The Hard Road to Fiscal Recovery

July 7, 2015

The Steep Road to Recovery. Because almost every state which authorizes municipalities to file for municipal bankruptcy imposes different requirements/mandates—including, in the case of Michigan, suspension or preemption of authority of a municipality’s elected leaders, the process of reverting to municipal authority for Detroit came with strings attached—there was no stomach in Lansing to see a substantial state investment in Detroit’s recovery fail; nor, as retired U.S. Bankruptcy Judge Steven Rhodes noted, did he ever want to be known as the first U.S. Bankruptcy Judge to have to preside over a second or repeat municipal bankruptcy. Therefore, when Judge Rhodes approved Detroit’s plan of debt adjustment, clearing the way for the state-appointed emergency manager Kevyn Orr to leave and Mayor Mike Duggan and the City Council to resume governance authority, that authority became subject to nearly a decade of state oversight by means of a nine-member Financial Review Commission, created as a key provision in Detroit’s plan of debt adjustment last November as part of the “Grand Bargain,” that is the agreement which involved both state fiscal assistance and a significant contribution from non-profits to ensure the Detroit Institute of Art remained in the city. The agreement created a mechanism to ensure the City of Detroit is meeting statutory requirements. Statutorily required members of the body include Michigan Treasurer Nick A. Khouri, who serves as chairman; State Budget Director John Roberts serves as the designee of the director of the state Department of Technology, Management and Budget. The oversight board also includes, by statute, Detroit Mayor Mike Duggan and City Council President Brenda Jones, or their designees, as well as five gubernatorial appointees. The Commission is charged with reviewing and approving Detroit’s four-year financial plan, and establishing programs and requirements for prudent fiscal management, among other roles and responsibilities. Detroit is operating under the oversight of a Financial Review Commission and must maintain a balanced budget for three consecutive years, among other requirements, to emerge from oversight in 2018. The commission is scheduled to meet on July 27th, when it will likely review the City Council’s decision to reject a hike in water rates–unless, in the nonce, the Mayor and Council reverse their position.

Under the new law, one of strict requirements is that the Mayor and Council may not enact a budget with a deficit. Thus, in a letter last Thursday to the Mayor and Council, State Treasurer Khouri raised apprehensions over the Council’s vote not to increase water rates, writing that if the vote is not reversed, the Detroit Water and Sewer District’s Enterprise Fund will be in deficit—ergo requesting that Detroit’s elected leaders either provide the Commission with information to demonstrate the city’s plan to comply with the approved budget for the current fiscal year, or the basis upon which it will seek a budget amendment. In addition, Treasurer Khouri wrote that he was seeking details with regard to whether Detroit could — without the rate increase — meet its obligation to provide quarterly certifications to the commission that it can meet debt service requirements though the end of the fiscal year. Unsurprisingly, the City Council is expected to reconsider its decision to reject proposed water and sewer rate increases for city residents as early as today, with President Pro Tem George Cushingberry, Jr. expected to offer a motion asking the Council to revisit its June 30th vote on the rates recommended for the new fiscal year, which began July 1st. In its earlier vote, the Council voted 6-2 against the hikes proposed by the Detroit Water and Sewerage Department, with some members expressing apprehension with regard to how residents already having trouble paying their bills would be affected. Under the rejected and to be reconsidered proposal, DWSD’s average Detroit customer would pay about $64 more a year for service—in contrast, under the Council’s rejection of the proposed increase last week, an estimated $27 million leak was created in the city’s budget, triggering the state apprehension and response—with Detroit’s Chief Operating Officer Gary Brown noting last week that he has been educating Council members on the “unintended consequences” of the decision, reminding them that the no vote went against the Council’s unanimous support in March of the city’s fiscal year budget—a budget which, he noted, included revenue for the water department.

As the very fine editorial writer Daniel Howes of the Detroit News this morning notes: “Detroit’s bankruptcy would be an enormous waste of time, money and unparalleled cooperation between the public and private sectors, foundations and state legislators, unions, retirees and pension funds, if the city’s leaders choose grandstanding over financial discipline…Detroit collapsed into the largest municipal bankruptcy in American history in large part because its elected officials refused to do what they agreed to do. If their successors repeat the mistake, the result is likely to be less forgiving.”

Is Puerto Rico Being Held Up? Puerto Rico Gov. Alejandro García Padilla yesterday reported he had created a Working Group for the Economic Recovery of Puerto Rico. The effort, to be led by Chief of Staff Victor Suárez, Government Development Bank President Melba Acosta, Secretary of Justice César Miranda, and the Presidents of the Senate and House, Eduardo Bhatia and Jaime Perelló, is to focus on how to achieve a consensus on the restructuring of Puerto Rico’s public debt, or, as Gov. Padilla described it: “The ultimate goal is a negotiated moratorium with bondholders to postpone debt payments a number of years, so that the money can be invested here in Puerto Rico.” In a response, Senate Pres. Eduardo Bhatia said, “I have long anticipated this moment. Restructuring the debt has always been the right way, but it is not an easy road. I constantly referred to the 3 Rs: reducing costs, increasing revenues, and restructuring the debt.” Absent access to a federal bankruptcy court, where a timeout could be called by a federal judge and Puerto Rico could provide critical public services, even as it worked to put together a plan of adjustment in negotiation with all its creditors; the U.S. territory instead confronts an expensive challenge from one of its biggest bondholders as it seeks to reduce debt service payments for several years. OppenheimerFunds has announced it intends to defend the municipal bond promises to its clients—in effect following up on its successful legal challenge last summer to the Territory’s proposed bankruptcy measure for its public corporations. Puerto Rico has appealed this case to a higher court, where it is still being considered. The profound challenge for Puerto Rico is how it can adjust its debts in a manner to ensure the ongoing ability to provide essential public services, as well as to ensure economic growth: clearly, it has long since passed the time when it has the fiscal resources to pay each and every one of its creditors 100 cents on the dollar. Consequently, GDB President Acosta will be meeting with representatives of the island’s municipal bondholders and representatives of the muni bond industry in New York City and Washington, D.C. to discuss restructuring of the bonds: the stiff challenge: how to juggle about $72 billion of total outstanding Puerto Rico public sector debt outside of a public process or federal court supervision. Because it is appears clear that Puerto Rico cannot pay all of its debt–even if it took strong measures to cut spending and increase revenues—the issue is how, or is it even possible, to create a process outside of bankruptcy—to restructure? The ever effervescent Natalie Cohen, a managing guru at Wells Fargo Securities, yesterday put it—as she invariably does, succinctly: “I agree that Puerto Rico’s current trajectory is unsustainable and lack of immediate action will only make their situation more painful to resolve. I thought the [Puerto Rico — A Way Forward] report was balanced and shows that without action, there is a financing gap of $3.7 billion in 2016, growing substantially in future years as Affordable Care Act reductions and loss of Act 154 benefits disappear (about 20% of General Fund revenues).”

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

The ABC’s of a Sustainable Fiscal Future. Chicago Mayor Rahm Emanuel reports that the Chicago School District, the third largest of the country, will be eliminating 1,400 jobs, while at the same time increasing borrowing in response to the growing fiscal crisis facing both the State of Illinois and the Windy City, noting that the job cuts at the Chicago Public Schools, which largely shield teachers and include positions that are vacant, are part of a plan to cut annual spending by $200 million, or roughly 3.5%. The announcement came in the wake of a decision by Chicago officials to make a $634 million payment due to the teachers’ retirement system before a Tuesday night deadline, with Mayor Emanuel noting: “These payments do not come without a cost…There is a series of political compromises and patchwork over the years that can no longer continue.” The announcement comes in the wake of inaction by the Illinois legislature—in a state where state lawmakers have considerable control over education spending and the pension systems—but where, at least to date, no steps to assist the city school system—or, as Mayor Emanuel put it: “Your stalemate is having consequences.” In the immediate term—to ensure the city’s schools open on time and keep class sizes from rising, the district drew down on two credit lines to make the pension system payment due this week. Now it is seeking to put off for a year $500 million in pension payments due in the new fiscal year. For his part, Mayor Emanuel has proposed that teachers’ pension contributions and local property taxes would be increased if the state would make increased payments into Chicago’s teacher retirement system. But the prospects are most uncertain: the state government remains entrapped in its own budget Armageddon—at an impasse over this fiscal year’s state budget, which had yet to be approved nearly a week into the new fiscal year and now faced with a partial state government shutdown.