The Importance of Property Taxes in Municipal Bankrupcy Recovery

November 11, 2015. Share on Twitter

Does the Motor City Have to Change its Property Tax? Detroit has one of the broadest tax bases of any city in the U.S.: municipal income taxes constitute the city’s largest single source, contributing about 21 percent of total revenue in 2012, or $323.5 million, the last year in which the city realized a general fund surplus. Thereafter, receipts declined each year through 2010, reflecting both a rate reduction mandated by the state and the Great Recession. But the path to municipal bankruptcy also reflected not just the significant population decline, but also the make-up of the decline: the census reported that one-third of current residents are under the poverty line and that the composition of businesses—unlike any other major city in the nation—are primarily made up of public organizations. The reduction also reflected state mandates. Only Chrysler and DTE Energy pay business taxes. Detroit’s revenues had been declining year-over-year. And, even while spending has declined, spending had exceeded revenues, on average, by more than $100 million every year since 2008. Moreover, state law prohibits cities from increasing revenues by adding a sales tax or raising residential property tax rates more than inflation. Now, having emerged from the largest municipal bankruptcy in U.S. history, Detroit is still hindered in its recovery by structural flaws in its property tax system, according to a new report published by the prestigious Lincoln Institute of Land Policy, which has reported that Detroit’s high property tax rates, delinquency problem, inaccurate assessments, and overuse of tax breaks—together with limitations imposed by the Michigan constitution and state statutes, continue to expose the post-bankruptcy city to fiscal stress, with authors Gary Sands, a professor emeritus of urban planning at Wayne State University and co-author Mark Skidmore, a visiting fellow at the Lincoln Institute and a professor of economics at Michigan State University, writing: “Property tax reform is just one of several challenges facing Detroit and its residents, but tackling it could have a real impact on the city’s economy and quality of life, and could serve as an example for other cities struggling with population and job losses and a shrinking tax base….Detroit has an opportunity to restore the basic covenant that should exist between every city and its residents — fair and efficient taxes in exchange for good public services and reliable infrastructure.” In the post-bankrupt city, where Mayor Mike Duggan has secured Council approval to lower assessments 5 percent to 20 percent in some neighborhoods, the report recommends Detroit cut its tax rate, which is the highest of any major U.S. city and more than double the average rate for neighboring cities (The rate for homeowners is 69 mills, $69 for every $1,000 of assessed value).The report, Detroit and the Property Tax: Strategies to Improve Equity and Enhance Revenue, suggests key, post-bankruptcy reforms which could help, including: improving the city’s assessment system—a pre-bankruptcy system under which significantly over-assessed properties was a key contributor to the Motor City’s exceptional property tax delinquency rate—a rate which, the report notes, has improved, yet remains still about 30 percent, or ten times the median rate for major U.S. cities—adding the city also should reconsider its property abatement practices: Detroit has granted property tax breaks to over three percent of its 11,400 private properties; yet the report notes that research shows that the fiscal benefits of abatements are often outweighed by the costs. Significantly, the authors recommended the city should implement a land-based tax, a municipal tax based purely on the value or size of a piece of land, but with no additional tax for new development or improvements—an approach favored over the traditional property tax by many economists because it discourages holding property vacant or underutilizing land, and encourages development. The report also recommends eliminate Michigan’s “taxable-value cap,” a mechanism adopted by the state’s voters in 1994 which restricts the growth of the city’s tax base as the real estate market recovers, and which, the authors warn, also provides preferential treatment to longtime homeowners, locking in low effective tax rates at the expense of new buyers. The authors finally recommend reducing the city’s statutory tax rates, noting Detroit has the highest tax rate of any major U.S. city, more than double the average rate for neighboring cities. Lowering the rate could reduce delinquency and help increase property values, and could help offset increased tax burdens that may otherwise result from reducing abatements or eliminating the taxable-value cap.

Unschooled in Pensionary Math? While fixing Detroit’s revenue and tax systems is an ongoing issue, addressing its bankrupt public school system is key to the city’s fiscal future. Yet, now that the Detroit Public Schools (DPS) has to count its pension obligations, DPS’ balance sheet, in the first set of annual financial statements since Detroit emerged from municipal bankruptcy, the system has reported a $1.66 billion net deficit—or more than double that of a year ago—a change in significant part attributed to a new line on the balance sheet: $858 million of unfunded pension liabilities—a change reported in the wake of the implementation of a new accounting law which requires shortfalls to be counted against an entity’s assets on its annual balance sheet: DPS’s pension funded ratio as of last June 30th was 66.2%, according to the document. In contrast, other parts of DPS’s finances appear to be improving: its operating deficit was $42 million, a significant drop from the previous $70 million, and DPS appears to be modestly reducing its expenditures, where figures released demonstrated a modest reduction from $887 last year to $863 million. DPS state-appointed Emergency Manager stated: “Our team is working diligently every day to become a solvent school system which will allow local control to be restored.” Nevertheless, under strong pressure from Michigan Governor Rick Snyder, the state continues to seek a fiscal sustainable solution through a potential restructuring plan which would split DPS into two divisions: one responsible for the math: financial management, and other for the arithmetic: education. Indeed, DPS remedial math is an issue: In the first set of annual financial statements since Detroit emerged from bankruptcy, the system reported a $1.66 billion net deficit—equivalent to a 118 percent increase over last year, with the increase most adversely impacted by some $858 million of unfunded pension liabilities—liabilities which the system reports issued yesterday show DPS’s pension funded ratio as of June 30, 2015, was 66.2 percent.

Betting on the Garden State? In the wake of his conditional vetoes of the New Jersey legislature’s Atlantic City relief package, Gov. and Republican Presidential contender Chris Christie yesterday vowed he would meet with state Senate President Steve Sweeney (D-Gloucester) in an effort to agree on an alternate relief package for Atlantic City—a relief package the legislature sent to him last June—with the pair rolling the dice in issuing a joint statement that they intend to “construct a final and fast (sic) resolution path for Atlantic City.” Given that his veto was not issued until the very last possible moment, it is unclear what the Governor’s concept of “fast” means, but the clock began yesterday, with the legislature’s session scheduled to end in early January. In their joint statement, they said: “We remain jointly committed to Atlantic City’s long term viability as a great resort destination for entertainment, gaming and sports…Additionally, we both now understand more clearly how challenging this revitalization will be as a result of all the hard work that ensued this past year.” The timing with regard to Gov. Christie’s commitment is further complicated by the looming $11 million debt service payment due in December—a payment which Atlantic City Revenue Director Michael Stinson said would be made even if the redirected casino funds from the conditionally vetoed bills is not approved. Atlantic City Mayor Donald Guardian, who apparently was not consulted about the Governor’s last minute vetoes, is seeking better explanations and understanding from the New Jersey Office of Community Affairs with regard to the state’s concerns—especially as the clock is ticking. Or, as Garden State Assemblyman Vince Mazzeo (D-Northfield) put it: “Since June, we’ve been hopeful that Gov. Christie would do the right thing and sign these bills without delay…These bills were designed to bring real long term sustainable reforms to Atlantic City, help stabilize the tax base and generate new investments and business opportunities in the region.”

Windy City Pension Instability. Credit rating agency Moody reports, gloomily, in a special credit report, that Chicago’s unfunded pension obligations could continue to grow for at least the next decade, notwithstanding the record property tax that Mayor Rahm Emanuel secured from the City Council for the city’s public safety pension funds—and even assuming Chicago is successful in its pending legal challenges. The city’s general obligation bond ratings have steadily dropped in large part due to its accumulation of some $20 billion in unfunded liabilities, with the steep path down accelerating last spring when the rating agency dropped Chicago’s investment grade rating and issued a negative outlook. Moody analyst Matthew Butler noted: “The analysis indicates that, despite significantly increasing its contributions to its pension plans, Chicago’s unfunded pension liabilities could grow, at a minimum, for another ten years…Chicago’s statutory pension contributions will remain insufficient to arrest growth in unfunded pension liabilities for many years under each scenario,” adding that growth in the city’s unfunded liabilities and pension costs will continue “for some time regardless of the outcomes of the state’s and court’s decisions.” The credit report setback comes despite the record tax hike—a hike committed to the city’s proposed re-amortization of the schedule to implement increases in public safety pension contributions under a 2010 Illinois state mandate to fund them on an actuarial basis. Moreover, while the state legislature has passed and sent that re-amortization proposal to the Governor—a proposal which would delay the Chicago’s shift to an actuarially required contribution payment, that bill has become part of the accumulating morass caught up in Illinois’ dysfunctional ability to adopt its FY2016 budget—an inaction which is only driving up Chicago’s liabilities more, even as it prepares for a showdown before the Illinois Supreme Court next week over pension reforms approved for its municipal and laborers’ funds in Public Act 98-0641 to preserve and protect the funds’ solvency—a showdown which is an effort to overturn the lower court’s decision that the reforms violated Illinois’ constitution. A lower court judge in July voided the reforms, finding benefit cuts violated the state constitution. Yet even a win with the Supremes, Moody testily noted, despite being a “credit positive,” would still fail to address what the rating agency termed its “expectation of future growth in unfunded liabilities and the associated credit risk.” In response to the report, the city said: “Mayor Emanuel is committed to ensuring that city employees and retirees have a pension to turn to. Both SB777 and SB1922 were passed after successful discussions with the impacted unions, securing the retirements of our employees and retirees without burdening taxpayers with unsustainable pension contributions…These pension reform plans are sensible and represent a shared path forward in addressing the pension challenges that threaten Chicago’s future, while reducing the impact on taxpayers, and as Moody’s accurately states, the passage of SB777 and upholding of SB1922 are credit positives for the city.”

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The Steep Road Out of Municipal Bankruptcy

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November 9, 2015. Share on Twitter

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

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

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

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

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

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

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

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

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

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

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

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

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

And yet.

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

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

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

Avoiding Municipal Insolvency, Except as a Last Resort

October 20, 2015. Share on Twitter

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

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

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

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

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

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

Ethics & Their Role in Municipal Fiscal Distress

October 15, 2015. Share on Twitter

Unravelling SWAPs & Paying the Windy City’s Pipers. In a new report, the Chicago Civic Federation rendered its support for Mayor Rahm Emanuel’s City of Chicago proposed FY2016 budget of $7.8 billion—applauding the Mayor’s proposals to take on the Windy City’s public safety pension funding crisis, but expressing apprehension that perhaps the largest municipal property tax increase in U.S. history, by itself, might be insufficient to stabilize Chicago finances, especially given continued legal uncertainty with regard to the city’s public pension and retiree health care reforms. The big kahuna in the Mayor’s proposed FY2016 budget is a $1.26 billion property tax levy, an increase of more than 33% from the originally adopted FY2015 budget, rising in subsequent years to $544.2 million between FY2015 (payable in 2016) and FY2018 (payable in 2019) with those proceeds dedicated entirely to fund the city’s Police and Fire pension funds, with the always insightful federation leader Laurence Msall noting: “Mayor Emanuel and his team deserve credit for transparently outlining a plan to address one of the City’s most urgent financial crises,” adding, however, that “[G]reater sacrifice will be needed to address the pension funding crises for non-public safety funds, the liquidity crises at Chicago Public Schools (please see below for the criminal, ethical, and fiscal challenges to CPS), and Chicago’s ongoing structural deficit, urging the city to consider greater cost savings and efficiencies, “especially in public safety operations that have largely avoided budgetary scrutiny in recent years.” Mr. Msall noted that the Mayor’s FY’2016 budget reduces Chicago’s reliance on what the Federation terms “scoop and toss,” or what he notes is “an expensive practice which extends the life of existing [municipal] bonds and dramatically increases the cost of providing government services—” a practice Mayor Emanuel pledged to the Association he would phase out by FY2019, beginning with a $100 million reduction in FY2016. {Please note next item, “Gambling,” with regard to this prohibitive municipal finance process.] Nevertheless, Mr. Msall expressed apprehension with regard to the as yet unreleased portion of the city’s proposed budget on its plans for how to fund two significant potential expenses in its upcoming fiscal year: an additional $220 million pension contribution and an increase in retiree health care costs. In its proposal, the city’s budget assumes the state will act to adopt the Mayor’s proposed changes to the City’s pension funding schedule. Indeed, such legislation has passed both houses of the Illinois legislature; however, the bill has not been released for Governor Rauner’s signature, nor has Gov. Rauner indicated that he will sign it: without such a signature Chicago will be required to contribute an additional $220 million to its pension funds in the new fiscal year. Moreover, the city still faces uncertainty with regard to the ongoing litigation over its proposed phase-out of its retiree health care benefits—where an adverse court ruling could significantly increase retiree health care costs.

Gambling on a City’s Future. At the exceptional conference, Bankruptcy and Beyond, hosted by Professor Juliet Moringiello of the Widener Law School in Harrisburg, Pennsylvania last year, there was substantive focus on the dangers of municipal involvement with so-called swaps—or municipal instruments packaged by Wall Street to make bets on interest rates—bets which Bloomberg this week insightfully noted are “costing [Chicago] taxpayers at least $270 million since Moody’s Investors Service cut its rating to junk in May,” noting that while traditionally, the exchange of one kind of municipal security for another to change the maturity (bonds), quality of issues (stocks or bonds), or because investment objectives have changed has been a more or less regular practice—one which has left all too many municipalities susceptible to significant fees and risk; more recently, so-called swaps have expanded to include currency and interest rate swaps—all leading to increased payouts to Wall Street banks, but coming, as noted above, as the Windy City considers a record tax increase to cover its public pension liabilities—swap costs in this case that are more than the city spends annually for the collection of garbage at 613,000 homes, or the equivalent of hiring more than 2,000 police officers. And that is before the city is forced to pay the piper to unwind municipal derivatives as it considers still another round of municipal debt restructuring—a round which could cost the debt-stressed city $110 million to unwind derivatives on its water debt—or, as the ever prescient Richard Ciccarone, the CEO of Merritt Research Services: “I don’t think the public should be gambling with its funds…Save the speculation for people who risk their own money, not for taxpayers.” Indeed, as can be seen from Bloomberg’s chart, Chicago confronts enormous debts to banks—not to teach in its troubled schools or to protect it citizens, but almost as a penalty for failing for too many years to address its rising pensions and borrowings to cover debt service. Instead of such critical investments, the city—and other cities and counties, as Bloomberg noted, “and other municipal borrowers in the past decade made bets on the future direction of interest rates through agreements with banks to swap interest payments. But when rates fell under the Federal Reserve’s attempt to stimulate the economy after the financial crisis, many issuers ended up on the wrong side of the bets. Since then [municipal] issuers have paid at least $5 billion to unwind the agreements.” Indeed, the city was scheduled to sell $439 million worth of municipal of bonds yesterday—with nearly 20 percent set aside to cover some $70.2 million to end an interest-rate swap tied to variable-rate debt for the city’s sewer system—and that, as Bloomberg adds, is “on top of $185 million paid to unwind swaps on general-obligation and sales tax debt since May.”The estimated $270 million total also includes the cost to banks and other professionals to restructure, according to data Bloomberg compiled from city documents. Chicago owed as much as $396 million to banks in March, before the city started terminating the swap agreements, according to market values at the time. Saqib Bhatti, a Chicago-based fellow at the Roosevelt Institute, told Bloomberg: “We’re paying these fees at the same time the city is looking at the biggest tax increase in its history,” adding that he has been recommending that governments with swaps should push to cut the fees rather than pay Wall Street banks: “Working residents of the city are going to have to sacrifice for the city to pay these fees to the banks.”

Aiding & Abetting Municipal Fiscal Distress. While they might teach math in Michigan’s schools, it might be that ethics ought also to be mandatory there and in Chicago—both places of exceptional fiscal challenges, but with, seemingly, one common denominator: unethical behavior from the top with abhorrent fiscal consequences. Thus it was Tuesday that former Chicago Public Schools (CPS) head Barbara Byrd-Bennett pled guilty to her role in a scheme to steer $23 million in no-bid contracts to education firms for $2.3 million in bribes and kickbacks. As part of her agreement, prosecutors recommended that Ms. Byrd-Bennett serve 7.5 years in prison for one count of fraud—an agreement under which prosecutors said in return they would drop the 19 other fraud counts, each of which carried a maximum 20-year term. The disservice by which Ms. Byrd-Bennett harmed Chicago’s fiscal sustainability and its children’s future came from her own past disservice to Detroit, where, as the former Detroit Public Schools chief academic officer, she had stepped down in the wake of a federal investigation into a contract between the district and SUPES Academy, a training academy where she once worked.—an investigation in which prosecutors allege the scheme started in 2012 — the year Mayor Rahm Emanuel hired her to become Chicago’s school district CEO. The indictment alleged that the owners of the two education service and training firms offered her a job and a hefty one-time payment, a payment purported to be a lucrative signing bonus — once she left CPS. The indictment alleges Ms. Byrd-Bennett expected to receive kickbacks worth 10 percent of the value of the contracts, or close to $2.3 million—or enough as Ms. Byrd-Bennett emailed to executives more than three years’ ago so that she could make money, writing: “I have tuition to pay and casinos to visit.” Her untimely departure comes in the wake of leaving the Detroit Public Schools system with what, today, is $327 million in debt with no visible means of repayment, and contemplating municipal bankruptcy, even as its debt insurer, Assured Guaranty Ltd., is pressing the Michigan legislature to bar the system from such a filing. Without the agreement, the insurer has threatened to accelerate long-term debt payments, raising the annual payment amount from $21 million to $45 million. In some sense, Ms. Byrd-Bennett brought her unethical and criminal fiscal legacy with her: SUPES Academy and Synesi Associates LLC owners Gary Soloman and Thomas Vranas have been accused of offering Ms. Byrd-Bennett money, along with sporting-event tickets and other kickbacks, in exchange for the contracts. Synesi Associates, which trains principals and school administrators—one shudders to imagine what kind of training they offer, was awarded contracts with Detroit Public Schools under Ms. Byrd-Bennett’s tenure, according to records posted on DPS’ website.

The ABC’s of Municipal Fiscal Challenges. The Holland, Michigan, School District, more than 100 years old—as may be observed from one of its oldest photos—is, like many Michigan school districts, confronting sharp and unexpected enrollment declines—declines adversely affecting their bottom lines; or, as Moody’s yesterday moodily opined, Holland illustrates not the place to skate all Winter, but rather the kinds of severe fiscal challenges of too many Michigan school districts—districts facing declining enrollments, stagnant state aid, and limited ability to raise additional revenues. Holland, a city of about 33,000 in the southwestern part of the lower peninsula, not unlike Detroit, is confronting a severe fiscal, as opposed to scholastic challenge in its K-12 system—or, as Moody’s this week reported, the A-1 credit-rated school district, has experienced a 174-student drop in enrollment—a drop nearly double what the district had anticipated and budgeted for in its current fiscal year—an enrollment drop which translates into a revenue loss of $591,000 in state aid, or, as Moody’s moodily explains: “The enrollment decline is not only credit negative for the district, but reflects the widespread credit challenges that continue to face Michigan school districts.” Moody analyst David Levett wrote: “Such pressures have led us to downgrade 44 Michigan school districts this year.” Holland’s six consecutive general fund operating deficits have been driven primarily by declining enrollment and the ensuing reduction in state aid under Michigan’s per-pupil funding system. As Mr. Levett notes: “Although officials are still analyzing this year’s enrollment figures, the district’s long-term trend of enrollment declines is attributable to significant competition from charter schools and an aging population,” effectively a fiscal one-two punch—two trends, however, which appear to be schooling Michigan’s elementary and secondary school fiscal sustainability, albeit with a potential steepening of the downward curve—or, as Mr. Levett added: “Even [school] districts that plan for declines may miss the mark on the magnitude of those declines.” Demographics are contributing to the fiscal python squeeze; the Census Bureau reports Michigan’s under-18 population is projected to decline an estimated 13% from 2000 to 2012, so that, as Mr. Levett further writes, “The state’s funding structure, demographic trends and liberal enrollment policies create an unpredictable and competitive environment for districts.” Indeed, close to 80 percent of Michigan’s school districts with more than $25 million in outstanding municipal debt experienced enrollment declines between 2009 and 2013—creating not just arithmetic opportunities for the system’s students, but math problems for the state’s school fiscal officers.

Restructuring Municipal Debt & Supermunis. Treasury Department and Puerto Rico officials are negotiating options for restructuring the U.S. commonwealth’s $72 billion in debts, especially with it becoming increasingly clear that the absentee U.S. Congress is unlikely to take any action to ensure Puerto Rico can avoid insolvency and be unable to provide essential public services. Under the evolving plan, the Treasury, or an agreed upon third party, would be in charge of an account which held a significant portion of Puerto Rico’s tax revenues—which would, effectively, be designated to pay holders of so -called super municipal bonds—municipal bonds, in this instance, held by bond owners in Puerto Rico and every state in the country who agreed to trade in their existing bonds for the new hybrid—albeit, a post “haircut” hybrid which, as in the case of a municipal bankruptcy, would be worth less than before the exchange, but which would be backed by employment and other taxes that the U.S. Treasury would collect for the territory, as well as possibly some of Puerto Rico’s own Treasury revenues. Under the evolving proposal, Treasury would act as a kind of intermediary; it would not be providing the territory with any kind of direct financial assistance or any guarantee; rather its role would be to serve as a quasi-trusted third party in a financial arrangement under which the new super municipal bonds would not only be backed by a much broader range of taxes than those that back the individual bonds of the territory and its authorities currently, but also indirectly through the unprecedented role of the U.S. Treasury—protecting and providing greater assurance to Puerto Rico’s bondholders of repayment. The discussions have not resolved whether any Congressional legislation would be needed, albeit, it is clear that the U.S. territory’s elected leaders would have to agree to potential debt exchange.

Steep Roads to Municipal Solvency

eBlog

September 17, 2015

The Steep Road to Fiscal Recovery. Notwithstanding Detroit’s successful recovery from the nation’s largest municipal bankruptcy and the signs of an apparent turnaround in surrounding Wayne County, the fiscal challenge and importance of Michigan’s Governor Rick Snyder and the legislature reaching an agreement as part of pending state transportation financing legislation to enable the Motor City to collect its income tax from commuters becomes more readily apparent in the wake of the release yesterday by the U.S. Census Bureau of its report finding Detroit to be the most impoverished major city in the U.S. with 39.3 percent of its population living below a poverty line of $24,008 for a family of four—even as the report found Michigan to be among 12 states which realized a decline in the percentage of people living in poverty in 2014—albeit Michigan’s poverty rate remained higher than the national average. Census found Flint, just an hour from Detroit, to be the nation’s poorest city, with 40.1 percent of its residents living in poverty. If there was a bright spot in the new Census data, it was a decline in the percentage of Michiganders without health insurance coverage: Census reported a decrease from 1,072,000 in 2013 to 837,000 in 2014–due in part to Michigan’s Medicaid expansion, which began enrolling residents in April 2014. Nevertheless, the numbers led Laura Lein, Dean of the School of Social Work at the University of Michigan, to comment: “The economic recovery is not yet affecting poverty or wage levels…It’s simply not affecting the part of the population that is economically challenged.” According to the new Census report, poverty rates remained flat across most of the Metro Detroit, and median income remained stagnant, or, as Richard Lichtenstein, associate professor of health management and policy at the University of Michigan’s School of Public Health, put it: “Most of the growth in income has been happening among the affluent and very little of it has been floating down to people at the lower income level.”

Poverty in big cities: Below, according to the new Census data, are the U.S. cities with the highest 2014 poverty levels:

  • Detroit, Michigan 39.3
  • Cleveland, Ohio 39.2
  • Fresno, California 30.5
  • Memphis, Tennessee 29.8
  • Milwaukee, Wisconsin 29
  • St. Louis, Missouri 28.5
  • Stockton, California 28.1
  • New Orleans, Louisiana 27.8
  • Miami, Florida 26.2
  • Philadelphia, Pennsylvania 26
    *Cities with population of more than 300,000
    Source: U.S. Census Bureau

Learning to Escape Poverty. The depressing Census numbers with regard to poverty in Detroit emphasize the importance of learning opportunities for the city’s children—but there the fiscal challenge remains daunting: Detroit Public Schools’ (DPS) deficit is increasing by millions of dollars. The system is issuing millions in new debt—at seemingly usurious rates: according to a quarterly report issued yesterday by the Michigan Department of Education, DPS, Michigan’s largest school district, has projected its deficit at $238.2 million as of June 30, or nearly 50 percent greater than a year earlier—that is: a trajectory towards bankruptcy—and making DPS among 14 Michigan school districts whose deficits climbed in 2014-15—a depressing trajectory which Michelle Zdrodowski, a DPS spokesperson, described as due to lower revenue from property taxes and asset sales, higher maintenance and utility costs, and a charge for legal contingencies. DPS, at the end of last week, borrowed $121.2 million through the Michigan Finance Authority—benefitting from being able to borrow through the lower interest rates than it would have been forced to pay on its own (the Michigan state aid revenue notes carry a 5.75 percent interest rate and are due Aug. 22, 2016); nevertheless, according to a state document detailing the financing, DPS has $337.8 million in outstanding loans. Thus the new borrowing to keep the system above water – so-called cash flow borrowing — to “assist with immediate cash flow needs” — coming at the commencement of the academic year (an option in Michigan made available to all public school districts on an annual basis to provide funding during those months when school districts do not receive state aid payment) nevertheless is unlikely to be the kind of math that would lead to good grades—or, as Gary Naeyaert, who leads a school-choice advocacy group, the Great Lakes Education Project, described the fiscal apprehension yesterday: “Michigan’s taxpayers should be outraged by DPS’ continuing efforts to increase their operational debt by borrowing money they simply won’t pay back…When you’re in a hole this deep, the first priority should be to stop digging.” He added that the seemingly usurious interest rate on the loan is a sign of the Detroit Public School District’s increasing fiscal peril: “The standard interest rate on these School Aid Notes is 1 percent for creditworthy districts…The fact that DPS is being charged 5.75 percent indicates what a terrible financial deal this is.” DPS, which has been experiencing declining enrollment for decades, has run a deficit in nine of the past 11 fiscal years—a period during which four state-appointed emergency managers have been named.

Pathway to Solvency. Meanwhile, in surrounding Wayne County, Michigan, County Executive Warren Evans yesterday advised his fellow elected commissioners that the County had reached tentative labor agreements with its employee unions, with his spokesperson stating: “We anticipate announcing major labor agreements with all of our unions in the very near future.” Even without providing details, the spokesperson for the County reported the new contracts would enable Wayne County to achieve the savings it needs without a 5 percent wage cut that the Evans’ administration had proposed earlier this year—a sign which, he indicated—was likely to augur that the unions will vote on the tentative agreements in the next few days. The seemingly upbeat news came as the Commission, meeting yesterday as a committee of the whole, voted preliminary approval to Mr. Evans’ proposed $1.56 billion county budget for FY 2015-16. That vote came as Mr. Evans submitted a projected, reduced $1.45 billion budget for the 2016-2017 fiscal year—with final votes expected today. In proposing the new budget, Mr. Evans told his elected colleagues that his budget would eliminate what remains of Wayne County’s $52 million structural deficit, that it would decrease unfunded health care liabilities by 76 percent, and reduce the need to divert funds from departments to cover general fund expenditures. In short, for a county in state-designated fiscal emergency, the budget would create a pathway to solvency. The county, Michigan’s largest—and the home to Detroit—had successfully sought a state declaration of a financial emergency last June, leading to the consent agreement with the state approved last month. Notwithstanding its potentially disappearing structural deficit, Wayne County still confronts one other daunting hurdle: a $910.5 million underfunded public pension system.

The Sharing Economy. The San Bernardino County Fire Protection District—the body key to the city of San Bernardino’s proposal, as part of its municipal bankruptcy plan of debt adjustment before the U.S. bankruptcy court, to annex or incorporate the city’s fire department—yesterday voted (with the vote taking place in San Bernardino City Council chambers) unanimously to make that and two related applications its top priority, an action intended to ensure the annexation process can be completed by next July 1st. If approved, the savings to bankrupt San Bernardino could be close to $12 million annually, coming from both the operating and capital savings, as well as the related parcel tax (a $143-per-year tax on each of the city’s 56,000 parcels) which requires annexation to implement. The vote could pave the way for public hearings next February, reconsideration in May, and actual commencement of the process by April—albeit an annexation process which could be terminated if more than 50 percent of registered voters protest, or lead to an election if written protests are received from either 25 to 50 percent of registered voters or at least 25 percent of landowners who own at least 25 percent of the total annexation land value. It turns out that in the emerging, sharing economy; sharing can be a most difficult, hurdled process—even where critical to emerging successfully from municipal bankruptcy.

Robbing a Capitol City’s Fiscal Future. Senior Pennsylvania District Judge Richard P. Cashman, voicing concern and apprehension about former Pennsylvania capitol city Harrisburg Mayor Stephen Reed’s style of governance, has upheld some 485 theft and corruption charges filed by the state attorney general’s office and sent the case to trial. Judge Cashman, ruling in Dauphin County court on Tuesday, ruled probable cause exists in the case against the former Mayor, whom the state attorney general’s office alleges used millions of dollars of municipal bond proceeds to purchase Wild West artifacts for a planned museum: the municipal bond proceeds, according to the prosecutors, were to be dedicated for retrofitting of the city’s municipal incinerator, the city’s school system, the Harrisburg Parking Authority, and the Harrisburg Senators minor-league baseball team, which the city owned at the time. The museum never got off the ground, but the municipal bond financing for the incinerator involved cost overruns which led the city to the brink of insolvency (the city successfully exited receivership in March, 2014); indeed, it was during former Mayor Reed’s long tenure as Mayor (from 1982 to 2009) that Pennsylvania’s capital city plummeted to the brink of bankruptcy. Bond financing overruns from the incinerator project largely accounted for the city’s $600 million-plus liability. At a Sept. 14 preliminary hearing, special agent Craig LeCadre, the lead investigator for Attorney General Kathleen Kane’s office, likened Reed to “a hoarder on steroids,” reporting that his investigators found roughly 10,000 artifacts in the basement of Mr. Reed’s apartment near the state capitol, and prosecutors presented a slide show which featured included a vampire hunting kit, a bronze statue of a cowboy on a bucking bronco, and a Spanish armor suit. They valued the latter two at $19,000 and $14,000, respectively.

Protecting Public Health & Safety in Fiscal Distress. The Puerto Rico Aqueduct and Sewer Authority (PRASA) has reached a tentative settlement with the U.S. Justice Department and EPA under which it will spend $1.5 billion to upgrade and improve its system-wide sewer systems serving the municipalities of San Juan, Trujillo Alto, and portions of Bayamon, Guaynabo and Carolina, according to the U.S. Justice Department—as well as to invest sufficient funds to construct sanitary sewers to serve communities surrounding the Martin Peña Canal—improvements affecting the health and safety of some 20,000 U.S. citizens. Under the terms of the agreement with the Justice Dept., and in recognition of PRASA’s fiscal stress, the Justice Dept. waived civil penalties for violations alleged in a complaint, noting that many of the “provisions of the agreement have been tailored to focus on the most critical problems first, giving more time to address the less critical problems over time.” John Cruden, Assistant Attorney General for the Justice Department’s environment and natural resources division, noted that certain projects required under the 2006 and 2010 agreements had been found to be no longer necessary, because the island’s population has declined, so that the stipulated upgrades were no longer critical to protect public health and safety from the “public’s exposure to serious health risks posed by untreated sewage,” adding that—in reaching the settlement, “The United States has taken Puerto Rico’s financial hardship into account by prioritizing the most critical projects first, and allowing a phased in approach in other areas.” The settlement, which is pending before the U.S. District Court for Puerto Rico, is subject to a 30-day public comment period and must be approved by the federal court.

The Seemingly Irreconcilable Challenge between Addressing Debt & Investing in the Future

September 11, 2015

Investing in Kids? S&P has lowered its ratings on the Michigan Finance Authority’s series 2011 revenue bonds to A from A-plus and series 2012 revenues bonds to A-minus from A-plus with a negative outlook—bonds issued by the MFA for the Detroit Public Schools, with S&P analyst John Sauter writing: “The district’s continued overall financial and liquidity deterioration is another contributing factor.” The bonds, which are payable from the repayment of loans made by the MFA to the Motor City’s school district—loans secured by all appropriated annual state aid to be received by the school district—which has irrevocably assigned 100% of its pledged state aid to the loans (and thereby to the authority’s bonds). The district’s 2011 obligation holds a first-lien pledge of state aid, and the 2012 obligation a second lien. The district’s limited-tax general obligation (GO) pledge also secures both obligations. The ratings reflect the strength and structural features of the district’s state aid pledge to its obligations. Mr. Sauter noted: “The downgrade is based on severe declines in the district’s enrollment, and subsequently, pledged state aid available to pay debt service.” DPS’ credit downward trajectory appears to reflect continued fiscal stress as indicated by significant growth in DPS’ accumulated operating fund balance deficit from FY2014 and ongoing declines in enrollment—declines which pressure operating revenue, as well as the perception that DPS lacks the capacity to reverse the negative operating trend. But the rating also takes into consideration the weak economic profile of the City of Detroit (B3 stable), DPS’ substantial debt burden, and an operating budget constrained by high fixed costs. Absent enrollment and revenue growth, fixed costs will comprise a growing share of DPS’s annual financial resources and potentially stress the sufficiency of year-round cash flow. The unholy combination of falling revenue, rising costs, and credit downgrades can raise the cost of borrowing money—creating a vicious cycle that erodes the fiscal capacity to invest in Detroit’s future taxpayers. Michigan law prohibits its school districts from raising property taxes for operating funds over 18 mills on non-homestead properties; thus, many districts have cut spending, laid off teachers and other staff and eliminated some school programs. DPS has been under the auspices of a state emergency manager for several years and has about $483 million in debt. The district’s enrollment was once well above 100,000 students, but now is about 47,000. Former state superintendent of Public Instruction Mike Flanagan wrote earlier this year in a report to education appropriation subcommittees as he was leaving his post that cash needs could force Detroit Schools to refinance even more debt. The downgrade affects both costs and reputation: for Detroit, its ability to leverage families to move into the city is inherently dependent upon the reputation of its public school system.

Planning Debt Adjustment. When a municipality is in bankruptcy, it is forced to juggle thousands upon thousands of issues relating to constructing a plan of debt adjustment with its creditors that will secure the federal court’s approval—a process made ever more difficult with the approach of elections. This adds stress—and confusion—as could be observed in San Bernardino in the wake of a brief welter of confusion yesterday when a tentative contract agreement already reported to U.S. Bankruptcy Judge Meredith Jury was abruptly pulled off the City Council agenda—a contract with the city’s general unit, which represents some 357 employees who are not in another union, such as police or management. Nevertheless, the contract is now set for the Council to review in closed session at the city council’s meeting scheduled for a week from Monday—in this instance, a contract with regard to leave policy for the city’s employees, who have been working under a contract which expired June 30th as they negotiated with the city for a new contract. The need for a revision arose in the wake of the city’s implementation of one part of its 2012 bankruptcy plan — freezing leave which had accrued before August 2012, when the city filed for bankruptcy protection. That meant that by this year, many employees wound up with negative leave balances—a situation which a city official described to the Council as “very detrimental to the employees.”

Debt Restructuring Outside of Bankruptcy. If you can imagine an NFL football game without any referees or under-inflated footballs, you can begin to imagine the chaos triggered by the release in Puerto Rico this week of its quasi plan of debt adjustment—a plan which, unsurprisingly, calls for its municipal bondholders in each of the nation’s 50 states to accept less than they are owed. The U.S. territory has $13 billion less than it needs to cover its debt payments over the next five years—and that is even after taking into account the proposed spending cuts and measures to raise revenue in the newly proposed plan. Puerto Rico officials estimate that the island will have only $5 billion of available funds to repay $18 billion of debt service on $47 billion of debt, excluding obligations of its electric and water utilities. The projected debt-funding shortfall is after anticipated savings from the consolidation of 135 public schools, reductions in health-care spending, additional subsidy cuts and reductions in payroll expenses. So now, in an unrefereed, unprecedented fiscal process, Puerto Rico’s fiscal team plans to present its investors with a debt-exchange offer in the next few weeks. It also intends to seek a moratorium on principal payments. And it will not have long: the whistle will blow by the end of the year, leaving the unenviable challenge and task of seeking to get all the creditors on the field quickly: Puerto Rico is on course to run out of cash by the end of this calendar year unless it can refinance its debt—or as non-football BlackRock analyst Peter Hayes yesterday put it: “They have a real solvency issue…They have a liquidity crisis on their hands that grows very dire by the end of the year.” And the fiscal threat and challenge was exacerbated by S&P’s dropping of Puerto Rico’s tax-backed debt to CC from CCC-, and removal of the U.S. territory’s ratings from CreditWatch, where they had been placed with negative implications July 20. The outlook is negative. With the near certainty of a default or restructuring—or fiscal event, there is an increased likelihood of either a missed debt service payment or a distressed exchange which would resemble a default. Gov. Alejandro Garcia Padilla stated that if Puerto Rico’s creditors are unwilling to partake in restructuring negotiations, Puerto Rico would have no alternative but to proceed without them even if it involved “years of litigation and defaults.”

Herding Angry Sheep. In a television address, Gov. Padilla yesterday announced the appointment of a team of debt restructuring experts to negotiate with Puerto Rico’s creditors—a process which would be unprecedented as those creditors run from some of the world’s most sophisticated to tens of thousands of individual municipal bondholders in each of the nation’s 50 states—and a process which, absent action by Congress, might more resemble gladiators in a coliseum than the kinds of overseen negotiations which took place under the aegis of U.S. Bankruptcy Judge Steven Rhodes in Detroit. Adding to the uncertainty, the report on which such negotiations is premised is technically only a recommendation. Try and imagine a football game not only without referees or under inflated balls, but also without agreed upon rules. That report projects Puerto Rico’s treasury will exhaust its liquidity by November—and only until then if Puerto Rico takes extraordinary measures to preserve cash. Unlike a non-governmental corporation—Puerto Rico has no ability to act unilaterally: actions require legislative and gubernatorial action and concurrence. Moreover, it is not just Puerto Rico, but also the Puerto Rico Government Development Bank (GDB)–which is projected to exhaust its liquidity before the end of calendar 2015. And there are dozens and dozens of municipalities at growing fiscal risk (Puerto Rico’s municipalities cannot file for Chapter 9 bankruptcy protection, and a local debt-restructuring law enacted in June 2014 was thrown out by a federal judge in San Juan.). But, like in football game, there is a clock: and it is already running: we know that Puerto Rico will not have fully sufficient fiscal resources in FY2016 to make payment on its scheduled tax-supported debt, including its General Obligation (GO) debt, so that for creditors, it is almost as if the music for a game of musical chairs has already started. The report released this week forecasts a total central government deficit as a whole, including the general fund, GDB net revenue, COFINA, federal programs, and Puerto Rico Highways & Transportation Authority (HTA) net revenue, in fiscal 2016 of $3.2 billion, or about 16 percent of expenditures, including payment of debt service; it projects only a $924 million surplus available before payment of debt service. That is, it appears, as in musical chairs, that there simply will be insufficient fiscal capacity to meet the obligations to pay $1.8 billion of GO and GO-guaranteed debt service (GO debt service alone is $1.2 billion), much less total central government debt service, including GO debt, of $4.1 billion. Or, as Mr. Hayes wrote: “We rate all Puerto Rico tax-backed debt at the same ‘CC’ level, except for Puerto Rico Public Finance Corp. (PFC) debt, which is currently in default and rated ‘D,’ reflecting the report’s projection of limited liquidity to meet all debt service before the end of calendar 2015, including GO debt service, and the report’s recommendation to enter restructuring discussions with all tax-backed debt holders.”

The Exceptional Governing Challenges in Municipal Bankruptcy

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June 17, 2015
Visit the project blog: The Municipal Sustainability Project

Getting Down & Dirty near L.A. The San Bernardino City Council yesterday, in the wake of a session which some of its members described as “dysfunctional,” voted 4-3 not to act on a proposed short term contract for street sweeping. Unlike Michigan or Rhode Island—states where an emergency manager usurps elected authority (albeit with a new Michigan Appeals court decision—please see below—the extent of such state usurped control is in some question)—San Bernardino’s elected officials have had to be not just responsible for voting to approve the city’s plan of debt adjustment to submit to U.S. Bankruptcy Judge Meredith Jury, but also to continue to govern whilst the city’s future is being determined in her court. Nevertheless, in the interim, the Mayor and Council bear the responsibility to keep the city operating—including making determinations with regard to what public services are essential. Thus the nearly transfixing issue with regard to street sweeping swept the council into confusion: it appears that the city’s Public Works Director, Tony Frossard, had reassigned street sweepers several weeks ago to pick up trash, determining that refuse collection was a priority and that the ongoing departures of city employees left too few people to do both—a decision which, apparently, was not conveyed to either the city manager or Councilmembers—who were apparently only informed of the decision last week—leading to this week’s public session and divided vote, after City Manager Alan Parker had hurriedly sought street sweeping proposals from three companies, with the services to be provided for the next four months—at which time San Bernardino would expect to select a firm to assume annual responsibility for refuse collection, street sweeping, and other duties, consistent with the city’s outsourcing proposals in its plan of adjustment awaiting consideration by the U.S. Bankruptcy Court. In the wake of such confusion, the Council voted to defer any action until July 6th, with councilmembers expressing frustration with regard to both the timeliness and breadth of information they had received—as well as the short notice on which to act—or, as Councilmember Henry Nickel put it: “I don’t know whether these crises are being engineered or people are dropping the ball…Either way, it’s unacceptable.” It turns out that managing a municipal bankruptcy and governing a municipality is challenging, and, in San Bernardino, it appears to be adding stress between staff and elected officials: As Councilmember Virginia Marquez put it: “If we have not been told about the street sweeping, are there other issues we have not been told about?…I don’t like being in the dark.”

The city is, in a sense, caught between state law (municipalities are responsible for having trash picked up every seven days, while streets must be swept at least once per year) and its already submitted plan of debt adjustment, wherein, as 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.” In fact, the plan is specific with regard to the issue at hand: it 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,” with much of the outsourcing proposed to begin this year—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.

Going to School on Municipal Bankruptcy. Detroit Public Schools Emergency Manager Darnell Early yesterday testified before the Detroit City Council that the Motor City’s recovery from municipal bankruptcy will fail absent a turnaround of its education system—a system with falling enrollment and a deficit of more than $160 million: “We all have a vested interested in seeing Detroit Public Schools emerge from its financial difficulties, just as the city was able to emerge from the largest municipal bankruptcy in United States history…Without it, the city will be incomplete.” Mr. Early said his goal, not unlike his former counterpart Kevyn Orr, was to return the city’s school district from state back to local control, but testified: “we’re not there yet.” His appearance before the Council comes in the wake of his proposed restructuring plan for the 47,000-student district–a plan Mr. Early said would both save $10 million a year and give principals more autonomy when its fully implemented by July 2016, adding: “This is very important work because it involves the future of not only our city, but the future of our children…Failure is not an option, because we’re talking about failing our children. We’re talking about failing our community.” He vowed there would, despite falling attendance, be no school closures in the upcoming academic year, but that he had proposed reducing its current 60 departments to 16 offices overseen by five divisions, as well as recruit four deputy superintendents to lead its other divisions: academics and school support, strategy, talent management, and finance and operations. There is much work to be done: the Detroit Public School System spends $1,963 per student on administration, one of the highest figures in the state among districts with more than 1,000 students.

There are many players at the table, because the stakes for Detroit’s future loom so high—and the challenges are intergovernmental. Even though Mr. Early is a state-appointed emergency manager, just as Kevyn Orr was for the city, Gov. Rick Snyder has proposed his own plans for reconstructing Detroit’s public education system, including restructuring the guidelines for appointments to the school board, so that Gov. Snyder and Mayor Mike Duggan would be responsible for appointing the city’s school board to run a new debt-free public school district, with a six-year timetable back to electing a more traditional school board. Some of that governance stress became evident yesterday when Councilman Gabe Leland urged Mr. Early to not leave the school district’s elected board members out: “As you go about your work, I hope that you can build relationships…particularly with the Board of Education here in the city of Detroit, who were elected by the residents of this city…The residents that this city elected have no voice on that board, and to the extent you can build those relationships and make them part of the decision-making process, I think we all win.”

Reining in Colas? The Wayne County Commission, as early as tomorrow, could take up a proposal to eliminate the fund the nearly insolvent county administers to provide what the county terms the 13th check to its retirees—in this case given as a bonus in lieu of cost-of-living increases. The decision came on a 9-3 vote, with two abstentions, to move the measure forward to full commission—and came at a public hearing, but one at which no members of the public spoke. Deputy Chief Executive Officer Richard Kaufman told the Commissioners that the elimination of the fund, the Inflation Equity Reserve Fund, would not achieve annual savings to Wayne County, but that it would enhance the county’s fiscal health. The issue arose in the wake of a court decision fining Wayne County $49 million, because the court determined the County did not make its required annual pension contribution in 2010—a judicial order which led to the imposition of a one-time property tax assessment for this summer of about $50 for a house assessed at $100,000. Nevertheless, the possibility of taking away inflation adjustments raised apprehensions about the potential consequences for public retirees on low or modest incomes, with some on the Commission suggesting the consideration of a sliding scale that would eliminate the bonus for those with higher pensions. However, Deputy COO Kaufman was adamant: “The administration doesn’t believe we have any money to fund a 13th check.” County officials expect eliminating the so-called 13th check would help enhance the sustainability of the county’s public pension fund—currently estimated at an estimated 44-45% level, advising the elected leaders that if it were eliminated, the assets would be transferred to the general pension fund, telling the members they would prefer to ensure the health of the entire pension system rather than worry about the bonus check—and reminding the elected leaders that Wayne County currently faces an unfunded pension liability of $850 million to $940 million.

Is There an Emergency with Michigan’s Emergency Manager Law? The State of Michigan Court of Appeals—in the first case addressing the extent of the power or authority granted to state-appointed emergency managers—state-appointed managers in place of elected municipal leaders, to date, in five school districts and 12 municipalities in Michigan—has now, in the first judicial examination of the state’s power to, in effect, suspend democracy in a city, county, or school system, ruled that emergency managers cannot simply ratify actions imposed by local officials; rather they must closely follow local ordinances when imposing their own orders, with the court noting: “Our decision today only highlights that authority for a closer look at the statutory boundaries of the EM’s power.” Indeed, in overturning the lower court, the panel wrote that its decision had been “premised on its understanding of the EM’s authority as broad, substantial, and complete,” noting the need for a “closer look at the statutory boundaries of the EM’s power.” The decision (Kincaid et al v. City of Flint) arose from a challenge to a former Flint emergency manager’s order imposing steep water and sewer rate increases, with the appeals court here reversing the trial court’s dismissal of that case, the three judges writing: “The EM is a creature of the Legislature with only the power and authority to do what is granted by statute…That authority was not as broad as defendant argues.” One firm, Miller Canfield, noting it was the first case to analyze the extent of an Emergency Manager’s authority, wrote: “[P]previously [there was an] undefined limit on an EM’s powers and by implication narrowed the EM’s authority to ‘act for and in the place and stead’ of local officials.” In the specific instance of the City of Flint, the ruling means the loss of revenue generated by the water and sewer rate increases a former emergency manager imposed—creating a fiscal sustainability issue for the city and an ironic question with regard to whether or not Flint will appeal the ruling to the Michigan Supreme Court. In Flint’s instance, prior to the state’s imposition of an Emergency Manager, the City finance director had recommended increasing the municipality’s water and sewer rates, a recommendation subsequently approved by the city council and the mayor. In the nonce, the state appointed Michael Brown to take over the city as emergency manager—whereupon Mr. Brown ratified the finance director’s rate increase, imposing water and sewer rate increases of 12.5% and 45%, respectively. The actions led Flint City Councilmember Scott Kincaid and other residents to file suit, alleging the city did not follow local ordinances in imposing said increases, including adhering to a 30-day waiting period, among other things, and that an EM could not ratify an action imposed prior to his or her appointment. In a press conference Monday, Councilmember Kincaid and other plaintiffs said they hope to reach a settlement with the city to end the lawsuit.