The Exceptional Challenges of Municipal Recovery: Can a State–or the Federal Government–Make It Even More Challenging?

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eBlog, 9/02/16

In this morning’s eBlog, we consider the ongoing challenges to Detroit’s long-term recovery from the nation’s largest municipal bankruptcy: can it restore—via a unique Emergency Manager—its public schools to a level sufficient to attract families with children back into the city? Then we look southeast to the fiscal challenges and rising crime challenges of Ferguson, Missouri; and we ask to what extent has the federal government aggravated each of those challenges, potentially putting the municipality on a course to insolvency.   

New Math? According to a list released yesterday by the Michigan School Reform Office, more than a third of the lowest performing schools in the State of Michigan are in the Detroit Public Schools Community District (DPS): the list of 124 schools in the bottom 5 percent for academic achievement includes 47 in DPS. The School Reform Office also announced seven schools in which it found sufficiently improved student achievement to be removed from the list of failing schools, only one of which was in Detroit: a charter school, Frontier International Academy. The release of the highly anticipated priority schools list comes less than two weeks after the School Reform Office said low-performing schools across the state could be in jeopardy of closing; nevertheless, notwithstanding the large number of DPS schools on the list, a top aide to Gov. Rick Snyder said the Snyder administration believes the state’s $617 million DPS package would prevent any DPS school from being closed in the next three years. (Michigan law allows the School Reform Office to close schools which fall into the lowest 5 percent academically for three straight years.) John Walsh, Governor Snyder’s director of strategic policy, cited an August 2nd memo from the Miller Canfield law firm to DPS Emergency Manager Steven Rhodes which suggested the three-year countdown to close struggling schools was reset when those buildings were moved to a new, debt-free Detroit district last July. A spokeswoman for the Governor, Anna Heaton, yesterday said that no schools have been closed by the state since the priority schools list was established in 2010, noting: “We are following the law as written…Because Detroit is a new district, schools that were failing under the old district can’t be closed by the School Reform Office. Please note that they could still be closed by the district.” Interim DPS superintendent Alycia Meriweather said putting school closures on hold would provide the new Detroit district time to improve student performance: “The students of Detroit have a fresh start for a new educational opportunity as a result of this decision…I’d like to thank the Governor’s Office, State Legislators, and the SSRO for recognizing DPSCD as a new district as it relates to data, in the same way we are recognized as a new district legally and financially.”

Unsurprisingly, however, the Governor’s position attracted mathematical opposition from state Republican legislative leaders and charter school advocates, who argued that a three-year reset would give the Detroit public district an unfair advantage. In a statement, House Speaker Kevin Cotter said: “As a simple matter of common sense, it cannot be said with a straight face that the Legislature intended for the worst-of-the-worst schools in Detroit to remain open…This mistaken interpretation would also require failing charter public schools to be closed while failing traditional public schools are allowed to persist and drag down class after class of Detroit students, which is an absurd conclusion.” Senate Majority Leader Arlan Meekhof (R-West Olive) said he was disappointed by the Governor’s decision “to use the opinion of one law firm as a reason to eliminate a tool intended to help students in the Detroit Public School Community District,” noting the schools in question are persistently failing schools that are not educating Detroit children: “The Senate passed multiple bills that included mechanisms to close failing schools…Part of delivering a better education to the students of Detroit includes the ability to right-size the district to meet the needs of the community.”

The Trend Gap & Federal Intervention: What Are the Implication’s for Municipal Solvency? A year ago last March, the U.S. Justice Department released a report finding racial bias and discrimination pervading police and court practices in Ferguson, Missouri, the small city of just over 20,000, majority black, with nearly one-third female householders with no husband present. Mayhap ironically, the report came just over a year after the Boston Federal Reserve tag team of Bo Zhao and David Coyne released their working paper, “Walking a Tightrope: Are U.S. State and Local Governments on a Fiscally Sustainable Path?” In its report, the Department of Justice argued that the Ferguson Police Department and the City of Ferguson relied on unconstitutional practices in order to balance the city’s budget through racially-motivated excessive fines and punishments. U.S. Attorney General Eric Holder said the federal government would use all the power it had, including dismantling the Ferguson Police Department—a threat which the city’s then-Mayor warned could mark the first time in U.S. history that the federal government might force a city into chapter 9 municipal bankruptcy. Indeed, Moody’s has placed the city’s already junk-level rating on review for downgrade because of threats to the city’s solvency—with the downgrade of the city’s general obligation rating reflecting what the credit rating agency described as “the continued pressure on the city’s finances from a persistent structural imbalance and incorporating the recently approved U.S. Department of Justice (DOJ) consent decree, projected to increase annual General Fund expenses over the next several years.”

The downgrade also took into consideration the outcome of last April’s ballot election, in which voters rejected a proposed property tax hike (but approved a sales tax for economic development). Both ballot measures were integral to city management’s proposed solution to close a large General Fund budget gap that existed before accounting for the additional federal consent decree costs. (Moody’s had updated its assessment after the U.S. Justice Department filed a lawsuit last February, marking the latest setback in Ferguson’s struggle to recover from a controversial police shooting in 2014.) The Justice Department also accused the City of Ferguson of policing and municipal court practices that violated constitutional and federal civil rights. The credit rating company had noted that its rating concerns had been driven by the uncertainty of the potential financial impact of litigation costs from the lawsuit and the price tag for implementing the proposed DOJ consent decree: “We believe fiscal ramifications from these items will be significant and could result in insolvency.”

Today, two years after the shooting of Michael Brown put a national spotlight on Ferguson police and provoked the Justice Department fiscal intervention, Ferguson is fiscally pressed to maintain the number of police officers it needs: its department is facing 13 vacancies; the staff is more than 30% reduced from just two years ago. The combination of federal unfunded mandates and fines combined with officer fatigue and stress from months of Ferguson protests may be emboldening criminals and contributing to an uptick in crime. Ferguson Police Chief Sam Dotson and St. Louis County Chief Jon Belmar suggest that their forces may not be large enough to handle the “new normal:” Aggravated assaults and robberies are up in both jurisdictions since Michael Brown was shot to death, but arrests are down. Or, as Chief Dotson calls it: “It’s the Ferguson effect: I see it not only on the law enforcement side, but the criminal element is feeling empowered by the environment.”

Financial constraints, including federally imposed financial penalties, related to the fallout since Mr. Brown’s death, including legal fees, reduced municipal court revenue, and costs for Justice Department-mandated changes have given the city little choice but to reduce the authorized number of officers to 49 compared to 55 two years earlier.

Ferguson voters last month approved a utility tax hike which is projected to generate $700,000 annually, the municipality’s second voter-approved tax increase this year—and, in this instance, a critical step: had the measure failed, the police force’s authorized number would have been reduced to 44, and firefighter jobs would also have been cut. Mayor Knowles said last month’s action by the Council to increase the tax was intended to make clear the city is fiscally stable; he added that the city has received 20 new applicants for the police force since it was approved, noting: “I think we’re seeing more confidence in Ferguson now, and hopefully we’ll get more qualified candidates.”  

Might there Be a Federal Role in Causing Severe Municipal Fiscal Distress?

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eBlog, 8/23/16

In this morning’s eBlog, we revisit Ferguson, Missouri—a small municipality in St. Louis County struggling to recover from racial violence and an expensive U.S. Justice Department imposition of subsequent unfunded fiscal mandates. Yesterday, a federal judge found the city’s school board election system biased against black voters. The judge’s findings and a Moody’s downgrade combine to raise questions with regard to the municipality’s solvency: has the U.S. Justice Department unintentionally made the small city a candidate for municipal bankruptcy? It brings back to mind, in addition, an old question: are there too many municipalities in St. Louis County? Can we afford so many? Could a municipality dissolve itself? Then we turn to archipelago of the U.S. Virgin Islands—seemingly a hop, skip, and a jump from Puerto Rico, where the U.S. territory’s unbalanced budget, rising debt burden, and unfunded pension liabilities put still another U.S. territory at risk of insolvency.

Public Schools & Arithmetic. U.S. District Judge Rodney Sippel yesterday, writing that “The ongoing effects of racial discrimination that have long plagued the region, and the District in particular, have affected the ability of African-Americans to participate equally in the political process,” ruled that Ferguson, Missouri’s school board elections are biased against black voters. The suit, filed by the American Civil Liberties Union, claimed that the Ferguson-Florissant School District makes it unlawfully difficult for black candidates to win positions on the school board. Voters in the district elect school board members at large, rather than on a ward or sub-district basis, a process, Judge Sippel wrote, which has reduced black representation. Currently, three out of seven board members are black, a ratio that reflects the demographics of the city, the school district has argued. Black students make up four-fifths of the 13,200-student population. During the trial, a demographer demonstrated that Ferguson’s black population is concentrated and politically unified enough to affect results if the FFSD were divided into voting districts: black voters would constitute a majority in four out of seven of those theoretical districts. U.S. District Judge Rodney W. Sippel said that while he does not see evidence of intentional discrimination, there is a more subtle “complex interaction” of political processes that deter black voters from electing the candidates of their choice, writing: “Rather, it is my finding that the cumulative effects of historical discrimination, current political practices, and the socioeconomic conditions present in the District impact the ability of African-Americans in (the school system) to participate equally in Board elections.” The Ferguson-Florissant district serves about 11,200 students in parts of 11 municipalities. About 80 percent of those students are black, and 12 percent are white. District residents are nearly evenly split between black and white. (The ACLU filed the lawsuit on behalf of the Missouri National Association of the Advancement of Colored People in the wake of protests over the shooting.) The court decision comes in the wake of Moody’s placing the city’s already junk-level rating on review for downgrade because of threats to the city’s solvency—with the downgrade of the city’s general obligation rating reflecting “the continued pressure on the city’s finances from a persistent structural imbalance and incorporating the recently approved U.S. Department of Justice (DOJ) consent decree, projected to increase annual General Fund expenses over the next several years. The downgrade also took into consideration the outcome of an April 5 ballot election, in which voters rejected a proposed property tax hike (but approved a sales tax for economic development). Both ballot measures were integral to city management’s proposed solution to close a large General Fund budget gap that existed before accounting for the additional consent decree costs. Moody’s had acted after the U.S. Justice Department filed a lawsuit in February, marking the latest setback in Ferguson’s struggle to recover from a controversial police shooting in 2014. The Justice Department accused Ferguson of policing and municipal court practices that violate constitutional and federal civil rights. The credit rating company had noted that its rating concerns had been driven by the uncertainty of the potential financial impact of litigation costs from the lawsuit and the price tag for implementing the proposed DOJ consent decree: “We believe fiscal ramifications from these items will be significant and could result in insolvency.”

Is there Promise from PROMESA? Fitch ratings has reduced the U.S. Virgin Islands’ bond ratings to junk level, citing the U.S. territory’s unbalanced budget, rising debt burden, and unfunded pension liabilities. Fitch noted that the enactment of the PROMESA legislation for neighboring Puerto Rico could open the door for a comparable restructuring of the Virgin Island’s debt. The territory, where the author trained for his Peace Corps service in Liberia, West Africa, is comprised of a number of islands in the Caribbean not far from Puerto Rico. The islands cover just under 134 square miles and boast a population of just over 100,000. Tourism is the primary economic activity, with the manufacture of rum a significant sector. The islands are classified as a non-self-governing territory—one which since 1954 has held five constitutional conventions—with its most recent, its fifth, adopting in 2009 a proposed Constitution—one rejected by Congress the following year, with Congress urging the convention to reconvene to address the concerns Congress and the Obama Administration had with the proposed document. The convention subsequently reconvened in October of 2012, but was not able to produce a revised Constitution before its October 31 deadline. In its ratings, Fitch downgraded the Virgin Island’s gross receipts tax bonds, affecting $722 million in debt; Fitch also downgraded the territory’s senior lien matching fund revenue bonds to BB from BBB and subordinate lien matching fund revenue bonds to BB from BBB-minus. In amounts of debt, the former affected $773 million and the latter affected $428 million. Fitch also downgraded the Virgin Islands’ issuer default rating to B-plus from BB-minus. In its release, Fitch noted that the Virgin Islands plans to sell $217 million in gross receipts taxes bonds, $126 million in senior lien matching fund bonds, and $69 million in subordinate lien matching fund bonds near the end of next month—noting that the U.S. territory has a “severely unbalanced operating budget” and multiple years of borrowing to fund operating needs—and is expected to feature ongoing budget imbalances: its debt burden has increased, and its unfunded public pension liability has increased at a faster pace.

The Governing Challenge in Averting Insolvency

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eBlog, 6/10/16
In this morning’s eBlog, we consider the bipartisan legislation overwhelming passed by the U.S. House of Representatives last night to address Puerto Rico’s looming insolvency—and a related U.S. Supreme Court decision; then we look at the almost Detroit Public Schools filing for chapter 9 municipal bankruptcy. It almost seems as if these events and actions were staged just for my fine graduate class on public policy process.


Oye! The House last evening passed and forwarded to the Senate legislation to address Puerto Rico’s looming insolvency on a bipartisan 297-127 vote: Speaker Paul Ryan (R-Wi.) and Minority Leader Nancy Pelosi (D-Ca.) took to the House floor to urge support for the legislation, with Speaker Ryan noting: “The Puerto Rican people are our fellow Americans. They pay our taxes. They fight in our wars…We cannot allow this to happen.” The bill now heads to the Senate, where there is little evidence Senators are eager to remake the bill wholesale, particularly as conditions on the island continue to worsen. The only amendment to fail was one offered by Democrats that would have struck a provision of the bill permitting Puerto Rican employers to pay workers under 25 years old less than the minimum wage. The legislation is critical as Puerto Rico—being neither a municipality, nor a state, falls into a Twilight Zone in terms of authority to address an insolvency. Puerto Rico has defaulted on three classes of municipal bonds, including last month when it missed most of a $422 million payment, and faces $2 billion in payments on July 1 that the island’s governor said cannot be paid. That final vote on the amendment was 196 in favor to 225 against. Puerto Rico’s government has begun defaulting on $70 billion in debts, and has warned it could run out of cash this summer.

In pressing for the vote, the Speaker warned that pressure would mount on Congress to spend money rescuing the territory if it could not arrest its economic decline, telling his colleagues: “This bill prevents a bailout. That’s the entire point…if we do not pass this bill…there will be no other choice.” Anne Krueger, a former IMF economist who led a detailed review of Puerto Rico’s economy, has warned: “Come July 1, if nothing is done, Puerto Rico will technically be bankrupt…Assets will be tied up in courts. It is very likely that essential services will have to be suspended.”

As drafted, the House-passed legislation does not commit a single federal dollar to Puerto Rico. The legislation creates a federal oversight board—whose members will be appointed by Congress and President Obama, and not the governor—to determine whether and when to initiate court-supervised debt restructuring: it charges the board with the responsibility to determine the hierarchy of municipal debt obligations and encourages it to respect the existing legal framework, which places constitutionally backed general obligation debt above pension liabilities. The board terminates after Puerto Rico regains the ability to borrow at reasonable interest rates and balances its budget for four consecutive years. Congressional leaders and the Treasury hope the bill will avert a long, expensive courtroom battle between hedge funds and the federal government—a battle that could harm investment in the U.S. territory’s economic future and undercut its ability to provide essential public services (servicing Puerto Rico’s current debt burden today absorbs approximately 30 percent of the Commonwealth’s revenues)—especially as Puerto Rico is now at the forefront of the Zika virus. While critics have falsely warned the bill could set a precedent for distressed states to seek similar relief, the dual sovereignty created by the founding fathers—or statesmen—in the U.S. Constitution clearly undercuts such claims: Congress granted U.S. citizenship in 1917 under the Jones-Shafroth Act to residents of Puerto Rico, which was seized in the Spanish-American War of 1898. The U.S. gave the territory the right to elect its own governor in 1947.

 Republicans have been concerned that the language would allow the to-be appointed oversight board to elevate pensions above the island’s full faith and credit general obligation municipal bond debt: Rep. John Fleming (R-La.) submitted an unsuccessful amendment to require compliance with the legal hierarchy, calling the statutory use of the word “respect” a “weasel word.”

Hear Ye! By coincidence, the U.S. Supreme Court chimed in almost simultaneously in a 6-2 decision (Commonwealth of Puerto Rico v. Sanchez Valle et al., (2016), No. 15-108, involving a simple criminal prosecution for firearms sales, but also the related governance issue of the Commonwealth’s autonomy—a case in which attorneys for Puerto Rico argued that it should be able to try two men who already had pleaded guilty in federal court. Justice Elena Kagan, writing for the majority, said that would amount to double jeopardy, writing: “There is no getting away from the past…Because the ultimate source of Puerto Rico’s prosecutorial power is the federal government…the Commonwealth and the United States are not separate sovereigns.” Reasoning that even though Congress, in 1950, gave Puerto Rico the authority to establish its own government under its own constitution, that did not, in and of itself, break the chain of command that originates with Congress. As a result, the majority determined, the Commonwealth should be treated the same as other U.S. territories. While the 50 states and even Indian tribes enjoy sovereign powers that preceded the union or were enshrined in the U.S. Constitution, Justice Kagan wrote, Puerto Rico in 1952 “became a new kind of political entity, still closely associated with the United States, but governed in accordance with, and exercising self-rule through, a popularly ratified constitution,” adding that Puerto Rico’s Constitution, significant though it is, does not break the chain.” Justice Ruth Bader Ginsburg went further in her concurrence, suggesting that the high court should hear a case that tests whether states and the federal government should remain able to try defendants for the same crime.

During oral argument last January, a majority of Justices appeared to side with the Obama administration, which argued that, as a territory of the United States, Puerto Rico cannot try the gun dealers after federal courts have acted, with Asst. Solicitor General Nicole Saharsky arguing: “Congress is the one who makes the rules.” The majority appeared to agree: Justice Kagan, writing for the majority, noted: “If you go back, the ultimate source of authority is Congress.” Nevertheless, in their dissent, Justices Stephen Breyer and Sonia Sotomayor stood by Puerto Rico — with Justice Breyer writing that if the court ruled against it, “that has enormous implications” for setting back the U.S. territory’s legal status: “Longstanding customs, actions and attitudes, both in Puerto Rico and on the mainland, uniformly favor Puerto Rico’s position — that it is sovereign, and has been since 1952, for purposes of the double jeopardy clause.” Justice Sotomayor, whose parents were born in Puerto Rico, said during oral argument that the island is an “estado libre asociado” Ironically the case was the first of two involving Puerto Rico to come before the high court this term. The Court is also re weighing the Commonwealth’s effort to restructure part of its $70 billion public debt, an issue addressed last evening by the House: a federal appeals court blocked the restructuring because of conflicts with U.S. bankruptcy laws.

Schooling for What If & Municipal Bankruptcy. With uncertainty whether the Michigan legislature would be able to pass and send legislation to him before the Detroit Public Schools exhausted all its cash—and before the legislature completed its session, Gov. Rick Snyder’s administration had commenced discussion with regard to drafting a chapter 9 municipal bankruptcy filing for DPS—in some apprehension of a wave of vendors’ and employees’ suits against DPS—the city’s public school system foundering in more than $515 million in outstanding operating debt: key staff worked with attorneys on a possible DPS chapter 9 bankruptcy, and Gov. Snyder had exchanged text messages with his former law school colleague and appointee as Detroit’s Emergency Manager, Kevyn Orr, who had, as we have catalogued, served as Emergency Manager in charge of both taking Detroit into municipal bankruptcy, and then piloting it through its successful emergence and approval of its plan of debt adjustment. Michigan State Treasurer Nick Khouri recently estimated the DPS would need $65 million for capital costs, including deferred maintenance and upgraded security equipment; $125 million for cash flow needs due to the timing of school aid payments and other startup expenses; and $10 million for academic programming. Now, in the wake of partisan action on which we reported yesterday, DPS will be able to make payroll, pay vendors, and purchase supplies this summer to prepare for school this fall. Logistically, the new school district will be created by July 1: retired U.S. Judge Steven Rhodes, DPS’s emergency manager appointed by Gov. Snyder and now serving as DPS’ transition manager, is working with state administrators to implement the new agreement.

The Import of Integrity to Municipal Solvency

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eBlog, 5/25/16

In this morning’s eBlog, we consider the ongoing struggle of the small municipality of Ferguson, Missouri to find the revenues to comply with onerous federal mandates—penalties that risk the municipality’s fiscal future. We watch and await the outcome of House Speaker Paul Ryan’s and House Natural Resources Committee Chair Rob Bishop’s (R-Utah) markup of legislation to address Puerto Rico’s looming insolvency; and, finally, we observe the desperate fiscal collapse of the small municipality of Opa-Locka, Florida—where a combination of seeming malfeasance and fiscal distress seems certain to force a choice between municipal bankruptcy or a state takeover.

Will the Federal Mandate Help or Hurt Municipal Solvency? Voters in Ferguson, Missouri will be forced back to the polls this summer by still another unfunded federal mandate: they will vote on whether or not pay a higher utility tax in order to raise still more revenues to address U.S. Justice Department unfunded mandates to revamp the city’s police department and municipal court system—with Mayor James Knowles III and the City Council meeting Sunday to consider whether to place a 2-percent increase in the city utility tax on the August ballot—a consideration to which they unanimously agreed, even as they voted to table a proposed property tax hike also intended to help meet the city’s financial obligation under the city’s imposed agreement with the Justice Department. The unique Sunday session was forced by yesterday’s St. Louis County election deadline for items to appear on the August 2nd. But their decision was not unanimous—as some councilmembers supported submitting both tax hikes to voters, even though city voters had, earlier this year, rejected a proposed property tax increase. Nevertheless, there was consensus that gaining approval of two tax increases in one election to satisfy not the city’s residents, but rather the federal government, would be an uphill battle. In addition, while the utility tax increase needs only simple-majority approval for passage, any property tax increase would require approval by two-thirds of voters.

Mayor Knowles noted that he believes voters would support a higher utility tax even if it would not end all the city’s budget problems, or, as he put it: “I think we can stop some of the bleeding and keep up services with the utility tax.” The city estimated a 33% utility tax hike from 6 to 8 percent would generate $700,000 in annual revenue; whereas the potential property tax hike increase would have raised $500,000 annually. The utility tax hike would, if approved, come on top of the half-cent municipal sales and use tax increase adopted last April for economic development. The exceptional challenge for the small municipality as it works to adopt its FY2017 budget by the end of next month is how to balance federal mandates versus maintaining current services and not laying off three firefighters. While the federal government does not worry itself about balancing the federal budget, such imbalance is not an option for states, counties, or cities. City leaders are crossing their fingers in hopes there might be some federal grant funds that would help to address some of the costs of meeting Justice Department requirements that mandate police staffing levels, including—as we have observed on the opposite end of the country in San Bernardino, transferring some emergency response dispatching to St. Louis County.

The Promise of PROMESA. House Natural Resources Committee Chair Rob Bishop (R-Utah) opened yesterday’s markup of (HR 5278), the Puerto Rico Oversight, Management, and Economic Stability Act (PROMESA) by stating: “Puerto Rico is in the midst of a financial and economic crisis of historic proportions…Article IV of the U.S. Constitution states: ‘The Congress shall have Power to dispose of and make all needful Rules and Regulations respecting the Territory and other Property belonging to the United States.’ Stating the obvious, Puerto Rico is an American territory. Therefore, Congress has the power to enact laws affecting Puerto Rico. However, with power comes responsibility. Power without responsibility leads to tyranny on one hand, or abject neglect on the other. For too long, Congress has neglected its duties under Article IV. Congress has sown the wind, and Puerto Rico has reaped the whirlwind. We have a constitutional, political, and moral imperative to act, and this Committee has done so. Given the crisis, the question before us today is whether we fulfill this constitutional responsibility. H.R. 5278, the Puerto Rico Oversight, Management and Economic Stability Act, or ‘PROMESA’ establishes an Oversight Board to work with the government of Puerto Rico. The Board will audit their finances, figure out the true asset picture, and develop fiscally responsible budgets to repay creditors and meet basic human needs. It will restore the island’s access to credit markets, and review laws, regulations, and expenditures to assure compliance with fiscal plans and fair treatment of investors…This bill is Puerto Rico’s last and best chance to get on sound financial footing and put its economy on the path to recovery and prosperity…”
The markup which the Chair expects to complete today, has gained bipartisan support: it would create a mechanism for Puerto Rico to restructure $72 billion in debt and establish a financial control board. With the Memorial Day recess, however, the Committee’s reported bill is unlikely to go to the full House until next month, after the Memorial Day recess.

The markup commenced even as Puerto Rico Gov. Alejandro García Padilla late Monday proposed a budget for the upcoming fiscal year with 86% less allocated to pay debt service than the approved current-year budget: he stated his budget includes $209 million for interest payments on Puerto Rico’s debt; however, his proposal does not provide for funding for principal payments in the coming fiscal year. His comments left uncertain the fiscal treatment of the U.S. territory’s public authorities, municipalities, or the Puerto Rico Sales Tax Finance Corp. (COFINA); their debt is not paid from the General Fund. Gov. Padilla said that his proposed spending level was $9.1 billion for the new fiscal year—a level which, he said, would not require any new borrowing or any tax increases; nor would it, he said, force reductions or eliminations of several programs, even as he proposed increases in the budget’s contributions to certain items such as the teachers’ and employees’ pension systems and the Puerto Rico Medical Center. The Governor’s remarks came even as the Puerto Rico House of Representatives voted overwhelmingly to override the Governor’s veto of the legislature’s rejection of an increase in business-to-business taxes from 4% to 11.5%–a vote the Puerto Rico Senate is expected to take up anon.

Nopealocka? In a city government close to insolvency, Opa-locka, Florida, City Finance Director Charmaine Parchment broke ranks and warned her supervisors the city will run out of money after its payroll next week and that its recovery plans will not be enough to save Opa-locka from insolvency. Ms. Parchment on Sunday emailed acting city manager Yvette Harrell to report that the small municipality’s budget deficit is three times larger than what the city has revealed to its taxpayers; she demanded that her name be removed from a city recovery plan submitted to the state, adding: “After the next payroll, the city will not be able to pay its bills.” Opa-locka, a small municipality inside Dade County of about 6,000 households, but with a vacancy rate nearing 15 percent, and where more than one-third of households are headed by a female householder with no husband present, and nearly 30 percent are non-families—and where nearly one-third of families fall below the poverty level, is a potpourri of Cuban, Dominican, and Haitian residents with very low per capita annual incomes. The foundering municipality operates under a commission/city manager form of government: incorporated in 1926, its city commission consists of the mayor and four commissioners, who are responsible for enacting ordinances, resolutions and regulations governing the city. In 2004 Opa-locka had the highest rate of violent crime for any city in the United States; in an editorial nearly a decade later, a Miami Herald editorial described the municipality as “crime-plagued” with a “steadily deteriorating” police department—a department which had decreased from 50 to 16. Nevertheless, Ms. Parchment’s email appears to present an even more depressing and urgent fiscal distress picture than what has been made publicly available by either the city’s elected or senior appointed officials—including City Manager David Chiverton, who pledged at a public meeting earlier this month that Opa-locka would have a balanced budget by the end of the fiscal year—a far cry from what Ms. Parchment instead estimated would will soon be a $4.5 million deficit. Now, with City Manager Chiverton an apparent target of an FBI investigation of bribery and kickback, the issue seems to be whether the municipality will be forced to seek chapter 9 municipal bankruptcy under Florida’s §218.01, or whether Gov. Rick Scott might, somewhat as in New Jersey, declare an emergency and impose a state takeover of the city (while utility and transportation districts in the state have filed for chapter 9, no municipality has). For months, Opa-locka’s elected officials have been alerted about the looming fiscal collapse, but the city fired former City Manager Steve Shiver last November in the wake of his alerting state officials about the mounting municipal debts that had reached $8 million. Similarly, a financial task force warned that the city would have to make drastic cuts. Nevertheless, as City Commissioner Terence Pinder stated: “They kept kicking the can down the road.”

Driving a Municipality into Municipal Bankruptcy?

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eBlog, 4/28/16

In this morning’s eBlog, we consider the critical fiscal situation confronting Ferguson, Missouri—where the small municipality—confronted with seemingly prohibitive federal sanctions in the wake of the killing of Michael Brown, an unarmed man, by a police officer, in the wake of which there were riots and subsequent U.S. Justice Department sanctions imposed on the municipality—fiscal sanctions that risk the municipality’s viability.

Federally Driven Municipal Bankruptcy? Moody’s has further downgraded Ferguson, Missouri’s bond ratings into junk territory as the small city, amid tries to address the fiscal strains of dealing with fallout from the controversial 2014 fatal police shooting—the rating agency assigned the municipality a negative outlook in the wake of the city’s voters approving a sales tax for economic development, but voting down a property tax hike—meaning the city is likely to fall short of the revenues it projects it will need in the wake of the police shooting of Michael Brown in 2014. It seems the federally imposed fiscal penalties are further imbalancing the municipality’s chances of survival. The small city already faced imposing odds: Brookings analyst Elizabeth Kneebone last year had noted that at “the start of the 2000s, the five census tracts that fall within Ferguson’s border registered poverty rates ranging between 4 and 16 percent…However, by 2008-2012 almost all of Ferguson’s neighborhoods had poverty rates at or above the 20 percent threshold at which the negative effects of concentrated poverty begin to emerge.” But now, in the wake of voters’ approval of a 0.5% sales tax hike for economic development, but rejection of a proposed $0.40 per $100 of assessed value property tax hike that would have generated $640,000 annually, or 22.6% of the city’s projected budget deficit, the fiscal dilemma appears certain to deteriorate. The property tax increase would have cost about $76 annually for a home worth $100,000.

Ferguson, which has been experiencing a declining population, has average per family income of $36,645 annually. Thus, it can hardly seem surprising that its voters shot down a proposed $0.40 per $100 of assessed value property tax hike that would have generated $640,000 annually, or 22.6% of the city’s projected budget deficit. In contrast, voters approved the sales and use tax hike–expected to raise about $1 million per year, or 28.2% of the deficit. Ferguson operates on a $14.5 million budget. Thus the city’s leaders had warned both tax increases were needed to address the city’s deficit and the costs of compliance with the unfunded federally mandated police and municipal court reforms under a consent agreement the city recently reached with federal authorities.

As Moody’s moodily noted: “The downgrade reflects the continued pressure on the city’s finances from a persistent structural imbalance and incorporates the recently approved US Department of Justice consent decree, projected to increase annual general fund expenses over the next several years.” That pressure comes from the city’s projections that compliance with the federally-imposed implementation mandates could run as high as $1.5 million in the first year with costs falling under $1 million in subsequent years. Moody’s analysts further noted that, in the wake of the election: “both ballot measures were integral to city management’s proposed solution to close a large general fund budget gap that existed before accounting for the additional consent decree costs.” To make matters more fiscally grim, the credit rating agency expressed apprehension with regard to further credit erosion in the wake of the vote—as it will likely be forced to cut spending even further to meet the federally imposed penalties—with the agency apprehensive that the combination of unfunded federal mandates, reduced revenue, and substantial liabilities could lead not just to still further downgrades, but also potential default. City leaders say measures associated with the agreement will cost Ferguson $2.3 million over three years, including $1 million in year one—a seemingly overwhelming level for a municipality already facing a $2.9 million deficit due largely to fallout from the shooting, such as sales tax declines, skyrocketing legal costs, and the imposition of hundreds of thousands of dollars in court fines and fees from reforms already in place.

The pending FY’2017 budget calls for across-the-board pay cuts of 3 percent—but, in the wake of the voters’ actions, the city will likely be forced to lay off members of the police force, firefighters, and consider closure of a fire station—potentially imperiling the city’s implementation of the type of community policing mandated under the Justice Department settlement. Revenues to pay for requirements such as software and hiring of police record analysts would also be hard to come by. Indeed, the federal requirements could force the city into receivership or to file a chapter 9 petition, as provided for under Mo.Ann.Statute§91.730.

The Tensions of Governance & Municipal Bankruptcy

March 4, 2016. Share on Twitter

Unravelling in San Bernardino? A San Bernardino citizen has filed a notice of intent to circulate a recall petition of veteran Councilmember Fred Shorett: the notice claims the Councilman failed “in all aspects of his duties,” including through his hiring of consultants from outside the city while not coming up with original revenue ideas—or, as the petition puts it: “Council Member Shorett has acted with negligence by supporting fiscally irresponsible programs and general spending that has led to the downfall of our city and the depletion of our general fund.” It appears that if there is a real smoking gun, at least from Mr. Cioci’s perspective, the ill-disposition appears to be related to Councilman Shorett’s opposition to medical marijuana – from which Mr. Cioci apparently believes the city’s revenues could get appreciably higher—notwithstanding that the Councilmember has indicated he could be open to its legalization depending on public sentiment. Under San Bernardino’s city charter, the Councilmember will have an opportunity to publish an answer to the charges: the charter provides that, beginning a week after notice is given and an incumbent Councilmember’s response, a citizen will have 90 days to gather signatures from 25 percent of the registered voters in such a councilmember’s ward. That would mean that were Mr. Cioci able to secure some 3,143 signatures in that time-frame, a recall election will be held. For his part, the Councilmember has reported that the legislative review committee, which he chairs, has continued to study the issue since the City Council decided in 2014 to crack down rather than pursue possible legalization, telling the San Bernardino Sun: “We decided to do a poll and directed (former City Manager) Allen Parker to do that poll, but it fell through the cracks in the transition…The dispensaries are a serious issue. If the poll shows that people want to legalize it, I’m willing to consider that.”

The psychedelic challenge to the city’s most senior elected official can hardly help address the critical need for continuity as the city seeks approval from U.S. Bankruptcy Judge Meredith Jury—as it appears to echo what might be becoming a governance challenge in the bankrupt municipality, where, three years ago, former San Bernardino City Attorney James F. Penman and Councilwoman Wendy McCammack were recalled in 2013. Discontinuity in governance—especially in the middle of the longest municipal bankruptcy in U.S. history—is hardly likely to help. Of course, Mr. Cioci’s path of fiscal destruction is not limited: he has stated he also intends to simultaneously gather signatures to protest a parcel tax associated with the annexation of the city’s Fire Department—a petition, that were it to prove successful, would undo a critical element of the city’s plan of debt adjustment pending before Judge Jury.

Out Like Flint. A number of Flint residents Monday filed a federal, class action lawsuit against Michigan Gov. Rick Snyder as well as other current and former state government officials and corporation alleging that tens of thousands of residents have suffered physical and economic injuries and damages and, ergo, charging that Michigan officials failed to take action over “dangerous levels of lead” in drinking water and “downplayed the severity of the contamination.” The suit, filed on behalf of seven residents, adds to a growing list of lawsuits which have been filed on behalf of Flint residents since a public health emergency was declared last year. The suit was filed even as a report by Michigan’s the state auditor general last Friday found that state environmental regulators made crucial errors as Flint began using the new drinking water source that would become contaminated with lead: the report found that staff of the Michigan Department of Environmental Quality’s drinking water office failed to order the city to treat its water with anti-corrosion chemicals when the municipality switched to the river in April of 2014, but also said the rules they failed to heed may not be strong enough to protect the public. The report came as crews in the city started to dig up old pipes connecting water mains to homes. No level of lead in the human body is considered safe, especially in children. The river water also may have been a source of Legionnaires’ disease, which killed at least nine people in the region. Flint Mayor Karen Weaver last Sunday had announced that Union Labor Life Insurance Co. was committed to bring $25 million in low-cost loans to help remove lead pipes and improve water quality—as part of the “Fast Start” initiative the city has put together to replace all lead service lines in the city.

Federally Threatened Municipal Bankruptcy? According to the St. Louis Post-Dispatch, U.S. Department of Justice officials have assured Ferguson, Mo.’s elected leaders that the federal fiscal Sword of Damocles it is holding over their heads could still be resolved if they agree to a federal proposal to overhaul the municipality’s police and court practices. In addition, the Justice Department also appears to be claiming that its proposed fiscal fine would not be prohibitive and fiscally damaging to the city’s fiscal sustainability, e.g.: it would not force the small city into municipal bankruptcy. But, without question, the Justice Department has been clear it will continue to point a fiscal gun at the city’s leaders: the U.S. government is prepared to impose severe financial penalties to the already fiscally challenged municipality, or, as the head of the Department’s Civil Rights Division wrote to the city’s elected leaders: “We are fully prepared to litigate this matter…Should the city wish to avoid the litigation process we submit that the alternative is to sign the agreement…” The hard, hard question now for the city’s elected leaders–who are expected to vote to reconsider their vote less than a month ago to reject the federal fiscal penalty—effectively puts them between a rock and a fiscally hard place. In its most recent communication, the U.S. Justice Department rebutted the city’s understanding that a provision requiring Ferguson to offer police competitive salaries meant that the city would have to provide its police officers and other employees 25 percent pay increases, as the city appeared to have understood, rather, the Justice Department wrote: “We have always been clear that the salary provision neither requires any specific salary increase nor prohibits increases from being implemented over a reasonable time period.” With the Council set to vote next week, Ferguson Councilman Wesley Bell said the new epistle for the Justice Department appears to indicate that the Justice Department has no intention of bankrupting the city; rather, he told the Dispatch, the new federal communication should ease the fears of those opposed mostly for financial reasons to the agreement. Nevertheless, with the Council expected to vote early next week, weeks after a new appointment to the council created a shift in favor of accepting a consent decree, but before municipal elections next month, the political and fiscal issues will be hard.

In February, the Ferguson Council had voted to accept the federal decree, but only with certain conditions, one of which would have effectively diluted its power: the Council sought to eliminate the so-called “poison pill” clause that made the decree apply to any other agency providing policing in Ferguson—a rejection which would have allowed the city, effectively, to disband its police department and thereby avoid the significant and potentially unaffordable federal hit on its budget solvency—an action, however, which triggered a 56-page federal lawsuit the very next day, but also came concurrently with a key change in the city’s elected leadership: council members had appointed Laverne Mitchom, a retired educator, to fill a council seat vacated in the wake, in January, of former Mayor Brian Fletcher’s death due to a heart attack. The appointment of Ms. Mitchom, who had participated in the protests following Michael Brown’s death in August of 2014, appears to have shifted the majority and made some agreement with the federal government more likely—albeit at an uncertain fiscal price and cost to the city’s sustainability. Indeed, in town meetings, residents have expressed concerns that the expense of enacting the lengthy list of federally-demanded reforms could lead to the city’s dissolution — fears further heightened by a presentation from Ferguson’s Finance Director, Jeffrey Blume, who, under one of the 450 proposed federal mandates of Justice Department plan, would be tasked with developing a plan to offer police salaries that are among the “most competitive” with comparable agencies in St. Louis County—an unfunded federal mandate which Mr. Blume fears could mean the city would be required to award 25 percent raises not only to police officers, but also to all its employees — raises which would cost the city $3.7 million in the first year alone, not counting the longer term fiscal costs for its pension obligations.

For its part, the Justice Department appears to have recognized that—unlike the federal government—Ferguson must balance its budget. Ergo, the Justice Department appears to be signaling it will work collaboratively and that Ferguson may have some latitude in carrying out the federally-imposed reforms, or, as the Department wrote: “…as we made clear during our negotiations…the precise contours of implementation…would be developed over time in close coordination and consultation with City officials, the Department of Justice, the independent monitor and the court.” Moreover, the Justice Department appears now to recognize it has a significant stake in Ferguson’s financial health: “The Department of Justice has a strong interest in ensuring the sustainability of the reforms in our consent decrees and we understand that sustainability often, as a practical matter, requires attention to the financial condition of the local jurisdiction during the implementation stage.”

Schooling in Insolvency. Retired U.S. Bankruptcy Judge Steven Rhodes, who presided over the largest municipal bankruptcy in U.S. history in Detroit and who is currently serving as a quasi-emergency manager for the nearly insolvent Detroit Public Schools (DPS), has named Alycia Meriweather, a longtime educator in Detroit Public Schools, as interim superintendent—the chief academic officer. Ms. Meriweather, a Detroit resident and DPS graduate, will lead day-to-day operations in DPS’ academics, talent, and strategy divisions, while Judge Rhodes will continue with his responsibilities for the overall fiscal leadership of DPS. Judge Rhodes, no doubt is hankering to devote more time to his electric rock band, the Indubitable Equivalents, nevertheless he has accepted the task of trying to right the fiscal ship as Gov. Rick Snyder and the Michigan legislature in Lansing are seeking to address both the crisis in Flint and the looming DPS municipal bankruptcy. Gov. Rick Snyder has proposed spending some $770 million over a decade to pay down DPS debt and to create a new school district. All parties appreciate the stakes: failure could potentially reverse Detroit’s post-municipal bankruptcy progress.

Presidential Contender Bankruptcy. While the issue of municipal bankruptcy and the fiscal sustainability of the nation’s municipalities has been absent from Republican Presidential debates, bankruptcy has not. If anything, Mr. Trump has bragged with regard to how successfully he has utilized bankruptcy—mayhap emphasizing how different a Trump bankruptcy is than a chapter 9 municipal bankruptcy might be in Atlantic City, where his most recent bankruptcy filing, Trump Entertainment Resorts, has just been completed: with the equity transferred to the senior lenders. Former debt holder Carl Icahn provided Trump Entertainment Resorts with $82.5 million in exit financing, so that Mr. Icahn now owns its properties, including the Trump Taj Mahal and Trump Plaza Hotel and Casino in Atlantic City. Indeed, Trump-branded casinos have been through bankruptcy multiple times. Mr. Trump had equity ownership for the first three: he has successfully used the bankruptcy process to protect his brand against litigation, to cut labor costs, and to restructure debt that it could not pay. Previous to the Trump Entertainment Resorts bankruptcy, Trump Atlantic City went bankrupt, then Trump Hotels & Casino Resorts went bankrupt, then Trump Atlantic City went bankrupt again. The Trump Entertainment Resorts bankruptcy was necessary to deal with $285.6 million of outstanding secured debt as well as $13.5 million of trade debt and $6.6 million of unpaid interest. Mr. Trump, at least to date, appears not to have discussed what role federal bankruptcy might play were he to be elected President.