State and Local Insolvency & Governance Challenges

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eBlog, 03/29/17

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

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

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

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

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

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

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

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

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

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

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

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