Double Transitions & The Challenges of Fiscal Governance

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eBlog, 12/14/16

Good Morning! In this a.m.’s eBlog, we consider the dual transition periods for the U.S. and Puerto Rican governments as they change administrations in the midst of Puerto Rico’s insolvency. President-elect Trump has devoted little focus on the U.S. territory’s fiscal and health care crisis—and governance on the island is about to change too in the wake of the election last month of Governor-elect Ricky Rossello, who won with 41% of the vote in a four-way race.

Puerto Rico Governor Alejandro García Padilla, who has 18 days left in office, yesterday affirmed that it will require creativity to pull Puerto Rico out of its fiscal and political crisis—and that it would also mean the territory must file for restructuring as soon as possible. He added that the federal government would have to be a critical partner if the commonwealth is to resolve its fiscal crisis. He noted that even though the new PROMESA law offered the island a legal structure to restructure its public debt, he noted that the new federal statute “interfiere con la Constitución de Puerto Rico al extremo de que permite una junta no electa imponer un plan fiscal y controlar los presupuestos bajo ese plan”—that is that the PROMESA law provided for an unelected group to impose its authority, adding that even though the U.S. Supreme Court had recognized the “political reality and the changed law” in the territory, he  noted that for many in Puerto Ricans, PROMESA has created an unconstitutional intrusion. Thus, he urged that “no crisis should go to waste,” so that an important part of any fiscal solution will hinge on the commonwealth filing for restructuring “now;” because, he warned: “The chaos of costly, protracted litigation that would ensue if the commonwealth does not seek restructuring can easily be avoided with swift, decisive action within the next two months,” referring to the expiration of the stay on litigation” imposed by PROMESA until Feb. 15th, at which point, he added: the “commonwealth will face a cash deficit of over $3 billion that would likely force a government shutdown…There should be no excuse to force Puerto Rico to depression economics.”

He insisted on the importance of Congress and the Administration’s commitment of economic assistance—including equal treatment of Puerto Ricans with regard to Medicare and Medicaid. The Governor’s remarks came as a double transition is underway—both in Washington, D.C. and in Puerto Rico—and where the incoming Trump Administration has, so far, been silent with regard to PROMESA’s implementation and next steps—and as the current PROMSEA oversight board is currently reviewing Puerto Rico’s fiscal plan in order to determine whether and how to file debt restructuring petitions on behalf of the territory and its entities in federal district court if voluntary negotiations with the islands creditors fail.

Fiscal Challenges Amid Governance Transitions

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eBlog, 12/06/16

Good Morning! In this a.m.’s eBlog, we consider the ongoing health and fiscal challenges of Flint, Michigan as we await the outcome of today’s mayoral recall election in the insolvent municipality of East Cleveland, after which we attempt to update readers on the porous state of Atlantic City’s municipal utility. Then we seek to escape winter by heading south to Puerto Rico—where the combination of changing administrations in both the U.S. and Puerto Rico leave unclear what the fiscal path forward will be if the U.S. territory is to avoid not just fiscal, but also health care insolvency.

Out like Flint. University of Michigan researchers have more than tripled their estimate of the number of water service lines in the small city of Flint which will need to be replaced, nearly quadrupling the number of lead or galvanized steel lines the city has from 8,000 to 29,100—or more than half service lines leading to 55,000 homes and businesses in Flint, according Mayor Karen Weaver, who notes the updated report makes it important that the city move beyond the use of filters and instead move toward wholesale replacement of water lines: “These findings make it even more imperative that the state and federal government step up to pay for replacing lead-tainted service lines.” The figures are daunting: of the municipality’s 29,100 parcels, 17,500 would need full replacement of service lines, while 11,600 would require partial replacement, according to the researchers. The estimate was mandated by EPA to comply with the requirements of the federal Lead and Copper Rule: because the lead in the city’s water supply exceeded the federal action level of 15 parts per billion, the city is mandated to replace more than 2,000 service lines by next June—a physical and fiscal challenge given that Flint’s records describing the location of lead service lines in Flint have proven to be unreliable, and records for some parcels appear to not even exist, according to city officials—meaning that visual inspections, more time-consuming and expensive route—has served as the city’s only means to obtain an accurate assessment of where lead and galvanized steel service lines were installed. Thus, under Mayor Weaver’s initiative, municipal crews continue to replace service lines in neighborhoods most likely to have lead service lines, and where a significant number of young children or seniors live: the Mayor’s goal is to have service lines replaced at 1,000 homes by the end of this month, although the actual number may be fewer if bad weather occurs—weather with this morning’s chilled rain at temperatures just above freezing augurs ill. To help, the state of Michigan has set aside $25 million to pay for pipe replacements through September of next year—estimated to be sufficient to pay for replacing pipes to about 5,000 homes. In addition, Congress is considering an aid package that would bring tens of millions of dollars to Flint which could be used to repair the city’s damaged water system. If the 29,100 figure proves accurate, replacing the other 28,100 service lines could cost at least $140 million. A key element on this health and fiscal challenge could be yesterday’s agreement between U.S. House and Senate leaders on a bipartisan bill to authorize $170 million for Flint and other cities beleaguered by lead in drinking water, and to provide relief to drought-stricken California. A vote on the water-projects bill could take place this week as Congress wraps up its legislative work for the year.

The Utility & Atlantic City. Atlantic City’s utility water authority board members last week raised rates in an effort to cover an unexpected budget hole—but then topped it off by paying themselves a $3,000 per board member, even as the Municipal Utilities Authority (MUA) board approved the 10 percent rate hike for next year, a 20 percent increase over what had been set at last week’s special meeting to cover lost revenue from a contract change with New Jersey American Water. Under the new plan, residential rates would increase to $50 per quarter from $45 last year; nevertheless, the utility’s rates would still rank near the bottom for the region, according to Atlantic County Utilities Authority data. The MUA’s $14.7 million 2017 budget, down just under 10 percent from last year, is scheduled to be adopted on December 21st, according to an authority news release. The increase would appear unlikely to garner much favor in the insolvent city—especially in the wake of the board’s decision to award themselves $3,000 gifts this December “for their dedicated service,” according to a resolution, notwithstanding that the money was supposed to be a parting gift, not a Christmas gift, according to one board member. Board Vice Chairman Gary Hill yesterday claimed the “December 2016” was an error in the resolution’s language. It appears it has been a tradition that MUA Board members are to receive a cash bonus or gift once they leave the board: the authority’s seven board members make $6,000 salaries and can receive benefits, according to public records. Now, however, the Board’s challenge could be complicated by a different kind of fiscal disruption: American Water, a private company which had been considered a potential buyer of the MUA, which had a $1.7 million contract with the MUA, and was the MUA’s top customer, has recently notified the MUA it no longer needs it to provide water; it turns out that capital improvements to its Atlantic County system have increased its water capacity and “in essence eliminated NJAW’s need to purchase water from the ACMUA,” according to the company letter to the authority; instead, American Water wanted to buy 500,000 gallons of water per day, down from the 1.2 million gallons per day it has recently purchased; however, the lower volume would convert the company from a “bulk purchaser” to a “commercial customer,” meaning it would have to pay a $7 million connection charge, according to the letter, so that, according to the company’s statement: “We cannot justify the additional costs the ACMUA’s proposal would have on the company and its customers, since these significant capital investments eliminate the need for New Jersey American Water to purchase additional water.” Ergo, the contract change and its effect on the MUA budget led to the special board meeting where rates were raised—and bonuses were raised; now MUA and American Water are discussing a potential agreement under which the company would only buy water from the MUA in emergency situations, according to Chairman Hill: the MUA could get just $200,000 under such an arrangement. The fiscal and physical situation is, of course, further complicated from a governance perspective as the city’s public water utility has been at the center of debate between Atlantic City and the State of New Jersey—which has just taken over the city. American Water lobbyist Philip Norcross attended a 2015 meeting with city and state officials in which the MUA was discussed. Mr. Norcross’ brother is South Jersey powerbroker George Norcross. Authority officials questioned the timing of the contract change, hinting it was a strategic move by American Water to get the valuable water works, according to the meeting transcript. “They’re putting pressure on,” said Deputy Executive Director Garth Moyle.

Administration Transitions & Puerto Rico. The new PROMESA law to create a quasi-chapter 9 mechanism for the U.S. territory of Puerto Rico will face signal challenges as the governance of both the U.S. and Puerto Rico are in transition to new administrations. Unsurprisingly, President-elect Trump devoted little time to addressing what his position would be with regard to the implementation and administration of the new law. Thus, while Congress and the Treasury Department have put together both a framework and a Board to assist in Puerto Rico’s recovery; whether and how those might be modified or addressed now will depend upon both the incoming administration in Washington and new Governor in Puerto Rico—where the new head of the Senate’s Health Commission, Ángel Chayanne Martínez Santiago, yesterday urgently requested a meeting with House Speaker Paul Ryan (R-Wisc.) to discuss a possible health emergency declaration because of apprehension that all federal health care funds could expire on the island by this summer, writing that the federal health care assistance affects some 1.6 million U.S. citizens: “We need to declare a health emergency in Puerto Rico immediately. We have no doubt that this is a matter of vital importance—nor can there be any question but that this is a matter of vital importance for Congress and the White House.” The letter warns that, without a doubt, the greatest portion of the territory’s existing Affordable Health Care funds will have been spent before the end of this month, noting: “We are urgently requesting this meeting with Speaker Ryan to set out a strategy to avoid having Puerto Ricans losing all access to health care.”

The situation is further complicated as Puerto Rico is going through its own governance transition. Thus, the U.S. territory’s Governor-elect, Ricardo Rosselló, now must determine not only how to coordinate with the PROMESA board, but also how to address Puerto Rico’s budget, debt, and grave health care situation—and how to seek to work with the new Trump administration after reviewing both the numbers in the Commonwealth’s current 10-year fiscal plan submitted last October by outgoing Gov. García Padilla. A critical issue will be Medicaid—an issue on which the outgoing administration had warned Congress “ultimately will have to address Puerto Rico’s inequitable treatment under Medicaid and its need for economic growth incentives.” The pending proposal by the outgoing Administration of President Obama opined that Congress create Medicaid parity between Puerto Rico and the states, and extend certain tax credits to the Commonwealth: this has now become a more urgent issue as Medicaid funding for Puerto Rico is due to expire near the end of 2017, creating what is called a “Medicaid cliff.” And even that challenge can be expected to be further muddied by potential consideration by the incoming Trump Administration to convert Medicaid’s entitlement status to a block grant program to the states. The risk for Puerto Rico in all this would be if it were to fall between the cracks: should that happen, Puerto Rico’s government, where annual health care expenditures are near $2.4 billion annually, the U.S. territory would either have to raise revenues and find ways to cut expenses while providing consistent levels of care or drastically pare healthcare benefits—benefits already significantly lower than to Americans living in the other 50 states, because Puerto Rico’s Medicaid funding is capped, rather than entitled—meaning that, despite disproportionate health care needs, it receives disproportionately less than any of the 50 states.  

Awkward Transition & Fiscal Death Spiral? Puerto Rico Governor-Elect Ricardo Rosselló this weekend declined outgoing Gov. Alejandro García Padilla’s offer to work on a fiscal plan for the federal PROMESA oversight board. Under the PROMESA law, the U.S. territory’s governor is mandated to submit a five-year plan which itemizes steps to bring about fiscal responsibility, regain access to capital markets, fund essential public services, fund provisions, and achieve a sustainable debt burden. Last October, Gov. Padilla indeed presented a 10 year plan to PROMESA’s Oversight Board which noted that Puerto Rico simply could not afford paying down its debt without federal aid, noting that the government would be still $6 billion short for operating expenses over the next decade absent federal help and without paying any debt service. Last month, the PROMESA Oversight Board members indicated they believed substantial cuts to Puerto Rico government spending beyond those included in the outgoing Governor’s plan were necessary—adding that the Board expected a revised version of the plan from Governor Padilla by next week—a demand with which Governor Padilla said he would not cooperate if it meant revising the plan to include additional austerity, noting the island has had enough austerity, so that further budget cuts would only lead to an “economic death spiral.” Thus, last Friday the Governor Padilla sent a letter to Governor-elect Rosselló to invite him to become part of a joint effort to put together a revised fiscal recovery plan. Gov.-elect Rosselló, however, publicly rejected the outgoing Governor’s offer, responding, at least according to El Vocero’s news website, that Governor Padilla had not released sufficient financial data for the incoming Governor to work with him—leaving the incoming Governor little time or opportunity to offer his own plan—and the PROMESA Board is scheduled to certify (or not) the plan set before it by the end of next month.

Democracy & Municipal Insolvency

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eBlog, 12/05/16

Good Morning! In this a.m.’s eBlog, we consider tomorrow’s mayoral recall election in the insolvent municipality of East Cleveland, after which we consider a stern editorial from the Richmond-Times Dispatch about the ongoing challenges to recovering from insolvency in the historic city of Petersburg, Virginia. Finally, with the Obama Administration preparing to vacate the White House by the end of the month, we look at a new report detailing its role in Detroit’s recovery from the nation’s largest chapter 9 municipal bankruptcy in American history.

Democracy & Insolvency. Tomorrow is Election Day in East Cleveland, a small municipality which has been seeking authority from the State of Ohio to file for chapter 9 municipal bankruptcy for nearly a year. This special election is to decide whether Mayor Gary Norton and Council President Thomas Wheeler will keep their jobs or be recalled. The Mayor is campaigning by claiming he has done a good job keeping the struggling suburb afloat, pointing to a big pay-down of debt and money saved by cutting overtime and converting to self-funded health care; he also claims a new Salvation Army Center, with programs for young people and seniors, will be a needed addition. Third, he boasts of the first new shopping space built-in the city in decades. In contrast, those supporting the recall argue he is undermining residents’ confidence in their city by pushing an annexation plan (with Cleveland)—even as the Mayor states the city’s long-range financial picture is unsustainable. Critics claim his lack of oversight of the department has led to misconduct by officers and costly settlements of lawsuits. Mayor Norton says the special election is a waste of money for the cash-strapped city, especially with a scheduled election coming next year. Tomorrow’s special election comes as the status of annexation with the neighboring city of Cleveland is on hold while Cleveland seeks an expert opinion with regard to what the impact would be on the city’s finances and operations.

Inflammatory Municipal Governance? The Richmond-Times Dispatch last Friday, in an editorial, (“Petersburg needs sunshine to restore”) wrote that  Previous Next Petersburg’s financial collapse has inflamed the citizenry: “The city’s response to its budget crisis has not restored trust. The editorial notes that the Virginia American Civil Liberties Union faults Petersburg officials for secrecy, a lack of openness. It cites special meetings called at the last-minute and held not only at inconvenient times but in cramped quarters: “The circumstances discourage public participation. Residents want to know. They have a right to know.” The editorial notes that Petersburg citizens have shown up at meetings with tape over their mouths, wryly noting: “This is not the image the city ought to project.” The Times-Dispatch thus applauded the hiring of the Robert Bobb Group to help Petersburg climb out of its deep fiscal abyss; however, writing: “The manner of the organization’s ascension troubles us, nevertheless. The process was not as open as it ought to have been. Jurisdictions should pursue a degree of openness greater than the law stipulates: Petersburg’s despair has implications for every citizen. Almost every function of government will be affected. Essential services have fallen under siege. Citizen cooperation remains key. Listen to the civic-minded people eager for engagement. Follow the ACLU’s advice. Let the sun shine.”

The White House Role in Detroit’s Recovery from the Nation’s Largest Municipal Bankruptcy. The Obama Administration has detailed in a nearly 60-page report, “Building and Restoring Civic Capacity: The Obama Administration’s Federal-Local Partnership with Detroit.” The report, released over the weekend, writes that a federal and local partnership commenced five years ago which used financial, technical and other support to help the city which emerged two years ago from the nation’s largest municipal bankruptcy. Federal staff was assigned to City Hall to work with community, business, and philanthropic leaders to identify resources to assist in Detroit’s recovery: financial assistance included more than $260 million in federal funds to demolish 6,000 vacant houses and a $25 million grant to improve Detroit’s bus system. HUD also guaranteed construction or rehabilitation of more than 1,400 houses across the city; while technical assistance from the Department of Energy helped install nearly 65,000 street lights.

The Hard Challenges of Fiscal Sustainability

eBlog, 11/29/16

Good Morning! In this a.m.’s eBlog, we consider the ongoing—and evolving–state role in addressing municipal fiscal distress in Atlantic City: what is the role of a state and the impact on fiscal sustainability? Then we turn to the grim fiscal and governance situation in East Cleveland, Ohio—where state un-governance and next week’s looming Mayoral election appear to bode fiscal ills. Then we head south to the challenge of determining whether and how there might be promise in the implementation and unrolling of Congress’ recently enacted PROMESA legislation—the quasi chapter 9 for the U.S. Territory of Puerto Rico.

Not the Moody Blues. Moody’s Investors Service was uncharacteristically unmoody in determining that the state takeover of Atlantic City was a “credit positive” for the city, citing the unlikely threat of immediate default through 2017 as the largest contributing factor in its outlook. The credit positive comes during the first month of Gov. Chris Christie’s appointment of Jeffrey Chiesa to oversee the city: under his appointment, he has wide-ranging fiscal authority—indeed, as Moody’s described it: “While the state has not officially guaranteed Atlantic City’s debt, [the State] intends to prevent any default.” The state takeover comes as the city confronts a $2.3 million payment this week, followed by a $4.8 million debt payment on December 15th—but in the wake of the New Jersey Local Finance Board’s unanimous vote to grant its director, Timothy Cunningham, far-reaching governing powers over the beleaguered city under the authority granted by the state’s Municipal Stabilization and Recovery Act, was the worst-case scenario for the city, which has been fighting a takeover for the last year, even as it barely escaped going broke; Moody’s described Mr. Cunningham’s expressed “willingness to go to the state treasury for assistance if necessary to pay debt service” as a credit positive—or, as Moody’s described it: “While the state has not officially guaranteed Atlantic City’s debt, Director Cunningham has said the state intends to prevent any default.”

Trouble in River City. In the wake of last month’s hefty fine ($114,100) by the Ohio Election Commission of East Cleveland, Ohio Mayor Gary Norton over incomplete, late, and missing fundraising reports—fine nearly quintuple last year’s—with this year’s levied in response to complaints from the Cuyahoga County Board of Elections that the Mayor failed to file a 2015 annual report, turned in his 2014 report late, and has yet to resolve issues with his 2013 reports. In a series of letters, the board of elections asked Mayor Norton to fix a number of discrepancies in his 2013 reports—including incorrect fundraising totals and missing addresses; the board has now also requested proof of mileage, bank fees, phone expenses, and other spending for that year. In response to the reports, the Mayor—and December candidate for re-election, responded: “I am aware of the situation regarding delinquent campaign finance reports…All required reports will be completed and filed. The decision of the elections commission will be appealed. Campaign finances and reporting are completely separate from city finances. No city or public funds are involved.”

It’s not as if the fiscally insolvent city is new at this game: Mayor Norton also faced complaints in the wake of several missing finance reports from years prior to 2013, according to elections commission case summary records. Many of those reports have since been submitted and posted on the county board of elections website. Last year, the Ohio elections commission imposed a $20,000 fine on the Mayor in connection with many of those cases. The problems come at an inopportune time: Mayor Norton faces a recall election next Tuesday.

Is There Promise in PROMESA? At a third session of the PROMESA oversight board, Puerto Rico Gov. Alejandro García Padilla warned the Board he will not cooperate with it to administer a fiscal plan which subjects his constituents to greater sacrifice, but offers no federal financial assistance. The response comes in the wake of last Friday’s warning by Board members that the solution to the U.S. territory’s problems will have to include deep government spending cuts and structural changes. None of the Board members emphasized the importance of paying Puerto Rico’s debt. Indeed, several board members emphasized that substantial federal aid was neither likely, but rather impossible. In the wake of last month’s implicit and at times explicit rejection of the fiscal plan presented by Gov. Alejandro García Padilla last month, PROMESA Board Member Ana Matosantos noted that “deep” restructuring was necessary—adding that additional reforms and spending cuts would also be necessary, warning that federal assistance was unlikely and that without it, there would have to be an additional $16 billion in spending cuts “before you pay a dime of debt service.” Indeed, Board member Andrew Biggs noted that the PROMESA Board will have to put together a recovery package which does not assume a federal bailout; but he also noted that in cases of sovereign debt crises, most attempts to turn the situation around fail, because they fail to examine and address the “big questions.” Thus, he warned: the successful turnarounds question the existence of the big social programs. PROMESA Board Chairman José Carrión III warned that he believed it unlikely Puerto Rico would receive all of the fiscal assistance the Governor was seeking—especially vis-à-vis health care, where the U.S. territory is not treated on a par with states—noting that the board must come up with multiple scenarios, and the Board would have to be bold and use the plan to encourage economic growth.

The PROMESA Board December 15th deadline would seem, as our colleagues at Municipal Market Analytics note, “in peril,” but also raise the specter of the legal authority of the PROMESA Board should a new gubernatorial regime prove unwilling to comply with or carry out mandates from the PROMESA Board. MMA notes, also, the near term impossible straddle between addressing its structural debt whilst making projected debt payments, adding that “an acceptable plan’s likely need for sweeping layoffs, service austerity, and, potentially, pension payout reductions increases the potential for social unrest on the island.”

Finding Hope in Flint. Brian Willingham, for the New York Times last week wrote of his services two decades ago with the Flint Police Department “because I believed I could make a difference,” asking: “How can a city fall so far that we lose sight of the possibility of solutions?”  Noting that wages and benefits in the city have been reduced by more than 25% since 2011—a period during which he was laid off and rehired thrice—he noted the police force today is one-third of its former size—adding that while the national average is three officers for every one thousand citizens, in Flint is half an officer for that number of citizens, writing: “In one of America’s most dangerous cities, the people who secure the city are less secure than they’ve ever been. Yet we continue serving, as we did through the loss of General Motors, through the crack cocaine epidemic and, most recently, through the mass lead poisoning of Flint citizens. The crisis around Flint’s poisoned water points to a larger issue of structural racism and poverty in urban society. How can citizens in Flint trust the police to protect them when they can’t even trust their government to provide them with clean water? This is the kind of question that has placed police officers and African-Americans on a collision course. Police officers are seen as outsiders in urban America. White officers are seen as racist, while black officers like me are seen as traitors to our race.”

Who Decides Post-Bankruptcy Futures?

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eBlog, 9/07/16

In this morning’s eBlog, we consider the risk that state legislative interference in Detroit’s public schools—even after the schools have opened—could have harsh fiscal consequences for a city emerging from the largest municipal bankruptcy in the nation’s history. Then we turn to the grim tidings from post-municipal bankrupt Stockton, where the incumbent mayor—and candidate for re-election in November, and who was Mayor when Stockton emerged from its chapter 9 municipal bankruptcy, is on trial, raising serious questions about his moral fitness for public office. Finally, we turn to the steps underway to initiate the promise of PROMESA, the quasi-chapter 9 legislation signed last month by President Obama to steer the U.S. territory of Puerto Rico out of insolvency–and to a very unique American leader whose contributions to Washington, D.C., New York City, and New York’s subway system are legend–and who now will utilize that experience and expertise to help the U.S. territory of Puerto Rico.

Who Will Decide Detroit’s Future?  Last year, not a single Detroit public school complied with Detroit’s public health and safety codes, one reason teachers protested with widespread sickouts that temporarily crippled the system. This year, 92% of schools are in full compliance; the more significant changes for the nation’s most challenged big-city school system, however, will be governance: who will be in charge of changes so critical to the city’s long-term fiscal recovery? There will be a learning process not just in the schools, but also between Detroit and Lansing, because the city’s kids are returning to a brand-new public school district—one no longer encumbered with mountains of debt, but one, however, encumbered by politics even as it struggles to overcome its physical and fiscal insolvencies.

As we have attempted to chronicle, Governor Rick Snyder last June signed a sweeping education package to provide financial support for Detroit’s public schools modeled on the 2009 restructuring of post-bankrupt General Motors: that legislation left the old Detroit public school district behind as a shell to pay down $515 million in operating debt, similar to GM’s Chapter 11 which had created an “old” and “new” General Motors, with the intent of restructuring a public school system that was all but bankrupt: the state allocated more than $600 million to repair the DPS’s aging facilities, and the legislation allowed the schools—which include some of the nation’s worst and have been under state-run emergency management since 2009—to return to a locally run school board. Or, as John Walsh, Gov. Snyder’s director of strategy put it: “DPS is fiscally sound now.” Today, Detroit has more than a third of the state’s lowest-performing schools, according to a recently released list from the state’s School Reform Office, which has the authority to close those schools after three consecutive years. But the state office has not closed any low-performing schools since it was created in 2010. The School Reform Office could close more than 100 failing schools that qualify for shuttering, which has spurred panic among parents, teachers and other education groups.

The issue comes to the fore in the wake of Governor Rick Snyder last June signing a sweeping education package to provide financial support for Detroit’s public schools modeled on the 2009 restructuring of General Motors. The legislation left the old district behind as a shell to pay down $515 million in operating debt, similar to GM’s Chapter 11 that created an “old” and “new” General Motors, with the aim of restructuring a public school system that was all but bankrupt. Millions of dollars were allocated to repair the district’s aging facilities, and the legislation allowed the schools—which include some of the nation’s worst and have been under state-run emergency management since 2009—to return to a locally run school board. “DPS is fiscally sound now,” says John Walsh, Gov. Snyder’s director of strategy. Snyder’s use of state-appointed emergency managers has been widely scrutinized since the water crisis in Flint, where lead leached into the municipal water supply while the city’s finances were being overseen by the state. The water crisis raised questions about Snyder’s reliance on state managers to step in and fix local issues. But the state legislation created a dual school system in the Motor City of charter and public schools—potentially undercutting the intent of ensuring that DPS will be able to provide quality education in the long-term to compete with the growing number of charter schools throughout Detroit. Indeed, there are apprehensions in the city that state legislative meddling might, unwittingly, have paved the way to potentially end the Detroit public schools altogether. Because the state legislation created not just a dual system of public versus charter schools, but also of dozens of authorizers who determine where charter schools can open or close—that is, outside of any coherent, local process, but rather one in which any number of authorizers who do not work together to plan comprehensively can create chaotic situations in some neighborhoods: according to Detroit Mayor Mike Duggan’s office, 80% of Detroit’s public and charter schools have opened or closed in the last seven years. This would hardly seem a bright, shining beacon to attract families with young children to want to move to Detroit.

Moreover, even as the state interference has created a seeming Charlie Chaplin gold rush to open up any number of uncoordinated charter schools, the state education package for Detroit fell far short in the math department: less than a sixth of the appropriated funds went to DPS for transition costs: indeed, Alycia Meriweather, DPS’s interim superintendent, reports that $105 million of the $150 million allocated to help get the new DPS up and running is already earmarked for financial obligations from the old Detroit Public School District, while only $5 million is available for repairing school facilities. While Detroit will be able to spend all of the $7,400 that is allocated per student on actual education costs this year—as opposed to last year, when $1,100 of that funding per student went to pay the district’s debt—the district still has needs that will not be met, including at least eight schools that still need facility upgrades.

The state package, because of the way it was imposed on Detroit, has already led fears of the city becoming divided: more than 51,000 children attended Detroit charter schools last year; less than 48,000 kids attended its public schools. There are apprehensions the state legislation is creating its own tale of two cities: one for low-income minority children, and one not; and raising the governance question: should the state or the city have a greater say in the city’s children’s futures? What seems growing clear is that running a school system is hard—but having dual managers with very different political perspectives seems to be putting children’s futures at stake. Arlyssa Heard, a member of 482Forward, a group of local parents who raise awareness about the state of the schools, perhaps has the best perspective: after all, she has a son who has started fifth grade this fall and has already been in three different Detroit schools so far—one public, one charter, one private. She notes: “We have people making decisions who do not have children here and don’t know anything about what educators are facing in the classroom…My dream is that there is some way to take this decision out of the hands of politicians and put it in the hands of educators and parents. Those are the two groups that have the most vested in the school system.”

Distant School Managers. No doubt, Ms. Heard is referring to the distant attempts at Detroit school governance emanating from the Michigan Legislature, where, yesterday, Michigan Senate Majority Leader Arlan Meekhof (R-West Olive) and House Speaker Kevin Cotter (R-Mount Pleasant) said they would consider requesting that Michigan Attorney General Bill Schuette involve himself in a dispute between the state legislature and Gov. Rick Snyder with regard to how soon some of the worst schools in Detroit could be closed. That is, even though the Detroit Public Schools has both a gubernatorial appointed Emergency Manager and an elected public school board, the two Republican state leaders insist Detroit’s public schools can still be closed immediately if they have been among the state’s lowest five percent of performing public schools for three consecutive years. Gov. Snyder’s administration, however, relying on a law firm’s interpretation of the $617 million bailout legislation for DPS, contends that none of the city’s 47 schools that are in the bottom five percent for academic achievement can be closed until July of 2019. Indeed, last month, Gov. Snyder’s director of strategic policy had provided a memorandum to DPS Emergency Manager and retired U.S. Bankruptcy Judge Steven Rhodes which opined that the three-year countdown to close schools had been reset when DPS was transferred to a new debt-free district in July. Nevertheless, Majority Leader Meekhof yesterday disagreed; he said the law clearly allows a state office to close schools prior to that date and is “confused” how the Governor’s office could have reached a different conclusion. With the issue coming to a head, even as the school year has already commenced, Leader Meekhof also emphasized his Republican caucus would not likely support allowing Gov. Snyder’s interpretation of the law to stand and that passing a clarifying law would not be a good option because “a lot of folks have fatigue on Detroit issues.” This, apparently, passes as a reason for far away state legislators to preempt local authority—and disrupt an already chaotic school year.

Detroit has more than a third of the state’s lowest-performing schools, according to a recently released list from the state’s School Reform Office, which has the authority to close those schools after three consecutive years. But the state office has not closed any low-performing schools since it was created in 2010. The School Reform Office could close more than 100 failing schools that qualify for shuttering, which has spurred panic among parents, teachers and other education groups. Perhaps, appropriately, the last wise word should come from Chris Wigent, director of the Michigan Association of School Administrators, who opposes closing poorly performing school districts: “I think anytime you walk into a community and mention closing a school, that creates a lot of concern,” said “There is no data that shows moving a child from one school to another school has any positive” impact on students’ test scores.”

Post Municipal Bankruptcy Blues. With elections just around the corner in post-bankrupt Stockton, incumbent/candidate Mayor Anthony Silva’s attorney yesterday charged his client has been victimized by “outrageous government conduct,” as he sought the suppression of evidence from a warrantless federal search and seizure of his electronic devices nearly a year ago at San Francisco International Airport. The candidate/Mayor is scheduled this afternoon for his second court date since his arrest last month on charges he participated in and illegally recorded an alcohol-fueled game of strip poker with teenagers in 2015 at his annual summer youth camp in Silver Lake. The Mayor pleaded not guilty at his initial court appearance last month: he claims he is the victim of a political smear campaign being waged because he is a “threat” to Stockton’s establishment; however, the court proceedings come as he faces his colleague in his bid for re-election against City Councilman Michael Tubbs in November. The “outrageous government conduct” allegation referred to by Mayor Silva’s attorneys apparently refer to the website of the U.S. Attorney’s Office, claiming the conduct by law enforcement agents was “so outrageous that due process principles would absolutely bar the government from invoking judicial process to obtain a conviction.” However, Amador County Chief Assistant District Attorney Robert Trudgen said the government is confident in its case, though he acknowledged that the amount of discovery the defense has received to date has been sparse. If the role of municipal elected leaders—especially in municipalities emerging from chapter 9 municipal bankruptcy—is to inspire confidence, the road ahead in Stockton could be rocky.

Puerto Rico’s Fiscal Future. The Congressional Task Force on Economic Growth in Puerto Rico yesterday announced it is extending to October 14th its deadline for interested stakeholders to submit recommendations on how to promote economic growth within the U.S. territory—extending the original deadline of last Friday: in part that appears to stem from the 300 plus submissions already received—none of which have, however, been made public. Congress crated the task force as part of the PROMESA law to explore critical issues related to potential improvements that could bolster job creation, reduce child poverty, and attract investment to the U.S. territory; it is distinct from the newly appointed seven-member oversight board charged with restructuring the island’s debt and fiscal future; it is chaired by Sen. Orrin Hatch (R-Utah) and includes Sens. Robert Menendez (D-N.J.), Bob Nelson (D-Fla.), and Marco Rubio (R-Fla.), along with House members Pedro Pierluisi (P.R), Rep. Tom MacArthur (R-N.J.), Sean Duffy (R-Wis.), and Nydia Velázquez (D-N.Y). The task force is charged with submitting a report by the end of this year which identifies any current impediments federal law and programs which might impede economic growth or healthcare coverage for the territory and, importantly, recommendations to fix them.  

Experience & Insight. Few Americans have better background or experience in the kind of expertise the Congressional Task Force was looking for than Richard Ravitch, who served on similar oversight boards for both Washington, D.C. and New York City. Ergo, unsurprisingly, Puerto Rico Gov. Alejandro García Padilla yesterday named the former New York Lt. Governor to represent his positions to the PROMESA oversight board, noting Mr. Ravitch has advised Puerto Rico’s government on an unpaid basis for three years. Under the new PROMESA statute, Gov. Padilla was authorized to either serve as a nonvoting, ex officio member of the board or to designate someone for this role. The governor has made clear his urgency in getting the new board to address the commonwealth’s fiscal problems—noting, especially, the urgency from his perspective of restoring democracy in Puerto Rico. Gov. Padilla noted, in his statement, that Mr. Ravitch has advised Puerto Rico’s government on an unpaid basis for three years.

Structures for Restructuring Fiscal Futures

eBlog, 9/01/16

In this morning’s eBlog, we consider yesterday’s appointments by President Obama of the PROMESA oversight board—a step which, as in Washington, D.C. and New York City a generation ago—challenge traditional concepts of democracy, but offer a fiscal chance for the U.S. Territory’s fiscal future—albeit it in a far more complex way than in the two mainland cities. Then we turn, once again, to the grim fiscal, ethical, and legal challenges confronting the Detroit Public Schools—the public system critical to a city hoping to begin to regrow—and, ergo, so dependent on attracting young families with children back into the city.

Is There Promise in Promesa? President Obama yesterday, describing the White House/Congressional PROMESA financial control board to oversee the restructuring of Puerto Rico’s $70 billion debt burden, noted the panel came“[W]ith a broad range of skills and experiences: these officials have the breadth and depth of knowledge that is needed to tackle this complex challenge and put the future of the Puerto Rican people first.” The newly named panel is mandated to, in effect, will manage the U.S. territory’s finances for at least five years. House Speaker Paul Ryan (R-Wis.), who steered the bipartisan legislation through Congress, said: “Drawing from a wide variety of practical experiences and policy prowess, the members have what it takes to serve Puerto Rico and help get the territory on a path to fiscal health.”

As announced, the board is comprised of four Republicans and three Democrats, was drawn by the White House were made from a list provided by Congressional leaders of both parties. Under the new law, the board is expected to serve similarly to previous such boards in Washington, D.C. and New York City—with the PROMESA legislation shielding Puerto Rico from bondholder litigation: the Democrats on the panel are: Arthur Gonzalez, a senior fellow at New York University’s School of Law and former Chief Judge of the U.S. Bankruptcy Court for the Southern District of New York; Jose Ramon Gonzalez, president and chief executive officer of the Federal Home Loan Bank of New York; and Ana Matosantos, who served as California’s budget director from 2009 to 2013. The Republicans are: Carlos Garcia, former president of Puerto Rico’s Government Development Bank and founder and chief executive officer of BayBoston Managers LLC, a minority-owned private equity firm; Andrew Biggs, a resident scholar at the American Enterprise Institute; David Skeel, a University of Pennsylvania law professor; and Jose Carrion III, co-founder of Carrion, Laffitte & Casellas Inc. Kin addition to political balance, the board also appears to mitigate apprehensions from Puerto Rico with regard to its own citizens by the inclusion of four of the new appointees being Puerto Rican.

The federally appointed control board will oversee Puerto Rico’s budget and any debt reduction, which can now be enforced by a court, similar to a municipal bankruptcy. The board will designate a chair within 30 days of the panel’s formation, according to PROMESA. For the newly named board, the first challenge will be governance: how can the board coordinate with Puerto Rico Governor Garcia Padilla on a quasi-plan of debt adjustment or fiscal plan that will enable it to—as in a municipal bankruptcy negotiation with creditors—work out a plan of debt adjustment. However, the federal legislation does not specify how to prioritize Puerto Rico’s many classes of municipal bonds—bonds which are backed by various revenues and legal protections, but the new federal law requires that any fiscal plan “provide adequate funding for public pension systems.”

Gov. Padilla is expected to submit a blueprint as early as the second week of September, according to one Puerto Rican official. The challenge—as in Detroit, San Bernardino, Stockton, etc.—will be double: what will the new board’s relationship be with the island’s elected leaders, and how will the board balance the financing of essential public services and public pension obligations versus obligations to creditors—especially given the ravaging explosion of Zika cases. Moreover, the amounts at stake are significant: the U.S. territory has been defaulting on a growing share of its debt: in July, Puerto Rico missed nearly $1 billion of principal and interest, the first time a state-level borrower skipped payments on its direct debt since the 1930’s. Puerto Rico and its agencies owe municipal bondholders in all fifty states $70 billion; Puerto Rico’s three retirement systems have an unfunded liability of about $43 billion. If that were not enough of a challenge, the courts will be involved in a separate lane: hedge funds holding Puerto Rico full faith and credit debt filed suit last July against the government, claiming Gov. Garcia Padilla is re-directing cash in violation of Puerto Rico’s constitution.

Unsurprisingly, David Bernier, the gubernatorial nominee for Puerto Rico’s Popular Democratic Party, was less enthusiastic about yesterday’s announcement: “We oppose the board, because we understand that it lacerates our own government and is anti-democratic…Given the reality of PROMESA, we will defend the interests of our people always before the board or any forum necessary so that what prevails is the welfare of Puerto Rican families.”

New Math? Detroit Inspector General Bernadette Kakooza yesterday issued a report detailing a new wave of alleged theft and fraud cases in the Detroit Public Schools Community District—a district already at the center of a federal probe of a kickback scandal involving more than a dozen employees and a vendor. The new report, coming as schools ready to open in what will be a quasi-divided city between charter and Detroit Public Schools, outlines an unreported payroll error that overpaid an employee more than $50,000, fraudulent teaching credentials, and missing equipment and money. Inspector General Kakooza notes that a June 2014 tip over fraudulent procurement practices ultimately led to a federal kickback scandal investigation in which 12 former DPS employees were convicted, along with district vendor Norman Shy.

The report comes in the wake of retired U.S. Bankruptcy Judge Steven Rhodes, DPS’s Emergency Manager, reinstatement last of the Office of Inspector General—reinstated to include two primary functions: investigations and internal audits—or, as Judge Rhodes described it: “The Office of the Inspector General (OIG) is a critical element for the new District and our commitment to zero tolerance for wrongdoing and misconduct by any individual or organization affiliated with this District…The OIG will serve an active role as the District’s watchdog to protect our resources, employees, children and families.” The office had originally been established in March 2009, but eliminated at the end of June 2015 by then-Emergency Manager Darnell Earley—the Gubernatorially-appointed Emergency Manager who served to the human health and fiscal detriment of Flint, before being transferred by Gov. Rick Snyder to the Detroit Public Schools—where he presided over DPS’ near municipal bankruptcy—before being ousted.

Among the investigative highlights: The removal of a district principal following claims in 2014 that the administrator had approved the operation of a food store in a district building that violated DPS’ fundraising guidelines and cash management policies. There was no evidence provided for accountability of sales proceeds; nor was there any evidence the proceeds were used to benefit the students, as required; an investigation last year revealed a district employee had claimed and received about $14,000 in unemployment compensation while partially on an approved Family and Medical Leave of absence. The employee also received $49,000 in earnings from the district during the same period.

Former DPS school supply vendor Norman Shy and 12 DPS officials are to be sentenced next month after taking plea deals in connection with the FBI investigation into public corruption at the district this spring. Federal prosecutors allege the scheme, which started in 2002 and ran through January 2015, was hatched by Shy, 74, of Franklin, who billed DPS for $5 million in school supplies but delivered less than what was promised. Mr. Shy, in return for the business, allegedly paid bribes and gave kickbacks to 12 former DPS principals and one assistant superintendent in the form of cash and gift cards totaling $908,518. The report comes in the wake of a two-year investigation of DPS in the wake of a tip from state auditors.  

The deep fiscal and trust chasm created and fostered by Mr. Earley has signal implications for Detroit’s kids’ future. It makes the task for Judge Rhodes all the more critical.

The Steep Climb Out of Municipal Bankruptcy

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eBlog, 7/12/16

In this morning’s eBlog, we focus—again—on the ongoing challenges over Detroit’s future: a new study indicates that lingering impacts from the Great Recession are contributing to an exodus of middle and upper income families from the city, a trend which will create hard governance challenges. Then we look at the challenges in Puerto Rico—where Congress acted yesterday to pass and send to the Senate legislation to give investors equal protection to those in the rest of the U.S., and where the challenge of access to capital for the island’s water and sewer authority awaits action by the White House to name the island’s oversight panel created under the new PROMESA law. As we have already learned from Flint, the ability of a municipal utility to provide water and wastewater services is critical.  

The Steep Climb out of Municipal Bankruptcy. Professor Jonathan Silberman of Oakland University, author of a new Economic Data Center report, has written that the two-tier autoworker wage structures, flat compensation rates in recent labor contracts, and lingering effects of the Great Recession are among the key reasons metro Detroit is in a minority of metro regions which is experiencing a decline in middle- and upper-income households. His study makes a correlation between manufacturing sector declines, the growth of lower-income households, and a decline in middle- and upper-income households. Coming against a backdrop of significant uncertainty about the future for Detroit’s public schools, the research data find that the metropolitan region experienced a 6.9 percentage point increase in lower-income homes, from about 21.2 percent to 28.1 percent of all households; middle-income households declined by 3.7 percent, and upper-income households by 3.2 percent to just over 20 percent. Professor Silberman attributes the demographic change to recession after-effects, two-tier wages, and few recent union gains in contracts with the automakers: he notes that the average manufacturing production worker hourly wage fell from $31.57 in 2004 to $22.02 in 2014 by 2014 dollars; total manufacturing employees were off by about 50,000 in the Detroit-Warren-Livonia metropolitan statistical area over the same period. In his original report, Kevyn Orr, the Emergency Manager appointed by Gov. Rick Snyder to take over Detroit and guide it into and out of chapter 9 municipal bankruptcy, described the city as “dysfunctional and wasteful after years of budgetary restrictions, mismanagement, crippling operational practices and, in some cases, indifference or corruption.” We noted that residents could “escape these debts simply by moving away; many have done just that: Of the 264,209 households in Detroit, only 9.2% are married couple families with children under 18. Another 78,438 households — or 29.7% of the total — are families headed by women—of which families more than half have children under 18.” This news does not gainsay the significant strides and progress Detroit has made, but demonstrates how great the challenges it faces are.

Equal Protection for Puerto Rico. The U.S. House of Representatives yesterday approved the U.S. Territories Investor Protection Act of 2016 (H.R. 5322), a bill to put an end to a current legal loophole that a lawmaker contends has led to financial losses for many Puerto Rican investors and retirees. The legislation, authored by Rep. Nydia M. Velázquez (D-NY) would close a decades-old loophole that has caused significant financial losses for many Puerto Rican investors and retirees. The bill (HR 5322) would extend to investment companies operating in Puerto Rico and all the U.S. territories the same rules as those that apply on the U.S. mainland—or as the Congresswoman yesterday told her colleagues: “For too long, this massive oversight in federal investment law meant that residents of Puerto Rico did not have the same consumer safeguards as are available on the mainland…The result has been that many retirees and others have suffered enormous losses on financial products they have been sold by unscrupulous companies.” She noted that it has been publicly reported that some actors in Puerto Rico have used the current law’s loophole to act both as an underwriter for the issuance of bonds, and then repackaged those same bonds into mutual funds which are sold exclusively to investors on the island—something permissible in Puerto Rico, but prohibited on the U.S. mainland. Now, as the Congresswoman notes, “The situation has been compounded by Puerto Rico’s ongoing debt crisis. Puerto Rican investors holding government bonds have suffered massive losses and are claiming that some financial companies did not properly disclose the risks of these funds, due to this conflict of interest”—adding: “I’ve heard of people losing their hard earned savings because of these gaps in the law: This bill would ensure statutory parity and prevent working families in Puerto Rico from being sold unsound investments that could not be marketed anywhere else in the U.S.” At the time the exemption was enacted in 1940, it was suggested that Puerto Rico and other “U.S. possessions” were physically located too far away for the Investment Act protections to be enforced.  Since then both Hawaii and Alaska, which are farther away from the mainland than Puerto Rico, have been granted statehood and, ergo, the protections in the 1940 Act. Additionally, air travel between the U.S. and Puerto Rico is common and many of these financial instruments are today traded electronically. Rep. Velasquez added the bill would ensure statutory parity and prevent working families in Puerto Rico from being sold unsound investments that could not be marketed anywhere else in the U.S.—noting that Puerto Rico’s current fiscal crisis has only compounded the negative effects of the loophole.

The Puerto Rico Aqueduct & Sewer Authority (PRASA) wants to issue the debt through a new agency to finance construction work delayed by the government’s fiscal crisis. As an inducement to skeptics, the agency would give investors first claim on revenue it collects from water and sewer bills, according to Efrain Acosta, the PRASA Finance Director. It may also exchange an additional $1.1 billion of securities for its outstanding bonds to investors willing to accept less than they’re owed. Yet, as Mr. Acosta notes, the municipal market is “tough at this moment,” adding: “[W]e have to go forward with our plan and see if we can get new money to pay our contractors and try to restart our construction plan.” Puerto Rico has not sold municipal bonds for more than two years. Now the uncertainty about new municipal debt issuance is further clouded by the uncertain governance situation: when will the PROMESA oversight board be named—and, when it is named by the White House—how will it act with regard to any new issuance of debt. Indeed, the day after President Obama signed the PROMESA act into law, Puerto Rico defaulted on nearly half of $2 billion of principal and interest that was due—a default which marked the single greatest payment failure ever in the U.S. municipal-bond market; instead PRASA negotiated with creditors to delay $12.7 million that it owed. That is, Puerto Rico is entering a very different kind of municipal finance territory than Detroit, Central Falls, Jefferson County, etc.—all previous chapter 9 municipal bankruptcy filers which have been able, post-bankruptcy—to return to the issuance of capital debt; but chapter 9 is not available to Puerto Rico, so now it has the very challenging task of determining what promise there might be in PROMESA: can the yet-to-be-named oversight board—as previous such boards did in New York City and Washington, D.C. help realign the fiscal stars to allow Puerto Rico to regain its fiscal feet. In addition to selling new municipal debt, PRASA would offer municipal bond investors a chance to exchange their securities at a 15 percent loss, according to Mr. Acosta: such new bonds would be backed by a pledge of as much as 20 percent of PRASA’s revenue.