Municipal Governance in Bankruptcy

February 16, 2016. Share on Twitter

Governance in Bankruptcy. Ronald Reagan, the former President and Governor of California, in his pre-political days, for General Electric, used to say: “Progress is our most important product.” Now, it appears, there might be some real governance progress underway in San Bernardino—perhaps presaging changes that will be critical not only to its hopes from emerging from the longest municipal bankruptcy in U.S. history, but also for realizing a sustainable fiscal future. Yesterday, a municipal committee tasked with reforming the city’s charter, made up of members whom the City Council and Mayor had appointed, provided an update on its progress toward a new charter—a key step as they are aiming at presenting final recommendations by April in order to ensure they may be put before the city’s voters in November.

In our original report on San Bernardino, we noted: “Everyone interviewed for this report made direct or indirect reference to the city charter one way or the other. And almost everyone indicated ‘I have never seen a more dysfunctional design for a city government than the provisions contained in the city charter.’ It is an understatement to say it is designed to diffuse power and prevent sound management, accountability, and transparency. It actually seems worse than the old commission form of government with all its fiefdoms. At least there you could hold a commissioner accountable. That being said, the people of the city have operated with that system for so long and they know so little about other options, that they cannot possibly understand it could be any other way. It is going to take some reformers to come along who can convince them to bring their system into the 21st (or even 20th) century. Then the political culture can start to change.”

Indeed, San Bernardino’s own, current version of its plan of debt adjustment, the committee in its written report to the City Council noted: “identified the city’s charter as a barrier to efficient, effective government, because it is overly complex, hard to understand, and contains elements that are inconsistent with best practices for modern municipal government…Subsequently, the charter committee has continued its work to develop recommendations for a new or substantially revised charter that reflects the principles of good governance and meets the needs of the community.” The draft plan notes: “the charter committee has continued its work to develop recommendations for a new or substantially revised charter that reflects the principles of good governance and meets the needs of the community.”

Nevertheless, any changes will confront challenges: it was just 14 months ago that the city’s voters rejected an earlier charter committee proposal to remove police and firefighter pay from the charter, which would have allowed those salaries to be set by negotiation, rather than a formula based on what other cities (larger municipalities with higher tax bases) pay, albeit voters did agree to a change to end the practice of paying terminated city employees while they wait for an appeal of their employment. (California law only allows changes to a municipal charter if approved by voters in a November election in an even-numbered year.) Nevertheless, there seems to be growing awareness of the need for governance change: In a survey the charter committee conducted last year, only 8% of 440 complete responses agreed that the charter should not be changed: 51% responded it should be revised; 42% said it should be replaced. For the committee members, of course, the harder question is just how voters—and leaders—believe it ought to be changed.

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The Steep Road Out of Municipal Bankruptcy

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November 9, 2015. Share on Twitter

The Steep Road out of Municipal Bankruptcy. While falling into municipal bankruptcy can be a crisis involving fiscal, stewardship, ethical, and criminal failures; getting out is the steepest road possible, because one’s city or county begins at such a disadvantage to all other cities and counties across the country. So imagine the hard choices and steps for Detroit: It is now one year since now retired U.S. Bankruptcy Judge Steven Rhodes approved the plan of debt adjustment to pave the way for Detroit to exit the largest municipal bankruptcy in the nation’s history, a year during which the unique state-foundation-city partnership forged under the aegis of Judge Rhodes and U.S. District Court Chief Judge Gerald Rosen paved the way for the Motor City to get back on its wheels. Exiting municipal bankruptcy does not, however—at a cost to the city and its taxpayers of $165 million, guarantee a fiscally sustainable future. Thus, while Detroit’s revenue streams appear on track or better than expected, progress on restructuring and restoring basic municipal services is consuming time, with some delays in key initiatives, such as hiring police officers. The city’s dysfunctional and embarrassing street-lighting system is nearly overhauled, and the greater downtown seems to be taking off with new development: it has already earned Detroit a bond rating upgrade. Detroit has replaced thousands of broken streetlights, and has sufficient funds to meet its daily bills and meet its reduced pension obligations; nevertheless, the task of trying to tear down thousands of blighted homes and commercial buildings, while improving city services—including public safety—has proven expensive. Moreover, critical issues not directly addressed by the plan of debt adjustment: fixing the city’s high poverty rate, unemployment, and poorly performing, fiscally bankrupt public schools—were largely left out of the plan; yet they represent grave threats to Detroit’s future. Nonetheless, Judge Rhodes told the Detroit News: “My impression is that the city is actually doing better at this point in time than we had projected during the bankruptcy case.”

The judicially approved plan cut more than $7 billion in unsecured municipal liabilities and provided for $1.4 billion over the next decade for basic services to rehabilitate a municipality which had suffered a severe population loss, criminal behavior by former elected leaders, and an inability to collect income taxes from both incoming and outgoing commuters. On the day the Governor’s appointed Emergency Manager Kevyn Orr dismissed the Mayor and Council, he estimated Detroit’s liabilities to be about $18 billion. Notwithstanding the erasure of so much debt, the city’s fiscal future still hangs in the balance: the road to recovery must overcome significant public school and public pension issues. To date, early returns for the investments since the city exited bankruptcy appear to be falling short: City officials and their watchdogs are already considering paying more into funds much sooner than prescribed by the city’s plan of debt adjustment, but how the city can pay is unclear. One of the most critical issues involves Detroit’s multibillion-dollar pension debt, where the plan will require the city to make a balloon pension payment, a payment estimated at more than $100 million, in 2024 alone—and that is assuming the city’s pension investments perform as anticipated. Or, as Michigan Treasurer Nick Khouri, who now chairs Detroit’s state financial oversight commission created during the bankruptcy, puts it: “We certainly know many people were hurt during the bankruptcy, but what would have been the alternative, and how would they have been hurt under the alternative?”

Detroit has benefitted too, not just from the federal judges and state leadership and investment, but also from its own business leaders: Detroit business leaders such as Dan Gilbert and Mike Ilitch are continuing to reinvest in the Motor City’s core, investing hundreds of millions of privately raised dollars to re-create neighborhoods where their employees and others can live, work, and play—investments which appear to be infecting enthusiasm from outside investors, including some of the country’s largest foundations and leading businesses, such as the Ford Foundation to JPMorgan Chase, and even India-based Sakthi Automotive. That is, there is important private investment in the Motor City’s economic and fiscal future—including some of the largest creditors during Detroit’s bankruptcy, who, nevertheless, assumed significant financial stakes in Detroit’s future by taking over city parking garages and securing redevelopment rights to landmark properties such as Joe Louis Arena. A $245-million bond offering to finance reinvestment in city services this summer came at a premium for the city, but it also benefited investment grades from rating agencies for a city once seen as earning only junk status.

A Tale of Two Cities? Nevertheless, outside of the core areas, for a physically enormous city of 139 square miles, but now with just a third of its former population, the task of recovery is bedeviled by the difficulty of focus. Indeed, as the Detroit News notes, some residents in neighborhoods have coined the phrase “Two Detroits” to describe a disconnect between the extraordinary redevelopment taking place in the city’s greater downtown core, even as in its fragile neighborhoods, the FBI reports Detroit to be one of the country’s most crime-ridden cities, despite nationally declining violent crime in 2014, according to FBI statistics. It remains a city of abandoned homes and buildings, and, as Wayne State law Professor John Mogk told the News, like the game whack-a-mole: “I think the city’s off to a very good start in removing blight, but it’s a moving target: As vacant buildings are removed, other vacant buildings crop up because of the rash of tax and mortgage foreclosures that are ongoing,” adding that the city’s high hopes of eliminating blight in as little as five years appear over-optimistic, albeit he regards a decade as more realistic. Nevertheless, that will be a challenge: Detroit is still losing population—surely, in some part—because of its separate, failing public schools. Thus, the city is still experiencing an outflow of citizens/taxpayers: the Census Bureau reported a 1 percent outflow in 2013.

Post-bankruptcy Governance. Emerging from bankruptcy is, after all, not only about restoring normalcy, but also about finding critical resources to invest in a competitive future. It is far harder to recover from than to fall into municipal bankruptcy. First, it requires restoring key municipal services: Detroit Mayor Mike Duggan reports that Detroit’s buses, for the first time in two decades, are meeting posted schedules, and that police and ambulance response times have been significantly reduced. Second, it requires constructing a fiscally sustainable future; thus, the city has begun that process by tearing down more than 7,000 blighted homes in the last year and a half; it has reversed fiscal deficits: revenues are growing: Mayor Duggan reports Detroit now expects to bring in more revenue than expected in its current fiscal year: thanks to rebounding real estate prices in neighborhoods across the city, property tax revenues are up; however, Mayor Duggan notes that income tax collections, the city’s most critical source of revenues, are coming in below projections. The Mayor notes: “We’re OK for now, but if we don’t deal with that, it will become an issue.”

Defining Fiscal Choices for the Future & Pensionary Apprehensions. Emerging from bankruptcy is about making defining choices. The centerpiece of Detroit’s plan of debt adjustment was its blueprint for the city’s future: the so-called grand bargain, an $816-million investment by the State of Michigan, some of the nation’s leading foundations, and the Detroit Institute of Arts (DIA) to preserve the city-owned art museum collection in exchange for helping to both reduce pension obligations and pay down the city’s pension debt. After emerging from the shadow of the city’s bankruptcy, the DIA hit its $100-million fund-raising goal for the grand bargain earlier this year: it is about directly confronting the long-term fiscal challenge of public pensions—that is, thinking outside the current year fiscal calendar to the issue which is vital to both a full emergence from municipal bankruptcy, but also about having a competitive workforce. For Detroit, that remains a front and center challenge: notwithstanding the concessions incorporated in the plan of debt adjustment, Detroit’s post-bankruptcy pension fund investments have performed below expectations in the first year after bankruptcy. And this is amongst the hardest of choices and responsibilities, because it requires such a disciplined, long-term commitment. Jim Spiotto, the guru of municipal bankruptcy, referring to the task before the city described the city’s approved plan of debt adjustment as “not only a grand bargain, but a grand bet,” adding that while the federally approved plan largely absolves Detroit of its obligation to pay into the pension system for a decade; nevertheless, “projecting 10 years out is quite difficult, so I think they are going to have to pay attention to that.” That is, perhaps the key inattention which contributed the most—along, of course, with criminally-related behavior by the imprisoned former mayor, now will require the most: Mayor Duggan and key city officials concur that the remaining municipal pension obligations are significant—even as early returns since the city’s emergence from bankruptcy have not been good: Detroit’s two pension funds reported rates of return on its investments of less than 4% in the first half of the year, not disproportionately from other cities and counties, but rather reflecting a poorly performing market: the Detroit General Retirement System, which covers most city retirees, posted a 2.7% return for the six months ending last June 30th, and projections are that the General Retirement System fund with a market value today of $2 billion could be worse, with a warning: It “will likely show an investment loss,” according to an actuarial report the week before last commissioned by the fund, wherein the most recent figures show the General Retirement System has a funding level of 62.5%–a level assuming the city will earn a 6.75% return on its investments in the coming decades—a likely optimistic assumption. Indeed, according to an analysis last month by the actuarial firm Gabriel Roeder Smith & Co. for the General Retirement System, if the return is lower — say 4.29%, or the equivalent of the current long-term municipal bond rate — the funding level would decline to less than 50%, a drop which could have fiscal and taxing consequences for not just Detroit’s employees, but also its taxpayers. Martha Kopacz, who analyzed the plan of debt adjustment for Judge Rhodes and serves as a member of the Detroit Financial Review Commission, is apprehensive that low public pension investment returns, especially in the early years, could mean the payments still owed by the city will have to increase when it resumes its funding of the system. Under the city’s plan of adjustment, Detroit is already obligated to pay its largest pension fund $118 million in 2024—even if the funds met projected investment returns, according to one recent pension analysis. Worryingly, as the invaluable Ms. Lopacz notes: “There was really no Plan B if it doesn’t work…People just get tired of me chirping about this, but this is a really big number.”

Can Detroit grow its way out of a pension problem? As part of Detroit’s court-approved plan of adjustment, the pension systems lowered their annual expected growth rate to 6.75% from 7.9%; yet what appeared to be a conservative adjustment might not have been sufficient: Eric Scorsone, Professor and Director of the Center for Local Government Finance at Michigan State University, worries that even that lower assumed rate of return could be a challenge to achieve: “To be quite frank (no, not a pun), what they’re using is still pretty high.” At a meeting late last month, Detroit Financial Review Commission member Darrell Burks, a former senior partner at PricewaterhouseCoopers, noted: “We need to be prepared — whatever the number is — to accept the reality that it’s going to be a substantial amount in 2024,” adding that he estimates an adjustment in the upcoming city budget “somewhere between $100 to $200 million to accommodate this problem.” Original forecasts submitted to Judge Rhodes with regard to the city’s public pension obligations showed the city paying roughly $92 million into the pension funds between now through 2024, aided in no small part by the so-called grand bargain; however, by 2024, pension payments made by the city alone could explode in subsequent decades: Detroit’s pension payments between 2024 and 2034 are expected to be roughly $1 billion, according to forecasts produced by former Detroit Emergency Manager Kevyn Orr’s staff, with the debt owed by the city remaining at about $900 million between the years FY2034 through 2044, before dropping to about $629 million, according to the 40-year projection submitted as part of the bankruptcy. As with a teeter-totter, Detroit leaders are counting on investments today to reverse the city’s population outflow and, thereby, increase its tax base—an increase which would enhance its ability to pay off its pension debt without blowing a hole in its budget.

Reversing Detroit’s Outflow & Investing in its Future: Let there be light! Indeed, the hard choices about what investments would be most critical to reversing Detroit’s out-migration which has left a smaller workforce to meet a growing number of pensioners is central to the city’s viable fiscal and sustainable future. One of Detroit’s plan of adjustment revenue-related proposals included $483 million in anticipated new municipal revenues realized from higher bus fares and improved tax collection—an improvement in part dependent upon a change in state legislation so that the city could collect income taxed owed by commuters both into the city—and residents who commute out of the city. Thus, in its plan, Detroit proposed both a $1.4-billion reinvestment initiative to rebuild the city, as well as to enhance its ability to realize some $358 million in cost savings from establishing a more efficient city government, savings which could then be translated into an addition to its reinvestment plan. But doing a 180 degree turn from disinvestment to reinvestment is a challenge: Detroit CFO John Hill notes Detroit’s municipal budgeting process is, most unsurprisingly, deliberately cautious: in the wake of its bankruptcy, that city has imposed stricter rules for each city department in order to meet financial goals. But this is a bold step and the space between cup and lip can be great: A $185-million project to overhaul and modernize the Motor City’s ancient and non-performing street-lighting system is on budget; it is ahead of schedule with more than 56,000 new LED streetlights installed of the planned 65,000, according to officials, thanks to the newly created Public Lighting Authority of Detroit. Seeing the light, many Detroiters are, unsurprisingly, pleasantly surprised: As the city’s patron saint of its exit from municipal bankruptcy, Judge Rosen, notes: “The lights are coming back on…All these new young kids moving back to Detroit, it really creates a sense of optimism and momentum.” But shedding light is, unfortunately, an achievement with consequences: it might better enable citizens and property tax payers to fret that the estimate by former Emergency Manager Orr had envisioned of as much as $500 million to battle blight over the next decade now, under the harsher light of fiscal reality, will be only what Mayor Duggan is able to snag from beyond the city’s municipal revenues. For his part, Mayor Duggan has empowered the Detroit Land Bank Authority to take the lead: the Land Bank, confronted with nearly 80,000 blighted or abandoned parcels, has auctioned and closed the sale of 527 houses to new owners and sold 2,655 vacant side lots to current homeowners, according to city figures; it has also posted 5,133 “eyesore” properties with notices of coming action and filed 3,246 lawsuits against the owners of those properties, with more than half of those cases already resolved in the city’s favor. Moreover, there has been a bonus to this hard-fought turnaround: Executive Fire Commissioner Eric Jones reports that the blight removal, to date, has been crucial to reducing the number of fires: “If you remove 7,000 blighted, vacant structures, that is fuel that arsonists don’t have to burn…it’s gone.” Nevertheless, it is a small bite of a colossal challenge: With roughly 100,000 vacant lots in the Motor City, and tens of thousands of vacant buildings, Detroit could devote years at its current stepped-up pace before ridding the city of all eyesores—years during which how to continue to finance this critical but unprecedented effort for any major American city will be harder and harder to answer.

Workforce Challenges. As if Detroit does not face enough challenges, the one it confronts with regard to labor is one of epic proportions. The revived Detroit Workforce Development Board, which convened for the first time late last month to tackle the goal of creating 100,000 jobs in the city, is working toward streamlining programs to create a systematic, unified approach to employing Detroit residents—residents who are disproportionately unskilled, underemployed, and undereducated—and where the challenge is further complicated, complex, and massive, because jobs do not match the population. Today, just over half of Detroit residents work—and of those who do, a majority have no more than a high school diploma. The future is hardly heartening: with the Detroit Public School System itself failing, it is hardly serving as a pipeline for Detroit’s future sustainability; the harsh reality for Detroit’s leaders is how to put 49,000 of its residents to work just to match the Michigan state average of labor force participation. Indeed, notwithstanding dozens of labor training programs, new business investments, jobs are not coming fast enough: Last year, Detroit had 258,807 jobs and a population of 706,663, according to an April report by the Corporation for a Skilled Workforce and funded by J.P. Morgan Chase & Co.: e.g.: only 0.37 jobs for every resident — one of the lowest levels in the country. Consultants and the expert witness U.S. Bankruptcy Judge Steven Rhodes hired to assess Detroit’s plan of debt adjustment questioned the capacity and ability of the city’s workforce to adjust, reporting that large numbers of workers and even managers lacked skills and education that would be prerequisites for their responsibilities. Detroit’s plan of adjustment calls for spending millions on training and retraining workers, in addition to an overhaul of the city’s human resources operations. That will be a critical effort: today, of the 258,807 jobs in Detroit, 71 percent are held by employees commuting from the suburbs—ergo the extraordinary situation of reverse commuting in the region—a region where there are more middle-to high-skilled jobs in the city than in the suburbs, but where the city’s work force is largely under trained and under educated: 38 percent of jobs in Detroit are considered high-skill, requiring at least an associate degree—a higher level than any of the city’s surrounding counties; but 63 percent of working Detroiters possess no more than a high school diploma, increasingly leaving city residents unqualified for jobs where they live. As Mayor Duggan told Crain’s: “What this says is that we need to do a whole lot better with our buses…We need a whole range of jobs, and what we’ve done is make it easier for business to open in the city by simplifying the permitting process.”

Trying to Put Out Fiscal Fires. As if Detroit and Mayor Duggan do not face enough superhuman trials, now chronic problems at the Detroit Fire Department are converting into higher fire insurance rates—hardly a change for a city seeking to draw in new residents—especially to a city which already has the highest rates in Michigan—and which now appear likely to rise again in the wake of a downgrade by Insurance Services Office, which analyzes and rates city and county fire protection for insurance companies—and which has downgraded Detroit, making the first change in Detroit’s rating in a quarter century—a downgrade, in effect, with immediate impacts on Detroit’s homeowners—changes in some cases of as much as 70%, with the impact of the rate change varying by agency and policy. The average premium in Detroit is about $1,700 per year, more than double the Michigan statewide average. Statewide, it was $802 in 2012, the last year records were available from the National Association of Insurance Commissioners. Eric Jones, who was confirmed last week as Fire Commissioner by the Detroit City Council, told the Detroit News that Mayor Mike Duggan is committed to improving the rating: “Clearly, Detroit was hurt by the downgrading of the status…The Mayor made it one of my highest priorities….It’s huge.” The Insurance Services Office (ISO) ranks about 48,000 municipalities across the country with regard to their ability to respond to fires — and save homes — on a scale of 1 to 10: the lower the number, the better the protection offered, noting that two decades ago, Detroit received a 2 rating, which escalated to a 4 by November of 2013. These ratings remain in place for a decade unless communities apply to the ISO to be re-evaluated—an application Commissioner Jones reports he plans to do by next year, as, in keeping with the city’s plan of debt adjustment, the city has been focused on replacing fire engines, fixing its 9-1-1 service, investing in new gear, demolishing some 7,000 vacant homes—homes which became targets for arsonists, and increased its fire department by more than 25 percent. Last year, fires caused $229 million in damage in Detroit, or nearly half the damage realized statewide, according to National Fire Incident Reporting System. Arson and burglary appear to be the two key ingredients which contribute to Detroit’s record as having the highest homeowner insurance rates in the state—but, without question, the combination of higher rates and the apprehension about arson and fire will increase the heat on the Department.

Foundation for the Future. Critical for any future for Detroit is fixing its fiscally bankrupt public school system—a challenge if the city is to have realistic hopes of drawing young families. State lawmakers and Gov. Rick Snyder are seeking to do the math and design a state financial rescue of the Detroit Public Schools by the end of this calendar year, an arithmetically $715 million state rescue of the Detroit Public Schools, but one where it is less the math, and more the politics that are proving to be an obstacle. The governance challenges involve both the fiscal costs and the governance reforms. Republican leaders are apprehensive about any proposed bailout and reforms, while Democrats oppose any bailout unless power is taken from the state-appointed emergency manager and restored to Detroit’s elected school board. Part of the challenge is any perception that a state bailout would be still another drain on the state for the City of Detroit—or, as Senate Majority Leader Arlan Meekhof (R-West Olive) perceives it, a source other than the state’s School Aid Fund, which would be drained by $50 a pupil for each of Michigan’s 1.5 million students for the next decide under Gov. Snyder’s proposed plan; whilst House Speaker Kevin Cotter (R-Mount Clemens) notes: “We want to take our time and make sure we’re doing right by them.”

Voting for a City’s Post-Bankruptcy Future. The San Bernardino Sun, in an editorial, could hardly have written it better:

“You are one of the 7,000-plus who voted in Tuesday’s election to seat four San Bernardino City Council members, we thank you. And we have a job for you. Tell your neighbors why you voted. Tell them why it matters. Tell them that while you’re happy to make decisions on their behalf, you’d rather see them disagree with you at the polls. Tell them to get involved. Three years into what is the city’s biggest crisis in a generation — municipal bankruptcy — it’s discouraging to see that so few residents took the time to choose a batch of city leaders who will be tasked with moving San Bernardino toward a more fiscally sound future. In the race for city treasurer, the only contested citywide race on Tuesday’s ballot, 7,367 votes were cast, according to unofficial election results. That amounts to slightly less than 10 percent of the city’s registered voters. There are those working to boost the city’s appalling turnout — which, by the way, is not unique. Countywide, turnout was about 10 percent Tuesday. But in a city where so much is at stake — from whether the city can afford to pay police officers to whether it can maintain public parks — it’s difficult to understand why turnout is not higher. We’re not alone in asking this question. The League of Women Voters of San Bernardino is puzzling its way through a plan to engage voters. Other groups such as Generation Now are working to get out the vote. Candidates themselves do a huge amount of networking with their supporters in trying to bring people to the polls.

And yet.

In a report on Tuesday’s dismal turnout, staff writer Ryan Hagen showed that, in the past three elections, the only one to crack the still-not-enough 25 percent turnout rate involved a controversial measure that would have changed the way the city pays its public safety employees. It also happened to coincide with the general election, a switch for San Bernardino. The city has long-held its elections for local office in odd-numbered years, as dictated by the century-old City Charter. Efforts to overhaul the charter have been met with mixed results (see the November 2014 attempt to erase the charter section outlining how the city should set salaries for certain public safety employees). But, based on recent experience, a group working to bring charter reform measures to voters may have reason to consider pushing forward with a measure to switch San Bernardino’s elections to even-numbered years, as Los Angeles has done. In the meantime, those who already know the power they wield by turning out to the polls have a few months to convince relatives, friends and neighbors in the 6th and 7th wards to take the time to vote in the February runoff. Their job is just beginning.

Waiting for Godot. Five bills which, could help avert municipal bankruptcy for Atlantic City and put it on the path to a sustainable fiscal future will become law today unless Governor and Presidential candidate Chris Christie intervenes—including a controversial plan, the Casino Property Taxation Stabilization Act (PILOT), to allow casinos to make fixed annual payments instead of highly variable property-tax payments, legislation intended to help reduce the instability and uncertainty of the city’s property-tax system—but legislation which surrounding Atlantic County’s top officials believe could do more fiscal harm than good, with Atlantic County Executive Dennis Levinson calling it “one of the worst pieces of legislation that anyone has ever seen.” The bill, if enacted, would permit casinos to stop making property-tax payments to the city; instead, they could make payments in lieu of taxes equivalent to $150 million in payments annually for two years, dropping to $120 million for each of the next 13 years. The bill, which the legislature sent to the Governor last June, along with bills to dismantle the Atlantic City Alliance, Atlantic City’s nonprofit marketing arm, and sharply reduce funding for the Casino Reinvestment Development Authority (an authority which uses casino-paid taxes to finance large local events and development projects). Under the pending state legislation, funds would be diverted from those agencies and instead go toward paying down Atlantic City’s debt and expenses. Despite how long Gov. Christie has had to react to these bills, however, he has been uncharacteristically silent. The issue of property taxes has put Atlantic City into a Twilight Zone of governance—caught between a state-appointed Emergency Manager and City Hall, but the underlying issue has been the difficulty for the city to have budgeting certainty in the wake of annual casinos court appeals over the assessed values: almost like spinning the dials, the appeals force the city not only to expend resources addressing the challenges in court, but also at risk of being mandated to make out-sized property-tax refunds to the gaming resorts—refunds in excess of $100 million, in one instance. Thus, as Assemblyman Vince Mazzeo (D-Atlantic) notes, if the PILOT becomes law, “[T]there will be no more tax appeals from the casinos.” The city is not alone in hoping the bill becomes law: the Casino Association of New Jersey, which lobbies for Atlantic City casinos, worries that more casinos will close if the bill is not enacted. New Jersey Assemblyman Chris Brown (R-Atlantic), a supporter of the legislation, told Bloomberg Atlantic City has made progress in reducing its budget, but its outstanding liabilities are still too large to convince him it will not need to increase taxes in coming years, stating he would prefer the bill to be rewritten to shorten the duration of the PILOT program and amend the formulas that determine the payment amounts, noting: “We have to find a way to stabilize property taxes for everyone in Atlantic County.”

Safeguarding a City’s Sustainable Fiscal Future. Romy Varghese, writing for Bloomberg this morning examined another peril that could lead to a fiscal drowning in Atlantic City: Even as its over reliance on casinos has imposed great fiscal risk, so too, it turns out, its public pension benefits have not exactly been fiscally lifesaving, reporting that, in what she termed: “[O]ne of those relics from the lavish and loud Prohibition-era Atlantic City depicted in television and film. Despite just a four-month beach season and a battered casino industry, lifeguards who work 20 years, the last 10 of them consecutively, still qualify at age 45 for pensions equal to half their salaries. When they die, the payments continue to their dependents. About 100 ex-lifeguards and survivors collected anywhere from $850 to $61,000 from the city’s general fund last year, according to public records. In all, it comes to $1 million this year. That’s a significant chunk of cash for a municipal government with annual revenue of about $262 million and, more importantly, it’s emblematic of the city’s broader struggle to downsize spending and contain a budget deficit that has soared as the local economy collapsed. Kevin Lavin, the emergency manager appointed by Governor Christi, has cited lifeguard pensions as a possible item for “shared sacrifice” in a community already forced to fire workers and raise taxes. Mr. Lavin is expected to report this week on the likely timetable for his report and recommendations. Mr. Varghese notes the lifesaving benefits of lifesaving in the fiscally distressed city: “About 100 ex-lifeguards and survivors collected anywhere from $850 to $61,000 from the city’s general fund last year, according to public records. In all, it comes to $1 million this year—emblematic of the city’s broader struggle to downsize spending and contain a budget deficit that has soared as the local economy collapsed.” Mr. Lavin, in his report which could be completed this week, is not expected to throw a lifeline to the retired but unretiring lifeguards, citing the lifeguard pensions as a possible item for “shared sacrifice” in a community already forced to fire workers and raise taxes. By the same token, the retired lifeguards appear unlikely to sit on their lifeguard stands and idly play their beach ukuleles whilst their pensions are floated out to sea, with one noting: We worked under the precept that we were going to get a pension, and that’s a certain amount of money…I’m not responsible for the mismanagement of the politicians, and I’m not responsible for the casinos leaving.” Or, as they might say at one of the city’s casinos” ‘A card laid, is a card played.’

Municipal Fiscal Transparency & Democracy

October 21, 2015. Share on Twitter

Municipal Fiscal Transparency in Insolvency. With municipal election day in San Bernardino less than two weeks away, Deputy City Manager Nita McKay has reported to the Mayor and Council that a critical element for the city’s municipal bankruptcy case pending before U.S. federal bankruptcy Judge Meredith Jury will be made more complete via the submission of its long-delayed audits, stating: “In meeting with the city’s auditor, Macias, Gini and O’Connell LLP (MGO), they have committed to us that they will have the fiscal year 2012-13 financial audit, including the independent auditor’s report on the assurance of whether the financial statements are free of material misstatement and whether they can be relied upon by the readers of those financial statements.” This is an older audit—long past due–of San Bernardino’s FY2012-13 financial statements—expected to be completed today and presented to the City Council and public on Monday, November 2nd—the day before the city’s voters go to the polls—an audit which could well provide important financial information not just for the city’s elected officials and candidates vying for seats on the City Council and the position of Treasurer, but also for the city’s many, many creditors in its municipal bankruptcy, its taxpayers, and voters. It will mark the first key fiscal information on the city’s finances in the wake of its filing for municipal bankruptcy in 2012—a municipal bankruptcy which has already lasted longer than any in U.S. history. The pre-election day audit release will not, however, include the way overdue FY2013-14 audit, although according to Ms. McKay, MGO will provide the Mayor, Council, and public a more detailed report a week from Monday. Ms. McKay advised the Mayor and Council the additional information could also be leading to the completion of still another important and inexplicably overdue single audit—a costly delay, because the California State Employment Development Department began, last February, withholding $125,000 a month in assistance to the city’s San Bernardino Employment and Training agency because of the city’s failure to complete its single audit report for the 2012-13 year—a report due in March of 2014. Auditor Jim Godsey, of MGO, however, appeared much less confident the single audit would be done this week; however, he said the financial statement audit likely will be completed by today, adding that he had requested additional information from City Hall in the wake of discovering that its latest response may not have answered all of MGO’s questions. Ms. McKay, who supervises the city’s finances under the city manager, told the Mayor and Council: “We provided all of the requested information…Then he (Mr. Godsey) said they sent a follow-up on questions that were still outstanding. I just received a follow-up email tonight, at 6:41 p.m., when I’m in this meeting, that they have further follow-up questions.” The back and forth has placed the city’s elected leaders-candidates in an awkward quandary with regard to how much to blame city staff and how much to blame MGO for the exceptional and costly delays.

Stay tuned: San Bernardino’s next City Council meeting falls on Monday November 2nd—the day before the city’s voters go to the polls to vote on the city’s future leadership.

The Importance of Being Earnest for a Municipality in federal Bankruptcy Court

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September 21, 2015

Don’t Count Your Marbles Before They’s Hatched. In a decision U.S. Bankruptcy Judge Meredith Jury acknowledged “puts a bunch of marbles on the road to reorganization” for San Bernardino, Judge Jury last Thursday ruled San Bernardino had not met its legal obligation to bargain with the fire union before outsourcing the Fire Department. The costly setback now means the city has an expensive pothole to repair—something which will consume both time and the city’s inadequate fiscal resources—and as the municipal election and the consequently related issues draw ever closer. San Bernardino, to comply with Judge Jury’s decision, will now have to re-open negotiations if it is to implement its proposed fire services outsourcing—a key fulcrum in its proposed plan of debt adjustment: a plan through which the city had anticipated operating and capital savings, as well as new parcel tax revenues, which would have increased annual general fund revenues by $12 million. The rocky road to exiting municipal bankruptcy also demonstrated the dysfunction created by the city’s fiscal year, throwing off the finely honed timeline under which the proposed outsourcing would have become by July 1. Missing that deadline means waiting 12 months for the beginning of the next fiscal year. If there is one fiscal ray of hope, it is that Judge Jury determined San Bernardino could continue negotiating an interim contract with the San Bernardino County fire district and working through the annexation process required by the Local Agency Formation Commission for San Bernardino County.

The legal setback for the city could make its road to exiting bankruptcy steeper, as San Bernardino’s integrity also appeared to be at risk. While Judge Jury claimed she was uninterested in assigning blame with regard to the negotiation breakdown between San Bernardino and its fire union, telling the courtroom the future should instead be the focus, she was critical of San Bernardino’s claim that it had met about fire outsourcing—a claim Judge Jury found to be contradicted by the city’s own evidence: According to a transcript of a meeting last October at which the city said it had negotiated over outsourcing, for instance, labor attorney Linda Daube and City Manager Allen Parker both say multiple times that contracting out is not part of the proposal they were discussing, with Mr. Parker, according to the transcript, stating: “I am in no position to even recommend that.” That meeting preceded last October’s imposition of new terms of employment on the city’s firefighters, terms which Judge Jury had ruled the city could implement, albeit, as she put it, she had not ruled on the specifics with regard to what the city imposed—adding that, once that happened, San Bernardino, essentially, had used up what she referred to as its “free pass” that municipal bankruptcy gave it to change contracts without going through the normally required process: “Once they have changed the terms and conditions of employment…my reading is they have created then a new status quo, and if they want to modify it further, then they have to modify it under state law, which would require bargaining with the union.”

Judge Jury further noted it was “suspect” that San Bernardino reported in September that it had authorized the city manager in an April closed session meeting to request proposals to provide fire services. But, Judge Jury, who has prior experience representing cities before becoming a judge, said that under California’s open meeting law, the Brown Act, that decision would normally be made in open session —and actions taken during closed session are usually reported publicly immediately afterward — not months later, after a litigant says authorization was never given, adding: “The timing of this is disturbing…It would appear that that (purported closed session vote) was not done, but I can’t make a finding on that today.” In the courtroom, fire union attorney Corey Glave said he might argue that San Bernardino had violated the Brown Act provision which mandates city council approval of contracts over $25,000—adding that because of that the Request for Proposals was improperly issued and would have to be discarded, he would testify at a hearing next week whether the union would pursue that argument. That created still another uh-oh moment, with Judge Jury telling the courtroom that if she agrees with that claim, it could set the city’s municipal bankruptcy case back months—meaning the prohibitively expensive municipal bankruptcy will almost certainly become the longest in American history, and leading Judge Jury to note: “I take this ruling very seriously…“I understand it has a significant impact on this case, and it’s probably the first time I’ve ruled in such a way against the city.”

Steepening Hurdles to Bankruptcy Completion. The timeline setback—and diminution of assets that might be available to be divvied up under a revised San Bernardino plan of debt adjustment can only make more miserable some of San Bernardino’s other creditors, for now the wait will not just be longer, but the assets available under any revised plan of debt adjustment are certain to be smaller. So it can hardly come as a surprise that municipal bond insurers—who now stand to be on the hook for ever increasing amounts—are objecting to San Bernardino’s just sent back to the cleaners proposed plan of debt adjustment. Paul Aronzon, of municipal bond insurer Ambac, filing for his client, wrote, referring to the pre-rejected plan of debt adjustment: “The long-awaited plan is a hodgepodge of unimpaired classes and settlements in various stages – some finalized, some announced but not yet documented, and some that are hinted at, but appear to be more aspirational than real, at this point.” Ambac could be on the hook for its insurance for some $50 million in pension obligation bonds. Fellow worrier and insurer, Erste Europäische Pfandbrief-und Kommunalkreditbank AG (EEPK) attorneys fretted too, claiming San Bernardino proposed “an incomplete set of solutions” based upon “internally inconsistent, and stale, data.” Ambac’s attorneys, referring to the now tossed out plan of debt adjustment’s proposed/anticipated savings from outsourcing fire services and other revenue sources, which the municipal bond insurers claim were not considered in calculating the impairment to the city’s pension bondholders, adding that San Bernardino had not justified the need for $185 million in capital investments to the city’s infrastructure and that the municipality had failed to include $3.9 million in income from the sale of assets to be transferred to the city from its redevelopment successor agency. But they saved their greatest vitriol to claim that the most remarkable feature of San Bernardino’s now partially rejected plan of debt adjustment came from the city’s proposed “draconian” impairment of both the pension obligation bond claims and general unsecured claims, on which the city has proposed to pay roughly 1 penny on the dollar, according to Ambac’s attorneys. EEPK’s attorneys told the federal court that if San Bernardino had utilized its ability to raise sales and use taxes or even parking taxes, it would be able to repay the city’s pension obligation debt in full, or at least substantially more than the 1 percent offered, noting that the severity of the discount warranted explanation. Nevertheless, EEPK’s attorneys added, “[N]owhere does the disclosure statement even attempt to articulate how or why the city formulated the oppressive treatment it proposes for these classes,” in urging Judge Jury to reject the plan—adding that : “In short, the city must be held to its twin burdens of both disclosure and proof that its plan endeavors to pay creditors as much as the city can reasonably afford, not as little as the city thinks it can get away with…The city can and should do better for its creditors — and indeed must do so if its plan is to be confirmed.”

Bankruptcy Protection? The Obama administration late last week urged Congress to move precipitously to address Puerto Rico’s debt crisis, with U.S. Treasury Secretary Jacob Lew stating: “Congress must act now to provide Puerto Rico with access to a restructuring regime…Without federal legislation, a resolution across Puerto Rico’s financial liabilities would likely be difficult, protracted, and costly.” The warning came in the wake of Puerto Rican elected leaders warning the U.S. territory might be insolvent by the end of the year—and with Congress only scheduled to meet for portions of eight weeks before the end of the year. In the Treasury letter to Congressional leaders, Sec. Lew appeared to hint the Administration is proposing to go beyond the municipal bankruptcy legislation proposed to date: rather, any Congressional action should, effectively, treat the Commonwealth in a manner to the way municipalities are under current federal law, so that Puerto Rico, as well as its municipalities, would be eligible to restructure through a federal, judicially overseen process—or, as Secretary Lew wrote to U.S. Sen. Judiciary Chairman Orrin Hatch (R-Utah) in July, “a central element of any federal response should include a tested legal bankruptcy regime that enables Puerto Rico to manage its financial challenges in an orderly way.”

The Rocky Fiscal Road to Recovery. Wayne County’s road to emergency fiscal recovery was helped by a Wayne County Circuit Court decision denying a request from a union representing more than 2,500 Wayne County workers to block any wage and benefit changes made under the county’s consent agreement with the state, but fiscally threatened by the County’s recent disclosure that the IRS is conducting a targeted audit of $200 million of bonds—a problem, because, as Moody’s moodily notes: the fiscally stressed largest county in Michigan could face a hard time covering the full costs of the bond payments were the bonds deemed taxable. The denial came in the wake of a Wayne Circuit Court restraining order last week to block wage and benefits changes for Wayne County Sheriff Supervisory Local 3317 union’s affiliates, last week. The decision, according to county officials, “[P]ermit Wayne County to continue its restructuring efforts and move closer to ending the financial emergency.” In its suit, the union had alleged the defendants “have illegally bound themselves by a ‘consent agreement’ with the state’s Executive Branch,” and that “protected and accrued benefits will be dramatically slashed or terminated, contrary to the U.S. Constitution.” The successful appeal comes in the wake of the county’s budget action last week to eliminate what it estimates is left of Wayne County’s $52 million structural deficit; the budget decreases Wayne’s unfunded health care liabilities by 76 percent, reduces the need to divert funds from departments to cover general fund expenditures and, mayhap most critically, creates a pathway to solvency. On the investigation front, however, the county’s recent disclosure that the IRS is conducting a targeted audit of $200 million of bonds is, according to Moody’s, not such good news; rather it is a credit blow for Wayne—to which Moody’s currently assigns the junk-rating of Ba3. The audit involves some $200 million of recovery zone economic development bonds Wayne County issued in 2010 to finance construction of a jail in downtown Detroit—a jail which has subsequently been halted amid cost overruns—and municipal bonds for which the county currently receives a federal subsidy equal to 45% of annual interest payments on the bonds. As Moody’s moodily notes: “The [IRS] examination is credit negative, because it raises the possibility that the county will have to repay $37 million of previously received subsidies and lose $41 million of subsidies over the next five years,” or, as Moody’s analyst Matthew Butler succinctly put it: “Such a loss would further strain the county’s weak but improving fiscal condition,” adding that “Due to statutory limitations on revenue raising, the county would not be able to raise revenue for the increased interest cost.” Mr. Butler gloomily added: “[M]anagement would be challenged in offsetting the loss by implementing further cuts beyond the significant operating cuts already made.” Unsurprisingly, the jail in question has its own financially sordid history: undertaken by former Wayne County Executive Robert Ficano, the fiscal undertaking had led to the indictment of Wayne County’s former CFO and two others connected to the project for misconduct and willful neglect of duty tied to the jail financing. Unsurprisingly, current Wayne County Executive Warren Evans has said that addressing the failed project is his top priority after eliminating the structural deficit. That is a fiscal blight for which successful action is important not just to Wayne County, but also for Detroit.

A Big Hill of Debt to Climb. Hillview, the Kentucky home rule-class city of just over 8,000 in Bullitt County—which filed for chapter 9 municipal bankruptcy last month—has been anticipating that Truck America LLC—the municipality’s largest creditor–would “aggressively” challenge the city’s petition—where objections must be filed by a week from Thursday—reports, according to City Attorney Tammy Baker in her discussions with the Bond Buyer, that Hillview plans no restructuring of any of its municipal bonds in its proposed plan of debt adjustment. The small municipality is on the losing side of a court judgment to Truck America for $11.4 million plus interest—a debt significantly larger than the $1.78 million it owes as part of a 2010 pool bond issued by the Kentucky Bond Corp. and $1.39 million in outstanding general obligation bonds Hillview issued in 2010. Nevertheless, City Attorney Tammy Baker advised The Bond Buyer Hillview “does not intend to restructure any of its outstanding municipal bonds through the filing.” The U.S. bankruptcy court’s acceptance of the municipality’s filing triggered the automatic stay on any city obligations, thereby protecting Hillview’s ability to retain some $3,759 in interest payments to the company which have been accruing each and every day on its outstanding trucking debt. According to the city’s filing, the judgment, plus interest totaled $15 million that is due in full—an amount equivalent to more than five times the municipality’s annual revenues. Nonetheless, Moody’s opines that Hillview could face an uphill battle in the federal bankruptcy court in convincing the court that it is insolvent and, thereby, eligible for chapter 9, because, as the credit rating agency notes: “Generally, a municipality must prove that it is not paying its debts on time or is unable to pay the obligations as they become due.” But Moody’s notes the small city could raise its property and/or business license taxes—or it could even issue more debt to finance its obligations to TruckAmerica.

The Unexpected Fiscal Challenges to Sustainability

July 16, 2015

Putting the Pieces together to Achieve Savings. U.S. Bankruptcy Judge Meredith Jury yesterday ruled that nothing in San Bernardino’s city charter prevents the city from outsourcing its Fire Department—a ruling which the city’s fire union immediately said they would appeal. Nevertheless, the decision paves the way for the city to implement its plan to achieve significant savings by replacing its firefighters—savings which, under its proposed plan of debt adjustment—could be as much as $7-$10 million annually. Judge Jury’s ruling, however, was not a carte blanche: she warned that the union’s attorneys may be able to convince her subsequently that California law requires San Bernardino to go through a formal “meet and confer” process with union officials prior to outsourcing. Indeed, the attorney for the fire union, Corey Glave, responded to Judge Jury that her decision was “not unexpected,” adding the union regarded the city’s bankruptcy case as “an anti-labor case from the beginning and it continues as such.” To which Judge Jury replied: “I don’t buy that, but go ahead.” For its part, the union is alleging that the city’s charter contains a number of provisions which mandate the municipality to have a Fire Department composed of city employees—including a 24-year old opinion from former City Attorney James Penman, who had once advised the city leaders that its charter did not permit outsourcing the police or fire departments—a piece of advice, however, countered by an opinion of current City Attorney Gary Saenz. Notwithstanding, Judge Jury noted that Mr. Saenz’s recent opinion should not be a factor: “Quite frankly, almost none…I know that case law says I’m to give them (city attorney opinions) weight unless they’re ‘clearly erroneous.’ I guess I think it’s a flawed analysis of the law (to say the charter prohibits outsourcing), and if that makes it clearly erroneous, if that’s the words I’m supposed to say, I find it clearly erroneous.” The union argued, however, that among the charter provisions are requirements mandating a fire chief and as many other employees as the city finds appropriate and outlining how city officials supervise the Fire Department—to which Judge Jury noted there was no such thing as an “implied” restriction in a city charter…Unless something is specifically prohibited by the charter, a city may do it.”

What Happens when the Money Runs Out? Melba Acosta, the President at Government Development Bank for Puerto Rico, yesterday said the bank, a financing unit of the Puerto Rican government, had failed to make a $93.7 million debt-service payment, because the Puerto Rico legislature had failed to appropriate the funds as part of the budget: “In accordance with the terms of these (municipal) bonds, the transfer was not made due to the non-appropriation of funds.” The non-payment leaves uncertain whether Puerto Rico will make a $36.3 million payment due on August 1st for bonds maturing on that date—a non-payment, were it to occur—that would mark the U.S. territory’s first default. In this instance, the Public Finance Corporation, which the government created to assist in addressing Puerto Rico’s chronic budget deficits, currently has slightly more than $1 billion in outstanding bonds—municipal bonds backed by a promise that the Puerto Rican legislature will appropriate the cash needed to pay them down—but a promise unmet—because the legislature did not appropriate the funds, or, as Ms. Acosta stated: “In accordance with the terms of these bonds, the transfer was not made due to the non-appropriation of funds.” While appropriation bonds are generally considered a weaker credit than GO bonds (full faith and credit) – especially in Puerto Rico where, in addition, these bonds are backed by an unusual constitutional promise to pay such bonds before any other expenditures. Ergo, to date, Puerto Rico has been making its scheduled payments on its $13 billion of general-obligation bonds. But with the clock ticking and the funds dwindling, Puerto Rico faces a growing list of obligations, including $276 million by the end of September to a fund which collects cash to distribute to Puerto Rico’s GO bondholders, not to mention a key payment on August 1st, when the Government Development Bank, is scheduled to repay $140 million of principal—mayhap explaining the well-financed opposition by hedge funds to any approval by Congress of legislation to allow Puerto Rico the same access to municipal bankruptcy as each state: in the past year, much of Puerto Rico’s GO debt has been acquired at deeply discounted prices by hedge funds, which stand to make a profit if other types of debt go unpaid, leaving more cash to pay the general-obligation bonds.

Might Help Be on the Way? Yesterday, Sens. Chuck Schumer (D-NY) and Richard Blumenthal (D-Conn.) introduced legislation to would allow Puerto Rico municipalities and state-owned corporations to restructure their debt under Chapter 9 municipal bankruptcy—warning that if Congress fails to act to provide the U.S. territory the authority to restructure its $73 billion in public debt, a default could trigger a humanitarian crisis, warning a shutdown of government services would risk the lives and property of the 3.5 million American citizens who live and work in Puerto Rico, with Sen. Schumer noting: “The fact of the matter is the $73 billion in debt that Puerto Rico can’t resolve could lead to a humanitarian crisis unlike any Puerto Rico has ever seen…We are talking about the potential loss of critical public services, schools shutting their doors, ultimately the shutting down of government across the island.” Thus, the Sen. told his colleagues, Congress should give Puerto Rican municipalities the ability to file for bankruptcy under Chapter 9 of the U.S. Bankruptcy Code—an option already open to cities and counties in all 50 states. Similarly, Sen. Blumenthal warned that “Failure to pay that debt without an orderly workout would in effect begin a cascading series of chaos, and litigation would ensue all around the U.S., maybe around the world, in courts throughout the states here on the mainland, as well as in Puerto Rico…Seventy percent of Puerto Rican debt is owned by people who live on the mainland…The litigation costs alone would be substantial,” adding that the cause of this looming disaster likely rests with Congress: “Congress really enabled, and perhaps encouraged, a lot of the debt that is now burdening Puerto Rico so heavily through the tax incentives that allowed businesses to move there and then move away.” Consequently, he added, Congress “has a responsibility” to make sure Puerto Rico resolves its debt. As of yesterday, seven other Senate Democrats had co-sponsored the legislation, including Senate Minority Leader Harry Reid (D-Nev.).

Essential Public Services

July 8, 2015

Essential Public Services. A key purpose of chapter 9 municipal bankruptcy is to ensure that a city or county can continue to provide essential services. While that reads well, it is more difficult in practice—so it is that in the midst of a searing drought the second of San Bernardino’s fire stations has been unstaffed since July 1st, and will likely remain unstaffed until new firefighters are available in August; similarly, the paramedics at Station 223, which had previously been “browned out,” or temporarily closed, is without city personnel, as is Station 230—which has been closed for budget reasons since last October. There are multiple constraints, including the expiration of a FEMA grant affecting 9 firefighters; the city is increasingly unable to attract new firefighters, because of its bankruptcy status, its lack of competitiveness in compensation (San Bernardino pays about 8-10 percent less than its surrounding neighbors), and its proposal in its plan of debt adjustment pending before the U.S. Bankruptcy Court to, increasingly, contract out; and the city simply lacks the fiscal resources to compete in the hiring markets. Citing a lack of stability and a perceived lack of respect from city officials, firefighters have been leaving the city in record numbers this year. In May, when 10 had left for jobs with other agencies, that was more than the previous four years combined, and more than triple the average for 2005-2014. The situation has reached what City Manager Allen Parker reports to be a situation “bordering on a crisis,” noting he understands that at one point the growing dearth of firefighters had recently forced the closure of four stations at a single time. San Bernardino currently has 20 vacancies in the Fire Department—but reports it now has 14 ready to be hired, and to commence training; yet, unsurprisingly, 9-1-1 response times remain slower than the industry standard. Response times, of course, can sometimes demarcate the difference between life and death. The dearth of firefighters is creating a separate policy issue for the City Council: which station or stations to close? Councilmember John Valdivia, who last year was outvoted when the Council provided authority for stations to be closed, believes it is unfair to always close one station, especially in this instance where he believes the station most affected happens to serve a particularly poor, minority neighborhood. The life and death choices have been further complicated by San Bernardino’s charter, which mandates that salaries for firefighters be raised to the average of 10 like-sized cities—a critical factor in the bankrupt city’s 4-3 vote Monday evening to provide an increase of $500,000 in base pay, overtime, and pension benefits. San Bernardino is trying to contract out fire services, as part of its plan of debt adjustment pending before U.S. Bankruptcy Judge Meredith Jury, claiming the move, if approved, could achieve $7 million to $10 million in savings.

Is Puerto Rico Being Held Up? A U.S. Court of Appeals yesterday rejected the U.S. Territory’s effort to overturn the lower court’s rejection of its restructuring law (Franklin California Tax-Free Trust v. Commonwealth of Puerto Rico, 15-1218, U.S. Court of Appeals for the First Circuit), adding further pressure on Congress to act on options to ensure Puerto Rico is able to continue to provide essential public services as it nears insolvency. Writing for the majority, Judge Sandra Lynch wrote: “Congress preserved to itself that power to authorize Puerto Rican municipalities to seek Chapter 9 relief.” In his concurring opinion, Judge Juan Torruella wrote there was no legislative basis for not allowing Puerto Rico public entities from seeking Chapter 9 relief: “A tracing of its travels through the halls of Congress sheds less light than a piece of coal on a moonless night regarding the reason for its enactment. Thus, the majority’s statement that ‘Congress [sought to] preserve to itself th[e] power to authorize Puerto Rican municipalities to seek Chapter 9 relief’, is pure fiction.” Nevertheless, the decision found the Puerto Rico Public Corporation Debt Enforcement and Recovery Act, enacted last year to allow the territory’s cash-strapped public utilities to restructure, is not valid and cannot be implemented because of the lack of bondholder consent, in effect giving a victory in favor of two groups of holders of nearly $2 billion of PREPA bonds — Franklin California Tax-Free Trust and BlueMountain Capital Management, with the court affirming the lower court’s holding that Puerto Rico’s recovery law violates §903(1) of the U.S. bankruptcy code, which prohibits states from passing laws that would allow their public entities to restructure without the approval of those entities’ creditors. The court, interestingly, wrote that the commonwealth is considered a state under bankruptcy law even though it was deemed ineligible for filing for bankruptcy protection under Chapter 9 in amendments to the bankruptcy code enacted in 1984. That opinion contrasted with Puerto Rico’s attorneys, who had argued that the U.S. territory is in a “no man’s land,” because it is not a state, and, therefore, ineligible for chapter 9 bankruptcy protection to ensure continuity of vital services and protection from creditors. The decision had the effect of rejecting the Puerto Rican statute which would have permitted the territory to adopt chapter 9-like provisions so that its municipalities and public agencies could seek protection from creditors. Puerto Rico Attorney General Cesar Miranda Rodriguez said Puerto Rico may appeal to the U.S. Supreme Court, noting that, in his view: “It’s arbitrary and inconceivable that Puerto Rico will be deprived of a tool that allows for an orderly negotiation of public debt.” Absent either a Supreme Court reversal or action by Congress, Puerto Rico confronts a free-for-all. In contrast, lawyers representing hedge funds and municipal bondholders claimed that Congress has not permitted Puerto Rico to create its own bankruptcy laws.

Puerto Rico & Greece: A Disparity

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July 6, 2015
Is Puerto Rico at the Tipping Point? Almost like an old hour clock, the sand is running out for Puerto Rico—defaults could occur as early as September—when an exchange of notes may be needed in order to maintain liquidity at the Government Development Bank (GDB) of Puerto Rico. With Puerto Rico running low on cash and Governor Padilla making clear the U.S. territory has no viable option but to restructure its debt, it remains to be seen if the rating agencies or other observers would see any exchange as voluntary. Last month, El Vocero reported that GDB leaders were meeting with investors about possible exchanges of up to $4 billion of GDB notes—an exchange, which, were it to happen—could avert the triggering of such note exchanges in September: the critical challenge, in effect, is to reorganize its debts without access to the U.S. Bankruptcy Courts, so Gov. Padilla has few options but to try and work with the government’s creditors. The government, in the financial report it released last week, at the end of its fiscal year, estimated it would end with a General Fund deficit between $705 million and $740 million, or 7.4 percent. Viewed from the perspective, however, of the report Gov. Padilla released last week, “Puerto Rico – A Way Forward,” which provided a far more comprehensive perspective and analysis, Puerto Rico’s General Fund government deficit in the just-ended fiscal year would be almost $2 billion—meaning the government now believes its FY2014 the General Fund ended with a $1.1 billion deficit—more than 30 percent greater than its initially announced $783 million.

An American Challenge. A swirl of events puts Puerto Rico’s looming insolvency in some context: Greek voters, by a significant margin, yesterday voted to reject the harsh conditions proposed by the European Union as a condition of a bailout. Mayhap ironically, the rejection came almost simultaneously with the award to the CEO’s of federally bailed out Fannie Mae and Freddie Mac CEO’s of annual salaries of $4 million, effective Wednesday. These two quasi federal agencies, which claim to be exempt from most state and local taxes, received a $187 billion federal bailout in 2008 to rescue them from insolvency. In contrast, of course, there has been no federal bailout of Detroit, Vallejo, Jefferson County, or Stockton—nor has one ever been contemplated for either San Bernardino or Puerto Rico. But what can strike one as perhaps odder is to contrast the significant efforts of the European union to reach out and help Greece compared to the seeming disinterest and unwillingness of the U.S. Congress to even provide a judicial process or access to a means to protect the health and safety of the U.S. citizens of Puerto Rico without any bailout. That is, while Europe is offering a conditional bailout to Greece with, admittedly, harsh terms; Puerto Rico has never requested a bailout: what it would like would be a federally, judicially overseen process to ensure continuity in its essential public services and a process overseen by a federal bankruptcy court to adjust its debts. 

Emergency Support. Gov. Rick Snyder last Thursday appointed a team to review Wayne County’s finances, a day after state officials determined the County is in probable financial distress, stating: “The individuals appointed today bring diverse and extensive experience to the review process…And given the county executive’s request for an expedited review, I have directed this review team to work as quickly and efficiently as possible, to establish a solid baseline of facts on the county’s finances and a report which we can collectively work from.” Gov. Snyder said members of the team include: Clarence Stone, director of Legal Affairs for the State Housing Development Authority; Jeffrey Bankowski, chief internal auditor, State Budget Office; Tom Davis, deputy director at the Senate Majority Policy Office; Sharon Madison, owner of design and construction firm Madison International, and Frederick Headen, legal adviser for the Michigan Department of Treasury. Mr. Headen brings experience as a former member of the financial review team for the city of Detroit that was appointed in December 2011. The review team will have up to 60 days to report to Gov. Snyder whether a financial emergency exists in Wayne County—albeit State Treasurer Nick Khouri, a member of the Local Emergency Financial Assistance Loan Board, said he expects the review to be completed within “weeks, not months.” The Michigan Board’s preliminary review found troubling conditions in Wayne, including:
• Deficits in the General Fund began in fiscal year 2008, with a deficit of $10.6 million. Without taking corrective steps, the county is projecting a $171.4 million deficit by fiscal year 2019;
• County officials had not filed an adequate or approved deficit elimination plan with the Department of Treasury since fiscal year 2010. No plan has been submitted for fiscal year 2014, which was due when the audit was submitted in March;
• During the past several years, the county’s taxable property values declined about 24 percent, reducing the amount of property taxes received. Since 2007, General Fund property tax revenues dropped more than $156 million, while total expenditures increased more than $50 million.
• The county’s primary pension plan is 45-percent funded and has a liability of $910.5 million based on the latest actuarial valuation in September 2013. In the past 10 years, the county’s underfunding of its pension plan has accelerated and its unfunded liability has increased to more than 18 times its 2004 balance.

Burning Issues in San Bernardino. The city of San Bernardino’s firefighters—even as the city is in municipal bankruptcy—are scheduled to receive a raise today—nearly a year after the city charter guaranteed it to them. The nearly $500,000 in base pay, overtime, pension, and post-retirement healthcare benefits from the bankrupt city will likely complicate the city’s trial—but reflect a separate reality: the severe drought in California and excessive heat have unleashed two major brush fires, both erupting just before the July 4th celebrations. The larger one, the Lake Fire, has consumed more than 31,000 acres in and around the San Gorgonio wilderness and southeast of Big Bear and has destroyed one home in the Burns Canyon area along with three outbuildings; the other fire threat, the Sterling Fire, came from the base of the hill east of Del Rosa Avenue in the City of San Bernardino. There is no way in putting together a plan of debt adjustment to anticipate the kinds of costly, essential services a city in bankruptcy might be called upon to provide. The fiery situation, however, is further complicated by apprehension by the city’s police union that it has still not received its COLA, which it claims is guaranteed by the same charter section (Please see box below for description of charter requirements.). Nevertheless, the City Council is not scheduled to approve that raise today. For their part, the city’s firefighters, apparently unaware of today’s council schedule, had issued a statement noting: “Judge Jury has made it clear that bankruptcy does not give city leaders license to ignore our Charter. The City’s decision to single out Firefighters for discriminatory treatment was both an inappropriate political act and a violation of law.” City Manager Allen Parker, who apparently was under the impression late last week that public safety units had already received raises, claimed the delay was another casualty of what he said was the fire union’s refusal to negotiate — a step technically required by the city’s charter. Mr. Parker added that he had forgotten about the raises until the firefighters told him at a recent meeting, adding that in most years, San Bernardino approves the salary change several months in August, and then retroactively pays the difference.

Section 186 of the city’s charter sets police and firefighter salaries as the average of 10 California cities with a population between 100,000 and 250,000. Each year, unions representing firefighters and fire management — and their counterparts in the Police Department — strike out the lowest-paying cities in the state, while city negotiators eliminate the highest-paying, until only 10 remain. In practice, that means the 10 cities represent the state average in pay for mid-sized cities. But critics of the charter section — which more than 55 percent of voters chose to retain in 2014, when presented with a ballot measure that would have set public safety salaries by collective bargaining as every other city in the state does — point out that San Bernardino, even before its bankruptcy, had median income far below the average mid-sized city. Among the 10 Southern California cities selected this year are Costa Mesa, Garden Grove, Irvine, Pasadena and Torrance. Collectively, for all of 115 of the city’s fire safety employees (firefighters, paramedic/firefighters, engineers and captains), the salary increase is nearly $258,000, and with overtime and related costs such as pension increases it adds, according to the city, $517,776 to the budget for 2014-15, the fiscal year that ended this week. The percent increase that individual employees will get varies by rank, ranging from 1.84 percent to 3.01 percent, and means monthly pay — before the overtime that tends to form a huge portion of firefighter salaries — begins at $5,679 for the least-experienced firefighters and reaches $9,349 for fire captains. That will be paid retroactively, as though it had gone into effect Aug. 1. No interest is paid.

July 2, 2015
Is Puerto Rico at the Tipping Point? Gov. Alejandro García Padilla of Puerto Rico has made clear the commonwealth cannot pay its full $72 billion in accumulated debt, a position backed up by this week’s report; rather the issue is how to come up with a credible plan to put the island’s finances and economy on sound footing, e.g. how to ensure the continuity of essential services while putting together a credible plan of debt adjustment—but, so far, without either the protection of municipal bankruptcy and its freeze of debts until such a plan is approved by a federal bankruptcy court, or any seeming possibility to come to an agreement with the island’s thousands of creditors. Thus, even though Gov. Padilla has made clear he is prepared to implement even deeper cuts in spending—on top of the 70,000 or nearly 25 percent cut in commonwealth jobs since 2009—he also recognizes that straight insolvency would have significant, life threatening consequences for thousands of his citizens. Thus, he is seeking some understanding from the commonwealth’s lenders, including mutual funds, hedge funds and other investors, to reduce the principal owed on some loans and allow more time to pay back other debts—even as it seems to have become increasingly clear that absent federal action to provide a time out in order for the island’s public corporations, such as its electric utility (PREPA) and highway authority, to restructure their $25 billion in debt in bankruptcy court (as every other corporation in the U.S. can), there is a growing risk to the Commonwealth’s future. To address its $47 billion in debt, the Gov. is asking creditors, voluntarily, to give Puerto Rico more time to pay back interest on its outstanding municipal bonds—bonds held by mutual funds and U.S. citizens in virtually every state in the U.S. With Congress not even in session this week, the Puerto Rico Electric Power Authority, PREPA, averted the most immediate fiscal threat when the public utility made its principal and interest payments on time—and reached agreement to continue negotiations with creditors to restructure its $9 billion of debt. Its bonds rallied. The utility also borrowed $128 million from bond insurers, including Assured Guaranty Ltd., with the provision that it will have to pay that debt back in December—an action that marked the first cliff and key step to avert default—and, maybe, a hint that its negotiations with its creditors may make some progress, not to mention free up some fiscal resources to modernize a public utility whose high electricity costs have left it saddled with unpaid bills. As part of the yesterday’s agreements, PREPA extended a forbearance pact with creditors until Sept. 15th, which will keep discussions out of court: that triggers a September 1st deadline by which the utility must negotiate a plan to overhaul its debts.

Help from the Capitol? Sens. Richard Blumenthal (D-Conn.) and Charles Schumer (D-N.Y) have announced they intend to introduce legislation to grant Chapter 9 bankruptcy authority to public entities in Puerto Rico—a companion bill to pending House legislation, albeit it remains somewhat uncertain whether a Senate version would be modified to give Puerto Rico itself authority to seek municipal bankruptcy. Under current law, unlike every state, Puerto Rico and other U.S. territories lack access to Chapter 9 bankruptcy authority to authorize municipalities to file for chapter 9 bankruptcy—a provision which allows a U.S. bankruptcy court to temporarily effectively freeze such city’s debt obligations to ensure that there is no interruption in essential public and life-saving services while negotiating with all its classes of creditors a plan of debt adjustment which would have to be approved by the federal court. That is, the House version of the bill would, if enacted, permit Puerto Rico to authorize its 147 municipalities access to federal bankruptcy—under whatever mechanisms the territory chose to impose, similar to the 36 states that have so acted; it would not, however, apply to Puerto Rico. Despite the introduction of the House version of the bill—introduced last February—the House Judiciary Committee has demonstrated no interest to date in acting. Its author, Rep. Pierluisi (D-P.R.) yesterday expressed his hope the bill would receive “careful consideration” in the Senate: “H.R. 870 does not require the federal government to spend a single dollar. It would simply grant the government of Puerto Rico a power that all state governments have, namely the ability to authorize one or more of its insolvent public enterprises to work out a path forward with its creditors under the supervision of a federal bankruptcy judge based on federal substantive and procedural law…It is clearly the best course of action for both Puerto Rico and its creditors. The alternative is a legal no-man’s land that benefits neither Puerto Rico nor those who have loaned the territory money.” Sen. Blumenthal responded to Politico that he and Sen. Schumer have received “strong interest” on the bill from both Democrats and Republicans. In perhaps a key change, the White House this week also expressed support for Congressional consideration of granting municipal bankruptcy authority to Puerto Rico, when White House press secretary Josh Earnest Monday told reporters there were “strong merits to having an orderly mechanism for Puerto Rico to manage the financial challenges of its public corporations if needed…We’ve urged Congress to take a close look at this particular issue…A Chapter 9 scenario that would be available to all of the 50 states is not one that’s currently available to Puerto Rico, and that’s something that only Congress can change.”

Emergency Support. Wayne County, one of the nation’s largest counties—and one which encompasses Detroit and other municipalities, as well as the insolvent Detroit Public Schools, and which is projecting a $171.4 million deficit by 2019 absent remedial actions—yesterday received some positive response to its request to the state: Michigan’s three-member Local Emergency Financial Assistance Loan Board approved a resolution of probable financial stress in Wayne County—a finding which triggers Gov. Rick Snyder’s authority to appoint a review team to take a deeper look at county finances. It could also, however, be a first step towards a state takeover or appointment of an emergency manager. The emergency loan board’s declaration is the first step in the process of declaring a financial emergency. Gov. Rick Snyder will now appoint a review team to delve deeper into the county’s finances. The team will then make a recommendation to Gov. Snyder, who will make the final decision. If the Governor agrees to declare a financial emergency, there would be four options for the county: municipal bankruptcy, and/or an emergency manager, a consent agreement, or a neutral evaluator.
The response came in the wake of County Executive Warren Evans’ request two week ago for Michigan to declare a financial emergency in the county; Executive Warren hopes to develop a consent agreement to address Wayne County’s financial crisis—a plan which would surely have repercussions for continuity in Detroit’s implementation of its federally approved plan of debt adjustment. After the Board’s unanimous vote, Michigan State Treasurer Nick Khouri noted that one of Wayne County’s biggest issues is its unfunded pension obligations, emphasizing the importance of speed in the state’s response: “The sooner we can get to solutions, the easier (it will be) for all residents of Wayne County…We want to move as quickly as we can,” adding that he thought it would be “weeks, not months,” before he is able to submit Gov. Snyder with the review team’s finding and recommendations. A spokesperson for Gov. Snyder noted: “We appreciate the hard work of County Executive Evans and his team and their seriousness and diligence in addressing some longstanding financial issues. We stand ready to work with them.” The Michigan loan board, composed of Treasurer Khouri, Mike Zimmer, director of the Michigan Department of Licensing and Regulatory Affairs, and Michigan Budget Director John Roberts, voted after a treasury official read highlights from the state’s final preliminary review report, which cited Wayne County’s unfinished jail, its $4.5 billion in long-term obligations, its failure to file an adequate deficit elimination plan since 2010, and other issues. The county is projecting a $171.4 million deficit by 2019 absent remedial actions. Both the Wayne County Commission and the County Executive’s Office were represented at the session: Dwayne Seals, Wayne’s Chief Fiscal Adviser and budget director, stressed the positives: he testified that the county deficit had increased, but at a lower rate than in the past; he added that the most current data demonstrates that the pension funding level is at 47% rather than 45%, and he predicted that the level would rise to 50% because of changes the county is undertaking—noting: “It’s a huge hole that we’re looking at, but we’re gradually climbing out of it.” Nevertheless, Jay Rising, who was representing the Snyder administration, warned id the positive changes were not “indicative” of a long-term recovery: “I think of some of these legacy cost issues are not something that can be handled without a consent agreement.”

Nevertheless, it was clear that fiscal stress also creates political and intergovernmental stress: Wayne County Commission Chairman Gary Woronchak (D-Dearborn), as he addressed commissioners during their scheduled full board meeting yesterday, noted that the commission submitted comments on the state’s interim report only a few hours before the state issued its final report of the preliminary review, but he was concerned and said that the commission felt the report contained certain financial data that was inaccurate and a “description of certain events that was, in our opinion, incomplete or mischaracterized.” Chairman Woronchak, who issued a revised estimate that the governor could declare a financial emergency within the next two weeks, took issue with claims by the state that the commission had not submitted any evidence or information, which would have caused the Treasury to amend its final report: “Rest assured,” he stated, “that if they had expressed interest in receiving ‘evidence,’ the form of our response would have been different. In any event, I strongly disagree with their conclusion, as we did our best to submit detailed financial and other information, and made extensive legal argument.” In fact, the commission took issue with several of the state’s findings, including a reference to the recent judgment levy facing county property taxpayers, noting that County Executive Evans had vetoed the commission’s attempt to pay the $49 million court judgment in a pension case without assessing the one-time tax. After the commission meeting, Commissioner Raymond Basham, D-Taylor, said that based on the speed of the review “The only way the Commission is going to have a role in this is if it’s a dinner roll.”

Rolling the Dice on a City’s Fiscal Future. Three months after an interim fiscal report urged “shared sacrifice” to turn severely fiscally distressed Atlantic City around, former (and, ergo exceptionally experienced) spokesperson for Detroit Emergency Manager Kevyn Orr, Bill Nowling—now the spokesman for Atlantic City’s emergency manager Kevin Lavin reports that all options remain on the table, noting yesterday that a negotiated solution with Atlantic City stakeholders would be the most ideal way to stabilize the city’s finances. Nevertheless, Mr. Nowling did not rule out a potential municipal bankruptcy filing as the city grapples with a $101 million budget gap, making clear that for Mr. Lavin: “All options are on the table.” Referring to Mr. Lavin’s March 22 report, which included suggestions for the city’s municipal bondholders, such as extending maturities, exploring refinancing opportunities that may reduce interest rates, and rearranging the amortization schedule of bonds to delay principal repayments—and included the appointment of mediators to work with union leadership and casino representatives on possible solutions in an effort to cut city expenses by $10 million this year, Mr. Nowling said: “The March plan the emergency manager put forward was crafted as the best way his team saw to reach a negotiated restructuring of Atlantic City’s financial issues for 2015 and beyond…A mutually agreed to resolution of the city’s financial emergency is the surest and most efficient way to long-term financial stability.” The statements and continued governance stress of having Mayor Guardian and a state-imposed emergency manager thus continues—even as Mayor Guardian and the City Council await to see if Gov. and now announced Presidential candidate Chris Christie will sign the legislation approved by the New Jersey Legislature, which Mayor Guardian cited as vital to Atlantic City’s fiscal sustainability at our session at the New York Federal Reserve, which would reallocate the casino alternative tax to pay debt service on Atlantic City-issued municipal debt: the New Jersey Legislature approved a package of bills on June 25 aimed at stabilizing Atlantic City finances that authorizes casinos to make payments in lieu of taxes over the next 15 years.