The Desperate Price of Fiscal Unaccountability

October 14, 2015

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

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

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

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

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

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

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

Advice & Consent

September 15, 2015

Motor City-County Bonds? Wayne County Executive Warren Evans has issued his first order under the County’s consent agreement with the State of Michigan—an order which requires all county employees to comply with the consent agreement and report any potential breaches to his office, and which requires all county departments to obtain permission from the Wayne County CFO prior to entering into any contracts which could be considered debt under the terms of the county’s consent agreement. (The decree requires Wayne to continue to make timely debt payments—and bars the county from filing for chapter 9 municipal bankruptcy while operating under the decree.) Mr. Evans’ order directs county workers to comply with the consent agreement and outlines protocols for breach: “The purpose of issuing this order is to ensure that county employees, elected officials, along with our contractors understand what is required while the consent agreement is in place.” The extraordinary fiscal authority comes as the County—of which Detroit is the seat—is grappling with a $52 million structural deficit, stemming from a $100 million drop in annual property tax revenues since 2008 and an underfunded pension system. The county’s primary pension plan is 45 percent funded and has a liability of $910.5 million, based on its latest actuarial valuation. That is, Wayne County and Detroit’s respective fiscal foundations are inextricably connected. Mr. Evans is seeking to fix the county’s finances under the consent agreement by reducing future pension obligations and retiree benefits and taking other actions to eliminate the structural deficit. Under the agreement, Mr. Evans and the county commission retain their powers and responsibilities: the unique agreement also grants Mr. Evans the power to impose contract terms with the county’s unions if they are unable to hammer out labor agreements after a month of good-faith negotiations—an avenue Mr. Evans has said repeatedly he prefers to reach agreements with the county’s unions at the bargaining table. Among the agreement’s provisions he has emphasized to Wayne County employees:
■All county contracts or agreements must include the requirements of Public Act 436 and the consent agreement.
■All county employees, elected officials or entities that have contracts with the county must inform the executive of any potential breach of the consent agreement.
■Before any contract is entered into that is considered debt under the consent agreement, a copy must be given to the county’s chief financial officer for approval.
In addition, the county has also put up a new web page so that citizens and taxpayers can follow and understand the issues. Mr. Evans noted: “The purpose of issuing this order is to ensure that county employees, elected officials, along with our contractors understand what is required while the consent agreement is in place…It is important for everyone to understand what to expect as we move together through this process to restore our financial health.”

The order which was approved by the County Board last month, comes as Mr. Evans is in the middle of a 30-day period of negotiations with county unions on new labor contracts. Should the negotiations produce no agreements, Wayne County—under the consent agreement with the state, is authorized to impose its own labor contracts. While the 12-page agreement with the State allows Wayne County to try to restructure some of its debt or reach settlements with creditors, it bars Wayne County from issuing any more municipal bonds without state permission. The consent agreement gives Wayne County until Jan. 31st to present the state with a plan for its abandoned jail project in downtown Detroit—an unfinished facility, which was financed with $200 million of municipal bonds. The forlorn project has been abandoned since 2013 due to cost overruns, but, under Wayne’s agreement with the state, Michigan will assume financial oversight over the project. It will be up to Michigan Treasurer Nick Khouri when to release Wayne County from the agreement—and, in any case, under its terms, Michigan will continue to monitor Wayne’s finances for two additional years following any release from the agreement by the state.

Perhaps unsurprisingly, however, the new consent agreement is already being tested: Wayne County is appealing a restraining order won by Wayne County Sheriff Supervisory Local 3317, which is seeking to block changes to sheriff deputies’ wages and benefits made under the county’s consent agreement. The County reports it will seek an emergency appeal of the ruling by Wayne Circuit Judge John Murphy after Wayne County Sheriff Supervisory Local 3317 petitioned the court for relief from changes to compensation the county imposed for command officers at the sheriff’s office—in effect, a challenge not just to Wayne County, but also to the State of Michigan.

Scrambling in Scranton. Even as agent from the Pennsylvania state Attorney General’s office yesterday showed Senior District Judge Richard Cashman slides of many of the artifacts that former Harrisburg Mayor Stephen Reed, who served for 28 years, is charged with illegally using public funds to purchase for museums which never materialized in a preliminary hearing on hundreds of criminal counts including theft, misapplication of government property, criminal solicitation, bribery and tampering with evidence; the losses created continue to wreak fiscal havoc. Elsewhere, yesterday, Scranton Mayor Bill Courtright announced the city likely will lease, rather than sell, its five parking garages and on-street parking meters to a nonprofit organization which will operate them. In addition, the city and financial consultant Henry Amoroso launched a new website,, to inform the public about the progress of Scranton’s recovery plan initiatives. Mayor Courtright, in announcing his plan to try to monetize the municipal garages, said the result likely would be a concession lease agreement with the nonprofit National Development Council: “We have taken a disciplined and focused approach to finding solutions to our financial challenges. Step-by-step we are restoring confidence and moving Scranton forward…I am confident that the steps we have taken will provide us with the best possible fit for our city, which will allow us to retain ownership of our parking assets while reducing the financial burden on the City.” The fiscal scrambling comes in the wake of a series of decisions by the City Council three years ago which led to the default by the Scranton Parking Authority (SPA) on payments owed under two loans, one issued in 2009 by Pennstar Bank and another in 2011 by Landmark Community Bank, as well as a June 2012 payment owed by the authority municipal parking bonds. The decision to default on the bank loans resulted in over two-years of litigation; the decision to miss the bond payment resulted in the court appointment of a receiver to oversee the operations of the authority. As Mayor Courtright puts it: “Since coming into office, our focus has been on getting Scranton’s finances back on track…We’ve been able to clear up the Pennstar and Landmark defaults, and now we’re progressing into responsibly monetizing the City’s parking assets so we can eliminate or significantly reduce the bad Parking Authority debt for which the City is now responsible.” Currently, the City must budget about $2.9 million a year to cover SPA-related costs. He said a responsible monetization will take the form of a lease concession, where the City will maintain ownership of valuable parking assets and control over key decisions while shifting burden of excessive debt payments off of Scranton taxpayers, or, as the city’s consultant put it: “Whenever the SPA (the parking authority) cannot make its debt service payments out of its own revenues, the City must make up the difference.” Scranton’s financial consultant, Henry Amoroso added: “The numbers speak for themselves…The City can’t continue to shoulder the burden of SPA-related costs. It’s unsustainable.”

The road back to fiscal sustainability has been steep: On August 23rd, 2012, the City of Scranton took its first step in restoring long term fiscal stability and repairing the City’s creditworthiness by adopting a new Recovery Plan that replaced the 2002 Recovery Plan with a new Recovery Plan to provide the fiscal framework for the City’s governing bodies to follow through 2015: the 2014 Budget called for a tax increase of 49.99%. Additionally, the City of Scranton has increased current refuse fees, which will allow the City to receive an additional $2.2 million dollars. Further revenue enhancements such as increasing the Rental Registration Fee will allow the City to receive an additional $300,000.

Under the new parking arrangement, the plan calls for the city to lease its parking system, to eliminate Scranton Parking Authority debt that the city guarantees, retain ownership of the parking assets, and eliminate a court-appointed receivership which has controlled the parking garages since a 2012 default of SPA debt by that authority and the city. Under the agreement, along with retaining ownership of garages and meters, Scranton will retain veto power over key public policy considerations during the term of the concession lease, such as rate setting and certain capital improvement projects. Upon closing of the transaction, Scranton will be able to retire most SPA debt and refinance leftover debt, called stranded debt, at more favorable rates and terms; the city also will have the opportunity to share in revenue generated from the concessionaire’s operation of Scranton’s parking system. Or, as Mayor Courtright noted, his administration previously cleared up two other related defaults of bank loans which stemmed from the SPA default and harmed Scranton’s creditworthiness: “We have taken a disciplined and focused approach to finding solutions to our financial challenges. Step-by-step we are restoring confidence and moving Scranton forward…I am confident that the steps we have taken will provide us with the best possible fit for our city, which will allow us to retain ownership of our parking assets while reducing the financial burden on the city.”

The Hard Choices Forced by State or Local Fiscal Distress


August 28, 2015

The Distressing Costs of Municipal Debt Adjustment. For a municipality, state, or—in this case, U.S. territory in serious fiscal distress, without access to bankruptcy so that the options for ensuring sufficient cash to provide essential services are at risk, just the costs of structuring a plan to return to a fiscally sustainable future can be daunting. Indeed, early reports indicate Puerto Rico has already spent as much as $60 million over the last two years as it nears its deadline for proposing a quasi-plan of debt adjustment in this twilight zone where there is neither a U.S. bankruptcy court nor any other official arbiter to adjudicate whatever proposals Governor Padilla ends up proposing next week to address Puerto Rico’s unpayable $72 billion in accumulated debts. Moreover, of course, the meter is still running—each day consuming more legal and consulting fees that leave less and less for upset creditors, public services, and the island’s bondholders in every state of the U.S. Fabulous Matt Fabian of Municipal Market Analytics tersely sums up the dilemma: “It’s an incredibly complex restructuring, with a lot of different investor groups, a lot of different securities and moving parts.” Puerto Rico’s public power utility and its creditors face a Tuesday deadline on a restructuring plan for its $9 billion of debt or an agreement that keeps discussions out of court will expire. Nevertheless, as the nation’s preeminent municipal bankruptcy wizard Jim Spiotto noted, the investment in these outside professionals could be critical to providing a way out for the commonwealth that will improve the economy and make its debt sustainable: “The analysis part is important in addressing it in an effective way, so that the money you spend is well spent, because you’re going to need a recovery plan that is going improve the situation, grow the commonwealth, and, thereby, improve the situation for everyone.”

What Options Does Congress Have? Even as Puerto Rican leaders are perusing options to sort out its overwhelming debt, the Congressional Research Service has offered Members of Congress options, “Puerto Rico’s Current Fiscal Challenges,” it could act upon in response to Puerto Rico’s fiscal crisis ranging from backstopping its debt to authorizing the U.S. territory access to municipal bankruptcy. The report notes that the U.S. government “has generally been reluctant to offer direct financial assistance to individual states in fiscal distress, although Congress at times has adjusted technical parameters of federal programs to provide direct or indirect support for states…The independence of state governments to set their own fiscal paths has been linked to an expectation that those governments take responsibility for the consequences of their fiscal decisions.” Under the dual sovereignty of our form of government there are constitutional limitations on any federal authority.  Arkansas, Illinois, Indiana, Louisiana, Maryland, Michigan, Mississippi, and the former Territory of Florida all recorded bankruptcies in the period running up to and through the great Panic of 1837. By 1841, 19 of the then 26 states, as well as two of the three U.S. territories had issued municipal bonds and incurred state debt—debt on which these aforementioned states and Florida defaulted. Ironically, the majority of state debt was owed to parties outside the U.S., primarily Europe. Nevertheless, the state debts were largely paid off in full by the late 1840s, notwithstanding that no direct sanctions were enacted to force repayment.

In this new report to Congress, the CRS author noted that Congress could:

• amend the current Chapter 9 bankruptcy law to allow access to Puerto Rico’s public corporations and municipalities; or,
• backstop Puerto Rico’s debt, which would help reduce its borrowing costs (noting that this has been done in the U.S. and elsewhere, usually contingent on budgetary or structural reform requirements.)

CRS also reported that the U.S. government guaranteed Mexico’s government debt in 1994-1995, as well as provided indirect credit support to some states in the 1930’s through 1950’s via the Reconstruction Finance Corp., noting, for example, the RFC “acted as an intermediary in helping to roll over $136 billion in debt for the State of Arkansas” after Arkansas had defaulted on its debt in 1933. The report also suggested Congress could waive the Jones Act for Puerto Rico—a significant unfunded federal mandate which requires ships operating between U.S. ports to be owned by U.S. citizens or companies, to have been constructed in the U.S., and to be operated by U.S. citizens. The CRS report also noted that Congress, as it did for the District of Columbia in 1995, could call for a financial control board. Finally, the CRS report notes that whilst Congress has traditionally been reluctant to provide assistance to states overwhelmed by fiscal storms, it has not been reluctant after natural storms—mayhap timely given yesterday’s memories of the federal assistance granted to Louisiana in the wake of Hurricane Katrina—and, Congress provided both direct and indirect support for New York City in the wake of its fiscal crisis in 1975.

First Chapter 9 since Detroit. Hillview, Kentucky City Attorney Tammy Baker has described the small city’s filing for federal bankruptcy protection as “a very difficult decision” for the city’s elected leaders, but, because of the mounting interest costs from a court judgment against the city, costing it more than $3,700 a day, she notes: “The city really ended up with no choice…With the interest accruing at that rate, it’s just really going to be impossible for the city to pay that judgment.” Counselor Baker has advised the Bond Buyer that the Kentucky municipality, which has filed for municipal bankruptcy, does not intend to restructure its municipal bond debt as part of its plan of debt adjustment. Hillview, the first municipality to file for bankruptcy since Detroit, filed its petition in order to halt payments it owes of thousands of dollars in accruing interest in the wake of an $11.4 million judgment against it—or, as Counselor Baker described it: “What the [municipal] bankruptcy has allowed is breathing room for the city…The interest has been stopped.” The effective halt on the interest payments offers breathing room for the small municipality to develop a plan to address the breach of contract judgment it lost to Truck America Training LLC. Its plan of debt adjustment will have to address some $1.39 million in debt it owes on outstanding general obligation municipal bonds Hillview issued in 2010, and $1.78 million as part of a 2010 pool bond issued on its behalf by the Kentucky Bond Corp. However, in her email to the Bond Buyer, Counselor Baker wrote: “The city does not intend to restructure any bonds through the filing…In fact, we are of the belief that such a restructuring could not be done.” In describing why the city filed its abrupt municipal bankruptcy last week, Ms. Baker noted: “The main reason the city filed for bankruptcy is to halt the crushing interest [of] $3,759 daily from accruing while we develop a plan.” While the filing might provide some instant r-o-l-a-i-d-s for the small municipality, it comes not only with the kinds of costs Puerto Rico is experiencing, but also in terms of borrowing costs: S&P last Friday dropped the municipality’s credit rating five notches to B-minus from BB-plus, and placed the lower rating on CreditWatch with negative implications pending a determination by the federal bankruptcy court on the city’s petition—the lower rating appears to have already translated into at least a ten percent increase to the cost of capital borrowing for Hillview—which, in its petition to the federal bankruptcy court, estimated its liabilities as high as $100 million versus assets of $10 million.

The Difficult Road to Fiscal Sustainability


August 20, 2015

The Hard Road to Recovery in Detroit could be paved by state legislative deal-making over the legislature’s efforts to agree on a highway infrastructure financing plan by freeing up state legislation designed to help Detroit collect city income taxes from residents who commute to the suburbs. Mayor Mike Duggan testified yesterday in Lansing in support of legislation to require employers to withhold city income taxes from paychecks of Detroit residents. Businesses with fewer than 10 employees and less than $500,000 in wages would be exempt. An alternative would authorize the state to use audit and penalty procedures when it takes over Detroit’s income tax collection in 2016. The Motor City’s income taxes constitute the city’s largest single source, contributing about 21 percent of total revenue in 2012. The legislature is back in session for a three-day session, with House members debating a still-emerging bill to provide some $600 million a year in additional fuel and vehicles taxes and set aside $600 million in general funds for deteriorating roads and bridges — a compromise between legislation approved by the House and Senate in recent months (indicating that state legislatures—unlike the federal legislature—are actually able to function). In May, voters defeated a sales tax increase that would have triggered more money for roads, education, and municipalities. If the House votes this week, the bills would go to the GOP-led Senate and then Gov. Rick Snyder for his signature. Each penny increase in the state’s current 19 cents per gallon in gas and diesel taxes would raise about $50 million more annually—the un-wooden nickel increase under consideration would generate roughly $300 million. No longer letting registration fees drop in the three years after the purchase of a new car — a component of the failed ballot proposal — and increasing truck fees would pump $100 million more a year into road upkeep within three fiscal years.

To Market, To Market to Finance a Recovery…Detroit’s post-municipal bankruptcy debut in the U.S. municipal bond market yesterday resulted in costly yields for $245 million of bonds, perhaps indicating investors are still leery about prospects for Detroit’s longer term road to fiscal sustainability. Even though the 4.5% rate was lower than anticipated on the city’s bonds maturing in 2029, the rate was significantly higher than for other cities and counties. The city also marketed nearly $110.3 million of taxable bonds maturing in 2022, which were priced at par with a 4.60 percent coupon – a 300-basis-point spread over comparable U.S. Treasuries, according to the deal’s pricing scale. John Naglick, Detroit’s finance director, said the pricing resulted in an overall interest rate of 4.44 percent, which is lower than the 5.75 percent rate assumed in the city’s court-approved plan of debt adjustment—achieving $2.2 million in average annual interest cost savings. Clearly one’s perspective matters—as the sale of the city’s debt was “substantially” oversubscribed, thereby permitting the city to reduce the interest it had initially priced—even though Detroit will have to pay approximately 100 basis points over similarly situated cities—a price some dubbed a “bankruptcy premium.” S&P had given the Motor City’s bonds an investment-grade A rating, in no small part due to the state’s statutory lien on the city’s income tax revenues pledged to pay off the debt, even as it retained Detroit’s underlying credit rating at a B, deep in the junk category, citing Detroit’s “very weak” economy, management, and budgetary flexibility, as well as its previous bond defaults. In the sale, the city including a warning to potential investors: “[T]here can be no assurance the city of Detroit will not file another bankruptcy petition in the future.” Proceeds from the initial $275 million of bonds, which were privately placed with Barclays Capital, were earmarked for retiring a prior $120 million Barclays loan to the city, to pay certain creditor claims from the bankruptcy and to finance city improvements. Detroit has said it was able to reduce the size of the upcoming borrowing by $30 million to $245 million after the city’s bankruptcy consultants reduced their fees.

Gambling on Property Taxes. The Atlantic City Metropolitan area continues to lead the nation in foreclosure activity, with a rate four times the national average, according to RealtyTrac—a serious issue for a city whose property tax base has declined by nearly two-thirds since 2010. According to the new report, however, one in every 258 housing units had a foreclosure filing in July, the worst showing of any statistical area with a population of 200,000 or more. Nationally, new foreclosure starts are down to their lowest level since 2005, even though overall foreclosure activity was up 7 percent from the previous month and 14 percent from last July; Atlantic County starts were up almost 72 percent from last July, even as RealtyTrac noted that “Atlantic City is in for a tougher and longer haul back to a healthy housing market,” adding that it was impossible to predict when the market might return to normal in Atlantic County, noting: “We believe some of the repossessions are still tied to the last crisis, while starts are more likely tied to recent economic problems,” adding that Stockton and Phoenix were both leading the nation’s foreclosure rates about five years ago, but that their respective markets have turned around in both regions—and that they now have foreclosure rates lower than the national average. It is not just Atlantic City, moreover: New Jersey’s statewide foreclosure starts are up 129 percent over last July, with the state posting the third-highest overall foreclosure rate for states, behind just Florida and Maryland.

Arriba! Víctor Suárez Meléndez, Chief of Staff for Puerto Rico Governor Alejandro García Padilla, yesterday said that the exchange of Government Development Bank notes is the most likely approach to Puerto Rico’s liquidity crunch. The issue is apprehension that the government could run out of operating funds prior to the end of its fiscal year: it needs an additional $400 million to $500 million beyond the funds it currently has on hand or anticipates—adding that without additional fiscal measures, Puerto Rico anticipated running out of money in November. Mr. Suárez Meléndez said Puerto Rico is exploring other options besides the notes exchange—options that would not require restructuring of debt. He added that the Government Development Bank’s net liquidity had risen in recent weeks: as of May 31st the GDB had a net liquidity of $778 million.

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

July 31, 2015

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

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

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

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

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

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

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

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

Restructuring Municipal Debt: Is there a Lesson to be Learned from China?

May 14, 2015
Visit the project blog: The Municipal Sustainability Project

Getting Ready to Rumble. San Bernardino will release a proposed, sweeping plan of municipal debt adjustment this afternoon for the Mayor and Council to vote upon on Monday—a plan expected to propose sweeping changes which will affect the city’s businesses and residents, employees, and creditors for years to come—albeit, those changes, which will affect not just the different classes of the city’s creditors, but also its citizens, will not all be the same. City Attorney Gary Saenz yesterday noted: “It treats our citizens much better than our municipal bondholders…We expect our plan is going to provide for a substantial impairment of those (outside-the-city) groups, all for the purposes of increasing our service levels for our citizens. For each dollar we don’t pay our pension obligation bondholders, we will have a dollar to provide services.” Mr. Saenz, emphasized that the city had already made clear its intent to fully meet its public pension obligations to the California Public Employees’ Retirement System―in order, he noted, to retain employees―bit which, he noted, had already led to litigation against the city from its pension obligation bondholders. Without directly addressing the specific changes to cuts in basic city services, Mr. Saenz did state there would be “increased efficiencies” in municipal services, as well as other, unspecified “tough choices,” adding: “We are committed to it as a city…If we fail to implement in a significant way… Judge Jury (U.S. Bankruptcy Judge Meredith Jury) will have jurisdiction to call the city on that and require that we implement.” Dissimilar to the processes of finalizing plans of debt adjustment in Central Falls, Rhode Island and in Detroit; San Bernardino’s plan has been put together after seeking considerable citizen and business impute, strategic planning sessions by its elected leadership—or, as Mr. Saenz put it yesterday: “It was very much our intention, through the strategic plan and otherwise, to get input from the entire community — both the business community, the education community, and of course the everyday citizens — with regard to the city they want in the future…It was our intention to incorporate that into the Plan of Adjustment. We believe we have been successful in doing that, and we believe that the core team will concur that to the degree that we could, that we have been successful in doing that.” In fact, the city’s “core team” of 17 community representatives, as well as any other interested community members, will meet Saturday morning for a lengthy session to discuss the proposed plan of adjustment and other aspects of the city’s long-term future—a key session in advance of Monday’s vote. With Mr. Saenz warning, in advance, that the plan will involve some pain for many groups: “I believe that one of the primary purposes of Chapter 9 bankruptcy law is that a city that needs the protecting and the assistance of the bankruptcy court to readjust itself in order to continue providing services is going to need to do a number of things…That includes, unfortunately, impairment not only of a number of our creditors but of employee groups as well, and even to some extent impairment of our citizens who are going to have reduced service levels.” Nevertheless, he added, like castor oil, such a plan could be a keystone to a better and more sustainable fiscal future: “That’s the essence of it, a plan that essentially incorporates what the council will adopt as our recovery plan,” he said. “And that, of course, is going to describe for the court and all our creditors and, most importantly, for our citizens, how our city is going to recover and how we’re going to reestablish service solvency — which in my mind is the most important objective.”

An Ill Fiscal Wind. Citing the unremitting burden of debt from the Illinois Supreme Court’s recent decision finding the state’s proposed public changes unconstitutional, Moody’s has reduced the City of Chicago’s debt rating to junk with a negative outlook, writing that the city’s options for reducing the growth of its public pension liabilities “have narrowed considerably.” The rating agency dropped the Windy City’s $8.9 billion of general obligation, sales tax, and motor fuel bonds to a speculative grade Ba1—an action which will exacerbate Chicago’s borrowing costs when it reoffers floating-rate debt in fixed-rate mode later this month, and which could trigger a series of fiscal tribulations relating to bank support on its short-term borrowing program and other credit contracts: “Based on the Illinois Supreme Court’s May 8 overturning of the statute that governs the State of Illinois’ pensions, we believe that the city’s options for curbing growth in its own unfunded pension liabilities have narrowed considerably…Whether or not the current statutes that govern Chicago’s pension plans stand, we expect the costs of servicing Chicago’s unfunded liabilities will grow, placing significant strain on the city’s financial operations absent commensurate growth in revenue and/or reductions in other expenditures…The magnitude of the budget adjustments that will be required of the city are significant. In response, Chicago described Moody’s action as not only premature, but also irresponsible—an action which the city decried as playing politics with Chicago’s financial future by pushing the city to increase taxes on its residents without reform. Chicago’s four pension plans, collectively, have more than $20 billion in unfunded liabilities—leaving the city as much as about half the assets necessary to meet its promises. In response, Mayor Rahm Emanuel said: “While Chicago’s financial crisis is very real and at our doorsteps, today’s irresponsible decision by Moody’s to downgrade the City’s credit by two steps goes far beyond that reality,” adding that the agency both failed to acknowledge the city’s growing economy or its progress in addressing its fiscal challenges. Though the Illinois Supreme Court decision does not directly implicate Chicago’s pensions, it raises the risk that the city’s own proposed pension reforms will be similarly held unconstitutional—leading Mayor Emanuel to call the rating agency “irresponsible” to base its decision on the overturning of a state pension bill that did not include the city’s changes. In its action, Moody’s also dropped its ratings on the city’s senior and second lien water bonds, dropping them to Baa1 and Baa2 from A2 and A3, respectively; Moody’s also downgraded senior and second lien sewer bonds to Baa2 and Baa3 from A3 and Baa1, respectively, affecting $3.8 billion of revenue debt. The outlook remains negative.

As of April 20, the city was carrying about $589 million on its short-term borrowing program that includes lines of credit and a commercial paper program with a total capacity of $900 million. A speculative grade rating triggers an event of default on the city’s banking agreements that support the short term program. All of the liquidity contracts expire over the next year. The city has reported ongoing negotiations with liquidity providers to extend the dates. Moody’s action appears in stark contrast with other rating agencies: S&P recently affirmed Chicago’s A-plus rating and negative outlook, and Kroll Bond Rating Agency affirmed its A-minus rating and stable outlook. Fitch Ratings rates the city A-minus with a negative outlook. The change makes Chicago the only major city, other than Detroit, to carry a junk bond rating from Moody’s. Howard Cure, director of municipal research at Evercore Wealth Management in New York, said his firm has been avoiding Chicago general-obligation bonds “for a while;” nevertheless, he said he was surprised Moody’s cut the city’s rating low enough to place it in junk territory. “It’s not as if the city’s economy is doing badly,” Mr. Cure said. “They’re actually gaining population and having growth downtown. They have some big-city problems, but it’s not a Detroit situation.”

Taxing Times. With a growing sense that Congress will not act to provide Puerto Rico with the authority that every state has to offer access to municipal bankruptcy for its 78 municipalities, Gov. Alejandro García Padilla is seeking to go back to the legislature with a revised tax and spending proposal to try to address the U.S. Territory’s looming insolvency. In the Gov. Padilla’s latest proposal, he proposes a 13.25% value added tax (VAT), which would replace Puerto Rico’s current 7% sales and use tax. The VAT would consist of 11.75% for the commonwealth government and 1.5% for the municipalities—instead of the current 7% sales and use tax, divvied up so that 5.5% goes to the commonwealth and 1% to the municipalities. The remainder 0.5% also is collected by COFINA until late in the year, after which those revenues, too, are directed to municipalities. Under Gov. Padilla’s new revenue proposal, of the 1.5% portion, a 1% sliver would go directly to the municipalities and 0.5% would go to a Corporation for Municipal Finance (COFIM), which would hold money for bonds for the municipalities. Governor Padilla and Puerto Rico Senate President Eduardo Bhatia apparently have also reached consensus that the tax increase would be combined with a $500 million cut in government spending. This week, Gov. Padilla met with Sen. President Bhatia and House of Representatives President Jaime Perelló to discuss the proposal, before the Governor presented it to members of his Popular Democratic Party in the Puerto Rico House and Senate. This new taxing effort comes in the wake of the legislature’s rejection, in April, of Gov. Padilla’s tax reform proposal to reduce income taxes and increase consumption taxes―he had proposed a value added tax or VAT tax of 16%–which, after it aroused a beehive of anger—he modified to 14%–still not enough for the legislature: the House voted 28-22 to reject the modified tax changes. The Governor is scheduled to meet with party leaders this morning in an effort to try to reach a consensus solution for the commonwealth’s fiscal year 2016 budget. The budget for the current fiscal year is for $9.56 billion in spending. The government has indicated that it needs to come up with more than $1 billion in spending cuts and/or revenue increases to achieve a balanced budget in fiscal year 2016.

Saving Motor City Homes. Detroit, before going into municipal bankruptcy, had 78,000 vacant structures and 60,000 vacant land parcels—vacancies which presented an ongoing public safety and public health concern, forcing the city, despite the signal loss of population, to provide and maintain services over its 139 square miles—and to be vulnerable to its 66,000 blighted and vacant lots which encouraged arson and other crimes. The vacancies did—and do—not stop at the city’s boundaries, but also crossed into adjacent and surrounding Wayne County, where, this week, County Treasurer Raymond Wojtowicz extended this week’s deadline for homeowners in the Detroit metropolitan area to make payment arrangements on overdue taxes to June 8th—marking the second extension of the previous March 31 deadline. The notice came in a year when foreclosure proceedings have been started on about 75,000 properties―most in Detroit. Taxpayers remitted their taxes on nearly 20,000; 24,000 others are on payment plans. Slightly over one third of the 30,000 properties still facing foreclosure are occupied. Detroit Mayor Mike Duggan called Mr. Wojtowicz’s efforts “vital to the stabilization and rebirth” of Detroit neighborhoods. Gov. Rick Snyder signed a bill this year that allows homeowners facing financial hardship to use a payment plan to pay off debts and avoid foreclosure.

Restructuring Municipal Debt. Even as Congress has now voted expressly not to help municipalities at risk of insolvency in the U.S., China is launching a broad stimulus to help its municipalities restructure trillions of dollars’ worth of municipal debts by means of a debt-for-bond swap program under which the People’s Bank of China’s plan will allow commercial banks to purchase local government bailout bonds which could then be used as collateral for low-cost loans from the bank. The new stimulus effort comes as China’s cities, which have $1.1 trillion renminbi in outstanding municipal bonds, are confronted with unsupportable levels of municipal debt—even as their borrowing costs remain high. China’s State Council has recently instructed the country’s top economic agencies, including its Finance Ministry, central bank, and the China Banking Regulatory Commission to put together a plan to help the nation’s local governments address their mounting debts.