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  #571  
Old 09-11-2018, 12:00 PM
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Mary Pat Campbell
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CHAPTER 9 BANKRUPTCY

https://www.forbes.com/sites/investo.../#1af51c51b190

Quote:
What 'Adult Entertainment,' Puerto Rico And Chapter 9 Bankruptcy Have In Common

Spoiler:
To keep a sense of perspective during the ongoing contentious priority-of-liens fight in the Puerto Rico bankruptcy proceedings, consider the case of Eric Joelner, Fish, Inc. d/b/a XXXtreme Entertainment v. Village of Washington Park, Illinois. In the annals of municipal bankruptcy, this is a very small footnote, for sure, but still relevant.

Back in 2003, Washington Park was having a hard time paying its bills. The usual economic suspects were making it tough on this 2.5 square mile town of 5,300 residents with a 42% poverty rate—manufacturing jobs were gone, there were cuts to state aid, and people were leaving. By its own admission, it was “in the red” on its $3.8 million budget.

To make ends-meet, the town raised licensing fees on its highest revenue generating businesses: “adult entertainment” establishments. Those businesses within the city limits saw their licensing fees jump ten-fold, from $3,000 to $30,000.


Mr. Joelner, a long-time proprietor of such a “public service” business (the court’s words, not mine) took exception on First Amendment grounds, sued and prevailed. Washington Park didn’t get the revenues. The Village ultimately filed for bankruptcy protection, in part due to, among other things, yes, monies owed to the owner of a certain topless bar—Mr. Joelner, to be exact.

Priorities

That put the judge in the case in the rather thankless role of determining the priority of unsecured liens that, in addition to the bar’s claim, included fees to lawyers, the police pension and one Johnny “Chico” Matt, the town’s former public safety director. While the jokes write themselves about how to weigh the priority of lawyers against adult entertainment owners in the Washington Park case, the judge handling Puerto Rico’s case faces the same issue of prioritization, just without any of the humor.

MORE FROM FORBES
For example, look at the recent intricate proposal by the bondholders of Puerto Rico’s sales-tax backed COFINA (Puerto Rico Urgent Interest Fund Corporation) debt seeking court approval in an upcoming hearing. It includes, in addition to a bond swap, a provision to pay themselves the $1.2 billion in Trustee-held funds. In justifying the plan, COFINA bondholders point to Act 91-2006 as the statutory security for their senior priority of lien claim.

The general obligation bondholders disagree vehemently. In their view, the plan gives COFINA investors, senior and subordinate, priority over what they see as their constitutionally protected priority lien. They point to Article VI, Section 8 of the Puerto Rico’s Constitution.

Let the legal fisticuffs ensue.

Practitioner's Perspective

This problem of prioritizing and resolving conflicting claims falls to the job of the U.S. District Court magistrate. When it comes to municipal bankruptcies, one former judge on that court has given this a great deal of thought. Drawing from his considerable experience on the bench, most notably overseeing the $3 billion bankruptcy filing by Jefferson County, Alabama, the Honorable Thomas B. Bennett (Ret.) (now of Counsel with Bailey & Glasser) reflected on the problem of unsecured or conflicting liens when a municipality files under Chapter 9.

A Quick History Of The General Obligation Pledge

Since the general obligation (GO) security pledge backs the vast majority of debt issued by municipalities, the Counselor offered some key legal history as to how it came to pass. A democratic government is by and of the people; government entities cannot offer a lien on those things owned by the people. Hence the “general obligation” pledge: a promise to pay but not a lien on any specific public assets.

That left governments seeking to borrow with a problem. They lacked traditional hard assets to offer as a lien to secure payment. A promise to pay is not a lien. To make up for that, some states established a statutory mandate to back the GO pledge. Often local governments added unlimited taxes to the pledge as further, tangible security.

An Unsecured Security

But as the Detroit bankruptcy demonstrated, even the “unlimited tax” pledge has limitations. Bondholders found themselves fighting not only other unsecured creditors but also pensioners who claimed, well, a superior claim. Bondholders discovered, to their chagrin, that court can only rule on the GO pledge’s priority in the pantheon of liens and claims; it cannot impose nor raise “unlimited taxes” by judicial decree. The “unlimited tax” bondholders took a cut that left them with 74 cents on the dollar.

James E Spiotto, retired partner of Chapman and Cutler LLP and now Managing Director Chapman Strategic Advisors LLC framed the problem succinctly: a paper right might not exist in reality. He too comes from a practitioner’s perspective. A published author in the field of Chapter 9 bankruptcies, Spiotto not only practiced bankruptcy law but also provided testimony and written statements to the U.S. House of Representatives and Senate on the 1988 Amendments to Chapter 9 legislation.

A More Secured Security

Unsecured creditors are but one lien issue the court has to vet through. As government and its services expanded, politicians got “cutesy”— Bennett’s words exactly. To avoid taking on more municipal debt on their balance sheet and having to go to the voters to raise taxes to support it, they created new financing authorities and agencies to fill the need. This begat types of security other than the GO pledge to back those bonds. Correspondingly, a cascade of varying liens and carve-outs developed as revenues from fees, sales taxes, taxes on incremental property values, tolls, fuel taxes and structured settlements—to list a few—were codified in bond documents as secured liens to repay debt holders.

Liening On The Law

As these liens developed, the law did not keep pace. This created a problem for the U.S. District Court judge adjudicating a Chapter 9 proceeding. Bennett observed that in a municipal bankruptcy, the law hasn’t been fully fleshed out and the issues haven’t been worked. Because municipal bankruptcy is rare and the causes unique, the Bench has limited guidance from which to draw when looking to apply legal criterion to determine priority among unsecured creditors. To misapply the words from Tolstoy’s Anna Karenina, happy bondholders are all alike; every unhappy bankruptcy participant is unhappy in their own way. Stockton, Vallejo, Harrisburg and Central Falls make for good headlines; they leave little in terms of precedent in the case law for the courts to cite. The plethora of other liens, as the Puerto Rico example highlights, only complicates matters.

Statutory Direction

Bennet offered that, in the courtroom, the judge can only rely on the facts presented and make a determination based on the law. Here is where turning to the actual statute should offer direction. The Chapter 9 legislation establishing the municipal bankruptcy framework was drafted to offer guidance but also to be flexible. Since experience and case law didn’t offer much, legislators had limited experience from which to draw. Additionally, there was the tacit acknowledgement of the varying circumstances in each bankruptcy. No law can be so comprehensive as to cover every situation, nor should it be. The courts need some leeway to find direction in working the law. Additionally, the drafters had to consider the varied state statutes governing bankruptcy; there are state by state laws as to whether or not a municipality can file and under what terms they can file if so permitted. Consequently, to take all these factors into account, the statute was crafted to offer guideposts as to process and procedure, but not dictate outcomes.

Spiotto contends that there is one aspect of the law that is clear. The U.S. Bankruptcy Court is bound to adhere to the Tenth Amendment of the U.S. Constitution and co-sovereignty the states. State laws and mandates cannot be rewritten from the bench. Equally, his view was that a municipality not only must pay any revenues dedicated to creditors but also those dedicated revenues cannot be used for other purposes until creditors are paid. Moreover, the municipality cannot be compelled by the court to not pay that which the state, by statute or otherwise, has mandated to be paid—which was the rationale behind the 1988 amendments to the federal statute.

Ultimately, that is the legal root of the dispute that continues to this day in Puerto Rico.

Academic Thinking

Discerning and prioritizing claims in municipal bankruptcies is on the minds of legal scholars as well. David Schleicher, professor of law, Yale Law School and fellow authors Adam J. Levitin, professor of law Georgetown University Law Center and Yale Law School graduate Aurelia Chaudhury, in their upcoming article Junk Cities: Resolving Insolvency Crises in Overlapping Municipalities (California Law Journal) take up the central question of conflicting security interests in Chapter 9 bankruptcy.

In this thoroughly researched and well-written piece, the authors contend that conflicts between bondholders as seen in Puerto Rico are just the tip of the iceberg and are likely to get more intractable. For example, one count had residents of Chicago paying taxes to 21 different districts, entities and authorities with separate levies on essentially the same underlying taxable boundary. It is not difficult to imagine the troubles one or more bankruptcy filings could create.

Seeing the emerging problem and noting that “Chapter 9 does not currently address the problems of overlapping local debt crises” and that the “statutory language is sufficiently capacious and indeterminate,” Schleicher, et alia view that as an opportunity. They advocate that the vagueness leaves room for “both courts and state legislatures [to] develop tools to stop local governments from acting in ways that are collectively harmful, even if individually rational, during insolvency crises.” Given the events in Puerto Rico, the authors may be both current and prescient.

What Guides The Final Plan

If plan approval were solely a matter of clean-cut law, the dispute would be over and done with in Puerto Rico, as some contend it should be.

But the fact that it hasn’t been clean cut summons the issue that the law is conjoined by another factor the court must weigh—public policy. Municipal bonds fund essential public purposes. It is the core of their strength as an asset class. Businesses may come and go as public tastes change and technologies evolve. Municipal services—good schools, paved roads, clean water, green parks, lit streetlights and such—are necessary regardless. The law can say whatever it says but, if at the end of the day, a plan leaving a municipality bereft of resources to provide its citizens basic services yet still pays bondholders in full is dead before the ink dries on the brief.

This critical factor weighs on the mind of every justice overseeing a Chapter 9 proceeding and likely, in particular, the judge overseeing the case in cash-strapped and economically destitute Puerto Rico.

So what guides the court through the fog of litigation to address both the law and public policy so a plan can be approved? Spiotto presented three simple and to the point questions:

Is the plan feasible both economically and by implementation?
Is it in the best interest of the creditors?
Is it fair and just?
For a plan to be approved, the answer to each of these questions must be an unequivocal “yes."

There is a lesson for the municipal bond investor. When sorting through the seemingly overwhelming number of debt issues, their jumble of security liens and unduly complex documents, keep in mind that good economics and an essential public purpose will do more than any carefully drafted legal protections. Otherwise, be ready to face the risk of joining the unhappy bankruptcy family.

Barnet Sherman has over 30 years of investment experience in the fixed income markets in credit analysis and portfolio management.
Barnet Sherman. Portfolio Manager, Credit Analyst, Published Author, and Speaker has over 30 years of investment experience in the fixed income markets.
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  #572  
Old 09-28-2018, 12:43 PM
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NEW YORK

https://www.bondbuyer.com/opinion/ne...e-its-too-late
Quote:
Commentary New York bond buyers must increase due diligence before it’s too late

Spoiler:
Anyone intending to buy or already holding New York bonds needs to increase due diligence of those issuers’ risks. The recent Internal Revenue Service’s decision to deny the State and Local Tax (SALT) cap work around proposed by elected officials for high property tax municipalities in New York is viewed negatively by Moody’s credit rating agency. Analysts at Moody’s September Credit Outlook stated that “The SALT cap will likely dampen housing price growth in high-tax states and states with a high percentage of SALT filers by removing an incentive for homeownership. Slower price appreciation will curb growth in assessed values.” Moody’s analysts also emphasized that, “depending on how taxes are structured and local governments' capacity to raise them, reduced assessed value growth will also reduce growth in property taxes.” Giving food for thought to elected officials in all of New York, Moody’s said: “With a cap on SALT deductions, voters in some municipalities will be more likely to reject tax increases because they will not be partially offset by a federal tax benefit.”


Mayra Rodríguez Valladares
Not only should the threat of lower tax revenues to New York State be a concern, but so should be the current state of the New York state economy and New York municipality balance sheets. Unfortunately, New York State lags behind the rest of the country in economic growth. Growth could slow down even more depending on how the New York state economy will fare with the Trump administration’s tariffs. According to the US Chamber of Commerce, about 2.7 million jobs in the state are supported by trade. New York State unemployment is about 4.5%, higher than the national average of 3.9%, though it has come down significantly since 2011 when New York state unemployment stood at 8.3%. Much of the job growth and decrease in unemployment, however, is being fueled by New York City.

At the state level, New York State Comptroller, Thomas Di Napoli announced that “spending will outpace revenues over the next three years with potential cumulative gaps totaling $17.9 billion.” New York counties are also suffering significant gaps. Westchester County, for example, is coping with a budget gap of almost $29 million; the amount of the shortfall could grow depending on the outcome of ongoing labor contract negotiations.

New York municipalities are challenged not only at revenue level, but they also have significant balance sheet problems due to unfunded liabilities. According to Truth in Accounting, a Chicago-based not-for-profit organization that analyzes municipal finances, New York State has about a $143 billion shortfall, a figure which also estimates off-balance sheet liabilities. Given this shortfall, Truth in Accounting gave New York State a failing grade of F for its state of finances. According to Truth in Accounting CEO Sheila Weinberg “hundreds of billions of dollars have been promised to government workers in the form of pension and health care benefits, but the state has set aside less than one percent in assets to fund these promises.” New York State’s shortfall means that each New York state resident would need to come up with about $21,500 to cover this significant gap; this figure is just for the state; each resident would also be on the hook for her own city and county gaps.
At the beginning of this year, Truth in Accounting published its research on New York City, which like New York State received a failing grade of F. According to the analysis, “New York City's financial problems are largely driven by long-term debt and runaway entitlement obligations in two categories: pensions and retiree healthcare benefits. The city has $69.7 billion in unfunded pension promises and $79.4 billion in unfunded retiree healthcare benefits. While New York City has promised these benefits, little money has been set aside to fund them.”

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Community charters
This month, Truth in Accounting gave a grade of ‘D’ to Westchester County and to the Village of Scarsdale, two of the most affluent counties and cities in the United States. According to the analysis of Westchester County “elected officials have made repeated financial decisions that have left the county with a debt burden of $2.8 billion.” This debt burden equates to $8,400 for every Westchester taxpayer. Westchester County's financial problems stem mostly from “unfunded retirement obligations that have accumulated over many years. Of the $5.8 billion in retirement benefits promised, the county has not funded $173.5 million in pension and $2.5 billion in retiree health care benefits.”

Truth in Accounting’s analysis found that Scarsdale Village’s Taxpayer Burden of $14,600 is higher than 88 of the 100 most populated cities in the U.S. ; the population of Scarsdale is under 20,000 residents. According to Weinberg this level of taxpayer burden, “is a result of Scarsdale’s elected officials pushing current costs, especially those related to unfunded pension and retiree health care promises, onto future taxpayers. Elected officials have been using the city’s and county’s credit cards to charge current services and benefits; future taxpayers will be the ones stuck with the government’s credit card bills when the time comes.” A taxpayer in the Village of Scarsdale is on the hook for a total of $44,500 in combined state, Westchester County and Scarsdale Village debt.

Between the curbs on SALT deductions and New York state, county and municipal levels of indebtedness, it is imperative that New York bond investors scrutinize elected officials’ actions more. Investors in New York bonds need to ask questions of elected officials such as: what is the expertise of their property assessors since these individuals hold the key to property tax levies? What pet projects that increase a municipality’s leverage can be cut? What municipal services can be shared? Do municipalities have strategic plans to increase retail in their towns to diversify the tax base? And do municipalities have long-term financial plans to withstand unexpected downturns in the economy? By not asking probing questions, investors in New York bonds might remember caveat emptor way too late in the next market downturn.
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  #573  
Old 10-02-2018, 06:12 PM
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NEW YORK

https://www.crainsnewyork.com/op-ed/...rker-you-think

Quote:
The fiscal picture in New York is darker than you think
The Empire State and its municipalities could use some truth in accounting

Spoiler:
We keep hearing about how great the economy is doing, but when I look around New York, I see a lot that concerns me.

Start with the Internal Revenue Service’s decision to deny the workaround that the state developed to counter the federal tax reform's limit on state and local tax deductibility. The IRS's move was viewed negatively for the state by Moody’s, which wrote, “The SALT cap will likely dampen housing price growth in high-tax states and states with a high percentage of SALT filers by removing an incentive for home ownership. Slower price appreciation will curb growth in assessed values.”

Moody’s added, “Depending on how taxes are structured and local governments' capacity to raise them, reduced assessed value growth will also reduce growth in property taxes.” And this statement by the credit rating agency should give New York elected officials food for thought: “With a cap on SALT deductions, voters in some municipalities will be more likely to reject tax increases because they will not be partially offset by a federal tax benefit.”

Not only is the threat of lower tax revenues a concern, but so should be the current state of the state economy and municipalities' balance sheets. Unfortunately, New York state's economic growth lags the rest of the country's. Growth could slow down even more depending on how the state economy fares with the Trump administration’s tariffs. International trade represents 13% of New York state’s GDP. Almost 30% of the employed workforce in the state is in trade-supported jobs. New York state's unemployment rate is about 4.5%, higher than the national average of 3.9%, but at least it has come down significantly since 2011 when it stood at 8.3%. Much of the job growth and decrease in unemployment, however, is being fueled by New York City.


Earlier this year, Comptroller Thomas Di Napoli announced that “spending will outpace revenues over the next three years with potential cumulative gaps totaling $17.9 billion.” New York counties are also facing significant gaps. Westchester, for example, is coping with a budget gap of almost $29 million; the amount of the shortfall could grow depending on the outcome of ongoing labor contract negotiations.

New York municipalities are challenged not only at revenue level, but also have significant significant liabilities. In its ninth annual State of the State Finances, which was released late last month, Truth in Accounting, a nonpartisan, nonprofit organization that analyzes municipal finances, gave New York state a grade of F. We are ranked 42nd in the nation largely because, as Truth in Accounting CEO Sheila Weinberg explains, “Hundreds of billions of dollars have been promised to government workers in the form of pension and health care benefits, but the state has set aside less than 1% in assets to fund these promises.” New York State’s $143 billion shortfall means that each New York state resident would need to come up with about $21,500 to cover this significant gap; this figure is just for the state; each resident would also be on the hook for her own city and county gaps.

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At the beginning of this year, the same organization published its research on New York City, which like the state received a failing grade. According to the analysis, “New York City's financial problems are largely driven by long-term debt and runaway entitlement obligations in two categories: pensions and retiree health care benefits. The city has $69.7 billion in unfunded pension promises and $79.4 billion in unfunded retiree health care benefits. While New York City has promised these benefits, little money has been set aside to fund them.”

In early September, TIA gave a grade of ‘D’ to Westchester County and to the Village of Scarsdale. According to the Westchester County analysis “Westchester County's elected officials have made repeated financial decisions that have left the county with a debt burden of $2.8 billion.” This debt burden equates to $8,400 for every Westchester taxpayer. Westchester County's financial problems stem mostly from “unfunded retirement obligations that have accumulated over many years. Of the $5.8 billion in retirement benefits promised, the county has not funded $173.5 million in pension and $2.5 billion in retiree health care benefits.” In New York State Comptroller Thomas DiNapoli’s annual report Fiscal Stress Monitoring System, which was released this week, Westchester County was designated as a municipality in “significant financial distress;” this is worse than last year, when its distress was designated as “moderate.”

Truth in Accounting’s analysis found that Scarsdale Village’s taxpayer burden of $14,600 is higher than 88 out of the 100 most populated cities in the U.S. The report mostly blamed Scarsdale's unfunded retirement obligations, which have accumulated over many years. “Elected officials have been using the city’s and county’s credit cards to charge current services and benefits; future taxpayers will be the ones stuck with the government’s credit card bills when the time comes.”

Of the $275.1 million in retirement benefits promised, the village has not funded $11 million in pension and $91.2 million in retiree health care benefits. “Scarsdale's financial condition is not only disconcerting, but also misleading as government officials have failed to disclose significant amounts of retirement debt on the village’s balance sheet. As a result, residents and taxpayers have been presented with an inaccurate and untruthful accounting of their government’s finances.” A taxpayer in the Village of Scarsdale is on the hook for a total of $44,500 in combined state, Westchester County and Scarsdale Village debt.

Between the curbs on SALT deductions and New York state, county and municipal levels of indebtedness, it is high time for elected officials to analyze carefully what waste can be eliminated, what services can be shared, and what policies can be implemented to generate significantly higher economic growth. New York state elections are Nov. 6. As taxpayers it is high time we demand more accountability from all local elected officials to deliver more than just promises.

Mayra Rodríguez Valladares is managing principal of MRV Associates, which provides financial consulting, research and training on financial regulation issues.


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Old 10-02-2018, 10:42 PM
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https://www.forbes.com/sites/morgans.../#2f04c97dcb3e

Quote:
Muni Bonds Are More Exciting Than You Think: An Activist Investor's Approach
Spoiler:

Not many people are aware that Flint’s water crisis resulted from a fraudulent infrastructure bond.
Justice is needed for those who have been financially and culturally harmed, and muni bonds are one of the best-kept secrets for getting us there.




Linda PartonSHUTTERSTOCK.COM

Let’s face it—no one gets particularly excited about muni bonds. They are a portfolio bedrock for stability and liquidity, but they don’t make for great cocktail conversation. The latest on your munis in Texas doesn’t seem nearly as riveting as Tesla’s last quarterly call.

But perhaps that’s just because we’re not paying enough attention. The “muni” in muni bonds is “municipality”—these are bonds issued by government entities that raise money for communities to do critical public works. Funding muni bonds isn’t just pushing paper around to make a return—its enabling real projects in the real world.

Sometimes these projects are great for communities, like helping a city improve its water supply or building low-income housing. Other projects can harm a community or reinforce its questionable and inequitable practices.



Activest is a new organization founded to make muni bonds exciting—by leveraging their power for positive social transformation. This interview with Ryan Bowers, co-founder of Activest, is part of The Money Story Behind the Story series that examines the role of money in critical current events. In particular, he highlights how muni bond investors can become social activists.

Q: Activest was incubated by Frontline Solutions, a racial justice organization—why did a racial justice organization decide to take on muni bonds?

YOU MAY ALSO LIKE
Frontline Solutions is a social justice management consulting firm serving foundations and nonprofits for over a decade. Our team is a mix of former grantmakers and bond traders, activists, researchers, and policy specialists. In 2015, after Michael Brown was shot and killed by the police in Ferguson, MO, some of our philanthropic clients asked us to connect them with civil rights groups in Ferguson to help them devise a rapid response grantmaking strategy. While in Ferguson, we learned from people on the ground about the patterns of institutional behavior that led to Michael Brown’s death.

City police and the municipal courts were using local residents as a revenue source, engaging in financial shakedowns for minor violations in the municipal code. Those predatory revenues accounted for a fifth of the city’s budget (the national average is closer to 2%). Before the news broke nationally of Ferguson’s racially biased policing practices and the U.S. Department of Justice’s investigation, major credit rating agencies listed Ferguson with the highest rating available (A3), which indicated that it was, according to Moody’s, “among the safest obligations in the market.” However, on September 17, 2015, after the Justice Department released its report and the Ferguson Police Department entered a consent decree, Moody’s downgraded Ferguson’s bonds to junk status. The credit rating agency’s justification was that Ferguson wouldn’t be able to pay for the combined costs of the police reforms required by the consent decree, the mounting class action suits, and its current debt service.

After watching this drama unfold in the capital markets, we wondered if the rating agencies were finally forcing Ferguson to recognize these off-balance sheet liabilities, which apparently weren’t seen as risky before the downgrade. We decided to create Activest to galvanize investors and build a movement for more responsible investment in local government.

Q: What are some examples of muni bonds gone wrong?

Not many people are aware that Flint’s water crisis resulted from a fraudulent infrastructure bond. Karegnondi Water Authority (KWA), which services Flint’s surrounding counties, proposed a pipeline to bring water to Flint from Lake Huron. The project wasn’t financially feasible unless Flint made a significant investment in the deal, which many didn’t think prudent given that Flint had already reached its debt limit and had no credit. It’s been reported that KWA leadership coordinated with elected officials to wave Flint’s debt ceiling limit. This allowed Flint to participate in the deal through a mechanism that circumvented a public vote. The city signed on to finance 34% of the Karegnondi bond offering for a total of $85 million, even though the bond would arguably benefit Flint least out of all municipalities in the region.

The money for Flint’s share would be generated by increasing the already-high water rates paid by Flint residents. Furthermore, the official bond statement required Flint to source its water from the Flint River while the project was underway. The corrosive, untreated river water caused lead to leach from residents’ pipes into their drinking water, and criminal charges were filed against members of the Emergency Managers Office and local officials for using false pretenses to participate in the Karegnondi bond sale. Class action lawsuits have further imperiled the city’s finances, and Flint is still stuck with a repayment pledge to support $64 million in Karegnondi Water Authority bonds--even though the city is no longer drawing water from the new pipeline.

Notably, Moody’s assigned the original Karegnondi deal an “upper-medium grade” of A2, and The Bond Buyer choose it as the Midwest “Deal of the Year.” If I told you Ferguson and Flint had something in common, you probably wouldn’t have guessed it was stellar bond ratings.

Higher education also provides examples of bond buying practices that can deepen the impact of injustice. Researchers at Duke University recently documented how historically Black colleges and universities (HBCUs) face “redlining” in the bond market, where they are charged higher investment fees and interest rates than predominately white institutions (PWIs). Compared to PWIs, HBCUs also pay higher fees to underwriters. This remains true when controlling for other factors such as median student income, size of school endowment, and student academic growth gains--implying that investors actively avoid accepting HBCU bonds in their portfolios, even when HBCU bonds are on par with other available securities. The effect is three times greater in the South. These barriers to capital are a critical issue for a segment of schools that research has shown perform better than most colleges at moving the lowest-income students into the highest income bracket as adults.

Q: How does Activest hope to lead the charge towards more responsible muni investing?

Every investment has both financial and extra-financial outcomes. As a society, we haven’t prioritized measuring the lines that don’t have a dollar sign on them.

Municipalities have a long history of employing extractive structural efforts such as redlining, gentrification, inequitable tax breaks, and environmental racism. At the same time, private industry has historically worked alongside local governments to further inequity—be it through Jim Crow debtors’ prisons or, more recently, Wells Fargo’s predatory lending to Black and Latino homeowners.

At Activest, we’re focused on getting local government and businesses to stop employing practices that exploit communities, and to govern and invest in ways that correct past exploitation. Justice is needed for those who have been financially and culturally harmed, and muni bonds are one of the best-kept secrets for getting us there.



We refer to our approach as Restorative Finance, emphasizing that the actions of an offender--whether a developer, financier, or municipality--harms the entire community. Restoration is created through a transparent, community-inclusive process that measures success by how much harm is repaired.

Muni investors who are considering a social justice approach should start by thinking about the cities and other entities that are issuing the bonds they purchase: Is the governing board reflective of the community? Does the city enforce any equity policies such as hiring inclusive practices, workforce development, etc.? How transparent is the issuer – do they have impact measurements and share results? Investors should also ask these questions at the project or deal level: was the community involved in a meaningful way in the planning process? Were local contractors employed on the project? Are local and/or minority-owned banks involved? These are basic “101 level” questions that investors should begin with and that they can easily bolt onto their existing due diligence processes. But ensuring that an issuance lives up to the full potential of Restorative Finance requires more advanced tools for determining its social justice merits. These include metrics for rating agencies, municipalities, and residents, reflecting unified goals and expectations across the parties involved.

At Activest, we’ve developed a proactive model for how an equitable muni bond can be issued and how investments can be chosen, and we’re seeking to partner with investors and municipalities to implement our criteria.

Q: Typically investors participate in muni funds, which purchase pieces of many muni bond offerings across the country. How can investors ensure these funds are following the sorts of standards you seek for environmental and social responsibility?

Socially responsible municipal bond funds provide reassurance that you won’t invest in anything toxically unjust, but this is largely a harm-reduction strategy: none of the existing muni funds proclaim to pursue a structural social change strategy. The entire $3.8 trillion municipal bond market has lagged on the environment, social and governance (ESG) indicator front: an enormous missed opportunity in what is probably the largest social impact market in the U.S. Add that to the $250 billion in Community Reinvestment Act (CRA) funds and the more than $5 billion in New Market Tax credits.

I would also caution readers not to invest in a bond simply because it’s labeled “green” or “social.” For instance, Los Angeles recently issued $300 million in what they’re referring to as social bonds for voter-mandated homelessness projects. However, the bond’s offering statement adds the disclaimer, “’Social Projects’ and ‘Social Bonds’ are entirely self-designating labels and lack any objective criteria.”

It should be noted that banks and insurance companies hold around 50% of all assets in the muni market, as there are substantial tax and CRA benefits for holding municipal bonds. Given the potential negative brand impact of investors’ morally questionable municipal holdings, and the modern-day redlining still occurring under many CRA-qualified investments, financial institutions should be doubly sure to know what’s actually in their portfolios. We at Activest see it as our responsibility to make that known.

Activest can only succeed if it's informed by those who would benefit most from an improved assessment of municipal risk. We need a more robust dialogue between investors of all stripes and the communities in which they invest. Whether from endowments, financial advisors, banks, insurers, or family offices, we welcome feedback from anyone interested in how municipal bonds can be used as a tool for social change. Share your thoughts, questions and real-world examples on our website, Activest.org, and join the movement for municipal bondholder activism.


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Old 10-03-2018, 06:50 AM
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http://www.governing.com/topics/fina...m_medium=email

Quote:
How a State's Age Affects Its Financial Health
The older a state is, according to new research, the more likely it is to have money problems.

SPEED READ:
The longer a state has been around, the more likely it is to have financial problems, according to the annual "Financial State of the States" report by the transparency organization Truth in Accounting.
Politics is to blame. Older states tend to have thriving environments for special interest groups, which have been shown to suppress economic vitality by running up pension and retiree health-care debt.


Spoiler:
As the nation's median age ticks up, recent research from S&P Global Ratings has warned that an older population may burden states' economic growth. As it turns out, a state's own age may also be an economic burden.

That's the suggestion from researcher William Bergman, a former financial markets analyst for the Federal Reserve Bank of Chicago and now director of research for the state debt transparency organization Truth in Accounting. Analyzing data from its annual "Financial State of the States" report, Bergman found that the longer a state has been around, the more likely it is to have financial problems.

RELATED
Pensions Are Shelling Out Billions in Fees -- and It's Not Paying Off Some States Are Less Prepared for a Recession Than a Decade Ago A Troubling Trend for Cities: Slowing Revenue But Rising Spending Growth The primary driver behind this correlation, says Bergman, is politics.
In addition to skewing older, states that have the worst financial conditions also tend to be more gerrymandered and in many cases have a higher-than-average share of lawyers in its population. Both of these characteristics can indicate a thriving environment for special interest groups, which suppress economic vitality, according to landmark research by British economist Mancur Olson in the 1980s.

This certainly appears to be the case in Illinois, Louisiana, Maryland, Massachusetts, New Jersey and Pennsylvania -- all admitted to the Union between 1787 and 1818. All six states have a high rate of lawyers per capita and are ranked by the geospatial software firm Azavea as home to some of the more gerrymandered congressional districts. These same states also rank in the lower third for taxpayer burden, according to Truth in Accounting. Louisiana's debts, at one end of the spectrum, tallied up to more than $15,000 per taxpayer. At the other end, New Jersey's equaled more than $61,000 per taxpayer.

These states, says Bergman, have allowed special interests groups to run up debt in the form of unfunded pension and retiree health-care benefits. These debts, in turn, are hurting economic growth. "You see more often the tendencies to borrow for these special interest groups as opposed to raising taxes," he says. "They're kicking the can down the road and thus putting the burden on taxpayers."

The experience of these older states should serve as a "warning" to newer ones. "It shows the importance of respecting the public purse," says Bergman, "we all have a common interest in it."

In other words, younger states like Iowa and Utah, both admitted to the Union in the 1890s, aren't necessarily doomed to face the same fate. As it stands, they both have a taxpayer surplus and relatively low levels of political machinery by traditional economic measures.

Of course, there are some outliers to Bergman's findings. Hawaii, one of the newest states in the Union, already ranks among the bottom for taxpayer burden thanks to the roughly $18 billion it owes in unfunded pension and retiree health-care benefits.

All told, 40 states have some kind of debt burden on taxpayers, much of it due to unfunded pension and retiree health-care liabilities. While some amount of debt is normal and even healthy for states, 10 states were given failing grades from Truth in Accounting because of their repeated failure to balance budgets and address growing financial burdens.


This seems a bit silly, because the states weren't founded randomly across the continent. There were spurts of state-founding. Also, I would assume Alaska & Hawaii have been around long enough at this point for them to have special interest groups, the supposed reason for bad public finance.
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NEW HAVEN, CONNECTICUT

(and others)

not being able to tax non-profit universities


http://www.governing.com/topics/educ...m_medium=email
Quote:
Towns, Gowns, and Real Estate
Spoiler:
The sun hadn’t yet risen in New Haven one day this summer when a line started forming outside the new L.L. Bean store on Elm Street. People were queuing up to get first crack at the gift certificates advertised as part of a grand opening weekend, a three-day gala with music, food, a block party and a free yoga class.

Yale University is the landlord for the new store, which is the latest addition to the Shops at Yale at Broadway, a 9,000-square-foot retail triangle just a block north of the main campus. The exact university boundary is hard to identify because Yale’s presence is stitched throughout New Haven. It comprises not only academic and research buildings and dormitories, but also the hundreds of homes Yale has bought for faculty and staff, and equally important, commercial land holdings valued at more than $100 million. The university has reshaped a city where the Ivy League campus once felt like a world of its own, separate from the factory town where thousands of workers assembled bolt-action rifles.

When the new L.L. Bean opened in August, it wallpapered a nearby column with pictures of its signature duck boot. The boot’s color matched Yale’s blue. It was not a coincidence. Yale is New Haven’s biggest player in commercial retail development. The Shops at Yale, the Chapel Street Historic District and the Whitney-Audubon Arts and Retail District are almost entirely under university control. In many of the commercial corridors, quirky local businesses have been displaced by high-end national retail chains. Where Cutler’s Records used to sell used and new vinyl albums, the British clothing brand Barbour now offers a line of trendy cotton jackets. Patagonia, Lou Lou and J. Crew are all part of the Shops at Yale, and coffee shops and bistros, all Yale tenants, line up along adjacent Chapel Street. Lauren Zucker, the university’s associate vice president for New Haven affairs and university properties, admits she often has to think like a mall operator. Yale isn’t in the retail business to lose money. Still, she insists, the university places aesthetics ahead of pure profit in selecting commercial tenants. “If you wanted to make a quick buck in retail,” she says, “you’d lease it to a fast food restaurant or a bank.”

That a university with more than 300 years of history and a $27 billion endowment would have to decide on the location of a frozen yogurt store speaks to the university’s vested interest in all of New Haven. Former Mayor John DeStefano has called the relationship between the university and the city, once frosty but thawed since the late 1980s, a matter of “mutual self-interest.” The city, long battered by economic headwinds, needs the injection of capital, the jobs that come with the expansion of a large research institution, and the affluent talent base that follows. Yale needs New Haven to provide an attractive backdrop for its campus to compete against Columbia, Harvard and Princeton universities in attracting top students and talented faculty members. As Amy Cotter, who studies town and gown politics at the Lincoln Institute of Land Policy, says, “Universities are fooling themselves if they think the community and the region around them are not part of the draw.”



The university owns the Shops at Yale, a retail triangle just a block north of campus. (Shutterstock)


The connection between a university and its host city has traditionally been one marked by mutual benefit, but also mutual suspicion and, in the worst cases, mutual disdain. Even Harvard, an icon in Greater Boston, has felt the wrath of local politicians, most notably in the 1990s when it used an outside agency to buy Boston property secretly because university officials believed anyone knowingly selling to Harvard would demand top dollar. That move earned an angry rebuke from then-Boston Mayor Thomas Menino. But the town and gown relationship has taken on a new dimension in recent years as universities’ abilities to drive the economic engine both benefits and clashes with the needs of the local communities.

It’s a challenge for cities all across the country. With 14,000 employees, Yale is the largest single employer in New Haven. Harvard ranks second and the University of Massachusetts ranks fourth among employers in Greater Boston. The University of Southern California has for more than a decade been among the largest private employers in greater Los Angeles. In at least 25 metropolitan areas in America, higher education institutions and their accompanying hospitals, a sector often dubbed “eds and meds,” account for roughly 1 in 6 local jobs, according to an analysis of 2016 federal data by the Martin Prosperity Institute.

Mayors in New Haven, Boston, Philadelphia and Pittsburgh have all been largely supportive of benefits from the expansion of the universities. But the growth comes at a steep dollar cost to these college towns. Boston, Cambridge, Mass., New Haven, Philadelphia and Pittsburgh have collectively lost billions in property tax revenues because of the tax-exempt status of their universities and affiliated medical centers.

According to a Lincoln Institute study in 2009, universities in Boston were sitting on more than $12 billion in real estate, which if taxed would have generated more than $340 million for the city. Through voluntary contributions in lieu of taxes, colleges and hospitals in Boston sent the city about $14 million that year. Tom Murphy, the former mayor of Pittsburgh, says this is the predicament cities who play host to major research universities invariably confront. “You want the universities to grow, you need the jobs they provide,” Murphy says. “But as they grow, you lose property off the tax roll.”


Gifted with its huge endowment, Yale has created an urban center that would not exist without its money and influence. Each summer, parents, prospective students and tourists flock to the city to lay eyes on an institution older than the country itself, and to spend money in the Yale-controlled business district. This is the New Haven that nearly all the visitors see. But it is not the only New Haven. Once a manufacturing hub where the rifle maker Winchester Repeating Arms employed more than 15,000 workers, the industrial core of the city has been hollowed out over the last 40 years. Poverty has followed and persisted. Currently, 1 in 4 New Haven residents lives at or below the poverty line.

For many years, as the town struggled and the university grew, Yale remained an island seemingly cut off from the ills of the city. A statewide fiscal crisis in the late 1980s began to change that. New Haven was on the verge of bankruptcy in part because the state was underfunding aid meant to compensate cities for the taxes lost to large nonprofit landowners like Yale and the university’s hospital. Douglas Rae, who teaches management and political science at Yale and was chief of staff to the mayor in the early 1990s, helped broker a deal where Yale would voluntarily pay New Haven a fee each year to offset the cost of public services that benefited the university. It wasn’t so much a partnership; it was the university throwing the city a lifeline that would in turn help Yale. “The university,” Rae says, “was willing to make modest concessions to the city, but wanted wherever possible to justify it through direct self-interest that alumni would understand.”

Yale was slowly acknowledging that its fate was tied to New Haven. The “Yale bubble” was pierced for good in 1991, when a varsity lacrosse player, Christian Prince, was murdered walking to his apartment near the campus. “The Prince murder,” Rae says, “was the event that caused Yale University and the Yale Corporation to say we have to give the highest priority to the community around us.”

Former Yale President Richard Levin took office in 1993, shortly before DeStefano became mayor. They each served nearly 20 years. And it was under the leadership of the two that town and gown would enter a marriage of sorts.



Under former President Richard Levin, Yale aggressively expanded its real estate footprint. (AP)


Under Levin, the university began to aggressively extend its real estate footprint both commercially and in residential real estate. Yale purchased the financially challenged Chapel Street Historic District and became landlord to the businesses in that district. It began to extend its reach into the residential neighborhoods through handsome housing subsidies offered to faculty and staff. Yale offers $30,000 in cash assistance to employees who buy in the city, with an additional $5,000 for those who purchase homes in the long-blighted Dixwell neighborhood. In all, the program has invested $31 million since it was launched. “Certainly, there are pros and cons when the university and its students and faculty expand their footprint in the city,” says the Lincoln Institute’s Adam Langley. Yale employees buying homes are contributing to the city’s tax base. But the investment has come at a cost.

The housing cash incentive has helped fuel gentrification in places such as East Rock, a traditional Italian enclave where rising home prices and corresponding spikes in property taxes have pushed out working class white residents. The Dixwell and Dwight neighborhoods have also felt the impact of Yale’s homeownership program in the form of displacement.

DeStefano and Levin’s transformation of New Haven resembles events in other cities with powerful universities. The neighborhoods surrounding the University of Pennsylvania in Philadelphia have seen similar shifts in the housing market thanks to home-buying subsidies and major investments by Penn in the nearby University City neighborhood. Housing prices have tripled there in the last 15 years, while the black population in University City has declined by more than half.

As Yale has reshaped -- and in many ways, revived -- its host city, it has left a gaping hole in the city budget. Thanks mostly to the university, a full 54 percent of all the property in New Haven is tax exempt. Student housing, academic buildings, research facilities and Yale’s sprawling hospital complex all escape taxation. Despite these exemptions, Yale is still the fourth-largest property taxpayer in New Haven, because of the size of its retail presence. But of the $3 billion in real estate Yale owns, it pays property tax on roughly 3 percent -- the commercial space it rents out in the city. Since 2014, Yale has invested $700 million in new construction, all of it tax exempt.



The areas highlighted in blue encompass Yale’s tax-exempt academic properties (but not its taxable commercial land holdings).


The sales tax money collected in New Haven goes to the state, which in turn sends some of it back in the form of state aid. Under its payment in lieu of taxes (PILOT) program, the state is supposed to reimburse the city at a rate of 77 cents for every $1 of untaxed property owned by an institution of higher learning. But the cash-strapped state has never met the terms of the agreement, and in recent years has sent New Haven 33 cents on the dollar. The reduction in state aid through PILOT, coupled with city pension obligations, caused Standard & Poor’s to downgrade New Haven’s bond rating to BBB+/Negative in July.

Standard & Poor’s report predicted that the city, despite its large and wealthy university, would have to turn to its homeowners to pay more in property and car taxes to fill the budget gap. “This could prove difficult,” the report noted, “given New Haven’s overall high amount of tax-exempt property and weaker wealth and income factors relative to other Connecticut municipalities.”

Yale has attempted to fill some of the gap left by the state. This year it will increase its voluntary contribution in lieu of property taxes from $7.5 million to $10 million. But as pension and health-care costs continue to stress the city financially, and the state continues to cut back on aid to cities, New Haven will face fiscal headwinds despite the success of its famous tenant. “We are looking at fiscal strains to New Haven that voluntary contributions by Yale are not going to cope with,” Rae says. “I don’t think we are near what would be realistic levels in terms of New Haven’s financial needs in the next 25 years.”


As big universities go, Yale is far from the worst tax evader. Its voluntary contribution is actually the largest in the nation paid by a single university to its host city. By comparison, the University of Notre Dame, which has an annual television deal with NBC worth $15 million to broadcast its football games, voluntarily gives the city of South Bend $500,000 under its PILOT program. In Pittsburgh, neither the University of Pittsburgh nor Carnegie Mellon University provides a contribution in lieu of taxes directly to the city, despite recent efforts to establish voluntary payments.

Pennsylvania is an interesting case. It compensates municipalities which are home to state parks, but it refuses to reimburse Pittsburgh and Philadelphia for the revenue losses caused by large research universities. Pittsburgh tried to sue the University of Pittsburgh Medical Center in 2014 over its tax-exempt status, but pulled back and has since tried to negotiate a voluntary payment system. The University of Pittsburgh, the medical center and Carnegie Mellon have chosen instead to contribute to Pittsburgh Promise, a program that pays college tuition for graduates of the city’s public schools. Similarly, in Philadelphia, the University of Pennsylvania and Drexel University have balked at direct payments to the city, and have not committed to a plan favored by Mayor Jim Kenney that would use revenue from those institutions to help shore up funding for K-12 schools in lower-income districts in the city.



In Philadelphia, the University of Pennsylvania has balked at the idea of direct payments to the city. (Shutterstock)


Penn and a handful of other colleges and universities in the Philadelphia area fund what is called the University City District, a partnership between the colleges and neighborhood nonprofits which provides additional policing, street cleanup, funding for street lighting and job placement for low-income residents. Since the mid-1990s, Penn has spent more than $2 million a year on programs and poured $640 million in payments to the Philadelphia Police Department for additional patrols around campus.

Kenney has considered trying to establish a PILOT program funded by the universities, but that would be difficult. A Pennsylvania law bars cities from taking legal action against universities that fail to compensate them for the cost of public services. Prior to the enactment of that law in the 1990s, Philadelphia collected $9 million a year in PILOT payments from its universities. Opponents of a new PILOT program point out that Philadelphia levies a wage tax on all who work in the city. While New Haven is almost entirely dependent on property taxes, Philadelphia collects much more in wage taxes than it does from taxes on property.

Although many universities agree to voluntary PILOT programs, the agreements leave a tremendous amount of leverage with the universities. Take Harvard. In 2014, when Harvard offered $4.3 million, or just a bit more than half of what Boston city officials asked for, the university pointed to the more than $45 million it had given to Boston and Cambridge in the preceding decade. Officials continue to accuse Harvard and other Boston-area universities of being “one-sided” in their community relationships. “The frustration is that you’re talking about a university -- this isn’t John Smith Vocational School,” then Cambridge Councilman Marc McGovern said. “Harvard has more money than many third-world countries. They are going to be expected to do more.”

Yale says its obligation to New Haven has never been to make the city whole for hosting the university, but to recognize the interdependence of the two entities. This is a common argument. “The current law in states around the country is that nonprofits are completely exempt from taxes,” says Langley of the Lincoln Institute. “And part of the reason for that is these nonprofits and these anchor institutions do provide a lot of important benefits to the cities where they are located.”

Still, officials in New Haven have been growing more aggressive about lobbying for a higher PILOT contribution from Yale. Connecticut state Sen. Martin Looney has called on Yale to guarantee 50 cents on the dollar to New Haven. Some have pushed for the city to sue Yale in an effort to tax the school’s endowment. Those efforts would be in vain, however. Yale’s nonprofit status is enshrined in the Connecticut Constitution.


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PENNSYLVANIA

https://www.watchdog.org/pennsylvani...99537e29b.html
Quote:
Report: Pennsylvania's debt much higher than reported, up to $82 billion
Spoiler:
Like other states, Pennsylvania is staring at a public pension debt that raises alarm bells.

Pennsylvania did pass a pension reform bill in 2017, a fact cited by incumbent Gov. Tom Wolf recently during the lone gubernatorial debate of this election cycle, but Republican challenger Scott Wagner argued that the reform, while well-intentioned, was hardly sufficient.

According to good government group Truth in Accounting, Wagner may be more right than he knows, and in fact the size of the state’s public pension and retiree health care debt may be larger than the state itself has acknowledged. That’s according to a recent report, “The Financial State of the States,” which assigns Pennsylvania a “D” grade and identifies $82.1 billion in unfunded debts.

Truth in Accounting said the debt works out to $18,800 for each taxpayer, an increase from the $8,200 per capita debt the group calculated for 2009.

“Pennsylvania's financial condition is not only alarming but also misleading as government officials have failed to disclose significant amounts of retirement debt on the commonwealth’s balance sheet,” the TIA report says. “Residents and taxpayers have been presented with an unreliable and inaccurate accounting of their government’s finances.”

TIA’s CEO and founder, Sheila Weinberg, and state Rep. Seth Grove, R-York, each told Watchdog.org in separate interviews that new federal accounting rules will soon eliminate the reporting problem when it comes to public pension and retiree health care debt. But either way, that debt is looming.

“in 2015 … state and local governments finally had to start putting their pension liability on the face of their balance sheets,” Weinberg said. “But they are not required to put the majority of their retiree health care liabilities on their balance sheets. Next year, they'll be required to do that. But they're still hiding some of those liabilities.”

Grove said that the sheer size of Pennsylvania’s debt, even in light of the recent reforms, threatens to create a “financial death spiral.”

‘I look at failed entities, whether it's a private business, or it’s an individual, or it’s a government, it always starts with their debt,’ he said. “So they’ll ring up debt, and then their debt payments pull money out of their operational fund, and then they can’t pay their bills. ... Pennsylvania is moving that direction. We’ve got to tighten the belt, we’ve got to stop using borrowing as a revenue source, and continue working on pensions.”

+1
PA Rep. Pamela DeLissio Fall 2018
Pennsylvania state Rep. Pamela DeLissio, D-Philadelphia, speaks during a recent meeting of the House Local Government Committee.

Image courtesy of the Pennsylvania House of Representatives
State Rep. Pamela DeLissio, D-Philadelphia, told Watchdog.org that the failure of the 2017 reform to really tackle the pension debt was at least partly the fault of the Republican majority in the Legislature.

“The majority party led General Assembly put forth [Senate Bill 1] in 2017 (now Act 5) that was labeled as pension reform, and the discussion on funding the existing liability was deferred,” she said. “The reform will aid in ensuring that the unfunded liability will not grow in future years and will also spread risk in future years. Act 120 of 2010, as I understand it, remains on track to reduce the unfunded liability over the projected 20 some years.”

Grove said that the flaws of SB1 were the result of Gov. Wolf’s failure to properly grapple with the scope of the pension crisis, and that the legislation put forth by Republican leadership was the best they could hope for given the reluctance they were facing from the administration.

“I think the pension bill we passed was as good as we're going to get from a governor who, when he started in office ... said we didn't have a pension problem,” he said. “It took a lot of work to get him to the point where – and I think it was mostly that he just didn't want to deal with it anymore, versus whether he actually thought there was a pension problem in Pennsylvania. But we were able to get some reform through.”
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https://www.jpmorgan.com/directdoc/ARC4_ES.pdf

Quote:
The ARC and the Covenants 4.0
J.P. MORGAN PRIVATE BANK
The State of the States, 2018

The “ARC and the Covenants 4.0” is our latest analysis of fiscal stress facing US states. We define stress as the percentage of state
revenues needed to pay interest on general obligation debt, and meet all future pension and retiree healthcare obligations.
Most states have burdens that are manageable (which we define as 15% or less). However, there are a few states whose burdens
are so large as to require tax increases or spending cuts that may not be politically or economically feasible. I participated in a
seminar at Harvard’s Kennedy School last year, and there was a sense that the US should use the Promesa legislation for Puerto
Rico as a dry run for creating state-level bankruptcy rules, just in case. Based on the trajectory of funding ratios in a couple of
states, I understand why some public policy analysts advocate the expansion of Chapter 9 legislation to states as well.
Spoiler:
The ARC and the Covenants: The State of the States, 2018
A few years ago, we launched a project to assess the fiscal stress that US states, cities and counties face
due to unfunded pension and retiree healthcare obligations. While these obligations are not explicitly
cross-defaulted with municipal bonds, recent precedent suggests that we pay close attention anyway:
when public sector employees suffer writedowns to pensions or retiree healthcare, bondholder losses are
usually worse1
. As managers of $75 billion in municipal bonds on behalf of our clients (Q3 2018), the
issue of unfunded obligations is of paramount concern.
We named this project “The ARC and the Covenants”. ARC stands for “Annual Required Contribution”,
and refers to the amount municipalities would have to pay each year to fully meet unfunded obligations
over time, based on certain assumptions. We divide ARC payments by municipal revenue to get a sense
for how large the burden is. The chart shows the results from our latest analysis on US states, for which
we reviewed over 300 single and multi-employer pension, defined contribution and retiree healthcare
plans. The bottom line: many states have ratios that are manageable (which we define as 15%
or less). However, there are a few states with severe problems. I participated in a seminar at
Harvard’s Kennedy School last year, and there was a sense that the US should use the Promesa legislation
for Puerto Rico as a dry run for creating state-level bankruptcy rules, just in case. I think the expansion of
Chapter 9 legislation for states makes sense, and I’m not the only one2
.

1
Examples include Central Falls (RI), Vallejo (CA), San Bernadino (CA), Stockton (CA) and Detroit (MI), which we
discussed in Exhibit SM7 of our 2017 ARC and the Covenants piece on cities and counties.
2
"The city of Chicago and the state of Illinois should act now to restructure their liabilities and put the fiscal mess
behind them. This can be accomplished by utilizing Chapter 9 and other tools Congress just gave Puerto Rico. The
process would entail about two years of unpleasant headlines, but the city and the state will rebound far sooner
and less painfully than if they stay on their current paths", former FDIC Chairman William M. Isaac, 2016.
0%
5%
10%
15%
20%
25%
30%
35%
40%
45%
50%
IL
NJ
HI
CT
KY
MA
MD
PA
DE
WV
CA
AK
GA
TX
SC
RI
AL
VT
MT
CO
ME
MO
NY
WA
LA
NH
NM
MS
NC
NV
VA
OR
AR
KS
MI
WI
IN
UT
FL
MN
OK
AZ
TN
IA
OH
WY
ID
SD
NE
ND
What states would have to pay assuming a 6% plan return and 30 year level dollar amortization
What states are currently paying
Source: J.P. Morgan Asset Management, State Annual Financial Reports, Moody's. FY 2017.
The cost of unfunded pensions and retiree healthcare as a % of state revenues
% of state revenues required to pay the sum of interest on net direct debt, the state's share of unfunded pension and
retiree healthcare liabilities, and defined contribution plan payments
EYE ON THE MARKET  J.P. MORGAN
MICHAEL CEMBALEST October 9, 2018
2
We refer to our ratio as an “IPOD” ratio, since it measures Interest, Pension, OPEB (retiree healthcare)
and Defined Contribution payments as a percentage of state revenues. In our analysis, we amortize
unfunded balances over 30 years, and assume a 6% return on pension and OPEB plan assets.
To understand the stress a few states are under, look at Table 1. The current IPOD ratio indicates how
much states now pay as a % of revenues, and the revised IPOD ratio is what they would need to pay to
fully meet unfunded obligations over time. The middle section shows the primary ways the gap could be
filled: tax hikes, increased worker contributions or higher investment returns. Illinois and New Jersey
come closest in my view to deteriorations in pension finances that are practically irreversible.
 Increase tax revenues. To be clear, this tax hike would have to be in place for 30 years, and be
used solely for contributions to underfunded plans. It’s unclear if such tax increases are politically
viable when considering that state public sector workers generally represent 3%-7% of all workers in
the state. If spending cuts were chosen instead of tax hikes, they would be similar in magnitude3
.
 Increase public sector worker contributions. Require active public sector workers to shoulder the
burden on their own, with no help from taxpayers4
. The increases are 4x or more in some cases.
 Achieve massive investment returns on plan assets. First thing to notice: there are no solutions
for some plans given how underfunded they are, or if states are dealing with them on a “pay-go”
basis and not prefunding them at all. Second: even when required investment returns can be
computed, I consider any investment return in double digits to be practically unachievable5
.
Table 1

3 Most states run balanced budgets so the figures are similar, but spending cuts would need to be a bit larger
since cuts would have to be made to non-pension spending (and not overall spending).
4
In Hawaii, public employees are required to contribute between 6% and 8% of pay to the retirement system.
However, employers end up paying most of these contributions on their behalf. As a result, baseline amounts of
actual worker contributions paid are small, and would have to increase astronomically to close the funding gap.
5
The 90th percentile of all 30-year real returns on a 70/30 stock bond portfolio since 1956 is 7.1%. Assuming 2.5%
future inflation, the 90th percentile nominal return since 1956 would be 9.6%. As a result, any breakeven return
above 9.6% would require returns in the top decile of historical performance.
TAXPAYERS PUBL SEC WORKERS STATE FUND MANAGERS
State
Current
IPOD
ratio
Revised
IPOD
ratio
Increase in
tax revenues
Increased
contributions
Req. pension
inv return
Req. OPEB
inv return
IL 26% 51% 25% or 689% or 11.5% and No solution
NJ 17% 38% 22% or 521% or No solution and No solution
HI 21% 37% 16% or 117091% or 11.3% and 18.2%
CT 22% 35% 12% or 408% or 10.5% and No solution
K Y 12% 28% 16% or 427% or No solution and No solution
MA 14% 25% 10% or 237% or 10.2% and No solution
MD 13% 20% 7% or 216% or 8.1% and No solution
P A 7% 17% 10% or 532% or 13.0% and No solution
DE 10% 17% 7% or 614% or 7.6% and No solution
WV 14% 16% 2% or 116% or 6.1% and 17.5%
CA 8% 15% 6% or 387% or 8.6% and No solution
Source: J.P. Morgan Asset Management, State Annual Financial Reports, Moody's. FY 2017.
Largest revised IPOD ratios Who funds the gap, every year for 30 years (mutually exclusive)
EYE ON THE MARKET  J.P. MORGAN
MICHAEL CEMBALEST October 9, 2018
3
Why do some states have such large unfunded obligations relative to revenues? Some enacted
benefit increases before a market decline, which resulted in a large funding gap. Some contributed well
below recommended levels for many years, worsening funding ratios further. And in some cases, the
size of the pension/OPEB system is large relative to the state’s economy and tax base.
Table 2 summarizes key statistics on pension and OPEB plans for the weaker states:
 Funding ratios6
. The reported versions indicate what states disclose for their pension and OPEB plans.
The revised versions are what we estimate them to be, using a 6% discount rate.
o The projected 10-year pension funding ratio represents our rough estimate assuming the state
continues its contribution pattern, and earns a 6% return on assets. Most projected ratios are
not substantially different from current ones, suggesting that depletion risks are not imminent.
o However, this assumes that states like IL, CT and HI continue to allocate 20%-25% of state
revenues to underfunded plans; this may not be feasible forever, given competing needs related
to public services, infrastructure and education7
. There’s also the risk of market volatility that
depresses funding ratios, which would raise ARC payments further. In other words, these are
rough estimates that are sensitive to a variety of investment and political outcomes.
o Most states do not prefund OPEB plans, and use a pay-as-you-go approach
 Contributions to underfunded plans. “Actual vs reported ARC” shows what the state paid in FY
2017 relative to its reported ARC. The revised version shows the state contribution relative to our
recomputed ARC, using both different return and amortization assumptions. “Level dollar” vs “level
percent” amortization makes a big difference, and is explained in the supplementary materials.
 Pension vs OPEB shares. The last 2 columns show the pension and OPEB shares of the combined
revised state ARC. Bottom line: unfunded pensions are generally the larger problem.
Table 2

6
For context, the average corporate pension funding ratio was 86% in 2017, according to the Milliman 100 Index.
Corporate plans also use lower discount rates (3.6% avg) than public plans (7.1% avg) use to discount liabilities.
7 A 2017 paper from UC Berkeley found evidence that rising pension expenditures are crowding out public
services. Major finding: a 10% increase in per-employee pension expenditures is associated with a 0.73% drop in
city employment the following year, as well as declines in spending on construction and equipment.
State
Reported
funding
ratio
Revised
funding
ratio
Projected 10-
year pension
funding ratio
Actual vs
reported
ARC
Actual vs
revised
ARC
Reported
funding
ratio
Revised
funding
ratio
Actual vs
reported
ARC
Actual vs
revised
ARC
Pension
share
OPEB
share
IL 38% 34% 52% 95% 53% 0% 0% 17% 11% 78% 22%
NJ 36% 40% 27% 49% 35% 0% 0% 30% 36% 58% 42%
HI 55% 48% 65% 100% 41% 9% 7% 89% 61% 56% 44%
CT 41% 35% 53% 99% 62% 3% 4% 57% 42% 71% 29%
K Y 34% 40% 40% 72% 36% 33% 29% 138% 43% 77% 23%
MA 60% 50% 64% 100% 45% 5% 7% 29% 36% 78% 22%
MD 69% 56% 71% 99% 61% 3% 4% 63% 63% 79% 21%
P A 55% 48% 61% 102% 28% 1% 2% 55% 47% 75% 25%
DE 82% 74% 82% 99% 58% 4% 6% 43% 45% 39% 61%
WV 79% 67% 76% 100% 93% 25% 22% 69% 53% 71% 29%
CA 68% 57% 72% 100% 53% 1% 1% 53% 36% 68% 32%
Source: J.P. Morgan Asset Management, State Annual Financial Reports, Moody's. FY 2017.
PENSIONS OPEB Unfunded ARC
EYE ON THE MARKET  J.P. MORGAN
MICHAEL CEMBALEST October 9, 2018
4
Other than tax increases, spending cuts and increased worker contributions, is there anything
else states can do to solve this problem? Once pension obligations have been accrued, they cannot
be altered; case law has confirmed this. The only exception: states can reduce cost of living adjustments,
but most have already done that. Retiree healthcare (OPEB) obligations, on the other hand, can be
altered at the state’s discretion; the most common changes are increased retiree premium contributions,
co-payments and deductibles. Since our last state analysis two years ago, some states enacted changes
that substantially reduced projected OPEB liabilities: Iowa (-38%), Kansas (-100%), Louisiana (-34%),
Minnesota (-69%), Nevada (-73%), North Carolina (-37%), Texas (-38%) and Virginia (-28%). In other
states, they rose compared to last time. And as stated on the prior page, unfunded OPEB obligations are
usually smaller than unfunded pensions.
To see how sensitive IPOD ratios are to OPEB restructuring, we ran an alternative scenario that makes an
arbitrary 33% reduction to all retiree healthcare liabilities, and that amortizes unfunded pension
and OPEB obligations over 50 years instead of 30 when computing ARC payments
8
. Both assumptions
lower the IPOD ratios, but not by enough to change our assessment of risk for the weaker states on the
left hand side of the chart.
Some states make payments on behalf of local municipalities, referred to as Special Funding situations.
For example, Illinois, New Jersey and Connecticut IPOD ratios would fall substantially if local
municipalities started making these payments instead. However, our sense is that most local entities are
not financially sound enough, or politically willing, to do so. See SM2 in the Supplementary Materials for
more information on Special Funding.
Since we’re just a few weeks away from one of the most widely anticipated midterm elections in years,
here’s some history on the local politics of underfunded pensions. The weaker states are generally
“blue” ones: of the 11 states with IPOD ratios over 15%, 7 have state legislatures that were controlled
by Democrats for the last 20 years; 2 state legislatures were mixed (Kentucky and Delaware); and 2 state
legislatures were controlled by the GOP (Alaska and Pennsylvania).

8 This effectively allows states to maintain funding ratios from 60%-70% for many years while they wait
for compounding benefits to kick in.
0%
5%
10%
15%
20%
25%
30%
35%
40%
45%
50%
IL
NJ
HI
CT
KY
MA
MD
PA
DE
WV
CA
AK
GA
TX
SC
RI
AL
VT
MT
CO
ME
MO
NY
WA
LA
NH
NM
MS
NC
NV
VA
OR
AR
KS
MI
WI
IN
UT
FL
MN
OK
AZ
TN
IA
OH
WY
ID
SD
NE
ND
IPOD ratio based on reported OPEB liabilities and 30 year amortization
IPOD ratio assuming 33% haircut to reported OPEB liabilities and 50 year amortization
Source: J.P. Morgan Asset Management, State Annual Financial Reports, Moody's. FY 2017.
What if states make large cuts to retiree healthcare and use a much longer amortization period?
% of state revenues required to pay the sum of interest on net direct debt, the state's share of unfunded pension and
retiree healthcare liabilities, and defined contribution plan payments
EYE ON THE MARKET  J.P. MORGAN
MICHAEL CEMBALEST October 9, 2018
5
While a lot of states have low, healthy IPOD ratios, they are generally not the ones issuing all the debt.
The next chart shows each state’s IPOD ratio alongside its proportion of all general obligation debt.
Over 50% of general obligation debt outstanding corresponds to states with IPOD ratios over
15%. For these reasons, our asset managers are generally cautious about general obligation exposures
to weaker states. When they do invest there, they consider what (if any) exposure a particular issuer may
have directly or indirectly to a state retirement system. In the $3.7 trillion municipal bond market, many
issuers have no exposure, such as the Northwestern Memorial Healthcare in Illinois, or Princeton
University in New Jersey. Other issuers, such as local public utilities, may also be separate legal entities,
and enjoy segregated revenues and participate in a better-funded local pension.
Before concluding, I want to be clear about something. Public sector workers form a critical part of
our civil society. They risk their lives to protect us when we’re in danger; they make our lives safer,
cleaner and more efficient; they educate our children; they enforce the rule of law and provide remedies
when laws are broken; they ensure access to clean air, water and food; and they heal us when we’re
sick. The legal, medical, environmental and educational problems sometimes found in other countries are
a reminder of what life might be like without them. They have earned the benefits they accrued and
which were granted by state legislatures, and have the right to expect them to be paid.
The supplementary materials review the debate around public plan discount rates, the risks around
the timing of market returns, Special Funding situations, the pace of asset depletion in underfunded
plans, the history of public plan funding ratios since 2000, some history on New Jersey, descriptions of
our methodology and data sources, and full results tables for all 50 states.
Michael Cembalest
JP Morgan Asset & Wealth Management

Supplementary material:
https://www.jpmorgan.com/directdoc/ARC4_SM.pdf
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