Schooling in Municipal Bankruptcy

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August 27, 2015

Schooling in Muni Bankruptcy. Paul Vallas, CEO of the Chicago Public Schools (CPS) from 1995 to 2001, this week warned that were CPS to file for municipal bankruptcy—should the legislature authorize municipal bankruptcy in Illinois as proposed by Governor Bruce Rauner—that could devolve CPS, whose credit rating has been reduced to junk status by Fitch, into a financial “death spiral.” Mr. Vallas warned that such a filing would lead to an exodus of students from the system, which, in turn, would trigger a decline in state aid—in effect triggering a vicious fiscal cycle. Gov. Rauner, in proposing authorization of chapter 9 for Illinois municipalities has said CPS would be a good candidate for such a filing. The warning came as Mayor Rahm Emanuel’s CPS school board yesterday unanimously approved CPS’s budget, relying heavily on borrowed money and the hope of a nearly $500 million bailout from the legislature—a legislature which appears to be in a semi-permanent stalemate. Absent the assumed state aid, CPS will have few options but to make searing cuts in January. The $5.7 billion spending plan contains another property tax hike — an estimated $19-a-year increase for the owner of a $250,000 home — as well as teacher and staff layoffs. The CPS budget action came as the Chicago Board of Education also prepared to issue $1 billion in municipal bonds and agreed to spend $475,000 so an accounting firm can monitor a cash flow problem so acute that CPS considered skipping a massive teacher pension payment at the end of June. Mayor Emanuel’s new choice for board president, former ComEd executive Frank Clark, summed up the financial peril: “This is much like, in your personal lives, if you begin to have revenue shortfalls…you start living off your credit cards…And you can do it short-term, but sooner or later, those credit cards max out and you’ve got yourself in a very serious situation. That’s where CPS finds itself today: It is a budget that keeps us going today. It is not a sustainable approach long-term.” Indeed, the more than 8 percent hole in the adopted budget leaves little option but for Mayor Emanuel and new CPS Chief Forrest Claypool to try to get Gov. Rauner and the legislature to enact changes to CPS’ teacher pension obligations. On the reality front, CEO Vallas asked: “Who wants to send their kids to a bankrupt school district?” He warned that litigation and potential teacher strikes could “totally destabilize the system which means people would flock away from the system which means you would put the system in a financial death spiral,” adding: “At the end of the day bankruptcy is literally the kiss of death…that would decimate the finances so it’s simply not an option.” Chicago Civic Federation President Laurence Msall described the proposed CPS budget as “[Y]et another financially risky, short-sighted proposal and [one which] fails to provide any reassurance that Chicago Public Schools has a plan for emerging from its perpetual financial crisis…If stakeholders do not come together now to develop a multi-year plan, the Federation is deeply concerned that CPS could fail, with devastating consequences for the future of Chicago and Illinois.”

To Be or Not to Be. With Gov. Alejandro García Padilla theoretically set to release a fiscal stability and economic development plan for Puerto Rico’s future next Monday, there has been increased discussion of the cancellation of the Puerto Rico Aqueduct and Sewer Authority’s (PRASA) bond offering, apparently out of apprehension with regard to global market conditions and an apparent lack of investor appetite for the municipal bonds—but without any official statement released on a change to the status of the sale, either from PRASA officials or from the Commonwealth. In addition, the U.S. territory has asked the U.S. Supreme Court for a ruling to overturn a ban which prevents Puerto Rico public agencies from restructuring, seeking permission for the right to restructure its debt — which has reached $72 billion — under its own quasi-bankruptcy law. The uncertainty came as Nuveen yesterday noted: “The Government Development Bank reports liquidity sufficient to operate until November…In addition, the Department of Justice has designated Puerto Rico a ‘high risk grantee,’ requiring Puerto Rico to account for how it spends federal funds going forward.” Yesterday, in addition, Moody’s added: The PRASA postponement of a $750 million bond offering after repeated delays “shows the difficult obstacles blocking Puerto Rico’s capital market access…Investor sentiment has deteriorated sharply since the commonwealth’s last public offering almost a year and a half ago. If underwriters can eventually complete the PRASA sale, it may signal a return to some degree of market access that would help maintain liquidity.” If anything, with Puerto Rico impinging on its self-set August 31st deadline to reveal its plan to restructure its staggering $72 billion debt, the island likely is opting not to move ahead with its controversial proposal to borrow an additional $750 million to pay for PRASA improvements—likely out of at least some apprehension it could not borrow the money — by issuing bonds — at an affordable interest rate. Adding to the messy situation, a working group, appointed by Gov. Garcia Padilla, has been trying to put a proposal together for several months; however, Puerto Rico’s main opposition party has dropped out of the group—raising grave doubts about any consensus. The PRASA debt issuance cancellation is more worrisome—as the utility provides essential services and is authorized to increase rates, within reason. Moreover, the utility’s bondholders have a first claim on its revenues: they are authorized to bring in a receiver to enforce collections.

A Post Muni Bankruptcy High? Recovering from municipal bankruptcy is like recovering from surgery. There are scars, but lessons learned. Thus, as post-bankrupt Stockton continues its comeback, City Attorney John Luebberke notes: “The City Council’s goal is to pursue the betterment of the community…Now that we’re out of bankruptcy, we can pursue some of these opportunities. Even in an era of constrained resources, we’re going to do what we can to improve the community.” One action, in which Mr. Luebberke is taking a lead role, is to enforce the city’s medical marijuana ordinance. Thus, post municipal bankruptcy Stockton last week filed two lawsuits last week aimed at preventing a pair of medical-marijuana dispensaries from operating in Stockton in violation of a city ordinance. While one has closed, the other—Collective 1950—will remain open while the city’s lawsuit is being adjudicated, with court dates not scheduled until mid-January. Mr. Luebberke said it is uncertain whether Stockton initially will seek a temporary injunction to immediately close Collective 1950 or choose to gain permanent injunctions from the court against Collective 1950 and Elevate Wellness. For Stockton, the issue of municipal enforcement of Stockton’s medical-marijuana ordinance is complicated by California’s “Compassionate Use Act,” which allows for marijuana use and possession for medical reasons—whilst Stockton’s ordinance is focused on preventing unregulated dispensaries from selling to minors and seeks to reduce the potential for “nuisances” and crimes associated with the presence of the facilities, according to Mr. Luebberke. According to Stockton’s lawsuits, the city can enforce its municipal code by “public nuisance abatement,” “civil injunction,” and “civil penalties of up to $1,000 per day of violation.”

First Chapter 9 since Detroit. Some of the first transatlantic passengers to come to America on the Arbella—passengers who left England in 1630 with their new charter–had a great vision. They were to be an example for the rest of the world in rightful living, or as then Gov. John Winthrop put it: “We shall be as a city upon a hill, the eyes of all people are upon us.” But there is a different perspective from Hillview, the small Kentucky municipality which last week filed for chapter 9 municipal bankruptcy in the first municipal bankruptcy since Detroit, with Rick Cohen noting: “With its Chapter 9 filing, Hillview may have liabilities of around $100 million, against assets potentially only as much as $10 million…There may be a reason that Hillview found bankruptcy preferable to paying out, even at a lower rate than the court ordered, to the trucking company.” His thesis, referring to Moody’s report this month: “Municipal Bankruptcy Still Rare, but No Longer Taboo,” notes that Moody’s Senior VP Al Medioli appears to find that recent chapter 9 decisions have treated public pensioners “as a group above other creditors, and that further places pensions on a higher plane above all other liabilities, regardless of bond security or legal revenue pledge.” He notes that Kentucky confronts an unfunded pension liability of over $9 billion, making it the nation’s least well-funded state pension system, albeit he confesses there is insufficient information with regard to Hillview’s pension obligations that might have been affected by the municipality’s bankruptcy filing and potential proposed plan of debt adjustment.

Stately Oversight. In a brief released yesterday by Pew, the organization determined that New Jersey’s long track record of “strong state oversight” has, at least to date, been a key factor in fiscally protecting Atlantic City from being forced into municipal bankruptcy. Noting that the Garden State established its first fiscal oversight program in 1931, the report finds that the state has taken an active role to prevent municipal defaults and bankruptcies: Camden, before the state intervened with additional funds to help the city meet its obligations, came close in 1999 to becoming the first New Jersey municipality to file for Chapter 9 since Fort Lee in 1938, noting that New Jersey’s “tradition of intervention” is a stark contrast to other states such as California and Alabama which leave it up to local governments to resolve their own fiscal challenges, noting: “Most states tend to react to distress when it’s too late and not be proactive and that is not the case with New Jersey.” The report adds that Atlantic City also has benefited this year from New Jersey’s Municipal Qualified Bond Act, which allowed it to issue $43 million in general obligation bonds to cover repayment of a state loan for refinancing $12.8 million in bond anticipation notes. Atlantic City also received a $10 million increase in state funds this year under the state’s transitional aid program designed to assist distressed local governments. Pew cautioned, however, that while New Jersey has a strong record of avoiding municipal bankruptcies, no municipality in modern times has experienced close to the city’s 64 percent tax base decline, driven largely by casino closures from increased regional gambling competition, noting that the state still might be forced to “bail the city out” if it is to avoid filing for municipal bankruptcy—adding that such a rescue could be manageable given Atlantic City’s relatively small size.

The Difficult Road to Fiscal Sustainability

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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.

Protecting the Ability to Provide Essential Public Services

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July 1, 2015

Is Puerto Rico at the Tipping Point? As Puerto Rico nears insolvency, the White House and key members of Congress, perhaps observing events in Greece, appear to recognize that any reorganization of the U.S. territory’s debt outside of the U.S. judicial system would be chaotic and prohibitively expensive. Nevertheless, with Congress in recess, some of the island’s creditors are threatening they will continue to oppose any effort by Puerto Rico to have access to federal bankruptcy courts. Oppenheimer Funds, the largest holder of Puerto Rico debt among U.S. municipal bond funds, yesterday warned Puerto Rico it stands ready to defend the terms of the municipal bonds it holds, challenging Gov. Alejandro Padilla’s proposal to begin restructuring Puerto Rico’s debt and to postpone interest payments on outstanding Puerto Rican municipal bonds. Oppenheimer’s fierce denunciation came in the wake of Gov. Padilla’s proposal Monday to create a Working Group for the Economic Recovery of Puerto Rico, led by Chief of Staff Victor Suárez, Government Development Bank President Melba Acosta, Secretary of Justice César Miranda, and the Presidents of the Senate and House, Eduardo Bhatia and Jaime Perelló: with the group charged to develop a consensus on the restructuring of Puerto Rico’s public debt—or, as Gov. Padilla put it: “The ultimate goal is a negotiated moratorium with bondholders to postpone debt payments a number of years, so that the money can be invested here in Puerto Rico.” .That is, absent the kind of neutral referee created under the U.S. bankruptcy laws and courts, chaos could reign as Gov. Padilla seeks to restructure the island’s $73 billion debt to relieve its fiscal problems. Retired U.S. Bankruptcy Judge Steven Rhodes, who presided over Detroit’s 18 month municipal bankruptcy trial before approving its unprecedented plan of debt adjustment—a plan under which Detroit’s municipal bondholders took significant reductions—and who has been retained to assist Puerto Rico as it seeks to restructure its debts in a way that preserves the island’s abilities to provide essential public services, such as 9-1-1, water, street lights, etc. yesterday told Reuters it would be impractical to expect Puerto Rico to restructure its $72 billion of obligations outside the court system: “I just don’t think that an out-of-court negotiation process is feasible here…There are too many creditors, too many different kinds of creditors. They’re all over the place,” adding Puerto Rico will need access to federal bankruptcy courts for more than just its public agencies, which would be allowed under H.R. 870, a bill introduced by Rep. Pedro Pierluisi, Puerto Rico’s non-voting member of Congress: “The commonwealth itself needs access to Chapter 9 relief as well…Puerto Rico is not a state. It’s not a sovereign in the same sense that Michigan or Pennsylvania or Illinois is. Congress has complete and plenary authority over it. Without violating any of our constitutional principles, it could grant the commonwealth that relief, if it chose.”

The U.S. House Judiciary Committee has, to date, refused to take the bill up for consideration—especially in the face of a well-financed campaign by hedge funds lobbying against any Congressional action. Support from Congressional leaders for providing Puerto Rico access to U.S. bankruptcy began to build this week, however. Sen. Charles Schumer (D-NY), the third-highest ranking Democrat will sponsor a companion of H.R. 870. In addition, Josh Earnest, a spokesman for the White House, said that Congress should “take a look” at the bill. In addition, a spokeswoman for House Minority Leader Nancy Pelosi (D-Ca.) said the legislation should be voted on when the House of Representatives returns to work later this month.

The inaction in Congress follows rejection last year by a U.S. District Court of proposed Puerto Rican legislation which would have enabled Puerto Rico’s public corporations to file for federal bankruptcy protection: U.S. District Judge Francisco A. Besosa last February held that the proposed legislation, the Public Corporation Debt Enforcement and Recovery Act, violated the U.S. Constitution in a suit brought in federal court by municipal bond funds affiliated with Franklin Resources Inc., Oppenheimer Rochester Funds, and Blue Mountain Capital Management—firms which had sued Puerto Rico, arguing the law was unconstitutional and that, if enacted, would have depressed the value of the $2 billion in Puerto Rico power utility municipal bonds they held. Puerto Rico has appealed.

Oppenheimer Funds, which has an estimated $4.5 billion exposure on municipal bonds on behalf of its clients according to Morningstar, claims it believes Puerto Rico could repay municipal bondholders even while providing essential services to its citizens and taking steps to revitalize the island’s economy, adding that it stands ready “to defend the previously agreed to terms in each and every bond indenture,”—and that it is “disheartened that Governor Padilla, in a public forum, has called for negotiations with other creditors, representing and including the millions of individual Americans that hold Puerto Rico municipal bonds.” Oppenheimer’s statement came in the wake of Gov. Padilla’s statement Monday that his goal was to come up with a negotiated moratorium with the territory’s municipal bondholders to postpone debt payments for a number of years. No doubt, the fierceness of Oppenheimer and other of the island’s municipal bondholder servicers is related to recognition that in the resolutions of plan of adjustment approvals granted by the U.S. Bankruptcy courts in the Stockton and Detroit cases, the respective cities’ municipal bondholders took very steep haircuts—an outcome that clearly affected Puerto Rican bonds yesterday, which fell sharply for the second consecutive day, with general obligation 8 percent bonds maturing in 2035 as low as $64.50 versus a low of $68.75 on Monday. A Moody’s chart reflects the significant cuts bondholders took in the Vallejo, Detroit, and Stockton chapter 9 municipal bankruptcies—as well as the reductions proposed in San Bernardino’s proposed plan of debt adjustment pending before U.S. Bankruptcy Judge Meredith Jury. Almost 10 percent of municipal bonds that traded Monday were Puerto Rico-related, according to Janney Capital Markets. A key part of the drop, no doubt, came from downgrades by S&P and Fitch, with S&P warning that a default, distressed exchange, or redemption of Puerto Rico’s debt within the next six months seemed inevitable. Nevertheless, S&P reported it expects Puerto Rico to make its scheduled payment today of $655 million on general obligation debt; while Puerto Rico’s public utility corporation, PREPA, which has a current estimated debt in the range of $9 billion, is in discussions with creditors with regard to its own $400 million payment due today. One gets an appreciation of how fiercely municipal bond funds have been opposing giving access to the federal courts by Puerto Rico or any of its 147 municipalities: U.S. open-ended municipal bond funds have $11 billion of Puerto Rico bonds and nearly 53 percent of such funds have exposure to the commonwealth—with the biggest exposure including Franklin Templeton, which already was thoroughly bloodied in the Stockton federally approved resolution to its emergence from municipal bankruptcy.

Gov. Padilla, earlier this week, in the wake of the release of the Puerto Rico “Way Forward” report, made clear the U.S. territory could not pay all of its debt, even if it took strong measures to cut spending and increase revenues: “All the measures we have taken in the last two years reflect our willingness to pay and, had we not taken them, we would not be in a position today to request restructuring…We have done all that was within our power, but, as the report makes clear, the next step must be to ensure more favorable terms for the repayment of our debt.” That same day, the redoubtable Natalie Cohen of Wells Fargo Securities noted: “I agree that Puerto Rico’s current trajectory is unsustainable and lack of immediate action will only make its situation more painful to resolve. I thought the report was balanced and shows that without action, there is a financing gap of $3.7 billion in 2016, growing substantially in future years as Affordable Care Act reductions and loss of Act 154 benefits disappear (about 20% of General Fund revenues).”

• According to Gov. Padilla, the Working Group formed this week will create a long-term fiscal agenda by Aug. 30 aimed at:
  • Establishing the parameters for a five-year fiscal plan; proposing additional cuts in spending — including cuts in some services — to avoid an increase in taxes; * *Restructuring the Department of Treasury to increase the efficiency of income gathering;
• promoting alliances with the private sector to provide some of the services that are today provided by the public sector, such as the successful projects like the Moscoso Bridge, the airport, and the highway to Arecibo;
• radically changing the way in which we work with government finances and economic statistics, to establish greater transparency and credibility;
• guaranteeing our citizens’ essential services and our pensioners a just income; [and] creating a fiscal board which, outside political considerations, will guarantee the continuity and honor of the commitments agreed upon by us during the restructuring process.
• Seeking passage in Washington of Chapter 9 eligibility for Puerto Rico’s public corporations, a more equitable distribution of Medicare payments, and the end of the Jones Act, which increases costs of shipping to and from the island.

Retirees v. Municipal Bondholders. The incredible Boston Federal Reserve report, “Walking a Tightrope: Are U.S. State & Local Governments on a Fiscally Sustainable Path?” by Bo Shao and David Coyne came as increasing data makes clear that municipalities have never recovered in terms of employees from pre-recession levels—so there are fewer employees paying into municipal pensions—even as retirees appear to have the gall to live much longer than any previous generations: the teeter-totter is fiscally teetering. Thus, when Chicago Public School system, last week, announced it intended to issue some $1 billion in new debt to finance its $600 million-plus pension payment due yesterday; it created still another battlefront between firms like Oppenheimer and states and municipalities. It also appears to have been a key factor in Moody’s sharp downgrade of the Windy City’s credit rating—a downgrade Moody’s attributed almost entirely to Chicago’s pension issues—adding to apprehensions that should the Illinois legislature grant Chicago and other Illinois municipalities access to municipal bankruptcy, the municipalities’ constitutional and political inabilities to reign in pension liabilities could trigger future U.S. Bankruptcy court decisions that, as in Puerto Rico, would have signal repercussions for municipal bondholders. . In the bankruptcies of Detroit, Vallejo, Stockton and San Bernardino, bondholders have faced losses of up to 99% of their holdings, according to a Moody’s report dated May 18. Meanwhile all three California cities chose to preserve full pensions for their employees, while Detroit only cut pensions by approximately 18%.

The Extreme Challenges of Governance in Bankruptcy

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June 19, 2015
Visit the project blog: The Municipal Sustainability Project

Wait a Minute, Mr. Postman. In the wake of Wayne County Executive Warren Evans’ request for Michigan to declare the county in a financial emergency, Wayne County yesterday announced it would defer a $186 million note sale originally scheduled for today—a step taken so that potential investors have time to settle—and the county, which surrounds Detroit, might be able to enter into a consent agreement with the state. The sale is intended to tide over the county in order to make up for late property tax collections for its local governments. (Wayne County has 34 cities, including Detroit, and 9 townships—making it the 19th largest county in the nation.) Nevertheless, Wayne County cannot wait long: Deputy Treasurer Christa McLellan reports Wayne wants the money by the end of its fiscal year—June 30th, advising the Bond Buyer: “The request for state review will necessitate a delay in the sale of the notes which was to have taken place today, June 18,” Ms. McLellan said. “It is now expected to be rescheduled to Wednesday or Thursday of next week, in order to give investors time to digest and react to the executive’s announcement as well as understand the strengths and vitality of the delinquent tax program…Although the executive’s announcement has delayed our timing slightly, we are moving forward with a goal of closing on the notes before the end of this month.”

Getting Ready to Rumble. At the first hearing in U.S. Bankruptcy Judge Meredith Jury’s courtroom this week, the bulk of San Bernardino’s creditors were generally positive about the city’s proposed plan of debt adjustment—and how the city had finally come together to complete it. Unsurprisingly, the attorney representing San Bernardino’s municipal bondholders—creditors with some $50 million at risk—was less than enthusiastic about a plan under which, if approved by the federal court, those bondholders would receive about one penny on the dollar. The issue, very much as in Stockton’s bankruptcy case before U.S. Bankruptcy Judge Christopher Klein, will pit the city’s bondholders against almost all its other creditors—creditors in this case who generally told the federal court they respected the progress in a case that began with San Bernardino’s initial filing for chapter 9 municipal bankruptcy in August of 2013. The bondholder’s attorney charged that San Bernardino’s foot-dragging on the case had already been demonstrated by the city’s failure to propose a date for the hearing, which the attorney said would be standard practice, and he criticized the municipality for proposing a plan of debt adjustment which he noted might not work, because, he told Judge Jury, it depends on changes to the city charter that cannot be voted upon until 2016, and, it could then be rejected, testifying: “(The city’s filing) fails in our view in what was intended to be its central purpose, which was to finally move this case along…And raises once again the question of what the city has been doing for the almost three years that it has been under the protection of Chapter 9 (bankruptcy).” Democracy, of course, is quite different than a quasi-dictatorship: as we have noted, a key distinction between state laws which provide for municipal authority to seek federal bankruptcy protection, is whether such laws provide for an emergency manager or receiver, as opposed to leaving the elected leadership in place. Democracy can be messy—especially with regard to such agonizing public decisions. Indeed, interestingly, Ron Olinor, who represents the San Bernardino Police Officers Association, testified in praise of the city’s progress: “Obviously bondholders — Wall Street — don’t like the plan, and they’ll take their shots…You forced the city to move forward. They made hard decisions…I would say today is a very good day for the city and a very good day for this case.” The attorney representing a committee of retirees, Steven Katzman, also took issue with the bondholders’ attorney: “What Mr. Marriot ignores — even though I don’t think it’s the right place (to discuss it), but he brought it up…my committee has agreed to forsake $40 (million) to $50 million in health care benefits…It’s about the same amount of money that they’re owed. To say that they’re in the same place as us is sort of like saying Bill Gates and I are in the same place. They’re Bill Gates — they’re well off, they’re well-heeled — and my clients are giving up the same amount of money as his clients are.” For his part, San Bernardino City Attorney Paul Glassman testified the city’s proposed plan of debt adjustment does not depend on voters approving changes to the charter: “We’re simply talking about a reorganization that would assist the city and be viewed as helpful…We worked very hard to put together a plan that is not dependent upon an election happening.” Counselor Glassman told Judge Jury San Bernardino was operating under an interim charter agreement—a challenge to governance, and another hurdle drawing further criticism from the bondholders’ counsel, who told the court: “I don’t know how long the city can operate on a basis that’s inconsistent with its own charter.” The pension obligation bondholders are already appealing Judge Jury’s earlier decision that bondholders do not have to be paid the same as the California Public Employees’ Retirement System (CalPERS)—a replay of a similar challenge from the Stockton bankruptcy case. It appears now the next step will come next month, when Judge Jury will hear arguments about the fire union’s temporary restraining order against the city’s attempt to outsource the Fire Department—a key provision in the city’s plan of debt adjustment that could reduce its debts by as much as $7-10 million, but which the city’s fire union contends is prohibited by the city charter. Judge Jury has scheduled a hearing for October 8th to determine whether the financial disclosure statement San Bernardino filed along with its plan of debt adjustment is adequate, noting the city’s fiscal situation could change significantly by then.

The Fate of a U.S. Territory. In preparation for a possible debt crisis, Puerto Rico Gov. Alejandro García Padilla is seeking legislation to grant immunity from some lawsuits to the leadership and staff of Puerto Rico’s Government Development Bank (GDB), because, unlike the directors of most corporations and banks, the GDB’s leadership lacks immunity from lawsuits over their decisions. The proposed legislation would provide immunity to the banks’ leaders should they opt to default on particular GDB debt obligations; nevertheless, the leaders could still be sued for embezzlement or other illegal actions. There has been some apprehension that absent such legal protections, the bank’s leadership would opt to resign rather than risk liability over their decisions. With uncertainty with regard  to unlikely action by Congress to offer the U.S. territory legal options available to U.S. states, Gov. García Padilla warns that the Commonwealth is in the greatest financial crisis in its history: the timeline is shrinking, as the commonwealth, last March, issued a report saying that it might not be able to pay all obligations coming due in July and August. There is about $72 billion in public sector debt in the commonwealth. Historically, the GDB has financially supported many of the debt issuers. There are now two immunity bills in the legislature, with some hopes for progress, as one is currently in conference between the Puerto Rico House and Senate right now, and Representative Jesús Santa Rodríguez’s spokesperson reports the conference committee is on the verge of approving the measure. The action comes as the Puerto Rico House hopes to complete and send to the Senate the territory’s FY2016 budget as early as today. The last minute budget and debt negotiations come as creditors of Puerto Rico’s nearly insolvent public power utility PREPA have agreed to extend a creditor agreement to the end of the fiscal year—a key step to ensure more time for restructuring negotiations, and to protect the PREPA from default: the agreement had been scheduled to expire last night. PREPA, with about $9 billion of debt, also has a June 30 deadline by which to reach a restructuring deal with creditors—with the issue being the reaction to its proposed quasi plan of debt adjustment, which needs some $2.3 billion in investments to make its business more sustainable: its long-term prospects depend on converting a largely oil-fired generation fleet to natural gas—a key to lowering operating costs, and improving collections and increasing efficiencies, while also keeping electricity rates at the lowest possible levels to help spur economic growth. With PREPA confronting a July 1 deadline for a $400 million payment to its bondholders, creditors are questioning the proposal—with one going so far as to describe the utility’s proposal as “unworkable.”

Municipal Bankruptcy & Alternatives for Distressed Cities

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April 15, 2015
Visit the project blog: The Municipal Sustainability Project

Fire in the Hole. The union representing San Bernardino’s firefighters has sued the city in a pair of lawsuits, alleging city officials are violating San Bernardino’s charter in an ongoing pay dispute. The union had so threatened last October in the wake of San Bernardino’s imposition of changes in their public pensions—a critical issue the city has to address as part of any plan to exit municipal bankruptcy—but where its ability to do so has been threatened not only by the legal objections, but also by charter requirements that make San Bernardino the only city in the State of California which must base its police and firefighter pay on the average of 10 similarly sized cities (all, however, larger in this instance)—a mandate or requirement, nevertheless, which a majority of the city’s voters, last November, rejected the opportunity to change, when they voted by a 55% majority to reject a change which has left the city as the only one in the state to set police and firefighter salaries by comparison with other cities, rather than by collective bargaining. At the time, the Mayor had urged voters to adopt the new measure, arguing that the bankrupt city could ill afford to pay wages dictated by the wealthier cities that are used to setting police and firefighter pay under Charter Section 186. San Bernardino’s fire union chief, in a press release, noted: “We want to stop these violations and ensure that city leaders follow the laws that they have pledged to uphold.” In the suits, filed late last week in U.S. Bankruptcy Court in Riverside, the union asks the federal court to roll back last fall’s changes. San Bernardino City Manager Allen Parker noted, referring to the fire union: “They threatened to do this, and it was just a matter of time…They have been unhappy with the rulings of the bankruptcy court all along, and the bankruptcy court judge is the one who approved the action, so they ought to be angry with the judge, not us.” The intriguing intergovernmental clash before the U.S. Bankruptcy Court, following in the wake of Judge Meredith Jury’s ruling last September that San Bernardino could reject its then-existing contract with the firefighters—but not granting the city’s request that it be granted the authority to impose its own contract—has created a kind of legal limbo. Only, this time, the legal limbo and suit add still another legal hurdle to the city’s ability to cobble together its plan of adjustment to meet U.S. Bankruptcy Judge Meredith Jury’s May 30th deadline to submit its plan of debt adjustment.

Chapter 9 Municipal Bankruptcy & Alternatives for Distressed Municipalities & States. In an unprecedented session hosted by the New York Federal Reserve yesterday, and co-hosted by the Volcker Alliance and the George Mason Center for State & Local Leadership, the three U.S. Bankruptcy Judges of the largest municipal bankruptcies in U.S. history spoke of the lessons learned from Detroit, Stockton, and Jefferson County: with Judges Steven Rhodes (Detroit) and Christopher Klein (Stockton) noting the critical appointment of the “right” mediator, Judge Rhodes driving home the importance of what he termed “pedal to the metal,” and noting that an ‘adversarial process will not work,’ so that the appointment of a “feasibility” expert was invaluable. With Judge Klein noting the “dynamic” nature of municipal bankruptcy resolution, Judge Thomas Bennett, who oversaw the Jefferson County bankruptcy, spoke of the importance of “long-term municipal sustainability” as a key outcome of any successful municipal distress outcome—in addition to an effective restructuring of a city or county’s debt. For municipal leaders, Judge Rhodes noted that any such long-term sustainability had led him to abjure Detroit’s citizens to “remember your anger,” as we discussed the uncertain future of this generation of cities and counties that have—or appear to be en route—to emerging from municipal bankruptcy to what Judge Bennett defined as “long-term sustainability,” a plan which must entail a structuring of a recovering municipality’s pensions and debt service, and which Judge Klein noted might mean there ought to be consideration of some sort of “enforcement mechanism.” Judge Klein, noting that “bond financing is a really good business,” suggested this might be an arena in need of adult supervision, echoing concerns expressed by both the Urban Institute and Judge Bennett (speaking of states which do not give home rule authority to municipalities—a decision, he noted, which precipitated Jefferson County’s historic municipal bankruptcy), and warned could become especially problematical for municipal leaders in ‘no new tax states.’

Municipal DNA. The participants concurred that while there are commonalities or a DNA that connects all municipalities amongst distressed and bankrupt cities and counties; nevertheless, each is unique: in almost every instance, there has been a slow, gradual decades-long demise which begins with the governing body—council or board—based upon financial dealings with labor, developers, financiers—and not with the eyes on long-term fiscal sustainability—or, as one of the experienced federal bankruptcy judges explained it, how, in a triangle of employees, finances, and taxpayers: who has to give up what? –especially, in an era, as Judge Rhodes noted, when the challenge of valuing liabilities of a municipality is its most difficult hurdle with such signal consequences towards a municipality’s long-term fiscal sustainability. The judges emphasized that critical steps required that elected leaders of a bankrupt municipality had to take ownership of a resolution; the value of the adversarial process of municipal bankruptcy; and—in stark contrast with a business, as opposed to municipal corporation bankruptcy; chapter 9 is a “dynamic” process in which the goal is, as Judge Bennett explained, “long-term sustainability,” echoing the guidance of the Boston Federal Reserve’s important paper about the exceptional challenge of state and local leaders “[W]alking a Tightrope: Are U.S. State and Local Governments on a Fiscally Sustainable Path?”

At the session, we were treated to the municipal leadership perspective from the bird’s eye view of Atlantic City Mayor Don Guardian, Syracuse, N.Y. Mayor Stephanie Miner, and former San Jose Mayor Chuck Reed—with Mayor Reed warning of reverse incentives for municipal leaders in the budget process—a process governed by too much secrecy, and Mayor Miner describing the real world consequences that fall on an urban Mayor whose city has already experienced 130 water main breaks so far this year—a year in which the state has continued a long-term process of disinvestment in its municipalities—but her city has seen a 400% increase in its pension and OPEB liabilities—imposing a greater and greater burden on communicating with her constituents, noting: “The truth shall set ye free’”—albeit potentially encumbered by ever increasing legacies of debt. Mayor Guardian spoke eloquently of what it means to be a newly elected Mayor of a city with an 88% reliance on the property tax—but where the assessed value of his city’s properties have declined by 85 percent.

Federal Reserve Bank of New York President and chief executive officer William Dudley opened yesterday’s historic session by warning that municipalities are getting into fiscal trouble by borrowing to cover operating deficits: “When a jurisdiction borrows to invest in infrastructure, the cost of the debt to local residents — and those considering locating in the jurisdiction — is offset by the value of the services that the infrastructure provides. This tradeoff is part of the ‘fiscal surplus’ that a jurisdiction offers: the value of the services minus the tax price that residents have to pay. A well-run capital budget will match these costs and benefits over the life of each project to ensure that the jurisdiction remains attractive to current and future residents.” Nevertheless, Mr. Dudley warned that some municipalities are putting themselves in trouble by borrowing to cover operational deficits and achieve “balanced” budgets, just as New York City did in the 1970’s leading up to its famous fiscal crisis: “The key distinction between these two types of borrowing is that in the former case an asset is producing services that help to offset the cost of the debt, but this is not so in the latter case…Indeed, using debt to finance current operating deficits is equivalent to asking future taxpayers to help finance today’s public services.” Mr. Dudley said that residents of a municipality managing its finances that way could react by leaving, shrinking its tax base and exacerbating its fiscal problems; he directed significant focus to the underfunding of public pensions, a practice which the Securities and Exchange Commission has targeted for enforcement actions, and which regulators and market participants alike have said could be a serious threat to state and local finances and bondholders in the future—noting that the need to compromise with pensioners during Detroit’s recent bankruptcy proceedings, for example, cost the insurers of the city’s bonds millions of dollars—and, warning participants that the Motor City’s experience, as well as that of Stockton, Ca., could be emblematic of more systemic problems: “While these particular bankruptcy filings have captured a considerable amount of attention, and rightly so, they may foreshadow more widespread problems than what might be implied by current bond ratings…We need to focus our attention today on addressing the underlying issues before any problems grow to the point where bankruptcy becomes the only viable option: state and local governments have enormous financial obligations, as well as critical service delivery responsibilities. Managing their liabilities in such a way as to ensure that these vital services continue to be provided, and citizens’ view[s] that they are getting appropriate value in exchange for their taxes is a daunting challenge.”

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March 27, 2015
Visit the project blog: The Municipal Sustainability Project

Taking Stock in Stockton. Franklin Templeton Investments has filed its first brief (Appeal from the United States Bankruptcy Court for the Eastern District of California, Case No. 12-32118, U.S. 9th Circuit Court of Appeal) to U.S. Bankruptcy Judge Christopher Klein’s approval, last October 30th, of Stockton’s plan of debt adjustment—allowing the city to exit municipal bankruptcy and to begin to implement its fiscal recovery plan. Franklin’s brief follows in the wake of its November request to the city’s exit plan—a rejection Judge Klein formally rejected last month, writing that Stockton could proceed in implementing its recovery plan and opining that Franklin’s likelihood of winning on appeal was slim. In its revised brief, Franklin Templeton asserts that Judge Klein erred in approving Stockton’s plan of debt adjustment, because, according to Franklin, the plan was “discriminatory and punitive” against Franklin. Stockton has until May 28th to respond. The city, which declared bankruptcy in July 2012, has developed a long-range financial plan for the duration of the agreements in its federally approved plan of adjustment, some of which extend out to 2053. Franklin’s objections center on the significant disparity between how it is treated under that plan versus the California Public Employee’s Retirement System (CalPERS), with Franklin getting back about one cent on the dollar of what it is owed, versus CalPERS being fully repaid. Absent a success on its challenge, Franklin will remain at risk of nearly a 99% loss on the $35 million of the city’s municipal bonds which it owns. All other major creditors settled with the city ahead of the bankruptcy confirmation. Whilst Franklin has asserted its recovery rate on its unsecured municipal bonds was less than 1%, the city’s attorneys have responded in a filing that Franklin’s total recovery rate on secured and unsecured claims is closer to 17.5%. Franklin will receive $2.1 million in collateral from the bond reserve account that is not accounted for in Judge Klein’s opinion, $4.05 million from the sale of a golf course, plus the $285,227 on its unsecured claim for a total of $6.4 million — equal to a 17.5% total recovery on the $36.6 million claim, according to the city’s filing. Stockton Record columnist Michael Fitzgerald, writing about how the city’s leaders handled its bankruptcy process and the opportunities which are now possible, emphasized lessons that public officials, municipal employees, city residents, and policy makers can take away from Stockton’s Chapter 9 Federal bankruptcy process, with the most significant being to keep politics from policy making. “If I could boil the lessons of Stockton’s crash down to one point, it would be this: Don’t allow city fiscal policy to be politicized.” He stresses that strong fiscal policy cannot be crafted under the pressure of special interests. From these lessons, Stockton can look to the future, and begin to reimagine its downtown and create new economic development….the city is now running on a smart fiscal model, the economy is recovering, and, for that matter, it’s spring. Stocktonians are looking at a new beginning.”

Getting Moody in Atlantic City. Credit rating agency Moody’s has responded moodily to New Jersey’s state-appointed emergency manager’s report with regard to Atlantic City’s fiscal crisis, calling the plan a credit negative which could pave the way to default. Analysts Josellyn Yousef, Orlie Prince, and Naomi Richman wrote that in addition to opening up the possibility of the city defaulting on its debt, the timeline proposed by emergency manager Kevin Lavin relies on rapid legislative action, state aid and “timely tax payments from struggling casinos―” adding that Atlantic City is also at fiscal risk of losing access to the capital markets by next Tuesday if it does not receive an extension of $40 million loan payment from the state. Noting that the Lavin report calls for the legislature to pass two bills proposed late last year which would direct $17.5 million in excess investment alternative taxes on gaming revenues and $30 million of Atlantic City Alliance marketing funds to the city, Moody’s noted that debt service payments due on Aug. 1st and Dec. 15th may be at risk if the two bills are not “swiftly” adopted and the state does not provide a timely revenue infusion. The analysts also noted that Mr. Lavin proposed that Atlantic City delay or defer $42 million in state health and pension benefits for the year―but such a delay could require state approval: “Given the city’s cash flow projections and assuming that pension and health benefit payments are delayed or deferred, the state legislature will have only three months to adopt the two bills before the city reaches a liquidity and debt service crisis.” The three Moody musketeers added, referring to Mr. Lavin: “His potential options for long-term restructuring include potential impairment to bondholders in the form of restructuring amortization schedules and the extension of maturities. We may consider any of these events to be a default or distressed exchange…” The trio expressed concerns, in addition, with regard to the odds (no pun) for late or delinquent property taxes from casinos—an apprehension, they noted, not reflected in what they termed “already dire liquidity projections” in the Lavin report.

Keystone Municipal Fiscal Sustainability. Even as the State of New Jersey is divided and legally unclear what its role and responsibility is with regard to the fiscal fate of Atlantic City, right next door, the Keystone State’s Senate Appropriations Committee yesterday gave close consideration to issues and concerns relating to stabilizing municipal fiscal distress. Legislators wanted to know whether state economic development incentives were working; they want cost-benefit analyses; they want to understand whether and how economic development incentives are working. Referring to Pennsylvania’s Neighborhood Improvement Zone program, State Rep. David Argall (R-Berks/Schuylkill) told the state’s acting Department of Community and Economic Development (DCED) Secretary Dennis Davin, referring to the program which was designed to help revive Allentown: “I haven’t seen that kind of revitalization in a community since Berlin Wall came down…but you don’t sound like you’re a fan.” Sec. Davin responded noted: “My only response was, essentially, based on…the Governor’s proposal and different look at tax structure, perhaps there will be a time when it might not be necessary,” adding that he has the same views with regard to the Community Revitalization Zone program. The Secretary noted his department is slated to receive funding restored to levels of two years ago for its Keystone Communities economic development programs, and intends to partner with universities to encourage research and training for the manufacturing sector. A different kind, but mayhap greater concern was expressed with the purported $8 billion municipal public pension debt, with Sen. Randy Vulakovich warning: “They (Pa. municipalities) are never going to get out of it. We’re going to have to do to bring something together on the state level.” Sen. Vulakovich subsequently elaborated, stating he thinks the state should force severely distressed pension funds (those with less than half costs projected for retirees and retirement payments to working public employees, once retired) into the Pennsylvania Municipal Retirement System (PMRS). PMRS manages about 600 of the state’s approximately 2,000 local pension funds; the remainder deposit their funds with private firms, an appointed board, or both. The state also provides aid to distressed local pensions, basically offsetting the required minimum amount the municipality (as employer) must pay into the pension fund in any given year. The fiscal dilemma comes as DCED has another $1 million this fiscal year for its early intervention program―less than half a percent of DCED’s total allotment of the state’s general fund budget, yet sufficient to boost funding for early intervention by 50 percent: the intervention program attempts to help cash-strapped local governments avoid a full-blow fiscal crisis. DCED’s most able Local Government Center Executive Director Fred Reddig reports the extra funding will let the state help more municipalities—help which could prove increasingly critical given the local pension situation. This comes, moreover, as Mr. Reddig is charged with realigning the state’s Act 47 program (the next step in state intervention), which, under changes enacted last year, now limits cities to five years, before a municipality may be dissolved.

Citizens’ Great Stakes in Municipal Bankruptcy

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February 26, 2014
Visit the project blog: The Municipal Sustainability Project

Blueprint for the Motor City’s Future. The newly retired judicial architect of Detroit’s fiscal future, Judge Steven Rhodes—honored yesterday in the Motor City along with his colleague, U.S. Chief District Court Judge Gerald Rosen and former emergency manager Kevyn Orr―noted: “The residents of the city had a great stake in the outcome of the case, a personal stake, each and every one of them…This is something that we in the bankruptcy court are totally unfamiliar with.” Judge Rhodes also cited another key element or outcome of the historic case, noting that, at his urging, Detroit’s bankruptcy reorganization spurred an agreement between city and suburban leaders to regionalize the governance of Detroit’s water and sewerage department (of which one component remains unfinished): “We have to find a way to build upon the momentum for regional cooperation …I think that is essential to the ultimate success of the city, and the region and the state.” Judge Rhodes, without his electric rhythm guitar, nevertheless made clear he was “very optimistic and enthusiastic about the city’s future: All of the ingredients for success are there. The balance sheet has been fixed.” Judge Rhodes, as well as his two colleagues, also discussed their concerns and shared thoughts about the broader topic of fiscal sustainability, with Judge Rhodes noting he remains “deeply concerned” ― in the wake of his experience in the Motor City approving reductions in pensions and health insurance for more than 32,000 Detroit retirees ― about the unfunded pension liabilities of other cities, suggesting Detroit and other cities need to consider moving away from costly pension plans and transition employees towards 401(k)-style defined contribution retirement plans. Judge Rhodes cited publicized estimates that cities and counties have unfunded pension liabilities ranging between $1 trillion and $4 trillion: “It flies largely under the radar and it doesn’t get a lot of attention and it doesn’t get a lot of management, and I’m deeply concerned about that…Because that’s money cities don’t have that they have promised to their retirees, and I think that solution across the country, and including in Detroit, has to be at some point defined contribution (plans).” The retired bankruptcy judge’s remarks, which drew protests outside the event, reflected on the Motor City’s federally approved plan of debt adjustment, under which non-uniform retirees will receive reductions of a minimum of 4.5 percent, while police officers and firefighters realized reduced COLAs―with the reduced benefits scheduled to begin showing up in retirees’ pension checks in March. The plan of adjustment does retain a hybrid pension plan under which new employees contribute more to their retirement.

Judge Rhodes suggested Detroit missed a chance to exit the traditional defined benefit pension business altogether—a reflection with which Mr. Orr did not concur. Mr. Orr, asked whether it was a missed opportunity for the city, said: “I don’t think so…Our general services pensions are modest, $19,400 (per person) on average.” (Police and firefighters receive pensions that average about $25,000 a year, but they are not eligible to collect Social Security like other retirees.) Under its plan of adjustment, as approved by the federal bankruptcy court, Detroit was able to reduce its $3.13 billion unfunded pension liability by 54 percent to $1.45 billion through reduced benefits and the 20-year “grand bargain” infusion of $816 million in contributions from state taxpayers, private foundations, and donors of the Detroit Institute of Arts donors. The approved plan provided for significantly greater savings through its profound cuts in promised retiree health insurance benefits―from $4.3 billion to $450 million.

Taking Final Stock in Stockton. “We have spent the last several weeks finalizing dozens of complicated legal and real estate documents and making preparations for thousands of checks that must be issued for the effective date…The stigma of bankruptcy is lifted and we can move our city forward toward recovery,” Stockton City Manager Kurt Wilson said yesterday, as the California city formally exited municipal bankruptcy—nearly one thousand days after filing for federal bankruptcy protection in July of 2012. Stockton’s route to exiting municipal was profoundly different than Detroit’s, as there was no state takeover; rather the elected leaders, as in Jefferson County, Alabama’s municipal bankruptcy, remained in charge and accountable to the citizens throughout the process—and, as in Alabama—despite, rather than with any assistance—such as was provided to Detroit and Central Falls from their respective states. U.S. Bankruptcy Judge Christopher Klein had lifted the stay preventing Stockton from exiting bankruptcy last month on January 20th, saying during a hearing that Franklin Templeton was not likely to win on its appeal of his decision. Manager Wilson said Stockton has developed a long-range financial plan for the duration of the agreements in its approved plan of debt adjustment, some of which extend out to as far as 2053. Thus, today marks a successful $2 billion municipal financial restructuring. Mr. Wilson and the city’s legal team will be in Judge Klein’s courtroom today for what is expected to be a routine conference updating the status of Stockton’s case, noting that the work in the city over the past three weeks to put the city’s plan of debt adjustment approved by Judge Klein into effect has been “heroic,” adding it has involved dozens of people, “not only people working on behalf of the city, but also people working on behalf of creditors. These are incredibly complicated transactions, and we were doing all of them and trying to get them completed on the same day.” Mr. Wilson said Stockton gave top priority to the 1,100 retirees who gave up some $544 million in lifetime medical benefits as their part or contribution in helping Stockton put together its plan of debt adjustment—with the final agreement providing the retirees a $5.1 million payout instead. Checks were mailed to retirees at the beginning of the week, with Mr. Wilson noting: “We’ve heard very clearly from some retirees that every day of delay has been a hardship…We made those a priority over everything else. They are ahead of everybody else.” Nevertheless, the city’s long municipal bankruptcy still will have another chapter: Franklin Templeton, the financial behemoth which had lent Stockton $36 million for a variety of projects in 2009, but which will receive only $4 million under the city’s approved plan of debt adjustment, is appealing Judge Klein’s decision to the 9th U.S. Circuit Court of Appeals—albeit, the appeal will not affect Stockton’s implementation of its restructuring plan. Mr. Wilson did note that few will discern any bright line etched in the sand of the precise moment in time when Stockton becomes a formerly bankrupt city; nevertheless, he remarked, it is a significant milestone: “We understand we’ll be under the microscope for every financial transaction we make for the next few decades…You’d be hard-pressed to find another city that has a handle on its finances going forward the way we do.” He added that it will be incumbent upon the city to make difficult spending choices going forward, even to deny increasing expenditures on universally popular services if those financial outlays do not fall within Stockton’s long-range economic projections: “In the past, the city sometimes made financial decisions based upon how worthy a cause was…The city used to make decisions where if something was worthy, just do it. We’re no longer in a position to just do it…We have to either make it fit into our model or reduce some other expenditure to get there. That will be difficult for people who say, ‘Hey, we’re out of bankruptcy.’ The reality is, where we were before bankruptcy was an unstable place.”

Hard Choices. San Bernardino, unlike Detroit, has no state-appointed emergency manager to make hard choices about the city’s difficult road to bankruptcy recovery—nor can it count on any assistance from the state. Nevertheless, it does appear that City Manager Allen Parker’s team might have the fiscally stressed city on the verge of a significant turnaround―a turnaround that marks a signal change in fiscal direction critical to the city’s hopes of completing and submitting its plan of debt adjustment to the federal bankruptcy court in three months—and to the city’s future sustainability. As Mr. Parker notes: “We stopped the bleeding…Revenue just exceeded — just by a bit — what we projected, and we were able to contain costs, so we’re on schedule to finish the year in the black.” Thus, the San Bernardino City Council has unanimously approved adjustments to the city’s budget—adjustments which are projected to actually provide for a small surplus, in part made possible by the politically difficult choice to shut three of the city’s five pools to the public this summer. However, as Assistant City Manager Nita McKay notes, even with the hard choices, the city’s successful efforts to balance its budget is different than in a normal, municipal budget process, because it relies upon the city’s chapter 9 filing as a key protection to prevent creditors from suing the city for money owed to them: “It is important to note that the city’s balanced General Fund budget for the fiscal year is made possible because the city is under the protection umbrella of Chapter 9 bankruptcy.” Moreover, City Manager Allen Parker warned there is as much as $15 million the city “hasn’t figured out how to pay yet.” With the ever-approaching May 30th deadline for the city to file its plan of debt adjustment with U.S. Bankruptcy Judge Meredith Jury, the city reports its sales and use tax revenue is expected to continue to climb to the highest level since 2006-07, which, along with property tax and administrative civil penalty revenue increases, are projected to provide the city $1.3 million toward $2.8 million in expenditure increases—leaving a surplus of about $113,000, with no reserves, according to budget documents. San Bernardino lists $5.2 million in “salary savings,” or money budgeted for positions that are now vacant. It is now trying to fill some of those positions, particularly police and firefighters, Ms. McKay said. Nevertheless, San Bernardino confronts significant budget burdens, including some $2 million for increased firefighter overtime, unanticipated, because, according to Mr. Parker, there was a three month delay before cuts to the Fire Department that were supposed to take effect last July 1st actually became effective. The city also approved general fund increases of $600,000 for 36 new police vehicles, $190,000 in part-time hours for the Parks and Recreation Department, $25,000 for Code Enforcement and $12,000 for the city treasurer’s office. The Council rejected, 4-3, a motion to add $60,000 to keep the other three pools open—notwithstanding a councilmember’s argument that these pools are the type of quality-of-life issues residents depend on a city for and that attract businesses, with Councilmember Valdivia noting the affected pools would be in minority areas. But, in rejecting the motion and noting the chapter 9 hanging over their heads, Councilman Fred Shorett responded that while a good argument could be made to keep pools open, and to reverse any of a number of cuts to “sacred cows” the city has made during bankruptcy; San Bernardino needed to put money toward paying deferred costs and emerging successfully from bankruptcy, adding: “I can balance my budget, too, if I don’t pay my cable bill or my gas bill or my electric bill.” In a sobering note, Councilmember Valdivia had requested staff to provide his colleagues with a summary of the municipal bankruptcy costs the city has accumulated since it filed for federal protection nearly three years ago: more than $9.3 million. Without those bankruptcy-related services, the city would have to pay significantly more than $9 million as creditors came after it, said Parker and City Attorney Gary Saenz.

The Ineluctable Challenge of Weighing a City’s Past Versus its Future

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February 20, 2014
Visit the project blog: The Municipal Sustainability Project

Electronic Musical Chords. Nathan Bomey of the Detroit Free Press yesterday did a terrific interview with U.S. Bankruptcy Judge Steven Rhodes, with Judge Rhodes telling him he never believed the City of Detroit had to choose between paying its creditors or reinvesting in services. Judge Rhodes noted that cuts to Detroit’s pensioners and bondholders were necessary, but said that without a feasible plan to place the city on a financially sustainable path, retirees and financial creditors would have fared worse down the road, so, he said: “[T]he goals of satisfying the interests of creditors and satisfying the interests of the residents in my view were never in conflict…In fact, they were symbiotic. In order for creditors to be repaid, there had to be a vital city:” Please note I have taken the liberty of highlighting some of Judge Rhodes’ responses, as they seem especially insightful.

QUESTION: Do you think Detroit’s collapse was an isolated incident or does it portend a broader crisis of some sort?
ANSWER: It was in some senses unique to Detroit and in some senses a part of a national phenomenon. The part that’s national is the economic factor of it, the decline of manufacturing generally in this country and the migration of what manufacturing remains really out of the Rust Belt.
Q: And our unique amount of mismanagement and perhaps even corruption?
A: We did have obviously one corrupt mayor. It’s hard for me to judge how much of the city’s issues are directly attributable to that.
Q: You chose Judge Rosen to be your mediator. What was the reasoning behind that?
A: I was convinced of the importance of mediation and a mediated and negotiated settlement to the prompt disposition of the case. And I also felt that the prompt disposition of the case was essential to the city’s revitalization.
So I felt it was necessary to appoint the strongest possible mediator that I could. And I felt that Chief Judge Rosen had all of the necessary qualities. Weight of office. Weight of personality. Commitment to the city. Personal and professional contacts. Political contacts. He was the right person.
Q: Early on you set a really expeditious pace for the case.
A: I didn’t really perceive of it as expeditious. I perceived of it as what was necessary given the circumstances of the case.
Q: Is it accurate to say that you prioritized the health and welfare of the people of Detroit over the repayment of creditors?
A: Everyone in the state had a personal stake in the outcome of the case. Even more specifically, in order for any plan to be feasible, the city had to develop a plan by which it could deliver municipal services adequately.
So the goals of satisfying the interests of creditors and satisfying the interests of the residents in my view were never in conflict. In fact, they were symbiotic. In order for creditors to be repaid, there had to be a vital city.
Q: By the time Detroit filed for bankruptcy, were pension cuts inevitable?
A: Inevitable’s a pretty strong word. I would say very highly likely.
Q: People blamed Kevyn Orr and perhaps even you for cutting pensions. But in reality, the promises to pay those pensions had been broken many years ago.
A: The city did not have the resources in its pension plans to fulfill its obligations to pensioners. There really never was much dispute about that.
Q: But from a legal perspective it wasn’t a difficult call for you?
A: That’s true. We in bankruptcy impair contracts all day, every day. That is what we do.
Q: No municipal bankruptcy judge had had to decide that question or been willing to decide that question. Was there hesitancy that you’re going to be the first?
A: There was always going to be lots of groundbreaking in the Detroit case. It is certainly true that there was not a lot — or sometimes even any — precedent for the legal decisions I had to make.
Q: Former Mayor Kwame Kilpatrick’s $1.4 billion debt deal, executed in 2005 and 2006, was a disaster for the city. Was it the point of no return financially?
A: Yes. I have said the city should have filed for bankruptcy then and perhaps even before then.
Q: The governor has said he was always representing each individual person in Detroit. Was democracy suspended in Detroit?
A: The people lost the ability to have the direct impact that they have when there’s a mayor and a City Council in charge when the emergency manager was appointed. That’s a taking away of democracy to that extent.
Q: But you never felt that the law was unconstitutional obviously.
A: I did not. And really, primarily for the reasons that Gov. Snyder identifies. The democratically elected Legislature passed this law. The governor signed it. The city is an arm of the state. And it is always subject to state law.
Q: One of the most surprising moments of the bankruptcy was when you killed the second swaps settlement. There was a gasp in the courtroom. Did you hear it?
A: I can’t say that I did. But I was not surprised that they were surprised.
Q: Your relationship with Detroit emergency manager Kevyn Orr seemed complicated. At times you chided him. But also you’ve praised the job that he did. What is his legacy in Detroit?
A: I hope his legacy is that he took on an enormous and some might say impossible challenge and met that challenge with grace, dignity, professionalism, and proficiency. Of all of us who were challenged by Detroit’s insolvency, he had the most challenging and difficult job of all.
Q: How much credit does Gov. Snyder get for authorizing the bankruptcy?
A: A lot of people maintain that it was a very courageous thing for him to do and that it was something his predecessors were not willing to do and did not do. From an economic or fiscal perspective, it doesn’t seem to me it was a very hard decision. As I’ve said, it should have been made a long time ago. Politically, on the other hand, I’m sure it was hard for him.
Q: When did you first hear about the concept of the grand bargain?
A: I remember Judge Rosen sketching it out for me in the broadest details after he had the parties on board in concept, but I’m not sure I can tell you precisely when that was.
Q: Mr. Orr has said he was skeptical at the beginning. Some people withheld judgment. What was your initial reaction? Did you think it was doable?
A: I had no basis to judge that other than the optimism that Judge Rosen was exuding. He was optimistic about it from the beginning, and so was I.
Q: It’s well established at this point that cities cannot be forced to sell assets in municipal bankruptcy.
A: Yes, that’s true.
Q: What would have happened had Kevyn Orr decided selling DIA property was necessary?
A: I would have needed to be persuaded.
Q: Because you said in your opinion the DIA and the attorney general would be more likely to prevail if there was to be an argument over this in court.
A: Not only was I persuaded of that, I was also persuaded of the necessity of maintaining the DIA and the art in the DIA intact to assist in the city’s revitalization.
Q: There were many who said we should prioritize pensions or services over keeping an admittedly wonderful art collection. How did you balance that from a philosophical and judicial perspective?
A: I understood that perfectly well. But here’s the thing about bankruptcy. Bankruptcy requires shared sacrifice. And the deeper truth than that immediate one that they were trying to express is simply this: Without a revitalized city, any pension promises that the city might make would be impaired.
A revitalized city was essential to any long-term promises that the city might make to any creditor, including the pensioners.
Q: Were there nights where you thought, I am going to have to cram down something here?
A: Oh yeah. I believed that until the last creditor settlement. Until FGIC and Syncora settled — those were the last two — I assumed and believed that they would not settle and that I would have to consider the city’s request to cram down the plan over their objections.
Q: Syncora in particular waged an extremely aggressive campaign against the city. At one point you even told both sides to stop using war analogies because it had gotten so intense. What did you make of their strategy?
A: They argued zealously, but they always did it with civility. And their arguments were well argued, well structured, well organized, well presented. They were really good lawyers. So I had no problems with the zealousness with which they advocated their position.
Q: Of course at the end of the case, when they attacked the ethics of the mediators, you were extremely upset.
A: I was. I felt that was totally unjustified. And I struck it, and I was prepared to consider sanctions until they apologized for it.
Q: How close did you come to sanctions?
A: Well, I would have been interested in what they had to say on why they shouldn’t have been sanctioned. But I felt like sanctions should be given very serious considerations and not minor sanctions either.
Q: How taxing was this case for you personally?
A: There were obviously times when it was extremely taxing for me personally. It was, for stretches and sometimes long stretches, very intense.
Q: We were all at news conferences where Judge Rosen was present and in some ways he was much more visible as a mediator than a lot of people expected. Were you worried about that at all?
A: Judge Rosen is a political animal in a way that I totally am not. So I had complete faith and trust in his political judgments as to what he felt he needed to do to fulfill his obligations as a mediator.
When I appointed him and he agreed to be appointed, I told him that his deliverable to me was a confirmable plan of adjustment in this case and he delivered that.
Q: How much did you coordinate with Judge Rosen during the case and how much did you know about what was happening in mediation?
A: At the beginning of the case, we agreed on two basic principles. The first was, I would keep pedal to the metal in litigation, and he would keep pedal to the metal in mediation, and we would run them in parallel with one important exception. If he recommended to me that I let off on the gas and apply the brakes to litigation, I would do that. I would follow his recommendation when he thought that would facilitate settlement.
There were also times when he thought it would facilitate mediation for me to advance litigation and to hold a hearing and to ask the hard questions of the lawyers to get them to realize what the strengths and weaknesses of their case were. I would do that.
Q: Did the city need $1,000-per-hour attorneys to run this case?
A: The question is for me whether their fees were reasonable or not and I’ve made my judgment about that.
Q: They could have made more money elsewhere, right?
A: I assume. The rates that they charged were in some senses for them below market rates because they did discount the ultimate fee that they charged to the city in many different ways. The city’s lawyers brought to the case an expertise that is very rare in this country.
Q: Did you believe that the city needed to account for the DIA’s value in some capacity in the plan? Could the city have executed a plan of adjustment without someone accounting for the value of the museum?
A: It did. The plan we have takes no account of the value of the art. So the answer to that question is yes. It gets back to the fact that what the city does with its property is entirely its own decision and not one that the bankruptcy court can exercise any control over whatsoever.
Q: Then the natural question is, was there a false crisis in the sense that the DIA was never really in trouble?
A: Well, the question you’re raising really is at what point in the process from beginning to end could or should that issue have been resolved.
If I had decided early in the case and teed up the issue of whether the art was in play or not, would we have gotten $816 million in a grand bargain? I’m not sure about that.

The Motor City’s Future. Michigan Governor Rick Snyder is considering options for the state to provide debt relief for the cash-strapped Detroit Public Schools (DPS)—a system with an estimated $55 million annual cost to finance its accumulating debt. Governor Snyder has proposed a $75 million distressed schools fund as part of his 2016 executive budget as part of a plan to help financially struggling school districts across the state, telling the legislature: “We are still evolving in terms of the best way to implement the entire program, but there are districts that need substantial readjustments in terms of their finances…I’d like to start establishing a reserve fund for financial resources to do the restructurings…I don’t view this is a bailout, but only where we’re truly solving problems in the long term.” Such a fund would be designed to help DPS cover debt payments, or shifting shift DPS into a new district, with the remaining bonds being serviced with an outstanding levy. The Governor’s strategy director, John Walsh, however, told the Detroit News: We’re not talking about [municipal] bankruptcy — the governor has been very clear about that…We have to find a method that will recognize that they can’t bear the weight [of their debt].” Because the school system is not part of Detroit’s budget, its financial distress was not addressed in the Motor City’s plan of debt adjustment—nor was it part of the so-called “Grand Bargain,” they magic elixir to the city’s obtaining U.S. Bankruptcy Judge Steven Rhodes’ blessing of its largest in U.S. history municipal bankruptcy exit plan. Nevertheless, it is difficult to imagine a more critical criterion to the Motor City’s future than the recovery and financial and educational stability and competence of its school system. It will be key not only to any hope of reversing the unprecedented decline of the city’s population, but also to its future. In Detroit, the challenge is especially daunting: according to the Ann E. Casey Foundation KidsCount report, Detroit continues to have more children living in extreme poverty than any of the nation’s 50 largest cities: More than 59 percent of Detroit children lived in poverty in 2012, the most recent year for which data is available—an increase of 34 percent since 2006. It is, in some ways, a microcosm of the state, where one in four children live in extreme poverty, according to the report—itself an increase of 35 percent over six years, to nearly 25 percent―a devastating percentage which some attribute to steep cuts to social services. The other side of such decreases, one may observe, imposes a double whammy: huge increases in burdens on the City of Detroit―reports of child abuse and neglect increased 77 percent in Detroit from 2008-12, with about 15 percent of Detroit children living in homes that have been investigated by child protection workers: confirmed neglect or abuse increased 40 percent. The death rate for young people ages 1-19 increased 14 percent between 2004 and 2012, mostly because of increased homicide and suicide among teenagers―and a devastating and discouraging message to families with children that might be considering moving to Detroit. Fortunately, the Casey Foundation report showed improvements in some measures of well-being:
• The number of children in out-of-home care decreased 71 percent in Detroit, and 33 percent statewide.
• Births to teens aged 15-19 decreased 13 percent in Detroit, and 16 percent across the state.
• The number of fourth-graders scoring “not proficient” in reading declined 24 percent in Michigan, and 16 percent in Detroit, from the 2008-09 school year to the 2013-14 school year.
The Motor City’s public school system carries roughly $2.1 billion of debt, of which approximately 75% is unlimited-tax general obligation bonds secured by Michigan’s School Bond Qualification and Loan Program. Another $325 million is long-term state aid revenue bonds, secured by an intercept feature on state aid; and $108 million is in the form of loans from the Michigan School Loan Revolving Fund, according to Moody’s Investors Service. In 2013, fixed costs, including debt service and retirement costs, made up 35% of operating revenue and were expected to grow at least 3% or more in fiscal 2015, according to Moody’s, which maintains junk ratings and a negative outlook on the district. The Detroit School District faces a $170 million deficit in fiscal 2015.

Don’t Rush to Bankruptcy Judgment. A week after pushing Detroit neighbor Wayne County, Mich. to junk territory, credit rating agency Standard & Poor’s analyst Jane Ridley yesterday wrote it is premature to “start treating Detroit’s neighboring municipality as if it were about to file for municipal bankruptcy: As we recently saw in Detroit, bankruptcy is a significant issue, with serious potential repercussions for bondholders. We take very seriously any possibility of bankruptcy, but we don’t want to rush to judgment before letting the process to take its course.” Nevertheless, Ms. Ridley wrote S&P could change its view of the likelihood of municipal bankruptcy if Michigan were to appoint an emergency manager, based upon the experience of the accelerated transition from Gov. Snyder’s appointment of Kevyn Orr to Detroit’s filing for federal bankruptcy protection…if past is prologue: “While many consider it a positive step to bring in a third party who has powers to make changes, such as the Emergency Manager option, given Detroit’s recent experience and very rapid move to bankruptcy, our view on the county’s trajectory could well change with the appointment of an emergency manager.” Last Friday S&P downgraded Wayne to BB-plus from BBB-minus, with a negative outlook―costing the county its final investment-grade rating; Moody’s moodily had at the beginning of the week dropped the county three notches to junk. The respective downgrades came in the wake of newly elected County Executive Warren Evans’ warnings when he took office last month that Wayne County is on a trajectory to run out of cash by August 2016 and that municipal bankruptcy or state takeover are on the table without major financial fixes.

Tense Futures & Pasts. For every municipality in severe fiscal distress, the challenge between the past and the future—between public pension obligations versus capital investment for a sustainable future can best be described as a nightmare. For instance, in Stockton, as U.S. Bankruptcy Judge Christopher Klein opined, notwithstanding the Golden State constitution, the federal chapter 9 municipal bankruptcy law trumps the state constitution protection of public pension contracts. So there was a legal basis—as there is, with, presumably, U.S. Bankruptcy Judge Meredith Jury’s acquiescence―but there is a harsher reality. Not only are there unique attributes to California’s CalPERS public retirement system vis-à-vis municipalities, so that, for instance, had Stockton, in its proposed plan of debt adjustment, opted to include reductions in pensions; CalPERS would have cut pensions a little more than half for current retirees and employees in order to avoid having other California municipalities being forced to subsidize Stockton: CalPERS had no authority under state law to cut by a lesser percentage. Even as it was—and is in San Bernardino, which faces a similar quandary with regard to its public pension obligations to CalPERS—any action to cut pensions would likely have rendered Stockton far less competitive in its ability to attract qualified recruits to its public safety departments—a critical factor for cities in distress which, more often than not appear to have disproportionate rates of violent crime—a vital issue to address in any plan of adjustment or municipal bankruptcy recovery plan. So, for example, San Bernardino ranks as a city with one of the highest violent crime rates in California, should the city, as part of its developing plan of adjustment, opt to impair its CalPERS contract, technically employees would have 6 months to find another CalPERS job (state law)—under California law such individuals would be deemed “legacy” or “classic” employees: that would enable their retention of their current pension formulas with their new employer; however, if they were unable to find another job until after 6 months, they would then be deemed a “new” employee in CalPERS and take a significantly reduced pension benefit. This complex state-local dilemma narrows—an understatement—a California city’s options. In San Bernardino, the city had already lost 100 police officers due to compensation reforms prior to its filing for municipal bankruptcy protection—even though, on too many days, the city has been in Code Blue―that is, only responding to crimes in progress. It is, thus, nearly impossible to contemplate what would the impact on the city’s public safety would be were it to propose—as part of its plan of debt adjustment due in May to Judge Jury—adjustments in its public pension obligations. Would the city risk losing another 100-150 police officers? What would be the chances of the city to attract highly qualified replacements? What might be the impact on families—either those weighing whether to stay—or, much less, those who might be considering moving to San Bernardino? This is part of the intractable imbalance in municipal bankruptcy between a city’s obligations to its municipal bondholder creditors—vital capital, after all, and its employees and retirees: to its most critical goal in putting together its plan of debt adjustment: to transition back to service solvency. But as one reader aptly notes: “creditors don’t care about this fact and don’t understand it…the need, for a municipality, to be a viable employer is critical to ensuring service solvency.” That can be especially true in the Golden State, where, currently, it takes 100 applicants to get a single police officer.

Unappealing Options. Jefferson County, Alabama Commissioner George Bowman and several litigants who filed an appeal of the decision approving the county’s municipal bankruptcy plan of debt adjustment on behalf of ratepayers on the county’s sewer system yesterday wrote Alabama Gov. Robert Bentley and Attorney General Luther Strange requesting they intervene in the appeal of Jefferson County’s municipal bankruptcy case, writing that the Governor and Attorney General should “do their job to protect the public interest by joining in the existing appeal.” Commissioner Bowman said they hope to meet with Governor Bentley and the AG to discuss a number of issues raised in the appeal, including their apprehensions with regard to the plan’s proviso that the federal court oversee implementation of the plan — and sewer system rate increases — for the next 40 years. The appeal promises to add to the hefty price tag for Jefferson County taxpayers: Jefferson County has already expended close to $30 million for its bankruptcy—a price that is certain to veer upward with the appeal. In their appeal, the litigants claim the federal oversight violates Alabama’s rights in violation of the U.S. Constitution. Commissioner Bowman opposed the County’s decision to file for municipal bankruptcy protection in 2011; he also voted against the county’s plan of adjustment or exit plan which U.S. Bankruptcy Judge Thomas Bennett approved a year ago last December—a plan which authorized Jefferson County to issue $1.8 billion of sewer refunding warrants to write down the county’s debt, and exit what was, at the time, the largest municipal bankruptcy in U.S. history. Commissioner Bowman complains that the federally approved plan of adjustment burdens some of Jefferson County’s poorest citizens with 40 years of sewer system rate increases which he believes they will be unable to afford, warning that over the next forty years rates will increase 471% to service the sewer refunding warrants that have been issued. U.S. District Judge Sharon Blackburn has previously rejected the claim by Jefferson County that because the plan of debt adjustment has already been implemented the appeal is moot; Judge Blackburn made clear she has discretion to overturn various provisions in the plan of adjustment—both issues on which Jefferson County has appealed to the 11th U.S. Circuit Court of Appeals.

Underwater in Puerto Rico. Moody’s has downgraded Puerto Rico’s general obligation rating to Caa1 from B2, reporting that the territory’s anemic growth is harming tax revenues—imperiling the Commonwealth’s liquidity. The gloomy, if moody assessment comes as the U.S. House Judiciary Subcommittee on Regulatory Reform, Commercial and Antitrust law readies its hearing next Thursday on draft federal legislation to allow Puerto Rico government-owned corporations to restructure their debts under Chapter 9 municipal bankruptcy. The hearing comes amid increasing apprehension that the Twilight Zone for U.S. territories—which are neither states nor municipalities—leaves them no options for bankruptcy protection—unlike every other corporation in the U.S. The Commonwealth of Puerto Rico has said that while it supports amending Chapter 9, it fears that waiting for Congress to act could be like waiting for Godot. Moody’s downgrade now drops the island lower than S&P’s and Fitch’s most recent reassessments. Moody’s Caa is used for state and local bonds in “poor standing and subject to very high credit risk.” Moody’s analysts Ted Hampton and Emily Raimes wrote in yesterday’s report that tax revenue shortfalls, because of sluggish economic growth, may harm the Commonwealth’s liquidity; they noted that General Fund revenues have been coming in 2.5% below projections through the first 7 months of the fiscal year: “In view of still anemic economic trends, the revenue gap could widen after April income tax payments…Puerto Rico’s Economic Activity Index as of December was down 1.4% on a year-over-year basis.” The dynamic duo also noted apprehension about Puerto Rico’s ability to issue new debt to would shore up liquidity, adding that Puerto Rico anticipates a 35% increase in debt service in FY 2016―even more daunting will be the subsequent years as rising debt service requirements impose an ever increasing burden―noting that the Commonwealth’s debt burden is high compared with U.S. states: Puerto Rico’s adjusted net pension liability was 223% of revenues compared with a U.S. state median of 60% of revenues: “Downgrades of some ratings to Caa2, a notch below the commonwealth’s GO rating, reflect the vulnerability of pledged revenues to a constitutional provision that provides a claim in favor of general obligation bondholders.”

A Musical Lessons Learned from Municipal Fiscal Distress

eBlog

February 19, 2014
Visit the project blog: The Municipal Sustainability Project

Electronic Musical Chords. U.S. Bankruptcy Judge Steven Rhodes, the rhythm guitar-playing member of the Indubitable Equivalents who oversaw the largest municipal bankruptcy in U.S. history in Detroit, completed his judicial—but not musical—career yesterday with some reflections on lessons learned from the historic case. Speaking on Detroit’s WDET “Detroit Today” show, Judge Rhodes reflected on a concern that U.S. Bankruptcy Judge Thomas Bennett, who oversaw the Jefferson County municipal bankruptcy, has mentioned: what is the role for a citizen and taxpayer of a city or county going through municipal bankruptcy? In the interview, Judge Rhodes said he invited citizens to speak in his courtroom on multiple occasions during the case, because he wanted to hear their input: “It wasn’t just show. It wasn’t just me trying to persuade people that I’m fair…I have to say that from a legal perspective, it was not a particularly difficult decision…I was genuinely interested in what their concerns were and how I could possibly deal with them, if I could. So that was important to me.”

With regard to one of the most profound issues that arise in these historic cases—a city or county’s future fiscal sustainability versus its past obligations—Judge Rhodes remarked it was an easy legal decision to authorize pension reductions in Detroit’s bankruptcy, even though he still felt compassion for the Motor City’s retirees and citizens who suffered because of the city’s financial collapse and water shutoffs. Nevertheless, the electric rhythm guitar-playing judge affirmed that his groundbreaking ruling last December 3rd to give then Detroit emergency manager Kevyn Orr the authority to reduce the city’s pension obligations was prudent—notwithstanding Michigan’s Constitution, which describes public pensions as a contractual obligation that cannot be cut—an issue that had been primed for challenge at the 6th U.S. Court of Appeals in Cincinnati—as well as the 9th U.S. Court of Appeals in California in the parallel Stockton municipal bankruptcy case; however, neither appeal was pursued. These cases, which have pitted bondholders against public pensioners, in effect pit a city or county’s accrued liabilities against its costs for investing in its future. The greater the accrued liabilities, the higher the interest rate potential municipal bondholders will demand—in effect risking putting a city or county in a vicious cycle where its costs of long-term investment in its future economy and infrastructure are greater than other cities and counties. It risks becoming less competitive and confronting a stagnant or declining population at risk of credit downgrades.
Judge Rhodes also noted his frustration during the bankruptcy proceedings last year when Detroit began shutting off water to delinquent ratepayers, including too many people who could not afford to pay: “It weighed on me very heavily…I was concerned that the city’s response was not adequate. Now, that inadequacy, however, was not something I had any jurisdiction over and I tried to make that clear.” Nevertheless, Judge Rhodes admitted he used his powerful courtroom stage to pressure Detroit—remember, a city at the time having just—after more than a year, reverted to its own elected leaders, into altering its course. Mayor Mike Duggan assumed control of the department from Emergency Manager Orr, issued a temporary moratorium on shutoffs, and distributed information about assistance that was available to low-income citizens before resuming the shutoffs in a more targeted manner.

So Long. In his electronic swan song, as it were, Judge Rhodes said he had been “hoping” the news media would file an official motion seeking to broadcast live audio of court hearings in the historic municipal bankruptcy, but it never happened; he also noted the path-breaking role played by the chief mediator he had appointed, U.S. Judge Gerald Rosen, whose now famous cocktail napkin diagram became the grand bargain that connected the dots between the Detroit Institute of Arts, reduced public pension cuts, bipartisan leadership by Governor Rick Snyder and the state’s House and Senate bipartisan leaders, and non-profit foundations―the dramatic electrical key that triggered pledges of the equivalent of $816 million over 20 years to the grand bargain, and retirees approving the agreement by voting to accept cuts—or, as Judge Rhodes described it: “The work that Judge Rosen and his team did on the grand bargain was absolutely miraculous and unprecedented, not only in the history of bankruptcy but in the history of mediation, as far as I know…They went outside of their roles as mediators to go out and solicit money to solve the city’s problem. And that was enormous.” Finally, in a cautionary note, Judge Rhodes reiterated previous statements he had made that former—and now imprisoned―Mayor Kwame Kilpatrick’s $1.4 billion pension debt deal in 2005 “should have been a red flag,” because it “was structured to be an intentional evasion of the legal debt limits that municipalities are by state law required to stay within. It was too innovative. It was too creative.” That was the point in time, the Judge noted, when Detroit should have filed for bankruptcy.

The Devastating Costs of Municipal Bankruptcy. In a year which commenced with scholars Bo Zhao and David Coyne of the Boston Federal Reserve asking if U.S. state and local governments are on a fiscally sustainable path—and where we have observed, as newly retired U.S. Bankruptcy Judge Steven Rhodes does above―the difficult stresses between commitments of the past versus securing investment for the future―we now learn that he California Public Retirement System (CalPERS) has—to date—expended some $7 million in legal fees to two law firms representing the state public pension system attorneys in the Vallejo, Stockton, and San Bernardino municipal bankruptcies. Yet, as Ed Mendel, who covered the Capitol in Sacramento for nearly three decades, most recently for the San Diego Union-Tribune, wrote, the costly legal representation was ineffective, at best. U.S. Bankruptcy Judge Christopher Klein ruled that CalPERS pensions can be cut in bankruptcy. In the case of the Vallejo municipal bankruptcy, the city, in its plan of debt adjustment, did not seek to reduce its pension obligations; further south, San Bernardino has reached an agreement with CalPERS to protect public pensions. At times in the Stockton case, Judge Christopher Klein verbally jabbed the CalPERS attorney, Michael Gearin (of whom it was noted at one point that he was “bellowing and pawing the sidelines”), as if, in Mr. Mendel’s words, “he were an over-blown nuisance of questionable relevance.” Judge Klein, in his 54-page written ruling confirming Stockton’s plan of debt adjustment and successful exit from municipal bankruptcy, wrote: “As CalPERS does not guaranty payment of municipal pensions and has a connection with a municipality only if that municipality elects to contract with CalPERS to service its pensions, its standing to object to a municipal pension modification through chapter 9 (bankruptcy) appears to be lacking.” Yet, after Judge Steven Rhodes held, in approving Detroit’s plan of debt adjustment bankruptcy, that pensions can be cut; CalPERS joined unions in an appeal with the 6th U.S. Circuit Court of Appeals, arguing that CalPERS is an “arm of the state,” not a city-run plan like Detroit―thus arguing it is protected under chapter 9 municipal bankruptcy law. But in his ruling, Judge Klein held that Stockton has contracts with unions and CalPERS, finding that what he called the “third leg” of the triangle―the relationship between CalPERS and active and retired employees―is not a contract, but rather a “third-party beneficiary relationship,” adding that contrary to the widespread “myth” that CalPERS was Stockton’s largest creditor, it was rather a “small-potatoes creditor” and “pass-through conduit” only owed administrative expenses. Instead—or rather—Judge Klein noted the substantive pension debt is owed to employees and retirees, adding that nothing about state structure or procedure “necessitates” CalPERS. [Golden State law does not require that city employees have pensions: in California, municipalities may choose other pension providers: private, county, or the creation of their own system.] Nevertheless, once a city contracts with CalPERS, there can be a bear trap situation: two state laws sponsored by CalPERS, which do not apply to county or city retirement systems, make the prospect of leaving CalPERS prohibitive and especially challenging: California law bars rejection of CalPERS contracts in bankruptcy; the other state law places a lien on the property of a city that terminates its CalPERS contract in bankruptcy, second only to wages, that enforces immediate payment of future pension obligations. Moreover, on termination, CalPERS sharply escalates future pension costs by dropping its investment earnings forecast of 7.5 percent a year from a diverse portfolio to a bond-based 2.98 percent, ensuring payment, because employer-employee contributions cease. Thus, in the Stockton case, had the city—as part of its bankruptcy exit plan―sought to exit CalPERS, the debt or unfunded liability due immediately on termination of its CalPERS contract would have skyrocketed from $211 million to $1.6 billion—an amount Judge Klein likened to a “poison pill―” if the city tried to move to another pension provider. Nevertheless, in his oral and written opinions, Judge Klein held that the threat of a CalPERS termination lien forcing a $1.6 billion payment was a “toothless tiger” in a chapter 9 municipal bankruptcy, finding that the CalPERS lien is unenforceable in municipal bankruptcy, because the federal law “authorizes the avoidance of liens that are not perfected or enforceable at the time of the commencement of the case.” Judge Klein wrote that states cannot modify federal law, citing a Texas law allowing a school bankruptcy if state bonds were protected, which was overturned by the courts. Another “myth,” Judge Klein noted, is that because the Stockton plan to cut debt and exit bankruptcy leaves pensions intact, employees and retirees are “not sharing the pain” with bondholders. In addition to pay cuts, however, Stockton replaced its retiree health benefits valued at $545 million with a $5 million lump sum payment.
Stockton negotiated approval of its debt-cutting plan with all of its unions and its largest bondholders. A lone holdout, Franklin, received $4.35 million (the value of its weak collateral: two golf courses) for $36 million in bonds, a return of 12 percent. Franklin, planning an appeal, contended the Stockton plan’s failure to cut the municipality’s largest debt, pensions, is unfair and not proposed in “good faith.” Bondholders filed a similar objection to San Bernardino’s agreement with CalPERS to avoid pension cuts. Indeed, the situation in San Bernardino has previously caused greater headaches for CalPERS. San Bernardino had filed an emergency bankruptcy, which the city had claimed was urgent to keep making payroll, and subsequently took the unprecedented step of stopping payments to CalPERS for the rest of the fiscal year. After resuming regular CalPERS payments, however, San Bernardino is seeking to catch up on its skipped payments, some $13.5 million plus fees and interest—something which must be addressed by its approaching Memorial Day deadline set by U.S. Bankruptcy Judge Meredith Jury for the city to propose its plan of debt adjustment. In San Bernardino’s case, the stoppage of payments to CalPERS gave the state agency grounds to terminate its San Bernardino contract; yet that might have resulted in pension cuts, something CalPERS is battling to avoid in the municipal bankruptcies―a state, after all—which now leads the nation in the category.

Federalism Writ Large by U.S. Bankruptcy Judge Christopher Klein & Neighboring Fiscal Trouble in Wayne County Could Implicate Detroit’s Recovery

Taking Stock in Stockton. U.S. Bankruptcy Judge Christopher Klein, in resolving the “the single objection to confirmation of the chapter 9 plan of adjustment of debts by the City of Stockton,” wrote that it “necessitates answering the threshold question whether, as a matter of law, pension contracts entered into by the City, including the pension administration contract, may be rejected pursuant to Bankruptcy Code § 365. 11 U.S.C. § 365.” Finding that in the affirmative, Judge Klein came to what he termed the main question: “whether, as matters of law and fact, the City’s chapter 9 plan should be confirmed even though the plan does not directly impair the City-sponsored pensions.” Even though, in its confirmed plan of debt adjustment, Stockton did not seek to impair its obligations to the California Public Employees’ Retirement System (CalPERS), Judge Klein—writing that “Ca1PERS has bullied its way about in this case with an iron fist insisting that it and the municipal pensions it services are inviolable. The bully may have an iron fist, but it also turns out to have a glass jaw. This decision determines that the obstacles interposed by Ca1PERS are not effective in bankruptcy. First, the California statute forbidding rejection of a contract with Ca1PERS in a chapter 9 case is constitutionally infirm in the face of the exclusive power of Congress to enact uniform laws on the subject of bankruptcy under Article I, Section 8, of the U.S. Constitution – the essence of which laws is the impairment of contracts – and of the Supremacy Clause. U.S. CONST. art. I, § 8 & art. VI. Second, the $1.6 billion lien granted to Ca1PERS by state statute in the event of termination of a pension administration contract is vulnerable to avoidance in bankruptcy as a statutory lien. 11 U.S.C. § 545. Third, the Contracts Clauses of the Federal and State Constitutions, as implemented by California’s judge-made ‘Vested Rights Doctrine,’ do not preclude contract rejection or modification in bankruptcy. Finally, considerations of sovereignty and sovereign immunity do not dictate a different result.” The mix of federalism issues and the tremendous struggle pitting bondholders of a city or county versus public employees and retirees—and the related Constitutional issues raised in the Detroit and Stockton cases with regard to whether the federal chapter 9 municipal bankruptcy law can, in effect, preempt a state’s constitution—challenges which had been pending in the 6th and 9th U.S. Courts of Appeal before they were dropped thus received a final parting shot from Judge Klein—but a shot which could have reverberations for Atlantic City and especially Wayne County, Michigan, with his pungent opinion that municipal pension contracts entered into by the city, including the pension administration contract, may be rejected pursuant to bankruptcy code, with the feisty Judge noting: “The California statute forbidding rejection of a contract with CalPERS in a Chapter 9 case is constitutionally infirm in the face of the exclusive power of Congress to enact uniform laws on the subject of bankruptcy under Article I, Section 8, of the U.S. Constitution – the essence of which laws is the impairment of contracts – and the Supremacy Clause.” Nevertheless, Judge Klein noted while Stockton, in its plan of debt adjustment, could have impaired the pension fund, he also noted that Stockton’s plan did achieve significant reductions, including lower pensions for new employees and the elimination of $550 million in unfunded health benefits that employees accepted in exchange for preserving existing pensions. Because Franklin Advisors last November filed an appeal to a three-judge U.S. Bankruptcy Appellate Panel of the Ninth Circuit, the appeals court will have the benefit of Judge Klein’s perspective. (Franklin is challenging Judge Klein’s decision under which it claims it received a loss on the $35 million of bonds it holds — a recovery rate it estimated amounts to about 1% — in contrast to CalPERS which received no haircut at all. For his part, on this issue, in his decision, Judge Klein noted: “[T]he value given up by retirees who accepted the plan is on the order of ten times the value given up by Franklin.”

“Tomorrow hopes we have learned something from yesterday.” (Quote from John Wayne) Warren Evans, Wayne County, Michigan and Detroit neighbor’s newly elected executive, yesterday warned of a potential municipal bankruptcy filing and state takeover—saying that both options had to be on the table, unless the County acted swiftly to achieve major structural fixes. The county, which encompasses Detroit, is confronting what County Executive Evans termed a “financial Armageddon,” warning that “Even with all of the funds pooled together, we’re going to get to the area where we just don’t have enough to pay the bills.” Noting that one of the prerequisites of seeking federal bankruptcy protection, an outcome he termed “an ugly word,” is “a bad cash picture…if you don’t have the cash it’s one of the triggers.” Evans said restructuring debt for savings is one possibility, but said the county’s main problem is not bond debt but its lack of general fund revenue: “There was a big creditor argument,” he said, referring to Detroit’s bondholders, “but in Wayne County that’s not really the problem. We borrow from ourselves: the general fund takes money from the road fund or the treasurer.” Nevertheless, without a workable deficit elimination plan, it seem more likely than not that the state will step in and take over the county, as it did with Detroit in the months before the city declared bankruptcy, or as Mr. Evans put it yesterday: “All things being equal, I think it could [lead to bankruptcy] but I don’t think it will, because we’re not going to let that happen.” As for emergency managers such as Kevyn Orr being imposed by Governor Rick Snyder, Executive Evans said: “I don’t think they’re circling overhead, but they can all smell the blood on the water…Whether we fix it or someone else fixes it, it’s going to get fixed.” Wayne has roughly $700 million of junk-rated, limited-tax general obligation bonds. Wayne County has suffered for years with a structural deficit and growing unfunded pension debt. Mr. Evans, who was elected last November, previously served as a Detroit police chief and Wayne County sheriff. Yesterday, he warned: “The bottom line is everything is on the table, there’s no sacred cows,” adding: “The Governor has said he would like to sit back and see Wayne County take care of it, but if we don’t do what we need to do, he will come.” He noted the County has shifted money from other funds into its general fund for years to cover chronic revenue shortfalls, and that the County’s pension funded status has fallen to 45% from 95% ten years ago; he warned the County will need to find roughly $70 million a year to cover the structural general fund shortfall and begin to shore up the pension fund. The dire report card—on an issue which could have repercussions for Detroit’s fiscal and economic recovery, came in the wake of the County Executives frenetic series of meetings with unions and other “stakeholders” over the last few weeks and in the midst of renegotiating at least 25 labor contracts. To make matters more serious, Wayne County is threatening to unravel a breakthrough deal that settled Detroit’s bankruptcy case unless it receives land or more than $30 million — money the city needs to finance Detroit’s revitalization under its federally approved plan of debt adjustment—the agreement, revealed via a bankruptcy court filing yesterday, indicates that Wayne County and Detroit are fighting over a nearly 40-year-old agreement to redevelop the landmark former Detroit Police Department headquarters at 1300 Beaubien in downtown Detroit. The tiff between the city and surrounding county could threaten to unravel a hard-fought bankruptcy settlement the Motor City reached with its fiercest bankruptcy creditor, bond insurer Syncora Guarantee Inc. to emerge from municipal bankruptcy late last year. The Wayne County Executive’s office, nevertheless, yesterday said it would exercise its option to control redevelopment of the land under the 1976 agreement with the city: “Wayne County is not seeking compensation from the city of Detroit, but rather specific performance,” albeit the statement left unclear exactly what the County would define as “specific performance.” Detroit’s bankruptcy attorney Heather Lennox, in a filing yesterday, noted: “The Wayne County objection was filed approximately 117 days after the court-ordered deadline to file such objection, and more than two months after” U.S. Bankruptcy Judge Steven Rhodes permitted Detroit to back out of the Wayne County deal. (The 1976 county-city agreement was supposed to be fulfilled in two phases. The first phase was completed and involved Wayne County acquiring land next to police headquarters and building the Andrew C. Baird Detention Facility. The second phase is unfulfilled, according to counselor Lennox: Detroit never demolished the headquarters after the Detroit Police Department moved two years ago into the former MGM Grand Casino site downtown, and Wayne County never paid for the headquarters site.