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.

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

eBlog

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.

Balancing between Sustainable Fiscal Futures & Creditors

July 15, 2015

Is Puerto Rico Being Held Up? Congressional refusal to act to permit Puerto Rico access to the U.S. courts means that it has fewer options than Greece in terms of dealing with its creditors. And not just creditors—but its own citizens and taxpayers. That is, Puerto Rico is near to entering Rod Serling’s Twilight Zone where it faces not just its many creditors without the kinds of protections granted by a U.S. bankruptcy court, but also its own citizens and taxpayers: Puerto Rico is embarking on an untraveled route where it must create a fiscal blueprint to address politics, angry creditors, and the island’s sustainable future. With default on its $72 billion debt looming, leaders from the U.S. territory met this week in New York with participant-creditors from among more than 300 representatives of institutional investment firms, hedge funds, and insurance companies—a meeting, unsurprisingly, that did little to resolve how the island could balance its obligations and public responsibility to provide essential public services versus its obligations to its creditors. This week’s meeting was an early effort to discuss options for the debt restructuring plan—or quasi plan of debt adjustment—Puerto Rico hopes to complete by the end of next month—a timeline far short of the 18 months it took Detroit to complete its plan of debt adjustment. Nevertheless, the meeting marked the first such meeting since Governor Alejandro Garcia Padilla last month issued his debt doomsday warning. With more municipal debt outstanding than any U.S. state but New York or California, the stakes and risks—especially without a referee such as a U.S. Bankruptcy judge—are unprecedented. Thus, unsurprisingly, Melba Acosta, president of the Government Development Bank, which handles Puerto Rico’s debt sales, told creditors it was “premature” to even begin to discuss which types of outstanding municipal bonds would be affected—much less how; instead, she asked for investor’s “patience while we develop a credible plan.” One can appreciate that absent a credible referee, the prospects for any orderly process on such an uncharted road are bleak: creditors or holders of Puerto Rico GO bonds have Puerto Rico’s constitutional pledge that such debt must be repaid before other expenditures, but without a judicial process, who is to judge? OppenheimerFunds Inc., the biggest mutual-fund holder of Puerto Rico debt, has already warned it is “ready to defend” its investments. What lies ahead could well be a disorderly conduct of irresolution. Moreover, this building battle will have different players: for instance, Puerto Rico’s Aqueduct and Sewer Authority is set to raise water rates and “should be able to meet its existing financial commitments without modification,” according to one advisor: that is, there are multiple classes of Puerto Rican debt at issue—and there is some recognition that every day devoted to litigation will drain not only revenues due to the islands bondholders—but also to essential public services. Puerto Rico faces a $93.7 million debt-service payment due today on its Public Finance Corp. bonds—and another $140 million on August 1st. Thus, at this week’s meeting, Puerto Rican officials devoted most of their time addressing the bleak fiscal condition of Puerto Rico’s economy and calling for drastic measures, such as cutting sick leave for local workers and lowering the minimum wage: that is, the U.S. territory is seeking to simultaneously reduce expenditures, while at the same time bolstering the economy—all in a place which today has more debt per capita than any other state. Anne O. Krueger, a former chief economist for the World Bank and co-author of the recent report on Puerto Rico’s fiscal unsustainability, told investors that the United States territory was caught in an unusual bind: it is not a struggling sovereign nation that can tap the International Monetary Fund, nor is it a state with voting members of Congress. Yet, she concluded that its economy had great potential and was entirely “underutilized.”

Recovery? Wayne County Executive Warren Evans has proposed a two-year budget—one which he believes would eliminate the county’s estimated $52-million structural deficit, noting: “The budget submitted to the (Wayne County) commission is realistic and balanced. It contains no trickery and has the support of the sheriff, prosecutor, and our department directors.” The $1.55-billion proposal for FY2016 proposes about a 10 percent reduction from this year’s: it comes with budget hearings scheduled over the next few weeks—and as a five-person review team appointed by Gov. Rick Snyder assesses whether Wayne County is in a financial emergency: if the state so finds, Wayne County could be on a path to a consent agreement, as the County Executive has sought—or, possibly, the appointment by Gov. Snyder of an emergency manager. Under a consent agreement, Mr. Evans would gain greater leverage as he negotiates for concessions from Wayne County’s unions in his efforts to implement, in effect, a voluntary “plan of debt adjustment,” or recovery plan—though which he is seeking $230 million in savings over four years. With Headlight Data yesterday reporting that Wayne County has the best manufacturing economy in the United States, the County Executive must be feeling upbeat: the new report finds that recently released data show that manufacturing job creation in 2014 across counties in the US varied from a high of 4,200 manufacturing jobs in Wayne County to a loss of 4,800 jobs in Los Angeles County: out of more than 2700 counties with data available, four counties in the Top 10 were in Michigan: Wayne, Macomb, Kent and Ottawa; three counties in the Top 10 were in California: Alameda County in San Francisco, Santa Clara County in San Jose, and San Bernardino County in Riverside. Wayne topped the list with the addition of 4,225 jobs in 2014.

Protecting the Ability to Provide Essential Public Services

eBlog

July 1, 2015

Is Puerto Rico at the Tipping Point? As Puerto Rico nears insolvency, the White House and key members of Congress, perhaps observing events in Greece, appear to recognize that any reorganization of the U.S. territory’s debt outside of the U.S. judicial system would be chaotic and prohibitively expensive. Nevertheless, with Congress in recess, some of the island’s creditors are threatening they will continue to oppose any effort by Puerto Rico to have access to federal bankruptcy courts. Oppenheimer Funds, the largest holder of Puerto Rico debt among U.S. municipal bond funds, yesterday warned Puerto Rico it stands ready to defend the terms of the municipal bonds it holds, challenging Gov. Alejandro Padilla’s proposal to begin restructuring Puerto Rico’s debt and to postpone interest payments on outstanding Puerto Rican municipal bonds. Oppenheimer’s fierce denunciation came in the wake of Gov. Padilla’s proposal Monday to create a Working Group for the Economic Recovery of Puerto Rico, led by Chief of Staff Victor Suárez, Government Development Bank President Melba Acosta, Secretary of Justice César Miranda, and the Presidents of the Senate and House, Eduardo Bhatia and Jaime Perelló: with the group charged to develop a consensus on the restructuring of Puerto Rico’s public debt—or, as Gov. Padilla put it: “The ultimate goal is a negotiated moratorium with bondholders to postpone debt payments a number of years, so that the money can be invested here in Puerto Rico.” .That is, absent the kind of neutral referee created under the U.S. bankruptcy laws and courts, chaos could reign as Gov. Padilla seeks to restructure the island’s $73 billion debt to relieve its fiscal problems. Retired U.S. Bankruptcy Judge Steven Rhodes, who presided over Detroit’s 18 month municipal bankruptcy trial before approving its unprecedented plan of debt adjustment—a plan under which Detroit’s municipal bondholders took significant reductions—and who has been retained to assist Puerto Rico as it seeks to restructure its debts in a way that preserves the island’s abilities to provide essential public services, such as 9-1-1, water, street lights, etc. yesterday told Reuters it would be impractical to expect Puerto Rico to restructure its $72 billion of obligations outside the court system: “I just don’t think that an out-of-court negotiation process is feasible here…There are too many creditors, too many different kinds of creditors. They’re all over the place,” adding Puerto Rico will need access to federal bankruptcy courts for more than just its public agencies, which would be allowed under H.R. 870, a bill introduced by Rep. Pedro Pierluisi, Puerto Rico’s non-voting member of Congress: “The commonwealth itself needs access to Chapter 9 relief as well…Puerto Rico is not a state. It’s not a sovereign in the same sense that Michigan or Pennsylvania or Illinois is. Congress has complete and plenary authority over it. Without violating any of our constitutional principles, it could grant the commonwealth that relief, if it chose.”

The U.S. House Judiciary Committee has, to date, refused to take the bill up for consideration—especially in the face of a well-financed campaign by hedge funds lobbying against any Congressional action. Support from Congressional leaders for providing Puerto Rico access to U.S. bankruptcy began to build this week, however. Sen. Charles Schumer (D-NY), the third-highest ranking Democrat will sponsor a companion of H.R. 870. In addition, Josh Earnest, a spokesman for the White House, said that Congress should “take a look” at the bill. In addition, a spokeswoman for House Minority Leader Nancy Pelosi (D-Ca.) said the legislation should be voted on when the House of Representatives returns to work later this month.

The inaction in Congress follows rejection last year by a U.S. District Court of proposed Puerto Rican legislation which would have enabled Puerto Rico’s public corporations to file for federal bankruptcy protection: U.S. District Judge Francisco A. Besosa last February held that the proposed legislation, the Public Corporation Debt Enforcement and Recovery Act, violated the U.S. Constitution in a suit brought in federal court by municipal bond funds affiliated with Franklin Resources Inc., Oppenheimer Rochester Funds, and Blue Mountain Capital Management—firms which had sued Puerto Rico, arguing the law was unconstitutional and that, if enacted, would have depressed the value of the $2 billion in Puerto Rico power utility municipal bonds they held. Puerto Rico has appealed.

Oppenheimer Funds, which has an estimated $4.5 billion exposure on municipal bonds on behalf of its clients according to Morningstar, claims it believes Puerto Rico could repay municipal bondholders even while providing essential services to its citizens and taking steps to revitalize the island’s economy, adding that it stands ready “to defend the previously agreed to terms in each and every bond indenture,”—and that it is “disheartened that Governor Padilla, in a public forum, has called for negotiations with other creditors, representing and including the millions of individual Americans that hold Puerto Rico municipal bonds.” Oppenheimer’s statement came in the wake of Gov. Padilla’s statement Monday that his goal was to come up with a negotiated moratorium with the territory’s municipal bondholders to postpone debt payments for a number of years. No doubt, the fierceness of Oppenheimer and other of the island’s municipal bondholder servicers is related to recognition that in the resolutions of plan of adjustment approvals granted by the U.S. Bankruptcy courts in the Stockton and Detroit cases, the respective cities’ municipal bondholders took very steep haircuts—an outcome that clearly affected Puerto Rican bonds yesterday, which fell sharply for the second consecutive day, with general obligation 8 percent bonds maturing in 2035 as low as $64.50 versus a low of $68.75 on Monday. A Moody’s chart reflects the significant cuts bondholders took in the Vallejo, Detroit, and Stockton chapter 9 municipal bankruptcies—as well as the reductions proposed in San Bernardino’s proposed plan of debt adjustment pending before U.S. Bankruptcy Judge Meredith Jury. Almost 10 percent of municipal bonds that traded Monday were Puerto Rico-related, according to Janney Capital Markets. A key part of the drop, no doubt, came from downgrades by S&P and Fitch, with S&P warning that a default, distressed exchange, or redemption of Puerto Rico’s debt within the next six months seemed inevitable. Nevertheless, S&P reported it expects Puerto Rico to make its scheduled payment today of $655 million on general obligation debt; while Puerto Rico’s public utility corporation, PREPA, which has a current estimated debt in the range of $9 billion, is in discussions with creditors with regard to its own $400 million payment due today. One gets an appreciation of how fiercely municipal bond funds have been opposing giving access to the federal courts by Puerto Rico or any of its 147 municipalities: U.S. open-ended municipal bond funds have $11 billion of Puerto Rico bonds and nearly 53 percent of such funds have exposure to the commonwealth—with the biggest exposure including Franklin Templeton, which already was thoroughly bloodied in the Stockton federally approved resolution to its emergence from municipal bankruptcy.

Gov. Padilla, earlier this week, in the wake of the release of the Puerto Rico “Way Forward” report, made clear the U.S. territory could not pay all of its debt, even if it took strong measures to cut spending and increase revenues: “All the measures we have taken in the last two years reflect our willingness to pay and, had we not taken them, we would not be in a position today to request restructuring…We have done all that was within our power, but, as the report makes clear, the next step must be to ensure more favorable terms for the repayment of our debt.” That same day, the redoubtable Natalie Cohen of Wells Fargo Securities noted: “I agree that Puerto Rico’s current trajectory is unsustainable and lack of immediate action will only make its situation more painful to resolve. I thought the report was balanced and shows that without action, there is a financing gap of $3.7 billion in 2016, growing substantially in future years as Affordable Care Act reductions and loss of Act 154 benefits disappear (about 20% of General Fund revenues).”

  • According to Gov. Padilla, the Working Group formed this week will create a long-term fiscal agenda by Aug. 30 aimed at:
    • Establishing the parameters for a five-year fiscal plan; proposing additional cuts in spending — including cuts in some services — to avoid an increase in taxes; * *Restructuring the Department of Treasury to increase the efficiency of income gathering;
  • promoting alliances with the private sector to provide some of the services that are today provided by the public sector, such as the successful projects like the Moscoso Bridge, the airport, and the highway to Arecibo;
  • radically changing the way in which we work with government finances and economic statistics, to establish greater transparency and credibility;
  • guaranteeing our citizens’ essential services and our pensioners a just income; [and] creating a fiscal board which, outside political considerations, will guarantee the continuity and honor of the commitments agreed upon by us during the restructuring process.
  • Seeking passage in Washington of Chapter 9 eligibility for Puerto Rico’s public corporations, a more equitable distribution of Medicare payments, and the end of the Jones Act, which increases costs of shipping to and from the island.

Retirees v. Municipal Bondholders. The incredible Boston Federal Reserve report, “Walking a Tightrope: Are U.S. State & Local Governments on a Fiscally Sustainable Path?” by Bo Shao and David Coyne came as increasing data makes clear that municipalities have never recovered in terms of employees from pre-recession levels—so there are fewer employees paying into municipal pensions—even as retirees appear to have the gall to live much longer than any previous generations: the teeter-totter is fiscally teetering. Thus, when Chicago Public School system, last week, announced it intended to issue some $1 billion in new debt to finance its $600 million-plus pension payment due yesterday; it created still another battlefront between firms like Oppenheimer and states and municipalities. It also appears to have been a key factor in Moody’s sharp downgrade of the Windy City’s credit rating—a downgrade Moody’s attributed almost entirely to Chicago’s pension issues—adding to apprehensions that should the Illinois legislature grant Chicago and other Illinois municipalities access to municipal bankruptcy, the municipalities’ constitutional and political inabilities to reign in pension liabilities could trigger future U.S. Bankruptcy court decisions that, as in Puerto Rico, would have signal repercussions for municipal bondholders. . In the bankruptcies of Detroit, Vallejo, Stockton and San Bernardino, bondholders have faced losses of up to 99% of their holdings, according to a Moody’s report dated May 18. Meanwhile all three California cities chose to preserve full pensions for their employees, while Detroit only cut pensions by approximately 18%.

The Extreme Challenges of Governance in Bankruptcy

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June 19, 2015
Visit the project blog: The Municipal Sustainability Project

Wait a Minute, Mr. Postman. In the wake of Wayne County Executive Warren Evans’ request for Michigan to declare the county in a financial emergency, Wayne County yesterday announced it would defer a $186 million note sale originally scheduled for today—a step taken so that potential investors have time to settle—and the county, which surrounds Detroit, might be able to enter into a consent agreement with the state. The sale is intended to tide over the county in order to make up for late property tax collections for its local governments. (Wayne County has 34 cities, including Detroit, and 9 townships—making it the 19th largest county in the nation.) Nevertheless, Wayne County cannot wait long: Deputy Treasurer Christa McLellan reports Wayne wants the money by the end of its fiscal year—June 30th, advising the Bond Buyer: “The request for state review will necessitate a delay in the sale of the notes which was to have taken place today, June 18,” Ms. McLellan said. “It is now expected to be rescheduled to Wednesday or Thursday of next week, in order to give investors time to digest and react to the executive’s announcement as well as understand the strengths and vitality of the delinquent tax program…Although the executive’s announcement has delayed our timing slightly, we are moving forward with a goal of closing on the notes before the end of this month.”

Getting Ready to Rumble. At the first hearing in U.S. Bankruptcy Judge Meredith Jury’s courtroom this week, the bulk of San Bernardino’s creditors were generally positive about the city’s proposed plan of debt adjustment—and how the city had finally come together to complete it. Unsurprisingly, the attorney representing San Bernardino’s municipal bondholders—creditors with some $50 million at risk—was less than enthusiastic about a plan under which, if approved by the federal court, those bondholders would receive about one penny on the dollar. The issue, very much as in Stockton’s bankruptcy case before U.S. Bankruptcy Judge Christopher Klein, will pit the city’s bondholders against almost all its other creditors—creditors in this case who generally told the federal court they respected the progress in a case that began with San Bernardino’s initial filing for chapter 9 municipal bankruptcy in August of 2013. The bondholder’s attorney charged that San Bernardino’s foot-dragging on the case had already been demonstrated by the city’s failure to propose a date for the hearing, which the attorney said would be standard practice, and he criticized the municipality for proposing a plan of debt adjustment which he noted might not work, because, he told Judge Jury, it depends on changes to the city charter that cannot be voted upon until 2016, and, it could then be rejected, testifying: “(The city’s filing) fails in our view in what was intended to be its central purpose, which was to finally move this case along…And raises once again the question of what the city has been doing for the almost three years that it has been under the protection of Chapter 9 (bankruptcy).” Democracy, of course, is quite different than a quasi-dictatorship: as we have noted, a key distinction between state laws which provide for municipal authority to seek federal bankruptcy protection, is whether such laws provide for an emergency manager or receiver, as opposed to leaving the elected leadership in place. Democracy can be messy—especially with regard to such agonizing public decisions. Indeed, interestingly, Ron Olinor, who represents the San Bernardino Police Officers Association, testified in praise of the city’s progress: “Obviously bondholders — Wall Street — don’t like the plan, and they’ll take their shots…You forced the city to move forward. They made hard decisions…I would say today is a very good day for the city and a very good day for this case.” The attorney representing a committee of retirees, Steven Katzman, also took issue with the bondholders’ attorney: “What Mr. Marriot ignores — even though I don’t think it’s the right place (to discuss it), but he brought it up…my committee has agreed to forsake $40 (million) to $50 million in health care benefits…It’s about the same amount of money that they’re owed. To say that they’re in the same place as us is sort of like saying Bill Gates and I are in the same place. They’re Bill Gates — they’re well off, they’re well-heeled — and my clients are giving up the same amount of money as his clients are.” For his part, San Bernardino City Attorney Paul Glassman testified the city’s proposed plan of debt adjustment does not depend on voters approving changes to the charter: “We’re simply talking about a reorganization that would assist the city and be viewed as helpful…We worked very hard to put together a plan that is not dependent upon an election happening.” Counselor Glassman told Judge Jury San Bernardino was operating under an interim charter agreement—a challenge to governance, and another hurdle drawing further criticism from the bondholders’ counsel, who told the court: “I don’t know how long the city can operate on a basis that’s inconsistent with its own charter.” The pension obligation bondholders are already appealing Judge Jury’s earlier decision that bondholders do not have to be paid the same as the California Public Employees’ Retirement System (CalPERS)—a replay of a similar challenge from the Stockton bankruptcy case. It appears now the next step will come next month, when Judge Jury will hear arguments about the fire union’s temporary restraining order against the city’s attempt to outsource the Fire Department—a key provision in the city’s plan of debt adjustment that could reduce its debts by as much as $7-10 million, but which the city’s fire union contends is prohibited by the city charter. Judge Jury has scheduled a hearing for October 8th to determine whether the financial disclosure statement San Bernardino filed along with its plan of debt adjustment is adequate, noting the city’s fiscal situation could change significantly by then.

The Fate of a U.S. Territory. In preparation for a possible debt crisis, Puerto Rico Gov. Alejandro García Padilla is seeking legislation to grant immunity from some lawsuits to the leadership and staff of Puerto Rico’s Government Development Bank (GDB), because, unlike the directors of most corporations and banks, the GDB’s leadership lacks immunity from lawsuits over their decisions. The proposed legislation would provide immunity to the banks’ leaders should they opt to default on particular GDB debt obligations; nevertheless, the leaders could still be sued for embezzlement or other illegal actions. There has been some apprehension that absent such legal protections, the bank’s leadership would opt to resign rather than risk liability over their decisions. With uncertainty with regard  to unlikely action by Congress to offer the U.S. territory legal options available to U.S. states, Gov. García Padilla warns that the Commonwealth is in the greatest financial crisis in its history: the timeline is shrinking, as the commonwealth, last March, issued a report saying that it might not be able to pay all obligations coming due in July and August. There is about $72 billion in public sector debt in the commonwealth. Historically, the GDB has financially supported many of the debt issuers. There are now two immunity bills in the legislature, with some hopes for progress, as one is currently in conference between the Puerto Rico House and Senate right now, and Representative Jesús Santa Rodríguez’s spokesperson reports the conference committee is on the verge of approving the measure. The action comes as the Puerto Rico House hopes to complete and send to the Senate the territory’s FY2016 budget as early as today. The last minute budget and debt negotiations come as creditors of Puerto Rico’s nearly insolvent public power utility PREPA have agreed to extend a creditor agreement to the end of the fiscal year—a key step to ensure more time for restructuring negotiations, and to protect the PREPA from default: the agreement had been scheduled to expire last night. PREPA, with about $9 billion of debt, also has a June 30 deadline by which to reach a restructuring deal with creditors—with the issue being the reaction to its proposed quasi plan of debt adjustment, which needs some $2.3 billion in investments to make its business more sustainable: its long-term prospects depend on converting a largely oil-fired generation fleet to natural gas—a key to lowering operating costs, and improving collections and increasing efficiencies, while also keeping electricity rates at the lowest possible levels to help spur economic growth. With PREPA confronting a July 1 deadline for a $400 million payment to its bondholders, creditors are questioning the proposal—with one going so far as to describe the utility’s proposal as “unworkable.”

The Intergovernmental & Governance Challenges to Municipal Sustainability

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June 18, 2015

Visit the project blog: The Municipal Sustainability Project 

S-O-S. Wayne County Executive Warren Evans yesterday, writing that “Wayne County’s fiscal situation will continue to deteriorate without further remedial measures,” requested the State of Michigan to issue, on an expedited basis, a declaration of financial emergency. Mr. Evans wrote to Michigan State Treasurer Nick Khouri to request a preliminary review and declaration of financial emergency, citing several key issues which, he wrote, “threaten the county’s ability to provide necessary governmental services essential to public health, safety, and welfare,” referring to a projection that Wayne County’s accumulated unassigned deficit would grow from $9.9 million in the current fiscal year to $171.4 million by 2019, the county’s junk bond rating, and the judgement levy this month in a pension case that will cost taxpayers an estimated $50 in a one-time property tax assessment this summer on a $100,000 house. The epistle comes in the wake of a stream of warnings Mr. Evans has provided with regard to the County’s structural deficit and its unfunded pension liability—a liability now estimated to be approaching $1 billion—and comes in the first year of neighboring Detroit’s implementation of its municipal bankruptcy plan of debt adjustment in a city where the school system is under a state-appointed emergency manager—and where there are, as we noted yesterday, questions about the state’s legal authority to impose an emergency manager. Mr. Evans, in a release subsequent to the request, reported Wayne County would continue to negotiate with stakeholders under a consent agreement: “Our recovery plan provides a clear path to financial stability for the county, but we are keenly aware that our time frame to get the job done is quickly fading…Throughout this process we are constantly evaluating where we stand and proactively seeking solutions to work ourselves out of this massive deficit. I am requesting this consent agreement because the additional authority it can provide the county may be necessary to get the job of fixing the county’s finances done.” Under Michigan’s law, the state will first determine if a preliminary review is warranted, and, if so, the Treasurer will have up to 30 days to complete a preliminary review and final report—after which the local emergency financial assistance loan board would have 20 days to determine if probable financial stress exists—a finding seemingly likely here, and one which, if made, would trigger Governor Rick Snyder’s appointment of a financial review team, which would have up to 60 days to perform a more in-depth study—a study which could result in the appointment of an emergency manager or a consent agreement or emergency manager.

Under a consent agreement, the county would retain authority to implement pieces of County leader Evans’ plans, although complicated by the existence of constitutionally mandated positions, such as the sheriff and prosecutor complicate the prospects for a workable consent agreement. A consent agreement would be designed to allow the county to maintain a level of local control while providing a plan for managing the financial crisis with state assistance. Mr. Evans said a consent agreement would allow the county to continue negotiations with stakeholders while giving the county the ability, if necessary, to find other ways to achieve cost-savings and address the county’s $52 million structural deficit — a recurring shortfall that stems from an underfunded pension system and a $100 million yearly drop in property tax revenue since 2008: “Our recovery plan provides a clear path to financial stability for the county, but we are keenly aware that our time frame to get the job done is quickly fading.”

Because Wayne County surrounds Detroit, the two municipalities are not just linked geographically, but also fiscally. It is hard to imagine what the impact of insolvency for Wayne County would mean for Detroit’s ongoing recovery and implementation of its federally approved plan of debt adjustment.

It Ain’t Over Until It’s Over. While going through municipal bankruptcy can be fiscally and governmentally draining, it turns out that emerging from municipal bankruptcy—even once a U.S. Bankruptcy Court has approved a municipality’s plan of adjustment, might not suffice. So it is that in the wake of U.S. District Judge Sharon Blackburn’s rejection last September of Jefferson County’s contention that the appeal of U.S. Bankruptcy Judge Thomas Bennett’s decision approving the county’s—at the time—exit from the largest municipal bankruptcy in U.S. history just might not prove to be the last word. In rejecting Jefferson County’s argument that the appeal was moot, Judge Blackburn also said that she would consider the constitutionality of the county’s approved adjustment plan that cedes the county’s future authority to oversee sewer rates to the federal bankruptcy court. So it was that this week. Jefferson County’s attorneys argued in the 11th U.S. Circuit Court of Appeals that investors in the financing that enabled the county to exit bankruptcy nearly two and a half years ago should not have the “rug pulled out from under them” by losing a prime security feature they relied upon in deciding to loan the county money—referring to the security feature of the federal bankruptcy court’s oversight of Jefferson County’s plan of adjustment for the 40 years that the sewer refunding warrants remain outstanding—a key provision of the county’s plan of debt adjustment. As the godfather of municipal bankruptcy, Jim Spiotto, notes, what transpires in this appeal will have broader implications for all municipal bond market investors who rely on security enhancements, such as promised rate covenants or court oversight as part of their investment decisions: “To the market, hopefully the result [of Jefferson County’s case] will be a reaffirmation that rate covenants will be and should be enforced, and if you make a promise, especially in a Chapter 9 plan, it should be enforced as any contractual promise is.” In its 93-page brief, Jefferson County attorneys requested oral arguments to examine the constitutional, statutory, and equitable principles of the case which “are particularly important to governmental entities that may consider Chapter 9 relief now or in the future, as well as to the municipal debt market.” The issue underlying the appeal centers on whether proper legal steps were taken when Jefferson County’s bankruptcy plan was appealed to the U.S. District Court in Alabama by 13 residents and elected officials on the county’s sewer system, described as the “ratepayers” in court documents, who, Jefferson County attorneys argued, had failed to obtain the required legal “stay” suspending the plan while the appeal proceeded. Without any barriers to re-enter the bond market, Jefferson County proceeded to issue $1.8 billion in sewer refunding warrants in December 2013 that allowed the county to write down $1.4 billion in related sewer debt and exit bankruptcy. With the sewer refunding warrants long since sold to new investors, the complex plan of adjustment cannot be unwound, the attorneys wrote. Mr. Spiotto notes that the issue here comes down to an interpretation with regard to what chapter 9 permits and whether the bankruptcy court’s supervision is actually the act of setting rates or insuring that the county complies with the covenants that it promised. In its petition for an appeal before the 11th Circuit, Jefferson County wrote that neither its court-approved plan of adjustment or Judge Bennett’s confirmation order “changes the substantive law of the state of Alabama with regard to the enforcement of rates established pursuant to contract or legislation…Rather, the plan merely retains the bankruptcy court as an available forum in which such substantive law may be enforced, using the same remedies available in Alabama state court…In no event will the bankruptcy court ever set sewer rates; it is simply a forum to enforce the plan and related contracts – just as an Alabama state court could.” As Mr. Spiotto notes: here, no person—or court—is attempting to usurp the right of the state or a municipality under state law: “At the same time, no state or municipality should believe that it can make a promise and not live up to it: Whether you give it as Detroit did as a statutory lien or you have the court involved there are different roads to the same summit.”

Who has standing in a municipal bankruptcy case–and whether taxpayers, citizens, citizen groups, and major businesses in a municipality should have a role e in connection with the plan of debt adjustment, was a question I posed to U.S. Bankruptcy Judge Steven Rhodes for an interview with State Tax Notes. Judge Rhodes, in his response, wrote:

  1. This is perhaps among the most difficult questions in chapter 9. One practical reality is that every resident and business in a municipality that is going through a bankruptcy case has a direct and personal stake in the outcome of the case, although that stake may or may not be a financial stake in the strictest sense. But another practical reality is that the case has to be manageable. Most cases therefore deny standing to residents, concluding that the municipality’s democratically elected leadership adequately represents the residents’ interest in the case. That was my conclusion in a previous chapter 9 case called Addison Community Hospital District.

But the question is more complex where, as in the Detroit case, the management of the case is in the hands of an un-elected agent of the state and not the municipality’s elected leadership. In the Detroit case, I decided that a looser application of the traditional standing requirements was needed and so I invited the public to participate in the eligibility and confirmation phases of the case.  I maintained the manageability of the proceeding in other, more creative ways.

I followed up: Should a debtor propose a plan of debt adjustment which requires the debtor to take action that is contrary to state law including disregarding the pledge or dedication of revenues to the debt payment required under state law? In reply to which, Judge Rhodes said: “Yes, if it is necessary to restore or maintain adequate services. Although the Fifth and Fourteen Amendments generally prohibit bankruptcy from impairing property rights, nothing in those amendments or the bankruptcy code prohibits a plan from impairing creditors’ statutory or contract rights under state law.”

The Fate of a U.S. Territory. As Congress readies a hearing next week to consider whether Puerto Rico should be eligible for statehood, pressure continues in a separate committee in the House with regard to whether Puerto Rico should have the same authority as all other states with regard to municipal bankruptcy—that is, the authority to enact legislation which would permit any of its 157 municipalities to file for federal bankruptcy protection. In the latter issue, the struggle is with regard to H.R. 870, legislation proposed by  Rep. Pedro Pierluisi (D-P.R.), which is pending before the House Judiciary Committee—and which has the strong support of Puerto Rico Gov. Alejandro García Padilla. As pending, the bill would allow nearly insolvent governmental authorities, including the islands cities to formally reorganize under U.S. Bankruptcy court supervision—if authorized by Puerto Rico. The legislation, unsurprisingly, is opposed by funds which invest in Puerto Rico bonds, including Franklin Municipal Bond Group and OppenheimerFunds, Inc.: the funds recognize that municipal bondholders—in the event of a municipal bankruptcy—are more likely than not to take a haircut. Thus, they oppose any efforts to grant Puerto Rico the same powers granted to every state, claiming the municipal bankruptcy process is filled with uncertainty. The issues are even more complex from a governance perspective, however: should the bill be amended so that Puerto Rico, itself, could seek access to chapter 9, or should the bill be adopted as proposed, authorizing Puerto Rico to consider whether its municipalities should have access to municipal bankruptcy. Gov. Padilla supports the legislation as drafted; however, municipal distress veteran and long-time specialist Dick Ravitch, who has experience not just from his leadership in averting bankruptcy for New York City in the 1970’s, but more recently during his volunteer service in Detroit’s bankruptcy, has been pressing Congress to modify the bill so that Puerto Rico would itself have access to the U.S. bankruptcy court to reorganize its own debts. Mr. Ravitch fears that the territory, because it has issued so much debt, cannot conceivably repay it all, noting: “I do not believe the economy in Puerto Rico can prosper without a significant restructuring of all the debt.” That position contrasts the veteran municipal distress expert with Rep. Pierluisi, who yesterday released a statement cautioning that Congress would not support the bill to allow the restructuring of the island’s general obligation bonds, stating: “To lobby to amend H.R. 870 to enable Puerto Rico to restructure its general obligation debt is unwise and unnecessary as a matter of public policy.” The questions and issues with regard to equitable treatment for cities in Puerto Rico comes as the House Natural Resources Subcommittee on Indian, Insular, and Alaska Native Affairs has scheduled a hearing for next Wednesday on H.R. 727, proposed legislation to provide a path to statehood for Puerto Rico: the bill would authorize a U.S. sponsored vote to be held in Puerto Rico within one year of its enactment—the gist of which would be whether or not Puerto Rico should become a state. Should that vote be authorized—and the voters in Puerto Rico approve it, then the new state would automatically gain the authority to determine whether its municipalities ought to have access to chapter 9 municipal bankruptcy. Such a decision would also eliminate any authority by Congress to determine the new state’s access to federal bankruptcy, as Puerto Rico would become a sovereign. Former Puerto Rico Gov. Luis Fortuño said the statehood bill is getting a hearing because Rep. Don Young, the Alaska Republican who chairs the panel, is a friend to Puerto Rico and remembers when Alaska was a territory prior to 1959.

Can Sharing Services Be a Linchpin to a Sustainable Fiscal Future?

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June 3, 2015
Visit the project blog: The Municipal Sustainability Project

Fire in the Hole. San Bernardino Mayor Carey Davis and Councilwoman Virginia Marquez journeyed north yesterday to Gov. Jerry Brown’s office to seek assistance on six issues important to the city’s ability to not just emerge from municipal bankruptcy, but also to be able to realize a sustainable fiscal future. The key issue was to obtain the Governor’s support for getting Cal Fire—which serves or provides contract fire services to some 150 cities, counties, and special districts in the state, including in the regions around San Bernardino, to submit a bid, noting that the sharing of such services would save taxpayers money. In addition, the Mayor and Council requested the Gov.’s assistance in reversing what the city deemed a “penalty” of $2 million imposed on the city by the California Public Retirement System (CalPERS); removing the cash hold and threat of decertification of the San Bernardino Employment and Training Agency—San Bernardino’s local workforce development organization, and a key to its plan of debt adjustment provisions for sustainability; access to the state’s California Infrastructure Bank—especially for critical seismic rehab and its recycled water project; support for pending state legislation which would permit the City, should it opt for shared fire services with San Bernardino County, to transfer the assets and liabilities associated with its CalPERS services for its fire employees; help in dissolving its former redevelopment agency; and, finally, assistance in modifications of the way Amazon is taxed, so that instead of the current method—in which Amazon e-commerce centers are effectively deemed as sited statewide, rather than in the municipality—meaning that San Bernardino, which hosts not one, but two Amazon distribution centers which comprise over 1.5 million square feet, imposing significant traffic demands, are subject only to a 1% sales and use tax—the proceeds of which are shared statewide. The San Bernardino delegation received no promises on any of the sextet of issues they raised, but appeared positive both that the Gov.’s office seemed well-briefed on the city’s issues and that the delegation will receive specific responses to the issues and concerns they raised—issued presented in their five-page letter to the Governor and their Sacramento delegation of state Senators Connie Leyva and Mike Morrell and Assembly Members Cheryl Brown and Marc Steinorth. Shared fire services has been a key issue for San Bernardino, but Cal Fire has been, to date, the most recalcitrant about engaging and has consistently rejected San Bernardino’s attempts to have the state agency prepare an estimate of what it would cost to provide fire services for the city, citing the city’s financial instability “and the difference in staffing models between Cal Fire and the City.” Thus, in their epistle, the Mayor and his fellow Councilmembers noted that elected state officials have authority over the agency and that they should insist upon a proposal. At the same time, the letter notes the city is achieving some progress: San Bernardino County and a private firm have each responded to the city’s RFP, with each response, according to the city, noting that “both indicate that significant efficiencies are available.” Because San Bernardino’s plan of adjustment submitted at the end of last week to U.S. Bankruptcy Judge Meredith Jury assumes some $7 million annually in saving through the outsourcing of fire services, one can appreciate how important the issue is. Assembly Member Steinorth (R-Rancho Cucamonga), after the meeting yesterday, noted: “The idea of the meeting today was to engage the Governor’s office and the office of the mayor and council to determine what resources are available to our city to help during this transitional period…They were very receptive, very astute. You could tell they paid very close attention. The mayor and the council members were very prepared and had all the supporting documentation to help them with their discussion and their request.”

Fighting over the Dregs

. With Congress apparently disinterested in the fiscal fate of the 3.6 million Americans living in 78 municipalities in Puerto Rico, meaning the U.S. Bankruptcy Court is unavailable to serve as an adult referee among the territory’s many, many classes of creditors; hedge funds and money managers are engaged in a growing war over the credit market’s scrap heaps. Bloomberg notes that some distressed-debt buyers are already engaging in what promises to be a trench war over the U.S. territory’s $72 billion of debt, a war which could pit investors such as Fir Tree Partners, which is among the firms which have purchased some $4.5 billion of municipal bonds—bonds which Puerto Rico must make payments on ahead of others of the territory’s debt obligations―against creditors, including Angelo Gordon & Co. and Knighthead Capital Management, who own a majority of the more than $8 billion of debt owed by the Puerto Rico Electric Power Authority (PREPA), which met with the financial adviser to its creditors Monday in an effort to restart restructuring negotiations—negotiations which could ask its bondholders to take a loss or wait longer to be repaid. According to Barclays Plc municipal-debt strategist Mikhail Foux, the island’s hedge funds now hold as much as 30 percent of the obligations of Puerto Rico and its agencies, or, as Joseph Rosenblum, director of municipal-credit research at AllianceBernstein Holding LP puts it: “It’s extremely disorderly and nasty…[this] messy approach to trying to resolve something with no clear structure or guidance doesn’t give a municipal bondholder any kind of confidence.” Bloomberg puts it concisely: “The reason so much hedge-fund money is riding on the island is simple: an increasing number of distressed-debt funds are chasing a declining number of opportunities. Little wreckage remains from the 2008 financial crisis, and six years of central-bank stimulus has kept tomorrow’s bankrupt companies flush with cash.” Ironically, two of the biggest borrowers that teetered after the financial crisis, Energy Future Holdings Corp., the Texas power producer formerly known as TXU Corp., and the main operating unit of Caesars Entertainment Corp., are now in the hands of federal bankruptcy judges—hands from which Congress has effectively barred Puerto Rico and its municipalities. Thus, with an eruption in growth of 24 new distressed-credit funds last year, the highest number since 2010, according to data provider Preqin, with total assets growing to $150.3 billion, shark hunting is under way, or, as Stephen Ketchum, chief executive officer of the $6.5 billion hedge-fund firm Sound Point Capital Management, put it: “There are not any obvious large distressed situations, such as a Caesars or a Lehman Brothers or TXU, coming down the pike…We were comparing Puerto Rico to some of the worst sovereign-debt situations in history, and it just didn’t make sense to us, especially since Puerto Rico is a U.S. territory.” Prices on Puerto Rico’s general obligation bonds plunged to as low as 55 cents on the dollar last July, according to data compiled by Bloomberg, albeit they have since rebounded to about 68 cents, while municipal bonds issued by PREPA reached 33 cents a year ago; these too have recovered to 56 cents. Angelo Gordon, Knighthead, D.E. Shaw & Co. and units of Goldman Sachs Group Inc. are among 11 firms which have agreed to delay a default on nearly $5 billion of PREPA’s debt until tomorrow—in the wake of PREPA’s Monday proposed restructuring plan—a plan some bondholders deemed a basis for further talks, while calling some aspects “unworkable.” So it is, ironically, that capital from the distressed funds or shark funds is currently the fiscal safety net offering borrowed—albeit at prohibitive rates—time in which the current government could act.

San Bernardino Prepares to Vote on a Plan of Debt Adjustment

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May 15, 2015
Visit the project blog: The Municipal Sustainability Project

Getting Ready to Rumble. San Bernardino yesterday made public its proposed plan of debt adjustment (San Bernardino Plan of Recovery) for consideration by the Mayor and Council to consider and vote upon Monday—a plan under which the city proposes to severely reduce post-retirement health care benefits, contract out for key municipal services, including fire and waste disposal, and cut by 99 percent what it will pay on its $50 million obligation to its pension obligation bondholders. Under the proposed plan, of the city’s ten classes of creditors, the draft plan proposes to make full payment to CalPERS and full payment where required by the state constitution. Notwithstanding the deep cuts in personnel already made, the draft plan proposes the elimination of an additional 250 positions, and continued deferral of $200 million in essential capital maintenance and replacement of fleet vehicles. Even then, the plan notes a structural deficit of more than $20 million would remain in the city’s general fund. According to the draft plan, about $51.7 million of the $357.9 million in potential labor savings for FY2015 through FY2034 have already been implemented through negotiations and mediation. The document reports that the city’s retirees have agreed to a settlement, under which they will pay more for retiree health care through moving to a separate healthcare plan—a move the document reports would save the city $370,000 annually beginning next year—and a change the president of the city’s retirees’ association told the San Bernardino Sun was worth it to ensure their pension benefits remained intact: “The immediate concern was the agreement that the city had with CalPERS…And the retiree association’s first priority was the preservation of our CalPERS benefits that have been earned by the retirees over the past several decades.” Under the draft plan, each of the eight groups of creditors proposed to be impaired would be entitled to vote to accept or reject the plan; nevertheless, the draft plan makes clear the city would seek to have U.S. Bankruptcy Judge Meredith Jury impose its proposed plan.
In his cover memorandum to the Mayor and Council, City Manager Allen Parker and City Attorney Gary Saenz wrote: “As the Recovery Plan makes clear, our first priority has to be the delivery of adequate municipal services…the pain will be shared among all stakeholders; employees, retirees, citizens (in the form of impaired service levels until the City can retain its footing) and capital market creditors. Only by undertaking the difficult process of refashioning the City into a modern municipal corporation can we be successful in creating a solvent future.”

The plan proposes to continue—or increase—the city’s pace of outsourcing some essential public services, to rewrite the city’s charter, as well as to continue to reduce the size of the city’s workforce, noting: “Contracting out of various services currently being provided ‘in house’ by the City is a keystone of this Plan…These include, but are not limited to, fire suppression, EMT services, and solid waste management collection/disposal.” Much of the outsourcing is proposed to begin this year, according to the draft 77-page recovery plan, including business license administration, fleet maintenance, and other services. With regard to the charter, the plan refers to the “interim charter agreement” under which city officials have already agreed to work, adding that the city expects the Council-appointed charter review committee to draft a proposed new charter and “place such proposed new Charter before the voters on the November 2016 ballot (or earlier if possible).” (In California, state law restricts proposed charter amendments to the November ballot in even-numbered years.) The forecast portion of the document forecasts that police and firefighters will continue to receive salary increases of 3 percent annually—an issue on which the city is mandated by its charter, in order to comply with the requirement to continue paying the average of what 10 like-sized cities pay for those positions. Salary compensation for non-safety employees is forecast to grow by 2 percent annually. Under the proposed plan, holders of $50 million in pension obligation bonds would receive an unsecured note and be paid based on a reduced principal of $500,000. Payments on that principal would begin in the sixth year after the Plan of Adjustment became effective. No payments would be made on bonds and certificates of participation issued in 1996 and 1999, respectively, for five years. Then, based on a new maturity date of 2035, only the interest would be paid for years six through 10, then interest and principal would be repaid through the term of the lease.

The City Council meets Monday to vote on the plan, which will be item six on its agenda: Resolution of the Mayor and Common Council of the City of San Bernardino Authorizing the Implementation of the City’s Fiscal Recovery Plan, the Filing of the Chapter 9 Plan of Adjustment and Disclosure Statement, and the Filing of Related Documents (#3853).
As San Bernardino City Attorney Gary Saenz earlier noted: “[The proposed plan] treats our citizens much better than our municipal bondholders…We expect our plan is going to provide for a substantial impairment of those (outside-the-city) groups, all for the purposes of increasing our service levels for our citizens. For each dollar we don’t pay our pension obligation bondholders, we will have a dollar to provide services.” Thus, Monday, San Bernardino elected leaders—much like their colleagues in Jefferson County, Alabama, and in Stockton—rather than a state-appointed emergency manager—will determine the fate of the proposed plan of debt adjustment—in an open and public forum―based upon a chaotic process of citizen and business impute, and strategic planning sessions by its elected leadership. There has been nothing pretty about municipal democracy, but a profound difference than preemption of local governance and accountability.

Governance Challenges. In the documents released by the city yesterday, one can appreciate the scope of the challenges—both in average per capita incomes, which mean the city has a significantly poorer tax base from which to meet mandates obligating it to pay salaries equivalent to those of its surrounding, higher per capita income jurisdictions. In addition, as the document notes, while the city’s new Charter created the position of city manager, an important step toward a council-manager form of government, the new Charter continued provisions which impede the city manager from exercising full responsibility and authority for effectively and efficiently delivering services throughout the entire city organization. Specifically, the new City Charter:

• Did not formally establish a council-manager form of government for the City of San Bernardino. Unlike many city charters, no form of government was specifically stated.

• Designated the Mayor as the chief executive officer of the City (strong Mayor), with responsibility for general supervision of the police chief and fire chief. While the city manager was designated to have day-to-day supervision of these functions, the new Charter did not achieve the objective of having a city manager position with full responsibility for managing the City.

• Maintained three separate departments under the administrative and operational direction of three advisory bodies (Component Boards) appointed by the Mayor and Common Council, not the city manager. The Mayor, however, lacks the authority to remove members from each of these boards. As a result, the water utility, library and civil service functions are not accountable to the municipal operation.

• Retained the authority of the Mayor and Common Council to appoint and remove department heads, division heads, and all unclassified City employees. Only classified employees within city manager-directed departments may be removed upon the recommendation of the city manager, without the additional required consent of the Mayor and Common Council. Due to contradictions within the Charter, it is unclear whether the city manager can remove department or division (classified employees) heads without the expressed consent of the Mayor and Common Council.

An Ill Wind in the Windy City. Following in the wake of Tuesday’s credit rating downgrade of Chicago, Standard & Poor’s yesterday dropped the city two steps (from an A+ to an A-)—and warned of possible further downgrades, but seemingly not because of any actions or inactions by the city, but rather because of the adverse fiscal impact of Moody’s downgrade, which, S&P warned, could inflict liquidity pressures on the city, in part because, under some current agreements Chicago has with some of its banking institutions, those banks could call or demand some $2.2 billion in debt repayments. S&P credit analyst Helen Samuelson noted; “The rating action reflects our view that the city’s efforts are challenged by short-term interference that prevents a solid and credible approach at this time…That said, we recognize that the city has a diverse tax base and a management team that has good policies in place,” adding that: “These are an important foundation for any city that needs to address the challenges that this city is facing.” S&P reported it expects Mayor Emanuel’s administration to address the city’s liquidity pressures, either by means of full re-negotiations or through utilizing its own internal liquidity – but warned that: “If the city does need to access its own internal liquidity, at levels we feel compromise its overall liquidity strength, this could lead to further downgrades.” The issue is that the Tuesday downgrade by Moody’s opened the door in a way that permits the city’s banks which provide credit or serve as interest-rate swap counterparties to demand repayment of $600 million in short-term credit lines, $1.1 billion in floating-rate debt and swaps, and $500 million in sewer or water related floating-rate paper and swaps. Although no such demands have been made, Chicago leaders maintain the city has the requisite liquidity and reserves necessary to cover the costs. Chicago CFO Lois Scott yesterday noted: “The city of Chicago’s financial crisis is real, urgent, and has been decades in the making…The downgrade by Moody’s of the city’s credit – a decision they say was driven by the Illinois Supreme Court’s reversal of the state pension reform bill – has substantially magnified the city’s challenges and will add real costs to Chicago’s taxpayers…Standard & Poor’s noted today that their own downgrade is driven by the short-term pressures on the city’s fiscal position that were created by Moody’s actions earlier this week. However, unlike Moody’s, S&P recognizes the City’s efforts to not only address its legacy liabilities, but that it has the right tools in place to address the challenges it faces.”

The Excruciating Choices of Municipal Bankruptcy

May 8, 2015
Visit the project blog: The Municipal Sustainability Project

Making Excruciating Choices. As San Bernardino races the clock to put together its proposed plan of debt adjustment by U.S. Bankruptcy Judge Meredith Jury’s fast approaching deadline three weeks from now, the city appears to have reached consensus to propose the elimination of retiree post-retirement health care benefits, according to an attorney involved in negotiations with city officials. The accelerated pace comes as the city is pressing to meet a deadline a week from yesterday to make public its proposed plan of debt adjustment. Steven Katzman, who represents a committee of retirees in talks with the bankrupt city, reported yesterday that a tentative agreement has been negotiated under which the city’s retirees would give up their benefits, but, as part of the agreement, receive a guarantee that San Bernardino will not reduce current pension benefits. Such an agreement would be consistent with the federally approved plans adopted by Stockton, but more generous than Detroit, where both pensions and post-retirement health care benefits were reduced. Under the potential consensus, the city would propose no reduction in its payments to its single largest creditor, the California Public Retirement System (CalPERS). The tentative agreement means retirees would move to a so-called “unblended” pool composed solely of retired workers, thereby realizing a significant increase in premiums they will owe. In addition, as part of the emerging agreement, the city would halt its current monthly subsidy of $112 San Bernardino currently provides its retirees to help with premiums, except that, under the provisional agreement, the city would continue to support a small number of older employees who are ineligible for Medicare.

The key negotiations represent a potentially significant breakthrough from negotiations behind closed doors with a committee of eight retirees, who are representing the city’s approximately 2,000 retirees. Notwithstanding the tentative agreement, these retirees, like all the city’s creditors, will be provided an opportunity to vote for or against San Bernardino’s proposed plan of debt adjustment prior to any final decision by Judge Jury. In describing the tentative agreement, Mr. Katzman noted: “The goal has been to reach a deal with the city, and the retiree committee’s recommendation is essentially to forsake health care benefits for protection of retirees’ pension benefits. The goal is to incorporate that agreement into a plan, and we are in active discussions with the city towards that objective.” Even as the tentative agreement could mark a significant milestone in San Bernardino’s goal of submitting its plan by the end of the month, other serious hurdles loom: negotiations with city firefighters, who are suing San Bernardino over contract issues, have broken down; the police union still has not signed off on parts of a potential bankruptcy agreement which would affect its affect its members, and some of the city’s municipal bondholders have sued San Bernardino over its decision to pay CalPERS in full, similar to the litigation in the wake of U.S. Judge Christopher Klein’s approval of Stockton’s plan of debt adjustment, under which Stockton chose to propose no reduction in its pension obligations to CalPERS, in effect forcing significant haircuts in its payments to bondholders—a decision consistent with San Bernardino’s position enunciated at the beginning of the year, when its city attorney told Reuters the city intends to cut its bondholder debt under the bankruptcy plan: San Bernardino has paid nothing to its bondholder creditors for nearly three years. Those bondholders include EEPK, the Luxembourg-based bank and holder of roughly $50 million in pension obligation bonds issued by San Bernardino in 2005, and Ambac Assurance Corp, which insures a portion of those bonds.

Here Come Da Judge. U.S. District Court Judge Otis D. Wright II yesterday rejected what he called “a trilogy of merit-less appeals” that the San Bernardino firefighters union had made seeking reversals of bankruptcy court decisions against them. In three opinions, Judge Wright affirmed rulings supporting the city’s position, with Judge Wright noting: “The city’s willingness to meet and compromise, and the union’s stubbornness, is quite apparent from the wealth of e-mail traffic between the parties…The union’s claim that the evidence regarding reasonable efforts is ‘scant’ is a misrepresentation of the evidence.” In harsh criticism of the union’s challenge, Judge Wright wrote that some of the union’s arguments in favor of appeal were: “vapid,” “surprisingly merit-less,” “befuddled,” and “legally unsupported and lazy.” Judge Wright’s first decision rejected the union’s appeal of Judge Meredith Jury’s decision last September to reject the city’s collective bargaining agreement with the union—a decision which paved the way for San Bernardino to impose a new contract reducing firefighter compensation; the second decision denied the fire union’s attempt to lift the stay which bars lawsuits against bankrupt entities―the union had sought to argue that the city had not complied with California state law in its negotiations. With regard to the third appeal, in which the union sought to appeal another of its motions for relief from a stay, arguing that the U.S. Bankruptcy court lacked the authority to “reinstate” a stay, Judge Wright opined the argument posed a hypothetical question which, Judge Wright noted, the court could not answer until it is determined that the automatic stay had, in fact, lapsed. Notwithstanding the trio of rejections, the San Bernardino City Professional Firefighters still have other suits pending, two filed last month alleging city officials are violating San Bernardino’s charter in an ongoing pay dispute. Indeed, with some 24 percent of San Bernardino’s general fund budget, some $28 million, currently devoted to its Fire Department, one can appreciate that the stakes for both sides are perhaps the fulcrum of any possibility for San Bernardino to either fashion a plan of debt adjustment—or to have a sustainable fiscal future. Unsurprisingly, the decisions came even as the city has continued behind closed doors this week to negotiate with three entities which could end up bidding to provide fire services for the city.

The Elephant in the Room. As noted above, San Bernardino’s emerging plan of debt adjustment will pit pensions versus bondholders—in a state, like Michigan, where the state Constitution protects contracts—but in the wake of decisions by both U.S. Bankruptcy Judges Steven Rhodes in Detroit’s bankruptcy and Judge Klein in Stockton’s case that the federal municipal bankruptcy law, chapter 9, can preempt state constitutions. The stakes are significant, as one could learn from data released yesterday by Transparent California, based upon pension data from the San Bernardino County Employees’ Retirement Association (SBCERA), which also represents employees of other state and local agencies including the South Coast Air Quality Management District, San Bernardino Superior Court, and the California Association of Counties. Transparent claims the average pension for a retired San Bernardino County employee who put in 30 or more years was $88,000 in 2014, and three retirees pull in more than $300,000 a year in benefits. Transparent California is a government watchdog organization that tracks salary and other compensation data of public employees. The watchdog group, which notes the information reflects employees who retired after working 30 or more years at their respective employers, wrote that in neighboring San Bernardino County, three retirees receive pensions topping $300,000 annually. Former County Counsel Ruth Stringer, who retired in 2010 after 33 years working for the county, receives $327,717 annually. Former Sheriff Rod Hoops, who worked 34 years with the county before retiring in 2012, receives a pension of $319,459.68. And former Undersheriff Richard Beemer, who retired in January 2010, receives $301,853.64 annually. Transparent determined that the average $88,000 pension benefit in San Bernardino County is higher than the $73,700 benefit received by Riverside County employees in 2013, and vastly higher than the $67,026 average of Los Angeles County retirees in 2014. Why does this matter to the City of San Bernardino? Cities, counties, and states compete not just with the private sector for the best employees they can hire, but they also compete against each other. But such competition is hardly equal: there are significant disparities in per capita income amongst jurisdictions in metropolitan areas. The data would seem to go a long way in explaining the very significant burden San Bernardino confronts in seeking to figure out how—in municipal bankruptcy—it can afford to provide and finance the very best emergency fire and response protection for its citizens.

Puerto Rico: A Perfect Storm. Michelle Kaske of Bloomberg puts it succinctly: “Time is running out for Puerto Rico,” writing that the U.S. Territory’s government will have to commence unpaid furloughs of its workers if it is to make a July payment on its junk-rated bonds, according to the Chairman of the House’s Treasury Committee. With a $630 million payment on its general-obligation bonds due July 1st, it appears Puerto Rico will need to start furloughing its public workers, because Puerto Rico’s constitution stipulates that revenue must first be used to repay general-obligation debt—or, as Representative Rafael “Tatito” Hernandez told Ms. Kaske in an interview: “We don’t have money in the general funds and we don’t have the financing….So we have to work with the cash flow. We have to balance the expenditures and raise a little money, with certainty. No improvising.” That is, July 1st looms large: not only is that the bond debt deadline, but also, as with most states, it is the budget deadline for its new fiscal year. Even though Treasury Secretary Juan Zaragoza reports that Puerto Rico’s July obligations “are covered” and that “We expect the commonwealth to fully pay the G.O. debt service due on July 1, since 1/12 of the payment is deposited on a monthly basis in a trustee account held with a private bank.” Nevertheless, as in Stockton—and now as emerging in San Bernardino―a struggle between the Commonwealth’s municipal bondholders scattered throughout the 50 states and its employees and retirees is front and center. Increasingly, Puerto Rico is faced with fewer alternatives but to implement unpaid furloughs for non-essential government workers and, possibly, issuing IOUs for other public employees. Ms. Kaske notes that Puerto Rico and its state agencies owe $73 billion, more than all but two U.S. states. Its unemployment rate is 11.8 percent, more than double the national average. The Government Development Bank, which lends to the commonwealth and its localities, had $1.1 billion of net liquidity as of March 31, a precipitous decline from the $2 billion it had in October. Puerto Rico’s 20-year GO bonds’ are returning an average yield of 10.45 percent, according to data compiled by Bloomberg: those precipitous yields on its municipal debt soared to 10.74 percent on Mayday after its legislature rejected Governor Alejandro Garcia Padilla’s proposed tax package. With insolvency looming, the government may need to slash spending by as much as $1.5 billion in the coming fiscal year. Rep. Hernandez notes: “We are in the middle of a perfect storm: No finance, no budget, and no revenue. And people are starting to realize what this means.”