Warning for CA: Harrisburg confronts bankruptcy

April 17, 2012 - By Tara Leo Auchey

Editor’s Note: This is the seventh in a CalWatchDog.com Special Series of 12 in-depth articles on municipal bankruptcy. In a warning for California, it examines the bankruptcy of Harrisburg, Pa.

What happened in Harrisburg, Pa.? One day there was nothing but murmurs about Pennsylvania’s capital city being in a fiscal mess. Then, all of a sudden, Harrisburg filed for Chapter 9 Municipal Bankruptcy protection.

What made the declaration all the more significant is that it’s the state’s capital. Everyone had been talking Jefferson County, Ala. or Central Falls, R.I., which filed for Chapter 9. But few figured Harrisburg would be the next to do so. However, the signs for this abrupt, bold move were there despite the state doing its best to control the situation. which includes not only a grave municipal fiscal crisis, epitomized by a defunct public project, but a power vacuum left behind by a seven-term mayor.

In November 2011, as Reuters reported, “Pennsylvania is poised to take over its struggling capital of Harrisburg after a federal judge said the city cannot file for bankruptcy to get out of its $300 million outstanding debt.” As the Wall Street Journal explained, “Judge Mary France of the U.S. Bankruptcy Court inHarrisburg ruled that a band of city councilors lacked the authority to put the city of roughly 49,000 residents under bankruptcy protection when they filed the Chapter 9 petition on Oct. 11.” City councilors who favor bankruptcy may challenge the ruling, but however it ends up, it’s clear that Harrisburg needs to be rescued from itself.

The picturesque city along the Susquehanna River is located halfway between Philadelphia and Pittsburgh. With a population of just under 50,000 people, it seems and acts more like an oversized town than a metropolis. Its daytime commuting population doubles the total residential population, as state government workers come in from the surrounding suburbs and countryside. About 53 percent of the city’s residents are African-American; and 30 percent of the citizenry live below the poverty line. Also note that 50 percent of the city’s assessed property is tax-exempt: government buildings, hospitals, colleges and universities, churches and non-profits are concentrated there.  As the city’s financial and infrastructure problems grow, more residents who can are leaving behind the spark of renaissance the city was starting to benefit from.

Operating under a strong-mayor model, Harrisburg’s government consists of an executive branch (the mayor) and a legislative body of seven city council members. On Oct. 12, the council voted 4-3 to pass back-to-back resolutions to retain a bankruptcy attorney and file for Chapter 9. As soon as the vote was over, the council’s new attorney, Mark Schwartz of Bryn Mawr, Pa., faxed off the petition. The next morning, it was officially received by the U.S. Middle District Bankruptcy Court. 

New Mayor

Mayor Linda Thompson was near the end of her second year in office. She had overthrown the 28-year-reign of Stephen R. Reed by beating him in the primary, then winning the general election against Republican opponent Nevin Mindlin. Thompson decried council action as “a sneak attack” and defined it as “procedural defectiveness” since the process of passing the resolutions did not proceed per city rules.

The state of Pennsylvania and Dauphin County also proclaimed the move invalid. On Oct. 17, the parties met in front of Federal Bankruptcy Judge Mary France for a Scheduling Conference of the proceedings. Attorneys from high-powered New York and Philadelphia firms filled the room, representing creditors, bond insurers and trustees. The state of Pennsylvania, joined by the county, requested an expedited dismissal of the city’s bankruptcy petition, arguing it is unlawful to file for Chapter 9 without the state’s approval. The office of the mayor argued for the petition’s dismissal, claiming it is unlawful for Chapter 9 to be filed without the mayor’s involvement. The bankruptcy opponents all asked Judge France to declare the filing illegal as soon as possible so all parties could move forward with their plans for Harrisburg

It’s precisely the bankruptcy opponents’ plans that drove the city council to file for municipal bankruptcy. A year ago, the city received a $4.3 million bailout from then-Gov. Ed Rendell in order to pay a $3.3 million general-obligation bond payment. Rendell insisted it was “not a bailout.” 

Act 47

Mayor Thompson unilaterally requested admission to Pennsylvania’s Municipal Financial Recovery Program, known as Act 47. Act 47 is Pennsylvania’s statutory response to a) dealing with fiscally challenged municipalities and b) controlling municipal bankruptcy filings. Pennsylvania is one of 19 states that require state authorization of Chapter 9, and its Act 47 program is its mechanism to do so. If a municipality finds itself unable to maintain essential public services, meet debt obligations, make payroll and pay bills — or ultimately, run the ship — then it must turn to the state for help. That help includes financial and professional assistance to devise a plan of solvency, called an “Act 47 Plan.” The goal is that an Act 47 Plan will fix the impoverished place’s problems. The statute lays out a formula and path for success. If success is not able to be met, then the state will permit Chapter 9 filing.

Since 1987, when Act 47 became a law, 26 municipalities have entered the program. Only six have emerged, and those were boroughs, each with a population of less than 5,000 people.

In Pennsylvania, Third Class Cities are defined as “cities under 500,000 population that have not elected to become a city of the second class A.” No Third-Class City has ever come out of it, and the longest one in has been there since 1987.

Only one Pennsylvania municipality had ever filed for Chapter 9 before Harrisburg. Westfall Township filed for Chapter 9 in 2009 because of a $20 million judgment against it, which was 20 times its yearly operating budget. Because the township had experienced no municipal fiscal distress prior to the judgment, Westfall was not in the Act 47 program, yet was able to skip the state’s requirements and file for Chapter 9 under “emergency” conditions triggered by the ruling.

Mayor Thompson applied for Act 47 status after nine months in office in Harrisburg and failing to get a grasp on the city’s financial crisis. Although she had served on the city council for 10 years, she said she did not know just how bad things were and indicated that the complicated financial problems of Harrisburg were far greater than her skill, experience or capabilities. A polarizing personality, the mayor found it challenging to secure the internal help she required to face a city insolvency that was decades in the making. Thus, Thompson turned to the state for assistance and applied for Act 47. 

Resistance

There was substantial resistance to Harrisburg entering the program. Residents, business owners and public officials testified in front of the state that Act 47 wasn’t designed to handle Harrisburg’s complex financial problems, which centered around a trash-burning facility, dubbed The Incinerator — what the Wall Street Journal called, “The Incinerator That Kept Burning Cash.”

To say The Incinerator is a regional public project gone bad is an understatement. In 1972, The Incinerator was built as the region’s answer to its waste. Ideally, the facility would convert trash to steam and electricity, which the city would sell. Ideally, the trash would be flowing in from places local and afar. Ideally, the whole thing would run cleanly, smoothly, efficiently and profitably. That was the public message. In reality, that hasn’t happened. Never quite right since it was built, the peak of The Incinerator’s troubles came in the 1990s, when massive disrepair plagued it and the county decided it was cheaper to use a landfill for 10 years instead of the city’s facility.

In 2003, when a modernization and retrofit was getting underway, The Incinerator was $104 million in debt. Fortunately, upon completion of the construction, the county agreed it would bring all of its trash back to The Incinerator. The county committed to guaranteeing some of the retrofit bonds and even received fees for doing so. 

More Funds Needed

The construction didn’t go as planned. Barlow Projects Inc. was unable to finish what it started.  More funds needed to be taken out. In 2007, the Harrisburg Authority that owned and operated The Incinerator borrowed more money. The city and county stepped in again to provide loan guarantees, and to guarantee received fees for doing so. As with the first guarantee agreement, this one was voted on by county commissioners and the city council, brought together by then-Mayor Reed, with only one dissenting vote among 10 elected officials. Current Mayor Thompson in 2007 sat on the city council for this guarantee and voted in favor of the borrowing. By the end of 2007, The Incinerator carried $230 million in debt, with very little revenue coming in from converting the trash into steam and electricity.

Currently, Harrisburg residents pay $200 a ton to dispose of their own waste at a facility within city limits, one of the highest trash rates in the country. Harrisburg residents are also on the hook for what has become an accumulation of principle, interest, penalties, legal fees, consulting fees, advisory fees and more. Harrisburg is the first and only full guarantor of The Incinerator’s debt. As second guarantor, Dauphin County guaranteed $144 million of it, but the agreement states that any payment the county makes, the city will pay back. Neither the authority nor Harrisburg has been able to make any of  The Incinerator’s debt payments for the past two years. For that reason, both the city and the authority have suits filed against them by the county, bond insurer and trustees.

Taking what probably should have been a private business and attempted to make it something to generate revenue for the city, The Incinerator is what makes Harrisburg’s financial crisis so distinctive and serious. While several parties facilitated the debt of The Incinerator over 15 years of debacles, it is the city that’s left holding the bag. The details of The Incinerator saga tell a chronicle of political maneuvering, creative financing, cronyism, bad business and citizen apathy. 

Beyond Act 47

In the past few years, though, details of Harrisburg’s crisis have caught the attention of more people. As the public became more aware of the city’s financial woes, people argued that the convoluted conundrum surrounding The Incinerator was beyond the scope of Act 47′s structural solutions. Act 47 was designed for dying industrial towns, not small cities with more intricate issues and massive debt. By last October, when Mayor Thompson applied for Act 47, the city was estimated to owe more than $320 million in debt tied to The Incinerator, along with a budget deficit of at least $5 million a year. In December 2010, Pennsylvania declared Harrisburg “fiscally distressed.”

From then until now, the city has been presented with two Act 47 fiscal recovery plans: one by the state-appointed coordinator, Novak Consulting Group; and a second by the mayor, who was required to present her own plan after a vote by the city council rejected the state coordinator’s plan. The coordinator’s plan and the mayor’s plan were essentially the same. The main solution of both plans is to sell or lease the city’s two primary revenue-generating assets, The Incinerator and the city’s parking system. While there isn’t much dispute that those privatizations are necessary, they still don’t resolve Harrisburg’s debt. According to the Act 47 plans, projections and anticipations, those transactions would still leave behind $26 million in stranded debt the city would be responsible for. Based on other interested parties’ calculations, the stranded debt has been calculated as much higher, upwards of $60 million to $80 million.

The four city council members who voted to file for Chapter 9 protection consistently voted down the Act 47 plans put before them. To vote to pass or reject the plans is one of the only powers the legislative body has in the Act 47 process.

Said Brad Koplinski, a councilmember who voted yes to move forward with Chapter 9, “In the Act 47 Plan, the numbers just weren’t going to work. In general, the plan overestimates revenues and underestimates costs and liabilities.Harrisburg residents can’t pay for those errors. Our residents have already absorbed some significant blows including increased trash fees and decreased services. Based on the Act 47 Plans, taxpayers will see a 30, 40, even 50 percent increases in taxes. There’s got to be shared pain among the parties. There’s no way the Act 47 suggestions can succeed in solving Harrisburg’s massive and unique financial problem.”

Both the state and the mayor have admitted the plan has errors, but contend, “It is a living, breathing document.” What worries the city council members is if Harrisburg passes an Act 47 plan and it becomes an ordinance. Then the city must follow the ordinance, or risk Act 47 consequences, which now include brand new legislation for a state-appointed receiver to manage the city’s financial recovery. “The State changed the rules on us,” Koplinski said. “And it’s the city that has the most at stake.”

The city council members in favor of Chapter 9 say the city has been bankrupt for years. They maintain now is the time to use the official tool of bankruptcy to get everyone to the table to work out a fair and equitable plan. The previous mayor, Reed, was efficient at moving money around without many checks and balances. Up until this point, the city was able to avoid what the city council sees as this inevitability of a bankruptcy filing. Through a series of municipal authority transfers and borrowing, Reed was able to bury the city’s deficits all the while hoping to reach the tipping point into legitimate solvency. 

Unsustainable Policy

Nevin Mindlin, the Republican who lost the 2009 mayor’s race to Democrat Linda Thompson, also criticized her predecessor, former Mayor Reed. Mindlin said Reed’s policy on The Incinerator was unsustainable, referring to it as a classic tale of robbing Peter to pay Paul. “Steve Reed kept moving money around, kicking the can down the road, and ended up having to cut the things that make a good community function,” Mindlin said. “When his gambles failed, it was the taxpayers that had to pay. That’s where we are now.”

While there is dispute about the best way to confront the city of Harrisburg’s fiscal quagmire, some taxpayers looked to municipal bankruptcy protection to help Harrisburg with the massive pubic debt it guaranteed.  However, on November 23, Judge France dismissed the Chapter 9 petition, declaring that the city council did not have the authority to make such a filing without the mayor’s or the state’s approval.

A week later, a state-appointed receiver was confirmed, bond attorney David Unkovic.  Unkovic had been outspoken that creditors will have to pay a fair share in Harrisburg’s debt solution – especially in light of what he testified as the “uncommon” Incinerator debt structure. Whether he will be able to negotiate “fair share” results is yet to be seen.

But on March 30, 2012, Unkovic resigned in the midst of receiving bids for The Incinerator and the parking system. Reported Reuters, Unkovic, “said in his resignation letter that he was no longer in a position to find a solution to the city’s financial crisis.” But Steven Kratz, spokesman for the Pennsylvania Department of Community and Economic Development, said, “The process is going to continue to move forward.”

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