Who Will Take Responsibility for Detroit’s Future?

January 19, 2016. Share on Twitter

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

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

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

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

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

The Road to Recovery from Municipal Bankruptcy

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November 12, 2015. Share on Twitter

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

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

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

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

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

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

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.”

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.’

Complexities of Democracy & Municipal Bankruptcy

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October 29, 2015. Share on Twitter

Complexities of Democracy & Municipal Bankruptcy. With election day just around the corner, San Bernardino Mayor Carey Davis spent an evening with constituents answering questions, including the inevitable ones about the status of the municipality’s 2012 municipal bankruptcy filing—where the city’s plan of adjustment has long since missed the deadline for submission set by U.S. Bankruptcy Judge Meredith Jury—and where, of course, next week’s election, if there are changes, could create still further disruption. Indeed, Mayor Davis admitted, in response to several residents’ questions, that San Bernardino is not there yet and confronts hard choices in putting together making further “haircuts” before its plan will be ready. Speaking to about 30 residents at Jovi’s Diner for his second “Evening with the Mayor,” he offered updates on key issues—and sought input. He discussed what he termed “seven strategies” the city had identified over the course of five strategic planning sessions or community meetings the city’s leaders had convened with citizens earlier this year, in an effort, he said, to demonstrate the impact community input can have, noting: “As a result of that process, public safety is a top priority of the recovery plan,” noting the city has hired more police, created a park ranger program, and used federal grants to purchase police body cameras and new patrol cars. (See: http://www.city-data.com/crime/crime-San-Bernardino-California.html). Nevertheless, as can be discerned from the data, the challenge of public safety remains, as the Mayor noted, an issue: “Our police are very engaged in trying to eradicate some of the problems in our community, but they’re overwhelmed at times with the heavy call volume.” On the related public safety front, Mayor Davis said the city was continuing in its efforts to outsource or regionalize emergency fire and rescue services with surrounding San Bernardino County, noting: “We’re working through the hoops and hurdles, but we hope to have that done probably by July of next year.” One of the hurdles has been the legal and political challenge by the fire union—a challenge with which Judge Jury has previously concurred with San Bernardino’s fire union was done without required negotiation. Nevertheless, the city and the Local Agency Formation Commission for San Bernardino County, the commission which is in charge of approving San Bernardino’s efforts to annex itself into the San Bernardino County Fire Protection District voted unanimously last month to make that and two related applications its top priority—a focus meant to ensure the annexation process can be completed by next July 1st for the applicants, which include San Bernardino, the Twenty-nine Palms Water District, and Hesperia Fire Protection District. Mayor Davis also pointed out other signs of progress, including the San Manuel Gateway College, a project of Loma Linda University Health with an expected 2016 completion date, which the Mayor reports will create career paths for local students while increasing the number of patient visits nearly tenfold from 30,000 to 200,000 per year. He said the city had issued more than 2,000 new business licenses over the last year—and that, for the first time in decades, the San Bernardino City Unified School District had registered higher graduation rates—and that the city’s Middle College High School had ranked ninth among California’s nearly 2,000 schools.

The Human Side of Municipal Bankruptcy. The bankruptcies of Central Falls and Detroit, perhaps more than any others, and the significant human and fiscal costs, appear to have been central to the exceptional efforts Wayne County, the jurisdiction encompassing and surrounding Detroit, has taken to avoid going into municipal bankruptcy—steps including reducing retirement health care benefits and transferring some of its retirees from employer-paid group health care to a system under which they will receive a monthly stipend enabling purchase of a plan on the federal Health Insurance Marketplace or a plan through the insurance company Wayne County has contracted with to manage the day-to-day administration of the stipend program. The seemingly harsh steps came in the wake of the State of Michigan’s declaration of a financial emergency in the county—a declaration short of municipal bankruptcy, but which triggered a consent agreement between Wayne County and the state which gives Wayne County Executive Warren Evans some powers normally made available only to emergency managers. It seems the experience with the largest municipal bankruptcy in American history has yielded some lessons learned which could be valuable to Michigan’s taxpayers, and Wayne County’s future. Nevertheless, there will be costs. That is to write that Wayne County continues to grapple with a recurring budgetary shortfall that stems from the steep, $100 million annual drop in property tax revenues since 2008. Wayne County officials have been able to drop the deficit be nearly half—nearly $30 million from a $52 million structural deficit. For the longer term challenge, the county faces an underfunded pension system, underfunded by $910.5 million, according to its most recent actuarial report—an underfunding which has been bleeding Wayne County’s general fund by about $20 million annually to prevent it from going under. That is, with the unique authority conferred by the state, the County has been acting with conferred state authority to take extraordinary fiscal steps to avert going into municipal bankruptcy—steps under which Mr. Evans last April announced a plan to cut $230 million from the budget over four years, including reducing health care benefits for employees, eliminating health care for future retirees, and restructuring the pension system—with the transition set to begin at the end of next month when the current health care plan ends and the new one takes effect on the first of December. County officials estimate some 4,000 retirees will be eligible. As James Canning, a Wayne County spokesperson noted: “We understand change is never easy…But moving from employer-paid health care to a stipend program was necessary to improve the long-term financial health of the county. We really appreciate our retirees’ understanding as we move through this process.” The plan also means health care benefits for the county’s current retirees will be affected: Wayne County officials switched an employer-paid group health care plan for retirees to giving them a monthly stipend—and has, in an effort to try to help its retirees through the wrenching process—hosted 13 informational meetings for retirees at sites across Metro Detroit in recent weeks, as well as set up an 800-number and a website at http://waynecounty.amwins.com/ to answer retirees’ questions about their health care benefits. Under the plan, Wayne County employees who retired before 2007 and are eligible for Medicare will receive a $130 monthly stipend for themselves and one for eligible spouses. Wayne County employees who retired before 2007 and are not Medicare eligible will receive a monthly stipend based on their household income: e.g., a retiree with a spouse or single dependent and who earns less than $35,000 a year, will receive a $150 monthly stipend; a retiree with a spouse who earns between $35,000 and $65,000 will receive $300 a month. Under the plan, retirees may buy insurance through a broker or an independent agent, or directly from an insurance carrier, or obtain coverage through a spouse’s employer. Prior to this change, as in many cities and counties, retirees paid a minimal amount out of their own pockets for health care. In Wayne County, for instance, most county retirees paid about $90 per month for coverage for themselves, two people or a family with Blue Cross or Health Alliance Plan under last year’s benefits structure, according to the county. Retirees in the supervisory unit paid about $44 a month for single coverage, $104 for two people and $122 for a family. In addition, county retirees paid a yearly deductible of $500 for themselves and $1,000 for a family. Co-pays for doctor’s visits ranged from $30 to 20 percent for general services from in-network health care providers. Under the new change, the county expects to realize savings of nearly $22 million in FY2015-16 alone. According to the County, effective this December 1st, the county will transfer about 4,000 retirees from employer-paid group health insurance to a monthly-stipend system. County employees who retired prior to 2007 and are Medicare-eligible will receive a monthly $130 stipend for themselves and one for spouses, if eligible; employees who retired before 2007 and are not Medicare-eligible will receive a monthly stipend based on their household income. Here is how it will impact county retirees who are not Medicare-eligible:

Single retiree:

■$100 for income less than $30,000
■$200 for income of $30,000-$45,000
■$400 for income $45,000-plus
Retiree and spouse or one dependent
■$150 for income less than $35,000
■$300 for income of $35,000-$65,000
■$750 for income of $65,000-plus
Family
■$150 for income less than $40,000
■$300 for income of $40,000-$55,000
■$400 for income of $55,000-$70,000
■$800 for income of $70,000-plus

Source: Wayne County

Down Under. Rene Vollgraaff and Xola Potelwa, writing for Bloomberg this week, noted that South Africa’s credit rating could drop to junk in “just a matter of time.” Fitch and Moody’s Investors Service, which rate the nation’s debt two steps above sub-investment, are set to bring their assessments in line with S&P’s at the lowest investment-grade level, noting that another step down would start triggering capital outflows. The cost of insuring South Africa’s dollar debt against default for five years has climbed 58 basis points in the past 12 months to 248, compared with the 142 median of five emerging-market economies with similar ratings at Moody’s and Fitch, and 215 for those rated one level lower. Weakening tax revenue is putting pressure on the country’s budget deficit, even as the country is close to a recession and confronting a 25 percent jobless rate. The budget deficit will widen from earlier forecasts, reaching 3.3 percent in the fiscal year through March 2017 and 3.2 percent in the following year. The federal government debt is projected to reach almost 50 percent of GDP this year. Having lived and worked in Africa—and visited Johannesburg last year, this national fiscal challenge, unsurprisingly, led me to apprehension about the fiscal fallout for the nation’s cities. A 2013 study by the South Africa Fiscal and Financial Commission grouped South Africa’s municipalities into three categories: fiscally neutral, fiscal watch, and fiscally distressed, based on short-term and long-term indicators. According to the short-term indicators, fiscally healthy municipalities decreased (from 34 per cent in 2011/12 to 24 per cent in 2012/13), and the number of municipalities in the fiscal watch and fiscally distressed categories increased. However, the long-term analysis revealed that a large percentage of municipalities are fiscally healthy, with the number of fiscal distressed municipalities remaining relatively low. The study recommended the federal government should develop an early warning system, which would detect municipalities heading towards fiscal distress. Once the probability of fiscal stress was detected, further investigation would be needed to identify the underlying root causes and frame appropriate and timely responses.

The question then becomes, what might that mean for South Africa’s cities? It was, after all, just three years ago that some 64 municipalities in that country were named on a list of financially distressed municipalities, where the report noted: “From evidence to date, it is clear that much of local government is indeed in distress, and that this state of affairs has become deeply rooted within our system of governance.” The assessments were designed to ascertain the root causes of distress in many of the country’s 283 municipalities in order to inform a national turn-around strategy for municipalities; they were carried out in all nine of South Africa’s provinces. One key finding was an overall vacancy rate of 12 percent for senior managers in local government, demonstrating the challenge—a challenge not unlike in many cities in the U.S.—of attracting the most competent managers—especially an issue for municipalities in distress, which often lack both the financial wherewithal, not to mention the budget to attract the top talent. Or, as the South African report found, insufficient municipal capacity due to lack of scarce skills, along with poor financial management, corruption, and service delivery delays all combined for disproportionate municipal fiscal instability and unsustainability. The report also found that the disparity in skills was exacerbated by the decline of municipal professional associations and poor linkages between local government and the tertiary education sector: “Functional overreach and complexity are forcing many municipalities into distress mode, exacerbated by the poor leadership and support from other spheres and stakeholders.” The report found that the distressed municipalities lacked financial and human resources to deliver on their mandate and citizens’ expectations. Or, as we wrote then: when we were in Johannesburg, the news reported: “Most people are not entirely clear about what the officials in this amorphous government department do all day long beyond, presumably, going to a great many meetings with various levels of government, chiefs and tribal councils, listening attentively, nodding sympathetically, and then going home to watch TV…but while the man in the pothole street might not be clear about the purpose and day-to-day functioning of cooperative governance…the minister of finance would have been acutely aware of the need to sort out local and provincial government where mayors and MEC’s buy themselves fancy 4X4’s from the public purse (even the provincial ambulance budget, if that’s what it takes), because their administrations either can’t or can’t be bothered to fix their roads….The job of cooperative governance minister might be less glamorous than divvying up the public sector kitty and deciding who gets taxed how much, but it is, in every sense, a real job, just one that hasn’t been done terribly well until now….”

Avoiding Municipal Insolvency, Except as a Last Resort

October 20, 2015. Share on Twitter

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

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

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

• The forthcoming bills are expected to include:

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

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

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

The Steep Road to Recovery from Municipal Bankruptcy

October 7, 2015

The Hard, but Critical Road to Recovery & Fiscal Sustainability. Few municipalities, especially compared to other corporations, go into bankruptcy. But for those that do, they do not disappear, as is the outcome in many corporate bankruptcies; rather they do not miss a beat with regard to providing essential services, even as they began the long and expensive process of putting Humpty Dumpty back together again by means of assembling a plan of debt adjustment in negotiations with their thousands upon thousands of creditors. While each of those plans must receive approval from a federal bankruptcy court—and the respected and respective judges do look to see that such proposed plans incorporate long-term fiscal sustainability provisions; nevertheless, those municipalities are not starting on a level playing field. So the question with regard to their ability to fully recover remains a story to be learned—because never before in American history has there been such a spate of major municipal bankruptcies. Ergo, unsurprisingly, Detroit—with its plan approved and the Mayor and Council restored to governance authority—in effect starts at a disadvantage compared to other municipalities: its road to climb is steep.

There is good news, however: a new report, “Estimating Home Equity Impacts from Rapid, Targeted Residential Demolition in Detroit, Michigan: Application of a Spatially-Dynamic Data System for Decision Support,” from the Skillman Foundation, Rock Ventures LLC, and Dynamo Metrics has found that the valuations of homes within 500 feet of a demolition funded by the U.S. Department of Treasury’s $100 million in Hardest Hit Funds have increased by an estimated 2.4 percent between December 2014 and May 2015. Indeed, blight removal has been a core element of any route to Motor City recovery: in May of 2014, the Detroit Blight Removal Task Force — which includes representatives from Detroit Public Schools, U-SNAP-BAC Inc. and Rock Ventures — identified more than 78,000 properties in need of sales, repair, or demolition. That is, federal help seems to have sparked a critical revival of affected assessed property values and, ergo, the Motor City’s revenues: the report found demolitions have increased the value of surrounding homes within 500 feet by 4.2 percent, or an average of $1,106. Citywide, that amounts to an increase in home values of more than $209 million. The bad news is that even as this innovative federal program is beginning to demonstrate its ability to contribute to Detroit’s comeback, the assistance in financing the demolition is drying up.

The report also suggests that combined with other efforts by the city—efforts which include code enforcement and sales of public assets such as side lots—have also begun to make telling fiscal differences: the value of homes nearby increased by 13.8 percent, or an average of $3,634. Citywide, that amounts to an increased assessed property value of about $410 million—or as Mayor Mike Duggan describes it: “The numbers are extraordinary,” noting that eliminating blight has allowed “good homes and good vacant homes” to increase in value: from January of last year until last, 5,812 blighted structures in the city were demolished thanks to funding from the federal “Hardest Hit” fund—a now drying up fund focusing nearly $8 billion in post Great Recession assistance foreclosure prevention in 18 states, including Michigan, with where Michigan’s share was over $498 million, of which Detroit received just over one fifth. Because those funds will be depleted this year, Mayor Duggan is planning to travel to Washington soon to meet with White House officials and others to lobby for the next round of money—especially since the demolitions to date have only addressed some 10 percent of the city’s blight.

Good Gnus. In its review of Chicago’s proposed FY2016 Budget, Kroll Bond Rating Agency (KBRA) reports it believes Mayor Rahm Emanuel’s budget includes “reasonable actions for closing the projected fiscal 2016 operating shortfall, and represents clear progress in confronting the challenges of unfunded pension liabilities.” The Budget closes the city’s FY2016 gap via proposed savings and reforms, efficiencies, and significantly increased property taxes from a four-year phased-in $543 million increase in the property tax levy, earmarked to specifically address rising police and fire pension liabilities. The rating agency wrote it believes the choice of a property tax levy increase demonstrates the Chicago’s political will to craft an effective and sustainable solution. Nevertheless, the agency noted there still remain numerous unresolved issues, which could potentially undermine budgetary goals: first, will the City Council, in an election year, approve the Mayor’s proposed budget? Second, the big shoulder city is relying on State action to increase the size of the home-owners property tax exemption, which would exempt homes valued at less than $250,000 from the increase—this a state legislature which is locked in a stalemate with the Governor. The phased-in property levy increases assume that Senate Bill 777, which reforms police and fire pension funding, will be enacted into law—and not be rejected by the Illinois Supreme Court. If not enacted, Chicago’s police and fire pension funding obligation would immediately rise from approximately $328 million to $550 million, and the city would have to identify and act on additional funding sources.

Not the Odor of Verbena. The Securities and Exchange Commission (SEC) has settled its almost six-year-old pay-to-pay case against two ex-JPMorgan bankers involved in hold-your-nose, soured sewer deals that thrust Jefferson County, Ala., into municipal bankruptcy. The SEC, according to a notice filed in federal court this week, reported it had reached agreement with Charles LeCroy and Douglas MacFaddin via mediation which resolves securities fraud charges against the two, albeit the actual terms of the settlement will not be made public until it is presented to the full commission for approval, with the independent federal securities agency advising the federal district court that, if the Commission approves the report, that would end litigation on the case. The long, simmering case dates back just about six years to when the SEC filed a civil suit alleging that Messieurs LeCroy and MacFaddin had improperly arranged payments to local broker-dealers in Alabama to assure that certain Jefferson County commissioners would award $5 billion in county sewer bond and swap deals to JPMorgan. The SEC suit, which charged that the two men “privately agreed with certain county commissioners to pay more than $8.2 million in 2002 and 2003 to close friends of the commissioners who either owned or worked at local broker-dealers,” sought declaratory and permanent injunctions against the two for federal securities law violations, as well as disgorgement of all profits they received as a result of their legal misbehavior, plus interest. The SEC had brought the suit simultaneously with its settlement of municipal securities fraud charges with the investment bank. Without admitting or denying the SEC’s charges, JPMorgan agreed to pay $75 million in penalties eventually turned over to Jefferson County, and to forfeit more than $647 million of claimed swap termination fees. In January, the SEC sought summary judgment in the case, leading U.S. District Court Judge Abdul Kallon to determine the five-year-old case was appropriate for mediation—this all in a case involving some nearly two dozen municipal elected officials, contractors, and county employees involved in Jefferson County’s sewer bond sales or construction of the sewer system who were jailed for bribery and fraud—and which led to what was, at the time, a filing for the largest municipal bankruptcy in U.S. history.

Wither Its Future—and Who Decides? Facing decades of structural budget gaps and unsustainable legacy costs, the City of Pittsburgh entered two forms of state oversight in 2004. In the subsequent decade, that engagement appeared to have been key to a turnaround in the city’s structural deficits, leading to annual positive fund balances, as the then-partnership helped restructure its crushing debt load, streamline an outsized government, and earn a triple-notch bond rating upgrade. Nevertheless, the Steel City still carried a $380 million pension liability, leaving questions with regard to whether the city was ready to graduate from state oversight – especially given the extra relief from restrictive state laws that the state’s Act 47 provides to city officials. Now that state-local tension seems to be back, with the Pennsylvania Intergovernmental Cooperation Authority (ICA), the city’s overseer, an authority state lawmakers formed in 2004 to oversee Pittsburgh’s finances, at a time the city was on the precipice of municipal bankruptcy, claiming it is justified by state law in withholding Pennsylvania gambling revenue from the city (ICA is invoking Act 71 of 2004, a state statute which grants, according to ICA, has “exclusive control” of the gaming revenues dedicated for Pittsburgh, the only second-class city under the commonwealth’s system of categorizing cities.), because, as the Intergovernmental Cooperation Authority’s Henry Sciortino, reports: “They haven’t met certain benchmarks.” Indeed, the former amity is now gone: Pittsburgh is suing the state agency in the Allegheny County Court of Common Pleas, accusing it of illegally withholding $10 million in annual gambling host city revenue funds the past two years related to the Rivers Casino—a costly dispute triggered by state agency claims that Pittsburgh Mayor Bill Peduto is backing off his commitment of $86.4 million to fully fund current payments to retirees – separate from the city’s overall unfunded pension liability estimated in the hundreds of millions. In addition, Mayor Peduto requested that Pennsylvania Auditor General Eugene DePasquale conduct an audit of the ICA—a request putting Mr. DePasquale now in a most awkward position in the wake of the city’s decision to file suit. Moreover, the city-state dispute—itself now becoming a costly court battle—arises even as the city faces daunting pension challenges: returns on the city’s employee pension funds have, according to the State Auditor, deteriorated from 16.3% in fiscal 2013 to 5.5% this year, reflecting the slowdown in financial markets, who estimates the city’s funds’ assets to be $675 million versus liabilities of almost $1.2 billion. Indeed, the Public Employee Retirement Commission considers Pittsburgh’s pension fund “moderately distressed.” In a letter to Gov. Tom Wolf and top legislative leaders a week ago, ICA Chairman Nicholas Varischetti called pension underfunding “one of the most serious barriers to Pittsburgh’s fiscal stability.” That statement comes in the wake of Pittsburgh’s efforts just five years ago to avoid a state takeover of its pension funds by earmarking nearly $750 million in parking revenues over three decades to prop its funding level above a state-mandated 50%. Keeping this growing state-local dispute constructive could matter: over the last decade, Pittsburgh has received 11 upgrades, most recently in early 2014 when S&P elevated its general obligation rating to A-plus, and Moody’s, just a year ago, revised its outlook to positive on the steel city’s general obligation bonds. The city’s suit alleges the ICA has been illegally withholding $10 million in annual gambling host city revenue funds the past two years, whilst, for its part, ICA officials claim Mayor Peduto is backing off his commitment of $86.4 million to fully fund current payments to retirees. Indeed, in an epistle to Gov. Tom Wolf, ICA Chairman Nicholas Varischetti wrote that pension underfunding was “one of the most serious barriers to Pittsburgh’s fiscal stability.” The state-local tension over the city’s pension liabilities is hardly new–five years ago Pittsburgh avoided a state takeover of its pension funds by earmarking nearly $750 million in parking revenues over 30 years to prop its funding level above a state-mandated 50%; however, once again, state apprehension is on the uptick that the city is, as one expert, David Fiorenza, a Villanova School of Business professor and a former chief financial officer of Radnor Township, said: Pa., said “[O]nce again the municipality is only fixing the leak and not curing the flooding problem of pension debt and other unfunded liabilities looming around like an albatross,” adding that he believes the state ICA can be a force to persuade cities to devote gambling revenues to other areas of the budget, such as pensions.

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.

Advice & Consent

September 15, 2015

Motor City-County Bonds? Wayne County Executive Warren Evans has issued his first order under the County’s consent agreement with the State of Michigan—an order which requires all county employees to comply with the consent agreement and report any potential breaches to his office, and which requires all county departments to obtain permission from the Wayne County CFO prior to entering into any contracts which could be considered debt under the terms of the county’s consent agreement. (The decree requires Wayne to continue to make timely debt payments—and bars the county from filing for chapter 9 municipal bankruptcy while operating under the decree.) Mr. Evans’ order directs county workers to comply with the consent agreement and outlines protocols for breach: “The purpose of issuing this order is to ensure that county employees, elected officials, along with our contractors understand what is required while the consent agreement is in place.” The extraordinary fiscal authority comes as the County—of which Detroit is the seat—is grappling with a $52 million structural deficit, stemming from a $100 million drop in annual property tax revenues since 2008 and an underfunded pension system. The county’s primary pension plan is 45 percent funded and has a liability of $910.5 million, based on its latest actuarial valuation. That is, Wayne County and Detroit’s respective fiscal foundations are inextricably connected. Mr. Evans is seeking to fix the county’s finances under the consent agreement by reducing future pension obligations and retiree benefits and taking other actions to eliminate the structural deficit. Under the agreement, Mr. Evans and the county commission retain their powers and responsibilities: the unique agreement also grants Mr. Evans the power to impose contract terms with the county’s unions if they are unable to hammer out labor agreements after a month of good-faith negotiations—an avenue Mr. Evans has said repeatedly he prefers to reach agreements with the county’s unions at the bargaining table. Among the agreement’s provisions he has emphasized to Wayne County employees:
■All county contracts or agreements must include the requirements of Public Act 436 and the consent agreement.
■All county employees, elected officials or entities that have contracts with the county must inform the executive of any potential breach of the consent agreement.
■Before any contract is entered into that is considered debt under the consent agreement, a copy must be given to the county’s chief financial officer for approval.
In addition, the county has also put up a new web page so that citizens and taxpayers can follow and understand the issues. Mr. Evans noted: “The purpose of issuing this order is to ensure that county employees, elected officials, along with our contractors understand what is required while the consent agreement is in place…It is important for everyone to understand what to expect as we move together through this process to restore our financial health.”

The order which was approved by the County Board last month, comes as Mr. Evans is in the middle of a 30-day period of negotiations with county unions on new labor contracts. Should the negotiations produce no agreements, Wayne County—under the consent agreement with the state, is authorized to impose its own labor contracts. While the 12-page agreement with the State allows Wayne County to try to restructure some of its debt or reach settlements with creditors, it bars Wayne County from issuing any more municipal bonds without state permission. The consent agreement gives Wayne County until Jan. 31st to present the state with a plan for its abandoned jail project in downtown Detroit—an unfinished facility, which was financed with $200 million of municipal bonds. The forlorn project has been abandoned since 2013 due to cost overruns, but, under Wayne’s agreement with the state, Michigan will assume financial oversight over the project. It will be up to Michigan Treasurer Nick Khouri when to release Wayne County from the agreement—and, in any case, under its terms, Michigan will continue to monitor Wayne’s finances for two additional years following any release from the agreement by the state.

Perhaps unsurprisingly, however, the new consent agreement is already being tested: Wayne County is appealing a restraining order won by Wayne County Sheriff Supervisory Local 3317, which is seeking to block changes to sheriff deputies’ wages and benefits made under the county’s consent agreement. The County reports it will seek an emergency appeal of the ruling by Wayne Circuit Judge John Murphy after Wayne County Sheriff Supervisory Local 3317 petitioned the court for relief from changes to compensation the county imposed for command officers at the sheriff’s office—in effect, a challenge not just to Wayne County, but also to the State of Michigan.

Scrambling in Scranton. Even as agent from the Pennsylvania state Attorney General’s office yesterday showed Senior District Judge Richard Cashman slides of many of the artifacts that former Harrisburg Mayor Stephen Reed, who served for 28 years, is charged with illegally using public funds to purchase for museums which never materialized in a preliminary hearing on hundreds of criminal counts including theft, misapplication of government property, criminal solicitation, bribery and tampering with evidence; the losses created continue to wreak fiscal havoc. Elsewhere, yesterday, Scranton Mayor Bill Courtright announced the city likely will lease, rather than sell, its five parking garages and on-street parking meters to a nonprofit organization which will operate them. In addition, the city and financial consultant Henry Amoroso launched a new website, scrantonforward.org, to inform the public about the progress of Scranton’s recovery plan initiatives. Mayor Courtright, in announcing his plan to try to monetize the municipal garages, said the result likely would be a concession lease agreement with the nonprofit National Development Council: “We have taken a disciplined and focused approach to finding solutions to our financial challenges. Step-by-step we are restoring confidence and moving Scranton forward…I am confident that the steps we have taken will provide us with the best possible fit for our city, which will allow us to retain ownership of our parking assets while reducing the financial burden on the City.” The fiscal scrambling comes in the wake of a series of decisions by the City Council three years ago which led to the default by the Scranton Parking Authority (SPA) on payments owed under two loans, one issued in 2009 by Pennstar Bank and another in 2011 by Landmark Community Bank, as well as a June 2012 payment owed by the authority municipal parking bonds. The decision to default on the bank loans resulted in over two-years of litigation; the decision to miss the bond payment resulted in the court appointment of a receiver to oversee the operations of the authority. As Mayor Courtright puts it: “Since coming into office, our focus has been on getting Scranton’s finances back on track…We’ve been able to clear up the Pennstar and Landmark defaults, and now we’re progressing into responsibly monetizing the City’s parking assets so we can eliminate or significantly reduce the bad Parking Authority debt for which the City is now responsible.” Currently, the City must budget about $2.9 million a year to cover SPA-related costs. He said a responsible monetization will take the form of a lease concession, where the City will maintain ownership of valuable parking assets and control over key decisions while shifting burden of excessive debt payments off of Scranton taxpayers, or, as the city’s consultant put it: “Whenever the SPA (the parking authority) cannot make its debt service payments out of its own revenues, the City must make up the difference.” Scranton’s financial consultant, Henry Amoroso added: “The numbers speak for themselves…The City can’t continue to shoulder the burden of SPA-related costs. It’s unsustainable.”

The road back to fiscal sustainability has been steep: On August 23rd, 2012, the City of Scranton took its first step in restoring long term fiscal stability and repairing the City’s creditworthiness by adopting a new Recovery Plan that replaced the 2002 Recovery Plan with a new Recovery Plan to provide the fiscal framework for the City’s governing bodies to follow through 2015: the 2014 Budget called for a tax increase of 49.99%. Additionally, the City of Scranton has increased current refuse fees, which will allow the City to receive an additional $2.2 million dollars. Further revenue enhancements such as increasing the Rental Registration Fee will allow the City to receive an additional $300,000.

Under the new parking arrangement, the plan calls for the city to lease its parking system, to eliminate Scranton Parking Authority debt that the city guarantees, retain ownership of the parking assets, and eliminate a court-appointed receivership which has controlled the parking garages since a 2012 default of SPA debt by that authority and the city. Under the agreement, along with retaining ownership of garages and meters, Scranton will retain veto power over key public policy considerations during the term of the concession lease, such as rate setting and certain capital improvement projects. Upon closing of the transaction, Scranton will be able to retire most SPA debt and refinance leftover debt, called stranded debt, at more favorable rates and terms; the city also will have the opportunity to share in revenue generated from the concessionaire’s operation of Scranton’s parking system. Or, as Mayor Courtright noted, his administration previously cleared up two other related defaults of bank loans which stemmed from the SPA default and harmed Scranton’s creditworthiness: “We have taken a disciplined and focused approach to finding solutions to our financial challenges. Step-by-step we are restoring confidence and moving Scranton forward…I am confident that the steps we have taken will provide us with the best possible fit for our city, which will allow us to retain ownership of our parking assets while reducing the financial burden on the city.”

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.”