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.

October 1, 2015

The Stress of Dysfunctional Governance in Municipal Bankruptcy. Last week, at a Governing panel I moderated in Washington, D.C., one of the questions I posed had to do with governance in municipal bankruptcy—a question I asked first of Kevyn Orr, the former Emergency Manger who steered Detroit through its long and complex process into and out of municipal bankruptcy: the differences and perspectives with regard to municipal bankruptcies in states which provide that the elected municipal leaders remain, such as in California and Alabama, versus the different laws in states such as Michigan and Rhode Island, where the Governor may opt to bring on a receiver (Rhode Island) or Emergency Manager, such as Gov. Rick Snyder of Michigan did in appointing Mr. Orr. In Central Falls’ municipal bankruptcy, the Governor named former state Supreme Court Judge Robert G. Flanders as Receiver – where, on day one, he ordered the Mayor and Council out of City Hall – and assumed total authority. Similarly, in Michigan, under the state’s law, Gov. Rick Snyder appointed Mr. Orr as the Motor City’s Emergency Manager—whereupon he took full power and authority for governance of the city—immediately upon his appointment. It was only on the respective federal bankruptcy court approvals of the two plans of debt adjustment that elected leaders (newly elected in the case of Central Falls) that governance reverted to those elected by the people. As we have noted, the model wherein a municipality’s elected officials remain in authority can work (please note, however, continuing challenges below in Jefferson County, Alabama), and in Stockton, California. But democracy in a crisis can sometimes be messy. Witness the imbroglio which is occurring in San Bernardino—now the city with the longest period in municipal bankruptcy in U.S. history, where recent events are painting a dismal picture of the city’s ability to operate and govern: there, in a late night and controversial decision, the city’s key consultant—who San Bernardino Sun insightful writer Ryan Hagen describes as “Arguably the only person with direct knowledge of much of the city’s complex redevelopment process,” was removed after serving nine “sometimes-controversial years at City Hall.” The removal of Jim Morris, who had been chief of staff during his father’s, Pat Morris, service as mayor, involved his work as a consultant on the dissolution of the city redevelopment agency: the issue before the Council was whether to extend his contract. Notwithstanding a 4-3 majority supporting a re-up of the contract, and a clear consensus by much of the city’s leadership, City Manager Allen Parker, City Attorney Gary Saenz, and Assemblywoman Cheryl Brown, who believe Mr. Morris was invaluable—Mayor Carey Davis vetoed any extension of his contract—citing concerns with regard to the delay in completing redevelopment tasks, particularly a long-range property management plan which had been projected to be finished last April, but which was not submitted to the Council until five months later. Mayor Davis noted: “If we’re paying for performance, it’s clear that maybe some of the delay was because concentration was taken from the (redevelopment agency) to city items.” According to Mr. Hagen, both messieurs Morris and Parker say the city made a plan which will allow it to meet state-imposed deadlines by moving in other people, with Mr. Parker writing: “Deputy City Manager, Bill Manis, who has been overseeing the team, will move into a more prominent role to continue the RDA dissolution process…Bill comes with extensive RDA experience and will work in tandem with the internal team and consultant, Urban Futures.” Nevertheless, the disruption comes as the city’s municipal bankruptcy creditors are making discovery requests—requests significantly above and beyond the normal obligations of a municipality, and requests which are increasing the workload for an already severely strained staff—a staff, after all, trying to operate and provide essential services, even as it is trying to marshal the resources to complete a plan of debt adjustment to the increasingly impatient U.S. Bankruptcy Judge Meredith Jury. All of this chaos, moreover, comes as voters are set a month from tomorrow to vote in the city’s election.

The Roots of Municipal Bankruptcy. According to the Detroit News, federal officials are investigating state Rep. Alberta Tinsley-Talabi (D-Detroit) who was a member of the Detroit City Council from 1993 to 2009 and served as a Wayne County Commissioner from 1987 to 1990. The investigation involves a bribery and kickback scandal which occurred during her years’ of service both as a Detroit Councilwoman, as well as a Detroit pension fund trustee. The News reports that Rep. Tinsley-Talabi’s nonprofit organization received at least one bribe from a businessman, during the time she was on a Detroit pension fund, and a time when her City Council campaign received thousands of dollars more from businessmen involved in a widespread corruption case, according to federal prosecutors. The allegations involving Rep. Tinsley-Talabi came out yesterday during the sentencing of a businessperson who had paid bribes to several former Detroit officials: no charges have been made yet in the widespread, years’-long federal probe of corruption at the Motor City’s City Hall, albeit there have been 38 convictions related to Detroit’s public pension funds, including former Detroit Mayor Kwame Kilpatrick and former City Council President Monica Conyers. The News also reported that federal court records clarify Rep. Tinsley-Talabi’s alleged involvement in a criminal case—a case which also has ensnared her former chief of staff, George Stanton, who will be sentenced today in federal court after agreeing to a plea bargain with prosecutors under which he agreed to secretly record conversations with Rep. Tinsley-Talabi and others. During her elected service in Detroit, Rep. Tinsley-Talabi, as a city pension trustee, had responsibilities to both oversee and help approve and select investments of said funds. She has founded a nonprofit group, Mack Alive, which serves the east side of Detroit. According to the News, in 2006 and 2007, when a Georgia businessman sought pension fund investments for his firm, Onyx Capital Advisers, and a real estate investment in the Turks and Caicos Islands on behalf of another company, PR Investment Group; the Detroit Police & Fire Pension Board, according to court records. On Dec. 21, 2006, then pension board member Tinsley-Talabi and other pension board members conditionally approved lending $10 million—an approval to which Detroit’s general retirement board approved another $10 million the following month. Now federal prosecutors allege that, within months, then Councilmember Dixon was handing out cash to city officials: “Evidence shows that Dixon gave the following things of value to Detroit and Pontiac pension trustees and staff in order to buy influence,” listing more than $244,000 worth of bribes, including a $1,000 check from Mr. Dixon to Ms. Tinsley-Talabi’s nonprofit on Aug. 22, 2007—perfectly timed just one day after the $1,000 donation. Further, the federal motion notes she introduced a favorable motion just prior to receipt of a $3,400 re-election campaign donation. In 2007, from Mr. Dixon—followed, just six days later by the Police & Fire pension fund’s grant of her request to have $1.15 million wired to Mr. Dixon’s firm, Onyx Capital Advisors. By December, 2007, the charges note Mr. Dixon paid for “City Official B,” referring to former Councilmember Tinsley-Talabi, to travel to the Turks and Caicos Islands—a trip which, the prosecutors note, two months later appeared to have some sway on her fellow pension trustees for a modified investment with PR Investment Group in the Turks and Caicos Islands, according to meeting minutes and court records. Ms. Tinsley-Talabi did not, however, vote on the proposed investment at the February meeting: she had left the pension board in December 2007 — the same month she took the Caribbean trip. The development came as Mr. Dixon yesterday earned a trip not to the Turks and Caicos, but, rather—in return for embezzling some $3.1 million from Detroit and Pontiac public pension funds, free lodging in federal prison for three and a half years for his role in the scandal, with the court finding he had paid $244,500 in bribes to former pension trustees, including the former Detroit City Councilmember and pension Board member—bribes for agreements which ended up losing the three public pension funds their entire investment of $23.8 million, according to the federal prosecutors. In all, Detroit’s pension fund appears to have suffered more than $95 million in a series of corrupt deals awarded to businessmen who bribed city public officials with cash, trips, free drinks, and other valuable items.

Municipal Bankruptcy Ain’t Over Until It’s Over. Jefferson County, Alabama, which—prior to Detroit—emerged from the largest municipal bankruptcy in American history, is finding that approval of its plan of debt adjustment by the U.S. bankruptcy court is not the last full measure: the county and its elected leaders confront a challenge or appeal to its plan of debt adjustment, creating hurdles to the County’s ability to issue municipal bonds. In addition, some restive opponents of the county’s approved plan of debt adjustment are also challenging court validation of a bond refunding—a refunding approved this year by the Alabama legislature—to provide the county with a source of new revenue. Such refunding revenues are needed to replace some 50 percent of the $70 million the County lost when a court struck down its occupational and business tax five years ago—a court decision which triggered the layoff of nearly 1,000 employees and significant cuts in public services. Jefferson County had filed for chapter 9 municipal bankruptcy in the wake of its inability to restructure $3.2 billion in its accumulated sewer debt. Under its court approved plan of debt adjustment, essential public services have been restored—but the county’s ability to issue bonds for key infrastructure investments and rehabilitation has been beset by ongoing legal challenges—or as the Bond Buyer’s inimitable Shelly Sigo writes: “[T]here isn’t funding for pent-up building, road and bridge repairs or improvements,” or County Commission President Jimmie Stephens noted yesterday: “We are getting the job done, but desperately need this revenue to improve the quality of life for our citizens…Our county buildings have deferred maintenance that needs to be addressed.” Notwithstanding, in a brief filed this week by Jefferson County tax assessor Andrew Bennett, state Reps. John Rogers and Mary Moore, and county resident William Muhammad, four of the 13 persons appealing Jefferson County’s plan of debt adjustment, claim Jefferson County’s claims are “belied by substantial fund balances” of $155 million in its FY2014 audit. In response, Commission President Stephens notes: “For anyone to state that the county does not need the funds, simply has not looked at our decaying infrastructure or simply doesn’t care,” with his statement coming as the County is planning its return to the municipal bond market for the first time since its successful exit from bankruptcy—planning to refund up to $595.5 million of warrants backed by a dedicated one-cent sales tax. Such a sale would provide for a refund a portion of the $1.05 billion of limited obligation warrants Jefferson County issued in 2004 and 2005, backed by the same dedicated sales tax—with the plan set so that the county could dedicate the proposed 40-year refunding plan to provide use sales tax proceeds to pay debt service, with excess tax revenues dedicated to Jefferson County’s general fund and unrelated county expenses such as schools, the Birmingham-Jefferson County Transit Authority, and the Birmingham Zoo—a plan authorized by the state legislature and signed by Alabama Governor Robert Bentley—but a plan for which the has filed a suit in Jefferson County Circuit Court in order to validate the refunding warrants and the state legislation—especially in the face of challenges that the law is unconstitutional.

The County’s fiscal challenges already confront legal hurdles from the two cases challenging its successful emergence from municipal bankruptcy—one by Jefferson County resident Keith Shannon, the other by Mssrs. Bennett, Rogers, Moore and Muhammad. In both cases, who argue the state legislation is unconstitutional. In addition, the attorney, financial advisor, and former broker-dealer, behind the challenge has also questioned Jefferson County’s need for new revenue, claiming if the proposed sales and use tax revenue is needed to fund infrastructure needs now, then the county misrepresented its insolvency before U.S. Bankruptcy Judge Thomas Bennett and its ability to pay the school warrant debt when it filed for bankruptcy, claiming: “The county having…$156 million in excess fund balance to pay school warrants and $155 million in unrestricted cash shows the bankruptcy was filed fraudulently,” he wrote in an email to the Bond Buyer. Ms. Sigo notes:

“Some market experts have suggested that Jefferson County faces a rocky return to the market given political undertones that led to its Chapter 9 bankruptcy, while others have suggested that any future deal might require extra credit support. The school warrants to be refunded later this year were untouched in the county’s bankruptcy. The case appealing the county’s bankruptcy exit involves only the county’s sewer debt. That case is continuing to move through the briefing stage before the 11th Circuit Court of Appeals in Atlanta. Jefferson County has asked the appellate panel to overturn a lower court judge’s ruling, which could result in revocation of a key credit factor supporting $1.8 billion in sewer refunding warrants the county issued in 2013 to write down $1.4 billion in related debt. The county’s reorganization plan authorizes the bankruptcy court to retain jurisdiction over the 40 years that the sewer warrants remain outstanding to ensure that the county provides adequate funds to pay debt service.”

September 30, 2015

The Stress of Democracy & Governance—and the Recurring Sins of the Past. Municipal bankruptcy and oncoming municipal elections make for governance challenges and hard votes. So it is that the San Bernardino City Council—by a one vote majority—passed a sewer rate increase (residents’ monthly sewer bills will rise $7.15 a month, starting in October–and increase more in future years). The narrow margin—a vote despite strong citizen opposition, swill trigger water and sewer collection fee increases, the first since 2010, which the department reported are necessary to avoid a sewer disaster in a system where holes have already been found and remain unfixed — and that is with only 20 percent to 40 percent of the 500 miles of pipes inspected. As the municipality’s water and sewer officials testified, the increase is critical, because the city’s “tires” could blow at any time, and replacing them after a blowout would only be more expensive. Moreover, as City Attorney Gary Saenz warned the elected leaders, not protecting and maintaining the system as required could lead to their prosecution and potential incarceration. Unsurprisingly, with elections looming now in less than five weeks, a stream of city residents (voters) urged the Council to reject the increase, claiming the rate increase was too much—and based on too little evidence. The ensuing 4-3 vote, nevertheless, means that the city’s sewer collection fee will rise about from $4 to $9 a month beginning tomorrow, then in July of every year until 2020, when sewer collection fees will total $11.47 for a single-family residence. The sewage-treatment fee, meanwhile, will rise 11.6 percent, to $20.65, effective tomorrow. By 2020, the total fee for single-family residences’ sewer collection and sewer treatment combined is projected to increase more than 50 percent from $22.50 to $35.32 a month. In adjusting the rates, the bankrupt city is restricted by California law, Proposition 218, which bars a municipality for setting or imposing fees higher than the cost of providing the service and restricts the revenues to a segregated account so that they may only be expended for related services. Notwithstanding the California law, prior to the city’s filing for chapter 9 municipal bankruptcy three years’ ago; in the lead-up to its 2012 municipal bankruptcy filing — San Bernardino officials who are now out of office did provided explicit details on the falsification of municipal budget documents—an admission which, at the time, led the then City Council members to delay a vote on whether to declare a state of fiscal emergency. (In California, a city must declare a state of fiscal emergency – the inability to pay its bills within 60 days without bankruptcy protection – to avoid mediation and other steps which would otherwise be required under state law.) That 11th hour admission—an admission which appeared to indicate criminal misconduct, and clearly triggered a need to consult with constituents, ended up forcing a delay in the city’s decisions with regard to the declaration of fiscal emergency and a resolution formally directing staff to file for Chapter 9 municipal bankruptcy—an admission and action coming in the wake of the City Attorney’s warning that 13 of 16 years of budget documents were falsified—falsifications which officials believed was related to the borrowing from restricted funds – funds specifically legally restricted only for certain purposes – in order to meet payroll and other expenses during months when cash was short. Such undercover borrowings were then repaid as the revenues flowed in later in the year. The city finance skullduggery, combined with a failure to produce city audits for fiscal years 2012-13 or 2013-14, audits which are way overdue but expected, perhaps as early as October, understandably raised hackles—or, as Councilmember Henry Nickel put it, in opposing the rate increase: “If you have money meant for tires and spend it on something else, that’s malfeasance…Until we have the audits in place, you do not have my support. We need to make sure we don’t re-enact sins of the past.” Unsurprisingly, with Councilmembers increasingly focused on next month’s election, supporters of the rate increase accused opponents of demagoguery, or, as Councilmember James Mulvihill, one of the two current Councilmembers on the ballot in November, put it: “Watch out for the politician that wants to manipulate your emotion and not solve the problem you’ll have, anyway,” said. Fellow Councilmember Nickel, the only other incumbent on November’s ballot, opposed the request.

Water and sewer issues—as we have observed in the nation’s two largest municipal bankruptcies—Detroit and Jefferson County—are critical pieces of the puzzle—or, in this instance, as former San Bernardino Councilmember Susan Longville warned prior to the vote: “You have an infrastructure nightmare waiting to happen,” albeit she said, any increase should come after a presentation that more effectively demonstrated the need for an increase.

Mixing Governance & Business. Serving as a municipal elected leader is a thankless task and never-ending challenge. It is a grave responsibility. The scrutiny of television and other media can only increase that pressure—especially if your city or county is confronting a crisis. That is a time when total focus would seem to be a prerequisite. Nonetheless, even as a citizen committee explained its recommended changes Monday to San Bernardino’s city charter during a City Council meeting, Councilman Benito Barrios was elsewhere: he was on the dais, but also on Facebook: he was trying to sell his friend’s gun—an effort which, unsurprisingly, within an hour, meant his efforts screenshots were being tweeted and shared in Facebook groups across the city—or as one constituent put it: “I guess his ward isn’t as important as that firearm and said friend.” While questions arose with regard to the legality of the gun sale (unclear), perhaps the more stressing issue related to focus—or, as the Councilmember stated: “This was during the presentations being given. So it took me 30, 40 seconds in between presentations…The perception is very bad for the people, and I’m aware of that. It’ll probably never happen again.” The occurrence, as former San Bernardino County Supervisor, and San Bernardino Councilmember Neil Derry told the San Bernardino Sun is about “multitasking: Intelligent people do it all the time. It’s a requirement for Marines.”

Rising Tide? Michigan Gov. Rick Snyder this week unveiled a new program, Rising Tide, intended to offer state-based mentoring for local officials of 10 struggling municipalities. The pilot, which the state calls Rising Tide, proposes no fiscal assistance; rather, it is designed so that Michigan economic development officials will work with 10 towns to help local leaders understand and create fiscal and economic development tools and strategies to attract and create new jobs—or, as Gov. Snyder stated: “We can collaborate with communities to help develop the tools to advance a strong economic vision and create new career opportunities for residents…This program will help economically challenged communities be better positioned for redevelopment opportunities.” The Governor announced the new initiative at a visit to River Rouge, a fiscally challenged Detroit suburb of less than 3,000 families—where the median age in the 2000 census was 33 years—and where, according to the most recent Census data, the median income for a household in the city was $29,214, and the median income for a family was $33,875. About 19.1% of families and 22.0% of the population were below the federal poverty level, including 30.6% of those under age 18 and 10.5% of those age 65 or over. The program will be led by the Michigan Department of Talent and Economic Development. State officials will offer mentoring help to local officials in struggling communities, and also outline common economic development tools to create jobs. The Governor’s office selected the municipalities based on unemployment rates, poverty levels and labor participation rate.

The Hard Road Down. In the wake of rating agency Moody’s downgrade of Ferguson, Missouri’s general obligation bonds or debt seven notches to Ba1—a steep drop which Moody’s attributed to not only Ferguson’s deteriorating fiscal situation, but also to apprehensions over the small municipality’s pending lawsuits and oncoming consent decree—a consent decree which will be based upon the federal investigation of police tactics and the city’s municipal budget reliance on traffic court fines—the municipality reacted with its own fire, moodily accusing Moody’s of being unwilling to give it more time to provide information that would offer a fuller picture. When a municipality is confronted by serious fiscal stress, a downgrading renders its ability to borrow both more difficult—and more expensive: precisely the opposite of what might be seen as a prerequisite for meaningful opportunity to recover. Moody’s, in its downgrading, however, noting that Ferguson’s fiscal reserves are shrinking—wrote that the municipality could be insolvent as early as 2017, citing city documents, noting, ergo, that its downgrade reflected “severe and rapid deterioration of the city’s financial position, possible depletion of fund balances in the near term, and limited options for restoring fiscal stability.” Missouri law provides that any municipality or subdivision may file for chapter 9 municipal bankruptcy (six cities have so filed—as well as one school district and one special district). Moody’s wrote. In its response, the small city—already besieged by extraordinary challenges—noted that in the midst of all the urgent demands, it had been unable to meet the severe timeline mandate imposed by Moody’s in which to respond with all the information requested, noting: “As a result, the city believes that Moody’s report is incomplete and fails to provide true transparency associated with Ferguson’s finances.” The municipality further noted it is still in the process of tabulating FY2015 revenues and preparing plans to address revenues and expenses—even as it confronts staffing constraints due to ongoing negotiations with federal Justice Department officials. Nevertheless, Moody’s downgrade will have adverse consequences: the downgrade will affect Ferguson’s $6.7 million of outstanding GO bonds, $8.4 million of certificates of participation from a 2013 issue, and $1.5 million of 2012 certificates.

No Consideration of Bankruptcy. The seeming outcome of a hearing convened by U.S. Senate Finance Committee Chairman Orrin Hatch (R-Utah) and Senate Finance Committee Chairman Charles Grassley (R-Iowa) yesterday is that the Senate is unwilling to even consider legislation to permit the U.S. territory to be eligible for chapter 9 municipal bankruptcy. Even while expressing disinterest, they claimed they want more information on Puerto’s Rico’s increasingly severe fiscal crisis—and that of its municipalities—and how to fix them. Instead, Chairman Grassley, whose committee has no jurisdiction over municipal bankruptcy legislation, offered that Congress should consider amending the Jones Act to exempt Puerto Rico from its onerous provisions which have the effect of imposing a tax on the costs of shipping goods from Puerto Rico to the U.S.—a federal law which has discriminated against Puerto Rico’s competiveness in the Caribbean, harming its economy. The Chairman also suggested Congress could reconsider the application of the minimum wage—which is currently 77% of the Puerto Rican median income compared to 28% on the mainland. Finally, mayhap thinking of the important value provided by the creation of financial control boards for both New York City and Washington, D.C., Chairman Grassley told the witnesses that a federal financial control board could be a good alternative. For his part, Chairman Hatch, whose Judiciary Committee has jurisdiction over federal bankruptcy laws, including chapter 9, seemed to defer to perspective of Douglas Holtz-Eakin, president of the American Action Forum, and the former Director of the Congressional Budget Office. Mr. Holtz-Eakin testified: “The primary focus (with regard to Puerto Rico) should be on policies that restore economic growth,” telling the committee that enacting legislation to offer Puerto Rico access to Chapter 9 bankruptcy (he did not address enacting such legislation so that—as under current federal law—Puerto Rico could authorize its municipalities access to municipal bankruptcy). But he also testified that the Puerto Rican government needs to provide Congress with better financial documents, noting that the commonwealth’s lack of “high quality” documents is “one of the very troubling aspects of this situation:” “debt sustainability analysis” needs to be done for Puerto Rico. Thus, he opined, that to authorize Puerto Rico access to municipal bankruptcy could do more harm than good, because, he testified, it would lead to one-sided “haircuts” on the residents who currently own about 30% of Puerto Rico’s municipal bonds; he added, however, that giving the U.S. territory access to municipal bankruptcy protection be warranted “somewhere down the road,” but not now. For his part, Ranking Member Sen. Chuck Schumer (D-N.Y.) advised that he intends to urge that Chairman Grassley hold hearings on the municipal bankruptcy bill which would alter Puerto Rico’s status. In their testimony, Resident Commissioner Pedro Pierluisi (D-P.R.) and Government Development Bank of Puerto Rico president Melba Acosta each told the two committees Puerto Rico needs access to municipal bankruptcy protection to put a halt on the increasingly rapid depletion of revenues—so that the leaders have more time to negotiate on its debts—a chapter 9 filing, once accepted by a U.S. bankruptcy court, immediately freezes obligations to debtors, and initiates a process overseen by a federal bankruptcy court to work out a plan of debt adjustment with all its creditors—even as it guarantees there is no interruption of the provision of essential public services. The pair warned that, absent such protection, projections point to Puerto Rico running out of money near the end of the year, and adding: “The unavailability of any feasible legislative option to adjust debts has created an overall environment of uncertainty that makes it more difficult to address Puerto Rico’s fiscal challenges and further threatens Puerto Rico’s economic future.”

Steep Roads to Municipal Solvency


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.”

How Does One Define “Essential Public Services” for a Municipality in Distress?

July 31, 2015

Securing a Safe & Sustainable Fiscal Future. Michigan Gov. Rick Snyder yesterday affirmed his declaration that Wayne County is in a financial emergency—an affirmation almost certain to trigger a partial state takeover of the county—a county which encompasses not just Detroit, but also 33 other cities and 9 townships. In his statement yesterday, Gov. Snyder said: “Officials have taken steps to begin addressing the county’s crisis, but there can be no disputing that a financial emergency exists and must be addressed swiftly and surely to ensure residents continue to receive the services they need and deserve and the county can continue its economic recovery.” The decision immediately started a stopwatch which will give the Wayne County Board until next Thursday to choose among four options offered under Michigan law to municipalities in financial emergencies:

• municipal bankruptcy;
• a consent agreement with the state;
• authority to request a neutral evaluator; or
• an emergency manager.

Wayne County Executive Warren Evans has said he has been hoping for a consent agreement to fix the county’s finances: such an agreement would spell out specific budgetary steps and reforms the county would have to undertake and complete to address the county’s $52 million structural deficit. Wayne County has been caught between a rock (significant declines in property tax revenues, estimated to be as much as $100 million annually since 2008) and a hard place: its underfunded public pension system. The county is confronted with an accumulated deficit of $150 million. Should the county opt for entering into a consent agreement, such an option would give Wayne Count broader authority to impose reforms on expired labor contracts and would leave the bulk of the restructuring under local, rather than state control. But, as some of the county’s commissioners warn, a consent agreement could instead lead to a preemption of local authority and a state takeover—as happened to Wayne County’s largest city: Detroit. Perhaps Wayne County Commission Chairman Gary Woronchak described it best: “We have a difficult decision ahead of us, because we have to choose from one of these four options…They may seem simple on their face, but there are little trap doors along the way that we should well be aware of while we’re making this decision.”

Stopping the Fiscal Bleeding & Financing Essential Public Services. Wayne County’s Treasurer is getting ready this fall to auction off as many as 30,000 properties: a record number of tax delinquent properties, nearly half of which were eligible for foreclosure years ago. About $193 million is owed in taxes and fees on the 30,000 Wayne County foreclosures, including $95 million in debt on properties that had more than five years in unpaid bills. Of that record number, nearly half are delinquent on their property taxes for five or more years: Michigan law provides for foreclosure after three years of nonpayment. As in Detroit’s experience, failure to foreclose creates a double whammy: first, an ever-growing erosion of assessed property values and collected property taxes in neighborhoods, and an ever-increasing cost and burden to the county to foreclose: this year, the Treasurer’s office is trying to foreclose on Wayne County’s vast majority of tax delinquent properties. To get some idea of the scope, over the last seven years, Wayne County has taken 108,500 properties to auction. A key issue, of course, is tax delinquencies: when the patient is bleeding, it is critical to stanch the flow, because, as Wayne County Chief Deputy Treasurer David Szymanski wrote in an email to The Detroit News: “Payment of these delinquent taxes is essential to support essential government services.” Wayne County is scheduling a first round of tax auctions in September, which is when foreclosed properties will be sold for the full debt owed—with whatever is not sold re-offered the following month.

Shared or Different Fiscal Destinies? Robert Frost, in his wonderful poem “Mending Walls,” wrote “good fences make good neighbors,” and so it is that Detroit and Wayne County are more than neighbors—as Detroit is in Wayne County. But even as Wayne County is in a financial emergency, Moody’s yesterday upgraded the City of Detroit one notch to B2 from B3, with a positive outlook, reporting that its upgrade reflects Detroit’s improved financial position following its exit from municipal bankruptcy. Moody’s added that the upgrade incorporates management’s continued improvement of city financial operations and signs of economic development in the city—even as it pointed out the city’s ongoing population loss, persistent tax base weakness, and taxable valuation declines—declines which it projects will continue over the near-term.

How Does on Define “Essential Public Services”? Perhaps the single most critical value of municipal bankruptcy is the immediate protection of a city or county’s ability to ensure the provision of essential public services while its sorts out its debts under the ever watchful scrutiny of a federal bankruptcy judge—certainly a part of the great apprehension in Puerto Rico is that, absent such a judicial protection, those in most dire need and who have the least legal or fiscal resources will be ill-equipped to compete with the hedge funds. But that raises a hard question: just what are essential public services? In San Bernardino, that question is front and center as the city, with an 18.9% unemployment rate, has determined, by a 4-2 Council vote, to appropriate $250,000 to keep a job center open for at least another two months as it appeals the state’s decision to reject the Mayor and Council’s request for funding—that is, $250,000 that the bankrupt city does not have. Nevertheless, the vote affirms the city’s decision to keep the doors of opportunity open for some 138 individuals currently enrolled in training programs or on-the-job-programs, to close out grants, and to otherwise wind down the agency. One can appreciate how hard it would be to draw the fine line between what is essential and what is not. San Bernardino Councilmember Rikke Van Johnson, in the majority of those voting to keep the city’s 40-year-old program on temporary life support said: “It’s integral, if we’re going to move out of this bankruptcy, that we keep our assets that will aid us in getting out of bankruptcy…and that’s what the San Bernardino Employment and Training Agency will do.” While the city’s workforce development attorney, in a seven-page opinion for the Council, wrote that she believes the city will be reimbursed most or all of the money, there was little certainty whether that would, in fact, happen as well as the growing expense—even as the city faces ever-growing bills over the next twelve to eighteen months from the prohibitive costs of municipal bankruptcy. Already San Bernardino has had to cut public safety, outsource jobs, and agree to a settlement under which its retirees will lose some $40 million in health benefits. Councilmembers Fred Shorett and Jim Mulvihill, who voted against the funding, wondered whether and how the decision might affect the city’s case in the U.S. bankruptcy court before Judge Meredith Jury—including with regard to the city’s fiscal discipline, noting: “We’re in bankruptcy because previous councils refused to say no.”

As we have written before, the exceptional complications of democracy and municipal bankruptcy—as provided under certain state authorizations of municipal bankruptcy, such as Alabama and California—create singular civic challenges—challenges that are about governing—and in sharp contrast to municipal bankruptcies in states such as Michigan and Rhode Island, where the Governor appoints an emergency manager or receiver and the mayor and council are barred from any role or governance responsibility—as are the voters and taxpayers. So it was perhaps unsurprising this week to note that the San Bernardino community came out in force for the meeting to determine the fate of the agency, an agency which, over the last four years has served about 48,000 people through job training, placement, and other services.

Cadena de Eventos. With the Congress off in the hinterlands and having spurned any action to provide Puerto Rico or its municipalities any access to municipal bankruptcy, the U.S. territory is on the brink of setting in motion a chain of events (cadena de eventos) which will take us into a state and local bankruptcy twilight zone—as tens of thousands of creditors will be caught up in unrefereed negotiations about how to restructure Puerto Rico’s $72 billion debt—with the triggering event the almost certain default of the Puerto Rico Public Finance Corporation, for which the legislature has not appropriated the requisite $58 million necessary for the utility to make payment to its bondholders tomorrow. That the default will happen should hardly come as a surprise: Governor Alejandro Garcia Padilla made clear last month that Puerto Rico cannot repay its obligations and sought a delay in debt payments—even as he hopes to propose a debt-restructuring plan by September 1st. The non-payment at issue, defined as a moral obligation bond—as opposed to full faith and credit—because it is dependent on a legislative appropriation—is more like the first granules in an avalanche that offer the briefest of warnings of what could follow. Nevertheless, with the Public Finance Corp. having (technically) until the end of business on Monday to make the payment, Puerto Rico tomorrow will enter into an uncharted and unprotected fiscal future—a future lacking the protections of a U.S. bankruptcy court to ensure the provision of essential public services—and a future in which those most at risk—such as Puerto Rico’s retirees and poorest U.S. citizens—will be least equipped to achieve a fair outcome or a sustainable fiscal future. Puerto Rico’s largest pension fund, according to Moody’s, could deplete its assets by 2020: it has 0.7 percent of assets to cover $30.2 billion of projected costs, according to financial documents. The PFC default will not be the only one tomorrow: other Puerto Rican debt payments due tomorrow include $91.5 million of principal and interest on Municipal Finance Agency bonds repaid with payments from San Juan and other towns—in addition to $252 million of principal and interest on debt backed by the island’s sales-tax levy. There are also Government Development Bank bonds due tomorrow (The bank, which lends to the commonwealth and its municipalities, has $140 million of municipal bonds maturing $29 million in interest payments due, according to data compiled by Bloomberg.) Perhaps forgotten in this telescoping of fiscal events is that Puerto Rico and its instrumentalities are not just facing default, but also a perilous slope of capital borrowing costs: costs which have increased by close to one-third.

Puerto Rico & Greece: A Disparity


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

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

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

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

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

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

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

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

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

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

The Challenge to Fiscal Sustainability of Public Safety


April 30, 2015
Visit the project blog: The Municipal Sustainability Project

The Fiscal Challenge of Public Safety. The gun shots that caromed in Ferguson, Missouri last year in the wake of riots which broke out after a white police officer shot and killed Michael Brown, a black teenager, echoed this week with the death of a young black man, Freddie Gray, in Baltimore. How the city, which has demonstrated remarkable fiscal resiliency, but which now confronts a more challenging fiscal future, responds will be a grave fiscal, human, and governing challenge. What can the Mayor and Council do to quell the violence and not only prevent families from leaving the city and eroding its tax base, but also not discourage other families and businesses from coming in? The President has condemned as inexcusable the looting and arson that spread across the streets, even as U.S. House and Senate negotiators yesterday agreed to a joint budget resolution which not only retains a sequester on domestic discretionary spending, but also specifically bars, “except in the case of Federal assistance provided in response to a natural disaster, any entity of the Federal Government from providing funds to State and local governments to prevent receivership or to facilitate exit from receivership or to prevent default on its obligations by a State government.” In a federal budget under which federal spending for defense will grow more than $100 billion and spending on every other category of spending will grow, the conferees focused on the smallest part of the federal budget to exact a toll. President Obama implied that the Baltimore Police Department had “to do some soul-searching,” as can be understood from a meticulously reported investigation by The Baltimore Sun of lawsuits and settlements that had been generated by police-brutality claims―and which have imposed nearly $6 million in settlements and legal costs on the city’s budget since January 2011. The Sun report noted: “Over the past four years…more than 100 people have won court judgments or settlements related to allegations of brutality and civil rights violations.” For his part, the President this week said: “This has been a slow-rolling crisis…This has been going on for a long time. This is not new, and we shouldn’t pretend that it’s new.” The President added that addressing the problem would require not only new police tactics, but also new policies aimed at helping communities where jobs have disappeared, improving education, and helping ex-offenders find jobs. The big mistake, he warned, is that we tend to focus on these communities only when buildings are burning down. But the message to Baltimore from Congress this week was unequivocal: ‘don’t count on us for anything but further disinvestment.’

In our report on six cities in fiscal distress, we found that Baltimore, like Detroit and other major U.S. cities confronting serious fiscal challenges, had experienced a severe population erosion: the city reached a peak population of 949,708 in 1960—a time when 30% of Maryland’s population resided in the city, but by 2010, the population had dropped to 620,961 and the city’s share of the state’s population fell to 11%. Like Detroit and many Eastern and Midwestern cities, a significant portion of this loss in population is attributable to the decline of its industrial base and suburbanization: Baltimore lost 110,000 jobs between 1990 and 2010—about 24% of all jobs―with some seventy percent of those lost jobs in manufacturing and related industries. The combination of job losses and population declines left the city with approximately 16,000 vacant and abandoned properties in the city—the equivalent of one blighted property for every 40 residents; it left the city with a median household income 44% lower than that of the state, but with crime 86% higher. Nevertheless, unlike other cities in our report, Baltimore was never in a fiscal emergency: it has maintained a relatively healthy balance sheet. Its largest categories of spending are public safety (30%) and the transfer to the local board of education (13%)—compared to just 6% for debt service. The city’s primary sources of revenue are the property tax (44%), state grants (15%), local income tax (13%), and federal grants (10%). The latter, of course, is declining—while the city’s single most critical source of revenues, property taxes, has abruptly been rendered at greater risk by the recent events. In our studies for the MacArthur Foundation, we determined that what set Baltimore apart from our other case studies (San Bernardino, Providence, Pittsburgh, Chicago, and Detroit) was the absence of financial emergency. The city’s adoption of a 10-year financial plan in 2013 provided a blueprint to demonstrate the difference between projected levels of spending and revenue (if no changes were made in policy or operations). That action provided a substantive basis for proposing changes to policies and operations. That is, despite significant challenges related to poverty, blighted housing and the need for broad economic development throughout much of the city, we found that “Baltimore is on solid financial ground. It has an AA- bond rating and holds an unrestricted fund balance of $216.5 million (equal to approximately10% of the city’s budget).” The city’s pension liabilities for police officers and fire fighters were funded at 82% and for other city employees at 73%―figures comparable to national averages for local governments nationwide—or, as we noted at the time: “Baltimore serves as a valuable case study in that it provides an opportunity to distill key factors that have contributed financial resiliency spite of significant declines in population and employment.” Key factors in the city’s fiscal sustainability, we found, related to its five-member Board of Estimate, which plays a particularly strong role in developing the city’s budget and monitoring monthly finances of the city: under Baltimore’s charter, the City Council cannot increase the overall budget from what the Board proposes; it can only decrease it. The Board has three members who are elected at-large by voters: the Mayor, Council President, and Comptroller. The remaining members are the Director of Public Works and City Solicitor—both of whom are appointed by the Mayor. The Board is constituted so that all members have a citywide perspective (rather than a ward-based perspective); it holds public meetings weekly to approve all contracts and oversees all purchasing in the city. Finally, we concluded: “the confluence of professionalism in budgeting and financial administration combined with a political culture where the advice and guidance of those professionals is heeded by elected officials contributes to Baltimore’s fiscal resiliency.” That resiliency now will be tested as mayhap never before.

In Like Flint. Michigan Gov. Rick Snyder yesterday declared the four-year long state of financial emergency is over in the city of Flint—the same day on which a state board approved a $7 million emergency loan, which Flint plans to use to plug a general fund deficit. As part of the Governor’s declaration, a receivership transition advisory board made up of five state appointees will now replace Jerry Ambrose, Flint’s emergency manager: the board will oversee the city for an undetermined period of time, but Mayor Dayne Walling, the city administrator, and city council will assume authority and responsibility over most daily operations. Michigan has taken over Flint, located 60 miles from Detroit, twice in the last 10 years, most recently in 2011. For his part, Mayor Walling yesterday said: “The citizens are back at the table,” while Deputy Treasurer Wayne Workman noted that it is routine for Michigan to give local governments a loan as they exit emergency management. In restoring local control, the state said that Flint had achieved several goals under emergency management, including reducing long-term liabilities more than 70% from $850 to $240 million. The restoration of authority comes in the wake of the city council and mayor having enacted several long-term fiscal sustainability measures―including the adoption of a two-year budget, five-year projections, a strategic plan, establishment of a fund balance reserve, and a budget stabilization fund. In making the announcement, Michigan Gov. Rick Snyder noted; “This is a new day for Flint, and the city is ready to move toward a brighter future…These are important steps as we work together to transition back to local control in the city.” Nevertheless, the road ahead promises to be arduous: Flint’s retirees have filed suit against the municipality to block post-retirement health care benefit: should they prevail, the city could find itself back in a fiscal quagmire. Moreover, in the wake of its separation from the Detroit public water system, the city is encountering new, unanticipated fiscal challenges: in moving to draw its municipal water from the Flint River, the city has been found to be in violation of the Safe Drinking Water Act due to high levels of trihalomenthanes.

Ill Fiscal Winds in the Windy City. Nuveen Asset Management LLC , in a new research report, warns that the City of Chicago could sink into speculative-grade territory if it fails to make quick headway in tackling its pension and long-term budget challenges, with author Kristen DeJong writing: “Chicago faces many fiscal challenges, and failure to swiftly address these issues could lead to further rating downgrades into sub-investment grade territory…How the city addresses its unfunded liabilities, including a looming pension payment spike next year, will be key to the city’s fiscal trajectory.” Looming over Mayor Rahm Emanuel’s new term is the city’s $19 billion in unfunded pension obligations, including a $550 million public safety pension payment spike, and a roughly $400 million operating deficit. The ever insightful Ms. DeJong adds that Moody’s moody downgrading last Winter added fiscal insult to financial misery because it triggered termination events on four interest-rate swap contracts, exposing Chicago to payments totaling $60 million if demanded by the counterparties: Chicago has renegotiated the terms of one of the swaps, avoiding a potential $20 million payment, and is working with Wells Fargo to address another. But it is the city’s pension challenge that poses the greatest threat to the city’s fiscal sustainability, with Ms. DeJong noting that balancing the budget and addressing the Windy City’s massive pension strains after years of underfunding poses a formidable task―a task so formidable she warns that it makes a “property tax increase inevitable.” If inevitable, it confronts the wily Mayor with a different kind of challenge in the wake of his election-runoff reelection, during which he campaigned on a promise to balance the city’s budget without a property, sales, or gasoline tax increase—even going so far as to call a property tax hike a last resort if state lawmakers fail to come through on a wish list that includes reform legislation that phases in the public safety spike, approval of a casino, and other tax proposals. A critical challenge for the city, as Nuveen notes, is the city’s reliance on the Illinois legislature—as, absent favorable action, the city loses control of its own revenue destiny: “Additional revenue raising opportunities such as a Chicago-based casino or expanding the sales tax to apply to services would require legislative action by the state and may take too long to implement to fund the looming pension payment.” In one bright spot, the Nuveen report cited recent studies by the prestigious Chicago Civic Federation, which has reported in a recent analysis that determined Chicago has the lowest effective tax rate among cities in Cook County and was among the lowest in a larger five-county region. Yet, even such a property tax increase—notwithstanding the Mayor’s campaign pledge and the sheer challenge of gaining city council approval—would have to be very significant if the city is unable to gain some public benefit reductions. Ms. DeJong notes that the size of any property tax increase would, absent other governmental relief, be exorbitant: a Chicago homeowner of a $400,000 property with a current property tax bill for $6,873 would be confronted with a $3,355 increase to fully fund the city’s growing public pension liabilities. While Mayor Emanuel has gained support for reform legislation for laborers’ and municipal employees’ pension funds that raised contributions and cut benefits, even those gains could be at risk: they are the subject of a legal challenge and await final decisions by the Illinois Supreme Court. The gravity is such, Ms. DeJong notes, that the scope and growth of Chicago’s unfunded liabilities raise the question whether solvency is at risk.

Taking Steps to Avert Municipal Bankruptcty


April 28, 2015
Visit the project blog: The Municipal Sustainability Project

Avoiding Municipal Bankruptcy. Wayne County Executive Warren Evans yesterday proposed a “recovery plan” to address the dire fiscal sustainability crisis in the county which surrounds Detroit, proposing cuts of $230 million over four years. He warned: “The county is in a very dire financial situation…(The plan), in my opinion, represents the most equitable and efficient attempt to eliminate the county’s unsustainable fiscal future: If we go on with business as usual, the money is going to run out in 2016…This plan will prevent bankruptcy even though in some areas we are worse off [than when] Detroit was pre-bankruptcy.” Since 2008, the county has plugged its general fund shortfall by shifting funds from its pooled cash fund, a move that has amounted to what the County Exec termed “robbing Peter to pay Paul.” By next summer, the county will not be liquid enough to rely on fund transfers anymore and will be entirely out of money, he warned: “This is a plan that will fix it if we come together as Wayne County…If not, it will come to the next level, whether that’s an emergency manager or a bankruptcy; trust me, it’s going to get fixed.” He blamed many of Wayne County’s problems on a loss of property tax revenue and “fiscal and managerial mismanagement:” The county receives 60% of its general fund revenue from property taxes, which fell nearly 33% to $289 million by FY2013 from $408 million in FY2008. Under his proposal, he said he assumes no increase in property tax revenue until 2018, and then only a $4 million boost.

Mr. Wayne’s proposed plan projects it would eliminate the county’s $52 million structural deficit; it does not address a $200 million, bond-funded jail project in downtown Detroit that the county abandoned half built due to lack of money. Mr. Evans said those problems would be tackled within a broader deficit elimination plan, but erasing the County’s structural deficit was the first step toward recovery: “We’re not going to be to do any of the projects we’ve talked about; we’re not in a position to borrow money or to do anything new until we get rid of the structural deficit.” Over the past six years, Wayne County has transferred millions of dollars from the county treasurer’s delinquent tax revolving fund to bolster the general fund. In 2014 and 2015, respectively, $91.6 million and $78.9 million was moved from the delinquent tax fund to the general fund, covering the county’s operating deficit for each year. Without the cash from the delinquent tax fund, however, which is dwindling, Wayne County has a structural deficit that has averaged nearly $52 million each of the last four years, according to Mr. Evans, so that adding to the deficit, the county has taken about $20 million from its general fund each year to help buck up its public pension system. But with the measures in his recovery plan, Mr. Evans projects annual general fund surpluses totaling $36.8 million from 2016-19.

Nevertheless, a key union leader deemed the proposal “essentially a nonstarter.” Under his proposal, the County Executive’s package proposes: pay and benefit cuts for current employees: All county employees would see 5% salary cuts; the end of post-retirement health care benefits for future retirees; and a restructured pension system. Mr. Evans described his proposed plan as “strong medicine” \which is necessary to fix an annual structural deficit that has grown to $70 million and a public pension fund that is funded at less than 50 percent. Absent action, he warned, Wayne County will be insolvent by August of next year. Under his proposal, there would be a 5 percent wage cut for most union and nonunion county workers, except for police officers; prosecutors, and nurses, would be exempt. He proposed changing labor agreements to allow work performed by county employees to be outsourced; cutting health care benefits for employees, as well as retirees, with retirees who retired before 2007 offered stipends to received health care. The county projects the health care cuts would save the county $28.4 million in 2015, with savings growing every year and hitting $49.8 million by 2020. Mr. Evans proposed restructuring Wayne County’s pension system, including cuts in future benefits and raising the minimum retirement age to 62 (currently, employees can retire at age 50 with 25 years of service, or 60 with five years of service). In response, Al Garrett, president of AFSCME Council 25, said the County Executive’s plan leaves out possible sources of new revenue, such as a millage request, and it unfairly exempts employees of the sheriff’s and prosecutor’s offices from cutbacks. Mr. Garrett also noted that he wished AFSCME had been asked for its input while the County Executive developed the plan, instead of being presented with it and then asked for suggestions; nevertheless, he allowed that the union had suggested a couple of ideas yesterday during its briefing with Mr. Evans and officials “seemed to be interested in them.”

Governance Issues. While the County Executive reported that his plan does not require approval by the Wayne County Commission, provisions, such as those related to collective bargaining agreements, would require board approval. Those provisions could be submitted to the board within a few weeks, depending on whether the county’s unions accept the plan. County Executive Evans warned that Wayne County’s pension fund is less than 50 percent funded and needs $910 million to become fully funded—even as, since 2008, property tax revenues have dropped $100 million annually. Thus, he warned: “Health care costs have to be significantly reduced for employees and retirees: For example, we have to eliminate health care for future retirees. And we’re going to have to move to high-deductible plans for employees and some retirees.” Since he took office this year, the County Executive has proposed a series of initiatives aimed at shrinking the county’s unsustainable fiscal situation, including the consolidation of three departments and a division, and a countywide spending and hiring freeze―all measures which are incorporated as part of the recovery plan. He added that last week, the county had offered AFSCME Council 25 a four-year contract with the 5 percent wage cut, the elimination of vision coverage, and an increase in employee contributions for health care insurance. He reported the union plans to file an unfair labor practice charge against him with regard to the proposed wage and benefit cuts; AFSCME’s local president Al Garrett said Wayne County workers have already taken 20 percent wage cuts and furloughs, and have gone six years without raises. The plan would eliminate health care for future retirees. It would move most employees and some retirees to high-deductible insurance plans and provide retirees with fixed and limited subsidies for the purchase of supplemental insurance, likely under the new federal health care law, similar to a move Detroit made in its plan of debt adjustment, shifting retirees to the national exchange. Mr. Evan’s plan would lift the retirement age to 62 and reduce future pension benefits by changing the pension multiplier, as well as increase the number of years used to determine compensation to 10 years from the current three- to five-year level. Altogether the cuts would mean $60.3 million in savings for the county’s funds, including $53.4 million in the general fund. Mr. Evans noted that county officials are working on revenue-generating ideas, but that he will not rely on them to balance the budget. Finally, the County Executive stated that he had delivered the plan to unions and elected officials yesterday prior to the press conference, making clear he expects a “lot of dialogue…But at the end of the day, the numbers have to total $52 million, and if they don’t, it’s a nonstarter.”

The Profound Challenge of Municipal Bankruptcy and Municipal Democracy

April 27, 2015

Visit the project blog: The Municipal Sustainability Project 

Post Municipal Bankruptcy Planning. Even as San Bernardino’s elected and appointed leaders are desperately working to meet U.S. Bankruptcy Judge Meredith Jury’s May 30 deadline to submit the bankruptcy city’s plan of debt adjustment, they are also trying to chart of post-bankruptcy future—and trying to accomplish this exceptional challenge in public meetings and discussions. The city’s-hired consultant Friday noted that San Bernardino’s charter is a significant obstacle, calling  it not only “unusual,” but also the greatest obstacle to the city’s fiscal, or post-bankruptcy future, saying its structure and vagueness “leads to turf fighting, friction, and difficulty getting things done.” The consultant, Andrew Belknap, a regional vice president for San Jose-based Management Partners, told the public meeting the city’s charter is a contributing factor to the city’s operational structure being “more complicated than other cities of its size.” Mr. Belknap presented a 19-page draft document: a draft which included priority goals in several areas: public safety, education and workforce development, quality of life, infrastructure and housing, business development and job creation, community engagement, public relations, and governance. This was not a new issue to the 17 gathered local leaders from various fields, including elected leaders, education, and business when they began this profound effort to remap a municipality’s future last March, but reaching some agreement has become increasingly urgent as the clock is ticking down. Unlike a private corporate bankruptcy, where the issue is about dissolving, municipal bankruptcy is a complex process that must encompass ongoing operations, exceptionally complex negotiations between all the creditors in order to put together and submit to a federal court a proposed plan of debt adjustment—but also a sustainable fiscal map for the future. Or, as San Bernardino County CEO Greg Devereaux, a committee member, and a former Ontario city manager put it: “It’s one thing to have goals, but there needs to be a decision about what is the job of the city and the role of the city in these goals.” Thus, interestingly, at the public meeting Friday, city staff also proposed, as part of the draft Strategic Action Plan: spending $1.7 million on ongoing additional emergency response personnel; $1.5 million for improved library hours, technology, and resources; and $300,000 annually for a repaid response team to rehabilitate vacant and boarded-up structures. Mike Gallo, president of the San Bernardino City Unified School board, and a member of the 17-member citizens group described that as “the most encouraging and surprising thing to come out of the meeting…It was the first time I have seen the city staff engaged in the planning process with the community…I could hear in their voices and see in their eyes that they were excited.” A related part of Friday’s discussion was to review the six guiding principles for the city’s strategic action plan, including the plan to form “a sustainable local government delivering a competitive mix of municipal services” and the city forming a “system of governance that is proven to ‘support satisfactory performance by other municipal corporations of comparable size and complexity.’” But, as Mr. Gallo responded: “This is the lowest expectation I can possibly imagine: We want to prosper. Not just set the floor.” An intriguing part of this discussion came near the end with a discussion between the city’s former and current mayors: former Mayor Pat Morris said he agreed with Mr. Gallo that the proposed mission statement was “mundane in the extreme;” he said the strategic plan needed to align more closely with the ambitions of the priority goals. Nonetheless, the former Mayor praised the meeting overall: “This process is unique in the city’s history…This process is important not just for the strategic plan, but for the advocacy for change.”

Running Out of Time. Standard & Poor’s has significantly downgraded Puerto Rico’s general obligation debt from a B rating down to a CCC plus grade, meaning S&P now grades the U.S. commonwealth’s debt rating four notches above the lowest possible grade of “default.” With Congress set to recess at the end of this week, the U.S. territory’s options for avoiding insolvency and default are waning. S&P reasoned that the island’s access to markets has further weakened, and that political problems, particularly a lack of consensus on elements of the 2016 budget, could further worsen fiscal pressure on the territory: “We base our downgrade…on our view that the commonwealth’s market access prospects have further weakened and Puerto Rico’s ability to meet its financial commitments is increasingly tied to the business, financial, and economic conditions on the island. Absent improvement in those conditions, we believe debt and other financial commitments will be unsustainable.” S&P’s sovereign downgrade came in the wake of the credit rating agency’s earlier downgrade of the Puerto Rico Electric Power Authority (PREPA) to CCC-minus from CCC, with S&P analyst Jeffrey Panger writing that a default seemed inevitable within six months. S&P reported it is concerned by PREPA’s repeated draws on its debt service reserve: PREPA withdrew $42 million in July of 2014, $9 million in October, and then $9 million this month, leading Mr. Panger to write: “We believe a default, distressed exchange, or redemption appears to be inevitable within six months, absent unexpected significantly favorable changes in the authority’s circumstances.” Mr. Panger also noted PREPA had a structural shortfall of revenues compared to expenses and a questionable access to the capital markets―and that it is unclear if PREPA could draw on the $236 million it has on deposit at the Government Development Bank for Puerto Rico. The public utility has $8.3 billion in bonds outstanding. Additional debt brings its debt total to over $9 billion. Both Moody’s and Fitch Ratings predicted a PREPA default is likely.

April 24, 2015

Facilitating Recovery from Municipal Bankruptcy. Stating that “We need to ensure Detroit’s debt is repaid under the terms of the bankruptcy to allow the city to continue its recovery,” Michigan Gov. Rick Snyder yesterday signed into law SB 160, new legislation, adopted overwhelmingly (107-3) in the House last Wednesday, which will provide the city’s municipal bondholders a statutory lien and intercept on Detroit’s income tax. The Governor added: “The savings from lower interest costs will allow Detroit to reinvest in critical areas like public safety and municipal services.” The state actions will likely not only pave the way for the Motor City’s reentry into the municipal bond arena, but also avert any potential adverse credit contagion for other cities and counties across the state. It marked still another sign of essential state support for the city’s future. SB 160 was enacted to create support for some $275 million in municipal income-tax backed bonds that the city privately placed with Barclays last December when it emerged from municipal bankruptcy. The agreement with Barclays required Detroit to roll its debt into long-term municipal bonds within 150 days of the placement—marking the key event of the city’s first post-bankruptcy public financing. While Gov.   Snyder called the bill a “technical fix,” it marks not just a milestone in the city’s return to the municipal market, but also a legal step which could save the city and its taxpayers some $20 million and $30 million in interest costs over the life of the bonds. Under Detroit’s agreement with Barclays, it will have to obtain at least two credit ratings; consequently, city officials hope the new statutory lien and intercept feature will win investment-grade ratings for the debt―currently all of the city’s bond debt is junk rated. Fiscal analysts reviewing the new law said the lien and intercept could save the city between $2 million and $3 million a year on debt service: the $275 million of bonds, which currently feature eight- and 10-year maturities, are Detroit’s only debt backed by an income tax pledge.

It Ain’t Over Until It’s Over. The U.S. 11th Circuit Court of Appeals yesterday ruled that Jefferson County, Ala., can proceed with an appeal related to the county’s plan of debt adjustment in which the County is challenging last year’s decision by U.S. District Judge Sharon Blackburn to reject Jefferson County’s position that its successful exit from municipal bankruptcy cannot be unwound, because its plan of adjustment has been largely consummated. While the appeal is specific to the county’s municipal bankruptcy, its outcome could have reverberations for cities and counties across the nation: in this case, both the Securities Industry and Financial Markets Association and the National Association of Bond Lawyers have filed amicus briefs claiming that a determination by the 11th Circuit Court of Appeals is essential to the stability of the municipal bond market and the certainty of future Chapter 9 bankruptcy cases—briefs accepted by the court this week. The issue revolves around U.S. Bankruptcy Judge Thomas Bennett’s confirmation of Jefferson County’s plan of debt adjustment from two and a half years’ ago—a confirmation which cleared the way for Jefferson County to proceed with the sale of $1.8 billion in sewer refunding warrants to write down $3.1 billion in related outstanding debt. That plan, as approved by the federal court, included provisions to protect new bondholders, including what some believe to be a precedent-setting provision under which that the federal bankruptcy court would continue to oversee promises made by Jefferson County to raise sewer rates over the next 40 years in order to service the sewer debt. But Judge Bennett’s confirmation was appealed by former broker-dealer Calvin Grigsby, a financial advisor and attorney representing a group of local residents and elected officials who are ratepayers to the county’s sewer system—an appeal which Jefferson County sought to dismiss; Jefferson County argued the appeal was constitutionally, statutorily, and equitably moot, because its approved plan of debt adjustment had been largely consummated, and because the ratepayers failed to ask the federal court to issue a stay which would have delayed implementation of the plan during the pendency of an appeal. Nevertheless, Judge Blackburn last September held that the ratepayers could continue their challenge, and that she could find some portions of the confirmation plan unconstitutional. In its amicus brief, the Securities Industry and Financial Markets Association wrote that a prompt review of the lower court’s decision was “imperative to the continued stability and accessibility of the municipal bond market…Accepting the petition will resolve the uncertainty caused by the challenged order about the finality and integrity of confirmed, non-stayed plans of adjustment that contemplate an emerging debtor’s issuance of new bonds or warrants to finance governmental projects and operations, thereby enhancing market acceptance.” The National Association of Bond Lawyers, in their amicus brief, wrote that resolving uncertainties with regard to the finality of U.S. Bankruptcy Court decisions with regard to cities’ or counties final plans of debt adjustment “would assist other financially challenged municipalities who are considering using the Chapter 9 plan process as a way of successfully accessing the public financial markets and to purchase of bonds proposed to be issued under confirmed Chapter 9 plans.”

How Do City’s Leaders Communicate to Citizens & Taxpayers in Preparing a Municipality’s Plan of Debt Adjustment to Exit Municipal Bankruptcy? Meanwhile, in San Bernardino, which is struggling to complete its own plan of debt adjustment under an-ever approaching deadline set by the U.S. Bankruptcy Court, the challenge of juggling the completion of that plan with the city’s responsibility to keep in communication with its citizens and taxpayers has continued to prove to be an exceptional challenge. How, after all, can one fashion a plan that attempts to divvy up far less than what one owes to thousands upon thousands of a city’s creditors—many of whom, after all, are city residents or businesses and taxpayers, in public? Would it be like a football team televising its deliberations in the huddle before the next play? This challenge of democracy in municipalities like Stockton and Jefferson County—and unlike in Detroit or Central Falls, Rhode Island—cities where the state municipal bankruptcy law, by means of the imposition of a receiver or emergency manager removed traditional obligations of transparency with citizens and taxpayers—is a more difficult hurdle. To give an idea of how difficult the process is, a struggle has erupted in San Bernardino with regard to whether a public meeting of the group leading the city’s strategic planning process last night should have been recorded or not — but not broadcast live — has consumed endless hours and emotions. Until Wednesday, City Manager Allen Parker had told City Council members and residents who requested a video recording of the daytime meeting — a meeting, after all, intended by key San Bernardino leaders to both communicate and secure support from the city’s citizens and taxpayers for any final plan of debt adjustment it will submit to U.S. Bankruptcy Judge Meredith Jury next month, that only an audio recording would be available. The decision, Mr. Parker wrote in an email Tuesday night, was made by school Superintendent Dale Marsden, whose San Bernardino City Unified School District both hosted and paid for the event and facilitator, because that facilitator was concerned participants would not speak candidly were it televised live—a decision that appeared to do more harm than good: it outraged Council Members and residents on both sides of the political aisle that divides San Bernardino citizens—or, as one city resident wrote: “We have been told repeatedly that our involvement in the Plan of Adjustment is critical to the success & implementation…Why the decision on this is not at city level is baffling. Why you have decided contrary to the city administration request to televise is mind numbing. The decision to not televise damages the credibility of the process and further amplifies the growing apathy in our city.”