Who Will Take Responsibility for Detroit’s Future?

January 19, 2016. Share on Twitter

What About the Future? Children are cities’ futures, so it is understandable that Detroit Mayor Mike Duggan is trying to change not only the math of the system’s failing fisc, but also the failed governance of a system currently under a state-imposed emergency manager. With black mold climbing the interior walls of some classrooms, and free ranging, non-laboratory rats occupying classrooms, the arithmetic of the schools’ finance merit an F: Of the $7,450-per-pupil grant the school district will receive this year, $4,400 will be spent on debt servicing and benefits for retired teachers, according to the Citizens Research Council. Absent a turnaround, the failing school system is hardly likely to spur young families to move into Detroit.

Math, as in any school system, is a fundamental issue: in Michigan, unlike other states, for more than two decades, the Detroit Public School System (DPS) has been funded, not from property tax revenues, but rather through state sales and income taxes—a system which provides the state with a disproportionate role in how Detroit’s schools are managed—or mismanaged. In addition, DPS, which has been on fiscal life-support since 2009: DPS is currently managed by the fourth state-appointed emergency manager—hardly an augury of stability—and with little indication the series of state appointees have earned good grades: DPS currently carries debt of over $3.5 billion, which includes nearly $1.9 billion in employee legacy costs (such as unfunded pension liabilities) and cash-flow borrowing, as well as $1.7 billion in multi-year bonds and state loans. For the fourth time since 2009.

DPS last year ranked last among big cities for fourth- and eighth-graders (children aged 8-9 and 13-14) in the National Assessment of Educational Progress, a school-evaluation program mandated by Congress. If attendance is some measure of the public’s trust, the report card is miserable: over the last decade, attendance has declined more than 66 percent: a majority of families have moved their children to charter schools. Today, the majority of Detroit’s schoolchildren attend state-funded, but privately managed charter schools. Although the massive shift has enabled DPS to reduce its staff by nearly two-thirds, the system’s fixed costs remain high because of its former size. That augurs for a bad report card: Michelle Zdrodowski of DPS recently warned that DPS will run out of cash in April. Mayhap unsurprisingly, the legislature has been not just unenthusiastic about crafting another Detroit rescue plan, but also uneager to even consider the draft, $715 million bill proposed by Governor Rick Snyder: a bill which would create a debt-free DPS, run by a state-appointed board, and with a shell that assumed DPS’s debt. Gov. Snyder is also proposing closing poorly performing charter and traditional schools. Michigan’s constitution proclaims primary and high-school education to be a right. But in freezing, rat-infested Detroit schools, some 50,000 children who might someday determine Detroit’s future are soon to learn how the Michigan legislature defines that “right.”

For Detroit, now more than a year after emerging from the largest municipal bankruptcy in American history, a new municipal bankruptcy might be in the report cards, as DPS is within months of insolvency—especially if the state legislature continues to spurn Gov. Snyder’s proposals. By next month, the amount of state aid to DPS which will have to be sidetracked to pay off debt is projected to be roughly equivalent to what DPS is spending on salaries and benefits—or, as Hetty Chang of Moody’s describes it: “It’s not sustainable…” adding that absent action soon, “they will run out of money.” Her colleague, Andrew Van Dyck Dobos, added that the “Continued sickouts (by teachers) may further incentivize students to flee the district, resulting in lower per-pupil revenues from the State of Michigan and continuing a downward spiral of credit quality.” DPS, Moody’s projects, will see its expenses rise by $26 million a month beginning in February—after our friend in Pennsylvania sees—or does not see—his shadow: February is when DPS is on the line to begin repaying cash flow notes issued to paper over operations—part of the depressing math that will now, inexorably, begin to eat into DPS’s monthly expenses: the increasing debt service will equal about one-third of DPS’ monthly expenses, according to Moody’s. Indeed, without some form of restructuring, Moody’s warns that DPS could lose even more students as it is forced to divert funds from the classroom—adding that teeming long-term pressures on the near-term operational debt payments as the district will impose a $53 million annual expense to repay long-term operational debt through FY2020. In Lansing, Gov. Snyder’s proposal to ask the state legislature to approve the $715 million in state funding, as unappealing to the legislature as it may seem, would prove more affordable to state taxpayers than an eventual default or potential legal action due to a municipal bankruptcy filing.

DPS’s burdensome debts.  President Barack Obama plans to visit Detroit tomorrow to witness the Motor City’s progress firsthand as part of his trip that includes a tour of the auto show. The trip will also be an opportunity to assess the outcomes of his creation of a federal coordinator and an interagency Detroit Working Group to help 20 federal agencies assist Detroit—agencies through which the federal government has since invested $300 million in Detroit through grants and programs involving blight demolition, transportation, and public lighting. The President will also visit the North American International Auto Show in an effort to showcase the record auto sales of 2015, the 640,000 new auto-industry jobs created since the federal auto bailout, and emerging technologies that could help reduce U.S. dependence on oil and keep the industry competitive. The visit could also help the White House assess the successes and failures of its own efforts to help Detroit out of bankruptcy—efforts, obviously, profoundly different than the federal bailouts of the bankrupt automobile industry in Detroit, including “embedding” full-time federal staff inside city government to help identify federal resources to help Detroit and cut through red tape. Among the Administration-supported projects provided to Detroit has been $130 million in federal funds for blight removal, and allowing the city to demolish more than 7,500 blighted buildings in fewer than two years—federal funds made available from the 2009 Hardest Hit Fund mortgage aid program. Among the projects that Mayor Duggan’s office continues to discuss with federal officials are expanding Detroit’s youth employment program and securing more aid for blight elimination. It is hard to imagine that the future of DPS will not be on the table too.

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The Road to Recovery from Municipal Bankruptcy

eBlog
November 12, 2015. Share on Twitter

The Road to Recovery from Municipal Bankruptcy. Jefferson County Commissioner David Carrington has put together a description what he labels “A Post-Bankruptcy Look at Jefferson County, Alabama” for a presentation at a Symposium on Modern Municipal Restructurings for Duke University this week to demonstrate the steps on the road out of what, at the time, was the largest municipal bankruptcy in U.S. history in Alabama’s largest county. Noting the county’s diverse economy, with a GDP ranking it 137th out of 3,134 counties, and its home to the Innovation Depot, the largest business technology incubator in the Southeast, as well as its robust rail and interstate transportation network, he pointed to last year’s 2014 new residential permits (in dollars) greater than 58 of Alabama’s—or some 19.2% of all the state’s 67 counties combined, as well as the balanced budgets the county has adopted each and every year since U.S. Bankruptcy Judge Thomas Bennett approved the municipality’s plan of debt adjustment. He also noted the county’s slimmed payroll: the county today has 1,000 fewer employees than when, 25 months after it emerged from municipal bankruptcy on December 3, 2013, adding the County long-term debt has declined by some $1.5 billion—more than one-third, and that the County has made significant structural changes, including closing an inpatient (not impatient) hospital, sold the nursing home assets, closed all four of its satellite courthouses, and achieved something which must make Chicago Mayor Rahm Emanuel most jealous: a county pension has a funded ratio of 105.6%. He reports that audits, which were three years past due when this Commission took office in 2010, are now actually published ahead of schedule. Mayhap one of the most important accomplishments might be a more constructive relationship with the Alabama Legislature, which has passed a replacement 1‒cent sales tax bill, an action which allows the County to refinance its school construction debt, a key step to providing additional funding for county operations, economic development, schools and community development, in addition to county debt retirement. On the economic recover front, the Commissioner reports that more than 1,300 condominium units are planned or under construction, along with a $30 million mixed use development in Midtown anchored by a 34,000 square foot Publix grocery store—and that new historic building tax credits enacted by the Alabama legislature have elicited more than $200 million in local investments in a metro region now ranked as the Top City for Millennial Entrepreneurs by Thumbtack, in addition to being ranked 6th overall and 5th for economic development potential among the Top 10 mid‒sized North, Central and South American “Cities of the Future.”

A Detroit International 911. Daniel Howes, the gifted Detroit News columnist and associate business editor, wrote a terrific column yesterday about Dovie Maisel, an Israeli architect for a cause called United Hatzalah, a network of trained volunteers in that country which responds to calls for emergency medical care in Israel’s largest cities and across the country — noting that Mr. Maisel is in Detroit as part of an international effort to work with Mayor Mike Duggan to see if the model could be replicated, with Mr. Maisel noting: “We are not coming to take any jobs. We are the community. We are coming to help them:” Detroit and its EMT units are in preliminary discussions with United Hatzalah to see if the Israeli concept, which is scheduled to be launched this month in Jersey City, New Jersey, could also be adapted for the Motor City—an audacious effort which is envisioned to complement, rather than compete with what Mr. Howes describes as Detroit’s “stressed EMT units.” The partnership would train community volunteers. Potentially it would create a cadre of skilled technicians who could apply for EMT openings in Detroit or the metropolitan region—with Mr. Maisel noting, carefully, that Hatzalah volunteers do not replace professional EMT units in Israel; rather, certified according to Israeli national standards, they are, nevertheless, often able to respond to emergencies more quickly, because they are embedded in their communities—so that they are closer. Indeed, the concept has similarities to the remarkable public safety partnership in No. Virginia, where a unique agreement between its local governments ensures that the first 911 response will come from the closest responder—irrespective of jurisdiction—an agreement which can make the difference between life and death—and, secondarily—savings. According to Mr. Maisel, in Israel, volunteers are not paid, and victims are not charged.

As Mr. Howes wrote: “It’s an audacious idea for Detroit, one Mayor Mike Duggan dismissed as fanciful in a city of 139 square miles with a population pushing 700,000 — until he heard the pitch and compared it to the city’s need to improve its response to emergency calls,” noting that in Israel, “a polyglot of ethnicity, religion and intermittent tension effectively bridged by United Hatzalah…a country of less than 8 million, the volunteer organization fields 700 emergency calls a day, carries 3,000 volunteers nationwide, and boasts an average response time of three minutes, even less in more densely populated major cities.” The organization use a fleet of 450 “ambucyles” volunteers use to answer calls, and counts 2,550 volunteer-owned vehicles that are used to augment its rescue fleet, adding: “With a budget of $10 million, all of it privately funded, Hatzalah maintains 40 branches across the country organized into eight districts — its volunteers treat victims regardless of ethnicity, sex or religion, with an ‘ultimate goal to save lives, to take the community and train them at all levels.’” As Mr. Howes writes: “This may be the right cause at the right time for Detroit. It could answer a public need, could ease pressure on EMT units, could teach volunteers from the city’s neighborhoods marketable skills, could tap an entrepreneurial vein in a (Mayor) Duggan administration generally open to alternative solutions, and could be funded by individual private donors and foundations”—especially in a city beset by an emergency response rate being among the lowest in the country. In this fascinating cross border effort, the Detroit Medical Center and Henry Ford Health Systems’ chief of emergency medicine are working with the Mayor’s office to assess the implications of trying to implement this potential international partnership—one which Mr. Howes forthrightly describes as “fraught with legal and medical issues, as well as reassuring union EMTs that the effort is not a back-door gambit to eliminate their jobs.”

Looming Default. The U.S. territory of Puerto Rico could default at the end of the month on at least a portion of its scheduled debt service payments—an event which would constitute its second default, as the island’s liquidity pressures increase: it upcoming fiscal obligations consist primarily of $354.7 million of debt service on notes issued by the Government Development Bank or GDB, which has less incentive to make a payment of $81.4 million in debt service on non-general obligation-backed debt, as the payment pledge does not benefit from constitutional protections. The greater sustainability risk is that the GDB may be forced to default also on the $273.3 million of GDB notes which are backed by Puerto Rico’s full faith and credit general obligation guarantee—a default, after all, which would likely trigger legal action—but an event long foretold: as Puerto Rico, without access to the kind of federal bankruptcy options available to municipalities across the rest of the U.S., but with a seemingly disinterested Congress, will have little option but to not make full faith and credit bond payments that would jeopardize essential government services, consistent with the rapidly approaching reality that “the Commonwealth cannot service all of its debt as currently scheduled.” Puerto Rico’s ability to meet any of its obligations is deteriorating, even as, like Nero, Congress fiddles.

The territory, absent access to external sources of financing, projects a negative $29.8 million cash balance this month, growing to a deficit of $205 million by next month. Even though some recovery is projected in early 2016 with the enactment of emergency liquidity actions, actions which could include utilizing tax revenues currently assigned to one or more government authorities and further delaying tax refunds, Puerto Rico’s November Financial Information and Operating Data cash projection report does not include any availability of funds at the GDB, noting its cash resources “may be fully depleted by the end of calendar year 2015.” Puerto Rico’s inability to sustain sufficient liquidity to meet its operating and debt needs, absent extraordinary measures or outside help or legal recourse, is now expected to lead to additional defaults. Even though, a government aide stated that Puerto Rico will make its scheduled December payment on GO guaranteed GDB debt, such payment will decrease what might be available for an approximately $330 million GO debt service payment due on New Year’s Day: that is, as Bloomberg noted: “While we expect the commonwealth to use all available measures to prevent a default on constitutionally protected debt, it has not been making the monthly sinking fund payments required for the 1 January payment since July 2015. Instead, it will rely on cash on hand in the Treasury’s single cash account to make the debt service payment, though as noted above the projected November and December balances in the fund are negative. The commonwealth is not eligible to file for bankruptcy and the absence of a debt-restructuring framework heightens risks to creditors because it prevents the government from using tools generally available to distressed corporations and some municipalities.” For his part, Puerto Rico Gov. Alejandro García Padilla the day before yesterday warned that if the island’s municipal bondholders do not agree to new terms on their debt, he will choose to pay for the needs of the people before paying the Commonwealth’s creditors: “…if they do not negotiate and force me to choose between creditors and Puerto Ricans, I’m going to pay the Puerto Ricans.’”

Providing Essential Services. Governor Alejandro García Padilla has said he will consider cutting hours for public workers to keep essential governmental services and functions running; he has already closed some schools, delayed tax rebates, and suspended payments to government suppliers. The Obama administration, lacking any constructive Congressional role, has, via the Treasury Department, proposed an assistance package that would sustain the island’s medical system by increasing reimbursement rates for Medicaid, which serves 46 percent of Puerto Ricans and is paid at rates 70 percent lower than in any U.S. state, according to the Puerto Rico Healthcare Crisis Coalition, a group of doctors, hospitals, and insurers. The proposed package would also offer some bankruptcy protections to help the government restructure more than $70 billion in debt—more than any state’s except New York and California. In return, under the proposal, Congress would gain more say over the island’s finances. Congressional leaders, however, report they will not agree to provide either any fiscal assistance—or municipal bankruptcy authority—unless Puerto Rico provides audited financial statements giving a complete picture of its finances, a challenge given that the self-governing U.S. territory missed a self-imposed Oct. 31st deadline for submitting statements from FY2014 and has yet to prepare FY2015 documents. Congress appears to want to impose a different standard than used for states with regard to chapter 9 municipal bankruptcy or other U.S. corporations, with Chairman Charles Grassley (R-Iowa) of the Senate Judiciary Committee claiming he “is waiting for some good-faith effort from Puerto Ricans.”

Whither Federalism?

October 26, 2015. Share on Twitter

Congressional Disinterest in the Complexities of Federalism & Municipal Bankruptcy. Despite White House warnings that only swift Congressional action can avert a string of impending defaults on $73 billion in Puerto Rican debt that could lead to a “humanitarian crisis,” the reaction by the Senate Energy and Natural Resources Committee (the committee of jurisdiction, because it was, formerly, the Committee on Interior and Insular Affairs, ergo the inclusion of Puerto Rico and other U.S. territories under its jurisdiction) was almost nonexistent: only two members of the majority, Chair Lisa Murkowski (R-Alaska) and Sen. John Barrasso (R-Wy.) even made the effort to attend. U.S. Treasury Counselor Antonio Weiss testified last Thursday, formally requesting Congress to act swiftly to provide expanded Chapter 9 municipal bankruptcy protection to both the Commonwealth of Puerto Rico, as well as its public authorities, and to provide other relief. Under the White House plan, in order to gain access to expanded Chapter 9 municipal bankruptcy relief, Puerto Rico would have to agree to federal fiscal oversight. The second part of the plan, Mr. Weiss said, would be for Congress to authorize the creation of an oversight body made up of broad group of stakeholders that would preserve Puerto Rican authority, but would be independent from the territory’s government. In addition, the administration requested that Congress provide funding and authorize technical assistance to help Puerto Rico bring its accounting and disclosure practices into the 21st century, warning that Puerto Rico’s government is on the verge of running out of fiscal resources with which to provide its three and a half million U.S. citizens essential public services. The response from the Committee, however, was—at best—dismissive. Chair Murkowski claimed the Committee lacked accurate enough financial information, and that, even if it had such information, the White House proposal could not be considered without offsetting cuts in other areas of the budget. Indeed, after a relatively brief rounds of questions, she ended the hearing, saying, “I apologize that we can’t give more time to this.” Puerto Rican leaders and many financial and legal experts have been saying for months that the U.S. territory cannot repay the approximately $72 billion it owes to hedge funds, mutual funds, and other investors. Indeed, the economy is in a whirlpool: it is not growing, and tens of thousands of residents are leaving every year for the mainland U.S. to look for work. More than 300,000 have left in the last 10 years. Puerto Rico confronts a public pension debt in excess of $40 billion; its adopted spending cuts and tax increases have failed to stem the rising debt tide. Mayhap unsurprisingly, many investors and owners of Puerto Rican bonds—that is, investors who stand to lose under any debt restructuring–are bitterly opposed to the Administration’s proposals: they claim Puerto Rico can repay all of its debt if it tightens its fiscal belt and privatizes utilities and other government-owned businesses. The complexity of addressing Puerto Rico’s looming insolvency is complicated in that federal municipal bankruptcy, in recognition of dual sovereignty, provides that no mainland municipality may file for municipal bankruptcy without state authorization. Since Puerto Rico is not a state, but rather a territory, not only does Puerto Rico not have access to chapter 9, but nor does it have the requisite authority to authorize access to any of the island’s 87 municipalities. Current negotiations have involved some 18 different municipal debt issuers—so that 20 creditor committees have been created, focused on competing interests.

Late for an Important Date. San Bernardino, last Friday, finally received a letter from its independent audit firm with regard to the accuracy of the accuracy of its financial statements—but not the promised full audit. The delivery, more than a year and a half overdue—and technically still due—was delivered two days after it was last promised, and more than a year and a half after the deadline imposed by the State of California. Deputy City Manager Nita McKay, nevertheless, advised the City Council the audit was “basically what you pay for…It’s the signed letter from the auditors, and what you’re hoping for is an unqualified opinion, which means there’s nothing they need to disclose. Last year there were two comments, and they’re the same comments again, about successor land held for resale…and then, because we’re in bankruptcy, they add a paragraph about that.” The municipality’s audit firm Macias, Gini and O’Connell LLP (MGO), which had promised completion and delivery last week now reports it will “likely” be ready this Wednesday—that is, just six days before November 3rd’s municipal elections. Ms. McKay advised the Mayor and Council the audit firm would be ready to present to the city’s administrators and a selection of elected leaders on the audit committee this Thursday. With the fast approaching municipal election, city staff and auditors have been sparring over responsibility for the audit delay, with the auditing firm falling further behind schedule, even as it sought nearly double its original asking price. The bankrupt city, according to Ms. McKay, has paid about $451,000 of that contract so far, and it is still awaiting its single audit—the audit of federal grants, a key step, as it has held the city hostage for the receipt of $125,000 a month for the San Bernardino Employment and Training Agency from the State of California. The city has scheduled a pre-election day public presentation of the findings in the 2012-13 audit for the Nov. 2 City Council meeting, according to City Clerk Gigi Hanna.

Dual Sovereignty & Municipal Bankruptcy

October 22, 2015. Share on Twitter

Complexities of Federalism & Municipal Bankruptcy. U.S. Treasury Counselor Antonio Weiss will testify today before the U.S. Senate Committee on Energy and Natural Resources, where he will ask Congress to act swiftly to provide expanded Chapter 9 municipal bankruptcy protection to both the Commonwealth of Puerto Rico, as well as its public authorities, and to provide other relief. The plan also would provide that in order to gain access to expanded Chapter 9 bankruptcy relief, Puerto Rico would have to agree to federal fiscal oversight. The second part of the plan would be for Congress to authorize the creation of an oversight body made up of a broad group of stakeholders that would preserve Puerto Rican authority, but would be independent from the territory’s government. In addition, the administration is proposing that Congress provide funding and authorize technical assistance to help Puerto Rico bring its accounting and disclosure practices into the 21st century.

The 11th hour effort comes in the wake of a growing liquidity crisis, and less than a day after Puerto Rico’s Government Development Bank ended discussions with a group of Puerto Rico’s municipal bondholders without reaching any consensus on restructuring the Bank’s debt—the Bank plays a key role, as it lends to Puerto Rico’s agencies and faces a looming municipal bond payment of more than $350 million due on December 1st. It also comes in the wake of Puerto Rico Governor Garcia Padilla’s, who will also be testifying this morning, repeated warnings that the commonwealth’s debts cannot be repaid—warnings that, to date, appear to have had limited impact on so far fruitless voluntary debt-restructuring negotiations. In his testimony this morning, Mr. Weill is also expected to call for “independent and credible” fiscal oversight from Congress, possibly referring to the concept of a financial control board—mechanisms which were key to avoiding insolvency for both New York City and Washington, D.C. Mr. Weiss is expected to propose a modified version or variation of the current federal statute for chapter 9 municipal bankruptcy—one which would be available to all U.S. territories, and which, obviously, would not be subject to state authorization, as it required under the current federal law for any municipality to be eligible for such protection. In addition, he is expected to propose the restructuring of Puerto Rico’s current $72 billion in outstanding municipal debt. In the Treasury’s legislative outline released late yesterday, the agency warned Puerto Rico would exhaust the emergency steps it has taken to remain solvent by this winter, noting: “As currently structured, Puerto Rico’s debt load is unsustainable.” The Treasury proposal also will recommend overhaul of the island’s Medicaid program, as well as access to the earned-income tax credit.

The complexity of addressing Puerto Rico’s looming insolvency is complicated in that chapter 9 municipal bankruptcy, in recognition of dual sovereignty, provides that no mainland municipality may file for municipal bankruptcy without state authorization. Since Puerto Rico is not a state, but rather a territory, not only does Puerto Rico not have access to chapter 9, but neither does it have the requisite authority to authorize access to any of the island’s 87 municipalities. Current negotiations have involved some 18 different municipal debt issuers—so that 20 creditor committees have been created, focused on competing interests.

Avoiding Municipal Insolvency, Except as a Last Resort

October 20, 2015. Share on Twitter

Avoiding Municipal Insolvency, Except as a Last Resort. Gov. Rick Snyder yesterday outlined a $715 million plan to split the Detroit Public School System (DPS) into two separate districts: a plan to both help improve academic performance, but also pay down more than a half billion dollars in DPS’s operating debt, marking the second time in six months that the governor has detailed plans to overhaul education in Detroit. Detroit Public Schools has lost close to 100,000 students over the past 10 years, according to Gov. Snyder’s office. The district has not yet released enrollment numbers for this school year, which were taken during a recent student count day, but it had about 47,000 students last year. Gov. Snyder would not say outright whether the alternative is taking DPS into bankruptcy, given the amount of state liability vested in the existing district. Rather, he said, this plan would avert the need for bankruptcy. Should the district default on its debt, Gov. Snyder said the cost to the state could soar beyond the $715 million expected over 10 years as the current school system pays back its debt: “I don’t use the bankruptcy word except as a very, very last resort…It is very reasonable and fair to say that compared to this solution, that solution could be much more expensive.”

Pensionary Complications. Gov. Snyder is seeking legislative action by the end of this year to create a $715 million, debt-free school district in the Motor City over the next decade, meaning the current district would exist only to pay off the debt, noting in his presentation: “This package provides an answer that’s rational, that’s comprehensive, that is lower cost and much less chaotic than the other alternatives.” A key issue confronting the school system is its nearly $100 million liability to Michigan’s school employee pension system—a debt of such proportions that a judge could be petitioned to order DPS or the state to pay up—an order, were it to be issued, which could trigger higher property taxes for the city of Detroit or an emergency bailout by the Legislature. Gov. Snyder warned the state could be on the hook for DPS’ $1.5 billion unfunded pension liability if lawmakers are unable to stabilize the district’s finances by assuming a projected $515 million in operating debt payments that were mostly racked up by state-appointed emergency managers, noting: “That’s an unfunded liability that would get spread to the other districts if DPS wasn’t making payments…There’s a lot of extra money that would have to go out if this doesn’t get done.” Gov. Snyder’s dire warning came in anticipation of the long-expected introduction of legislation to create new layers of oversight of DPS in exchange for the state assuming the seemingly relentless growth in the system’s operating debt amassed by emergency managers in recent years—a debt the cost of which to pay off has now reached the equivalent of an annual cost of $50 for every child in Michigan. The accumulated operating debt of DPS is expected to top $515 million by June 2016. In his remarks, Gov. Snyder noted Michigan’s School Aid Fund can handle the roughly $70 million annual payment for the next decade without taking money away from other schools districts—that is, under his proposal, helping DPS would not have to come at the expense of other Michigan public school districts—a claim that might be semantical—as the ever insightful Citizens Research Council notes: “Clearly you’re taking money that would be available to other school districts to help a single school district.”

  • Costs. Under the Governor’s proposal, the new Detroit Community School District would need $200 million to cover $100 million in startup costs and initial capital improvements of facilities and $100 million to account for continued declining enrollment in the city. The new District would not be barred from seeking voter-approved millages for capital improvements unless and until the old district’s operating debt was paid off, and, according to John Walsh, Gov. Snyder’s strategy director, it is possible the $715 million figure could be reduced if Detroit’s economy continues to rebound, businesses relocate to the city, and property tax collections continue to increase, adding; “With property values going up, it could take less time to pay off.” Michigan’s contribution to Detroit’s federally approved plan of debt adjustment amounted to $350 million spread over 20 years—a state contribution which Mr. Walsh led, at the time, as a key leader in the Michigan House—leadership which will be critical for what is anticipated to be a “tough sell in the Legislature.” Moreover, such a new Detroit school district would still be liable for paying down the $1.5 billion in the system’s unfunded pension liabilities—with Gov. Snyder resisting the Coalition for the Future of Detroit Schoolchildren’s call for DPS to be exempted from continuing to pay its share of pension costs for current and former employees. As of last week, DPS was $99.5 million behind in public pension payments to the Michigan Public School Employee Retirement System—a debt exacerbated by $100,000 in monthly late fees and $12,000 in daily in interest penalties, according to state’s Office of Retirement Services.
  • Governance. Originally, the governor had proposed the creation of a new financial review commission to have oversight and veto power over spending decisions of the new school district in Detroit. In his revised plan, he is proposing to utilize the existing Financial Review Commission, which was created as part of the Detroit plan of debt adjustment, so that there would be long-term state oversight of Detroit’s finances. The Governor’s plan also retains another layer of oversight of all city schools in a Detroit Education Commission: it would entail hiring a chief education officer with the power to open and close academically failing schools run by DPS, charter schools, and the Education Achievement Authority. The commission’s membership would include three gubernatorial appointees and two mayoral appointees: it would be charged with streamlining some services for all schools, such as enrollment. But in the governor’s revised plan, he makes a common enrollment system voluntary. Gov. Snyder said he and Mayor Duggan are still discussing the mayor’s role in school reform in Detroit: Mayor Duggan has expressed a desire for more local control of Detroit schools, or, as Gov. Snyder put it: “The mayor sees the value in this, but there is a difference in governance: The mayor’s office still has issues they want to talk about, and I feel it’s important to get this dialogue going. We’ve taken a lot of input from the mayor. We have a supportive, positive relationship. No, we don’t agree on every issue.” Earlier this month, Mayor Duggan reiterated that he is advocating for local control, including an elected school board for Detroit to run its 100 public schools. He further proposed that an election be held next spring. Mayor Duggan has said the city needs an education commission with membership that he appoints, as recommended by the education coalition. The commission, he said, would level the playing field between public schools and charters and help to set standards for where they are needed and can locate.
  • Oversight. Gov. Snyder’s announcement follows news of an FBI corruption investigation involving DPS and the Governor’s K-12 reform district, the Education Achievement Authority, leading the Gov. to note: “I think it’s fair to say it complicates it.” Under his revised proposal, a new seven-member school board would be created to govern the new Detroit school district. The governor would appoint four board members, and Mayor Mike Duggan would appoint three board members. Mayor Duggan has resisted appointing school board members and has called for the return of an elected board. Detroit’s elected school board has been without policy decision-making powers for six years, during which time the district has been under the control of four state-appointed emergency managers. Gov. Snyder indicated he was open to changes in the legislative process. “Let’s get the legislative process going and let’s work through that…Not everyone is going to like every piece of this.” Members of the House Detroit Democratic caucus said they were ready to work with Gov. Snyder on a reform plan — as long as it includes local control of schools. “The state has controlled DPS for many years, and it has been a failure,” said Rep. Brian Banks, caucus chairman. “We have to find a better way, and we believe that way lies through local control. We look forward to working with all stakeholders to address all of the issues surrounding DPS.”
  • Partners. Gov. Snyder took care not to alienate the Coalition for the Future of Detroit Schoolchildren, which offered a reform plan in late March. One of the major differences between the coalition’s plan and the Governor’s is his recommendation for a voluntary enrollment system, as opposed to the mandatory system the coalition recommended. “We looked at the best practices around the country and they were all voluntary, and we felt that was the best way to go for parents, to give them more choice…We encourage charters to join the voluntary system in terms of making their school decisions.” Gov. Snyder also said the coalition presented far more recommendations than he used. “It’s not that we don’t agree,” he said. “It’s just that they (many of the recommendations from the coalition) didn’t appear to be prudent for state legislation.”
  • The forthcoming bills are expected to include:

• The Detroit Public Schools would be phased out completely once DPS pays down roughly $515 million in outstanding operating debt. It also collects a $70 million millage from city taxpayers. The city’s Financial Review Commission would oversee the old district while the debt is repaid.
• An additional $200 million would go to the new Detroit Community School District in startup funding and to cover anticipated operating losses due to potential declining enrollment. The new district also would be responsible for about $1.5 billion in pension obligations.
• A new seven-member board would be created to govern the Detroit Community School District. Its members initially would be appointed by Snyder and Detroit Mayor Mike Duggan, with elections phased in beginning in 2017. The board makeup would be majority-elected by 2019 and fully elected by 2021.
• A new Detroit Education Commission would be created, with oversight of the new Detroit school district, the Education Achievement Authority and charter public schools. Its members would be appointed by Snyder and Duggan and would be charged with hiring a chief education officer. The chief education officer would be in charge of academics, including having authority to close low-performing schools.
• A standard enrollment system would be introduced, with common forms and enrollment periods for all participating schools to help parents review options for their children. The common enrollment would be voluntary for schools, although all schools would be required to report academic and other performance standards for transparency.

Are There Alternates to Municipal Bankruptcy? In the absence of access to municipal bankruptcy because of Congressional reluctance, the U.S. Treasury, in discussions with Puerto Rico, has proposed consideration of the creation of a new municipal bond security—one which would be senior to Puerto Rico’s general obligation or GO bonds—and which could act as an exchange vehicle in a sweeping debt restructuring. Reportedly, the proposal would shift collection of all or some of Puerto Rico’s income, sales and use, and other tax revenues to the Internal Revenue Service or the Bureau of Fiscal Service in the U.S. Treasury: such tax receipts would pass through a quasi-lockbox before such revenues would then be effectively returned to the U.S. commonwealth—effectively creating a new governmental entity to securitize these new lockbox revenues. Because the potential governing and taxing structure would, effectively, bypass the existing constitutional revenue structure for the island and its constitution, the proposal appears to be a means under which Puerto Rico’s many, many municipal bondholders would be incentivized to exchange their newly-subordinated Puerto Rico municipal bonds at a discount for certificates of the new U.S. quasi-municipal security. The plan—in part based on a recognition that Congress appears almost certain not to act—nevertheless confronts signal hurdles and skepticism—or as our admired friends at Municipal Market Analytics put it: “[O]n its own, this debt strategy has little chance of success: without a meaningful, definitive, and well-supported program to restructure Puerto Rico’s revenue mix and operational spending, bondholders cannot judge the long-term effectiveness of any proposed debt haircut or the value in any exchange security, regardless of how structurally-insulated from PR’s economy and finances it appears to be….” Adding: “[T]here are massive execution risks in this plan, not the least of which is a (likely) need for Congressional approval. The US Treasury has been convincing that, beyond operational assistance, this plan intends no injection of Federal cash to PR and no other characteristics of a bailout. Yet, seeing as how Republicans oppose the extension of chapter 9 to Puerto Rico on the grounds that it would somehow be a bailout implies an extremely low hurdle for debt holders to successfully lobby their opposition to this plan.” In addition, of course, is the tricky issue of federalism: can you imagine any governor or state legislature which would willingly relinquish control of its income, sales and use, or other taxes to the federal government? MMA slyly adds that even were the Puerto Rican legislature to buy into such a proposal, there would be comparable doubt as to whether current Puerto Rico municipal bondholders scattered across the continental U.S. would be standing in long lines to exchange their current general obligation bonds for an untested new model. Moreover, as MMA masterfully writes:

“Finally, the island’s liquidity issues are on a much tighter schedule than a plan of this magnitude could hope to be. With the real possibility of a PR government shutdown and additional bond defaults before year end, this plan, if it happens at all, would most likely be a means for PR to cure, and not avoid, payment defaults. This is an important distinction, because ‘cure’ strategies have, by definition, a higher standard for long-term benefit, further complicating the plan’s implementation prospects. While this plan will help PR collect the taxes it is supposed to collect, any increase in taxes—even on “underground” economic activity—effectively relocates capital from PR citizens to the government, worsening the local economy and out-migration trends. So while the exchange security may get a first crack at all revenues—just as PR’s GO security is purported to do—it is unreasonable to expect that those revenues will move anywhere but downward over time, creating incremental pressure on now less-flexible PR finances. Any post-default implementation of this plan would need to consider these secondary effects and ensure that the new financing will not cripple PR in the future.”

The Desperate Price of Fiscal Unaccountability

October 14, 2015

Municipal 9-1-1. As U.S. District Court Judge Bernard Friedman noted late last month, the importance of Chapter 9 municipal bankruptcy is to ensure “the resources to provide [its] residents with basic police, fire, and emergency medical services that its residents need for their basic health and safety.” It is that very apprehension about such essential, lifesaving services that has been at the heart of the municipal bankruptcy turmoil of Rhode Island’s Coventry Fire District—one of four fire districts in a municipality of 36,000 people—and where each district has its own governing authority—and where, currently, a private ambulance company had been negotiating with local officials to provide “temporary/emergency” coverage in the Coventry Fire District during its fiscal crisis—but has backed out after several of its employees threatened to resign. Kent County Superior Court Judge Brian P. Stern presided last week as the district remains essentially paralyzed—its bank account is frozen; its firefighters have not been paid for about 45 days; and Fire Board Chairman Frank Palin had contacted a private fire service, Coastline, in the event the court orders the board to hire a private ambulance company. Judge Stern has issued a stern [yes, a pun] warning that the Coventry Fire District is approaching a public safety crisis and residents could be without fire protection in the imminent future. The judge issued an order that state emergency and revenue officials be notified that fire and rescue protection might end soon.

Indeed, the district has been in crisis mode for years: In May 2013, Judge Stern had ordered the Central district liquidated after the board and the union representing firefighters failed to reach a contract agreement, directing the board to sell off property and lay off employees to pay off its debts. The board sold off equipment, shrunk staff, and closed three of five fire stations; however, before the job was completed, former Rhode Island Gov. Lincoln Chafee stepped in and appointed the first of two receivers in May of 2014 to reorganize the department, and, if deemed necessary, to take the fire district into chapter 9 municipal bankruptcy—as former Rhode Island Supreme Court Judge Robert Flanders had done after his appointment as a state Receiver with Central Falls or Chocolateville in August, 2011. Ergo, by the New Year, the Governor had named a receiver, Mark Pfeiffer, appointed by Governor Gina Raimondo, directing a municipal bankruptcy reorganization through the state Department of Revenue.

The duration, however, was short-lived: last month, Mr. Pfeiffer and state revenue officials announced they were giving up trying to reorganize in the face of fierce opposition to his proposed plans of seeking chapter 9 bankruptcy for the fire district—fiery opposition from both the town’s elected leaders and fire district’s leaders. That adamant opposition appeared to be inflamed by Mr. Pfeiffer’s proposed five-year plan of debt adjustment’s inclusion of major contract concessions from the firefighters’ union; but also its proposal of tax increases.

Thus, U.S. U.S. Bankruptcy Court Judge Diane Finkle has granted the state’s request to withdraw the Central Coventry Fire District from chapter 9 municipal bankruptcy, effectively restoring control of the district back to the district’s fire board, noting: “Face it, the taxpayers want a different model,” adding it was time for the courts to get out of the way and the parties to resolve their issues through a “political or legislative” process. Judge Finkle’s decision puts control of the fire district back into the hands of its board, some of whom have made no secret that they want more affordable fire protection and rescue services, possibly even using volunteers and private ambulance service. But how to get there is uncertain: the District’s board of directors has just a week left in which to come up with a plan and put it before district voters at an annual budget meeting on Oct. 19th: the board will have to decide if it wants to return to the idea of liquidating the district — as voters in the neighboring Coventry Fire District did recently — or negotiate another contract with local firefighters.

Ergo, with an accumulating debt to Coventry Credit Union of about $465,000, and an accrued deficit of more than $600,000, the fire district is in a fiscal Twilight Zone amid a broader governance question with regard to whether the current system of fire districts ought to be replaced by town-wide fire departments and the elimination of fire districts. Yet, to date, the Coventry Town Council has proved unwilling to become involved in the fire district’s seeming insolvency—notwithstanding its ultimate responsibility for public safety or the town’s citizen, non-binding referendum last June to liquidate the fire district. Indeed, the town’s inaction appeared to provoke, last July, a letter from the Rhode Island Department of Revenue to warn Coventry’s elected leaders, in which the acting Director wrote: “[T]he Department of Revenue is operating under the premise that the Town of Coventry will assume responsibility for the safety and well-being of its residents…We fully expect the town to be taking the necessary steps to ensure that it will be able to provide fire protection services to the area covered by the Coventry Fire District in the event the district suspends its operations.” Noting the state was ready to help under Rhode Island’s Fiscal Stability Act, which makes it clear that “any and all costs incurred pursuant to the state’s involvement under the Fiscal Stability Act become obligations that must be paid by the locality.” In fact, that appears to be part of the hot potato problem: were the town’s fire district to dissolve, the town’s taxpayers would be forced to finance their services.

In this uncertain municipal governance and fiscally distressed environment, the fire district board has one week in which to complete and present a plan to voters about how fire and rescue services will be financed and provided to residents of the district.

In a state half the size of many counties, the multiplicity of governing districts and municipalities raises grave questions of not just fiscal accountability, but also the seemingly intractable nature of the fire district’s own charter—a charter which provides that only fire district voters have the authority to determine whether and how to tax district residents – a power apparently greater than even a state-appointed receiver’s, despite legislation passed last year to clear the way. Indeed, it was just that charter provision which imposed such a wrinkle in Rhode Island’s efforts to step in: U.S. Bankruptcy Court Judge Diane Finkle last July, during a municipal bankruptcy status conference, warned that portions of the state’s proposed five-year plan of debt adjustment would likely need voter approval—especially for the last four years of the plan wherein the plan called for tax increases once the state receiver had stepped aside and decision-making powers reverted to the fire district’s board—one of four in a town of about 35,000—and one where the Coventry Town Council has repeatedly refused to extend any further fiscal assistance to the district which already is in debt to the town for $300,000.

A Steepening Road to Municipal Recovery

October 9, 2015

Steeper Road to Recovery—where failure is not an option: U.S. Bankruptcy Judge Meredith Jury yesterday warned San Bernardino that the city will have to produce much more extensive information than the 77-page disclosure statement it has submitted if it is to gain the federal court’s approval of any plan of debt adjustment—the critical hurdle if the city is to emerge from the longest municipal bankruptcy in U.S. history. For the city, which has been attempting to put together its proposed plan of debt adjustment now for a longer period than any other applicant municipality for chapter 9 bankruptcy, the stern warning comes less than a month before looming municipal elections—a hurdle itself—and increases apprehensions about the city’s ability to meet any deadlines—and at what cost. Yesterday’s hearing on the adequacy of the disclosure statement the municipality had filed unsurprisingly drew objections from the city’s multiple creditors, undoubtedly raising further questions with regard to the city’s progress. For instance, the attorney for creditor Ambac Assurance Corp., the company which is the securer for San Bernardino’s $50 million in pension municipal obligation bonds, testified in the courtroom of his apprehensions, noting: “[I]t is pretty clear the city plans to pay unsecured (creditors) the least it can get away with, not the most it can afford…They’re trying to disclose a plan that is fundamentally flawed.”

For her part, Judge Jury raised mayhap a much more fundamental apprehension: can the bankrupt city present the federal court with convincing data and information to demonstrate the city’s proposed plan of debt adjustment would ensure the city would not collapse back into a second bankruptcy in a few years, noting: “I don’t really think it’s in anybody’s objection, but the public perception — the media perception –— of the two cities with confirmed (bankruptcy exit) plans, that being Vallejo and Stockton, is that they’re already in trouble because they didn’t impair CalPERS,” referring to the decision, a proposal also made by San Bernardino, to pay every cent of what the municipality owes to the CalPERS as those costs grow. Judge Jury added: “I don’t think there is adequate discussion of how much those raises are going to be. I have heard other things, I think in this court, that it is an exponentially increasing number that will have to be paid in order to keep retirement plans intact. There comes a point where no matter what I confirm it will fail.” San Bernardino’s actuaries project as part of the bankruptcy exit plan that $29 million a year will go to CalPERS by 2023-24—or an amount more than double its current annual payment. Ergo, for Judge Jury, the grave question is from whence will cometh those funds?

Equally unsurprisingly, San Bernardino’s creditors—all of whom understand that every day further into what has become the longest municipal bankruptcy ever—recognize that each additional day without an approved plan, the less resources remain to be divvied up amongst the city’s thousands of creditors. That apprehension led the attorney for creditor EEPK, a Luxembourg-based bank, which is the holder of San Bernardino’s municipal bonds secured by Ambac, to tell Judge Jury the city needed, in its proposed plan of debt adjustment, to show the value of properties held by the city and why many of them could not be sold to pay creditors—and explain why the city was not pursuing municipal tax increases—reminding the federal court of the critical and daunting fiscal action Stockton’s leadership took to anchor not just its plan of debt adjustment, but also its long-term recovery—or, as he told the court: “The city’s explanation for why it’s not pursuing some substantial potential revenue sources which require voter approval is ‘it would be hard…’ It’s not enough, when you’re paying creditors 1 cent on the dollar, to say ‘It’s hard.’ ” It is difficult to imagine Judge Jury could have emerged from the session with much optimism; nevertheless, she obtained a commitment from the city that it would provide more comprehensive information and responses by the day before Thanksgiving—at which point creditors will respond in writing, leading to still another day—and ever mounting costs—to assess the adequacy of the financial information provided by the city. Judge Jury also informed the parties she is trying to allow San Bernardino to exit bankruptcy as soon as is prudent: “I do intend to keep this pace moving, but not at a pace that is unreasonable.”