The Steep Road Out of Municipal Bankruptcy

November 9, 2015. Share on Twitter

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

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

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

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

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

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

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

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

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

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

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

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

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

And yet.

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

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

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

Municipal Bankruptcy Is Large, Complicated, & Seemingly Unending

September 10, 2015

Fiscal Gales in the Windy City. As the City of Chicago grapples with its growing unfunded pension liabilities, the city’s fiscal sustainability has become increasingly at risk—putting Mayor Rahm Emanuel nearer to a fiscal cliff for the Windy City. Increasingly the unfunded pension liabilities are threatening the city’s fiscal future, and the options on the table—such as a potential huge property tax hike to fund the city’s pension liabilities portray how risky the city’s fiscal future and options are: would a huge property tax increase discourage businesses and families from moving into Chicago? Or, as the ever insightful Laurence Msall, president of the Chicago Civic Federation, puts it: “How is Mayor Emanuel going to convince the City Council and the citizens of Chicago that with this very painful and, we believe, necessary increase?” The question arises as Mayor Emanuel may seek a record half billion property tax increase to address the city’s rising pension costs—and avoid bankruptcy. The city is also considering the imposition of a new levy for garbage collection, as well as other revenue sources to respond to a $328 million to $550 million scheduled annual spike in police and fire pension contributions under a prior state unfunded mandate requiring the city to make such contributions on an actuarial basis. The window for the Mayor is winnowing down: he is scheduled to release his proposed budget a week from Tuesday—a budget in which, in addition to tax and revenue proposals, Mayor Emanuel is also expected to propose a long-term fiscal plan which will also include changes in both spending habits and debt practices in what Mr. Msall denotes as a day of reckoning for Chicago. Chicago’s fiscal dilemma is further complicated by the ongoing stalemate in Springfield, where Gov. Bruce Rauner and the legislature remain deadlocked, so that there is still no FY2016 budge—where the stalemate shows little sign of abatement. For Mayor Emanuel, no matter the stalemate in the state capitol, he has just over 10 days to put together a proposed $754 million budget—one likely to incorporate a $233 million operating deficit, $93 million in increased city contributions owed to the municipal and laborers’ pension funds, and about $100 million in debt repayment the city previously intended to defer in its amortization schedule. The budget is almost certain to propose a $328 million hike in contributions for Chicago’s police and firefighters’ pension funds—but mayhap larger if the legislature and Gov. in Springfield are unable to reach consensus on pending state legislation which would re-amortize payments.

Fiscal Teetering in Pa.’s Capitol City. In his State of the City address this week, Harrisburg Mayor Eric Papenfuse warned that the city’s plan it adopted two years ago when the city narrowly averted filing for municipal bankruptcy must be amended—noting that the revenues assumed under that plan are falling short and will be insufficient by next year—and making clear that the deficiencies could not be offset by cost-cutting alone, especially since, he noted: “While the City is starving for capacity, we have already cut discretionary funding to the bone.” Indeed, Mayor Papenfuse noted the city has reduced its work force by nearly half over the last decade and that this fiscal year “will mark the second year in a row that we have significantly underspent our adopted budget.” Nevertheless, he warned, this city is simply not on a “sustainable course.” Therefore, he has proposed three key fiscal changes: 1) Tripling the municipality’s $1-per-week tax on employees working within the city limits to $3 per week; 2) Expanding the city’s sanitation operations, and 3) Transitioning to home rule authority.

Planning Debt Adjustment. The nation’s last large municipality in municipal bankruptcy, San Bernardino, has reached a tentative contract agreement with its largest employee group, its so-called general unit. The announcement, Tuesday, reached after last month’s agreement with the city’s Police Officers Association, means that San Bernardino now has plan of debt adjustment agreements with nearly all its employees—except its firefighters—where multiple legal complaints by the fire union against the city continue. Indeed, in the wake of the city’s rejection of its bargaining agreement with the fire union and implementing changes, including closing fire stations—in an election year—the city hopes to reach agreement on the fire front within a week, even as the city is proceeding in its process of having its fire department annexed into the San Bernardino County fire protection district—a key step anticipated to add more than $12 million to the bankrupt municipality’s treasury: $4.7 million in savings and $7.8 million in revenue from a parcel tax, according to San Bernardino’s bankruptcy attorney, Paul Glassman—or more than the $7 million to $10 million in savings the city incorporated into its proposed plan of debt adjustment it submitted to U.S. Bankruptcy Judge Meredith Jury—proposing that the funds should go toward pension obligation bondholders whom San Bernardino proposes to pay 1 cent for every dollar they are owed, according to the bondholders’ attorney—a proposal certain to be bitterly challenged in the federal courtroom. Complicating the process—and quite unlike any other major municipal bankruptcy—is that it remains unclear what might occur were the proposed annexation process to break down between now and July — especially were a sufficient number of San Bernardino voters to protest the tax and trigger an election. Although missing the deadlines required to complete the annexation process by July 2016 would be costly (because it would trigger a full fiscal year delay), an interim agreement with the San Bernardino County Fire Department would continue to provide services. Next up: Judge Jury has scheduled a hearing in her federal courtroom next month on the adequacy of San Bernardino’s financial statements and its modified plan of debt adjustment for October 8th.

Debt Restructuring Outside of Bankruptcy. The U.S. territory of Puerto Rico yesterday proposed a five-year plan Document: Puerto Rico’s Debt Plan under which the island would broadly restructure its unpayable debts, restructuring more than half its $72 billion in outstanding municipal bond debt, and seeking to implement major economic overhauls—and act under the direction of a financial control board—somewhat akin to the actions taken in New York City and Washington, D.C. to avert municipal bankruptcy. The proposed plan also proposed changes, such as welfare reform, changes to labor laws, and elimination of corporate-tax loopholes. Under the proposal, the governor would select a five-member control board from nominees submitted by creditors, outside stakeholders, and, possibly, the federal government—a panel which would have the power to enforce budgetary cuts. The document explains that Puerto Rico confronts a $13 billion funding shortfall for debt payments over the next five years—even after taking into account proposed spending cuts and revenue enhancement measures outlined in a long-awaited fiscal and economic growth plan. The report from Puerto Rico Governor Alejandro Garcia Padilla’s administration notes that Puerto Rico will seek to restructure its debt in negotiations with creditors as an alternative to avoid a legal morass which could further weaken the territory’s economy: it offered no estimates of what kind or level of potential losses would be anticipated from the owners spread across each of the nation’s 50 states of Puerto Rico’s $72 billion in outstanding municipal debt. The plan details the grim situation of Puerto Rico’s fiscal challenges—and of the dire consequences to the island’s 3.5 million residents: Puerto Rico will have less than a third of the fiscal resources to meet its obligations: it has only about $5 billion available to pay $18 billion of principal and interest payments to its municipal bondholders spread all across the U.S. and coming due between 2016 to 2020—and that only if the plan’s proposed savings from the consolidation of 135 public schools, reductions in health-care spending, additional subsidy cuts, and reductions in payroll expenses were realized. Mayhap the greatest obstacle under the proposed plan will be its proposal to restructure Puerto Rico’s general obligation bond debts, municipal bonds which were sold to investors with an explicit territorial constitutional promise that Puerto Rico would commit to timely repayments—repayments which would take priority over all other governmental expenditures. Nevertheless, the plan proposes to renege on the so-called ‘full faith and credit’ pledge attached to municipal bonds issued by state and local governments on so-called general obligation or ‘full faith and credit’ bonds—a proposal which is unconstitutional under the territory’s constitution—but which the island’s leaders contend is critical lest Puerto Rico were to run out of cash by next summer—as its current fiscal projections indicate is certain absent access to municipal bankruptcy protection or triggering a proposal such as has been now proposed. The plan leaves unclear how it squares with Puerto Rico’s constitution; yet island officials made clear that were Puerto Rico to continue to make such required payments, Puerto Rico’s treasury would be depleted by next summer—with such payments, were they not cut back, leaving the government short of cash for vital public services as early as November. Under the proposed fiscal blueprint, Puerto Rico will provide its creditors with more detailed cash flow projections so that negotiations could begin on repayment alternatives and options—negotiations not only pitting the island’s essential services against bondholders in every state in the U.S., but also between classes of municipal bondholders—with general obligation bondholders anticipated to seek the most favorable treatment. One of the exceptional challenges will be that—unlike in Jefferson County, Detroit, Stockton, or San Bernardino—there will be no referee, no federal bankruptcy judge—to oversee the process. In addition to the debt restructuring, the new five-year plan calls for an ambitious series of steps to deliver public services and collect taxes more efficiently, stimulate business investment and job creation and carry out long-overdue maintenance on roads, ports and bridges. Many of the measures will require legislative approval.

Financial Control Board. The plan proposes a five-member board of independent fiscal experts who would be selected from a list of candidates nominated by different parties, including classes of creditors, the federal government, and others. Such a board would be charged with: how to deal with disproportionate and inequitably imbalanced creditors—creditors imbalanced not just fiscally, but also in terms of capacity to represent themselves. How do the island’s poorest U.S. citizens (an estimated 48 percent of Puerto Ricans are Medicaid recipients) fare against some of the wealthiest U.S. citizens who live in Alaska, California, New York, etc., and who own Puerto Rican G.O. bonds? That is, as members of Governor Padilla’s working group have noted, the inability to have access to a neutral federal court and legal process could put the island—and especially its poorest Americans—at the greatest disadvantage.

Fiscal Challenges. Gov. Padilla’s working group plan projected that, if the plan were adopted and implemented, it would be key to bringing Puerto Rico’s five-year total fiscal deficit down to about $13 billion. To close it, however, they made clear, Puerto Rico could not meet its full municipal bond payment obligations. The working plan estimated that over the next five years, Puerto Rico would have to make $18 billion in principal and interest payments to municipal bondholders on some $47 billion in outstanding municipal bond debt—but that they would propose diverting $13 billion to finish paying for essential public services over the coming five years, leaving for a Solomon’s choice about how to apportion deep cuts in Puerto’s Rico’s constitutionally obligated payments to bondholders scattered all across America—and no road map or federal bankruptcy judge to opine what might be the most equitable means in which to opt to make such payments—much less what legal ramifications might trigger. Put in context, the plan proposes a fiscal restructuring significantly larger than Detroit’s record municipal bankruptcy filing—a filing with U.S. Bankruptcy Judge Steven Rhodes which involved some $8 billion of municipal bond debt. Puerto Rico entities are unable to access Chapter 9.

Muni Bankruptcy Is Large, Complicated, & Seemingly Unending. Jefferson County, which emerged from what was—at the time—the largest municipal bankruptcy in U.S. history nearly two years ago now can better appreciate that it “ain’t over until it’s over,” finding itself before the 11th U.S. Circuit Court of Appeals this week where a group of the County’s residents claimed they were denied constitutional protections under the decision of the U.S. bankruptcy court’s approval of Jefferson County’s plan of debt adjustment, with their attorney testifying: “The essence of our client’s position to the 11th Circuit Court of Appeals is that our clients are entitled to their day in court on the merits of the legal issues presented by the Jefferson County plan of adjustment,” adding that while it was “understandable that the U.S. bankruptcy court wanted to bring the case to closure…fundamental constitutional issues simply cannot be trumped by such concerns.” The issue is whether the court should accept or reject Jefferson County’s appeal of a September 2014 ruling by U.S. District Judge Sharon Blackburn, in which Judge Blackburn rejected the county’s arguments that the ratepayers’ municipal bankruptcy appeal was moot, in part because the plan had been significantly consummated, but also because Judge Blackburn claimed she could consider the constitutionality of Jefferson County’s plan of debt adjustment, which ceded Jefferson County’s future authority to oversee sewer rates to the federal bankruptcy court. The odoriferous legal issue relates to Jefferson County’s issuance—as part of its approved plan of debt adjustment—to issue $1.8 billion in sewer refunding warrants—an issuance which not only paved the way for Jefferson County to write down some $1.4 billion in related sewer debt, but also to exit municipal bankruptcy and the overwhelming costs of the litigation. Thus, with the sale of the new warrants consummated, Jefferson County exited (or at least believed it had…) municipal bankruptcy. The county’s sewer ratepayers, however, are claiming Jefferson County’s plan contains an “offensive” provision which would enable the federal bankruptcy court to retain jurisdiction over the plan for the 40 years that the sewer refunding warrants remain outstanding—a federal oversight which Jefferson County has argued has provided a critical security feature that has been key to attracting investors to purchase the warrants it issued in 2013—a transaction which the County alleges cannot be unwound—and added that the appeal by the residents is constitutionally, equitably, and statutorily moot, because the plan has already been implemented. The ratepayers have countered that even if the federal oversight provision were to be deleted from the County’s approved plan of adjustment, the indenture for the 2013 sewer warrants provides greater latitude to resolve a default: noting that were a subsequent fiscal default to occur, “the trustee shall be entitled to petition the bankruptcy court or any other court of competent jurisdiction for an order enforcing the requirements of the confirmed plan of adjustment.” (Such requirements include increasing rates charged for services, so that the sewer system generates sufficient revenue to cure any default.) But it is the provision allowing the federal bankruptcy court to maintain oversight which is central to Jefferson County’s position—in no small part because it offers an extra layer of security for bondholders and prospective bondholders of a municipality which opts to avail itself of a provision in the U.S. bankruptcy code which allows the judicial branch of the U.S. to retain oversight of a city or county’s plan of fiscal adjustment—or, as the perennial godfather of municipal bankruptcy Jim Spiotto puts it, the question in Jefferson County’s case involves an interpretation over what the U.S. bankruptcy code permits and whether the federal court’s supervision is actually the act of setting rates or insuring that the county complies with the covenants that it promised.

In Jefferson County, as in most cities and counties, sewer system rates have been set by resolutions approved by the Jefferson County Commission to fix rates and charges sufficient to cover the cost of providing sewer service, including funds for operations and maintenance, capital expenditures, and debt service on the 2013 warrants. Jefferson County’s attorneys have added that neither the plan of adjustment or U.S. Bankruptcy Judge Thomas Bennett’s confirmation order “changes the substantive law of the state of Alabama with regard to the enforcement of rates established pursuant to contract or legislation….Rather, the plan merely retains the bankruptcy court as an available forum in which such substantive law may be enforced, using the same remedies available in Alabama state court…In no event will the bankruptcy court ever set sewer rates; it is simply a forum to enforce the plan and related contracts – just as an Alabama state court could.” Ergo, part of the federalism issue and challenge relates to the Johnson Act, which essentially prohibits federal courts from taking actions that directly and indirectly affect the rates of utilities organized under state laws. In this instance, the ratepayers have claimed that the removal of the “retention of jurisdiction provision” from Jefferson County’s bankruptcy confirmation order would not unlawfully impose a new, involuntary plan on the county and its residents because “the indenture explicitly contemplates that the purchasers of the new sewer warrants may seek relief from courts other than the bankruptcy court.” Moreover, they claim the transaction would not have to be unwound were the U.S. district court to strike the jurisdictional retention provision from the plan, because the sewer bondholders could seek relief from other courts were Jefferson County to fail to increase sewer rates. The court directed Jefferson County to respond to its challenging sewer ratepayers by Monday, September 28th. Stay tuned.

The Intergovernmental & Governance Challenges to Municipal Sustainability



June 18, 2015

Visit the project blog: The Municipal Sustainability Project 

S-O-S. Wayne County Executive Warren Evans yesterday, writing that “Wayne County’s fiscal situation will continue to deteriorate without further remedial measures,” requested the State of Michigan to issue, on an expedited basis, a declaration of financial emergency. Mr. Evans wrote to Michigan State Treasurer Nick Khouri to request a preliminary review and declaration of financial emergency, citing several key issues which, he wrote, “threaten the county’s ability to provide necessary governmental services essential to public health, safety, and welfare,” referring to a projection that Wayne County’s accumulated unassigned deficit would grow from $9.9 million in the current fiscal year to $171.4 million by 2019, the county’s junk bond rating, and the judgement levy this month in a pension case that will cost taxpayers an estimated $50 in a one-time property tax assessment this summer on a $100,000 house. The epistle comes in the wake of a stream of warnings Mr. Evans has provided with regard to the County’s structural deficit and its unfunded pension liability—a liability now estimated to be approaching $1 billion—and comes in the first year of neighboring Detroit’s implementation of its municipal bankruptcy plan of debt adjustment in a city where the school system is under a state-appointed emergency manager—and where there are, as we noted yesterday, questions about the state’s legal authority to impose an emergency manager. Mr. Evans, in a release subsequent to the request, reported Wayne County would continue to negotiate with stakeholders under a consent agreement: “Our recovery plan provides a clear path to financial stability for the county, but we are keenly aware that our time frame to get the job done is quickly fading…Throughout this process we are constantly evaluating where we stand and proactively seeking solutions to work ourselves out of this massive deficit. I am requesting this consent agreement because the additional authority it can provide the county may be necessary to get the job of fixing the county’s finances done.” Under Michigan’s law, the state will first determine if a preliminary review is warranted, and, if so, the Treasurer will have up to 30 days to complete a preliminary review and final report—after which the local emergency financial assistance loan board would have 20 days to determine if probable financial stress exists—a finding seemingly likely here, and one which, if made, would trigger Governor Rick Snyder’s appointment of a financial review team, which would have up to 60 days to perform a more in-depth study—a study which could result in the appointment of an emergency manager or a consent agreement or emergency manager.

Under a consent agreement, the county would retain authority to implement pieces of County leader Evans’ plans, although complicated by the existence of constitutionally mandated positions, such as the sheriff and prosecutor complicate the prospects for a workable consent agreement. A consent agreement would be designed to allow the county to maintain a level of local control while providing a plan for managing the financial crisis with state assistance. Mr. Evans said a consent agreement would allow the county to continue negotiations with stakeholders while giving the county the ability, if necessary, to find other ways to achieve cost-savings and address the county’s $52 million structural deficit — a recurring shortfall that stems from an underfunded pension system and a $100 million yearly drop in property tax revenue since 2008: “Our recovery plan provides a clear path to financial stability for the county, but we are keenly aware that our time frame to get the job done is quickly fading.”

Because Wayne County surrounds Detroit, the two municipalities are not just linked geographically, but also fiscally. It is hard to imagine what the impact of insolvency for Wayne County would mean for Detroit’s ongoing recovery and implementation of its federally approved plan of debt adjustment.

It Ain’t Over Until It’s Over. While going through municipal bankruptcy can be fiscally and governmentally draining, it turns out that emerging from municipal bankruptcy—even once a U.S. Bankruptcy Court has approved a municipality’s plan of adjustment, might not suffice. So it is that in the wake of U.S. District Judge Sharon Blackburn’s rejection last September of Jefferson County’s contention that the appeal of U.S. Bankruptcy Judge Thomas Bennett’s decision approving the county’s—at the time—exit from the largest municipal bankruptcy in U.S. history just might not prove to be the last word. In rejecting Jefferson County’s argument that the appeal was moot, Judge Blackburn also said that she would consider the constitutionality of the county’s approved adjustment plan that cedes the county’s future authority to oversee sewer rates to the federal bankruptcy court. So it was that this week. Jefferson County’s attorneys argued in the 11th U.S. Circuit Court of Appeals that investors in the financing that enabled the county to exit bankruptcy nearly two and a half years ago should not have the “rug pulled out from under them” by losing a prime security feature they relied upon in deciding to loan the county money—referring to the security feature of the federal bankruptcy court’s oversight of Jefferson County’s plan of adjustment for the 40 years that the sewer refunding warrants remain outstanding—a key provision of the county’s plan of debt adjustment. As the godfather of municipal bankruptcy, Jim Spiotto, notes, what transpires in this appeal will have broader implications for all municipal bond market investors who rely on security enhancements, such as promised rate covenants or court oversight as part of their investment decisions: “To the market, hopefully the result [of Jefferson County’s case] will be a reaffirmation that rate covenants will be and should be enforced, and if you make a promise, especially in a Chapter 9 plan, it should be enforced as any contractual promise is.” In its 93-page brief, Jefferson County attorneys requested oral arguments to examine the constitutional, statutory, and equitable principles of the case which “are particularly important to governmental entities that may consider Chapter 9 relief now or in the future, as well as to the municipal debt market.” The issue underlying the appeal centers on whether proper legal steps were taken when Jefferson County’s bankruptcy plan was appealed to the U.S. District Court in Alabama by 13 residents and elected officials on the county’s sewer system, described as the “ratepayers” in court documents, who, Jefferson County attorneys argued, had failed to obtain the required legal “stay” suspending the plan while the appeal proceeded. Without any barriers to re-enter the bond market, Jefferson County proceeded to issue $1.8 billion in sewer refunding warrants in December 2013 that allowed the county to write down $1.4 billion in related sewer debt and exit bankruptcy. With the sewer refunding warrants long since sold to new investors, the complex plan of adjustment cannot be unwound, the attorneys wrote. Mr. Spiotto notes that the issue here comes down to an interpretation with regard to what chapter 9 permits and whether the bankruptcy court’s supervision is actually the act of setting rates or insuring that the county complies with the covenants that it promised. In its petition for an appeal before the 11th Circuit, Jefferson County wrote that neither its court-approved plan of adjustment or Judge Bennett’s confirmation order “changes the substantive law of the state of Alabama with regard to the enforcement of rates established pursuant to contract or legislation…Rather, the plan merely retains the bankruptcy court as an available forum in which such substantive law may be enforced, using the same remedies available in Alabama state court…In no event will the bankruptcy court ever set sewer rates; it is simply a forum to enforce the plan and related contracts – just as an Alabama state court could.” As Mr. Spiotto notes: here, no person—or court—is attempting to usurp the right of the state or a municipality under state law: “At the same time, no state or municipality should believe that it can make a promise and not live up to it: Whether you give it as Detroit did as a statutory lien or you have the court involved there are different roads to the same summit.”

Who has standing in a municipal bankruptcy case–and whether taxpayers, citizens, citizen groups, and major businesses in a municipality should have a role e in connection with the plan of debt adjustment, was a question I posed to U.S. Bankruptcy Judge Steven Rhodes for an interview with State Tax Notes. Judge Rhodes, in his response, wrote:

  1. This is perhaps among the most difficult questions in chapter 9. One practical reality is that every resident and business in a municipality that is going through a bankruptcy case has a direct and personal stake in the outcome of the case, although that stake may or may not be a financial stake in the strictest sense. But another practical reality is that the case has to be manageable. Most cases therefore deny standing to residents, concluding that the municipality’s democratically elected leadership adequately represents the residents’ interest in the case. That was my conclusion in a previous chapter 9 case called Addison Community Hospital District.

But the question is more complex where, as in the Detroit case, the management of the case is in the hands of an un-elected agent of the state and not the municipality’s elected leadership. In the Detroit case, I decided that a looser application of the traditional standing requirements was needed and so I invited the public to participate in the eligibility and confirmation phases of the case.  I maintained the manageability of the proceeding in other, more creative ways.

I followed up: Should a debtor propose a plan of debt adjustment which requires the debtor to take action that is contrary to state law including disregarding the pledge or dedication of revenues to the debt payment required under state law? In reply to which, Judge Rhodes said: “Yes, if it is necessary to restore or maintain adequate services. Although the Fifth and Fourteen Amendments generally prohibit bankruptcy from impairing property rights, nothing in those amendments or the bankruptcy code prohibits a plan from impairing creditors’ statutory or contract rights under state law.”

The Fate of a U.S. Territory. As Congress readies a hearing next week to consider whether Puerto Rico should be eligible for statehood, pressure continues in a separate committee in the House with regard to whether Puerto Rico should have the same authority as all other states with regard to municipal bankruptcy—that is, the authority to enact legislation which would permit any of its 157 municipalities to file for federal bankruptcy protection. In the latter issue, the struggle is with regard to H.R. 870, legislation proposed by  Rep. Pedro Pierluisi (D-P.R.), which is pending before the House Judiciary Committee—and which has the strong support of Puerto Rico Gov. Alejandro García Padilla. As pending, the bill would allow nearly insolvent governmental authorities, including the islands cities to formally reorganize under U.S. Bankruptcy court supervision—if authorized by Puerto Rico. The legislation, unsurprisingly, is opposed by funds which invest in Puerto Rico bonds, including Franklin Municipal Bond Group and OppenheimerFunds, Inc.: the funds recognize that municipal bondholders—in the event of a municipal bankruptcy—are more likely than not to take a haircut. Thus, they oppose any efforts to grant Puerto Rico the same powers granted to every state, claiming the municipal bankruptcy process is filled with uncertainty. The issues are even more complex from a governance perspective, however: should the bill be amended so that Puerto Rico, itself, could seek access to chapter 9, or should the bill be adopted as proposed, authorizing Puerto Rico to consider whether its municipalities should have access to municipal bankruptcy. Gov. Padilla supports the legislation as drafted; however, municipal distress veteran and long-time specialist Dick Ravitch, who has experience not just from his leadership in averting bankruptcy for New York City in the 1970’s, but more recently during his volunteer service in Detroit’s bankruptcy, has been pressing Congress to modify the bill so that Puerto Rico would itself have access to the U.S. bankruptcy court to reorganize its own debts. Mr. Ravitch fears that the territory, because it has issued so much debt, cannot conceivably repay it all, noting: “I do not believe the economy in Puerto Rico can prosper without a significant restructuring of all the debt.” That position contrasts the veteran municipal distress expert with Rep. Pierluisi, who yesterday released a statement cautioning that Congress would not support the bill to allow the restructuring of the island’s general obligation bonds, stating: “To lobby to amend H.R. 870 to enable Puerto Rico to restructure its general obligation debt is unwise and unnecessary as a matter of public policy.” The questions and issues with regard to equitable treatment for cities in Puerto Rico comes as the House Natural Resources Subcommittee on Indian, Insular, and Alaska Native Affairs has scheduled a hearing for next Wednesday on H.R. 727, proposed legislation to provide a path to statehood for Puerto Rico: the bill would authorize a U.S. sponsored vote to be held in Puerto Rico within one year of its enactment—the gist of which would be whether or not Puerto Rico should become a state. Should that vote be authorized—and the voters in Puerto Rico approve it, then the new state would automatically gain the authority to determine whether its municipalities ought to have access to chapter 9 municipal bankruptcy. Such a decision would also eliminate any authority by Congress to determine the new state’s access to federal bankruptcy, as Puerto Rico would become a sovereign. Former Puerto Rico Gov. Luis Fortuño said the statehood bill is getting a hearing because Rep. Don Young, the Alaska Republican who chairs the panel, is a friend to Puerto Rico and remembers when Alaska was a territory prior to 1959.

The Many Interlocking Parts Critical to a Sustainable Fiscal Future


May 22, 2015
Visit the project blog: The Municipal Sustainability Project

The Many Interlocking Parts Critical to a Sustainable Fiscal Future. The Wayne County Board last evening unanimously approved County Executive Warren Evans’ reorganization plan—a plan which will now give the green light to consolidate county departments and reduce the county’s structural debt by about 5 percent—a savings Mr. Evans believes vital to averting a potential state takeover if the county—which surrounds Detroit—is unable to make major changes. Thus these changes, adopted last night as a first step and abrupt change in fiscal direction, have critical implications for Detroit’s fiscal sustainability and recovery, as well as Wayne’s. Wayne’s structural debt is a toxic fiscal product of its underfunded pension system and a $100 million drop in annual property tax revenues since 2008. At the time Mr. Evans took office, Wayne County was on course to be insolvent by August of next year, according to an Ernst & Young audit: Wayne has, for years, run a structural deficit now estimated at $50 to $70 million. It has an accumulated deficit of roughly $161 million and a pension plan with a funded status that’s fallen to 45% from 95% ten years ago. Thus, the county’s elected leaders confront a hard fiscal road to sustainability ahead—and Detroit has, very much, a stake in that endeavor. The reorganization plan approved Thursday is part of a larger, structural recovery plan which Mr. Evans had unveiled in April. That plan proposes to eliminate the structural deficit by eliminating retiree health care, increasing employees’ retirement age, and making various pension changes. Under the plan adopted yesterday, the county would eliminate various departments and consolidate others as it begins its efforts to face down its $52 million structural general fund deficit. As County Executive Evans put it yesterday: “My team and I invested a great deal of time and thought into how the county should best serve our residents and businesses…It represents the ‘new Wayne County’ — how we need to work to provide services more efficiently and effectively.” Indeed, as Commissioner Tim Killeen (D-Detroit) said immediately prior to the vote: “This is the third reorganization that I’ve been here for, and I very much appreciate the negotiations, the coming together of minds (with the administration) on this…I think there was a lot more depth to this reorganization plan than I’ve seen in previous ones…I think overall it bodes well as the commission and the executive branch are trying to…get the county on a better path.” For his part, Mr. Evans notes: “(The plan) represents the ‘new Wayne County’ — how we need to work to provide services more efficiently and effectively for residents and businesses to live and grow.” Under the plan, the county will combine its Children and Family Services, Health and Human Services, and Veterans Services departments into a new department of Health, Veterans and Community Wellness. In addition, the plan also calls for shifting the Department of Economic Development Growth Engine’s functions to the Wayne County Economic Development Corp., a quasi-public agency—a move projected to eliminate 50 jobs. Nevertheless, getting there was not easy. Just as in San Bernardino, charter provisions hampered efforts: for instance, after county commissioners raised questions earlier this month about what they believed were potential violations of the county charter in the plan, Mr. Evans yesterday informed them that he and his staff had made some changes to address commissioners’ concerns: for example, the Senior Services Department was to be combined into the same department as Children and Family Services, Health and Human Services and Veterans Services, but, instead, the plan was revised so that senior services is to be reorganized into a separate department overseen by the director of the new health and community wellness department. Reversing fiscal directions and constructing a long term fiscal sustainability plan may be one of the greatest challenges of governance.

The Critical Nature & Tie of Education to Municipal Fiscal Sustainability


March 26, 2015
Visit the project blog: The Municipal Sustainability Project

Detroit’s ABC’s of Bankruptcy. In Monopoly, if one gains a “Free Get Out of Jail” card, one’s chances of winning are improved. But gaining federal judicial approval to exit from the largest municipal bankruptcy in history offers no such equivalent benefits. In all the juggling Michigan Gov. Rick Snyder, Detroit Mayor Mike Duggan and the Detroit City Council must now confront if Detroit is to have a sustainable human and fiscal future, getting the ABC’s of fixing the city’s school system are critical. That promises to be a tall order: “By most measures, Detroit’s school system (DPS) remains in a financial free-fall,” Shawn D. Lewis of the Detroit News wrote yesterday. The system is $53 million behind in its public pension obligations—an unexcused tardiness that has triggered the already virtually bankrupt entity $7,600 a day in interest penalties; DPS is on pace to be $81 million behind in mandatory pension contributions by July 1, according to Michigan state records, but that is before counting in the additional late homework debt of $78,000 in fees for each month the Motor City’s system DPS remains delinquent — a sign Ms. Lewis writes of “worsening finances for Michigan’s largest school system as it continues to rack up debts and hemorrhage students and cash. Forgoing required contributions for pension payments mirrors a cash-hoarding tactic the city of Detroit pursued in November 2012 — nine months before declaring bankruptcy.” DPS now has a projected fiscal deficit of $166 million this year; at the same time, DPS is running an increasing human deficit: its enrollment has dropped to 47,238 students this year, less than a third of a decade ago―and this notwithstanding state oversight for 12 of the past 15 years and the recent arrival of its fourth state-appointed emergency manager, or, as Ms. Lewis writes: “The Detroit district has run a deficit in nine of the last 11 fiscal years, sometimes papering over its debts with borrowing against its future school aid revenues. It has resulted in a net accumulated deficit of $1.28 billion during that period.” Is a meaningful, long-term recovery from municipal bankruptcy and a fiscally sustainable path to the future for the Motor City’s fiscal future absent a reversal of its nearly two-thirds population decline – and its fiscally deteriorating and unsustainable perception of its public school system possible? The gravity of this fiscal challenge to Detroit’s future now, it appears, lies not with retired U.S. Bankruptcy Judge Steven Rhodes, but rather with the Coalition for the Future of Detroit Schoolchildren, formed to look for ways to try and address—and turn around―Detroit’s long-troubled educational system. The coalition has been examining how the city’s fragmented school systems impact student outcomes and efficiency in operations; it is looking to outside education experts from Detroit and across the country in an effort to identify the best ways to improve the city’s broken education system. The leaders of the 31-member Coalition, which include Skillman Foundation President and CEO Tonya Allen; the Rev. Wendell Anthony, Fellowship Chapel and President of the Detroit branch of the NAACP; David Hecker, president of AFT Michigan/AFL-CIO; John Rakolta Jr., CEO of Walbridge Aldinger Co.; and Angela Reyes, executive director of Detroit Hispanic Development Corp. expect to issue its findings and make recommendations for making Detroit’s school system more equitable, accessible, and successful for all Detroit children next Monday―a report Ms. Allen notes in which the coalition will “share a common belief that Detroiters should have a say in coming up with solutions that can make Detroit schools work for kids, and that now, as the city is recovering in so many other ways, is the time to make real change happen.” The coalition appears to understand that Detroit’s road to economic recovery will be neither sustainable, nor even possible if people do not have confidence in the city’s education system: “Detroit’s vitality and global competitiveness is linked to its schools, which are educating our future workforce.”

Borrowing that Could Bankrupt Detroit’s Future. High administrative and special education costs and debts―nearly $1,200 in DPS funds now are diverted―per student―toward paying off past operating deficits: an unsustainable fiscal road to perdition that officials report will handcuff DPS at least until 2022: this is debt service burden which is reported to be higher than virtually any other Michigan school district, according to state officials, with the debt—and late fees―owed to the Michigan Public School Employees Retirement System. That means that of the amounts left for actual classroom education of the Motor City’s children, out of the $14,444 DPS budgeted per child last year, just 27 percent went toward basic classroom instruction—a signal disparity from other school districts in the metropolitan region, and less than half the statewide average, according to a Detroit News analysis of the 2013-14 spending data. In contrast, the Detroit school system has among the highest per-pupil costs for administration ($1,963 per student) in the state, among districts with more than 1,000 students, with Ms. Lewis noting: “Even with cost-cutting state emergency managers, the district’s 204 central office employees last year are more than the 200 it had a decade ago when there were 100,000 more students and 5,000 more teachers.” Even though DPS drastically undercuts its investment in the city’s future workforce, it faces a special needs population considerably higher than the state average: close to one in five DPS five students receives some form of special education services: “Special-needs students have been a rising share of Detroit’s enrollment since 2003. And a geographically large footprint and the district’s competition with charter schools and suburban districts for students compound its transportation costs. Its average cost to bus a student — $651 — is twice the cost elsewhere in Wayne County, according to state data.


March 25, 2015
Visit the project blog: The Municipal Sustainability Project

Rolling the Die on Atlantic City’s Fiscal Fate. New Jersey Governor Chris Christie’s appointed emergency manager Kevin Lavin yesterday issued his assessment (please see opening part below) and recommendations as directed under the state executive order which tasked him, along with former Detroit emergency manager Kevyn Orr, with determining whether the city should be forced into municipal bankruptcy or not. Noting that “[B]ankruptcy is not something that we are contemplating,” Mr. Lavin instead said, “We think that this process can be done without that necessity.” That is, the report and recommendations mean there will continue to be a hybrid form of municipal government between the city’s mayor and council and the state-appointed emergency manager for the forseeable future. The report, as one expert notes, “kicks the can down the road,” and offers no specifics with regard to specific steps the city could take to grow its eroding tax base so that it could someday have a fiscally sustainable path to a viable future. Mr. Lavin’s report indicates that, even taking adjustments into account, including deferring municipal contributions into pension funds, operational cuts and the addition of $77 million of state aid―Atlantic City’s cash flow would still dip below zero twice by August, or, as he put it yesterday: “Absent the continuation of significant state assistance…the city simply cannot stand on its own.”

In the report, Mr. Lavin wrote: “The decline in revenues has exceeded the worst estimates that were published earlier this year. Moreover, absent the continuation of significant state assistance, the City is simply incapable of self-funding even its reduced budget for the coming fiscal year and this incapacity will only continue and worsen throughout the following years. The City simply cannot stand on its own. Thus, one thing is clear: there is no reasonable likelihood that these headwinds will abate at any point in the near future. In fact, as discussed in detail herein, all reasonable forecasts confirm that these troubling factors will continue to beset the City for the foreseeable future and, absent immediate and urgent corrective action, the City’s ability to function as a thriving and viable municipal enterprise is imperiled. In short, the acute financial distress facing the City is imminent and the causes of such distress are not transitory. Absent an urgent, material realignment of revenues and expenses, this crisis will rapidly deepen and will threaten the City’s ability to deliver and maintain essential government services impacting the health, safety and welfare of its residents. Lastly, the taxpayers of the City need and deserve a much more efficient and financially stable place to live and work. Atlantic City is a beautiful place with great people and tremendous potential. Indeed, I believe we all would like to see investors and developers aggressively pursuing investment opportunities here. Together we need to fix these challenges the City is facing and to that end I look forward to continuing to work closely and collaboratively with Kevyn Orr, the Mayor and his team, City Council, Atlantic County (the “County”) and the State of New Jersey (the “State”) personnel as well as all other City stakeholders.”

Mr. Lavin’s report notes the city will confront a liquidity crisis by the third quarter of this year and that its ratable tax base has declined 64% to just $7.35 billion in 2015 from $20.5 billion in 2010, as its casinos suffered from competition in neighboring states, noting the city’s fiscal deterioration is actually “a lot more severe than we thought when we first started.” About 85% of Atlantic City’s budget is derived from property taxes. Four Atlantic City casinos have closed since the start of 2014. The city’s gambling revenue has dropped from $5.2 billion in 2006 to $2.6 billion in 2014, as casinos have proliferated across the region. Casinos also have appealed their property-tax bills and often won rebates, creating “significant refunds and unsustainable debt load,” the report said. Mr. Lavin said he would appoint a mediator to negotiate with stakeholders, including labor unions and casinos. Atlantic City currently is projecting a deficit of $101 million. Without significant change, Mr. Lavin noted, the cumulative deficit will be $393 million over five years. The cuts, he noted, will have to come from a combination of operational cuts and a 20 percent to 30 percent reduction of the city’s 1,150 or so full-time employees. That warning comes as six of Atlantic City’s labor contracts have expired and are already in negotiations. Those negotiations will also have to address public pension obligations—not only of the employees, but also with regard to the separate retirement plan for the city’s lifeguards. The report said bondholders may need to consider negotiating lower interest rates for the city. And it called for possible changes in benefits for certain city retirees. The emergency managers did not specify whether discussions had taken place about layoffs or cuts to employee benefits. The city’s workforce of about 1,100 has already been trimmed by Mayor Don Guardian. The emergency managers said another 20% to 30% of the workforce might need to be cut. The city’s school system also has about a $45 million budget gap, according to the report. They recommended possible layoffs in the school system and said the state probably would need to help keep the system afloat.Their ideas for fixing the city’s troubled finances were largely dependent on state assistance and reductions in expenditures—not on additional revenue. While city and state officials have emphasized a need for diversification in the city’s economy beyond casinos, the report proposes taking money that was used to do that through a tourism and marketing agency, and using it to close the budget gap.

Governance. Mayor Don Guardian yesterday said he had been working with the Lavin—Orr team, which will consider long-term solutions in a second phase of work. But the nature of this quasi-shared governance is not addressed in Mr. Lavin’s report. Ergo, the nature or balance of power remains unclear—especially as very hard choices have been deferred. The decision, however, not to direct or mandate Atlantic City to file for chapter 9 municipal bankruptcy in federal court indicates the state has a vested stake in trying to make Atlantic City come out whole instead of throwing the city to the federal bankruptcy court. That could be an important step to the prevention of further fiscal contagion for other New Jersey municipalities.

Governor Chris Christie appointed me as Emergency Manager and Kevyn Orr as Expert Consultant to the City of Atlantic City on January 22, 2015. This action was taken only after numerous reports analyzed and described the dire financial status of the City that currently threatens the City’s ability to provide the crucial services that the citizens, businesses, visitors and stakeholders of the City expect and deserve. Since my appointment, I have met with numerous stakeholders, including: elected officials, business partners, taxpayers, union representatives and other interested parties to discuss their observations and concerns about the financial and operating state of the City. Commendably, the City, County, and State have made great efforts to confront these headwinds and develop plans to address the significant revenue shortfalls that are a direct consequence of the precipitous decline in both the City’s ratable tax base and other limited revenue sources, a decline that has become even more severe within just the past 90 days. Indeed, the decline in revenues has exceeded the worst estimates that were published earlier this year. Moreover, absent the continuation of significant state assistance, the City is simply incapable of self-funding even its reduced budget for the coming fiscal year and this incapacity will only continue and worsen throughout the following years. The City simply cannot stand on its own. Thus, one thing is clear–there is no reasonable likelihood that these headwinds will abate at any point in the near future. In fact, as discussed in detail herein, all reasonable forecasts confirm that these troubling factors will continue to beset the City for the foreseeable future and, absent immediate and urgent corrective action, the City’s ability to function as a thriving and viable municipal enterprise is imperiled. In short, the acute financial distress facing the City is imminent and the causes of such distress are not transitory. Absent an urgent, material realignment of revenues and expenses, this crisis will rapidly deepen and will threaten the City’s ability to deliver and maintain essential government services impacting the health, safety and welfare of its residents. Lastly, the taxpayers of the City need and deserve a much more efficient and financially stable place to live and work. Atlantic City is a beautiful place with great people and tremendous potential. Indeed, I believe we all would like to see investors and developers aggressively pursuing investment opportunities here. Together we need to fix these challenges the City is facing and to that end I look forward to continuing to work closely and collaboratively with Kevyn Orr, the Mayor and his team, City Council, Atlantic County (the “County”) and the State of New Jersey (the “State”) personnel as well as all other City stakeholders.

Chinese Municipal Fiscal Distress. The Economist this week notes that severe municipal fiscal unsustainability is not unique to the U.S., writing that China’s finance ministry has proposed measures to address still another cloud looming over the heretofore booming economy: local government debt, which, the Ministry reports, has ballooned to over 40% of GDP. To help (this is where China is profoundly different than the U.S. federal government), local Chinese governments will now be permitted to refinance $1 trillion yuan (about $160 billion) of exiting high-interest municipal debt for lower cost municipal bonds—federal government assistance which could save these cities as much as 50 billion yuan in interest costs alone this year. 哇!

Is New Jersey Gambling with Atlantic City’s Future?


March 2, 2015
Visit the project blog: The Municipal Sustainability Project

Spinning for Municipal Bankruptcy: In the Red or Black? Try and imagine the intractable quandary of Atlantic City Mayor Don Guardian: his Governor, Chris Christie, appears not only determined to crash land the city into municipal bankruptcy, but has also imposed an emergency manager—without any guidance which official is really in charge; the city’s assessed property values are plummeting; and the city’s plans to fix the way its casinos pay property taxes appears mired in inaction in the state legislature. These are all issues of time—a luxury the city does not have. In his State of the City presentation last week, Mayor Guardian had pledged to “do everything humanly possible” to avoid a property tax increase this year—even though the official budget he will present to the Council in June will come in at $235 million, a $30 million drop compared to FY2014: he noted that Atlantic City’s assessed total property values will soon be assessed at $7.35 billion, down from a high of about $20 billion. In the face of that decline, the city underspent its 2014 budget by $10 million, according to the Mayor―a savings that can be applied to cash-flow needs in the coming year. In addition, Mayor Guardian said city staffing will have been reduced by 200 positions as of June, but he told his colleagues that has not adversely affected the quality of municipal services, because of increases in efficiency: noting official statistics demonstrating drops in crime along with fewer public complaints lodged against the police. By the end of this month, Atlantic City will have reduced its police force by nearly 15 percent down to 285 active police officers from 330. Mayor Guardian reported, moreover, that all patrolling officers will receive body cameras, while a new computer system will allow the department to prioritize resources in real time; the city’s municipal court will operate 8-10 hours a day, four days a week, allowing officers to return to street patrol on the fifth day. Nevertheless, Mayor Guardian told his colleagues the city’s debt remains his front and center issue, noting he was supporting state legislation to redirect casino taxes to debt service, and that the city will, by the end of the month, attempt a $52 million bond sale covering the $12 million it recently borrowed and the $40 million it owes back to the state. On the revenue side, he praised new development initiatives, such as those taken on by Stockton University, Boraie Development LLC, and Bass Pro Shops―all of which have helped to create a double: create new jobs, and enhance the city’s tax base. Nevertheless, he made clear how critical new forms of state assistance are to Atlantic City’s solvency, telling his Councilmembers Atlantic City receives far less than many other municipalities in school and budgetary aid and advocating that a greater percentage of revenues from the city’s room, luxury, and parking taxes should be returned to the municipality generating them: “Atlantic City isn’t a step child.” Reminding his colleagues that last year – a “terrible” year ― Atlantic City still brought in $700 million in taxes, clarifying: “We’re not asking for a buyout…We’re asking for a little of that $700 million to come back to Atlantic City.” In response, Council President Frank Gilliam offered support for Mayor Guardian’s presentation, but said the council must continue to look for further ways to cut the 2015 budget. He said council aims to put forward its own budget in March, before emergency manager Kevin Lavin produces his findings.

Coming up Lemons? Mayor Guardian’s please for a better return of the revenues the city has previously sent to the state, however, risk coming up three lemons: A quarter of the year after the “Casino Property Taxation Stabilization Act,” or payment in lieu of taxes (PILT) plan was in the state legislature as a means to transform the way Atlantic City casinos pay property taxes, there has been little, if any progress. Under the proposed legislation, casinos would no longer pay property taxes; instead, they would cumulatively make $150 million in PILT payments annually for two years, then $120 million for each of the next 13 years. The key sponsors, New Jersey Senate President Stephen Sweeney, Sen. Jim Whelan, and Assemblyman Vince Mazzeo describe the bipartisan bill as one which would help Atlantic City escape from the perennial property-tax appeals which, for years, have made fiscal planning a nightmare for Atlantic City, because challenging the city’s assessments in court has become almost as routine as spinning the roulette wheel for casino operators. Nevertheless, the bill, part of President Sweeney’s five-card Monte package of bills to come to the fiscal rescue of Atlantic City remain spinning without stop in the legislature. Even the Casino Association of New Jersey, has pressed the legislature for favorable spins, lobbying that the legislative proposal was the only cure for Atlantic City’s reeling gambling industry, which has seen about half its revenue disappear since 2006: “Make no mistake. Without this plan, certain casinos that remain in Atlantic City are at risk.” Nevertheless, the proposal appears iced over: despite sailing through committees last December, state Democrats have repeatedly balked at putting the legislation to a general vote: but no one appears to have an explanation why. One issue could be uncertainty with regard to Gov. Christie’s position: he has never publicly supported the proposed legislation—and, last week, did not return a request for comment about the bill.

A Chilling Credit Wind in the Windy City. Credit rating agency Moody’s has dropped Chicago’s credit rating to its second lowest investment grade, with analysts Rachel Cortez and Matthew Butler noting: “The main thing is that another year has passed and gone by without a solution to the pension issues, both with respect to curbing the growth in the unfunded liabilities and dealing with the police and fire pension spike that is getting closer and closer.” The decision, coming in the midst of Mayor Rahm Emanuel’s runoff campaign for re-election (he faces an April 7 runoff versus Jesus “Chuy” Garcia, a Cook County board commissioner), risks both the city’s reputation—and likely will adversely impact its costs of borrowing—or, as the prescient president of the Chicago Civic Federation Laurence Msall put it: “This is wakeup call for anyone still asleep as to the precarious financial condition of the state of Illinois and many local units of government especially Chicago…The downgrade has immediate financial costs to the taxpayers and puts enormous additional financial pressure on the city’s budget which is dependent on access to the credit markets.” Last month, the Federation had noted that between FY2004 and FY2013 the long-term debt for eight major Chicago governments had risen by just under 60 percent over the last decade to $20.4 billion; but mayhap more worriedly, long-term direct debt per capita rose at a faster rate, increasing by 66.8% from $4,504 to $7,514. A key concern is the city’s $20 billion unfunded pension tab. Moody’s decision means the Windy City now has a lower credit rating than all other major cities with the exception of Detroit. Nuveen lists Chicago as a pre-distressed credit which is “getting to a pretty critical point.” In their report, the Moody analysts wrote that their lowered credit rating “incorporates expected growth in Chicago’s already highly elevated unfunded pension liabilities and continued growth in costs to service those liabilities, even if recent pension reforms proceed and are not overturned in legal appeal,” adding that Chicago’s tax base is significantly leveraged by the direct debt and pension obligations of the city, as well as indirect debt and pension obligations of overlapping governments—albeit partially offset by the significant improvements Mayor Emanuel has achieved in structurally balancing its budget and strong economic base. Indeed, the Mayor’s office responded to Saturday’s moody report with a statement: “We strongly disagree with Moody’s decision to reduce the city’s credit rating and would note that Moody’s has been consistently and substantially out of step with the other rating agencies, ignoring the progress that has been achieved.” Fitch, indeed, last week affirmed its A-minus rating and negative outlook, whilst S&P affirmed its A-plus rating and negative outlook last Friday. The city has for years faced a reckoning on its public safety pensions in 2016 when a longstanding state mandate to stabilize public safety systems through actuarially based funding kicks in, driving Chicago’s annual contribution up by $550 million.

Pensions & State/Local Municipal Bondholders on the Teeter-Totter


February 10, 2014
Visit the project blog: The Municipal Sustainability Project

State of the Motor City. Detroit Mayor Mike Duggan will deliver Detroit’s first State of the City address following the city’s historic exit from municipal bankruptcy tonight. The address will come amid the Mayor’s aggressive blight removal campaign that includes demolishing thousands of vacant houses and finding owners for others that can be rehabilitated—as well as his initiative to lower property tax assessments for many residential properties in Detroit.

Betting on a City’s Future. Atlantic County—in which Atlantic City and 22 other municipalities may be found―Executive Dennis Levinson is proposing cutting the county Open Space Tax to decrease the burden on taxpayers by $1.5 million, after several mayors asked him to re-examine the county budget for savings. Under the proposal, the tax rate would decrease from one-half cent per $100 valuation, to one-eighth of a cent, according to Mr. Levinson’s letter last week to the county’s 23 mayors dated Feb. 5.
The response, according to Somers Point Mayor Jack Glasser, president of the Atlantic County Mayors’ Association, an average saving of $91.50—cuts offset by cutting back on county library hours (most branches would lose Monday night hours from 5 to 8 p.m.). In his epistle to the county’s mayors, Mr. Levinson said he is proposing the extra cuts because of “the unprecedented decline in Atlantic City’s ratable base and the effect it has on county government and property taxes in all Atlantic County municipalities,” noting that the uncertainty of what will happen with Atlantic City property taxes is making the budget process more complex this year. In New Jersey, the open space tax and the county library tax are paid by towns separately from the operating budget, which would remain up 2.7 percent from $196 million to $201 million. The Atlantic County budget was introduced at the end of last month; there will be a public hearing on it March 10. The tradeoffs demonstrate the difficulty—especially with the looming uncertainty about what Gov. Chris Christie will decide with regard to the fate of Atlantic City and its elected leaders—e.g. whether to, in fact, preempt their authority entirely and put the city into municipal bankruptcy—a threat which has already, as we have noted, imposed significant increases in borrowing costs for cities throughout the count—or, as Mayor Glaser puts it: “We still don’t know what will happen down the road. We’re still waiting for everything going on in Atlantic City.” In addition, the New Jersey legislature has still not voted on legislation to create a Payments in Lieu of Taxes, or PILOT, program that would require the casinos to pay $150 million annually in property taxes to Atlantic City for two years, and $120 million annually for the next 13 years—again because of uncertainty with regard to the Governor’s intentions: New Jersey State Senate President Steve Sweeney in the Philadelphia Inquirer last week was quoted as saying that he does not see a point in passing the legislation, if Governor Chris Christie is likely to veto it. The uncertainty comes despite an agreement between Mr. Levinson and Atlantic City Mayor Don Guardian.

Pensions & Bankruptcy. Illinois Gov. Bruce Rauner has proposed legislation to modify the state’s municipal bankruptcy law—which currently only applies to the state’s Illinois Power Agency, but which the new Governor has proposed to expand to municipalities—along with a constitutional amendment on pensions―an issue currently pending before the Illinois Supreme Court. The twin ears of corn, as it were―incorporated in his State of the State address—have yet to be fully detailed, but could be elucidated as early as next week, when the Gov. is expected to release his final FY2016 budget proposal. However, under the “Taxpayer Empowerment and Government Reform Package” section of the Governor’s plan, Gov. Rauner included that he intended to “pursue permanent pension relief through a constitutional amendment” and “extend to municipalities bankruptcy protections to help turn around struggling communities.” Some believe that such a constitutional amendment could offer a long-term solution to the state’s troubled pension system if the Illinois Supreme Court, in a ruling expected later this year, affirms the lower court’s holding that the legislature’s pension overhaul lawmakers passed in 2013 is unconstitutional. The state faces more than $100 billion of unfunded obligations. With regard to municipal bankruptcy, Illinois currently offers assistance for stressed communities with populations under 25,000 through its Fiscally Distressed City Act―after a municipality requests the General Assembly to appoint a special commission to consider whether the municipality meets the act’s criteria—upon which, if approved, the municipality can qualify for state financing assistance. The Grand Poohbah of Municipal Bankruptcy, Jim Spiotto, yesterday told the Bond Buyer: “The question is how do you want to approach it? Should there be―like in 12 other states―a second look?” (He noted that another 12 states do not require an additional layer of review, and that, since 1954, the rate of bankruptcy filings is four times higher in states with no second look compared to states that require another additional approval.), adding: “A second look requires the input of a supervising adult who can say there are other available options,” and the state has to “make sure it doesn’t cost its municipalities more borrowing costs” in the way it treats creditor classes.” The Governor’s proposal comes in the wake of State Rep. Ron Sandack’s (R-Downers Grove) recently introduced House Bill 298 to allow local governments to file for municipal bankruptcy protection, with Rep. Sandack noting: “As more and more municipalities are looking for relief and ways to deal with rising pension liabilities and other costs, this is a tool that can help them stabilize and reorganize financial affairs in ways that benefit taxpayers.” For his part, Mr. Spiotto, in concert with the crack Civic Federation of Chicago, has proposed the creation of an authority designed to intervene before fiscal strains reach crisis stage for local governments. Meanwhile, the fabulous Matt Fabian of Municipal Market Analytics notes: “In Illinois, it’s unlikely that a bankruptcy law would be passed, and even more unlikely that what might be passed would protect bondholders over employees: The cost of capital would very likely rise. Illinois’ local governments already pay interest rate penalties for the financial distressed of the state government.” He added, however, that a constitutional amendment on pension benefits, on the other hand, could offer sweeping relief down the line.

Cornhusker Prioritization. The Cornhusker unicameral legislature has set a hearing date for proposed legislation, LB 67, to prioritize bondholders over pensioners in the event of a municipal bankruptcy. The hearing, in which the legislature could consider amendments to the state’s current statute §13-2524—under which some 55 municipal entities have previously sought protection― will be held on March 3rd; the legislature could also hold a hearing on a related measure, LB 66, which would require a county, city, village, school district or agency of state government to disclose on the front page of offering documents if bondholders have no priority over pensioners, but only after the LB 67 according to an aide to Sen. Paul Schumacher (R-Columbus), the author of both bills. Several muni market participants testified against LB 66 in a public hearing on the proposed legislation two weeks ago. Sen. Schumacher said the lack of clarity on the federal level regarding the position of bondholders versus pensioners prompted him to re-introduce the legislation.

A Kernel of Affirmation. Fitch has affirmed its A rating on Kern County, California’s outstanding pension obligation bonds (POBs) and its implied general obligation (GO) rating at A+ with a stable outlook, noting the county’s financial position presently is satisfactory, with healthy reserve levels, and that, even though fund balances are likely to be drawn upon to support operations over the near term due to anticipated revenue declines, they are expected to remain adequate for the rating. The rating agency expects a decline in property tax revenues, noting its tax base is highly concentrated in oil production properties that have been preliminarily assessed at a much lower value for fiscal 2016 due to the sharp drop in oil prices. Thus, Fitch notes, the county’s general fund and fire fund expect to lose approximately 6% and 14% of total revenues (relative to FY2014), respectively, due to the tax base decline. In addition, the agency determined the regional economy, because it is centered on oil and gas production and agriculture―industries expected to be negatively affected by the decline in oil prices and the ongoing drought—that any significant job losses in these industries could “negatively impact the county’s structurally high unemployment rate and below average income levels.” Nevertheless, Fitch perceives that Kern’s “unrestricted general fund reserve and traditionally conservative budgeting practices” are important factors in supporting the current rating, notwithstanding that a “material reduction beyond current projections would likely lower the unrestricted fund balance below levels commensurate with the level of financial risk facing the county, leading to negative rating action.” Finally, Fitch notes that the projected revenue decline in FY 2016 is significant, estimated at approximately $32 million or 6% of operating revenues (based on fiscal 2014), largely driven by preliminary estimates of assessed value (AV) that reflect large losses from oil properties due to the sharp drop in oil prices. While the figures are preliminary and subject to change, “oil properties are projected to lose more than 40% of their value, resulting in a nearly $44 million revenue loss to the county.” Fitch notes that management’s flexibility to reduce expenditures to match the projected revenue decline is constrained to some degree by increasing fixed costs, particularly pension contributions and POB debt service payments, with general fund pension and POB costs expected to climb by approximately $13.4 million (1.8% of fiscal 2014 spending) in FY2016. Another limitation is a lean budget following multiple years of constrained spending. It found that the loss of property tax revenue due to lower oil prices is expected to leave a $17 million (14% of fiscal 2014 revenues) budgetary gap in the county’s fire fund—and the general fund “may need to support the fund if costs cannot be restructured to match the lower revenue levels.”


Civic Leadership & Responsibility. Laura Berman of the Detroit News yesterday wrote: “As 32,000 current and former city employees study their ballots and ponder their future, the cameras roll, and the officials hold their breath. Nobody can take these workers — now cast to be the city’s saviors or spoilers — for granted.” That is to write that much hinges on how the Motor City’s retirees vote: the city, she notes, is at a “moment of triumph and tension, with many players still waiting to exhale.”  She describes this moment in time – with “so many working parts, and so many people who don’t ordinarily speak to each other” as “at once awe-inspiring and incredibly fragile.”  Continue reading


One More Lap.  Detroit Emergency Manager Kevyn Orr late yesterday proposed a 235-page revised plan of adjustment and a revised disclosure plan with the U.S. Bankruptcy Court that proposes steeper cuts to retirees unless they support a restructuring plan that includes money to shield the Detroit Institute of Arts from creditors. The plan revises how the Motor City is seeking to allocate its debts amongst its 170,000 creditors—and to preserve about $1.5 billion to invest in its future. In its filings, the Motor City made clear it expects to make further revisions in each of the documents—both hundreds of pages long—between now and Judge Steven Rhodes’ April 14th hearing  when creditors expect to challenge the completeness of the respective documents. Continue reading