Should Municipal Bankruptcy Be a Last Resort?

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November 3, 2015. Share on Twitter

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

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

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

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

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

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

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Complexities of Democracy & Municipal Bankruptcy

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October 29, 2015. Share on Twitter

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

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

Single retiree:

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

Source: Wayne County

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

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

Ethics & Their Role in Municipal Fiscal Distress

October 15, 2015. Share on Twitter

Unravelling SWAPs & Paying the Windy City’s Pipers. In a new report, the Chicago Civic Federation rendered its support for Mayor Rahm Emanuel’s City of Chicago proposed FY2016 budget of $7.8 billion—applauding the Mayor’s proposals to take on the Windy City’s public safety pension funding crisis, but expressing apprehension that perhaps the largest municipal property tax increase in U.S. history, by itself, might be insufficient to stabilize Chicago finances, especially given continued legal uncertainty with regard to the city’s public pension and retiree health care reforms. The big kahuna in the Mayor’s proposed FY2016 budget is a $1.26 billion property tax levy, an increase of more than 33% from the originally adopted FY2015 budget, rising in subsequent years to $544.2 million between FY2015 (payable in 2016) and FY2018 (payable in 2019) with those proceeds dedicated entirely to fund the city’s Police and Fire pension funds, with the always insightful federation leader Laurence Msall noting: “Mayor Emanuel and his team deserve credit for transparently outlining a plan to address one of the City’s most urgent financial crises,” adding, however, that “[G]reater sacrifice will be needed to address the pension funding crises for non-public safety funds, the liquidity crises at Chicago Public Schools (please see below for the criminal, ethical, and fiscal challenges to CPS), and Chicago’s ongoing structural deficit, urging the city to consider greater cost savings and efficiencies, “especially in public safety operations that have largely avoided budgetary scrutiny in recent years.” Mr. Msall noted that the Mayor’s FY’2016 budget reduces Chicago’s reliance on what the Federation terms “scoop and toss,” or what he notes is “an expensive practice which extends the life of existing [municipal] bonds and dramatically increases the cost of providing government services—” a practice Mayor Emanuel pledged to the Association he would phase out by FY2019, beginning with a $100 million reduction in FY2016. {Please note next item, “Gambling,” with regard to this prohibitive municipal finance process.] Nevertheless, Mr. Msall expressed apprehension with regard to the as yet unreleased portion of the city’s proposed budget on its plans for how to fund two significant potential expenses in its upcoming fiscal year: an additional $220 million pension contribution and an increase in retiree health care costs. In its proposal, the city’s budget assumes the state will act to adopt the Mayor’s proposed changes to the City’s pension funding schedule. Indeed, such legislation has passed both houses of the Illinois legislature; however, the bill has not been released for Governor Rauner’s signature, nor has Gov. Rauner indicated that he will sign it: without such a signature Chicago will be required to contribute an additional $220 million to its pension funds in the new fiscal year. Moreover, the city still faces uncertainty with regard to the ongoing litigation over its proposed phase-out of its retiree health care benefits—where an adverse court ruling could significantly increase retiree health care costs.

Gambling on a City’s Future. At the exceptional conference, Bankruptcy and Beyond, hosted by Professor Juliet Moringiello of the Widener Law School in Harrisburg, Pennsylvania last year, there was substantive focus on the dangers of municipal involvement with so-called swaps—or municipal instruments packaged by Wall Street to make bets on interest rates—bets which Bloomberg this week insightfully noted are “costing [Chicago] taxpayers at least $270 million since Moody’s Investors Service cut its rating to junk in May,” noting that while traditionally, the exchange of one kind of municipal security for another to change the maturity (bonds), quality of issues (stocks or bonds), or because investment objectives have changed has been a more or less regular practice—one which has left all too many municipalities susceptible to significant fees and risk; more recently, so-called swaps have expanded to include currency and interest rate swaps—all leading to increased payouts to Wall Street banks, but coming, as noted above, as the Windy City considers a record tax increase to cover its public pension liabilities—swap costs in this case that are more than the city spends annually for the collection of garbage at 613,000 homes, or the equivalent of hiring more than 2,000 police officers. And that is before the city is forced to pay the piper to unwind municipal derivatives as it considers still another round of municipal debt restructuring—a round which could cost the debt-stressed city $110 million to unwind derivatives on its water debt—or, as the ever prescient Richard Ciccarone, the CEO of Merritt Research Services: “I don’t think the public should be gambling with its funds…Save the speculation for people who risk their own money, not for taxpayers.” Indeed, as can be seen from Bloomberg’s chart, Chicago confronts enormous debts to banks—not to teach in its troubled schools or to protect it citizens, but almost as a penalty for failing for too many years to address its rising pensions and borrowings to cover debt service. Instead of such critical investments, the city—and other cities and counties, as Bloomberg noted, “and other municipal borrowers in the past decade made bets on the future direction of interest rates through agreements with banks to swap interest payments. But when rates fell under the Federal Reserve’s attempt to stimulate the economy after the financial crisis, many issuers ended up on the wrong side of the bets. Since then [municipal] issuers have paid at least $5 billion to unwind the agreements.” Indeed, the city was scheduled to sell $439 million worth of municipal of bonds yesterday—with nearly 20 percent set aside to cover some $70.2 million to end an interest-rate swap tied to variable-rate debt for the city’s sewer system—and that, as Bloomberg adds, is “on top of $185 million paid to unwind swaps on general-obligation and sales tax debt since May.”The estimated $270 million total also includes the cost to banks and other professionals to restructure, according to data Bloomberg compiled from city documents. Chicago owed as much as $396 million to banks in March, before the city started terminating the swap agreements, according to market values at the time. Saqib Bhatti, a Chicago-based fellow at the Roosevelt Institute, told Bloomberg: “We’re paying these fees at the same time the city is looking at the biggest tax increase in its history,” adding that he has been recommending that governments with swaps should push to cut the fees rather than pay Wall Street banks: “Working residents of the city are going to have to sacrifice for the city to pay these fees to the banks.”

Aiding & Abetting Municipal Fiscal Distress. While they might teach math in Michigan’s schools, it might be that ethics ought also to be mandatory there and in Chicago—both places of exceptional fiscal challenges, but with, seemingly, one common denominator: unethical behavior from the top with abhorrent fiscal consequences. Thus it was Tuesday that former Chicago Public Schools (CPS) head Barbara Byrd-Bennett pled guilty to her role in a scheme to steer $23 million in no-bid contracts to education firms for $2.3 million in bribes and kickbacks. As part of her agreement, prosecutors recommended that Ms. Byrd-Bennett serve 7.5 years in prison for one count of fraud—an agreement under which prosecutors said in return they would drop the 19 other fraud counts, each of which carried a maximum 20-year term. The disservice by which Ms. Byrd-Bennett harmed Chicago’s fiscal sustainability and its children’s future came from her own past disservice to Detroit, where, as the former Detroit Public Schools chief academic officer, she had stepped down in the wake of a federal investigation into a contract between the district and SUPES Academy, a training academy where she once worked.—an investigation in which prosecutors allege the scheme started in 2012 — the year Mayor Rahm Emanuel hired her to become Chicago’s school district CEO. The indictment alleged that the owners of the two education service and training firms offered her a job and a hefty one-time payment, a payment purported to be a lucrative signing bonus — once she left CPS. The indictment alleges Ms. Byrd-Bennett expected to receive kickbacks worth 10 percent of the value of the contracts, or close to $2.3 million—or enough as Ms. Byrd-Bennett emailed to executives more than three years’ ago so that she could make money, writing: “I have tuition to pay and casinos to visit.” Her untimely departure comes in the wake of leaving the Detroit Public Schools system with what, today, is $327 million in debt with no visible means of repayment, and contemplating municipal bankruptcy, even as its debt insurer, Assured Guaranty Ltd., is pressing the Michigan legislature to bar the system from such a filing. Without the agreement, the insurer has threatened to accelerate long-term debt payments, raising the annual payment amount from $21 million to $45 million. In some sense, Ms. Byrd-Bennett brought her unethical and criminal fiscal legacy with her: SUPES Academy and Synesi Associates LLC owners Gary Soloman and Thomas Vranas have been accused of offering Ms. Byrd-Bennett money, along with sporting-event tickets and other kickbacks, in exchange for the contracts. Synesi Associates, which trains principals and school administrators—one shudders to imagine what kind of training they offer, was awarded contracts with Detroit Public Schools under Ms. Byrd-Bennett’s tenure, according to records posted on DPS’ website.

The ABC’s of Municipal Fiscal Challenges. The Holland, Michigan, School District, more than 100 years old—as may be observed from one of its oldest photos—is, like many Michigan school districts, confronting sharp and unexpected enrollment declines—declines adversely affecting their bottom lines; or, as Moody’s yesterday moodily opined, Holland illustrates not the place to skate all Winter, but rather the kinds of severe fiscal challenges of too many Michigan school districts—districts facing declining enrollments, stagnant state aid, and limited ability to raise additional revenues. Holland, a city of about 33,000 in the southwestern part of the lower peninsula, not unlike Detroit, is confronting a severe fiscal, as opposed to scholastic challenge in its K-12 system—or, as Moody’s this week reported, the A-1 credit-rated school district, has experienced a 174-student drop in enrollment—a drop nearly double what the district had anticipated and budgeted for in its current fiscal year—an enrollment drop which translates into a revenue loss of $591,000 in state aid, or, as Moody’s moodily explains: “The enrollment decline is not only credit negative for the district, but reflects the widespread credit challenges that continue to face Michigan school districts.” Moody analyst David Levett wrote: “Such pressures have led us to downgrade 44 Michigan school districts this year.” Holland’s six consecutive general fund operating deficits have been driven primarily by declining enrollment and the ensuing reduction in state aid under Michigan’s per-pupil funding system. As Mr. Levett notes: “Although officials are still analyzing this year’s enrollment figures, the district’s long-term trend of enrollment declines is attributable to significant competition from charter schools and an aging population,” effectively a fiscal one-two punch—two trends, however, which appear to be schooling Michigan’s elementary and secondary school fiscal sustainability, albeit with a potential steepening of the downward curve—or, as Mr. Levett added: “Even [school] districts that plan for declines may miss the mark on the magnitude of those declines.” Demographics are contributing to the fiscal python squeeze; the Census Bureau reports Michigan’s under-18 population is projected to decline an estimated 13% from 2000 to 2012, so that, as Mr. Levett further writes, “The state’s funding structure, demographic trends and liberal enrollment policies create an unpredictable and competitive environment for districts.” Indeed, close to 80 percent of Michigan’s school districts with more than $25 million in outstanding municipal debt experienced enrollment declines between 2009 and 2013—creating not just arithmetic opportunities for the system’s students, but math problems for the state’s school fiscal officers.

Restructuring Municipal Debt & Supermunis. Treasury Department and Puerto Rico officials are negotiating options for restructuring the U.S. commonwealth’s $72 billion in debts, especially with it becoming increasingly clear that the absentee U.S. Congress is unlikely to take any action to ensure Puerto Rico can avoid insolvency and be unable to provide essential public services. Under the evolving plan, the Treasury, or an agreed upon third party, would be in charge of an account which held a significant portion of Puerto Rico’s tax revenues—which would, effectively, be designated to pay holders of so -called super municipal bonds—municipal bonds, in this instance, held by bond owners in Puerto Rico and every state in the country who agreed to trade in their existing bonds for the new hybrid—albeit, a post “haircut” hybrid which, as in the case of a municipal bankruptcy, would be worth less than before the exchange, but which would be backed by employment and other taxes that the U.S. Treasury would collect for the territory, as well as possibly some of Puerto Rico’s own Treasury revenues. Under the evolving proposal, Treasury would act as a kind of intermediary; it would not be providing the territory with any kind of direct financial assistance or any guarantee; rather its role would be to serve as a quasi-trusted third party in a financial arrangement under which the new super municipal bonds would not only be backed by a much broader range of taxes than those that back the individual bonds of the territory and its authorities currently, but also indirectly through the unprecedented role of the U.S. Treasury—protecting and providing greater assurance to Puerto Rico’s bondholders of repayment. The discussions have not resolved whether any Congressional legislation would be needed, albeit, it is clear that the U.S. territory’s elected leaders would have to agree to potential debt exchange.

Public Service Delivery Insolvency

July 30, 2015

Securing a Safe & Sustainable Fiscal Future. With a violent crime rate more than 500% of the U.S. national average, but empty city coffers, San Bernardino’s municipal bankruptcy filing was critical to stanching not just its credit, but also its ability to protect its citizens. A critical purpose of the federal municipal bankruptcy law, after all, is to preserve the ability of a city or county to continue to provide essential public services. Ergo, notwithstanding its bankruptcy, it appears that the City of San Bernardino could be a step nearer a more secure future, with all the ramifications that would have for assessed property values, in the wake of its announcement yesterday that after more than two years’ of watching its police officers leave the force and the city, city negotiators and the police union said they had agreed on a new contract, albeit one subject to ratification by the City Council. The San Bernardino Police Officers Association yesterday reported an overwhelming vote in support of the new pact, with their spokesperson noting: “We also anticipate that the deal…will hopefully keep men and women on the force from exiting the city of San Bernardino.” U.S. Bankruptcy Judge Meredith Jury, at a hearing on the city’s municipal bankruptcy yesterday, praised the two sides for reaching the pact and a mediation judge for helping broker it, noting: “It is an incredibly important step… It is a very big step, and I hope the city votes in favor next week.” Judge Jury added she hoped it would end adversarial court filings by the police union, which has been one of the city’s main creditor challengers in her courtroom, albeit Judge Jury added that she did not expect the adversarial nature of the fire union to change at all: “Obviously that’s not going to happen….” After the hearing, Mayor Carey Davis said the deal was “very favorable” to the city, while City Attorney Gary Saenz said it was a milestone in efforts to turn around the city: “This is a very good deal for the city and a very good deal for the police, but most of all, it’s a very good deal for the citizens of San Bernardino…The Police Department and the city are once more on the same side, and police will have the stability to improve the crime rate that many people, in the survey we did as part of the strategic planning process, identified as one of the main issues in the city.” The agreement, if ratified by the Council, would replace the current terms imposed by the city two years ago in January—terms which police officers believe have contributed to the high rate of turnover. Nevertheless, the agreement, even though praised by Judge Jury in her courtroom, will not go unchallenged: even though it means the city’s plan of debt adjustment before the federal bankruptcy court will—if the agreement is ratified by Council—be modified to incorporate the agreement; it is a change that would likely come at further expense to the bankrupt city’s municipal bondholders—creditors already slated under the city’s plan to only receive one penny on each dollar they are owed. Bondholders’ attorney Vincent Mariott yesterday testified before Judge Jury he was concerned by the slow pace with which he claimed San Bernardino has provided documents, especially with regard to those which purport to defend the city’s plan proposal to, in a manner similar to Stockton, make disproportionately deep cuts to creditor bondholders—or, as attorney Mariott put it: “We’re of course entitled to a full understanding of why the city believes that wiping us out is necessary…We do need the city to be more responsive than it has been to date.”

Resecuring Fiscal Sustainability. Motown is fixing for its amazing comeback, planning to issue its first sale of municipal debt on August 19th—with an estimated issuance of $245 million in municipal bonds, with the proceeds of the sale dedicated to repayment to Barclays for the $275 million loan which marked the final key step which secured Detroit’s exit from the largest municipal bankruptcy in U.S. history. Mayor Mike Duggan yesterday said the new bonds are essential to improving Detroit city services—and have earned an upgrade to A from Standard & Poor’s, adding: “If you had said six months ago there was any chance the city of Detroit could be borrowing with an investment-grade credit rating, people would have thought that was very unlikely…But it gives you an indication of how far we’ve come in a short period of time.” S&P awarded the grade, with a stable outlook, to the Michigan Finance Authority’s Local Government Loan Program revenue bonds, e.g., bonds issued on behalf of Detroit and based on a first-lien pledge of the city’s income tax. In addition, the bonds are secured by a limited-tax general obligation pledge. The upgrade, according to the city, could mean savings of as much as $2.5 million annually and $20 million in interest costs over the life of the Motor City debt. The financial recovery bonds were originally privately placed with Barclay’s Capital Inc., in December as the city made its exit from Chapter 9. The savings highlight the exceptional role the State of Michigan has taken—in stark contrast to the states of California and Alabama, for instance—especially in view of Detroit’s own S&P B rating— five grades below the lowest invest-grade rating. The improvement also reflects the remarkable revenue turnaround: Detroit’s tax revenue has been rising for the past four years, The improved rating also reflects an intriguing wrinkle: the bonds are secured by Detroit’s municipal income tax—tax revenues in this instance which will bypass the city treasury and go directly to a trustee so that the tax proceeds must first be dedicated only to pay bondholders, even going so far as to provide, under the terms of the bond documents, for daily deposits as tax revenue is collected—or, as S&P’s credit analyst Jane Ridley describes it: “The ‘A’ rating isn’t based on the credit of the city itself…It’s based on the strength of the revenue pledge and the income stream. It doesn’t really stay in the city’s hands at all. It’s designed to be immediately taken by the trustee for the benefit of bondholders.” Gov. Rick Snyder, in April, signed into law legislation giving bondholders a statutory lien on the city’s income-tax revenue as way to ease Detroit’s first post-Chapter 9 return to the capital markets. The law also gives the bonds an intercept feature, sending income tax revenue first to a bond trustee who will extract enough to cover debt service and send the rest to the city. Put another way by the ever insightful Lisa Washburn, a managing director for Municipal Market Analytics, Detroit’s overall creditworthiness is unlikely to change until it posts 1) several years of growth and stability in tax revenues, 2) increasing investment in the city, and 3) a stable city government which can improve city services, adding: that will be a multi-year process.” The proceeds of the municipal bonds here will be dedicated to financing key priorities, including the overhaul of its financial management system and the Detroit Fire and Police department fleets.

Referring to the sale at an MSRB seminar Tuesday, Kevyn Orr, Detroit’s former emergency manager who guided the city into and out of municipal bankruptcy, kidded the Board: “I hope you buy early and I hope you buy often.” Under the original agreement, Barclays was to hold the taxable debt for up to 150 days in a variable-rate mode, and the city was to refund the bonds publicly in a fixed-rate mode. The loan was extended by 90 days in May. Of the $275 million, $38 million of the taxable proceeds paid off the banks that acted as counterparties on the city’s interest-rate swaps. Another chunk of proceeds financed new information technology as well as other capital and operating upgrades. The city floated $1.2 billion of bonds in December to pay off creditors, but none of the debt was floated on the public markets. It was directly placed with creditors and participants, though they are securities that can be traded on the markets.

Remembering Motown & Public Service Delivery Insolvency. Reminiscing yesterday about his service in Detroit and its truly remarkable turnaround, Mr. Orr—at the MSRB—said that as the city plummeted into municipal bankruptcy,
• 9-1-1 response time to the highest priority police and emergency medical calls averaged 45 minutes to an hour;
• tax collection was at 65%; 75% of parks were closed; and
• 72 water main breaks occurred in one day last August.
Or (not a pun), as he noted, the noted rhythm guitar playing and now retired (but volunteering his musical and peerless services in Puerto Rico) U.S. Bankruptcy Judge Stephen Rhodes called the U.S.’s largest municipal bankruptcy a “service-delivery insolvency.” But, as he reported yesterday: “Detroit’s a much better credit than it was two years ago,” and he has few qualms about its fiscal future and sustainability: “We built enough of a surplus…They should be fine.”

Too Little, Demasiado Tarde? U.S. Treasury Secretary Jacob Lew Tuesday warned that a failure by Congress to help Puerto Rico resolve its debts may hit the retirement portfolios of average Americans. Secretary Lew’s statements came as Congress was fleeing Washington for its long summer vacation—a departure just days before Saturday’s potential default. Sec. Lew endorsed federal legislation to grant the commonwealth the same access to an orderly municipal bankruptcy regime as every state, noting it was critical to prevent a chaotic and protracted resolution of Puerto Rico’s fiscal challenges—warning that a default would be costly, not just for Puerto Rico, but also the U.S. In an epistle to Senate Finance Committee Chairman Hatch (R-Utah) (and not to Chairman Charles Grassley (R-Iowa), Chairman of the Senate committee of jurisdiction, the Senate Judiciary Committee), he wrote: “The continued deterioration of Puerto Rico’s economic and financial conditions has the potential to further harm retiree investment portfolios across the country…A significant portion of Puerto Rico’s debt is still held directly by individual retail investors or indirectly through the municipal bond funds they own.” On Saturday, long after Congress will have left Washington, D.C. until after Labor Day, $36.3 million of bonds sold by Puerto Rico’s Public Finance Corp. become due. Puerto Rico’s legislature has not appropriated the requisite funds to settle that payment. Because Puerto Rico has not transferred cash to its Public Finance Corporation (PFC) trustee ahead of Saturday’s August 1 debt service payment, the likelihood increases there will be a technical default, or, in Spanish, an incumplimiento technico, a step ahead of what could become the U.S. territory’s first payment default on Tuesday if sufficient funds have not been advanced by the end of this week—a default, which as our ever astute market observers at MMA have already observed: “[E]nhances the political viability of additional defaults everywhere else.”

The Unexpected Fiscal Challenges to Sustainability

July 16, 2015

Putting the Pieces together to Achieve Savings. U.S. Bankruptcy Judge Meredith Jury yesterday ruled that nothing in San Bernardino’s city charter prevents the city from outsourcing its Fire Department—a ruling which the city’s fire union immediately said they would appeal. Nevertheless, the decision paves the way for the city to implement its plan to achieve significant savings by replacing its firefighters—savings which, under its proposed plan of debt adjustment—could be as much as $7-$10 million annually. Judge Jury’s ruling, however, was not a carte blanche: she warned that the union’s attorneys may be able to convince her subsequently that California law requires San Bernardino to go through a formal “meet and confer” process with union officials prior to outsourcing. Indeed, the attorney for the fire union, Corey Glave, responded to Judge Jury that her decision was “not unexpected,” adding the union regarded the city’s bankruptcy case as “an anti-labor case from the beginning and it continues as such.” To which Judge Jury replied: “I don’t buy that, but go ahead.” For its part, the union is alleging that the city’s charter contains a number of provisions which mandate the municipality to have a Fire Department composed of city employees—including a 24-year old opinion from former City Attorney James Penman, who had once advised the city leaders that its charter did not permit outsourcing the police or fire departments—a piece of advice, however, countered by an opinion of current City Attorney Gary Saenz. Notwithstanding, Judge Jury noted that Mr. Saenz’s recent opinion should not be a factor: “Quite frankly, almost none…I know that case law says I’m to give them (city attorney opinions) weight unless they’re ‘clearly erroneous.’ I guess I think it’s a flawed analysis of the law (to say the charter prohibits outsourcing), and if that makes it clearly erroneous, if that’s the words I’m supposed to say, I find it clearly erroneous.” The union argued, however, that among the charter provisions are requirements mandating a fire chief and as many other employees as the city finds appropriate and outlining how city officials supervise the Fire Department—to which Judge Jury noted there was no such thing as an “implied” restriction in a city charter…Unless something is specifically prohibited by the charter, a city may do it.”

What Happens when the Money Runs Out? Melba Acosta, the President at Government Development Bank for Puerto Rico, yesterday said the bank, a financing unit of the Puerto Rican government, had failed to make a $93.7 million debt-service payment, because the Puerto Rico legislature had failed to appropriate the funds as part of the budget: “In accordance with the terms of these (municipal) bonds, the transfer was not made due to the non-appropriation of funds.” The non-payment leaves uncertain whether Puerto Rico will make a $36.3 million payment due on August 1st for bonds maturing on that date—a non-payment, were it to occur—that would mark the U.S. territory’s first default. In this instance, the Public Finance Corporation, which the government created to assist in addressing Puerto Rico’s chronic budget deficits, currently has slightly more than $1 billion in outstanding bonds—municipal bonds backed by a promise that the Puerto Rican legislature will appropriate the cash needed to pay them down—but a promise unmet—because the legislature did not appropriate the funds, or, as Ms. Acosta stated: “In accordance with the terms of these bonds, the transfer was not made due to the non-appropriation of funds.” While appropriation bonds are generally considered a weaker credit than GO bonds (full faith and credit) – especially in Puerto Rico where, in addition, these bonds are backed by an unusual constitutional promise to pay such bonds before any other expenditures. Ergo, to date, Puerto Rico has been making its scheduled payments on its $13 billion of general-obligation bonds. But with the clock ticking and the funds dwindling, Puerto Rico faces a growing list of obligations, including $276 million by the end of September to a fund which collects cash to distribute to Puerto Rico’s GO bondholders, not to mention a key payment on August 1st, when the Government Development Bank, is scheduled to repay $140 million of principal—mayhap explaining the well-financed opposition by hedge funds to any approval by Congress of legislation to allow Puerto Rico the same access to municipal bankruptcy as each state: in the past year, much of Puerto Rico’s GO debt has been acquired at deeply discounted prices by hedge funds, which stand to make a profit if other types of debt go unpaid, leaving more cash to pay the general-obligation bonds.

Might Help Be on the Way? Yesterday, Sens. Chuck Schumer (D-NY) and Richard Blumenthal (D-Conn.) introduced legislation to would allow Puerto Rico municipalities and state-owned corporations to restructure their debt under Chapter 9 municipal bankruptcy—warning that if Congress fails to act to provide the U.S. territory the authority to restructure its $73 billion in public debt, a default could trigger a humanitarian crisis, warning a shutdown of government services would risk the lives and property of the 3.5 million American citizens who live and work in Puerto Rico, with Sen. Schumer noting: “The fact of the matter is the $73 billion in debt that Puerto Rico can’t resolve could lead to a humanitarian crisis unlike any Puerto Rico has ever seen…We are talking about the potential loss of critical public services, schools shutting their doors, ultimately the shutting down of government across the island.” Thus, the Sen. told his colleagues, Congress should give Puerto Rican municipalities the ability to file for bankruptcy under Chapter 9 of the U.S. Bankruptcy Code—an option already open to cities and counties in all 50 states. Similarly, Sen. Blumenthal warned that “Failure to pay that debt without an orderly workout would in effect begin a cascading series of chaos, and litigation would ensue all around the U.S., maybe around the world, in courts throughout the states here on the mainland, as well as in Puerto Rico…Seventy percent of Puerto Rican debt is owned by people who live on the mainland…The litigation costs alone would be substantial,” adding that the cause of this looming disaster likely rests with Congress: “Congress really enabled, and perhaps encouraged, a lot of the debt that is now burdening Puerto Rico so heavily through the tax incentives that allowed businesses to move there and then move away.” Consequently, he added, Congress “has a responsibility” to make sure Puerto Rico resolves its debt. As of yesterday, seven other Senate Democrats had co-sponsored the legislation, including Senate Minority Leader Harry Reid (D-Nev.).

Ensuring a Sustainable & Safe Municipal Future

July 9, 2015

The Road Back from Municipal Bankruptcy. Jefferson County Commission President Jimmie Stephens notes that the County’s return to fiscal sustainability in the wake of its successful exit from municipal bankruptcy—the largest in U.S. history at the time, has improved enough for the county to reenter the municipal market: “This Commission is dedicated and determined to follow the judge’s order and to follow the bankruptcy plan…There are still plenty of challenges, but we’re working together and that gives us opportunities for success…We’re doing our due diligence and making sure that we don’t revisit some of the mistakes of the past.” Jefferson County’s assessed property values have increased, sales and use tax collections are up, and Jefferson County is now prepping to host the World Games athletic competition in 2021. The county’s budget has remained structurally balanced, but, unsurprisingly, the recovery has been insufficient to provide for less anticipated needs: there have been insufficient revenues to resume some services, such as to complete the County’s road-paving program.

Commission President Stephens also reports rejuvenated relationships with the Alabama legislature, noting: “We went to the Legislature with a genuine set of needs, not wants…In order to do our job and be effective in our job, we needed additional revenue to reinvest in the future of Jefferson County.” The presentation included the detailed steps the County has taken as part of its implementation of its approved plan of debt adjustment by U.S. Bankruptcy Judge Thomas Bennett—albeit that plan has been under challenge before the 11th U.S. Circuit Court of Appeals for nearly two years: a key issue before the federal court is whether a lower-court appeal of Jefferson County’s plan of debt adjustment by a group of county sewer system ratepayers is moot, with Jefferson County’s attorneys arguing that the appeal is not viable, because the court-approved bankruptcy exit plan was largely implemented following the sale of $1.8 billion in 40-year sewer refunding warrants in December 2013—warrants which allowed the county to write down $1.4 billion in related sewer debt in an intricate transaction that cannot be unwound, according to the county’s attorneys. Notwithstanding, the federal judge presiding over the ratepayers’ appeal has ruled that the county’s plan of debt adjustment is not moot, because some key components are questionable, including a provision which requires the federal bankruptcy court to ensure that county officials adopt sewer rates sufficient to pay debt service on the refunding warrants—a key provision to the county’s ability to successfully issue a refunding two years ago. Jefferson County attorneys have urged that it is critical for the appellate court to resolve the mootness issue for investors and the stability of any municipality relying on exit financing to emerge from bankruptcy.

Is Puerto Rico Being Held Up? The U.S. House Judiciary Committee appears unwilling to provide Puerto Rico with access to the U.S. bankruptcy courts to offer the U.S. territory a time out to ensure the continuity of essential public services and to reorganize its debts under the oversight of a federal court. Chairman Bob Goodlatte (R-Va.) yesterday said: “Today, we met with our Republican colleagues on the Judiciary Committee to discuss the issues facing Puerto Rico…While no consensus was reached, a general concern was expressed that to provide Puerto Rico’s municipalities access to chapter 9 of the Bankruptcy Code would not, by itself, solve Puerto Rico’s difficulties, which are associated with underlying, structural economic problems.” That is, to offer protection to ensure the health and safety of U.S. citizens in the island’s 78 municipalities would, apparently, be an insufficient motive to act. The refusal to take any action as Congress nears its next five week recess—the very time period when Puerto Rico could default—could increase the import of the efforts by Sens. Chuck Schumer (D-N.Y.) and Richard Blumenthal ( D-Conn.), who indicate they intend to propose companion legislation to the now spurned H.R. 870 in the Senate. The House refusal to act comes as a number of Presidential candidates, including former Florida Governor Jeb Bush, former U.S. Senator and Secretary of State Hillary Clinton, and Sen. Bernie Sanders (I-Vt.) have also called for Congressional action on the issue.

Steep, Treacherous Fiscal Road Ahead. Just two years ago, we wrote: “Baltimore reached a peak population of 949,708 in 1960 and 30% of Maryland’s population resided in the city at that time. By 2010, the population had dropped to 620,961 and the city’s share of the state’s population fell to 11%. Like many Eastern and Midwestern cities, a significant portion of this loss in population is attributable to the decline of its industrial base and suburbanization. Baltimore lost 110,000 jobs between 1990 and 2010—about 24% of all jobs. Seventy percent of these jobs lost were in manufacturing and related industries. There are approximately 16,000 vacant and abandoned properties in the city—one blighted property for every 40 residents. Median household income is 44% lower than that of the state and crime is 86% higher. Through all of this change, Baltimore still retains its position as the only large city in Maryland and serves as its principal urban hub. Unlike other cities in this report, Baltimore has not been in a fiscal emergency and has a relatively healthy balance sheet.” Indeed, the Maryland legislature has explicitly rejected granting the option of municipal bankruptcy for its cities and counties.

But in the wake of the death of Freddie Gray last April, the fiscal and human challenges confronting the city are almost beyond our imagination. Yesterday, Mayor Stephanie Rawlings-Blake fired the city’s Police Commissioner, stating: “[A]s we have seen in recent weeks, too many continue to die on our streets, including three just last night and one lost earlier today.” As of yesterday, police report a 48 percent increase in homicides over last year–with May’s 42 the most in a month in a quarter century. Non-fatal shootings are 86 percent higher than last year–yet, even with the exceptional increase in shootings, the number of arrests is half of last year’s. In the wake of injuries to as many as 160 police officers during the rioting in Baltimore–even as uncertainty has increased with regard to what actions police officers can take when being assaulted–there appears to be greater and greater reluctance on the part of the rank and file to be entrapped between the Scylla and Charybdis of being injured or being charged with a crime for being too aggressive in enforcement.

According to the city’s police department, gunmen killed three people and wounded one yesterday near the University of Maryland, Baltimore—shootings in a municipality that has witnessed a record upsurge in homicides since April: shootings here which can hardly augur well for the University. While police stated the shootings were not related to the university, the Baltimore Sun reported that shots had been fired into a vehicle traveling on the same block five days ago. Police also report that looting of pharmacies during the unrest and a subsequent drug turf war have been behind a surge in killings in May—a month in which the city experienced 43 homicides, the highest number since 1972, but dropped the total to 42 when one killing was reclassified as justified. A police spokeswoman yesterday put the May homicide number at 41, the highest monthly tally since August 1990, without explaining the new total.

Baltimore reached a peak population of 949,708 in 1960—a time when 30% of Maryland’s population resided in the city; by last year, that number had dropped to 620,000–and the city’s share of the state’s population fell to 11%. Like many Eastern and Midwestern cities, a significant portion of this loss in population was attributable to the decline of its industrial base and suburbanization: Baltimore lost 110,000 jobs between 1990 and 2010—about 24% of all jobs: seventy percent of these jobs lost were in manufacturing and related industries. There were approximately 16,000 vacant and abandoned properties in the city in 2010—one blighted property for every 40 residents. Median household income was 44% lower than that of the state, and crime was 86% higher. This year, the city’s homicide rate—prior to last night’s shootings, had reached 155 homicides—or nearly 50 percent higher than at this point last year. The exceptional challenge—not just for the Mayor and Council, but also for Gov. Larry Hogan and the Maryland legislature is how to try to staunch the mayhem and its exceptional erosion of the city’s future fiscal stability.

The Challenge to Fiscal Sustainability of Public Safety

eBlog

April 30, 2015
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The Fiscal Challenge of Public Safety. The gun shots that caromed in Ferguson, Missouri last year in the wake of riots which broke out after a white police officer shot and killed Michael Brown, a black teenager, echoed this week with the death of a young black man, Freddie Gray, in Baltimore. How the city, which has demonstrated remarkable fiscal resiliency, but which now confronts a more challenging fiscal future, responds will be a grave fiscal, human, and governing challenge. What can the Mayor and Council do to quell the violence and not only prevent families from leaving the city and eroding its tax base, but also not discourage other families and businesses from coming in? The President has condemned as inexcusable the looting and arson that spread across the streets, even as U.S. House and Senate negotiators yesterday agreed to a joint budget resolution which not only retains a sequester on domestic discretionary spending, but also specifically bars, “except in the case of Federal assistance provided in response to a natural disaster, any entity of the Federal Government from providing funds to State and local governments to prevent receivership or to facilitate exit from receivership or to prevent default on its obligations by a State government.” In a federal budget under which federal spending for defense will grow more than $100 billion and spending on every other category of spending will grow, the conferees focused on the smallest part of the federal budget to exact a toll. President Obama implied that the Baltimore Police Department had “to do some soul-searching,” as can be understood from a meticulously reported investigation by The Baltimore Sun of lawsuits and settlements that had been generated by police-brutality claims―and which have imposed nearly $6 million in settlements and legal costs on the city’s budget since January 2011. The Sun report noted: “Over the past four years…more than 100 people have won court judgments or settlements related to allegations of brutality and civil rights violations.” For his part, the President this week said: “This has been a slow-rolling crisis…This has been going on for a long time. This is not new, and we shouldn’t pretend that it’s new.” The President added that addressing the problem would require not only new police tactics, but also new policies aimed at helping communities where jobs have disappeared, improving education, and helping ex-offenders find jobs. The big mistake, he warned, is that we tend to focus on these communities only when buildings are burning down. But the message to Baltimore from Congress this week was unequivocal: ‘don’t count on us for anything but further disinvestment.’

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

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

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