MuniLand

A bankruptcy scorecard for Detroit

Settlements in the Detroit bankruptcy case are arriving quickly. I thought that it might be useful to have a scorecard to tally the pieces. I took the chart above from the Detroit’s June 13, 2013 Proposal to Creditors (page 98). It lists the unsecured creditor claims. So far, Detroit has settled four unsecured liabilities valued at $4.107 billion for $1.213 billion, or 30 percent.

Here are four announced settlements with numerous caveats.

UTGO settlement: Detroit originally argued that the unlimited tax general obligation bonds (UTGO) were unsecured. This interpretation flew in the face of established muniland legal precedents and was watched closely by market participants. In its settlement with the bond insurers who wrapped these bonds, the city reversed its stand and agreed to acknowledge that the debt was secured by a specific lien on property tax revenues. Bond insurers will be paid 74 cents on the dollar and bondholders will be made whole by the insurers. The property tax lien will continue to be collected by the city and 26 cents on the dollar will go to a fund to help the lowest income retirees. It will cost the city $287 million to resolve $369 million in liability with the bond insurers.

Pension unfunded liabilities: Detroit originally estimated that its two pension systems were underfunded by $3.4 billion. Morningstar and others argued that the city had over-inflated the pension liability. They were right. Retirees will not face big cuts. The city has reached agreements with pension leaders. Detroit expects contributions from the state, private foundations and the Detroit Institute of Art to further fund the pension systems in exchange for preservation of the city’s art collection. The Detroit News has the pension settlement details:

Detroit reached tentative deals with two pension funds late Tuesday that would lead to modest reductions in monthly pension checks, free up cash to revitalize city services and speed the end of the biggest municipal bankruptcy in U.S. history.

The city’s general employees would take a 4.5 percent cut to pensions and lose an annual 2.25 percent cost-of-living adjustment under the proposed deal, multiple sources told The Detroit News.

New analytical tools for muniland

Some great new tools have arrived in muniland that begin to stretch the boundaries of how we organize and process our endless information. Staying on top of 80,000 municipal issuers, 50 states and unlimited private activity issuers is no easy task. Check out some of the new arrivals:

Standard & Poor’s

Standard & Poor’s Ratings Services announced the launch of a free interactive web application that gives muniland participants the ability to create and compare credit scenarios. Users can model different capital structures and see possible ratings based on Standard & Poor’s general obligation ratings framework and their own data inputs. This web app follows last year’s launch of the iPad-based S&P U.S. Local Governments Credit Scenario Builder. Log on and have fun. The Bond Buyer lays out some specs:

The app includes the seven criteria Standard & Poor’s uses to assign a credit to a municipality: economy, management, budgetary flexibility, budgetary performance, liquidity, debt and contingent liability, and institutional framework.

Puerto Rico government stumbles on teacher pension reform

The Puerto Rico government encountered a stumbling block in its efforts to right a sinking fiscal ship on Friday when its Supreme Court ruled that legislation amending the teacher’s pension system was unconstitutional. Reuters reports:

The Puerto Rico Supreme Court on Friday struck down a recently enacted overhaul of teachers’ pensions, dealing a major blow to efforts to fix the Caribbean island’s crumbling economy and budget.

Five of the court’s nine members determined that significant portions of the reform law were unconstitutional. Three judges dissented and one recused himself.

Fixed costs squeeze state and local government hiring

I’ve said for several years that hiring by state and local governments is unlikely to rebound after the declines following the 2008 recession. Governments have been faced with increasing costs for Medicaid, pension and retiree healthcare, which are fixed in law and through contract negotiations and are therefore difficult to adjust. The most viable way for governments to balance their budgets was initially through layoffs; now it’s through hiring freezes. Employment data from the Federal Reserve Bank of St. Louis proves this point:

 

Gabriel Petek and his team at Standard & Poor’s wrote a report that addressed the financial outlook for state and local governments. In it, they addressed the employment picture:

As service providers, state and local governments spend a sizable share of their budgets on personnel costs. In fiscal 2011, Census Bureau data show that 37% of spending on current operations went to wages and salaries. By accounting for such a prominent portion of governments’ spending, staffing reductions became a central component to state and local government cost-containment strategies. Outright workforce reductions as a way to lower personnel costs also faced fewer legal hurdles than did reducing current or deferred compensation and benefits.

The myth of Chicago’s “shadow budget”

EXCLUSIVE: Investigation shows @RahmEmanuel diverted pension/school money into secret slushfund enriching his donors http://t.co/mDttLsQ7MV

— David Sirota (@davidsirota) April 4, 2014

I’m not a big fan of tax increment financing (TIF) — property tax assessments that split off revenues derived from increases in property valuations and new construction in a geographically defined portion of a city. These revenues go into a separate pot that funds improvements to school buildings, sidewalk and curb construction and other infrastructure, away from a city’s general fund. I think splitting off revenue streams makes managing a city’s finances more complex, and reduces flexibility as the city’s fiscal priorities change.

Many cities, such as Boston and Pittsburgh, have TIF programs. Some are well-structured and monitored. Others — like the Redevelopment Agency (RDA) in San Bernardino, California (which the state dissolved in 2012) — tried to divert funds illegally. California is allowing bonds issued through the RDA program to mature, but is not issuing any new debt.

Where local government money comes from

Yesterday I wrote about local governments spending $100 billion a year on police, but I realize that I didn’t provide much context for how that fits into overall spending. Here are a few datasets from the U.S. Census Bureau’s 2011 Annual Surveys of State and Local Government Finances to provide a framework.

Local governments had revenues of $1.67 trillion in 2011, according to the U.S. Census Bureau. Here is how federal and state governments contributed to local government revenue flows:

Local governments generated $905 billion of their own revenue:

Local governments generated $578 billion of tax revenues:

Local governments generated $267 billion in fees and charges:

Local governments earned $134 billion in utility revenues:

Local governments also had $73 billion in insurance trust revenues and public employees contributed $73 billion in pension payments.

America’s police — the third rail

For decades, conventional wisdom has said that federal entitlement programs are the third rail of national politics. Any politician advocating reductions would be penalized at the election booth.

Many vital entitlement programs like the Social Security disability program are nearly broke, but no one discusses how to reform them to make them sustainable. Similarly, at the local level, spending on police has put massive pressure on budgets. But it would be political suicide for a politician to advocate reform.

Violent and property crime rates have dropped in America, but spending on police has soared since the 1990’s. According to a 2012 Justice Policy Institute report, the declining violent crime and property arrests have been replaced with drug arrests:

Late to the public pension game

Pew Charitable Trusts has released an ominous report, The Fiscal Health of State Pension Plans: Funding Gap Continues to Grow.” The report finds that in 2012, U.S. public pensions lost ground in their funding ratios and ended the year weaker than they started. What is not clear is why, in March 2014, Pew is reporting 2012 data. Because of large stock market gains in 2013, pension funding gaps are now actually shrinking, not growing. Reuters writes about the Pew report:

Factoring in promises made by local governments to fund pension benefits for their employees, total pension debt climbed to over $1 trillion as of June 30, 2012, the end of the most recent budget year for which data is available.

‘Even though we’ve seen recent market gains and reforms, the funding gap has continued to grow for pensions,’ said David Draine, a senior researcher at the Pew Center on the States.

The Puerto Rico corporate tax question

The Government Accountability Office published a report estimating the economic advantages and costs Puerto Rico would have if it enters statehood. The biggest cost would be that Puerto Rico citizens would be required to pay federal income tax on their domestic earnings. Currently they pay federal income tax on income they earn outside of Puerto Rico.

The GAO estimates that If Puerto Rico had been a state in 2010, the estimated income tax paid by individual taxpayers would have ranged from $ 2.2 to $ 2.3 billion. The report also estimates changes in federal entitlement benefits that would flow to the island. In many cases there would be additional federal funds for the island.

The critical piece of the puzzle would be the change in income taxes for Puerto Rico corporations and subsidiaries of U.S. corporations that do business on the island. These corporations are a big contributor to Puerto Rico general fund revenues. Puerto Rico corporations are currently treated as foreign corporations under U.S. tax law. Here is what the report says (page 115):

Muniland’s multi-purpose plumbing

 

There has been a lot of reporting about the more than 90 retail-size trades made in the $3.5 billion Puerto Rico general obligation bond that was issued March 11. The official statement for the deal says that transactions may not be done in amounts below $100,000 unless Puerto Rico is raised to investment-grade from junk.

I’m not sure if dealers were knowingly breaking the rules, too lazy to read the bond’s documents or thought that regulators would not be paying attention when they executed the trades. It could have been small regional dealers executing the illegal trades or maybe even the brokerage operation of one of the underwriters. Dealer identities on trades are never made public, so there is no way of knowing.

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