravaged neighborhoods. His comments came at a key moment as House Republican legislative leaders had been seeking support for a vote yesterday in Lansing on a package to address the $467 million school district, giving a new debt-free school district $150 million in transition money, but to exclude the proposed commission plan. However, the House adjourned last evening without voting on any Detroit school legislation, although House Speaker Kevin Cotter (R-Mount Pleasant) told reporters after the session: “We’re working on something, but it’s still not there yet.” Rep. Tim Kelly, Chair of the House Appropriations Subcommittee on School Aid, said he supports the tentative deal and is encouraging support from colleagues who voted last month for the original House package—a package which included $33 million in transition aid, but no commission—explaining the potential tradeoffs: “[W]without the commission” more dollars would go to DPS…That’s the exchange.” To which Mayor Duggan warned such a state aid package would be wasted unless there were a commission to help stabilize enrollment and finances at DPS, noting: “They know DPS is going to fail and that $600 (million) or $700 million is going to be blown…They know it. The Governor knows it. And they’re trying to pass it anyway.” Getting to the heart of the issue, Mayor Duggan was succinct: “Bringing back the riverfront and all of the houses isn’t going to mean a damn thing if we leave the children behind.”

The Mayor’s hopes seem to be earning a higher grade in the state Senate, where GOP leaders have been trying to preserve an education commission that could regulate where public and charter schools locate in the city. There the emerging compromise would include allowing a school board election for a new, debt-free Detroit school district to happen in November, according to an outline obtained by The Detroit News. Sen. Goeff Hansen (R-Hart), the lead sponsor of the state legislation overhauling Detroit’s public schools, and Gov. Rick Snyder both said yesterday they are still pushing for the House to include an education commission in the Detroit Public School District legislation.

For his part, Gov. Ric Snyder, who has been working with state Senate leaders in support of creating the proposed Detroit Education Commission, yesterday said: “I’m not willing to give up on the concept at this point in time,” in an interview with The Detroit News Editorial Board, although he signaled his main priorities for a DPS overhaul are mostly focused on paying off DPS’ $467 million in outstanding debt, so that a new Detroit Public School district would not only be debt-free, but also have access to $200 million in transition funding as well an elected school board, telling the News: “We need a financial solution, and I want the school board back, in particular.”

The final exam deadline for DPS and state leaders lapses in two weeks when the Legislature adjourns for its summer recess. Failure, warned John Rakolta Jr., Chairman and CEO of the Detroit-based Walbridge construction company, would trigger a mass exodus from Detroit Public Schools this fall if lawmakers fail to agree on a plan without the commission: “If we don’t pass the Senate bill, we’re going to have enormous student loss this October, and you better be prepared to go through this whole thing again next year at this conference, because we’re going to be another $150 million in the hole after we’ve paid off all of this debt.”

What Is an End Game for Municipal Fiscal Distress?

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eBlog, 5/12/16

In this morning’s eBlog, we wonder if the end game is nearing in Atlantic City. We observe the corrosive, criminal behavior by public school officials in Detroit’s public school system—and the potential consequences to efforts in the Michigan Legislature by Governor Rick Snyder—asking again—whether lessons were really learned from Detroit’s epic municipal bankruptcy. Finally, in the wake of U.S. Treasury Secretary Jacob Lew’s visit to Puerto Rico early this week—and Puerto Rico Governor Alejandro Garcia Podilla’s visit with House Speaker Paul Ryan, whether Congress is ready to act on legislation to avert a critical insolvency by July 1st.

The End Game for Atlantic City? Assemblyman Vincent Mazzeo of Atlantic County Tuesday said Democrats in the N.J. State Assembly have negotiated the basic framework for a compromise bill to address Atlantic City’s nearing insolvency—considering legislation that would give the municipality at least 150 days to “get its house in order” under a quasi-control board composed of five state and local officials—in effect a compromise version comparable to that offered by State Sen. President Steve Sweeney, who has been clear that a municipal bankruptcy by the city would be the “worst thing that could happen to the State of New Jersey.” The emerging proposal would allow Atlantic City some period of time to get its finances under control before a state takeover would trigger and add an element from the alternative bill introduced by Assembly Speaker Vince Prieto—one supported by Atlantic City Mayor Don Guardian, which would provide for a five member oversight panel to steer the city through a series of financial benchmarks. Assemblyman Mazzeo said the compromise under discussion would include some form of immediate aid to the city in the form of a loan or possibly the redirection of casino funds which have been long promised by the state to plug a $33.5 million hole in the city’s budget, noting: “We made a lot of progress as far as the details of the compromise.” The Assemblyman’s announcement could mark a significant breakthrough—especially because he had previously garnered significant apprehension by Atlantic City leaders due to his alignment with other South Jersey Democrats who have advocated for a full state takeover of Atlantic City.

Nevertheless, the Assemblyman has made clear that structural cuts in the city’s labor contracts will have to be made, but added that his new approach was considerably more realistic than previous state initiatives—noting, for instance, the original Senate “compromise proposal” giving Atlantic City 45 days to cut its budget nearly in half was unrealistic—albeit it is unclear whether any 50 percent cut is; but his new proposal would extend the 45 days to 130, even as he reports he is trying to understand “what is the number for the budget that Atlantic City can provide services to the residents.” His position seems at significant odds with Gov. Chris Christie, who, under his proposed state takeover plan, would have the state usurp power to end union contracts for municipal employees, excluding the teachers union, and preempt all municipal authority with regard to the sale of municipal assets. Finally, Assemblyman Mazzeo said his proposal to create a Payment in Lieu of Taxes system for casinos would likely be included in a future bill, not the compromise plan under discussion.

Detroit’s Unlearning Curve. Even as retired U.S. Bankruptcy Judge Steven Rhodes, the Emergency Manager for the Detroit Public Schools (DPS) has been working around the clock to secure state aid, the criminal behavior of some of the system’s former and current employees is consuming precious fiscal resources in the form of pensions and political support critical to DPS’s future. Now thirteen former and current Detroit Public School principals who have been charged with a felony involving a $2.7 million kickback and bribery scheme at DPS remain, nevertheless, eligible for their state pensions. More names are likely to be posted: U.S. District Judge Victoria Roberts yesterday asked Norman Shy, the alleged mastermind in the DPS bribery and kickback scheme at Detroit Public Schools, if the conspiracy extended to 13 former and current DPS principals, all of whom have been charged in the case, to which Mr. Shy responded: “I paid school officials monies and other things of value for their assistance…” adding there “may have been others. I don’t recall,” as he plead guilty to two felony charges: conspiracy to commit federal program bribery, a five-year felony, and income tax invasion, also a five-year felony. Mr. Shy, a graduate of the DPS system, was ordered to pay $2,768,846.23 in restitution; he will be sentenced in September. In addition, former DPS principals Ronnie Sims and Gerlma Johnson appeared yesterday to plead guilty to their roles in the scheme: Ms. Sims, a former principal at Fleming Elementary and Brenda Scott Middle schools from 2005-12, is accused of accepting 24 payments from Mr. Shy totaling $58,519.23—most in the form of bribes and kickbacks to a shell company he created called Educational Consultants USA, according to prosecutors: the 23-year career DPS employee appears poised to move from the classroom to prison. The dishonor roll continues to unroll: a grim unrolling even as the system is looking to the Michigan House and Senate for aid critical to opening the schools in the fall and offering a brighter future to the cities families.

But the harm is even greater—and, mayhap, irreparable: The U.S. Attorney’s Office does not have standing to request a federal court order to revoke the pensions of these individuals—or, as that office yesterday noted: “They will all be ordered to pay restitution, and, maybe they can use their pensions to pay that, but we don’t have any legal standing to take [their] pensions,” referring to the Michigan Public School Employees Retirement System fund pensions for both school administrators and teachers. Caleb Buhs, a spokesman with the Michigan Department of Technology, Management and Budget, which is in charge of the Office of Retirement Services and Michigan Public Employees Retirement System, said state statutory language provides that if an employee is found in violation of the public trust, a court can order a revocation of his or her public pension. But the determination with regard to whether the charge faced by the DPS administrators is considered a violation of the public trust is up to a judge. According to Mr. Buhs, in Michigan, “There is not a listing of crimes that fall into the category. It’s at the discretion of the judge.” One outcome does appear clear, a different judge, retired Judge Rhodes in his acting capacity as Emergency Manager at DPS, is committed to leaving no stone unturned in his Don Quixote quest to “investigate legal options for recovering the stolen funds.”

The disquieting DPS news, however, can hardly be expected to be good news for DPS even as Michigan Treasurer Nick Khouri warned the package of bills passed by the state Senate in an effort to avert a DPS municipal bankruptcy would provide insufficient revenues “to transition to the (new district).” Treasurer Khouri added that the “House passed package leads to a projected cash flow deficit of $22 million in August, rising to $80 million in September,” warning that, absent significant change, the proposed new, debt-free Detroit school district under the pending bill could become insolvent by its second month in existence under the House-passed $500 million debt-elimination plan—a warning to which Michigan House Speaker Kevin Cotter took exception. The Treasury Department analysis of the House plan concludes the new Detroit Community School District would have a $22 million deficit by the end of August and would continue to run deficits each month next school year with $33 million in startup cash. In contrast, the Senate version to eliminate DPS’s operating debts and provide the new school district with $200 million in transitional funding would leave the new district with a low balance of $86.9 million in September, according the Treasury analysis. The Speaker, additionally, noted he was “discouraged” to see the analysis come out five days after the House had voted—questioning the timing so long after he had requested the information—information based upon revisions of DPS Emergency Manager Steven Rhodes’ earlier request for about $200 million for transitional costs—some $125 million the new school system would need “at inception” to pay vendors and employees, and open school buildings in September, the one month Michigan school districts do not receive a payment from the state, according to the Treasury document. In addition, the Governor’s office has noted that the new DPS will need $65 million for deferred maintenance, school security equipment, and building-closing costs—with the Treasurer’s office adding a final $10 million in transition costs would finance “investment in key academic programs that have been deferred due to financial constraints and austerity measures.”

Speaker Cotter, last week, said House Republicans could not support the Senate’s proposal for $200 million in startup costs, because members were not given enough details about how the funding would be used, a position he reiterated Tuesday—that is before the startling revelations that emerged yesterday. The Speaker noted: “The taxpayers of the state are being asked to make an investment, and I don’t think it’s unreasonable to ask for at least something that resembles a business plan, to say how this money is going to be used,” with his spokesperson disputing the Treasury’s conclusion that the proposed House plan would lead to a quick insolvency. Perhaps trying to better inform all sides—and in compliance with Michigan’s emergency manager law, Judge Rhodes Tuesday convened a public informational meeting on his Fiscal and Operating Plan in Detroit at which he said his goal was “to set DPS on a path to long-term success” and added some of the $200 million would be used “to substantially upgrade our buildings and facilities to make them more efficient,” noting: “We also need transitional and working capital…We have certain minimum cash requirements in order to pay our bills until the first state-aid payment arrives in late October. We want to enhance our academic programs and to retain the ones we have…We absolutely need that minimum amount from our Legislature in order to set DPS on a course for success.” Nevertheless, Senate Majority Leader Arlan Meekhof (R-West Olive) warned that the that startup funding remains one of the main sticking points between the two houses—deeming the $200 million “critical,” even though he did not rule out negotiation.

State Treasurer Nick Khouri detailed the $200.2 million in transition costs Detroit Public Schools needs to create a new debt-free school district as part of a larger $670 million rescue plan:

Operation cash: $125 million
■ $58 million for cash flow based on timing of bills and lack of September state aid payment.
■ $55 million for accrued payroll costs, other pending contingencies and claims.
■ $10 million for professional transition costs in the information technology, human resources, financial and legal departments.
■ $2 million for academic and instructional support.
Building improvements: $65.2 million
■ $19 million for heating, ventilation and air conditioning.
■ $16 million for roof repairs.
■ $15 million for windows.
■ $10 million for upgrading school security equipment.
■ $3 million for lighting.
■ $2 million for school building closing and reorganizing.
■ $250,000 for fencing and paving.
Academic improvements: $10 million
■ $5 million for “educational enhancements” in art, music and gym
■ $3 million for literacy programs and libraries
■ $2 million “investment in innovation” for science, technology, engineering, arts and mathematics programs
Source: Michigan Treasury Department

Puerto Rico. Even as Major League Baseball and its players union have cancelled scheduled games in Puerto Rico due to fears about the Zika virus, House Speaker Paul Ryan’s efforts to pass and send legislation to address the U.S. territory’s looming insolvency—especially to meet a July 1 deadline payment of $800 million to holders of Puerto Rico general obligation bonds backed by the commonwealth’s constitution—in addition to some $1.2 billion in other municipal bond payments—are continuing to struggle after the House Natural Resources Committee yesterday postponed its scheduled release of revised legislation, albeit there is some hope Chairman Rob Bishop (R-Utah) will release it today—and the Committee still seems set to vote next Wednesday. The setback came as Ranking member Rep. Raul Grijalva (D-Ariz.) said: “We are making progress, but we are not there yet…The situation in Puerto Rico is dire, but a bill that doesn’t solve the problem, or doesn’t pass, won’t help anyone.” A Committee spokesperson noted that despite the many delays in moving the bill to date: “I would say that in the interest of protecting U.S. taxpayers, mitigating a humanitarian crisis, and avoiding any potential spillover and borrowing costs from a massive default that results in decades lost for American citizens on the island, yeah we want to get something before that deadline.”

Revisions to the bill, coming in the wake of visits by U.S. Treasury Secretary Jacob Lew and Puerto Rico Governor Padilla’s visit with House Speaker Paul Ryan (R-Wis.), are likely to be similar to the current version, but incorporate changes based on feedback Treasury and Puerto Rican officials, as well as creditors: there has been considerable discussion with regard to the proposed oversight board—with concerns about sovereignty and the potential authority to affect public pension obligations. Thus, refinements are expected to focus on those issues as well as clarifications with regard to maintaining the protection of the existing debt hierarchy.

Can Municipal Bankruptcy Not Work?

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eBlog, 5/09/16

In this morning’s eBlog, we consider, again, the likely municipal bankruptcy of East Cleveland—a potential – and likely—municipal bankruptcy that would demonstrate the limitations of chapter 9 municipal bankruptcy, because the city has so little outstanding debt; so it is unclear whether chapter 9 can even be a serious remedy. Then we turn the roulette table to Atlantic City—site of a visit today by former Mayor Bernie Sanders, where the clock is running out amid questions with regard to quasi-state owned property exempt from critically important property tax revenues. Finally, we try to untangle the arithmetic so critical to the fiscal soundness of the Detroit Public School System—an invaluable foundation for any long term certainty for Detroit’s recovery from the largest municipal bankruptcy in U.S. history.

Teetering on the Edge of Municipal Bankruptcy. The City of East Cleveland has asked the State of Ohio—a step which, under Ohio’s municipal bankruptcy law (§133.36), requires approval of its municipal tax commission—to approve a petition for municipal bankruptcy. East Cleveland Finance Director Jack Johnson said that Chapter 9 bankruptcy would protect the cash East Cleveland has in the bank and allow the city to continue providing services. According to Mr. Johnson, creditors owed legal judgments could choose to drain the city’s bank account at any moment through attachments or garnishments—noting that the city would lose an entire month of operating funds if a $638,000 judgment owed to a provider of photo traffic enforcement services, Nestor Traffic Solutions, were removed from its bank account. A $73,000 judgment related to unpaid overtime is another matter of concern, as is a separate ongoing dispute in which East Cleveland has been racking up $750 per day in fees related to unpaid overtime since April 15. Even if creditors continue to refrain from claiming their funds, financial Armageddon is close at hand. Johnson said that by the end of 2017, East Cleveland’s finances will be so dire that it will have to choose between having a police department and having a fire department, and in 2018, it won’t have enough money for either one.

East Cleveland has struggled financially for decades. Ohio’s state auditor, Dave Yost, declared a state of fiscal emergency there in 2012; the city previously operated under a fiscal emergency declaration between 1988 and 2006. Sharon Hanrahan, the Financial Planning Commission Administrator at Ohio’s Office of Budget and Management, painted a stark picture of East Cleveland’s finances in an April 18 presentation: As of Dec. 31, the city had a deficit totaling $3.4 million, past-due accounts payable of more than $3.4 million and a bank balance just under $639,000. Unpaid vendors include its employee healthcare provider, Kaiser Permanente, which is owed $741,000.

Nevertheless, Mayor Gary Norton has said the move is necessary in order to maintain the city’s payroll and essential services, calling it a temporary fix for the cost side of the city’s economic distress. He reports, however, that the real problem is that there is insufficient revenue coming in to support the city. The request came as an 11-year-old child was among several wounded in separate shootings late last night on the city’s East Side, and as municipal police officers also took fire. Mayor Gary Norton says it would be a temporary fix for the cost side of the city’s economic distress. The move, in some ways, is not a surprise: last year Ohio State Auditor David Yost’s office reported that chapter 9 municipal bankruptcy or merging with Cleveland were probably the most viable options for the city. Should its petition be approved, East Cleveland would be the first municipality in the state ever to file for bankruptcy protection.

East Cleveland, which is a charter city of about 18,000 granted its authority under the home rule provisions of the Ohio constitution, has seen its population fall dramatically over the years, from 39,600 in 1970 to the most recent census figure of 17,843 for 2010—even as its minority population has grown to 94.5 percent. The city’s median household income of $20,660 is less than half the statewide $48,849—indeed, based on median taxable income, the East Cleveland school district, which includes a small portion of Cleveland Heights, has the highest poverty rate in Ohio: 42.1 percent versus 15.9 percent statewide. Worse, the rate for the city’s children in poverty is higher at 60.2 percent, nearly thrice the statewide rate of 22.7 percent. The median home value (county appraisals) is $36,900—and the city currently has a vacancy rate of 37.1 percent—more than thrice the statewide 11 percent. In short, East Cleveland is a municipality not just with a past history of fiscal challenges, but now a point of perhaps no return. In its request to the state of its petition for chapter 9, the city notes that “Despite the city’s best efforts, East Cleveland is insolvent. Based upon financial appropriations projections for the years 2016, 2017, 2018 and 2019, the city will be unable to sustain basic fire, police, EMS [emergency services] or rubbish collection services…The city has tried to negotiate with its creditors in good faith…It has been a somewhat impracticable effort.”

East Cleveland, which currently has no outstanding municipal debt, but does have $3.4 million in outstanding accounts payable, including several judgments from lawsuits that have been settled, sees little light ahead on its revenue front, and fears that its state-approved recovery plan—a plan intended “to restore the city to fiscal solvency,” instead runs the risk of its critical public safety capacity. Indeed, in the wake of last night’s horrific killings, the city is apprehensive the plan “intended to restore the city to fiscal solvency,” would likely, instead, “have the effect of decimating our safety forces. Hence, our goal to effect a plan that will adjust our debts.” The problem is that with no municipal debt outstanding, it is unclear how municipal bankruptcy could really help the city: its fiscal challenge is not debt; rather it is a lack of revenue. Currently, the city realizes revenues from municipal income taxes, Ohio general revenue sharing (the Local Government Fund), property taxes, and trash collection fees, as well as a street lighting assessment. The state aid, however, has been disproportionately reduced in recent years, even as the city’s tax base has eroded. The state revenue sharing has been on a five-year downward slope—contributing to projections that East Cleveland’s revenues will decline by more than 10 percent this year from more than $11 million in 2015, according to a report from the state auditor that examined city finances and the impact of various fiscal options. East Cleveland has considered a merger with neighboring communities, such as Cleveland; however, according to the Ohio Tax Commission, the courts have not accepted such a proposal.

Formerly under a Commission and City Manager form of government, city residents and taxpayers, frustrated with that form of government in the wake of having two of its two commissioners charged with theft in office, and after a revolving door of city managers resulted in little stability and a reduction in services; Citizens for Sound Government, a group of East Cleveland residents, led a petition drive to elect a strong mayor and to create a five-member city council. Attorney Darryl E. Pittman, thus, became the first mayor to lead the city since 1908. Yet, during his second term, the Ohio State Auditor in the autumn of 1988 declared the municipality to be in a state of fiscal emergency in the wake of finding that the city’s water and sewer fund were found to have deficits in excess of $2 million. Subsequently, under the next Mayoral administration, the city increased its borrowing in an effort to recover from its fiscal emergency—a state in which it remained over the next eight years—culminating in the conviction on charges of racketeering and corruption of former Mayor Emmanuel Onunwor. Ergo, in his letter to Ohio Tax Commissioner Joseph Testa, current Mayor Gary Norton wrote, the city is in a trying effort to keep payroll going and to maintain services. Council President Thomas Wheeler said even if approved, filing for chapter 9 municipal bankruptcy would be a “Band-Aid” to keep the city going, not a solution. The Mayor, in his epistle, wrote that, based on the city’s fiscal projections, “the City will be unable to sustain basic fire, EMS, or rubbish collection services,” adding that the municipality’s Financial Recovery Plan, approved by the City Council, would have the effect of “decimating our safety forces.”

In Ohio, where no entity had previously filed for municipal bankruptcy protection, such a petition requires the approval of a municipality’s tax commission. While the Ohio Tax Commissioner’s office said it was preparing a response, it has yet to offer any public comment. For his part, Mayor Norton said that the municipal bankruptcy filing would be a temporary fix for the cost side of the city’s economic distress, but the real problem was with income—there simply, he warned—was insufficient revenue coming in to support the city—and that raising tax rates or imposing new fees would not provide an immediate solution. The request from the city can hardly come as a surprise to the state: State Auditor David Yost’s office last year had issued a statement that municipal bankruptcy or merging with the City of Cleveland were probably the most viable options for the city.

Running the Chapter 9 Tables in New Jersey. New Jersey Gov. Chris Christie late last week said he would rather Atlantic City file for chapter 9 municipal bankruptcy than to provide any state fiscal support. The Governor’s remarks, which came in the wake of both a failure by the Assembly to consider a Christie-opposed rescue package by House Speaker Vincent Prieto (D-Secaucus), which would have provided for a state takeover of Atlantic City, but only if the municipality failed to meet annual benchmarks, and the guesstimate of state officials that Atlantic City will run out of cash at the end of this week. Instead, Gov. Christie urged the legislature to back the Senate-passed package, which would empower New Jersey’s Local Finance Board to renegotiate outstanding debt and municipal contracts for as long as five years if the city failed to close its estimated $102 million budget deficit in 130 days: “If they come up with something: great. If they do not, then you know bankruptcy will be the only option, and, while I would regret having to go down that road, it is a road that I will have no choice but to go down: I am not sending any more money to Atlantic City without the authority to fix the underlying problem.” For his part, Speaker Prieto noted: “I’m looking for a bill that protects Atlantic City’s civil liberty, protects the workers that are there, protects their self-governance…We’re going to work, Monday, Tuesday, [to] hopefully get something that all the Assembly came come together on.”

Indeed, today promises to be an interesting day in Atlantic City, as it will gain attention with the visit of Sen. and Presidential contender Bernie Sanders (I-Vt.) and a renewed effort by the City Council for an alternative avenue to fiscal relief: it is seeking the payment by the State of New Jersey of property taxes by the Casino Reinvestment Development Authority (CRDA) on unimproved land it owns in the city—up to 100 percent of the assessed value of such parcels after seven years of ownership, with resolution author Councilmember Jesse Kurtz noting: “This is the first time, to best of my knowledge, that a formula has been developed and proposed to treat this situation.” Councilman Kurtz claims the resolution’s goal is to prod CRDA to sell or auction off their vacant parcels—a policy for which, unsurprisingly, the CRDA has registered little enthusiasm. The agency which, by state law, is exempt from property taxation, responded, noting it has spent more than $1 billion in improvements in the city: “The role, as a policy matter, of redevelopment authorities is to collect and remediate and clear property and remove hazards and assemble parcels…I think it’s a bad precedent to begin to pay taxes.” The tax dispute—in a municipality which has seen its property tax revenues careen from $20.5 billion six years ago to $6.6 billion today—is aggravated by the land-banking practices of the Authority: purchasing properties in the city, with no plans to sell or develop them—ergo eliciting Councilmember Kurtz’s resolution to note: “The City of Atlantic City recognizes the value of CRDA assembling real estate parcels in particular instances, but opposes the general practice of holding vacant lots off of the [city’s] tax rolls indefinitely.” Of the 111.5 acres or 5 percent of the city’s total land area, the CRDA owns, 75 are developed and would not be subject to the council’s proposed policy. CRDA claims 26 of its acres have a potential for development. CRDA’s vacant lots have a total assessed value of $51.6 million before tax appeals—e.g., at today’s market or assessed appraisals, Atlantic City could collect some $1.8 million in taxes. While that would be a small chip in the city’s $550 million in debt and $100 million budget deficit, it is CRDA’s developed lots that would make the much greater difference: if taxed at current assessed values, the Convention Center alone would generate $13.5 million per year in total taxes; Boardwalk Hall would generate $4.5 million before tax appeals. In fact, Gov. Christie’s own appointed Emergency Manager Kevin Lavin recommended that CRDA privatize those properties, something CRDA Chairman Robert Mulcahy has said the authority would consider. Under the Council proposal, CRDA would pay taxes on 20 percent of the assessed value of a vacant parcel starting in the third-year it owned the property; taxes would increase 20 percent each year until the seventh year, when the authority would pay on 100 percent of the assessed value.

Detroit’s Learning Curve. Against the backdrop of teacher sickouts and the admission by a former Detroit Public School (DPS) board president and union activist—one recently released from federal prison in Alabama for stealing $200,000—that a lack of oversight by DPS makes it far too easy to siphon money from public coffers, one can surely imagine the seemingly impossible challenge which retired U.S. Bankruptcy Judge and now DPS Emergency Manager Steven Rhodes confronts in trying to support prompt action by the Michigan legislature of Gov. Rick Snyder’s request for $200 million to create a new debt-free Detroit school district—a package the Michigan Senate has approved for startup and transitional costs to help DPS operate after shedding $515 million in debt that would be paid off over the next decade—but a package which has not gained passing grades in the House, which has instead approved $467 million for debt relief and $33 million for transitional costs. Judge Rhodes had proposed five areas where state funds for DPS are critical to keep the state’s largest public school district solvent in the new fiscal year that begins July 1 as well as to improve school buildings and educational programs in a bid to reverse decades of declining enrollment. The request includes $75 million for capital improvements to school buildings; $50 million for academic and instructional support and transitional costs for legal services, human resources, accounting and information technology; $25 million for “other pending contingencies and claims that may need to be funded” by the new school district, according to the plan; $25 million for improving academic programs; and $25 million for cash on hand at the inception of the new school district, because Michigan public schools do not receive a state aid payment in September, when the new school year begins and districts incur more monthly expenses. However, House Speaker Kevin Cotter (R-Mount Pleasant) claimed House Republicans had received insufficient information about how the proposed $200 million would be spent prior to its 4 a.m. vote last Thursday—so that, they instead only agreed upon $33 million for transitional costs—claiming their plan would erase $52 million in debt payments DPS owes in July and August and would appropriate $33 million to cover an expected deficit through the end of September.

Republican businessman John Rakolta Jr., who has studied DPS’ finances in depth as a co-chair of the Coalition for the Future of Detroit Schoolchildren, noted that the startup costs for academic needs include filling 180 teaching positions in DPS that were left vacant this year because of budgetary constraints, causing class sizes to swell to 40 and even 50 students in some classes—and that there are schools in Detroit which do not have math and science teachers. All of which has kept Judge Rhodes studiously at work with the Governor’s Office and the Michigan Treasury Department to refine the estimated transitional costs: the scholastically challenging process of paying off accumulated debts and providing competent educational opportunities.

How States Can Threaten a Municipality’s Fiscal Future

March 17, 2016. Share on Twitter

Because the federal government–and, increasingly, states no longer address fiscal disparities within states, that has provoked or invoked greater challenges for states–and increased fiscal despair for municipalities. Congressional elimination of general revenue sharing and countercyclical fiscal assistance has meant that states, such as New jersey and Michigan, for instance, now bear a burden and challenge. Will they opt for a constructive, passive, or destructive state fiscal policy?

Shutting Down a Municipality. Atlantic City Mayor Don Guardian yesterday reported that because of his city’s near insolvency (city officials have warned the city will run out of cash on April Fools’ Day), the city would be forced to halt all nonessential government services beginning in early April absent urgent state assistance: Mayor Guardian said the shutdown would start on April 8th and was likely to last until at least May 2nd, the date when quarterly tax revenues are due. During the shutdown, police, fire, and sanitation workers would perform their jobs—but without pay, which would be deferred pending receipt of taxes due; health care benefits would continue uninterrupted. Moreover, Mayor Guardian warned this was unlikely to be a one-time event, especially if the State of New Jersey does not step up with some kind of fiscal assistance, noting: “The city is in discussions with the state to avoid and forestall what may be an imminent financial predicament…Unfortunately, due to financial circumstances beyond our control, we will be forced to close City Hall.” The increasingly dire fiscal standoff comes as New Jersey Governor Chris Christie has warned he will not sign legislation to provide fiscal assistance to Atlantic City unless the New Jersey Legislature approves a state takeover of the city government. Atlantic City police union President Thomas Moynihan yesterday reported that Atlantic City’s police officers would report to work even if they “miss a paycheck or two in the meantime.”

Even though Gov. Christie claimed he had reached an agreement with New Jersey Senate President Steve Sweeney (D-West Deptford) to give the state control over the finances of Atlantic City for five years, that agreement has not secured House support, and has drawn criticism from New Jersey Assembly Speaker Vincent Prieto (D-N.J), who has made clear he would not ask the House to consider state legislation to alter or terminate union contracts unless and until local and state officials reach a compromise, noting: “The governor already has authority to help Atlantic City avoid financial disaster…It’s time for Gov. Christie to do his job and use his existing authority to resolve this once and for all.” In addition, Speaker Prieto’s spokesman notes that the New Jersey Local Government Supervision Act of 1947 already allows the state to control Atlantic City’s finances and government. For his part, Gov. Christie has made clear he will not sign any bill into state law that changes even a word of the Senate version.

Atlantic City, which has seen its tax base contract 64% since 2010, is deep in debt and not only unable to issue debt through the municipal bond market because of its low credit rating, but also faces a severe contraction of its tax base in the wake of the closure of four of its twelve casinos. It now faces worse odds of avoiding a state takeover. Even though Mayor Guardian yesterday said “We are making every effort to find solutions” prior to April 1st, his plan would mean that no employees would be paid until at least May 2nd, the date the city will receive its next installment of taxes. While essential services such as public safety and revenue collections will continue, other functions will cease and City Hall will close 4:30 pm local time on April 8. Moody’s Investors Service has warned that the city could default on debt as early as next month without state action, meaning its cost of borrowing is increasing—as are the possibilities the city could file for chapter 9 municipal bankruptcy.

Unbalancing. The Michigan Municipal League yesterday reported Michigan is the only state in the country in which there was an overall revenue decline for cities, townships, and counties over the decade from 2002 to 2012, due in large measure to state cuts in revenue sharing with cities, townships, villages, and counties by $7.5 billion over the decade—assistance vital to finance essential public services and to address fiscal disparities. The League, in its report, noted that U.S. Census Bureau data finds that Michigan’s municipalities experienced an 8 percent drop in revenues from what it has experienced from failed state fiscal policies toward cities and towns, noting that, according to the U.S. Census Bureau, Michigan is the only state in the country providing fewer economic resources to its cities in 2012 than it did a decade ago in 2002, adding that the tragic outcome in Flint reflects in many ways what should have been anticipated in a state which has adopted a state fiscal policy which incentivizes new building at the expense of what currently exists: “Our system attempts to balance budgets by only addressing the cost side of the equation. We have no mechanism to invest in our cities as a way of improving the financial well-being of a community.” The League’s report further points to the extraordinary state powers under Michigan law for Emergency Managers—powers the League warns which “virtually all relate in one way or another to cutting costs,” rather than taking into consideration the provision of essential services, such as drinking water, public safety, etc.: “Cost-cutting measures, with few very exceptions, result in a reduction in the services that the community will receive. Usually those reductions do not have tragic consequences, but make no mistake: the decision to switch from the Detroit Water and Sewer Department to the Flint River was an economic one driven by state laws and policies that significantly impact and restrain local government…This decision was not about improved service, water quality, infrastructure investment, or any other altruistic goal. This was an opportunity to save money and nothing more.”

A System Designed for Failing a Municipality: The special report notes that the state law and practice of appointing Emergency Managers has proven contrary to the long-term fiscal and human sustainability of the state’s communities, noting: “By design, emergency managers are outsiders with a single mission to reduce costs. I am in no way suggesting that this decision was made with malice or without forethought, but the emergency manager and, by extension, the state has only one objective during a financial emergency. That goal is to reduce costs until the budget is balanced. It is this approach that has brought us to where we are today. Emergency managers do not have to live, long-term, with service reductions and the diminishment to the community that they bring. When they have completed the mission, they move on. They have one focus: to balance the budget by cutting expenses until they equal revenues. But this approach fails to recognize, and in fact is in direct conflict with one of the fundamental tenants of Michigan’s municipal finance model, which is that the value of a community directly impacts the revenue that a community can generate to sustain services. It’s a system designed for failure.”

Think for a moment about how cities (& counties) generate revenue. Property taxes are a function of two variables: millage rates and taxable value. What makes taxable value higher in one community versus another, is, in essence, what makes one city or village more desirable than another. Great places can command higher prices, which translate into greater taxable value. This in turn generates more revenue. It is simple math. When an emergency manager balances the books by closing parks, eliminating programs and services and forgoing investments in infrastructure, he or she) makes it a less desirable place. This, of course, diminishes the value of the city and its revenue generating power. Consequently, the city offers even fewer services, which further diminishes it as a place where people want to live, which diminishes value, and so on. It’s a death spiral — a fundamentally flawed process that will never work given Michigan’s current municipal finance model. The system is broken.

Now think of that approach in the context of Flint. What have we bought with our cost-reduction approach to balancing budgets? A significantly damaged community in both a social and economic sense. If taxes are a function of value and millage, how have property values been impacted in Flint as a result of this cost-cutting decision? I think it is fair to suggest that the property values in Flint have been severely impacted as a result of the current crisis. Which will mean deep reductions in local tax revenue, which of course will mean reductions in service, which means a diminishment of value. The death spiral continues. Sadly, our only existing mechanism to address this will be through more cuts. We need a new way forward.

Our first priority must be to address the social and health impacts Flint is experiencing. Beyond that, we must address the policy that brought us here. We must invest in our local communities. Cuts beget more cuts. It is a race to the bottom, and in this case a tragic illustration of flawed public policy. Creating vibrant, desirable communities is proven to have positive economic impact as well as social value that we have lost sight of with our current approach. We must recognize that by investing to create great places we can improve both the quality of life and the economy of a city at the same time. A cut-only approach can only diminish the strength of a community and in extreme instances like this have a devastating human impact. We must learn from this disaster and redefine how we invest in Michigan cities.

February 26, 2016. Share on Twitter

Out Like Flint. The profound threats to human health and safety in Flint created in signal part by a state appointed emergency manager—especially for the city’s children—appear to have been issues brought to the state’s attention long before there was any action: key advisers to Gov. Rick Snyder urged switching Flint back to Detroit’s water system nearly a year and a half ago in October of 2014 in the wake of a General Motors Co. warning that Flint’s heavily chlorinated river water was rusting engine parts, according to governor’s office emails examined by The Detroit News: Valerie Brader, then Gov. Snyder’s environmental policy adviser, requested that the governor’s office ask Flint’s state-appointed emergency manager to return to Detroit’s system on October 14, 2014, three weeks before Gov. Snyder’s re-election. Moreover, Mike Gadola, then Gov. Snyder’s chief legal counsel—today a Judge on the Michigan Court of Appeals, appointed by Gov. Snyder– agreed Flint should be switched back to Detroit water nearly a year before state officials relented to public pressure and independent research demonstrated elevated levels of lead in the water and bloodstreams of Flint residents. Mr. Gadola’s memo reported: “To anyone who grew up in Flint as I did, the notion that I would be getting my drinking water from the Flint River is downright scary…Too bad the (emergency manager) didn’t ask me what I thought, though I’m sure he heard it from plenty of others.” Mr. Gadola added that his mother remains a resident of Flint, making his personal alarm part of his communication to Gov. Snyder’s Chief of Staff Dennis Muchmore, Deputy Chief of Staff Beth Clement, as well as then-Communications Director Jarrod Agen, writing: “Nice to know she’s drinking water with elevated chlorine levels and fecal coliform…I agree with Valerie (Brader). They should try to get back on the Detroit system as a stopgap ASAP before this thing gets too far out of control.”

The telltale emails make clear that that some of the Governor’s closest advisers were privately, but clearly put on notice of the human health threat to Flint—especially its children—long, long before the state began to act. The information comes in the wake of the Governor’s office this week releasing nearly 1,6oo pages of emails to The Detroit News related to Flint’s 2014 switch to river water—a switch which experts believe caused the deadly leaching of lead into Flint’s drinking water. If anything, the News notes, the emails make clear that the Governor’s aides discussed poor water quality in Flint as early as the fall of 2014 after the city issued limited boil-water advisories because of an outbreak of E. coli and total coliform bacteria in the water supply. Moreover, Ms. Brader’s email alluded to festering apprehensions with regard to how the chlorine used to kill the bacteria outbreak was causing the formation of a harmful disinfection byproduct known as trihalomethane, a carcinogen which can increase the risk of cancer, liver, kidney, and central nervous system problems—or, as she tellingly wrote: “Specifically, there has been a boil water order due to bacterial contamination…What is not yet broadly known is that attempts to fix that have led to some levels of chlorine-related chemicals that can cause long-term damage if not remedied (though we believe they will remedy them before any damage would occur in the population).” Two months later, the Michigan Department of Environmental Quality issued a Safe Drinking Water Act violation to Flint for the high levels of trihalomethanes in the water. According to state records, Flint violated the law twice more until coming into compliance on Sept. 2, 2015. Nevertheless, despite her concerns and other staff concerns about the city’s brownish water quality, the Governor’s staff never took a recommendation to him that Flint be switched back to Detroit water until the following October.

Perhaps unsurprisingly, the apprehensions by key members of the Governor’s staff were held in abeyance pending completion of the new Karegnondi Water Authority pipeline could be completed; however, Michigan Treasury Department officials seemed to feel that the cost to reconnect Flint to Detroit water — an extra $1 million per month — was more than the fiscally stressed city of Flint could afford, with, as one aide to the Gov. put it: “The assessment was you couldn’t do it, because it was a cost that should have borne by the system.” Nevertheless, Mr. Muchmore, in a subsequent email, advocated using a $2 million grant the state had given Flint to upgrade its troubled water plant toward reconnecting to the Detroit water system, tellingly writing: “Since we’re in charge, we can hardly ignore the people of Flint,” in an email he sent to communications officials in the Governor’s office, the state Department of Environment Quality, and the Treasury Department, adding: “After all, if GM refuses to use the water in their plant and our own agencies are warning people not to drink it…we look pretty stupid hiding behind some financial statement.” But when asked why the Governor’s office had not sought funding from the Michigan Senate and House appropriations Chairmen last winter for a supplemental appropriations bill to reconnect Flint to Detroit’s system, the former chief of staff told the Detroit News it would have been dead on arrival.

Indeed, the newly released trove of emails demonstrates that Ms. Brader learned of GM’s switch to Detroit water on October 14, 2014 from an aide in the office of Senate Minority Leader Jim Ananich (D-Flint): Ms. Brader sent a note that afternoon to other top gubernatorial aides writing that Flint’s water was “an urgent matter to fix.” By August and September 2014, the city of Flint had issued boil water advisories to residents after water tests revealed an outbreak of E. coli and total coliform in some parts of the city. To treat the outbreak, the city increased the amount of chloride added to the drinking water at the Flint water treatment plant—chlorine levels General Motors had cited when it disconnected from Flint’s water system and turned to nearby Flint Township’s water, which came from Detroit’s Lake Huron pipeline. The message, however, did not seem to impact Flint’s state-appointed emergency manager: On Oct. 16, 2014, the City of Flint reported that General Motors’ exit from Flint’s water system “ensures that Flint residents will continue to have safe quality drinking water but minimizes the impact on GM’s machining work.”

Puerto Rico. In the wake of two Congressional hearings this week, Congress appears to be leaning in support of creating a federal oversight control board for the U.S. territory of Puerto Rico—an oversight board not dissimilar to previous New York City and Washington, D.C. boards—authorized to restructure and oversee Puerto Rico’s debt, pension, and economic crises. The hearings come as House Speaker Paul Ryan (R-Wi.) has set a March 31 deadline for action by the full House—a critical timeline, as Puerto Rico risks insolvency as early as April. Legislators said the two hearings, one on the Treasury Department’s proposal for the commonwealth and the other on possible ramifications of a restructuring on the municipal bond market, were the last scheduled before they prepare to draft a legislative package before a March 31 deadline imposed by House Speaker Rep. Paul Ryan (R-Wisc.).

At one of yesterday’s two hearings, Antonio Weiss, a counselor to U.S. Treasury Secretary Jack Lew, testified the administration believes the best solution is for Congress to allow for territorial restructuring authority using the powers Congress has under the U.S. Constitution’s Territorial Clause: “This would give Puerto Rico the tools it needs to reach a resolution with creditors and adjust its debts to a sustainable level…Importantly, this authority would expressly not apply to states, which have an entirely different relationship with the federal government under the 10th Amendment.” Mr. Weiss’s testimony appeared to signal a shift in the Administration’s position to ask Congress to authorize Puerto Rico authority to restructure all of its debts under Chapter 9 bankruptcy protections—a proposal dubbed “Super Chapter 9,” which never gained support in Congress because of misplaced apprehensions and misunderstandings in Congress about the nation’s dual sovereignty. Mr. Weiss also dispensed with a second misapprehension with regard to Puerto Rico’s public pension liabilities, testifying that while the Treasury is “deeply concerned about the pensions in Puerto Rico,” he said there was no truth to some press reports that the administration is proposing to put the territory’s pension obligations above its debt obligations in a restructuring hierarchy. Instead he said everyone should come to the table in a restructuring. With regard to restructuring, the Administration believes it should be in three parts in addition to a balanced approach to any federal board’s authority: a temporary stay on litigation to allow for voluntary negotiations between creditors and the commonwealth; a voting mechanism to prevent a few hold-out creditors from blocking a reasonable compromise; and a court-supervised structure to assure an orderly resolution if negotiations fail. Mr. Weiss testified there would be room for further Puerto Rico proposals to address economic growth, territorial tax reform, and improving Puerto Rico’s access to federal healthcare programs, noting: “We believe it is for Puerto Rican legislators and the governor to identify the reforms that are needed structurally, but we think it is equally important that the oversight board makes sure that those reforms that are identified are implemented.” He also sought to address apprehensions about potential concerns which have been raised with regard to broader adverse impacts on the state and local municipal bond front, noting that a key focus was to ensure an orderly restructure of the islands debts precisely to avoid the kinds of “cascading defaults and litigation” over the next decade that could risk muni market destabilization, telling lawmakers: “The best thing for municipal bond markets is for this to be brought to an orderly solution.”

Chairman Rob Bishop (R-Ut.) of the Natural Resources Committee, in the wake of the hearing, seemed to concur that any entity given oversight authority in Puerto Rico would also need to have the power to restructure, stating: “Some organization that is going to do a restructuring in this situation has to be the logical solution and there’s no other way around it…But it’s not necessarily going to be a remake of other control boards that have happened in the past. It has to be dictated by the specific situation.”

In the companion, simultaneous hearing chaired by Rep. Sean Duffy (R-Wis.), Chairman of the House Financial Services Committee’s Subcommittee on Oversight & Government Reform, Mark Zandi, Moody Analytics’ Chief economist testified that the Chairman’s proposed legislation was “a very positive step in the right direction;” however, he said he believed it failed to be broad enough, noting that Puerto Rico needs a much broader restructuring of all of its debts—as well as its unfunded pension liabilities. (Chairman Duffy’s proposed legislation (HR 4199) would provide public authorities in Puerto Rico with Chapter 9 municipal bankruptcy authority in return for Puerto Rico’s acceptance of a newly created five-member Financial Stability Council to review and approve its financial plans, budget and borrowing plans.) Mr. Zandi testified that authorizing the territory to file for municipal bankruptcy might only help restructure 30% of Puerto Rico’s debt—and perhaps up to 75% if COFINA bonds were included, but the proposal could trigger expensive and lengthy litigation—consuming time that is running out; ergo, Mr. Zandi recommended a Financial Stability Council be authorized to implement a temporary stay of perhaps 12 to 18 months on all debt payments so that there would be sufficient time to “fashion a sustainable restructuring.”

Anne Krueger, a senior research professor of international economics at Johns Hopkins University who led a study on Puerto Rico’s economic situation and prospects, told lawmakers the Commonwealth needs to reform its financial policies to become sustainable, stressing that Puerto Rico must deal with its unfunded pension liabilities, reform its tax and business policies, and receive Medicaid equal to all other states. William Isaac, senior managing director and global head of financial institutions for FTI Consulting, testified that authorizing municipal bankruptcy authority to the territory, “would be unprecedented and would have far-reaching implications, including raising the costs of borrowers for the fifty states.” Subcommittee members responded that Iowa Gov. Terry Branstad had raised the same apprehensions in a recent letter to House leaders. But Rep. Nydia Velazquez (D-NY) noted: “There’s no evidence of this,” and asked Mr. Zandi for his perspective—in response to which, he replied: “Investors have said quite clearly that Puerto Rico’s situation is Puerto Rico’s situation and it’s no one else’s problem.”

Our respected and admired friends at Municipal Market Analytics this week provided their own key perspective on this tension we have observed in Detroit, Central Falls, Stockton, and San Bernardino, noting that by elevating Puerto Rico’s pension systems to a higher priority that its constitutional debt, the territory would be “abrogating its duty to creditors,” adding that such an elevation would also be picking one set of retirees over another—e.g., in this instance, Puerto Ricans, who own a significant amount of the U.S. territory’s debt: 30 percent of all outstanding Puerto Rico municipal bonds are owned on-island through retirement funds, leading MMA to write: “By choosing to support pensioners from the public employee system instead of debt, the Commonwealth would effectively be choosing public employees over private employees, biasing the system against retirees who saved in private markets in favor of retirees in the government-run program. Pension systems in PR are collectively underfunded by about $44 billion at present, according to the most recent actuarial estimates, and the contributions made by public employees into defined contribution plans have been liquidated alongside the contributions made for defined benefit plans in the past. Meanwhile, about 30 Puerto Rican credit unions (cooperativas) are on the brink of default due to losses incurred on PR bonds.” Thus, MMA worries: “If the stated purpose of a PR restructuring is to protect regular Puerto Ricans through shared sacrifice, proposals of the type advanced by the US Treasury (per Reuters) are not the route forward, as severe damage to the local financial system would ensue under such a plan.”

Seizing Atlantic City. If anything, the time line for insolvency could be direr in Atlantic City than Puerto Rico, potentially triggering a state takeover of the city even if the state fails to enact pending takeover legislation. The issue comes with regard to costs: according to a memo from the nonpartisan Office of Legislative Services (OLS), preventing a “catastrophe” would require significant, long-term state financial support. Such a situation could occur if the city defaulted on its bonds or were unable to transfer property tax payments to the state, local school district, or Atlantic County government. Atlantic City, which is on the edge of insolvency, has little to no ability to borrow: its credit rating is below junk-bond status. Under the Local Government Supervision Act of 1947 — the same law that allowed the state to imposed oversight of some parts of city government in 2010 — New Jersey has significant powers to intervene in the city’s finances, according to OLS. It also has additional authority because the local government receives transitional aid that is subject to a memorandum of understanding with the Division of Local Government Services. The memo notes: “At the point when Atlantic City cannot borrow, short-term, to pay its essential operating expenses and payments due to the county and other taxing districts, it is hard to envision the State refusing to exercise its powers under the Local Government Supervision Act (1947) to take control of the finances of the city.”

The new development comes as local leaders, led by Mayor Don Guardian, are pushing back against the takeover proposal sponsored by Senate President Stephen Sweeney and supported by Gov. Chris Christie, with Mayor Guardian and City Council members holding a press conference at the beginning of the week to oppose the legislation, with the mayor going so far as to describe it as a “fascist dictatorship.” Nevertheless, the Governor and Sen. Sweeney have stood their ground, albeit Assembly Majority Leader Lou Greenwald, the sponsor in the lower chamber, on Monday said he may not move forward with the proposal unless local leaders are on board. Nevertheless, Atlantic City’s leaders are rapidly losing leverage: Gov. Christie last month vetoed a bill that would have protected the city from the impact of court-ordered reassessments on the struggling casinos and injected millions of dollars in revenue in the near term. Now the new takeover proposal comes with similar legislation, which would create payments in lieu of taxes the casinos could pay to the city, the school district and county government.

If state lawmakers were to drop their takeover effort, some form of intervention increasingly seems inevitable, according to the legislative services memo, which asserts the state has “sufficient authority over the city’s finances to prevent a financial catastrophe.” In the short-term, the state could offer a low or no-interest loan. It could also force the city to liquidate debt and require the city’s financial officer to issue special reports and hold hearings, OLS says. While the state would not be able to unilaterally end existing collective bargaining agreements — a power included in the proposed takeover bill — it could negotiate new agreements with unions. But all that would not necessarily fix the city’s deep-rooted problems, according to OLS. The city owes hundreds of millions of dollars to bond holders and casinos that won tax appeals, and it also receives less money than it used to from the casinos. Referring to the pachyderms in the house, the memo notes: “Of course, the ‘elephants in the room,’ being the tax refunds owed by Atlantic City to the casinos and the corresponding loss of casino ratables to the city’s property tax base, will likely render the State’s financial supervision efforts insufficient to fully address Atlantic City’s financial situation without the provision of increased long-term financial aid to the city and school district.”

To make matters worse, federal bankruptcy protection — something that city had been mulling but would need state approval to seek — may not be able to solve the issue either. A judge may not have the authority to erase or “cram-down” the $170 million in debt the city owes the Borgata Hotel Casino & Spa, which had won tax appeals and is owed a refund. Because the casino is exercising its right to skip property tax payments until the city issues the refund, a judge might consider the debt a credit against future taxes, or, as OLS noted: “If the Borgata property tax refund can be characterized as a property tax prepayment for future tax quarters, then it is unlikely that the bankruptcy code’s automatic stay of action would apply.”

Marc Pfeiffer, the superb Assistant Director of the Bloustein Local Government Research Center, Bloustein School of Planning and Public Policy in New Brunswick, New Jersey, notes that generally, while New Jersey clearly has significant authority now, given the magnitude of Atlantic City’s immediate and long term problems, the traditional solutions may not work, pointing to immediate issues such as cash flow, the need for stability of calculating casino property values and the tax revenue they represent, and monetizing their accumulated debt and deficits. He wrote that the long term requires the city to restructure and rationalize the cost of running the city: the current cost structure (with a few exceptions) was effectively established when Atlantic City had 12 casinos of higher value (i.e., market value of $22B in 2007 and $7.4B today), adding that labor costs, staffing levels, and position allocations all need to be rationalized—and there is no adequate legal authority for that to happen. Further, he notes, city officials need to understand that the current and prior generations of elected officials could have done a better job of managing their resources. The city has traditionally been overstaffed with pay scales in excess. Historically the city has been rife with patronage appointments and expectation of privilege (he notes, for instance, that only in the last month did city council members give up their personal vehicles). That means they cannot do business as usual and blame the state; that does not win any arguments, adding that even though Atlantic City officials were aware of the drop in value, they did little to address it.

Similarly, he adds, New Jersey’s plans for the City over the last 6 years have not met expectations: political decisions along the way resulted in the today’s crisis: Instead of waiting until 2015 to engage via an emergency manager who only recommended actions, if stronger state action had been taken several years ago, the immediate crisis could have been avoided—adding that, nevertheless, the situation being as grave as it is, the parties need to quickly align and understand that dramatic action is needed now to avoid a municipal bankruptcy filing which would only prolong the problem and add more costs. He notes that while the state clearly has significant authority now, given the magnitude of Atlantic City’s immediate and long term problems, the traditional solutions may not work. The immediate issues: cash flow, the need for stability of calculating casino property values and the tax revenue they represent, and monetizing accumulated debt and deficits. Further, he wrote, city officials need to understand that the current and prior generations of elected officials could have done a better job of managing their resources. The city has traditionally been overstaffed with pay scales in excess.

He added that New Jersey’s plans for the City over the last 6 years have not met expectations: “political decisions along the way resulted in the today’s crisis. Instead of waiting until 2015 to engage via an emergency manager who only recommended actions, if stronger state action had been taken several years ago, we could have avoided the immediate crisis…But we are where we are, and the parties need to quickly align and understand that dramatic action is needed now to avoid a bankruptcy filing which will only prolong the problem and add more costs.”