Who Will Take Responsibility for Detroit’s Future?

January 19, 2016. Share on Twitter

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

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

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

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

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

The Odds of Staying out of Municipal Bankruptcy

November 13, 2015. Share on Twitter

Rolling the Die: What Are the Odds of Fiscal Recovery? In the wake of Gov. Christie’s conditional vetoes of the package of bills intended to help Atlantic City avoid the need to seek bankruptcy protection and the threat to essential public services, New Jersey Senate President Stephen Sweeney and Gov. Chris Christie, in a joint statement after the veto, said they would meet soon to “construct a final and fast resolution” to Atlantic City’s economic and fiscal stress—even as the Governor is in a critical point in his quest for the GOP Presidential nomination. The conditionally vetoed key elements of a rescue package approved by the legislature would have allocated $33.5 million in redirected casino taxes to pay off Atlantic City’s municipal bonds—and now leave the beleaguered city facing layoffs by the end of the year as Mayor Guardian and the Council grapple with a continued credit crisis.

The conditional vetoes, however, appear to have stirred up a regional hornet’s nest, even as they put Atlantic City between a rock and a hard place. Atlantic City Councilman Timothy Mancuso said the city is counting on more than $33 million in PILOT funds to balance its 2015 budget, noting: “It’s down to the wire, and now everybody’s throwing in different plans…“We can’t have that.” Chris Filiciello, a spokesman for Atlantic City Mayor Don Guardian, said Mayor Guardian “supports Governor Christie and Senate President leadership on this issue, and is looking forward to legislation being agreed upon and signed into law as soon as possible.” The problem, as one participant noted, is the critical time lost because of the Gov.’s very last minute veto—or as one party noted: “The past 12 months was the time to produce realistic alternative plans — now we need to focus on finishing the job of getting Atlantic City and Atlantic County back on the path to fiscal stability.” Atlantic County Assemblyman Chris Brown yesterday stated he would not vote for a sweeping plan to change the taxes paid by Atlantic City’s casinos, proposing instead an alternative which would increase the casinos’ annual tax bills by about $88 million in 2016 alone while keeping the city’s marketing and development agencies from being gutted. The new plan would, he hopes, replace the proposed legislation, a bill under which casinos would make a collective $120 million payment for 15 years, instead of traditional property-tax payments. The scurry to come up with alternative fiscal options come at the onset of what now could become a challenging state-local standoff, as well as a regional fiscal struggle. Gov. Christie’s conditional vetoes of the so-called PILOT package, even though they would maintain the payment in lieu of taxes or PILOT agreement’s structure, would give the state greater authority and control over the funds the agreement directs to Atlantic City. Thus the 24th hour conditional veto has triggered not only a state-local power struggle, but also a regional tussle.

Atlantic County Executive Dennis Levinson said he agreed that the Casino Redevelopment Authority needed one of the bills, which would have redirected some $25 million to $30 million in casino Investment Alternative Tax (IAT) collections to municipal debt payments, and that the casinos have to be assessed properly: “(The PILOT bill) just prevents the casinos from appealing their taxes for 15 years…It can be simplified. Assess the casinos fairly, correctly, properly.” That is to write that every local government in the region has a stake (bad pun) in the outcome—and the continuing delays in agreeing upon an outcome, because Atlantic City’s fiscal base relies on its casinos—not just for revenues, but also for employment: in addition to property taxes, Atlantic City’s eight casinos pay 9.25 percent in taxes on their gross gambling revenue. The 11th hour action by a Presidentially campaigning Governor now creates fear of risk that virtually all of the casino properties’ revenue streams, including revenue from food, beverage and entertainment operations, and jobs could be at risk. Assemblyman Brown reports that, in 2016 alone, the changes he is proposing would bring in about $11.8 million more receipts from his proposed 1.25 percent investment alternative tax, which funds the Casino Reinvestment Development Authority (CRDA), while his other tax on casino revenue, an 8 percent levy used to help seniors and the disabled in New Jersey, would, he reports, see receipts increase by nearly $76 million. In comparison, the conditionally vetoed PILOT package would have eliminated the $30 million annual budget of the Atlantic City Alliance, the city’s main marketing arm, and virtually defunded the authority, which orchestrates large development projects in Atlantic City, instead using those dollars to pay down Atlantic City’s debt and expenses. Assemblyman Brown, however, asserts that under his proposed pan, increased receipts from casinos could keep the alliance and authority running with $8 million and $10 million in annual funding, respectively. The CRDA could also forward $5 million of its IAT funds to the city as part of a PILOT for properties it owns in the city, and the remainder of, which he estimates would be about $18 million next year, would go to Atlantic City: or, as he put it: “If we are serious about protecting the future of Atlantic County…we need to preserve CRDA to continue to reinvest in nongaming attractions…At the same time, we need to market Atlantic City to ensure our continued growth and success.” The Assemblyman’s plan also calls for deeper county involvement in property assessments and proposes permitting Atlantic County to participate in property tax appeals valued at $10 million or more.

Why Not Tax the Guy Behind the Tree? Steven Scheinthal, General Counsel for Golden Nugget owner Landry’s Inc., presciently reminds folks: “If anyone thinks that they’re going to tax the casinos more than they already are being taxed, then they live in la-la land…And I bet you there’s seven other casino operators that would feel the same way.” In Rome, where the expression was tempus fugit or time is flying, the long delay by Gov. Christie is now on the verge of fiscal consequences, after all: Atlantic City Business Administrator Arch Liston Tuesday, in an epistle, warned that Atlantic City employees in five departments could be facing layoffs by the end of the year: the letter, sent by and first obtained by pressofatlanticcity.com, went to Atlantic City employees who work in the revenue and finance, health and human services, planning and development, public works departments, and the municipal courts—warning that such layoffs would take effect on Dec. 28. While the Governor delayed months in acting, Atlantic City faces an $11 million debt service payment due in December. That is not a payment that can be put off.

Addressing Structural Municipal Deficits or Compelling Municipal Bankruptcy?

November 11, 2015. Share on Twitter

Waiting for Godot. On the very last day before a package of legislation to help Atlantic City recover would have become law, New Jersey Gov. and GOP Presidential contender Chris Christie yesterday conditionally vetoed the bills, all intended as part of a state package the New Jersey Legislature approved last June, including legislation to establish a payments-in-lieu (PILOT) of taxes program for casinos over a 15-year period—meaning the $30 million the legislature had originally earmarked for Atlantic City will now be redirected to the state, boring a large fiscal hole in the struggling city’s fiscal recovery plans. The Governor conditionally vetoed:

• a bill to reallocate the casino alternative tax to pay debt service on Atlantic City-issued municipal bonds;
• a bill to cancel the Atlantic City Alliance’s partnership with the Casino Reinvestment Development Authority and direct its $60 million budget to the city for the next two years; and
• a bill in the legislation that would have required casinos to provide full-time employees with “suitable health care and retirement benefits.”

Gov. Christie did sign a bill in the relief package which authorizes supplemental school aid to the Atlantic City School District. In a statement accompanying his vetoes, Gov. Christie challenged Garden State lawmakers in his conditional veto message to devise a plan that “addresses the continuing structural deficit in a manner that does not merely shift the city’s obligations to the state,” noting: “While I commend the Legislature for attempting to devise measures to stabilize the City’s budget and finances, I am concerned that the bills, in their present form, fail to recognize the true path to economic revitalization and fiscal stability in the city…While these bills represent the bipartisan efforts of many to provide important, near-term support to the city’s immediate challenges, I do not believe they meet the goal of setting a course toward renewed, long-term prosperity, and economic growth. To achieve these goals, we must continue our work and go further to ensure that the next step leads to that economically vibrant future for Atlantic City.”

Gov. Chris Christie’s conditional veto of the Atlantic City payment in lieu of taxes legislation does not address how casino payments will be shared with the Atlantic County, thereby leaving local officials uncertain of its effect on their municipalities. The legislation had called for Atlantic City’s remaining casinos to pay $150 million in lieu of property taxes for two years, and $120 million annually for 13 years after that. Soon after the state Legislature passed the bill earlier this year, county and city officials called for a conditional veto because there was no agreement on how much of that money would go to the county, throwing a wrench into towns’ budgeting plans.

Next Steps. The New Jersey Senate and Assembly now have the option to make changes that might satisfy Gov. Christie’s objections, albeit with the Governor having been out of the state and in still another GOP Presidential debate tonight, the options for meaningful discussions appear to have been rare. Atlantic County Executive Dennis Levinson and Atlantic City Mayor Don Guardian had agreed Atlantic County would receive 13.5 percent of casino payments; however, that compromise was unacceptable to Atlantic City Council members; now some of the mayors in the County are calling for Atlantic City to file for municipal bankruptcy, rather than any proposal which they fear might put them at fiscal risk, such as the proposed PILOT agreement, under which there has been apprehension over the possibility of ever-larger county tax bills for 15 years.

Atlantic County Executive Levinson, in the wake of the vetoes, said he will sit down with Atlantic City and New Jersey officials to reach a compromise, noting: “I don’t want to gum things up and act like I didn’t get what I wanted…I don’t believe the Governor in his wisdom wanted winners or losers in this, but he wants a viable, good plan acceptable to everybody.” In fact, the Atlantic County freeholder board, the Atlantic County Mayors’ Association, and the League of Municipalities had joined the County Executive in calling for a conditional veto to specify the county share, arguing that anything less than 13.5 percent would transfer too big a county tax burden onto the other 22 municipalities in Atlantic County. By now, of course, the idea that there is a “good plan that is acceptable to everybody” appears more and more like a pipe dream.

Back to the Municipal Bankruptcy Option? In the wake of yesterday’s vetoes, several Atlantic County mayors said the best path forward now was for Atlantic City to file for chapter 9 municipal bankruptcy, with Galloway Township Mayor Don Purdy warning the region cannot have surrounding communities taking the hit for Atlantic City: “(Atlantic City) has too much old, lingering debt, and throwing good money at bad money won’t work…The only way to fix it is to go bankrupt at this point.” Egg Harbor Township Mayor James “Sonny” McCullough concurred, noting Egg Harbor suffered the most job losses after the casino closing and had the most foreclosures in Atlantic County, adding: “My recommendation — even before the PILOT — has been Chapter 9 bankruptcy…They need to reorganize their debt just like Detroit did. This is the best option of all, and it gives the municipality an opportunity to reevaluate its debt and reorganize its future.” Indeed, in the festering period while New Jersey municipal leaders awaited Gov. Christie’s 11th hour actions, mayors in surrounding municipalities had been warning taxpayers that their county tax rate would increase if Gov. Christie signed the PILOT bills. Atlantic County Mayors Association President Jack Glasser, the Mayor of Somers Point, said he had not had a chance to read the conditional veto, but said he would be disappointed if it did not clear up the issue of how payments would be shared, adding: “I’m going to have to discuss that with the mayors…Atlantic City needs help, but the bottom line is, it shouldn’t be on the backs of the rest of the county.” County Executive Levinson said he guessed that Gov. Christie was most likely intentionally vague about how Atlantic City and Atlantic County would share the payments in order to avoid creating winners and losers—something which no Presidential contender, after all, would wish to do. Mr. Levinson added: “Cool heads right now are what’s needed,” adding that he expects New Jersey’s Local Finance Board to have a lot of say in how the money is shared with the county, adding: “The Governor is always quoting Bruce Springsteen…“I’ll quote the Rolling Stones. ‘You can’t always get what you want, but if you try sometimes, you might find you get what you need.’”

With the issue thus sent back to the legislature, New Jersey Senate President Steve Sweeney (D-Gloucester) noted: “I am extremely disappointed in the Governor’s failure to enact the package of bills to aid Atlantic City’s financial recovery, and I am concerned by the time that was wasted since the plan was put on his desk close to six months ago…No one should ignore the fact that Atlantic City’s financial crisis continues and that a comprehensive, forward-looking plan is needed to prevent fiscal conditions from getting worse and that we need to act quickly. I am prepared to work constructively with everyone who is impacted by Atlantic City’s fate to help the city’s economy recover and grow.”

Municipal Elections: Will They Provide a Platform for Fiscal Sustainability?

November 6, 2015. Share on Twitter

Voting for a City’s Post-Bankruptcy Future. In an election, where a majority, or four of the seven San Bernardino City Council seats were on the ballot, to determine half of the leaders who will shape whether and how San Bernardino might emerge from the longest municipal bankruptcy in U.S. history, only one-third of the city’s residents are even registered to vote. The greatest number of votes—in an election with an abysmal turnout of about 10 percent—came in the race for city Treasurer, where the incumbent, David Kennedy easily won reelection by a 2-1 margin. Or, as City Clerk Gigi Hanna, who was re-elected in an uncontested election, describes it: “It’s abysmal,” referring to the low turnout: “It’s a perennial problem in this area.” Councilman John Valdivia, who ran unopposed, was re-elected with 641 votes. In the 6th Ward, four candidates split a total of 983, while there were just over 1,500 votes cast in the 5th and 7th wards—where in the latter, 7th Ward Councilman Jim Mulvihill will face a runoff — albeit it remains uncertain who his opponent will be. Final, unofficial results appear to indicate that Bessine Littlefield Richard will face Roxanne Williams in a runoff for the 6th Ward. In the 5th Ward race, incumbent Henry Nickel won re-election with 66 percent of the vote, while incumbent San Bernardino Treasurer was easily reelected with 71 percent of the vote. In the city races where none of the candidates reach 50 percent, the top two vote-getters will advance to a February run-off. The runoff in the 7th – in the north end of the city, where the abysmal voter turnout was about 5% — centered on incumbent Councilmember Mulvihill, who had been elected two years ago in the wake of a recall election of Wendy McCammack. In the 6th Ward race to replace retiring Councilman Rikke Van Johnson, Littlefield Richard of San Bernardino County’s Workforce Development Department has been narrowly leading Roxanne Williams, a program specialist for the San Bernardino City Unified School District — 370 votes to 356 votes — reversing their order from the first round of results. However, both are assured placement on the runoff ballot, beating out Anthony Jones (156 votes) and Rafael Rawls (101 votes). Challenger Karmel Roe failed to dislodge the long-term hold of incumbent City Treasurer David Kennedy, who has served for some 24 years. A mortgage broker who ran for Mayor two years ago and the 5th Ward City Council in 2014, Mr. Roe attacked Treasurer Kennedy for not having done more to help a bankrupt city. The specific commitments Ms. Roe campaigned on that said she would do to change the office — demanding audits, taking control of the Finance Department, encouraging economic development in the city — are, however, not issues in the city which the treasurer is authorized to handle under the current city charter. Incumbent City Attorney Gary Saenz, City Clerk Gigi Hanna and 3rd Ward Councilman John Valdivia all, successfully—and unopposed, were re-elected.

Waiting for Godot. S&P yesterday reported it was keeping Atlantic City on credit watch negative as the credit rating agency awaits both an updated report by Emergency Manager Kevin Lavin and an expected decision by New Jersey Governor and aspiring GOP Presidential candidate Chris Christie whether and when he might sign into law a financial assistance package approved by the New Jersey State Legislature. Atlantic City Revenue Director Michael Stinson said he expects resolution on the fate of the legislature-approved rescue package by next week before the state Assembly and Senate return to session. If Gov. Christie takes no action before the new session, the five bills automatically become law, according to Mr. Stinson: “If the bills are passed than we are going to get revenue…The uncertainty of the bills should be resolved by next week.” Atlantic City, which is in a fiscal and governance Twilight Zone, with its municipal finances overseen by a state-appointed overseer and Mayor Don Guardian, is closing a $101 million budget deficit this year by firing employees, and crossing its fingers for a state assistance package approval. The city’s proposed budget, approved by the state’s Local Finance Board at the end of last month, depends on Governor and Presidential candidate Chris Christie’s approval of bills that would allow the city to spend $33.5 million of revenue from casinos that now goes to redevelopment projects and marketing. The Atlantic City budget was adopted nine months late, but came in time to mail fourth quarter tax bills and also fully funds its annual requirements for settled tax appeals. Emergency Manager Lavin, testifying before the legislature in Trenton, told state lawmakers the budget was an initial step to ease a fiscal crisis in the city, while Mayor Guardian testified: “We understand that we can’t get out of this by ourselves.” The unique partnership between Mayor Guardian and state-appointed emergency manager Lavin has led to the dismissal of more than 100 employees, reducing the city’s workforce by nearly a third, and deferring payments for employee pensions and health-care benefits, while continuing to meet Atlantic City’s obligations to its municipal bondholders. Nevertheless, S&P last month cut the city’s credit rating deeper into junk, because it had yet to lay out detailed plans for dealing with its fiscal distress. S&P ranks the debt B, five levels below investment grade. Moody’s Investors Service grades it two steps lower at Caa1.

S&P analysts Timothy Little and Lisa Schroeer noted in a report yesterday that while the state’s Local Finance Board approved a balanced Atlantic City 2015 budget in late September, that budget relies on anticipated revenues of $33.5 million in redirected casino taxes and $38.9 million in deferred pension and health care expenses. The pending assistance package adopted by the legislature last June of five bills would allow the redirection of casino taxes to pay debt service. S&P said the city reported it will be able to make an $11 million December 2015 debt service payment even the anticipated redirected casino tax revenue is not received. S&P dropped Atlantic City’s credit rating three notches by S&P in August due to uncertainty over whether it could meet its 2015 fiscal obligations. Now the city awaits both the decision of the peripatetic Gov. Christie as well as a second report from Emergency Manager Lavin which is expected anon. The city is rated Caa1 by Moody’s Investors Service.

Unaccountability? The road to municipal bankruptcy can be paved by inattention and unaccountability. Thus, a California audit of the City of Beaumont, an LA suburb, found that the city failed to properly account for nearly three quarters of a billion dollars’ worth of municipal bond transactions and that the municipality was unable to provide the State Controller’s office with any accounting records for the bond transactions—and that neither the current city management nor its employees were able to provide any information or records of bond transactions, according to the audit. Beaumont officials say they are already taking steps to address what the report called pervasive shortcomings resulting in non-existent accounting controls for the city: the state report found that 95% of the city’s internal control elements reviewed in an audit of fiscal years 2012-13 and 2012-14 were inadequate—or, as California Controller Betty Yee stated: “These kinds of deficiencies are of great concern,” adding: “However, I am encouraged that city leaders recognize the need to implement major improvements.” The audit uncovered widespread deficiencies that rendered them effectively non-existent, with 75 of 79 internal control elements determined to be inadequate, or, as Ms. Yee explained: “These kinds of deficiencies are of great concern, especially to the citizens of Beaumont, who rightly expect their city government to safeguard their tax dollars.” The state fiscal investigation came in the wake of an FBI and Riverside County District Attorney’s Office search conducted at Beaumont City Hall. Controller Yee launched her audit last May, a month after the Riverside County District Attorney’s office and the FBI executed warrants at City Hall, former City Manager Alan Kapanicas’ house, and the Beaumont offices of Urban Logic Consultants, a firm which had provided many of the city’s top managers on a contract basis. No charges have been filed, but the investigation is ongoing; the audit found improper accounting by three city agencies for bonds issued between 1993 and 2014.

Among the state findings:

  • The city failed to properly account for bond transactions by three of its units, including financing and utility authorities and a community facilities district that together issued $626 million in bonds. As a result, the Controller’s team could not determine whether the bond proceeds were used for the intended purposes.
  • The former city manager and former public works director, both principals of outside consultants that provided city staff, received fees from bond proceeds for their services. In the absence of any written agreements, it was unclear whether these services were separate from their responsibilities as city officials. These two officials approved payments to the consulting companies where they were principals, creating conflicts of interests.
  • In 2008, Beaumont obtained a reseller’s permit from the state Board of Equalization, allowing it to purchase items outside the city without paying sales tax, even though the city did not appear to be in the business of selling goods. Beaumont also allowed one of its vendors to use the permit. The arrangement allowed the city to shift sales tax revenues from other jurisdictions by moving the supposed point of sale within its boundaries.
  • The city did not consistently follow its competitive bidding laws. City staff bought equipment or let contracts for public works without competitive bidding, arguing that the vendor was the only source, yet failed to provide documents supporting this claim. In 2013, the city entered into a no-bid contract with Urban Logic Consultants that allowed engineering projects to be approved through “job cards” rather than open, competitive bidding.
  • The city lacked receipts and descriptions for credit card purchases, supporting documentation for loans made to employees, and sufficient records for a loan to a private business. Invoices were missing, including purchases from a construction company totaling more than $1 million.
  • For five years in a row, the city ended the fiscal year with material deficits of as much as $10 million in its General Fund. It did not have sufficient revenue to fund existing levels of service. The city said it would cover these deficits with $21.5 million owed by its redevelopment agency. However, the redevelopment agency has been dissolved and it is highly uncertain that amount can be collected.
  • Beaumont failed to do timely bank reconciliations and did not segregate staff duties.

According to acting City Manager Elizabeth Gibbs-Urtiaga, the findings of the Controller’s office confirm what the City Council and the new city management team uncovered last summer, in the wake of which, last month, the former city manager signed a separation agreement valued at $213,702.75 to terminate his contract, according to city documents—or, as Beaumont Mayor Brenda Knight said in a statement: “We have been very busy correcting the business practices going forward.”

Should Municipal Bankruptcy Be a Last Resort?

November 3, 2015. Share on Twitter

Complexities of Democracy & Municipal Bankruptcy. On the eve of an election, San Bernardino’s voters, tomorrow, could help determine or reshape the city’s chances of getting out of municipal bankruptcy—especially with regard to how any plan of debt adjustment addresses public safety and taxes. There are three Council seats at stake, as well as the city’s Treasurer. In a city where key votes related to its efforts to exit bankruptcy have been decided by one vote margins, this election could well reshape the city’s future—indeed, determine whether it will have a future. In the Council races, Councilman John Valdivia is running unopposed, while 5th Ward incumbent Henry Nickel is being challenged. Next door, with current Councilmember Rikke Van Johnson retiring, there is a heated four-way race. In the 7th Ward, incumbent Jim Mulvihill, who was elected two years ago in a recall election, is facing four challengers.

Polee, Polee. In Liberia, the elders in the village, Konweaken, where I lived and worked, used to caution us with those words—which, literally, translate to “slowly, slowly; but surely.” So too credit rating company Standard and Poor’s seems to be cautioning Chicago Mayor Rahm Emanuel in the wake of his success in gaining passage a record $548 million increase in the Windy City’s property tax—warning the adoption of the city’s budget and record tax increase represent notable progress, but, nevertheless, adding: “While the actions taken in this budget to raise property taxes are intended to address the cost pressures in 2016, they may not be sufficient to mitigate the city’s financial stress…In our view, the extent of the city’s structural imbalance, when factoring in required pension contributions, will take multiple years to rectify,” noting that Chicago confronts some $20 billion in unfunded public pension obligations—and that the pace with which the city plans to stabilize its pension obligations will continue to “place pressure on the city’s budget—one of the primary drivers of our rating.” S&P rates Chicago’s general obligation debt BBB-plus with a negative outlook. In its new analysis, S&P analysts Helen Samuelson, John Kenward, and Jane Ridley noted the property tax increase was an “important first step” toward dealing with skyrocketing public safety contributions under a 2010 state mandate; nevertheless, the trio expressed apprehension over the plan’s reliance on approval by the seemingly dysfunctional state of a re-amortization of the police and firefighter fund contribution schedule. Chicago’s proposal would reduce by $220 million the amount due next year to $328 million: if the proposed changes are not approved by the state, the city will owe, instead, $550 million. Under the city-adopted plan, Chicago would phase in the changes over five years to an actuarially required contribution (ARC) level which, under Illinois’ 2010 mandate, is supposed to take effect in 2016—with the first year’s payment finalized by the end of this year—a problematic deadline given the stalemate in Springfield—and failure, as the S&P trio noted, would put “even more stress on the city’s budget.” Chicago’s contributions to its four pension funds now run to $978 million, a 78% increase from the $550 million the city budgeted in 2015, and the deteriorated fiscal condition of its pension funds appear to be falling far short. S&P also expressed concerns over the long -term impact of a looming Illinois Supreme Court ruling deciding the fate of Chicago’s 2014 pension reforms to its laborers and municipal funds—changes on appeal to the Illinois Supreme Court in the wake of rejection by the lower court, with oral arguments looming this month. If successful in its appeal, Chicago would see public pension payments due next year fall by about $100 million. Nevertheless, the city would still need to come up with a plan to keep the funds solvent that does not rely on benefit cuts.

Won’t You Be My Neighbor? Wayne County has filed a class action suit against Wyandotte, a small city of about 25,000 inside of Wayne County, over tax revenues which were supposed to be collected as part of a judgment levy earlier this year. Wayne County is alleging Wyandotte and its Downtown Development Authority and Tax Increment Finance Authority instead collected taxes intended for the judgment levy for their own use. The levy in question derives from a ruling last June which requires Wayne County to replenish funds it pulled from a retirement fund. In its filing, Wayne County charged: “The (city of Wyandotte, its Downtown Development Authorities, and Tax Increment Finance Authorities) have stated that they…intend to capture revenue raised from a special purpose millage levied by Wayne County…(They) have misconstrued applicable law to conclude that they are required to capture revenue from the judgment levy…If (the city of Wyandotte, its DDA and TIFA) divert a portion of the judgment levy to their own use, the county will be unable to satisfy the judgment levy, because the revenue collected will be insufficient.” A key reasoning behind the filing by Wayne County—which is in a state of fiscal emergency, is to protect against any intergovernmental precedent whereby other municipalities, development districts, or tax increment financing authorities would not capture and use revenues from the judgment levy. While it is unclear how much Wyandotte’s tax increment finance systems have collected, Wayne County’s lawsuit does state “the amount in controversy exceeds $25,000, exclusive of interest and costs,” as it seeks a speedy hearing. Wayne County Commissioners are scheduled to meet Thursday to hear further updates on the matter, which relates to a one-time tax on property owners Wayne County adopted last June in order to raise sufficient revenue to pay a $49 million judgment in favor of a Wayne County retiree fund, stemming a lawsuit retirees filed against the county for pulling $32 million from its “Inflation Equity Fund—” the fund which provided retirees what is referred to as the “13th check.” The $49 million made up for the amount taken from the fund, plus lost earnings. In the wake of the ruling, Wayne County Commissioners adopted a resolution to use the delinquent revolving tax fund to pay for the judgment, but County Executive Warren Evans vetoed it. The result was the average Wayne County homeowner had to pay an extra $35 on her or his summer tax bill.

Will the View Be Downhill? The question before U.S. Bankruptcy Judge Alan Stout is with regard to what makes a municipality eligible for chapter 9 bankruptcy. Now the question appears to be coming to a head in the small municipality of Hillview, Kentucky, which became, last August, the first municipality to file for municipal bankruptcy since Detroit did in July of 2013, with Hillview Mayor Jim Eadens stating to the U.S. Bankruptcy court: “I believe that we did everything humanly possible to try to work this out, but we will not commit to something that is too much and that we believe will impair the city too much as far as our obligations to provide care and services to our citizens.” The filing came in the wake of the small city’s unsuccessful appeal of a court ruling ordering it to pay $11.4 million in damages to Truck America Training. Now attorneys for Truck America have challenged Hillview’s request to utilize municipal bankruptcy, citing federal rules which require a municipality to negotiate with all its creditors—not just one—before turning to chapter 9 municipal bankruptcy, noting that the municipality neither tried to make deals, nor did it try to raise taxes on the small city’s growing population. Hillview’s occupational tax, the city’s key source of revenue, is much lower than the region’s average rate: indeed, according to Truck America, raising the rate to 2% from 1.5% would give the small municipality an additional $500,000 in annual reveues. The trucking company attorneys added: “We don’t think they ever seriously tried to raise taxes or negotiate other debts,” and the city had rejected an offer to repay the Truck America debt at a 40% discount the day before the bankruptcy. The company is seeking to convince Judge Stout that Hillview should be ruled ineligible for municipal bankruptcy. In fact, the city appears to have sought to negotiate a repayment deal, including in talks which were led by retired U.S. Bankruptcy Judge and lead rhythm guitar player for the Indubitable Equivalents Steven Rhodes—but those talks led to naught—a breakdown which created apprehension on the part of Mayor Eadens that Truck America would gain the requisite authority to freeze the city’s bank account a second time—with the Mayor noting that when that happened the first time, it “was extremely disruptive, scary, and a real crisis in city operations,” in the city’s court filings. Hillview, a municipality of about 8,000 people had about $13.8 million in debt, compared with revenue of $2.5 million in the 2014 fiscal year. That is, the municipality, at least according to Moody’s analyst Nathan Phelps, is in sufficient fiscal shape to issue municipal bonds to cover losses in legal judgments and pay off the resolution over the course of a decade or, it could increase taxes on wages, business profits and property. That is, there might well be less expensive ways for the city to avoid being towed into federal bankruptcy court—and, with Truck America petitioning the federal bankruptcy court by filing an objection to the city’s petition, claiming “Hillview cannot sustain its burden of establishing eligibility under 11 U.S.C. § 109(c) and has not filed its petition in good faith,” it might well be that the federal court will concur.

Municipal Information. The Center for Integrity and Public Policy in Puerto Rico has started a web site and municipal financial index to provide statistics on Puerto Rico’s 78 cities, http://fiscal.cipp-pr.org: the site will provide comparative rankings of the cities, and will provide information in both English and Spanish, including the financial rank of each of the municipalities overall and on different measures In its press release, the Center found that Puerto Rico’s cities or muncipios were generally in a difficult financial position:
• 70 municipalities have negative net assets (unrestricted);
• 50 municipalities have a general fund deficit;
• 43 municipalities have an accumulated general fund deficit (that is, a negative general fund balance);
• 24 municipalities spend more than 15% of their budget on debt service;
• 40 municipalities receive over 40% of their revenues from the central government;
• Total long-term debt of the municipalities exceeds $5 billion.

OPEN Puerto Rico [http://abrepr.org/], which is not in English, (lo siento!) has, simultaneously announced the launch of a Municipal Financial Health Index for all 78 municipalities, noting: “With this index we are providing a new measurement tool that will allow residents to compare their municipality to the others on the island utilizing a series of standardized financial indicators…Mayors can often arrive at their own conclusions about the financial health of their municipality, but now they can do it using the index and its underlying indicators and data that is information that can be independently verified,” with the financial information on the site current to FY2013. Over time as new data becomes available, OPEN Puerto Rico will update the financial information and the index values. The index values are based on a statistical analysis of 13 financial indicators and how municipalities compare to the current Puerto Rico municipal averages. The indicators of short-term financial health have a greater weight than the long-term measures, Cruz said. The index can take positive and negative values with no particular maximum or minimum value. It indicates how far each city or town is from the mean financial condition of the Puerto Rico municipalities. Positive values indicate the municipalities are better than average and negative values show the reverse. The index values are currently not on the web site proper but in a Spanish language paper which is linked on the web site.

Avoiding Municipal Insolvency, Except as a Last Resort

October 20, 2015. Share on Twitter

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

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

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

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

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

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

The Desperate Price of Fiscal Unaccountability

October 14, 2015

Municipal 9-1-1. As U.S. District Court Judge Bernard Friedman noted late last month, the importance of Chapter 9 municipal bankruptcy is to ensure “the resources to provide [its] residents with basic police, fire, and emergency medical services that its residents need for their basic health and safety.” It is that very apprehension about such essential, lifesaving services that has been at the heart of the municipal bankruptcy turmoil of Rhode Island’s Coventry Fire District—one of four fire districts in a municipality of 36,000 people—and where each district has its own governing authority—and where, currently, a private ambulance company had been negotiating with local officials to provide “temporary/emergency” coverage in the Coventry Fire District during its fiscal crisis—but has backed out after several of its employees threatened to resign. Kent County Superior Court Judge Brian P. Stern presided last week as the district remains essentially paralyzed—its bank account is frozen; its firefighters have not been paid for about 45 days; and Fire Board Chairman Frank Palin had contacted a private fire service, Coastline, in the event the court orders the board to hire a private ambulance company. Judge Stern has issued a stern [yes, a pun] warning that the Coventry Fire District is approaching a public safety crisis and residents could be without fire protection in the imminent future. The judge issued an order that state emergency and revenue officials be notified that fire and rescue protection might end soon.

Indeed, the district has been in crisis mode for years: In May 2013, Judge Stern had ordered the Central district liquidated after the board and the union representing firefighters failed to reach a contract agreement, directing the board to sell off property and lay off employees to pay off its debts. The board sold off equipment, shrunk staff, and closed three of five fire stations; however, before the job was completed, former Rhode Island Gov. Lincoln Chafee stepped in and appointed the first of two receivers in May of 2014 to reorganize the department, and, if deemed necessary, to take the fire district into chapter 9 municipal bankruptcy—as former Rhode Island Supreme Court Judge Robert Flanders had done after his appointment as a state Receiver with Central Falls or Chocolateville in August, 2011. Ergo, by the New Year, the Governor had named a receiver, Mark Pfeiffer, appointed by Governor Gina Raimondo, directing a municipal bankruptcy reorganization through the state Department of Revenue.

The duration, however, was short-lived: last month, Mr. Pfeiffer and state revenue officials announced they were giving up trying to reorganize in the face of fierce opposition to his proposed plans of seeking chapter 9 bankruptcy for the fire district—fiery opposition from both the town’s elected leaders and fire district’s leaders. That adamant opposition appeared to be inflamed by Mr. Pfeiffer’s proposed five-year plan of debt adjustment’s inclusion of major contract concessions from the firefighters’ union; but also its proposal of tax increases.

Thus, U.S. U.S. Bankruptcy Court Judge Diane Finkle has granted the state’s request to withdraw the Central Coventry Fire District from chapter 9 municipal bankruptcy, effectively restoring control of the district back to the district’s fire board, noting: “Face it, the taxpayers want a different model,” adding it was time for the courts to get out of the way and the parties to resolve their issues through a “political or legislative” process. Judge Finkle’s decision puts control of the fire district back into the hands of its board, some of whom have made no secret that they want more affordable fire protection and rescue services, possibly even using volunteers and private ambulance service. But how to get there is uncertain: the District’s board of directors has just a week left in which to come up with a plan and put it before district voters at an annual budget meeting on Oct. 19th: the board will have to decide if it wants to return to the idea of liquidating the district — as voters in the neighboring Coventry Fire District did recently — or negotiate another contract with local firefighters.

Ergo, with an accumulating debt to Coventry Credit Union of about $465,000, and an accrued deficit of more than $600,000, the fire district is in a fiscal Twilight Zone amid a broader governance question with regard to whether the current system of fire districts ought to be replaced by town-wide fire departments and the elimination of fire districts. Yet, to date, the Coventry Town Council has proved unwilling to become involved in the fire district’s seeming insolvency—notwithstanding its ultimate responsibility for public safety or the town’s citizen, non-binding referendum last June to liquidate the fire district. Indeed, the town’s inaction appeared to provoke, last July, a letter from the Rhode Island Department of Revenue to warn Coventry’s elected leaders, in which the acting Director wrote: “[T]he Department of Revenue is operating under the premise that the Town of Coventry will assume responsibility for the safety and well-being of its residents…We fully expect the town to be taking the necessary steps to ensure that it will be able to provide fire protection services to the area covered by the Coventry Fire District in the event the district suspends its operations.” Noting the state was ready to help under Rhode Island’s Fiscal Stability Act, which makes it clear that “any and all costs incurred pursuant to the state’s involvement under the Fiscal Stability Act become obligations that must be paid by the locality.” In fact, that appears to be part of the hot potato problem: were the town’s fire district to dissolve, the town’s taxpayers would be forced to finance their services.

In this uncertain municipal governance and fiscally distressed environment, the fire district board has one week in which to complete and present a plan to voters about how fire and rescue services will be financed and provided to residents of the district.

In a state half the size of many counties, the multiplicity of governing districts and municipalities raises grave questions of not just fiscal accountability, but also the seemingly intractable nature of the fire district’s own charter—a charter which provides that only fire district voters have the authority to determine whether and how to tax district residents – a power apparently greater than even a state-appointed receiver’s, despite legislation passed last year to clear the way. Indeed, it was just that charter provision which imposed such a wrinkle in Rhode Island’s efforts to step in: U.S. Bankruptcy Court Judge Diane Finkle last July, during a municipal bankruptcy status conference, warned that portions of the state’s proposed five-year plan of debt adjustment would likely need voter approval—especially for the last four years of the plan wherein the plan called for tax increases once the state receiver had stepped aside and decision-making powers reverted to the fire district’s board—one of four in a town of about 35,000—and one where the Coventry Town Council has repeatedly refused to extend any further fiscal assistance to the district which already is in debt to the town for $300,000.

The Rocky Road to Insolvency

September 18, 2015

The Road to Insolvency. Moody’s yesterday cut Ferguson, Missouri’s credit rating by four notches, a downgrade the credit rating agency said reflected the “severe and rapid deterioration of the city’s financial position, possible deletion of fund balances in the near term, and limited options for restoring fiscal stability…” adding the municipality could be headed for insolvency as early as 2017. [In Missouri, any municipality or political subdivision may file for municipal bankruptcy protection (six cities have previously]. The downgrade for the municipality of 21,000—one of 116 municipalities in the St. Louis metro area—came in the wake of the release of the Ferguson Commission report, which was released this week–more than a year after we began in this blog looking at the fiscal complexity of hundreds of municipalities operating in metropolitan areas (there are, for instance, over 280 in the Chicago metropolitan region). The downgrade was a sign of the fiscal fallout from the fatal 2014 police shooting of Michael Brown. The Ferguson report concludes:
• the State of Missouri should establish a publicly accessible database tracking incidents when police use force;
• Missouri’s Attorney General should step in as a special prosecutor in those cases which lead to a death;
• Municipal and county police should be trained with regard to the “implicit bias” which shapes decisions by people who had never consider themselves racist;
• The court system should stop jailing residents for non-violent offenses, locking them away from the jobs they would need to pay off their fines and speeding tickets in the first place, noting, pointedly: “When someone is jailed for failure to pay tickets, the justice system has not removed a dangerous criminal from the streets. In many cases, it has simply removed a poor person from the streets.”

The report, commissioned last fall by Missouri Governor Jay Nixon to dissect to roots of Ferguson’s unrest, also calls for the state of Missouri to expand Medicaid coverage (Missouri is one of 19 states which has refused to do so; it also urges adoption of a $15 minimum wage (the current floor in Missouri is $7.65 an hour). It calls for a cap on the interest predatory payday lenders demand of the poor, and an end to childhood hunger. It recommends smarter transportation investments, a commitment to early childhood education, and disciplinary reform in elementary schools. It even demands “inclusionary zoning” policies to ensure more low-income housing gets built-in neighborhoods with good schools and opportunity. The report, nearly 200 pages long, seeks to weave and connect every interlocking policy problem — in education, housing, transportation, the courts, employment, law enforcement, public health — implicated in the racial inequality at the heart of Ferguson’s unrest. A March report from the U.S. Justice’s Civil Rights Division found the Ferguson police department engaged in unlawful and discriminatory practices partially driven by the city’s reliance on court fine revenue to support its budget. Advocacy groups have filed a series of lawsuits challenging municipal ticketing operations. Between draws in fiscal 2015 which ended June 30, and fiscal 2016 projections, city reserves are expected to fall by 70% compared to audited fiscal 2014 levels.

Moody’s downgrade impacts $6.7 million of outstanding Ferguson general obligation municipal bonds, $8.4 million of certificates of participation from a 2013 issue, and $1.5 million of 2012 certificates or COPs, with the agency noting its downgrade “reflects 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: “Key drivers of this precipitous drop are declining key revenues, unbudgeted expenditures, and escalating expenses related to ongoing litigation and the Department of Justice consent decree currently under negotiation…”We believe fiscal ramifications from these items could be significant and could result in insolvency…We expect additional detail within the next few months as to the city’s final audited fiscal 2015 results as well as options and financial strategies for addressing these looming costs.”

Ferguson Mayor James Knowles III yesterday responded to the Justice Department report, saying he appreciated the hard work and dedication of the Commission by interviewing hundreds of community stakeholders throughout the metropolitan area, which included Ferguson residents and many of its business owners.

One outcome of the fiscal deterioration and the killing of Michael Brown in the wake of the subsequent rioting focused attention on aggressive policing tactics and the heavy reliance on court fines to prop up local government budgets. Critics note that stiff court fines imposed by local governments like Ferguson’s result in aggressive policing tactics which disproportionally target low-income and minority residents. Along with taxes and other revenue streams in 2010, the city collected over $1.3 million in fines and fees collected by its court. For FY2015, Ferguson’s budget anticipates fine revenues to exceed $3 million – more than double the total from just five years earlier, according to the report. The increase was not tied to crime figures. Ferguson responds that the city has taken action to with new ordinances to limit the use of revenue generated by court fines and fees to 15% of its budget. The city has also revised various policies on collections. The Missouri State Auditor’s office launched probes into 10 local governments’ use of court fines to ensure they comply with the law and plans more. Most Missouri local governments face new restrictions on the use of municipal court fines under legislation signed in July by Gov. Jay Nixon—especially in the wake of the new state commission’s recommendation of a sweeping overhaul of police tactics and court fine practices.

Bankruptcy Protection? Senate Finance Committee Chairman Orrin Hatch (R-Utah) reports his Committee will “have to have a hearing” on whether Puerto Rico’s agencies should be able to use bankruptcy to reorganize their finances. Interestingly, Chairman Hatch is in a very unique position to act—as it is the Senate Judiciary Committee which has jurisdiction over municipal bankruptcy legislation—and where Mr. Hatch is not only a member, but also a former Chairman. A staff member on the Finance Committee indicated it likely such a hearing would occur the week after next. For his part, Chairman Hatch, who spoke with Puerto Rico Governor Padilla this week, said “I always intended to have a hearing, because it’s a serious problem and we need to resolve it,” adding that the U.S. citizens of Puerto Rico are in “real trouble.” Chairman Hatch reports that legislation extending chapter 9 municipal bankruptcy protection to Puerto Rico, co-sponsored by Sens. Charles Schumer (D-N.Y.) and Richard Blumenthal (D-Conn.) will be discussed when panel meets.

The Teeter Totter between Voters & Municipal Fiscal Sustainability


August 25, 2015

Averting Bankruptcy Dismissal. The San Bernardino City Council yesterday voted 4-3 to move ahead in transferring responsibility for fire and emergency protection to the San Bernardino County Fire Department—an action that automatically triggered a new, $142-per-year tax on every parcel in the city—with the Council’s vote corresponding to the bankrupt city’s plan of debt adjustment pending before U.S. Bankruptcy Judge Meredith Jury. Unsurprisingly, there has been strong citizen opposition to contracting out for fire services—and this is an election year. Nevertheless, city leaders made clear they believe San Bernardino’s credibility in the federal bankruptcy court, and its ability to obtain approval for its proposed plan of debt adjustment required it to be consistent—as well as referencing that between the reduced costs from contracting out and new tax revenues, the city would realize as much as $11-15 million in annual savings. In addition, City Attorney Paul Glassman had warned the Mayor and Council that if the city failed to meet the terms of its own proposed plan of debt adjustment, San Bernardino would risk having its bankruptcy dismissed by Judge Jury—a dismissal that would almost immediately jeopardize the city’s ability to continue to provide essential public services—or, as Mr. Glassman told the Council: “This would have a catastrophic effect on the city such that it could not go on as an ongoing entity.” Nevertheless, the close vote reflected apprehension from Councilmembers who expressed apprehension that the proposed changes might not only jeopardize public safety, but also hurt the city’s already suffering economy. Councilman John Valdivia, speaking against the measure, told his colleagues that his constituents were strongly opposed to the new tax, adding: “We’re not here to bail the city out, one more dime.” Councilman Henry Nickel, who together with Councilmember Valdivia and Councilman Benito Barrios, opposing the proposal, after the meeting warned that San Bernardino was losing what little goodwill it had from citizens who will be asked to approve other taxes as part of the recovery plan.

The bare majority gave the green light to authorize San Bernardino city staff to begin negotiating with San Bernardino County and the County Fire District over the terms of the annexation—at the end of which another City Council vote will follow—a process that City Manager Allen Parker told the elected leaders could take 60 days. Even if the proposal gets to the Local Agency Formation Commission (LAFCO) in 60 days, there would still be no guarantee it will be approved by July 2016, possibly meaning it might not receive formal approval until FY2017: the Commission will have to study the proposal, hold public meetings, and make decisions on it. So even though it will not be subject to a citizen vote in the county, it is not clear what citizens’ reactions and pressure on San Bernardino County elected officials might be. In addition, if 50 percent of registered voters in San Bernardino protest, the proposal would fail. Protests from 25 to 50 percent of voters (or at least 25 percent of the landowners, who also own at least 25 percent of the assessed land value within the city) would trigger an election, according to LAFCO annexation rules.

The Sharing Economy? As state and local leaders know, the art of legislating is not unlike making spaghetti, and so it is that state leaders in Lansing—as part of an effort to help finance Michigan’s transportation infrastructure—have been considering a proposal to help make whole Detroit’s single most important source of municipal revenue: its income taxes—taxes which in 2012 made up about 21 percent of the city’s total revenue. That requires addressing a persistent gap in the law which does not provide authority to require suburban employers of Detroit residents to collect and remit the city’s income taxes. According to the Citizen’s Research Council, in 2011, 38 percent of Detroit residents worked in the city, while 62 percent of city residents were employed in the suburbs. With the House considering surface transportation legislation the Michigan Senate approved last month—a major road funding proposal that could double fuel taxes over four years and eventually raise up to $1.7 billion a year in new revenue for infrastructure—the House has been considering, as part of such a measure—amending the legislation to include a provision to provide authority for new state legislation designed to help Detroit collect city income taxes from residents who commute to the suburbs—but only for Detroit: not for the other 21 municipalities which also rely on municipal income taxes: Albion, Battle Creek, Big Rapids, Detroit, Flint, Grand Rapids, Grayling, Hamtramck, Highland Park, Hudson, Ionia, Jackson, Lansing, Lapeer, Muskegon, Muskegon Heights, Pontiac, Port Huron, Portland, Saginaw, Springfield, and Walker. Under the pending proposal, on behalf of which Detroit Mayor Mike Duggan testified, suburban employers would be required to withhold Motor City income taxes from paychecks of Detroit residents—except for businesses with fewer than 10 employees and less than $500,000 in wages. An alternative would authorize the state to use audit and penalty procedures when it takes over Detroit’s income tax collection in 2016. The Republican-led House Tax Policy Committee has approved legislation which would require suburban employers to withhold Detroit city income taxes from residents’ paychecks, but the outcome will have to await full legislative consideration: The Senate was in session last week, but did not take attendance, votes or introduce bills. Neither the Senate nor the House is expected back in Lansing until after Labor Day.

Any final legislative action by the legislature next month could also face concerns by municipal leaders from the other 21 municipalities which levy personal income taxes—indeed, Grand Rapids Mayor George Heartwell last week made clear he was “flummoxed” that Grand Rapids and 20 other communities were omitted from the legislation, noting he was “caught off guard,” adding he thought “We (referring to all 22 cities) were all on the same page about this,” noting he had met with Detroit Mayor Mike Duggan and several of the other communities that charge an income tax about ways to make collection a requirement for suburban employers. Grand Rapids is one of the exceptions in Michigan in that it collects income tax at a rate of 1.5 percent for residents and 0.75 percent for nonresidents who work in the city. The majority of the 22 cities impose an income tax of 1 percent on residents and 0.5 percent on nonresidents. Detroit has the highest rate with its residents who live and work in the city paying 2.4 percent; nonresidents who work in the city pay 1.2 percent. Eric Lupher, President of the Citizens Research Council of Michigan, said his organization supports equality for all, suggesting that every one of the state’s 276 cities should require employers to withhold city income taxes from employees: “The solution to the problem at hand is if you live or work in a city, then employers need to withhold tax from you…It shouldn’t apply only to cities with populations of 600,000 or more (such as Detroit)…The other thing is we don’t want to create disincentives to living in the cities…Most of the Michigan cities are down-and-up cities. They all are trying to revitalize themselves and be attractive in getting people to move there.”

Holy Cosmos! Fitch became the second credit-rating agency this week to upgrade Wayne County, removing the County’s negative rating watch from some Wayne County municipal bonds and terming Wayne County’s rating outlook “stable,” adding that the County’s approval of a consent agreement with the state to address its financial emergency was a step not only towards improving the county’s credit, but also to improving Wayne County’s fiscal outlook. Under the terms of the agreement, Wayne County Executive Warren Evans is granted the powers of an emergency manager in contract talks with the county’s unions—and, should the two sides be unable to achieve a consensus in good-faith negotiations 30 days after the consent agreement went into effect, he is authorized to impose terms such as lower wages, pension cuts, and employee contribution increases—all as part of a state-local effort to address a $52 million structural deficit—a deficit triggered by a $100 million drop in annual property tax revenue since 2008. Adding to the deficit, the county still has to contend with a significantly underfunded public pension system—as much as $910.5 million, according to the latest actuarial reports.

First Chapter 9 since Detroit. Hillview, a small (pop. just over 8,000) home rule-class city in Bullitt County, Kentucky, about 17 miles south of Louisville, has filed for chapter 9 municipal bankruptcy in the first chapter 9 filing by a municipality since Detroit’s filing more than two years’ ago—making the small city the 65th to file for bankruptcy in more than six decades. The city in Bullitt County about 17 miles south of Louisville listed assets of under $10 million and liabilities between $50 million and $100 million in its bankruptcy petition. Kentucky is one of 12 states which conditionally authorize municipal bankruptcy; however, Kentucky counties are not authorized to file for municipal bankruptcy protection unless the state local debt officer and state local finance officer have first approved said county’s plan of debt adjustment. The legal action was triggered by an $11.4 million judgment against the city for breach of contract after years of protracted litigation over a land sale—and after the municipality had been unable to reach any settlement agreement. Truck America Training LLC prevailed (see City of Hillview v. Truck America Training, No. 2012-CA-001910-MR.) Court of Appeals, Kentucky, March 7, 2014.), gaining an $11.4 million judgment for breach of contract against the city over a land sale. The judgment became final last March, after the Kentucky Supreme Court declined to review the case. Hillview, in its bankruptcy filing, listed assets of under $10 million versus liabilities between $50 million and $100 million. The city’s unsecured claims include $1.39 million of outstanding general obligation bonds issued in 2010, and $1.78 million of debt which is part of a pool bond issued by the Kentucky Bond Corp. in 2010 and operated by the Kentucky League of Cities. The decision to opt for municipal bankruptcy came in the wake of the city’s decision not to accept Truck America’s most recent settlement offer of approximately 40 cents on the dollar. To put those numbers in context, Hillview had total revenues of $2.7 million in FY2014, and a fund balance of $659,723 at the end of the year, according to its 2014 audit. Moreover, in addition to the judgment accumulating interest at 12% per year, the audit determined that Hillview had no insurance coverage available for the breach of contract litigation. S&P, last February, had downgraded Hillview’s full faith and credit GO bonds four notches to BB-plus, citing the judgment, as well as fiscal apprehensions with regard to the municipality’s FY2014 audit. In its analysis, S&P had included an examination of whether the Hillview could issue municipal bonds to pay the Truck America judgment, noting: “We believe the city has legally available options apart from [municipal] bankruptcy.”

Trying to Measure the Costs of Financing a Sustainable Fiscal Future

August 11, 2015

Fiery Issues. In California where, this summer, more than 1,000 homes have been evacuated in vast forest fires stretching across the state, the San Bernardino City Council will receive a report today recommending the city outsource fire services to the San Bernardino County Fire Department: the report and recommendation come as the Council is scheduled to select from among three options a week from Monday with regard to how to ensure this essential public service is available for its citizens—and at what cost to the bankrupt municipality. Under the staff preferred alternative, San Bernardino would realize some $7 million in savings—but experience increased fire and emergency response, according to City Manager Alan Parker: his recommended alternative would mean nearly $8 million in additional savings to San Bernardino’s general fund through a possible $139-per-parcel fee on the city’s residents, albeit the Manager reported his proposed plan would involve an annexation process, which the city must initiate with the Local Agency Formation Commission for San Bernardino County by the first week of September in order to ensure completion by 2016, advising the Mayor and Council: San Bernardino County would annex the city to a fire district: ergo, he noted, San Bernardino would no longer operate fire services. Nevertheless, he said, the proposal would not just ensure savings to the city, but also faster emergency response times: “We wouldn’t be going down this road if we didn’t think it would improve service…They would close one additional (fire) station, but they’d supplement that with one of theirs. The number, I think, would go from 38 to 41 (firefighters) on duty at a given time.” How the Mayor and Council will react, however, could itself be a fiery political issue: the manager, in putting together and recommending the proposal, broke his commitment to the seven top-ranked San Bernardino Fire Department employees, who form a union called the Fire Management Association, to seek their advice and input; yet, as San Bernardino Battalion Chief Michael Bilheimer wrote to Councilmembers: “Yet as of (Monday), we have been excluded from every step. It gravely concerns me that you have independently elected to draft a Request for Proposal, retained a consultant to review those proposals, barred us from reviewing the proposals, and are preparing to take action without ever having consulted with the leadership of the Fire Department.” In response, Mr. Parker promised he would meet with fire management this week, but only after the City Council had received a final copy of the report, admitting it was “probably” accurate he had made a commitment to involve the leadership. The failure to communicate has stirred up its own political fire, with Chief Bilheimer responding by emailing city community leaders a one-page “fact sheet” opposing outsourcing, pointing out that, under the pending plan, an extra $139 would be charged to the owners of each of San Bernardino’s 56,000 parcels, noting: “That’s a tax, even if they don’t call it a tax.” Bilheimer said, asking residents to call their City Council member to oppose the outsourcing move.

An Alternative to Municipal Bankruptcy. Wayne County, beset by a $52 million structural deficit, stemming from a $100 million drop in annual property tax revenue since 2008 and an underfunded pension system, yesterday completed a consent agreement with the Michigan Department of Treasury under which the County, under state oversight, hopes it will have the authority to achieve structural changes to the county’s fiscal approach to insolvency by reducing future pension obligations and retiree benefits, as well as obtaining authority to take other actions to eliminate Wayne County’s structural deficit. The County’s pension system is underfunded by $910.5 million, according to the latest actuarial reports. Under the proposed consent agreement, County Executive Warren Evans and the commission would retain their powers and responsibilities. Wayne County would be barred from selling assets worth more than $50,000 without the Michigan state treasurer’s permission, but County Executive Evans would receive “the powers prescribed for emergency managers…to act as the sole agent of the county in collective bargaining with employees or representatives and approve any contract or agreement.” The proposed agreement with the state—unlike the appointment by Governor Snyder of an emergency manager for Detroit—would ensure retention of local elected authority, if the Wayne County Commission opts to approve it at a special board meeting tomorrow: the 12-page agreement may not be implemented and enforced unless and until approved by the commission. A key issue will be what kinds of agreements County Executive Evans is able to work out with Wayne County’s unions—under the consent agreement, he has a significant advantage: should there be no agreement within 30 days, he is authorized to impose terms. Lawrence Verbiest, head of the Government Administrators Association, unsurprisingly, yesterday, expressed apprehension the agreement would enable Mr. Evans to drastically cut wages, pensions, and benefits, noting: “We know we have to do something to help the county solve its problem…But we’d rather the county tried to work it out than unilaterally and dictatorially impose contracts on us.”

To Market, to Market, to Buy a…Detroit returns to the municipal market for its first issuance since its exit from the largest municipal bankruptcy in the nation’s history next week—with significant uncertainty how the state-crafted, first post-bankruptcy issuance will go. Under the plan, the Michigan Finance Authority expects to price $245 million of local government loan program revenue bonds on behalf of Detroit—with the allure to potential municipal bond purchasers coming from a statutory lien and intercept feature on Detroit’s income tax—an issuance which has secured an S&P A rating. Because the deal is premised on the city’s income tax (Detroit has one of the broadest tax bases of any city in the U.S.: Municipal income taxes constitute Detroit’s largest single source, contributing about 21 percent of total revenue in 2012, but receipts have been declining for years, reflecting both a rate reduction mandated by the state, the recession, and, of course, the municipal bankruptcy. The declining revenues also reflect not just the significant population decline, but also the make-up of the decline: the census reports that one-third of current residents are under the poverty line and that the composition of businesses—unlike any other major city in the nation—are primarily made up of public organizations.) Thus, the success of the first post-bankruptcy sale hinges upon the Motor City’s fragile recovery. The issuance is to raise the cash to repay Barclays for a $275 million loan—the loan which helped the city finance its exit from municipal bankruptcy—and the issuance benefits from reduced fees from municipal bond attorneys and consultants; it is divided into two series: $134.7 million of tax-exempt bonds with a 2029 final maturity and $110.3 million of federally taxable bonds with a 2022 maturity. Under the deal, potential bondholders would have a superior, statutory lien on Detroit’s income tax revenue under legislation Gov. Rick Snyder signed last April – a state statute which also exempts the revenue held in trust from being levied upon, sequestered, or applied toward any other debts—and which a legislative fiscal analysis projects could save Detroit and its taxpayers as much as $2 million to $3 million annually in interest. The ever prescient Lisa S. Washburn, a managing director at Municipal Market Analytics, noted: “Michigan did its best to provide some structural protections that insulate the debt from a future Chapter 9 for Detroit, but you just don’t know going into another bankruptcy if the structure would hold up…If there is another bankruptcy, it’s likely that the income tax revenues are suffering anyway.” Indeed, if, God forbid, there were another municipal bankruptcy for Detroit, the preliminary bond documents warn potential investors: “Should the city file for bankruptcy protection, the bankruptcy court’s decision regarding these matters would be based on its own analysis of the law and interpretation of the factual evidence before it…The bankruptcy court would not be bound by legal opinions other than binding precedent, and there currently is no binding precedent regarding these matters.” That is, Detroit—and Michigan—are entering uncharted municipal finance waters. The income tax pledge is also complicated by Detroit’s set aside of a portion of those revenues—some 8 percent—to finance the Motor City’s police operations: a pledge superior to the bondholders’ lien. Should Detroit realize a net outflow of taxpayers—a key factor in its municipal bankruptcy—that could precipitate a serious problem; however, the city anticipates rising income tax revenues: they have increased from $228.3 million in 2011 to $248 million in FY2013—and are projected to grow to $256.5 million for FY2015. Nevertheless, as guru Washburn warns, the difficult balance between critical investments in the future and added debt can be a challenge; she notes that while the city’s income tax is “arguably the strongest revenue stream they have and they’ve pledged that specifically to repay this debt…” that was “exactly what they were trying to get away from in municipal bankruptcy — they were trying to prioritize services and their citizens ahead of investors, and here it seems once again: they’ve prioritized creditors: [Debt payments] could be taking a bigger chunk of the revenue in the coming years, meaning less money go to the city, so there’s a lot at stake for the city to experience stability and growth in the next several years.”

Digging an Agujero, or hole (in Spanish) might be one way to think about last week’s payment default in Puerto Rico, because, as MMA insightfully notes: “it has made the goal of a voluntary, consensual debt restructuring more difficult to achieve and has thus raised the potential for disorder on the island…In effect, the potential for the worst possible outcome for Puerto Rico and its investors continues to grow at the expense of the best possible outcome.” Noting that Puerto Rico’s decision to suspend monthly deposits into its general obligation bond redemption fund greatly increases the odds of Puerto Rico defaulting next January, the suspension threatens to undercut the island’s negotiations with PREPA and other municipal bondholders. While the suspension appeared to be focused on enhancing Puerto Rico’s liquidity—and avoiding still more borrowing, MMA notes monthly liquidity is “likely worsening amid a general economic slowdown and reported difficulties in reining in expenditures.” Ergo, unless the island can find new cash or financing by December, Puerto Rico’s fiscal hole or agujero has grown so deep it will confront a new payment cliff for general obligation debt interest payments by January.

Truth or Consequences: Could Puerto Rico Be Contagious? While Puerto Rico is neither a state, nor a municipality—and while it is far from the mainland; nevertheless, its approaching default, coming amidst on and off again discussions in the House and Senate tax-writing committees, could have Bob Barker back on the screen. State and municipal debt—and the interest thereon with their exemptions from federal taxation—could become juicier targets, potentially strengthening the arguments of those who would prefer to use the federal “revenue loss” for other tax expenditures. The manner in which Puerto Rico has kept investors in its municipal bonds—investors scattered throughout each and every state—could also have ramifications: your closest friends at the SEC and IRS might have some suggestions with regard to new federal mandates with regard to acceptable disclosure.

Potty Costs. The Puerto Rico Aqueduct and Sewer Authority (PRASA) anticipates paying as much as a 10% interest or borrowing rate on municipal bond on a $750 million issuance later this month—giving a better idea of the rising cost of public debt as the U. S. territory nears insolvency—and yet prepares to mark the island’s first general obligation bond issuance of the year. PRASA hopes to raise $1.45 billion for its five-year capital plan, of which $790 million would come from borrowing, with some help from $350 million in federal funds. Government Development Bank for Puerto Rico President Melba Acosta Febo said PRASA’s plan to issue the new municipal debt–just when Puerto Rico hopes to complete a plan to restructure its debts by the end of the month, “reflects the individual financial circumstances of the various debt issuers across the commonwealth.” One may get a sense of the fiscal risks and challenges ahead, however, by noting that—especially for a public utility—the island’s population decline over recent years (more than 7% over the past 10 years and the decline in the average daily water demand—declines which have forced the utility to raise rates on a shrinking customer base. The public utility, which provides service to some 97 percent of the territory’s population, increased its water rates by 60 percent two years ago and reports it plans to raise rates further in FY2018 and 2019. The bond proceeds will be used to finance a portion of PRASA’s capital improvement program, and to repay a $90 million bank line of credit—with any disputes about the bonds governed by the laws of New York unless it involves the authorization and execution of a receivership, which would be governed by Puerto Rico’s laws.
Municipal Risk. As we observe, today, Detroit seeking to reenter the municipal market—even as its surrounding county prepares to seek approval of a debt consent agreement with the State of Michigan—there are some jitters with regard to non-general obligation, full faith and credit pledges by cities and counties. Indeed, unsurprisingly, Moody’s has moodily modified how it rates such so-called sub‐GO security pledges to more fully incorporate what it perceives as the risk inherent in a municipality’s appropriation, general fund, or lease‐backed debt. Ergo, even as our admired friends at Municipal Market Analytics note that current municipal default rates remain very low—and are even lower for state and local issuers; nevertheless, MMA remarks that “the resilience of security pledges—meaning strength of post-default recovery—is weaker than originally believed,” reporting that “virtually no municipal security pledge has gone unscathed,” with special apprehension reported with regard to the core weakness in the appropriation pledge, because the “repayment is subject to the willingness of the legislature of the borrower to appropriate the necessary funds.” Democracy, alas: or, as MMA persists: “When a government’s willingness to allocate its resources is compromised because the financed project has underperformed (e.g. Lombard, Ill. Vadnais Heights, Minn.; Buena Vista, Va, etc.), its finances have faltered (e.g. Puerto Rico), or politics has stymied the budget process (e.g. Illinois), the risk of nonpayment rises.” MMA appropriately notes that where there is a payment default, the bondholders’ remedies are often limited (they may take over leased facilities) or non‐existent, adding that the “general market perception—even if not the reality—of the strength of other municipal security pledges has also been weakened as a result of recent defaults and bankruptcies.