Sunday, December 29, 2013

On Revenue Hills and Revisionist History

The PG has the first of a two part series looking at the state of city of Pittsburgh's finances. Use up your paywall quota reading: 10 years later, is Pittsburgh really climbing out ofthe red?

I'm just sorry... but no, that isn't the story. I feel for our media friends who must fit big long stories into column-inches that barely can tell the story of yesterday's baseball game. So in ten minutes, and my free marginal 'ink', here is my short short version of the financial history of the city of Pittsburgh that lead to the city's acceptance into Act 47 status by the Commonwealth of Pennsylvania.  

When Tom Murphy was elected in 1993, he likely felt fully disillusioned over the state of city of Pittsburgh finances he was about to inherit beginning in 1994.  What he thought he knew as a pretty bad situation was in fact far far worse once he had eyes on the actual budget from the inside.  PG May 6, 1994: Murphy's Method

What was setting in for Pittsburgh was not only the combined effects of history, a city which had seen its population decline by over 45 percent over the previous 5 decades, but also a legacy of infrastructure that dated as the nearly the oldest in the nation with minimal reinvestment following the economic miasma of the 1980s.There just wasn't an option to stop spending money on core infrastructure across the board, infrastructure that was as expensive to maintain here as anywhere.

Then they opened the books and the Masloff Administration showed that the situation was actually far worse than even the pessimists thought. On top of the dire economic and demographic circumstances, city books were showing the stress of changes just a few years earlier that made the city's already dire fiscal situation far worse.  As discussed here in the past, the Masloff Administration had proposed a tax swap entirely intended to keep young families residing in the city. A notional tax-neutral shift from a high earned income tax toward real estate taxes was put in place. As much as the proposal took immense political courage to even propose, the outclome likely could have been expected: the lower income tax was welcomed, but the corresponding real estate tax hike was protested. While it went through, the amount millage was raised by was insufficient to make up for the lost income tax and so was created a structural deficit in the city's budget going forward from 1989 on.  Like all deficits, short term fixes could get you through couple years, but right as Murphy was taking over, the situation was dire and until then much unnoticed.  

There really could only be one option, so bad was the situation.  Bankruptcy was the almost inevitable outcome, as unprecedented as that option was at the time. In fact, the only thing that likely prevented it was the opinion of lawyers that it was not even legally feasible.  Just a year earlier, the city of Bridgeport CT had attempted to file for Chapter 9 bankruptcy in federal court only to be told it was not allowed. Not because of any state law that proscribed the filing. Bridgeport, the judge ruled has sufficient fiscal capacity to get through its financial crisis. There were such few attempts at using federal chapter 9 bankruptcy code that the ruling was deemed as precedent at least outside legal circles.(my attorney friends tell precedent is actually not such an elephant in the ad-hoc world of bankruptcy filings... but what do I know?)  The lawyers, who generally love precedents, I am positive told Murphy that the ruling meant bankruptcy was not an option in Pittsburgh as well.  In retrospect I could make the case that the city of Pittsburgh's fiscal problems were so much worse than Bridgeport's at the time, and some legal research has said Bridgeport was only marginally above whatever legal Mendoza line was in the court's mind at the time.  I really believe that a counterfactual Pittsburgh bankruptcy filing would not have been rejected and the logic that says Act 47 or any similar state laws prevent Pennsylvania municipalities from availing them of federal relief has been proven pretty false by Detroit's successful Chapter 9 bankruptcy filing despite opposition by the state of Michigan.

Thus Pittsburgh at the very beginning of the Murphy administration faced an almost Kafka-esque financial state that continued through his entire term of office, or at least until Act 47 came to be here.  Unable to file bankruptcy it had to plow on.  Revenue raising was not really an option as most all would agree Pittsburgh was past the max revenue points of what economists call revenue hills, and any greater taxes would only have pushed people out of the city faster. Thus the remaining option of cutting all services to draconian levels, which would have been the only real way to put the city's budget on a sound structural basis.  Yet many believed the cuts required to make a dent in the budget deficit would only have made the city utterly unlivable and also further accelerate the decline. You really would have seen capital budgets cut to nothing and operating budgets slashed to levels never seen in the city.

So for good or bad the Murphy administration found other ways to carry on.  Whether one agrees with the tactics or not the real error that Murphy fully admits to in public is that he was planning for growth in the city. If there was future population or income growth, the fiscal deficits could be overcome.  But how to get to growth required investment. Since that growth did not come during his terms of office, the structural budget problems continued until there were no latent assets to tide the city over.

Thus came a decade of fully understood to be short term solutions.  The first was the 'sale' of the city's water assets.  To be clear the semantics of that are challenging since some today call for the privatization of the water authority. So what happened two decades ago?  I call it the monetization of the water department actually.  The city's municipal water department was spun off to an 'independent' water authority which in turn 'paid' the city for the assets and in doing go incurred a chunk of debt to be paid off in the future.  In the fiscal machinations common on Wall Street it was no big deal, but convoluted nonetheless.  So there was half of a privatization that provided the city a lump of cash that got it through the deficits of the first Murphy term, but not more. Those who are calling for a further 'privatization' of the water authority are talking about handing it over to an actual private sector company with equity ownership. There is no pot of gold in that potential transaction though. The high debt the water authority owes would take up any potential payment in the purchase... possibly the $$ on the table could not cover all of the debt, all which would be a real downer.

Then came the looming costs of pensions long since agreed to over previous decades coming due. Based entirely on recommendations  a report chaired by no less than then-future Secretary of the Treasury Paul O'Neill, the Establishing a Culture of Excellence report (I really hate euphemisms) the city was told outright it needed to float a big Pension Bond to refund the soon to be depleted (and I mean absolute zero dollar balance projected to happen by 2000) pension fund.  The city complied with the blue ribbon panel and did so by  floating two big bonds that pushed up the nominal funding ratio of the city's pension system from under 20% to over 66% (sound familiar?)  funded overnight, and thus push down the city's required cash contribution for many years, mostly getting through the second Murphy term.

The pension bond helped a lot, but by the third term it still was not enough and thus the third big trick commonly used elsewhere but not on such scale or impact as here.  The sale and again I prefer the term monetization of the vast unpaid tax bills on city of Pittsburgh real estate.  That is a monster story unto itself, but in brief a Wall Street firm called MBIA created a subsidiary with a mis-spelled if incredibly apt Spanish name for 'Black Hole' (I can't make this stuff up) to purchase at cents on the dollar the portfolio of tax liens the city nominally owned on unpaid real estate taxes. The firm obviously expected to collect on enough of those liens to make a profit. The city again received a chunk of change that continued to tide it through fiscal problems that had yet to structurally abate in any form. When that money ran out is when there was no other creative way to monetize anything else the city owned. Then and only then did the final phase come and the action by the state to come in and place the city in Act 47 status. Was there any reason the state could not have put the city in Act 47 a decade earlier? Absolutely not, but the state as happy as everyone else for the city to muddle through with short term fixes hoping for a long term future that somehow solved itself? 

Yes, that was ten minutes stream of consciousness with the exception of finding a few of the old reference links (I may add more later).  Maybe we will also make it two parts and cover the subsequent decade as well. I'll ponder that a bit longer.

Here is THE question historians will take up eventually.  Was it worth it?  Was there another option and would bankruptcy in the early 1990s have cleared the deck for future growth quicker? Or made things worse?  If Murphy had made other choices and made the cuts some wanted him to make in the early 1990s would the city's financial history be different.  One could argue that the cuts that would have been necessary would have made the city such an unpalatable place to live that the decline of the city's population would have accelerated.  Am I arguing that? No.. I just don't know the aswer. I am pretty sure that Murphy would have been a one term mayor if he had come close to closing the budget's structural deficit with expenditure cuts alone.  If that had come to pass, who knows what the counterfactual political history of the city would have looked like over the subsequent decade.Would it have been a Mayor Wagner 16 decades earlier? Mayor Cohen perhaps? Mayor O'Connor 8 years earlier? Mayor Ferlo possibly? The butterfly could have landed anywhere.

One thing is very clear, the fiscal state of the city in 1993, a place where population and incomes were declining rapidly, with a pension fund barely 17% funded (with optimistic assumptions no less), which was still dealing with the massive economic trauma of the decade before including the loss of many of the city's major employers located Downtown (Gulf anyone? just to begin), is just not a set of circumstances repeated going into the future. Those who think otherwise don't appreciate how bad the past was, despite a bit of gloss on the surface that kept the public from appreciating the worst of it at the time. Lots of folks straight line projections, and the city and region have already proven that to be a bad way to forecast most anything.  There are few of the circumstances of today similar to where the city was beginning in the 1990s which was trying at best to stop sliding faster, let alone ever dream of growing again.  


Blogger Vannevar said...

Brilliant, valuable, accessible, informative, presents behind-the-scenes insight in layman's term. This could be your Opus Numbern. Thank you for writing it.

Sunday, December 29, 2013 1:18:00 PM  
Anonymous BrianTH said...

Unfortunately this proposition is completely false:

"and the logic that says Act 47 or any similar state laws prevent Pennsylvania municipalities from availing them of federal relief has been proven pretty false by Detroit's successful Chapter 9 bankruptcy filing despite opposition by the state of Michigan."

In fact, as discussed at length in Judge Rhodes' opinion, Detroit's Chapter 9 filing was explicitly authorized by state law, including an unconditional approval from Governor Snyder. Here is the most relevant section of the opinion:

"On July 16, 2013, Mr. Orr recommended to the governor and the treasurer in writing that the City file for chapter 9 relief. Ex. 28. (Dkt. #11-10) An emergency manager may recommend a chapter 9 filing if, in his judgment, “no reasonable alternative to rectifying the financial emergency of the local government which is in receivership exists.” M.C.L. § 141.1566(1). On July 18, 2013, Governor Snyder authorized the City of Detroit to file a chapter 9 bankruptcy case. Ex. 29. (Dkt. #11-11) M.C.L. § 141.1558(1) permits the governor to “place contingencies on a local government in order to proceed under chapter 9.” However, the governor’s authorization letter stated, “I am choosing not to impose any such contingencies today. Federal law already contains the most important contingency - a requirement that the plan be legally executable, 11 USC 943(b)(4).” Ex. 29. at 4. Accordingly, his authorization did not include a condition prohibiting the City from seeking to impair pensions in a plan. At 4:06 p.m. on July 18, 2013, the City filed this chapter 9 bankruptcy case. (Voluntary Petition, Dkt. #1)"

I know Chris simply cannot bring himself to accept this aspect of Chapter 9, but it remains not only true but confirmed by the Detroit decision: state law governs when a municipality can file for Chapter 9, and in fact the state can put limitations on what the municipality can do when in Chapter 9 proceedings.

Sunday, December 29, 2013 2:56:00 PM  
Anonymous BrianTH said...

This portion of the opinion may also be helpful:

"Section 109(c)(2) of the bankruptcy code requires that a municipality be “specifically authorized, in its capacity as a municipality or by name, to be a debtor under such chapter by State law, or by a governmental officer or organization empowered by State law to authorize such entity to be a debtor under such chapter.” 11 U.S.C. § 109(c)(2). The evidence establishes that the City was authorized to file this case."

Sunday, December 29, 2013 3:08:00 PM  
Blogger C. Briem said...

To keep this from getting bogged down in minutia most will not want to read. How about this simple question. If the ruling had gone the other way and Detroit was precluded from bankruptcy, then what was going to happen when many bills went unpaid? The US court was going to watch a circus erupt with a virtual tsunami of claims dumping on the courts?

Yes, I take a not-attorney's liberty in not paying credence to the details of the opinion.

Remember, New York City never had any federal bankruptcy protection yet nobody in reality questions that the city was technically bankrupt by all meaningful definitions.

Sunday, December 29, 2013 3:13:00 PM  
Blogger C. Briem said...

I'll concede the error in stating Michigan in the end opposed the filing.

Sunday, December 29, 2013 3:35:00 PM  
Anonymous BrianTH said...

If the condition in Section 109(c)(2) had not been met, then yes, the bankruptcy court would have dismissed the case.

Creditors would in fact then have to pursue any possible remedies for their claims against Detroit in separate legal actions. Note this result is far from unprecedented.

For example, although there is an involuntary bankruptcy provision for Chapters 7 and 11 (but not 9), it is not universally-available and as a matter of practice is rarely used. So in fact sometimes creditors do resolve their claims against insolvent non-municipal entities without ever entering federal bankruptcy proceedings.

But in any event, no, a federal bankruptcy court is not going to ignore Section 109(c)(2), even if applying it would lead to a "circus" of creditor claims.

Sunday, December 29, 2013 3:56:00 PM  
Blogger Bram Reichbaum said...

Maybe if we tried using the identity property… only two (2) years ago, we were told our financial situation was so bad we needed to get "taken over" by the state, we needed a two hundred million dollar cash infusion to stabilize, we needed extreme measures and pain and only bad options… then, nothing (or more or less nothing) happened… now most people are scratching their heads wondering how anybody can claim Pittsburgh is in distress? How does this compute? I realize an incumbent administration spent about a year hyping up the City's strides on the happier half of its balance sheets in advance of a reelection bid, but do they actually have brainwashing ability? Did they unleash the Hypno Toad?

Sunday, December 29, 2013 5:09:00 PM  
Blogger C. Briem said...

The intent of that section is the fundamental separation of powers yes?

Is interesting in that the protection of states rights comes from the limited powers the court has in Chapter 9. By 'authorizing' a bankruptcy you can make the argument the state is also giving up some of those fundamental rights.

anyway.. while the case may have been dismissed for now. I find it inconceivable that a similar ruling would come once money really ran out in Detroit. The cases where creditors deferred or forgiven municipal debt are incredibly more benign than Detroit's case. Though the plenipotentiary powers of the state overseer in Detroit's case makes for another wildcard. I will end by saying we all hope never to get a case which answers the unknown.

Sunday, December 29, 2013 5:18:00 PM  
Blogger Mark Rauterkus said...


In 1990, families with special needs moved to the city from all around the region to insure that their kids would be well cared for and educated in Pittsburgh Public Schools.

Pittsburgh a Public Schools had exceptional gifted education, magnet schools, languages in elementary schools, music education at young ages, robust school choices and even a VoTech H.S.

The hinge of PPS is HUGE.

Furthermore, to speak your terms of finances, there was a time when the rainy day fund of PPS was >$500 M. Crossing guards and about $50 M a year was taken from the PPS and transferred to the city -- every year.

Schools matter greatly.

Sunday, December 29, 2013 5:25:00 PM  
Blogger C. Briem said...

Bram, just curious... who other than me is saying the parking asset is "more or less noting"? City council obviously thought it was very substantial. State agreed.. even the city's investment accountant signed off. I feel quite lonely.

Sunday, December 29, 2013 5:33:00 PM  
Anonymous BrianTH said...

I'm not sure of the legislative history behind 109(c)(2), or of Chapter 9 in general for that matter. But that limitation is broadly consistent with the principle of state sovereign immunity (as found in the 11th Amendment and Hans v. Louisiana) combined with the fact that under federal law, all local governments are considered creatures of the state. And I agree 109(c)(2) could be seen as a kind of waiver provision in that context.

Anyway, I find it inconceivable that a federal court would ever ignore such a clear limitation on its authority, no matter how dire the financial situation a municipality found itself in. If you are interested in thought experiments, consider that not only do over 20 states have no provision at all for Chapter 9 filings, but Georgia law actually expressly forbids such filings. So imagine Atlanta is insolvent, and tries to file under Chapter 9. Would a federal court actually ignore both the state of Georgia and the U.S. Congress and invent for itself the inherent power to conduct bankruptcy proceedings in such a case?

Any hypothetical case in which 190(c)(2) is not satisfied is really no different (Georgia's law is superfluous in that sense, hence why the other 20-some haven't bothered). And federal judges are very accustomed to opinions of the kind, "This is a very serious problem which undoubtedly deserves a remedy, but you can't get that remedy here, because Congress has said no."

Sunday, December 29, 2013 6:49:00 PM  
Anonymous marketdiamond said...

Very interesting discussion and even more enlightening blog post CB!

Sunday, December 29, 2013 7:00:00 PM  
Blogger Bram Reichbaum said...

Chris - I'm unaware of anyone else commenting on the nuances of this issue in any manner. But I do recall the administration deriding the maneuver in its aftermath as not a real solution, and certain other public officials saying things like "I don't believe they (the state) bought it" and a lot of conjecture that PMRS and the state were motivated by a fear of letting Pgh. wreck their own system.

Monday, December 30, 2013 11:08:00 AM  
Anonymous Kirk B. Burkley said...

Chris - I came across your blog and wanted to comment. I have written a few published articles on Chapter 9 in the past and have represented numerous creditors in Chapter 9 cases and consulted with municipalies about filing Chapter 9. Some of my articles are attached for your reading pleasure (if you like that kind of stuff).

In one of my earlier articles (published in Allegheny County Bar Journal) I predicted that based on the 9th Circuit's upholding of the decision in City of Vallejo that pension plans would be subject to restructure in Chapter 9. City of Vallejo is important becuase the court held that Chapter 9 was "take it or leave it." In other words, the State of California had to accept all of Chapter 9 once it allowed a municipality to file bankruptcy.

States can prohibit their municipal subdivisions from filing Chapter 9 due to issues of Federalism, but those same notions of Federalism mean that once a municipality is authorized to file the State cannot restrict what happens in bankruptcy. I realize that Judge Rhodes in dicta in the Detroit decision mentions that the Governor did not restrict Detroit, but I'm not so sure that would have mattered. It does get a little tricky when we talk about Federalism and issues of state substantive law, but in essence Congress has engaged in are preclusion by passing the bankruptcy Code. The various states have no right to legislate changing the bankruptcy code.

However, to answer some of the comments on this blog, there is absolutely no bankruptcy judge that would ignore a state prohibition on municipal bankruptcy. It just wouldn't happen. A perfect example is Harrisburg, which had its bankruptcy case thrown out by Judge France. In addition, the primary reason Pittsburgh's lawyers decided that bankruptcy wasn't a viable option is because the law of the Commonwealth requires the signature of the governor before Pittsburgh can file. That is something that is not likely to be forthcoming.

Anyway, here are a few links. I enjoyed reading the blog.

Thursday, January 02, 2014 1:11:00 PM  
Anonymous MH said...

Speaking of Harrisburg, I can't figure out how much of a hit the bond insurers or holders took. I don't know what the word "restructuring" means in this context. Better terms but no debt written off?

Thursday, January 02, 2014 1:41:00 PM  
Anonymous John Gotaskie said...

Kirk--As an experienced Chapter 9 attorney, you should know that it's not true that no entity in Pennsylvania has ever filed for Chapter 9 protection without state approval. Westfall Township, Pennsylvania, filed and completed a Chapter 9 case without ever having the approval of the state. DCED basically looked the other way when the filing was made, and only declared Westfall "distressed" under Act 47 after the bankruptcy case had been filed (maybe completed, my memory is not precise on that point). The bankruptcy was principally used to restructure a large judgment due to a single developer. Clearly, the Judge in the Westfall case felt comfortable proceeding in the face of the so-called state "prohibition". While I am not suggesting that the DCED would have looked the other way on a Pittsburgh filing, no one can profess to "know" what would have been the outcome because a filing was never tried or even seriously considered. I mean, as Chris has pointed out in another context, the Parking Authority's IOUs to the pension funds are little more that notional "assets", yet their full value has been credited by Harrisburg in order for it to conclude that Pittsburgh's pension is more than 50% funded. So mental gymnastics are not beyond the realm of possible for our bureaucrats in Harrisburg.

Moreover, it is a little incongruous to me that Pennsylvania has authorized bankruptcy filings by municipalities, but then says you need DCED "approval" to file. Perhaps DCED did not raise a fuss in the Westfall case because it did not want to run the risk of losing its "approval" argument in future cases.

An excellent overview of significant Chapter 9 cases, including Westfall Township, can be found here:

Thursday, January 02, 2014 5:21:00 PM  
Anonymous Kirk B. Burkley said...

John, I'm not sure if you are suggesting that I somewhere said a PA municipality never filed for Chapter 9. That is certainly not the case. If you are suggesting that Westfall filed without authorization, that is also not true. Westfall was in fact authorized, as PA is one of the states that authorizes its municipalities to file Chapter 9. The difference with Pittsburgh and Harrisburg is that the legislature specifically took that "authorization" away by requiring the sign off of the governor or legislature, respectively. It might be a nuanced distinction, but an important one nonetheless when advising clients.

I have used Westfall as an example to clients considering filing for Chapter as a way of doing it without DCED approval. The hard part, I think though, is that you almost have to file quickly before the legislature gets a chance to restrict your ability to file. Chapter 9 is an interesting animal and you have to be careful.

The other interesting part about Westfall, that I like and think was good lawyering, is that they filed a plan almost immediately and cut a deal with creditors before the issue had to be decided (eligibility and authorization).

I represented one of three creditors on the Jefferson County creditor committee, which was ultimately disbanded. In Chapter 9 the court has not authority over what is typically property of the estate and the debtor paid my client in full to squash the committee (we didn't complain). Alabama is a little different because they don't participate in the Office of United States trustee program and rather have a "bankruptcy administrator," but many of the concepts are the same.

I am pretty confident professing that had Pittsburgh filed without the governor's signature that the state would have objected and would have won. Others can disagree, but I wouldn't take that chance with my client's money. Someone else did with Harrisburg and lost. Now they are suing the City for attorneys' fees.

Thursday, January 02, 2014 8:18:00 PM  

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