The Road to Recovery from Municipal Bankruptcy

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November 12, 2015. Share on Twitter

The Road to Recovery from Municipal Bankruptcy. Jefferson County Commissioner David Carrington has put together a description what he labels “A Post-Bankruptcy Look at Jefferson County, Alabama” for a presentation at a Symposium on Modern Municipal Restructurings for Duke University this week to demonstrate the steps on the road out of what, at the time, was the largest municipal bankruptcy in U.S. history in Alabama’s largest county. Noting the county’s diverse economy, with a GDP ranking it 137th out of 3,134 counties, and its home to the Innovation Depot, the largest business technology incubator in the Southeast, as well as its robust rail and interstate transportation network, he pointed to last year’s 2014 new residential permits (in dollars) greater than 58 of Alabama’s—or some 19.2% of all the state’s 67 counties combined, as well as the balanced budgets the county has adopted each and every year since U.S. Bankruptcy Judge Thomas Bennett approved the municipality’s plan of debt adjustment. He also noted the county’s slimmed payroll: the county today has 1,000 fewer employees than when, 25 months after it emerged from municipal bankruptcy on December 3, 2013, adding the County long-term debt has declined by some $1.5 billion—more than one-third, and that the County has made significant structural changes, including closing an inpatient (not impatient) hospital, sold the nursing home assets, closed all four of its satellite courthouses, and achieved something which must make Chicago Mayor Rahm Emanuel most jealous: a county pension has a funded ratio of 105.6%. He reports that audits, which were three years past due when this Commission took office in 2010, are now actually published ahead of schedule. Mayhap one of the most important accomplishments might be a more constructive relationship with the Alabama Legislature, which has passed a replacement 1‒cent sales tax bill, an action which allows the County to refinance its school construction debt, a key step to providing additional funding for county operations, economic development, schools and community development, in addition to county debt retirement. On the economic recover front, the Commissioner reports that more than 1,300 condominium units are planned or under construction, along with a $30 million mixed use development in Midtown anchored by a 34,000 square foot Publix grocery store—and that new historic building tax credits enacted by the Alabama legislature have elicited more than $200 million in local investments in a metro region now ranked as the Top City for Millennial Entrepreneurs by Thumbtack, in addition to being ranked 6th overall and 5th for economic development potential among the Top 10 mid‒sized North, Central and South American “Cities of the Future.”

A Detroit International 911. Daniel Howes, the gifted Detroit News columnist and associate business editor, wrote a terrific column yesterday about Dovie Maisel, an Israeli architect for a cause called United Hatzalah, a network of trained volunteers in that country which responds to calls for emergency medical care in Israel’s largest cities and across the country — noting that Mr. Maisel is in Detroit as part of an international effort to work with Mayor Mike Duggan to see if the model could be replicated, with Mr. Maisel noting: “We are not coming to take any jobs. We are the community. We are coming to help them:” Detroit and its EMT units are in preliminary discussions with United Hatzalah to see if the Israeli concept, which is scheduled to be launched this month in Jersey City, New Jersey, could also be adapted for the Motor City—an audacious effort which is envisioned to complement, rather than compete with what Mr. Howes describes as Detroit’s “stressed EMT units.” The partnership would train community volunteers. Potentially it would create a cadre of skilled technicians who could apply for EMT openings in Detroit or the metropolitan region—with Mr. Maisel noting, carefully, that Hatzalah volunteers do not replace professional EMT units in Israel; rather, certified according to Israeli national standards, they are, nevertheless, often able to respond to emergencies more quickly, because they are embedded in their communities—so that they are closer. Indeed, the concept has similarities to the remarkable public safety partnership in No. Virginia, where a unique agreement between its local governments ensures that the first 911 response will come from the closest responder—irrespective of jurisdiction—an agreement which can make the difference between life and death—and, secondarily—savings. According to Mr. Maisel, in Israel, volunteers are not paid, and victims are not charged.

As Mr. Howes wrote: “It’s an audacious idea for Detroit, one Mayor Mike Duggan dismissed as fanciful in a city of 139 square miles with a population pushing 700,000 — until he heard the pitch and compared it to the city’s need to improve its response to emergency calls,” noting that in Israel, “a polyglot of ethnicity, religion and intermittent tension effectively bridged by United Hatzalah…a country of less than 8 million, the volunteer organization fields 700 emergency calls a day, carries 3,000 volunteers nationwide, and boasts an average response time of three minutes, even less in more densely populated major cities.” The organization use a fleet of 450 “ambucyles” volunteers use to answer calls, and counts 2,550 volunteer-owned vehicles that are used to augment its rescue fleet, adding: “With a budget of $10 million, all of it privately funded, Hatzalah maintains 40 branches across the country organized into eight districts — its volunteers treat victims regardless of ethnicity, sex or religion, with an ‘ultimate goal to save lives, to take the community and train them at all levels.’” As Mr. Howes writes: “This may be the right cause at the right time for Detroit. It could answer a public need, could ease pressure on EMT units, could teach volunteers from the city’s neighborhoods marketable skills, could tap an entrepreneurial vein in a (Mayor) Duggan administration generally open to alternative solutions, and could be funded by individual private donors and foundations”—especially in a city beset by an emergency response rate being among the lowest in the country. In this fascinating cross border effort, the Detroit Medical Center and Henry Ford Health Systems’ chief of emergency medicine are working with the Mayor’s office to assess the implications of trying to implement this potential international partnership—one which Mr. Howes forthrightly describes as “fraught with legal and medical issues, as well as reassuring union EMTs that the effort is not a back-door gambit to eliminate their jobs.”

Looming Default. The U.S. territory of Puerto Rico could default at the end of the month on at least a portion of its scheduled debt service payments—an event which would constitute its second default, as the island’s liquidity pressures increase: it upcoming fiscal obligations consist primarily of $354.7 million of debt service on notes issued by the Government Development Bank or GDB, which has less incentive to make a payment of $81.4 million in debt service on non-general obligation-backed debt, as the payment pledge does not benefit from constitutional protections. The greater sustainability risk is that the GDB may be forced to default also on the $273.3 million of GDB notes which are backed by Puerto Rico’s full faith and credit general obligation guarantee—a default, after all, which would likely trigger legal action—but an event long foretold: as Puerto Rico, without access to the kind of federal bankruptcy options available to municipalities across the rest of the U.S., but with a seemingly disinterested Congress, will have little option but to not make full faith and credit bond payments that would jeopardize essential government services, consistent with the rapidly approaching reality that “the Commonwealth cannot service all of its debt as currently scheduled.” Puerto Rico’s ability to meet any of its obligations is deteriorating, even as, like Nero, Congress fiddles.

The territory, absent access to external sources of financing, projects a negative $29.8 million cash balance this month, growing to a deficit of $205 million by next month. Even though some recovery is projected in early 2016 with the enactment of emergency liquidity actions, actions which could include utilizing tax revenues currently assigned to one or more government authorities and further delaying tax refunds, Puerto Rico’s November Financial Information and Operating Data cash projection report does not include any availability of funds at the GDB, noting its cash resources “may be fully depleted by the end of calendar year 2015.” Puerto Rico’s inability to sustain sufficient liquidity to meet its operating and debt needs, absent extraordinary measures or outside help or legal recourse, is now expected to lead to additional defaults. Even though, a government aide stated that Puerto Rico will make its scheduled December payment on GO guaranteed GDB debt, such payment will decrease what might be available for an approximately $330 million GO debt service payment due on New Year’s Day: that is, as Bloomberg noted: “While we expect the commonwealth to use all available measures to prevent a default on constitutionally protected debt, it has not been making the monthly sinking fund payments required for the 1 January payment since July 2015. Instead, it will rely on cash on hand in the Treasury’s single cash account to make the debt service payment, though as noted above the projected November and December balances in the fund are negative. The commonwealth is not eligible to file for bankruptcy and the absence of a debt-restructuring framework heightens risks to creditors because it prevents the government from using tools generally available to distressed corporations and some municipalities.” For his part, Puerto Rico Gov. Alejandro García Padilla the day before yesterday warned that if the island’s municipal bondholders do not agree to new terms on their debt, he will choose to pay for the needs of the people before paying the Commonwealth’s creditors: “…if they do not negotiate and force me to choose between creditors and Puerto Ricans, I’m going to pay the Puerto Ricans.’”

Providing Essential Services. Governor Alejandro García Padilla has said he will consider cutting hours for public workers to keep essential governmental services and functions running; he has already closed some schools, delayed tax rebates, and suspended payments to government suppliers. The Obama administration, lacking any constructive Congressional role, has, via the Treasury Department, proposed an assistance package that would sustain the island’s medical system by increasing reimbursement rates for Medicaid, which serves 46 percent of Puerto Ricans and is paid at rates 70 percent lower than in any U.S. state, according to the Puerto Rico Healthcare Crisis Coalition, a group of doctors, hospitals, and insurers. The proposed package would also offer some bankruptcy protections to help the government restructure more than $70 billion in debt—more than any state’s except New York and California. In return, under the proposal, Congress would gain more say over the island’s finances. Congressional leaders, however, report they will not agree to provide either any fiscal assistance—or municipal bankruptcy authority—unless Puerto Rico provides audited financial statements giving a complete picture of its finances, a challenge given that the self-governing U.S. territory missed a self-imposed Oct. 31st deadline for submitting statements from FY2014 and has yet to prepare FY2015 documents. Congress appears to want to impose a different standard than used for states with regard to chapter 9 municipal bankruptcy or other U.S. corporations, with Chairman Charles Grassley (R-Iowa) of the Senate Judiciary Committee claiming he “is waiting for some good-faith effort from Puerto Ricans.”

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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.

Whither Federalism?

October 26, 2015. Share on Twitter

Congressional Disinterest in the Complexities of Federalism & Municipal Bankruptcy. Despite White House warnings that only swift Congressional action can avert a string of impending defaults on $73 billion in Puerto Rican debt that could lead to a “humanitarian crisis,” the reaction by the Senate Energy and Natural Resources Committee (the committee of jurisdiction, because it was, formerly, the Committee on Interior and Insular Affairs, ergo the inclusion of Puerto Rico and other U.S. territories under its jurisdiction) was almost nonexistent: only two members of the majority, Chair Lisa Murkowski (R-Alaska) and Sen. John Barrasso (R-Wy.) even made the effort to attend. U.S. Treasury Counselor Antonio Weiss testified last Thursday, formally requesting Congress to act swiftly to provide expanded Chapter 9 municipal bankruptcy protection to both the Commonwealth of Puerto Rico, as well as its public authorities, and to provide other relief. Under the White House plan, in order to gain access to expanded Chapter 9 municipal bankruptcy relief, Puerto Rico would have to agree to federal fiscal oversight. The second part of the plan, Mr. Weiss said, would be for Congress to authorize the creation of an oversight body made up of broad group of stakeholders that would preserve Puerto Rican authority, but would be independent from the territory’s government. In addition, the administration requested that Congress provide funding and authorize technical assistance to help Puerto Rico bring its accounting and disclosure practices into the 21st century, warning that Puerto Rico’s government is on the verge of running out of fiscal resources with which to provide its three and a half million U.S. citizens essential public services. The response from the Committee, however, was—at best—dismissive. Chair Murkowski claimed the Committee lacked accurate enough financial information, and that, even if it had such information, the White House proposal could not be considered without offsetting cuts in other areas of the budget. Indeed, after a relatively brief rounds of questions, she ended the hearing, saying, “I apologize that we can’t give more time to this.” Puerto Rican leaders and many financial and legal experts have been saying for months that the U.S. territory cannot repay the approximately $72 billion it owes to hedge funds, mutual funds, and other investors. Indeed, the economy is in a whirlpool: it is not growing, and tens of thousands of residents are leaving every year for the mainland U.S. to look for work. More than 300,000 have left in the last 10 years. Puerto Rico confronts a public pension debt in excess of $40 billion; its adopted spending cuts and tax increases have failed to stem the rising debt tide. Mayhap unsurprisingly, many investors and owners of Puerto Rican bonds—that is, investors who stand to lose under any debt restructuring–are bitterly opposed to the Administration’s proposals: they claim Puerto Rico can repay all of its debt if it tightens its fiscal belt and privatizes utilities and other government-owned businesses. The complexity of addressing Puerto Rico’s looming insolvency is complicated in that federal municipal bankruptcy, in recognition of dual sovereignty, provides that no mainland municipality may file for municipal bankruptcy without state authorization. Since Puerto Rico is not a state, but rather a territory, not only does Puerto Rico not have access to chapter 9, but nor does it have the requisite authority to authorize access to any of the island’s 87 municipalities. Current negotiations have involved some 18 different municipal debt issuers—so that 20 creditor committees have been created, focused on competing interests.

Late for an Important Date. San Bernardino, last Friday, finally received a letter from its independent audit firm with regard to the accuracy of the accuracy of its financial statements—but not the promised full audit. The delivery, more than a year and a half overdue—and technically still due—was delivered two days after it was last promised, and more than a year and a half after the deadline imposed by the State of California. Deputy City Manager Nita McKay, nevertheless, advised the City Council the audit was “basically what you pay for…It’s the signed letter from the auditors, and what you’re hoping for is an unqualified opinion, which means there’s nothing they need to disclose. Last year there were two comments, and they’re the same comments again, about successor land held for resale…and then, because we’re in bankruptcy, they add a paragraph about that.” The municipality’s audit firm Macias, Gini and O’Connell LLP (MGO), which had promised completion and delivery last week now reports it will “likely” be ready this Wednesday—that is, just six days before November 3rd’s municipal elections. Ms. McKay advised the Mayor and Council the audit firm would be ready to present to the city’s administrators and a selection of elected leaders on the audit committee this Thursday. With the fast approaching municipal election, city staff and auditors have been sparring over responsibility for the audit delay, with the auditing firm falling further behind schedule, even as it sought nearly double its original asking price. The bankrupt city, according to Ms. McKay, has paid about $451,000 of that contract so far, and it is still awaiting its single audit—the audit of federal grants, a key step, as it has held the city hostage for the receipt of $125,000 a month for the San Bernardino Employment and Training Agency from the State of California. The city has scheduled a pre-election day public presentation of the findings in the 2012-13 audit for the Nov. 2 City Council meeting, according to City Clerk Gigi Hanna.

Dual Sovereignty & Municipal Bankruptcy

October 22, 2015. Share on Twitter

Complexities of Federalism & Municipal Bankruptcy. U.S. Treasury Counselor Antonio Weiss will testify today before the U.S. Senate Committee on Energy and Natural Resources, where he will ask Congress to act swiftly to provide expanded Chapter 9 municipal bankruptcy protection to both the Commonwealth of Puerto Rico, as well as its public authorities, and to provide other relief. The plan also would provide that in order to gain access to expanded Chapter 9 bankruptcy relief, Puerto Rico would have to agree to federal fiscal oversight. The second part of the plan would be for Congress to authorize the creation of an oversight body made up of a broad group of stakeholders that would preserve Puerto Rican authority, but would be independent from the territory’s government. In addition, the administration is proposing that Congress provide funding and authorize technical assistance to help Puerto Rico bring its accounting and disclosure practices into the 21st century.

The 11th hour effort comes in the wake of a growing liquidity crisis, and less than a day after Puerto Rico’s Government Development Bank ended discussions with a group of Puerto Rico’s municipal bondholders without reaching any consensus on restructuring the Bank’s debt—the Bank plays a key role, as it lends to Puerto Rico’s agencies and faces a looming municipal bond payment of more than $350 million due on December 1st. It also comes in the wake of Puerto Rico Governor Garcia Padilla’s, who will also be testifying this morning, repeated warnings that the commonwealth’s debts cannot be repaid—warnings that, to date, appear to have had limited impact on so far fruitless voluntary debt-restructuring negotiations. In his testimony this morning, Mr. Weill is also expected to call for “independent and credible” fiscal oversight from Congress, possibly referring to the concept of a financial control board—mechanisms which were key to avoiding insolvency for both New York City and Washington, D.C. Mr. Weiss is expected to propose a modified version or variation of the current federal statute for chapter 9 municipal bankruptcy—one which would be available to all U.S. territories, and which, obviously, would not be subject to state authorization, as it required under the current federal law for any municipality to be eligible for such protection. In addition, he is expected to propose the restructuring of Puerto Rico’s current $72 billion in outstanding municipal debt. In the Treasury’s legislative outline released late yesterday, the agency warned Puerto Rico would exhaust the emergency steps it has taken to remain solvent by this winter, noting: “As currently structured, Puerto Rico’s debt load is unsustainable.” The Treasury proposal also will recommend overhaul of the island’s Medicaid program, as well as access to the earned-income tax credit.

The complexity of addressing Puerto Rico’s looming insolvency is complicated in that chapter 9 municipal bankruptcy, in recognition of dual sovereignty, provides that no mainland municipality may file for municipal bankruptcy without state authorization. Since Puerto Rico is not a state, but rather a territory, not only does Puerto Rico not have access to chapter 9, but neither does it have the requisite authority to authorize access to any of the island’s 87 municipalities. Current negotiations have involved some 18 different municipal debt issuers—so that 20 creditor committees have been created, focused on competing interests.

Avoiding Municipal Insolvency, Except as a Last Resort

October 20, 2015. Share on Twitter

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

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

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

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

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

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

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.

October 1, 2015

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

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

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

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

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

September 30, 2015

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

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

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

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

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

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