Michigan emergency manager program may not survive the mess it made in Flint

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Michigan no longer has any local governments under emergency management and observers believe the state program to take over distressed local governments may be quietly laid to rest.

The EM program has been credited with helping put Detroit on a path to fiscal solvency but it’s also been blamed for contributing to Flint’s water contamination crisis. Two of Flint’s former EMs have been criminally charged in connection with the crisis.
The Flint crisis may make state officials leery of stepping in to control a local government, though municipal market participants and others see state oversight programs as a positive credit feature.

The release of Highland Park School District from state control in June marked the first time since 2000 that no city or school district in Michigan has an emergency manager. Some market participants believe that signals the state’s reluctance to use the program going forward, though the program remains on the books.

The last local entity placed under state oversight was Lincoln Park. Gov. Rick Snyder appointed an EM on July 3, 2014 and the city was released from state oversight at the end of 2015.

“Each situation that led to the financial emergency is unique, so I can’t give a broad-brush assessment about how the law will be used in the future,” said Ron Leix, a treasury spokesman. “For the first time in 18 years, no Michigan municipality or school district is under state financial oversight through an emergency manager. This is really about the hard work our local units of government have achieved to identify problems and bring together the resources needed to problem-solve challenging financial conditions.”

Michigan launched the emergency manager program in 1990. It gives the governor authority to appoint a manager with extensive powers over a troubled municipality or school district.

In 2012 Michigan voters repealed the emergency manager program in a referendum, but one month later Snyder and lawmakers re-adopted a similar intervention program. The new statute allowed local governments to choose among three new options in addition to the appointment of an emergency manager who reports directly to the governor: bankruptcy, mediation, or a consent agreement between the state and the city to permit local elected officials to balance their budget on their own.

Cities that exit emergency management remain under the oversight of a receivership transition advisory board while executive powers are slowly restored to elected mayors and city councils. The goal of the RTAB is make sure the city stays on track to meet its fiscal milestones.

“My experience was that rating agencies and investors took great comfort from the fact that the state took this proactive approach to ensuring that obligations to bondholders were honored to the extent possible,” John Naglick, Detroit’s chief deputy chief financial officer and finance director.

“A lot of the investor community and rating agencies believe that once the state intervenes, they will move heaven and earth to ensure bondholders are protected,” said Tom Schuette, a partner at Gurtin Municipal Bond Management. “However, we believe it is very important for investors to understand the mechanics of state oversight given that there are very different track records and tools available depending on where you are and what sector is involved. State intervention most frequently falls well short of being a legal guarantee that bondholders will be protected.”

Detroit's emergency manager, Kevyn Orr, led the city into a Chapter 9 bankruptcy that resulted in widespread bondholder losses.

State intervention has benefits but it’s not a panacea, said Howard Cure, director of municipal research at Evercore Wealth Management. “It depends on the ultimate economy and tax base, and it’s a lot easier to fix financial mismanagement with a tax base than it is with an eroding tax base,” Cure said.

The program had mixed success, said Michigan State University economist Eric Scorsone. “In some cases it’s worked well, like Allen Park where the situation was pretty clear cut and the solution was pretty clear as to what needed to be done,” said Scorsone, who previously served as interim deputy treasurer supervising the EM program.

Allen Park regained full local control of its operations and finances in February 2017 after nearly four years of state oversight. In June S&P Global Ratings upgraded the city to investment-grade BBB-plus from junk-level BB, crediting strong budgetary performance and financial flexibility more than 12 months after exiting state oversight. Allen Park struggled to pay bonds for a failed movie studio deal also led to Securities and Exchange Commission sanctions.

In other cases, critics say, emergency managers fell short with Flint a glaring example. Flint regained full control of its finances in April, ending nearly seven years of state oversight that was marked by a water contamination crisis that drew national headlines, congressional hearings and criminal charges.

Flint had four emergency managers: Ed Kurtz, Mike Brown, Darnell Earley and Gerald Ambrose. Earley and Ambrose – both appointed by Snyder-- face charges of criminal wrongdoing stemming from the lead contamination crisis and ensuing Legionnaire’s disease outbreak that claimed 12 lives.

Earley oversaw the decision to change the city's water source to the Flint River in April 2014 as the city awaited completion of a new pipeline. The city failed to properly treat the water, corroding water delivery pipes, spreading lead into the system.

“Michigan is going to be a little gun-shy after what happened in Flint because we have not heard the last of Flint,” said Cure. “I think just the health issues particularly for children from the intake of tainted water is going to keep this issue alive for a while.”
Cure sees the state taking on a less dominant role in financial crises, with the state taking a much more advisory role.

Two years ago, a task force Snyder appointed to investigate the Flint crisis called for a review of the EM law and said Snyder should look for alternatives to the current approach that engage local elected officials. No action has been taken to change the law.

Scorsone said that, at least under the current administration, it is unlikely that the state will step into another emergency. He doesn’t see the two major candidates in the Michigan gubernatorial race – Republican Bill Schuette and Democrat Gretchen Whitmer -- leading a full-scale state takeover of a local government. “Both candidates have either explicitly or implicitly made it clear that this is not the kind of approach that they would use,” Scorsone said.

Scorsone said it is unclear if the legislature will want to tackle the EM law or if it will just lie dormant.

“If they are not using it then there tends not to be a lot of momentum to do so, until a crisis breaks through,” Scorsone said.

On the upside Scorsone said that the fiscal health of Michigan local entities is the best it’s been in 20 years.

“There are still issues and problems but we are certainly as good at least since the 90’s,” he said. Things are pretty solid at the moment.”

Cure said that there is only so much the state can do if a local entity is facing a long-term economic decline.

“If it’s more of a short-term cash flow issue they may permit issue deficit financing bonds or loan them money or advance them state monies but there is only so much that can be done when you have an eroding tax base,” Cure said.

From a rating perspective the invention program carries some weight.

Jane Ridley, senior director in the U.S. public finance government group at S&P Global Ratings and sector lead for local governments, said that state oversight is considered as part of the rating agency’s local GO criteria.

“We do think that having a state that has oversight, especially if it’s a proven mechanism, can be very helpful for struggling entities,” Ridley said.

“If they ended oversight entirely it would likely have an impact on the institutional framework scores and their sub scores … and it would be reflected in our ratings but not necessarily to the point that we would change ratings,” she said.

“While an EM is in most cases is a last option, the ability for it to implement some policies and procedures is going to be typically viewed, at least at the onset, as a credit positive,” said Andrew Van Dyck Dobos, a public finance analyst at Moody's

For Detroit, the role of state, even in an inactive state, is considered a plus by some. The state relinquished control over the city’s finances on April 30, three years after Detroit's Chapter 9 exit in December 2014. The city now has the power to enter into contracts and enact city budgets without seeking state approval. The decision to scale back oversight was triggered by three consecutive years of balanced budgets along with three years of projected balanced operations.

Detroit must continue to present monthly information to the commission so that it may continue to monitor the city’s fiscal health and ensure that the city continues to meet the conditions for waiver.

“If they don’t meet certain benchmarks and put together balanced budgets and projections, the state’s financial control board can still step in,” said Cure. “Done right I think it gives comfort to an investor to have that effective oversight and an additional financial monitor on finances.”

In May, Moody’s upgraded the city’s issuer rating to Ba3 -- still junk -- from B1. In December, S&P Global Ratings upgraded the city’s issuer credit rating to B-plus. The outlook is stable.

Levett said that the city’s upgrade was driven certainly more driven by the strides that the city has made in its finances from a management perspective, such as planning for long-term challenges. Still he said that the fact that state can step in if things go wrong is an added benefit.

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