Affordable Housing Institute : US

[Continued from yesterday's Part 4 and the preceding Part 1, Part 2 and Part 3.]

 

By:David A. Smith

 

In late November, 2011, as the Commonwealth of Pennsylvania was moving to appoint a receiver for its state capitol, Harrisburg, the city council by a 4-3 vote abruptly filed a bankruptcy petition, which was immediately contested by the city’s mayor and the state, and rejected (as reported in the New York Times (November 23, 2011) (brown font):

 

Washington — A federal judge dismissed a bankruptcy suit for the city of Harrisburg, Pa., on Wednesday, saying that the filing, made by the City Council last month, was illegal.

 

The ruling on Wednesday had little effect on the city’s current financial situation. It dismissed a stay against claims from creditors, but creditors had not been actively pursuing those claims in court, so there was no immediate effect.

 

“Most people predicted the judge would rule this way,” said William W. Kannel, a partner at Mintz Levin in Boston, who is an expert on bankruptcy law. “It’s very clear, states are entitled to control their municipalities’ access into Chapter 9 bankruptcy.”

 

Who would file in Chapter 9 must answer me these questions three, ere the other side he see

 

Principal sources used in this post

 

New York Times (October 12, 2011) (teal font)

Harrisburg Patriot-News (July 19, 2012) (brown font)

Harrisburg Patriot-News (March 19, 2013) (green font)

SEC release 2013-82 (May 6, 2013) (blue font)

Wall Street Journal (May 7, 2013) (black font)

 

In came receiver David Unkovic, and his is the most remarkable tenure of them all.

 

I’m here to shake things up – that means you.

 

It lasted only 4½ tumultuous months and culminated in his resignation as receiver via a handwritten letter reproduced below.

 

 

The core text reads:

 

“I have done my best to use my powers as receiver to bring fiscal stability to the City of Harrisburg.  However, I find myself in an untenable position in the political and ethical crosswinds and am no longer in a position to effectuate a solution.”

 

“I wish the citizens of the City of Harrisburg well in their ongoing quest for fiscal stability and good government, both of which they truly deserve.”

 

And here’s a tidbit about that letter:

 

He even wrote his resignation letter by handso his secretary couldn’t be implicated.

 

According to a Patriot-News op-ed by community activity Michael Sand (April 13, 2012), “David Unkovic was a top-notch professional. …  When he reviewed the history of what had caused the massive debt, he was appalled.  At a public hearing, he got so upset that he banger on the table and talked about ‘twenty years of mismanagement’.  How many groups cooperated fully with him?  None.  How many groups cooperated at all with him?  None.  How many groups opposed every single step he took?  Every one.  Have you figured out yet why David Unkovic resigned?”

 

Now go away or we will taunt you a second time

 

Two and a half months after his resignation, Mr. Unkovic wrote a courageous and blunt op-ed for the Harrisburg Patriot-News (June 10, 2012):

 

The average citizens on the streets of Harrisburg did not know about the depth of harmful acts by those they had elected.

 

They could not have understood there was a highly sophisticated, multi-hundred million dollar debt scheme going on, as shown now in the forensic audit.

 

They did not know (and the suburban residents did not know) that sewer customers were being overcharged and those monies were being diverted to other purposes. The people who did know what was going on were certainly not telling the people of Harrisburg about it.

 

What went on in those 4½ months?  We learned only a year after Mr. Unkovic’s resignation, in a thorough article by dogged reporter Don Gilliland as reported in the Harrisburg Patriot-News (March 19, 2013) (green font):

 

If you do not tell us where we can buy a shrubbery, my friend and I will say … ‘Ni’!

 

Providence, R.I. — The education of David Unkovic didn’t take long.

 

Within a matter of weeks after arriving in Harrisburg as Pennsylvania’s first state-appointed receiver, the self-described “public finance technocrat,” realized the problem wasn’t nearly as simple as he’d imagined.

 

What’s more, he also suspected he would not survive, so he began to plan.

 

What sad times are these when passing ruffians can say ‘Ni’ at will to old ladies

 

Unkovic wrote: “I thought, going into the job, that Harrisburg had a debt problem due to the incinerator financings, and I was confident that I could, with assistance from consultants, fix the problem through a workout.”

 

Upon resigning his office, Mr. Unkovic basically went off the grid – he stopped responding to emails, took no phone calls, did no interviews.

 

He went birding

 

That silence was deliberate (with his resignation, Mr. Unkovic had lost his statutory immunity from libel), and he waited out the safe period.

 

In a white paper presented to a national symposium on Distressed Municipalities in Providence, R.I., hosted by public finance trade publication The Bond Buyer on Monday, Unkovic spelled out the financial challenges facing local municipalities generally – and his strategy for Harrisburg specifically.

 

According to the white paper, Unkovic “fairly quickly” came to seven “unsettling conclusions”:

 

There is a pestilence upon this land, nothing is sacred.

 

These are direct quotes from Mr. Unkovic’s paper, which is well worth reading in its entirety:

 

1.     The incinerator financings were very, very bad transactions in many respects, and some very disturbing things were done in those financings.

2.     In addition to the incinerator problem, the city had a very large structural deficit caused by other huge problems which would require significant resources to solve.

3.     The bond creditors were not willing to back off on their litigation against the city.

4.     The DCED recovery plan in its most important aspects simply did not work.

5.     I would need to come up with a new plan that would be much less favorable to the bond creditors.

6.     The bidding processes that had been conducted for the city’s assets were not acceptable and I would have to start new bidding processes.

7.     And there were very powerful political forces who wanted the DCED plan reconfirmed and the bond creditors taken care of.

 

Even those who arrange and design shrubberies are under considerable economic stress at this period in history

 

Mr. Unkovic decided that he had a finite amount of political capital, so he decided to spend it aggressively, expecting to leave when it reached zero. This is brilliant and brave. 

 

“I believed that there were certain things I could get done before I got immolated by the politics,” wrote Unkovic.

 

He began to put in place the things he believed were needed for a true recovery.

 

He pushed the forensic consultants to finish and issue the forensic audit on the Harrisburg incinerator financings as quickly as possible.

 

“The truth needed to come out for a fair outcome to be possible,” wrote Unkovic.

 

One can say only, Bravo.

 

Harrisburg could be … Camelot!

 

He set to preparing – and getting the Commonwealth Court to approve – “a recovery plan that could really work, that is, that was a true fiscal plan for the recovery of the city.”

 

He hired “a team of consultants that were highly qualified and could get the plan implemented” even if he were gone.

 

And Unkovic was determined to “deal fairly and directly with all the elected city officials and the people of the city to increase the likelihood that they would eventually accept the plan.”

 

“Over the course of four months, all those things were accomplished,” he wrote, and having put all the pieces in place, Unkovic went out on his own terms.

 

 

“The politics and litigation came to the point where I needed to and did call out the forces who were trying to undermine the recovery process,” he wrote in the white paper.

 

Unkovic suddenly – and unexpectedly – directed the spotlight of the receiver’s office onto the people and institutions he believed were operating in the dark, behind the scenes, to orchestrate a deal that would benefit themselves at the expense of the people of Harrisburg.

 

Be quiet!

 

Arthur: Be quiet!

Dennis: Well you can’t expect to wield supreme executive power just ’cause some watery tart threw a sword at you!

 

Do I look like I acted in Haste?  I’m repenting, I’m repenting

 

Both in federal court and in a press conference, Unkovic criticized Dauphin County Commissioner Jeff Haste, State Sen. Jeffrey Piccola,

 

Now out of politics.

 

No longer sitting behind a Senator’s placard

 

AGM,

 

That’s Apollo Global Management, a private equity and alternative-investment bank, led by Leon Black, few people’s favorite person.

 

Shut up!

 

Arthur: Shut up!

Dennis: I mean, if I went around sayin’ I was an emperor just because some moistened bint had lobbed a scimitar at me they’d put me away!

 

Obviously, Mr. Unkovic chose the moment for his dramatic last stand only when he had done everything else he thought he could.

 

financial group RBC Dain Rauscher (and Royal Bank of Canada, which acquired it), and Stan Rapp, who heads Greenlee Partners, a prominent lobbying firm that represents AGM, the county and RBC in the city’s debt crisis.

 

(Mr. Rapp’s web site bio describes him as “breathes, eats, and sleeps politics; will be first in line for a surgically implanted cell phone.”)

 

Not taking the Rapp

 

Arthur: Shut up!  Will you shut up!

Dennis: Ah, now we see the violence inherent in the system. 

 

You see ‘im repressin’ me?

 

He wrote to the state Attorney General and the U.S. Attorney asking them to conduct a criminal investigation of the incinerator financings.

 

When he was told he’d be removed as receiver but could stay on the state payroll in another capacity, Unkovic resigned.

 

And the machinery Unkovic put in place for Harrisburg’s recovery is still running.

 

The only thing that changed in the receiver’s office was the man with the title. The financial and legal experts were the same. The plan was the same. The strategy was the same.

 

Truly admirable – shrewd in the planning, clear in its decision, swift in its activity, and selfless in its implementation.

 

 [The new receiver, Major General William B. Lynch, USAF, Ret] has said that he would like to avoid a bankruptcy filing, and that the city is nearing a deal to sell the incinerator and lease parking assets –

 

Even more admirable, Mr. Unkovic praised both his successor’s work and the governor’s choice of successor:

 

According to Unkovic, “General Lynch is the right person to accomplish the difficult workout and bring Harrisburg back to fiscal stability… (Lynch) is doing a very good job. He continues to follow the recovery plan with the assistance of the consultants and state employees. His job is extremely difficult, but I am confident that the results of his efforts will be good for the city and the Commonwealth.”

 

As he explained it:

 

Unkovic writes: “As strange as this may sound, particularly coming from me, I think having two receivers for this process has actually been a good thing. I accomplished the four things I thought I could get done, and by outing the opposing forces, I got everything out in the open making it extremely difficult if not impossible for them to get their way through behind-the-scenes power maneuvers.”

 

It’s against this backdrop of dramatic events that, as we saw last week, the SEC rode onto the scene and demanded all the lupins Harrisburg had got.

 

A spokesman for the mayor couldn’t be reached for comment beyond the statement about the SEC settlement. Stephen Reed, who was mayor in 2009, couldn’t immediately be reached for comment.

 

I expect Mr. Reed is hunkered down and lawyered up.

 

 

The settlement is likely to add fuel to the city’s already heated mayoral race. Four Democrats, including Ms. Thompson, will face off in a primary May 21.

 

“We remain focused on the implementation of the recovery plan,” Mr. Angell said on Monday.

 

That means selling assets, cutting costs, and reducing financial leverage by crunching the bondholders.

 

 

Dennis: Anarcho-syndicalism is a way of preserving freedom.  

Woman: Oh, Dennis, forget about freedom.  Now I've dropped my mud.  

 

UPDATE: ENTER FORTINBRAS: Eric Papenfuse won the primary as current mayor Linda Thompson’s tenure was decisively rejected:

 

Papenfuse won the four-way race, getting 2,480 votes. City Controller Dan Miller finished second, with 2,084 votes, while Mayor Linda Thompson came in third, with 1,816 votes. 

 

Yep, that’s the Harrisburg mayor and city council, all right

 

While there will be a general election in November (six whole months away), in this Democratic-stronghold city Mr. Papenfuse is almost certain to be Harrisburg’s next mayor.  And because of this, even though there will be an election to hold, power will now begin inexorably to flow in Mr. Papenfuse’s direction.  He gained appeal in part because of his newness, contrasting with both Ms. Thompson and Mr. Miller, who have long been involved with Harrisburg politics, although Mr. Miller would have been my candidate, because of his demonstrated articulate numeracy.  On the other hand, with Dave Unkovic’s restructuring plan in place and a new receiver implementing it, Mr. Papenfuse may have a reservoir of goodwill and enough time to develop a forward-looking strategy even as Harrisburg goes through what will undoubtedly be a very messy and financially painful restructuring.

 

Does this tie make me look mayoral?

 

I’ll post more on Harrisburg in the upcoming week.

[Continued from yesterday's Part 3 and the preceding Part 1 and Part 2.]

 

By:David A. Smith

 

After a decade of borrowing, the latter half of which consisted of borrowing to pay debt service on previous unwise borrowing, the voters of Harrisburg had had it – in 2010, they voted out Mayor Reed, and elected city councilor Linda Thompson.

 

Arthur: Well, I am king.

Dennis: Oh king, eh, very nice.  An’ how’d you get that, eh? 

 

The Lady of Lake held aloft Excalibur from the bosom of the water

 

Principal sources used in this post

 

New York Times (October 12, 2011) (teal font)

Harrisburg Patriot-News (July 19, 2012) (brown font)

SEC release 2013-82 (May 6, 2013) (blue font)

Wall Street Journal (May 7, 2013) (black font)

 

Mayor Thompson’s arrival on the scene brought about a refreshing directness in acknowledging Harrisburg’s financial mess – but it also led to a fractured the city council and a bitter fight for power over who would control the painful restructuring they all agreed Harrisburg would face. 

 

The Council has been locked in battle with Ms. Thompson for months, voting to reject state-backed plan for financial overhaul plan largely on the ground that it demanded too little from creditors.

 

 “Everyone on Wall Street would have been paid, and the taxpayers would be left holding the bag,” said City Councilor Brad Koplinski by telephone.

 

Kolpinski’s against leaving taxpayers holding the bag

Ms. Thompson, for her part, has said the Council had no better plan and seemed only to obstruct the path to easing the city’s financial distress.

 

(With the fiscal positions reversed, these political dynamics – a mayor backed by a governor, but a city council in actual charge – recurred a year later in Detroit as Mayor Bing and Governor Snyder sought to force financial concessions.)

 

Dennis: By exploitin’ the workers – by ‘angin’ on to outdated imperialist dogma which perpetuates the economic an’ social differences in our society!  If there’s ever going to be any progress –

 

‘Angin’ on to outdated imperialist dogma?

 

In the middle of that political fight, and indeed as a dramatic escalation of tactics, Harrisburg in fact filed for bankruptcy, as reported in the New York Times (October 12, 2011) (teal font):

 

The City Council of Harrisburg, Pennsylvania’s financially troubled capital, filed for bankruptcy on Wednesday, a surprise move that was immediately opposed by the mayor and Gov. Tom Corbett, who argued that the filing was illegal under state law.

 

The filing — which listed debts in excess of $400 million, largely associated with a failed trash incinerator — pitched the city into political confusion.

 

Do we look confused to you?

 

Woman: Dennis, there’s some lovely filth down here.  Oh – how d’you do?

 

Dennis, there’s some lovely filth down here.

 

The Council’s decision came Tuesday night in a 4-to-3 vote. Immediately after, a lawyer for the Council faxed a petition for Chapter 9 bankruptcy to the United States Bankruptcy Court and filed it in person at 10 a.m. Wednesday.

 

As the filing lawyer, Mark Schwartz, explained it a year and a half later in the HarrisburgPatriot-News (May 7, 2013) (gray font):

 

“There is a ‘buck stops there’ liability for (city leaders), but the people who do the work are bond lawyers. These are bonds that never should have been issued. Reed cannot issue bonds on his own. Professionals were abysmal in terms of fulfilling their responsibilities to investors and they have gotten off scot-free. They’ve made millions.”

 

We’ll come back to Mr. Schwartz’s claim in the final part of this post – for now, he serves as a colorful herald to the ensuing political circus:

 

We’re just representing diversity

 

Woman: I didn’t know we had a king.  I thought we were an autonomous collective. 

Dennis: You’re fooling yourself.  We’re living in a dictatorship. 

 

I thought we were an autonomous collective

 

Unsurprisingly, the move was blocked before it could be effective:

 

The petition was called into doubt almost as soon as it was filed. A spokesman for Governor Corbett, Kelli Roberts, said the filing violated the state’s fiscal code, which was amended this year to bar cities like Harrisburg from filing for Chapter 9 bankruptcy.

 

“For us, this filing is illegal,” Ms. Roberts said. “It’s very clear.”

 

Regardless of the move’s strategic wisdom or lack thereof, Harrisburg had to do something to hold off the pack:

 

The petition states that the city is “in imminent jeopardy through six pending legal actions by creditors” that are associated with the city’s failed trash incinerator project, which has saddled the city with debts that are more than quadruple its annual budget.

 

[This is a misleading ratio in that it compares an income component (budget) to a balance sheet component (debt), when the proper comparable is debt service … but we'll let that pass. – Ed.]

 

I was misled

 

Meeting those legal demands would “substantially interrupt the city’s ability to provide health or safety services to its citizens,” the petition said. The amount of debt, the petition states, “is vastly beyond the ability of the city to pay.”

 

Chapter 9, the part of American bankruptcy code that allows municipalities to restructure their debts, is relatively rare, but a number of cities have been wrestling with it recently.

 

‘Relatively rare’ was written in October, 2011; obviously municipal bankruptcy has become much less rare since then.

 

Central Falls, R.I., filed for Chapter 9 this summer, and Jefferson County, Ala., moved to avoid it this month by agreeing with bondholders in a reduction of $3 billion in sewer debt.  [That didn't stick, and Jefferson County validly filed bankruptcy less than four weeks after this story. – Ed.[  It is still unclear whether Harrisburg will actually go down that path. Bankruptcy experts say it is onerous and most cities try to avoid it.

 

Cities do try to avoid bankruptcy, though mostly out of fear.  It worked brilliantly for Vallejo and it's going to be the salvation of many more cities.

 

The move exasperated the business community. “Just when you think it couldn’t get any more ridiculous, it did,” said David E. Black, president of the Harrisburg Regional Chamber of Commerce and Capital Region Economic Development Corporation.

 

Does anyone here at the HRCOC think it could get any more ridiculous?

 

The filing comes a week before the State Senate is set to consider a bill, already passed by the House, that would authorize Governor Corbett to assume responsibility for most of the city’s finances, something that some members of the Council had been trying to prevent.

 

The bankruptcy was thus a pre-emptive strike, but it failed, as even before the bankruptcy petition was heard, Pennsylvania's governor moved to declare a fiscal emergency in Harrisburg, as reported in the Harrisburg Patriot-News (October 24, 2011):

 

“City council’s failure to enact a recovery plan in order to deal with the city’s distressed finances has led me to declare a fiscal emergency,” Corbett said. “This action ensures that vital services will continue and public safety will be protected.”

 

This action follows Thursday's enactment of legislationthat would allow for a state takeover of the capital city's finances if a final attempt for city council to reach an agreement on a fiscal recovery plan fails.

 

In other words, the state and the city were racing to gain control of the insolvency proceedings, and the right to propose who'd get cut for what. 

 

Arthur: Then who is your lord?

Dennis: I told you.  We're an anarcho-syndicalist commune.  We take it in turns to act as a sort of executive officer for the week. 

 

We take it in turns to act as a sort of executive officer for the week

 

The legal battle was swiftly decided, as reported in the New York Times (November 23, 2011) (brown font):

 

Washington — A federal judge dismissed a bankruptcy suit for the city of Harrisburg, Pa., on Wednesday, saying that the filing, made by the City Council last month, was illegal.

 

The ruling, by Judge Mary D. France ("noted for fairness"), was a blow to the Council. A majority of its members had fought Harrisburg’s mayor, Linda D. Thompson, for months, saying she was seeking too little from creditors.

 

I won't delve into the equities of debtor-versus-creditor claims in this situation (this post is unwieldy enough as it is and I haven't read into the papers) –

 

Just taking a financial snapshot

 

Dennis: A self-perpetuating autocracy in which the working classes –

Woman: Oh there you go, bringing class into it again. 

Dennis: That's what it's all about!  If only people would –

 

– except to observe that precisely the same dynamics (albeit with different facts) operated in Jefferson County: a rich-poor divided that aligned with a white-black divided, an expensive sewer system that worked badly, a series of debt rollovers that failed, commingling of funds and political ambition, and a city/ county going bust as a result.

 

With the bankruptcy shelved, the state moved to take over:

 

The state filed a petition on Nov. 18 in the Commonwealth Court of Pennsylvania laying out its arguments for why the city meets the criteria for receivership. David Unkovic, a Pennsylvania lawyer, was named in the petition as the receiver.

 

The un-mayor looking unfazed … when he was appointed.

 

Later (when it was safe for him to do so), Mr. Unkovic wrote the following:

 

I believe the disdain for the law is so embedded in Harrisburg’s political culture that it constitutes a very insidious form of corruption.

 

The tentacles of this corruption stretch into many corners. And this degree of corruption is usually difficult for the public to perceive — such tentacles are often hidden from the average citizens.

 

Run away! Run away!

 

[Concluded tomorrow in Part 5.]

[Continued from yesterday's Part 2 and the preceding Part 1.]

 

By:David A. Smith

 

By now in our story of Harrisburg’s steps into insolvency, we’ve reached the point where Mayor Stephen Reed, whose political dominance was so great that candidates for city council ran as part of a “Reed team,” had persuaded the city to borrow another $25 million (against an indebtedness of $80 million, remember), not to do the retrofits but rather just to buy time, in hopes of assembling a retrofit package that would work.

 

You fight with the strength of many men, sir knight

 

Arthur: You fight with the strength of many men, Sir knight.  

I am Arthur, King of the Britons.  

[pause]

 

[Possibly exculpatory sidebar: if Harrisburg ends up having to file municipal bankruptcy, as seems increasingly likely, it may make little difference whether it is under water by $50 million or $250 million, because the taxpayers of Harrisburg will be able to afford only so much.  If so – that is, if the increased insolvency is translated dollar-for-dollar into increased creditor losses – then Mayor Reed's increasingly deceptive methods for securing additional financing may have an ex post facto justification, at least to the people of Harrisburg, thought obviously not to the capital markets.  On the other hand, deceit is still deceit. – Ed.]

 

Principal sources used in this post

 

New York Times (October 12, 2011) (teal font)

Harrisburg Patriot-News (July 19, 2012) (brown font)

SEC release 2013-82 (May 6, 2013) (blue font)

Wall Street Journal (May 7, 2013) (black font)

 

Unfortunately for all concerned, the $25 million – an increase of 30% in the borrowing – lasted barely a year before Mayor Reed was back before the council, needing more money still:

 

The following summer, the council agreed to borrow another $17 million to keep the incinerator running, in what Reed called the first step toward a retrofit.

 

Between these two borrowings, Mayor Reed had increased the total debt by 50% in little over a year – and still on the vision of a solution, not the tangible reality of that solution:

 

Although Barlow had projected that income from the new facility could pay for both the retrofit and the old debt, according to the forensic audit, the old debt came due too soon.

 

According to the audit, “revenues after completion of the retrofit — even as projected by Barlow — would not have been sufficient to pay the debt service almost from the beginning of the facility’s operations.”

 

The existing debt had to be restructured so that it came due later.

 

Home mortgages are self-amortizing – a series of equal payments, one per month, eventually yields a complete payoff of the loan.  Commercial loans, including bonds, can have a maturity earlier than their full amortization, at which point the remaining unpaid principal balance (usually called a balloon payment) comes due.

 

When it comes due, we’ll figure out what to do then

 

The emergence of loans with balloons is a saddle-point optimization between borrowers (who want small monthly payment, hence a long amortization period and a lower interest rate, in the normal circumstance when the yield curve is positive) and lenders who are willing to put their money out for discrete, stipulated intervals.

 

Between your interests and mine, here is the best point

 

Arthur: I seek the finest and the bravest knights in the land to join me in my Court of Camelot.  

[pause]

 

I seek the finest and bravest knights

 

Trouble comes only in two situations: if in the interval interest rates have risen substantially, or if the borrower’s creditworthiness has materially declined. In either case, new debt will be more expensive than the old debt – if new debt can be had at all.

 

So, in mid-2003, as Reed proclaimed, “We had our best year in history,” there was another borrowing.  According to the forensic audit, “It was a very expensive restructuring, resulting in approximately $10 million of additional interest expense.”

 

Back then, credit spreads were still low, and while the description is ambiguous (additional interest could have arisen due to an extended maturity), it’s more likely that borrowing costs had spiked, because of this inconvenient fact:

 

By that time, the Environmental Protection Agency had closed the incinerator.

 

Mayor Reed has embarked on this expansive borrowing – a 50% increase in little over a year – to prevent the incinerator from being shut down by the EPA.  Except the incinerator was shut down by the EPA.  This might give a normal man pause. 

 

What could go wrong?

 

Certainly, it gave the capital markets pause:

 

The bond insurer — a company now known as Assured Guaranty Municipal Corp. — notified the city that it would need more than the city’s guarantee to insure the next borrowing. According to the audit, the total debt after the retrofit would top $446 million.

 

 “If the retrofit did not work,” the audit says, “it appears that [the bond insurer] understood that the city would not have the financial capacity to repay the outstanding debt.”

 

The city asked the county to add its guarantee to the next $125 million borrowing to fund the actual retrofit.

 

Not only did the city ask, the county agreed to guarantee a large portion of the debt – which is the truly remarkable event. 

 

This new learning amazes me, Sir Bedivere.  Explain again how sheep’s bladders may be used to prevent earthquakes.

 

So curious am I about the back story of Harrisburg’s inveigling Dauphin County into the mess that ordinarily I’d delve more deeply into that back story … but this post will be long enough as it is, so we’ll skip over Dauphin County’s credulity and press on:

 

In September 2003, the county approved sending all the waste collected within its borders to the Harrisburg incinerator beginning in May 2006, five months after the retrofit was scheduled to be operational.

 

Everyone was now on board and all engines were running for what was to become the municipal financial equivalent of the Hindenburg.

 

Nothing to worry about here

(And no, kids, that’s not a Photoshop)

 

Decades ago – in 1983, to be precise – I did the equity syndication of a transaction, somewhere in this great land of ours, where I succumbed to the temptation of serial optimism. 

 

“It was true that the project was marginally feasible,” Lispi acknowledged. “I mean, the difference between revenues and expenses including debt service was very narrow.”

 

My long-ago syndication property’s success depended on four or five postulates all proving true.  Though each one was probable, to have them all work was highly improbable.  As it happened, the property and I lucked out, but in hindsight, it was foolish.

 

Ooh, yeah, we lucked out

 

Luck is not a strategy, and hope is not underwriting.

 

Barlow had problems practically from day one.  The project failed spectacularly, hemorrhaging millions as delays and change orders mounted and forcing further borrowing first to complete the project and then to fix technology that didn’t work after Barlow was fired and went bankrupt.

 

The unproven technology didn’t work.

 

The expansive contractor was fired.

 

The guarantees proved worthless.

 

Black Knight: None shall pass.  

Arthur: What?

 

None shall pass

 

And none of this should have been allowed to happen.

 

The forensic audit suggests the Debt Act should have stopped the project before it ever got that far.  Every time the city borrowed — or guaranteed — more money, it had to certify that what had previously been registered with the state as “self-liquidating” really was still paying for itself.

 

Each time the city borrowed more money, it needed to show it had the authority, which depended on the holy grail, and by this time, the city was not above making false statements:

 

That certification — known as a “clean 8110(b)” — assures the state there has been no “change in circumstances” that would cause some of the debt to be counted against the city’s limit.

 

According to the forensic audit, “substantially all” of the incinerator debt was certified as self-liquidating, and yet, according to the forensic audit, “the Authority had to borrow to pay for operations and debt service in 1998, 2000, 2002 and 2003, meaning that the facility was not paying for its outstanding debt during those years, and had borrowed at more expensive rates to pay off prior debt.”

 

As we saw in Part 1, Pennsylvania has a law, the Local Government Unit Debt Act, expressly designed to prevent localities from being over-indebted. 

 

Arthur: I have no quarrel with you, good Sir knight, but I must cross this bridge.  

Black Knight: Then you shall die.  

 

The LGUDA places a hard cap on their borrowing, with the loophole exception of properties that are entirely self-financing – in effect, truly off the city’s balance sheet. 

 

Arthur: I command you as King of the Britons to stand aside!

Black Knight: I move … for no man.  

Arthur: So be it!

 

I move … for no man

 

As the state capitol, Harrisburg can hardly claim ignorance of a state law enacted down the street, and yet here was Harrisburg gleefully running up the debts to fuel Mayor Reed’s expansive vision.

 

If the 1998 bonds no longer were deemed self-liquidating in 2003 when the facility was shut down, the audit found, then “the city’s remaining debt limit would have been approximately $25.9 million and it could not have guaranteed” the 2003 restructuring.   The audit says, if the 2003 restructuring had “not been qualified for self-liquidating status, the Barlow retrofit project likely would not have been financeable.”

 

The audit says Barlow and the city “probably would not have been capable” of formulating a report “that showed revenues sufficient to cover debt service for the first 22 years of operation.”

 

None shall borrow!

 

In simpler and more conclusive terms, each time it went for a new borrowing, Harrisburg was committing fraud – fraud against its own taxpayers, fraud against the bond buyers, and fraud against the Commonwealth of Pennsylvania. 

 

[Arthur chops the Black Knight's left arm off]

Arthur: Now stand aside, worthy adversary.  

Black Knight: 'Tis but a scratch.  

Arthur: A scratch?  Your arm's off!

 

In fact, the city certified as self-funding an incinerator that was both closed and partially demolished:

 

The state Department of Community and Economic Development “took an aggressive position by dismissing the lack of revenue stream from the then-shuttered [incinerator], and assuming that the city could take into account future revenues of a retrofit that had been discussed for over a decade and certain individuals hoped would be, but had not yet been, financed.”

 

‘Tis but a scratch

 

While it’s barely within the realm of possibility that a facility which has been shut down by the EPA could be considered self-financing (if the cost to put it back on line was small compared to the value after it’s been completed), the next claim is the real whopper:

 

Don’t think about it, just swallow it

 

The audit also adds: “The Barlow retrofit demolished a significant part of the old facility and replaced it with a substantially new (incinerator). The original facility the Authority purchased in 1993 and improved through the 1990s in large part no longer existed.  As a result, it is difficult to understand how the existing debt could continue to be considered self-liquidating … and how a clean 8110(b) certification could have been filed.”

 

The bondholders lent money secured by a property; now the property was gone, so the source of revenue to pay the old bonds was likewise gone. 

 

Arthur: Well, what's that then?

Black Knight: I've had worse.  

Arthur: You liar!

 

New borrowing was used to build a new facility, in the same location and probably reusing some parts of the old facility, but that new facility was pledged to the new debt.  To say with a straight face that a new facility (replacing one that didn’t work, remember) is worth so much it can pay for its own costs and the lost costs of the old one is more than faith; it’s falsehood. 

 

 “Setting aside the legal, technical issue” of self-liquidating debt, said Dan Lispi, “at the time, restructuring that debt, going forward with the retrofit appeared to be a far superior alternative than eating $104 million worth of debt.”

 

Perhaps so, but that wasn’t the test; the test was whether the new debt was self-funding.

 

The audit suggests “eating” the millions in debt was what should have occurred.

 

By framing the issue so as to remove any agency from the threat-maker, Mr. Lispi is making a classic mistake in logic of the kind used by kidnappers: If you don’t pay the ransom, we’ll kill your child, so his life in solely in your hands. 

 

It’s your fault; it’s always your fault

 

The audit said only that the new debt was unauthorized; it has no opinion on what should have happened with the old debt, because the auditors didn’t borrow the old debt (and as we saw before, much of the old debt lumped onto the incinerator was used to fund other unrelated projects).

 

“They can say what they want now,” Lispi said, “but at the time, who would have said that?”

 

Anyone who read the Local Government Unit Debt Act.

Arthur: Look, you stupid bastard, you've got no arms left.  

Black Knight: Yes I have.  

Arthur: Look!

Black Knight: Just a flesh wound.  

 

Just a flesh wound

 

[Continued tomorrow in Part 4.]

[Continued from yesterday's Part 1.]

 

By:David A. Smith

 

God: What are you doing now?

Arthur: I'm averting my eyes, oh Lord.  

 

Oh, don’t grovel.  If there’s one thing I can’t stand, it’s people groveling.

 

When yesterday’s post ended, longstanding Harrisburg mayor Stephen Reed, who had already embarked on an ambitious program of civic spending to build fixed-infrastructure amenities in (unfulfilled) hopes that these would attract tourists and businesses, confronted an inconvenient truth: the city’s incinerator was failing and threatened with EPA shutdown, and yet due to those past expenditures, the city lacked –legal authority to borrow what it would take to renovate the incinerator.

 

Principal sources used in this post

 

New York Times (October 12, 2011) (teal font)

Harrisburg Patriot-News (July 19, 2012) (brown font)

SEC release 2013-82 (May 6, 2013) (blue font)

Wall Street Journal (May 7, 2013) (black font)

 

Unless, that is, Mayor Reed was able to find the Holy Grail:

 

Good idea, oh Lord!

 

If a project for which a city is borrowing can pay for itself, the borrowing is considered “self-liquidating” and doesn’t count against the limit.

 

It is your sacred task to seek this grail

 

A cynic would call this a loophole – a flaw in legislation overlooked by its designers, which could be used by the unscrupulous to subvert the law’s noble purpose.  To borrow above debt limits, and hence to put the city at risk for payments which city revenues would be unable to repay, the city merely needed to find a credulous investment banker or auditor willing to opine that the future expenditure would pay for itself.

 

Harrisburg’s incinerator debt totals about $326 million.

 

Thus, the retrofitted incinerator would have to make enough money to be able to pay all its old debt as well as all its new debt in order for the solution to work.

 

To me, that is a loophole.  But to Mayor Reed – and thus to the city council which held their seats in fief to him – it was the holy grail.

 

God: Arthur, King of the Britons – your Knights of the Round Table shall have a task to make them an example in these dark times.  

 

We’re knights of the round table

 

Yet no one knew where the Grail was, how to recognize it, or even if it still existed.

 

But there’s a limit to how much it could make.

 

Mayor Reed appointed a pure knight in seek the grail:

 

A blessing!  A blessing from the Lord!

 

Dan Lispi [of DRL Consulting and Development – Ed.] [was] the man Reed put in charge of figuring out how to do the retrofit.

 

Mr. Lispi is an environmental consultant from Harrisburg, which means he ought to have been qualified in the subject matter (functionality of an incinerator).

 

Lispi said that in 1999, he was “desperately trying to find a way to make this retrofit project happen.”

 

Mr. Lispi emerges from the tale as an honest man, as evidenced by even a casual viewing of his later YouTube testimony on October 4, 2012; on the video, he speaks with no notes and with neither hesitation nor any apparent concern for himself. 

 

“You’re limited by the [Department of Environmental Protection] permit as to how many tons a day you can generate, and that drives how much revenue you’re going to make.”

 

Who says I look defensive?

 

In effect, Mr. Lispi was asked with finding a precise vision – a form of incinerator or upgrade that would handle a large volume of other people’s trash and yet cost no more than the amount which would make the plant self-funding. 

 

“There was a point at which, if the cost of the project increased, then it would no longer have been considered financially feasible or self-liquidating,” he said.

 

Neither he nor anyone else knew whether said grail existed, nor what form it might take.

 

Arthur: Good idea, oh Lord!   

God:  ‘Course it’s a good idea!  

 

Mr. Lispi’s quest was, in his own words, desperate, because the fate of Harrisburg’s financial kingdom, and with it depended the crown of Mayor Reed. 

 

Then he said he read an article in a trade magazine about how a Colorado company named Barlow had retrofitted a plant in Minnesota. It was new technology, and the plant in Minnesota was much smaller than Harrisburg’s, but “there were quotes in there from the owner of the plant saying how happy he was with Barlow. The technology had worked great.”

 

Such a search is guided more by faith than by science – and while that may be good for seeking redemption, it is no way to pursue municipal finance.

 

Lispi traveled to Minnesota to see for himself. He took the director of the Harrisburg incinerator, John Lukens, as well as former city solicitor Andy Giorgione, who was then in private practice with the firm Obermayer Rebmann Maxwell & Hippel LLP [And is now at Buchanan Ingersoll & Rooney – Ed.].

 

It is our sacred quest

 

God: Behold!   Arthur, this is the Holy Grail. 

 

Messrs. Lispi and Giorgione – both of them pilgrims, neither an expert in the construction or operation of sanitation facilities – were convinced.

 

“We watched the facility operate, and even though it was a smaller plant, you know, it was working very nicely,” Lispi said.

 

And Barlow suspected they could do the Harrisburg job for a cost within reach of the self-liquidating holy grail.

 

The devil hath power to assume a pleasing shape, and the power to use the unwary for his own purposes.  One needn’t believe evil intent in Barlow; they are engineers and manufacturers who can sell a product to people who very much want to believe it is what they are seeking.

 

Yes, I can help you find the most holy grrrrail

 

God: Behold!   Arthur, this is the Holy Grail.  Look well, Arthur, for it is your sacred task to seek this Grail.   That is your purpose, Arthur -- the Quest for the Holy Grail.  

Arthur: A blessing!   

 

They came back convinced.

 

Launcelot: A blessing from the Lord!   

Galahad: God be praised!   

 

Convinced, they became evangelists for the new investment:

 

“As I explained before, it seemed reasonable at the time.”

 

In January 2000, Reed and Giorgione joined then-Dauphin County Commissioner John Payne on a “task force” to determine whether the county and the city should team up on municipal waste.

 

Three months later, they decided they should, and in the cooperative agreement signed by the county, Giorgione is listed as working on behalf of the county.

 

Payne, now a Republican state representative from Derry Twp., said he did not recall the task force, but he noted that he and then-Commissioner Lowman Henry had been elected on a platform to shut down a landfill in northern Dauphin County and that it made sense, he said, to send the trash to the incinerator.

 

Switching clients as a matter moves forward, as it appears Mr. Giorgione did here, is not by itself unethical, as he would have been working for only one client at a time and the work involved was lawyering.

 

Later, Giorgione would be one of the principal players in the retrofit deal, working on behalf of the Harrisburg Authority, which regularly marched to whatever tune Reed established.

 

Just as in Jefferson County, the sewer authority existed alongside and virtually within the city government, but legally and financially distant – until it comes time to borrow money. 

 

Giorgione, who now works for the law firm Buchanan Ingersoll & Rooney PC, declined to comment for this story.

 

No matter; here is what he was quoted as saying in November, 2012:

 

The very comfortable Andy Giorgione

 

“All of that structure, everything that was done, had nothing to do with the failure of this plan.”

Very much comfortable with being in compliance with Pennsylvania law.

“We don’t know where all the money went.”

“It seemed reasonable at the time.”

 

I tought it penciled out

 

All through this period, the EPA has been expanding its mandate, raising the requirements for clean air, clean water, waste disposal, and environmental compliance – all these costs having to be funded from state and local budgets.  Though that’s no excuse, as hundreds of cities across the country were coping with similar challenges

 

Barlow submitted a preliminary report suggesting the project was feasible, and the Authority agreed to borrow an additional $25 million.

 

This new learning amazes me, Bedevere

 

That $25 million wasn’t going to secure the grail – no, it was for far less sacred purposes:

 

That money was used:

 

To restructure old debt at the incinerator

To generate working capital to run the plant

To plug a $4.2 million hole in the city budget

To officially hire Barlow to perform engineering services for the planned retrofit.

 

Via this action, faith was twisted into original sin.  Three of the four uses have nothing to do with finding the solution, they were just buying time or political capital – and as if to underscore the loss of moral compass, the spend included a little political vigorish:

 

According to documents at the Harrisburg Authority, $180,000 was deposited into the “special project” fund for Reed’s continued “artifact” shopping.

 

By now belief in the grail had become so strong that all normal caution was lost:

 

You can face the peril; there’s only a hundred and fifty of them

 

The following year, in December 2001 — after Barlow’s engineering study and financial projections were done — Reed notified City Council that he had begun preparations to finance the project.  Because the council would eventually have to back the borrowing with a city guarantee –

 

As in Scranton, though there may be a municipal authority, in the end its borrowing almost never stands entirely alone; the city is obligated on a guarantee.  (That didn’t happen in Jefferson County, Alabama, in part because the city and county operated different sewage systems.)

 

– he outlined the case for the retrofit in a detailed five-page letter.

 

From here until the end of his mayoralty Mr. Reed’s decisions and actions become progressively less defensible, progressively more dubious and deceptive.

 

And I know dubious, bro

 

“If the retrofit does not proceed,” he told them, “there are very significant adverse financial impacts on the city.”

 

There’s a classic of false implied duality, as beautifully expounded in Thank You for Smoking:

 

But you didn’t prove that vanilla was the best.

I didn’t have to. I proved that you’re wrong, and if you’re wrong I’m right.

But you still didn’t convince me

It’s that I’m not after you. I’m after them.

 

I proved that you’re wrong, and if you’re wrong, I’m right

 

Doing nothing risked bad results; so did borrowing a great deal more money to fund an unproven technology.

 

Reed told them that without a retrofit, millions of dollars would be lost in service charges. Water and sewer rates for city residents would spike to make up for the $983,000 the incinerator paid annually for utility service. Sixty city employees would lose their jobs, he said, with an additional $1.2 million to be paid out in unemployment compensation.

 

The employee-layoffs card is political manipulators’ trick, always pulled by those who wish to convince the innumerate. 

 

How many fingers am I holding up?

 

“Not going ahead with the retrofit,” Reed wrote in the letter, “would trigger a 5.2 mill tax increase on all property owners … a $120 per year increase in the trash disposal fee charged to all city households, and a layoff of many city staff.”

 

Can we have our votes back?

 

“From financial, environmental and long-range planning perspectives,” he said, “there is every reason to proceed.”

 

What Reed did not mention was the more than $80 million at that point in outstanding debt.

 

Nor was that all he failed to mention – such as the Authority twice having had to issue new bonds, at higher rates, just to pay debt service on the existing bonds.

 

[Continued tomorrow in Part 3.]

By:David A. Smith

 

Father: One day, lad, all this will be yours!   

Herbert: What, the curtains?

 

But I don’t want land

 

It began with a failing incinerator, and an ambitious politically invincible mayor.

 

Tomorrow, Tuesday May 21, Harrisburgers will vote in the most important mayoral primary in thirty years (in this mono-political city, the primary is the election).  As I write this, the weekend beforehand, it’s a tossup among three candidates: current mayor Linda Thompson, city controller Dan Miller, and bookstore owner Eric Papenfuse. In the Friday post, I’ll append the results.

 

Just recently I posted about Harrisburg’s drive-thru settlement with the SEC (same-day service, easy in, easy out), whereby the city neither admitted nor denied making misleading statements, issued as a warning to any other municipal malefactors that might materialize. 

 

As the new century dawned, the threat to [Harrisburg Mayor Stephen] Reed was clear.

 

The incinerator was one of the oldest of its kind in the nation, plagued by mechanical failures and wildly out of compliance with federal clean-air regulations.

In the three years since I first posted about Harrisburg, both the city and the municipal-bankruptcy landscape have changed substantially. 

 

About the only time you’ll see Harrisburg displayed prominently

 

The city, cursed with being the insignificant capital of a bipolar state with contesting power centers, has gone through gyrations and tribulations that would be hilarious were they not so representative of the other insolvent cities I’ve covered in this blog: Vallejo, CA; Jefferson County (Birmingham), AL; Detroit, MI; and Pennsylvania’s own Scranton.

 

Principal sources used in this post

 

New York Times (October 12, 2011) (teal font)

Harrisburg Patriot-News (July 19, 2012) (brown font)

SEC release 2013-82 (May 6, 2013) (blue font)

Wall Street Journal (May 7, 2013) (black font)

 

So, via multiple sources, herewith the tale of King Stephen’s quest for the Holy Grail.

 

Father: Listen, lad.  I’ve built this kingdom up from nothing. 

 

I will quote extensively from Donald Gilliland‘s article in the Harrisburg Patriot-News (July 19, 2012) (brown font), which as far as I can tell is definitive regarding the back story:

 

 

As the 21st century dawned in the city of Harrisburg, Mayor Stephen R. Reedwas being hailed by state senators, city residents and The Patriot-News as a “visionary” who had commanded an “about-face” for the city.

 

It’s easy to reverse yourself; just practice.

 

Stephen Reed was mayor of Harrisburg for 28 years, from 1982 through 2010, and politically supreme that entire period.

 

Even some critics credited him with leading Harrisburg from the brink of bankruptcy to economic prosperity.

 

Reed freely admitted his accomplishments depended on his own brand of “creative financing.” Still, his political clout was so potent that his critics had to campaign under a pro-mayoral “Reed Team” ticket to be elected to City Council.

 

As I posted three years ago, Mayor Reed decided that Harrisburg would be economically successful only by building itself up through investing in the creation of destination venues.

 

Vote for me and I will lead you to Tir-na-Og

 

Mayor Reed went on an ambitious program of expanding his city’s governmental services. Without for the moment trying to judge the wisdom of these moves, just count the number of times Mayor Reed made long-term expenditure commitments – new capital projects or assumed social mandates.

 

Reed is credited with conceiving and developing Harrisburg’s City Island park, the National Civil War Museum, the Harrisburg University of Science and Technology, and the high school that accompanied it.

 

I’ve documented previously (in Scranton) that capital investment by tertiary cities is potentially an example of what Matthew Healy, channeling Richard Feynmann, has dubbed ‘cargo cult economics’ – investments based on ‘rubber economics’, the belief that all investment – say, a historic renovated train station in Saco, Maine – must necessarily bring a return.

 

By logic, these two things must weigh the same

 

Spending money to build buildings adds a long cost. So does creating new civic attractions (like the National Civil War Museum) whose direct revenues are unlikely to cover their total costs.

 

In 2000, the Commonwealth of Pennsylvania placed Reed in charge of the failing Harrisburg School District, for which he imposed a massive reform and rehabilitation project.

 

Adding another cost.

 

Caught between Pittsburgh to his west and Philadelphia to his east, Mayor Reed decided to make Harrisburg the destination of choice along I-81:

 

Father: When I started here, all there was, was swamp.  All the kings said I was daft to build a castle in a swamp, but I built it all the same, just to show ‘em. 

 

With his political supremacy, he was able to get all these developments built.

 

Father: It sank into the swamp. 

So, I built a second one.   That sank into the swamp. 

So I built a third one. 

That burned down, fell over, then sank into the swamp. 

 

All there was, was swamp

 

Such was the fate of Mayor Reed’s incinerator:

 

It was also saddled with mounting debt.

 

Money was borrowed to fix it.

Money was borrowed to run it.

And money was borrowed to pay off earlier borrowed money.

 

In fact, according to the forensic audit, “the facility had a history of using new borrowing to pay old debt, often at higher rates and with greater expense.”

 

Borrowing new debt to pay service on debts that cannot be paid is a violation of fiscal responsibility so fundamental it is worthy of the Illinois legislature. Worse still, if such were possible, is this:

 

Some of the money from those borrowings was squirreled away into a “special projects reserve fund” from which Reed would purchase Wild West artifacts and other tchotchkes he claimed to be grist for future museums in the capital city.

 

In effect, the mayor had everyone mesmerized with the prospect of a booming Harrisburg economy, so they lent his city (him) all the money he wanted, and then let the city (the mayor) spend it on whatever he wanted, so long as no personal aggrandizement was involved.

 

Father: But the fourth one – stayed up. 

 

While the mayor was building castles that he thought would attract visitors away from Philadelphia or Pittsburgh, the city was neglecting its more basic responsibilities:

 

Achilles had his heel.

 

The Titanic had its iceberg.

 

Mayor Reed had anincinerator.

 

Debt service up in smoke?

 

Previous media stories that have focused on the incinerator as being Harrisburg’s albatross miss the larger point: money is fungible. 

 

A recent forensic audit of how the city has found itself once again teetering on the brink of bankruptcysays there were laws to keep it from happening and that those laws were not complied with.

 

The audit was conducted by a team of forensic accountants and certified fraud examiners from the Pittsburgh and Philadelphia offices of ParenteBeard LLC along with a team of regulatory specialists from the Philadelphia law firm of Klehr Harrison Harvey Branzburg LLP.

 

The incinerator, as we will see, picked up all that debt not for itself but because it was the only asset which passed the ‘cargo cult economics’ test – a tenuously plausible scenario could be advanced that it would pay for itself.

 

If the incinerator was forced to shut down in June 2003, as the federal Environmental Protection Agency assured Reed would happen, all that [incinerator] debt — $80 million at the time — would have to be paid by city residents.

 

Bear in mind that Harrisburg has 49,700 people and about 20,500 households, so an $80 million debt represents $4,000 per Harrisburg household, and the eventual $350 million represents $17,000 per household.

 

It might well have wrecked Reed’s political career.

 

Certainly it would have; the cost is breathtaking for a city whose median household income is about $30,000.

 

But the solution also was clear.

 

If Reed could get Dauphin County to agree to ship its trash to the incinerator, thereby guaranteeing a sufficient revenue stream, and then renovate — or “retrofit” — the incinerator so it was modern, efficient and in compliance with federal regulations, he would have another 25 or 30 years to take care of the debt.

 

Dauphin County is outside of Harrisburg, and at 525 square miles, with 40 municipalities and a population of 270,000 people, it’s quite obviously it’s much larger than Harrisburg.

 

 

What stood in the way of the incinerator retrofit was the Local Government Unit Debt Act. The Debt Act puts a limit on how much a city can borrow based on its tax base.

 

According to the audit, the city’s debt limit was just under $150 million, but it had already racked up nearly $81 million in debt, leaving $69 million remaining under the limit.

 

Much of that debt had gone for the trophy investments, like the National Civil War Museum, which were an enormous drag on the city’s cash flow and on its borrowing capacity.

 

That wasn’t nearly enough to accomplish the retrofit.

 

But the Debt Act has a loophole.

 

In fact, the Local Government Unit Debt Act describes a vision of the municipal Holy Grail.

 

It is your sacred task to seek this grail

 

[Continued tomorrow in Part 2.]