By Chriss Street

California State Controller John Chiang announced that the cities of Milpitas and Morgan Hill illegally tried to convert hundreds of millions of dollars of real estate, cash and investments that were required to be turned over to the State of California after  Gov. Jerry Brown and the State Legislature passed Assembly Bill 1x 26, terminating all municipal redevelopment agencies to help cover a $25 billion budget shortfall.

Before the controller’s audits, the state had collected less than $400 million of the $3 billion they expected from the state’s 400 community redevelopment agencies. The controller’s charges against two small towns are a home run for the state, but are a financial nightmare that will pound cities and counties across the state.

Under the new state law, all redevelopment agencies were required to cease operations by February 1, 2012 and transfer their assets and liabilities into a “successor agency” under the direction of an independent oversight board.  The new agency would then sell their assets, pay off their existing obligations, then transfer the cash to their county auditor-controller for distribution to schools and other local agencies.  To make sure cities and counties that sponsored the redevelopment agencies didn’t grab the assets, the law made any retroactive transfers after January 1, 2011 illegal.

Despite full knowledge of the law’s prohibitions, many of the redevelopment agencies’ sponsors converted the assets for their own use.  In response, the controller began conducting 14 initial audits and announced the following results for the first two audits:

Morgan Hill transferred $88.6 million to the City and $19.8 million to their Morgan Hill Economic Development Corporation.  The City of Morgan Hill created the MHEDC and transferred the assets in March 2011, three months after the effective date of Assembly Bill 1x 26.  The controller’s review also found that the city council sat as the MHEDC Board when the transfers were made.

Milpitas transferred $96.9 million directly to the city and $50.2 million to the Milpitas Economic Development Corporation. The controller’s audit found that the MEDC was established by the city council two months after the effective date of Assembly Bill 1x 26 and the board members were city council members. The Milpitas also failed to transfer an additional $87.6 million of redevelopment assets to their successor agency, and requires that these assets also be transferred to the successor agency.

After the audit

Following the audit, Chaing artfully said:

“As redevelopment agencies complete their wind-down, I hope that this provides an opportunity for local economic development to be re-imagined with a greater emphasis on measurable performance, efficiency and accountability.”

When it comes to imagination, the size of the charge backs against Milpitas and Morgan Hill far exceeded the dreams of the California Department of Finance, which had estimated that all 27 redevelopment agencies that paid only $6.7 million owed the state another $129 million.  At the time, Richard Keit, spokesman for San Jose, had complained bitterly about the Department of Finance’s initial estimate that the termination of his city’s redevelopment agency would result in a $39 million bill:

“It’s already gone.  The state Department of Finance knows we don’t have the $39 million — that we weren’t hiding it.  It was all committed and now expended.”

Assembly Bill 1x 26 gives California finance officials the power to intercept municipal tax monies from cities and counties. But California Finance Director Ana Matosantos sent a letter last month to the 27 local governments saying the state would not withhold sales tax revenue or seek a penalty until September.  But now that audits indicated the state will score higher cash, Finance Department spokesman H.D. Palmer warned:

“We hope that we’ll be able to resolve any differences between these successor agencies in an amicable manner.  That said; those tools were put into place to ensure that schools and cities and counties get the property tax that they are owed for that period.” 

With investors, like Warren Buffett, dumping California’s municipal  bonds after California sales tax revenue nose-dived by 33.5 percent, California is in survival mode.  The state is going to pound the California cities and counties for every penny it can get.

Chriss Street and Paul Preston Co-Host of
“The American Exceptionalism Radio Talk Show”
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Click Here to Listen:  http://www.mysytv.net/kmyclive.html

Editor’s Note: Correction Below

MARCH 13, 2012

By WAYNE LUSVARDI

Newspapers across the United States have told of the financial plight of three cities in northern California facing possible bankruptcy: Stockton, Hercules and Lincoln.

However, many may not be aware that four newly formed cities in Southern California may be facing disincorporation due to the California Legislature denying them property taxes in lieu of Vehicle License Fees that all other cities in the state receive.  These four cities are: Jurupa Valley, Eastvale, Wildomar, and Menifee.

They have a combined population of about 257,500 people, which would be similar in size to the city of Stockton.  Stockton is the largest city in California facing bankruptcy.

No city officials in any of the four Southern California cities are willing to say whether the actions of the Democratic-controlled Legislature create an appearance of partisan policy in denying taxes to only new cities in the Republican Inland Empire of Southern California.  Steve Harding, city manager for Jurupa Valley, said these four cities need bipartisan support to correct the legislature’s oversight about how this policy adversely affects newly incorporated cities.  According to CityData.com, three of these four cities voted a split ticket in the 2008 U.S. presidential election.

Cities With No Pension Spike or Debt Going Insolvent

Newer incorporated California cities such as Eastvale, Jurupa, Menifee and Wildomar have no substantial debt or pension obligations, as do older cities suffering from budgetary insolvency.  That is because the newer cities were incorporated from 2008 to 2010.  So bankruptcy is not an option because there is nothing financially to restructure.  Folding these cities back into Riverside County may be the only viable option.  But that would take a vote of the residents of each city.

Jurupa Valley, Eastvale, Wildomar and Menifee experienced a population boom from 2003 to 2008 due to the Housing Bubble. These four cities have lost from 17 to 46 percent of their operating budget when Vehicle License Fees were diverted to fund prison realignment in 2011.  The loss of these fees was not backfilled with property taxes, as happens in all other cities in California.

Typical salary and benefit costs for most city budgets are in the 70 to 80 percent range of the total budget. Thus, Jurupa Valley — which lost 46 percent of its budget — and Eastvale — which lost 38 percent — are the most susceptible of the four cities to becoming financially insolvent.  Insolvency is when expenditures exceed revenues.

Percent of Vehicle License Fees of City Budgets

In 2006, AB 1602 Made Incorporation Easier

State Assembly Bill 1602 passed on Sept. 29, 2006, made it easier for unincorporated areas to become cities.   Instead of a property tax on motor vehicles as many states have, California collects an annual Vehicle License Fee — called the VLF.  It allocates the revenues, minus administration costs, to cities and counties.

The unincorporated area of Wildomar incorporated on Feb. 5, 2008. In 2008, the unincorporated areas of Menifee, Sun City and Quail City merged and became incorporated as the city of Menifee. This spurred interest by the areas of Mira Loma, Pedley, Glen Avon, Sunnyslope and Rubidoux to merge and incorporate.  The new city of Eastvale incorporated on Oct. 1, 2010. On July 1, 2011, the census place of Mira Loma became incorporated with the city of Jurupa.  Another part of Mira Loma became part of the city of Eastvale.

Questions and Answers

Steve Harding, city manager of Jurupa Valley, was interviewed and provided some helpful answers on the financial crisis facing all four cities.

Q: What is the current status of VLF in Jurupa?

Harding: Currently, the city has lost all of its estimated $6.8 million in VLF for FY 2011/12 and is scheduled to receive only $180,000 in COPS [Community Oriented Policing Services] backfill funding. Additionally, this annual loss is ongoing into future years.

Q: Why was Jurupa disproportionately hit with the highest diversion of VLFs?

A: Jurupa Valley along with the three other cities that incorporated after 2004 (Eastvale, Wildomar and Menifee) do not receive property tax in Lieu of VLF that all other cities in the state receive. The four new cities were receiving this proportionate revenue in the form of VLF only on a population basis as per the 2006 AB 1602 legislation. Jurupa Valley, being the largest of the four cities, was thus hit with the largest proportionate loss. In fact, only the city of Los Angeles lost more than Jurupa Valley as a result of the SB 89 VLF diversion. But even Los Angeles, along with all the other cities in the state, retained their significant property tax in lieu of VLF apportionment.

Q:  Is Jurupa’s budget in a shortfall to be met with reserves or in a true deficit due to loss of VLF’s?

A: As a brand new city, we had anticipated ending FY 11/12 with an approximate $9.7 million surplus for reserve in the general fund, with future balanced budgets moving forward into future fiscal years. With the loss of the VLF this year, we are now projecting an approximate $2.9 million surplus for reserve. However, as this loss at present time is ongoing, and as the city transitions into its second year, there will be a significant budget shortfall that will exhaust this reserve and lead to insolvency prior to the end of FY 12/13 without very significant and draconian cuts to services.

Q: Has the county loaned Jurupa funds and how long would they continue to do so?

A: Riverside County did loan the city $1.7 million for cash flow purposes since our VLF apportionment scheduled to be received in August 2011 did not come forward. Now that the city has begun receiving sales tax and other revenues, we have repaid that loan. However, it is noted that the only reason the county was able to do that was under state law, they can make such a loan to a new city in its first fiscal year, but cannot do so after that fiscal year completes. Thus, we cannot receive any more loans from the county.

Q: Does the City have a Plan B in the event that VLFs are not restored in whole or in part?

A: The city is working on a Plan B. However, it is unlikely the city would survive very long. The city has no employees at this time and all functions are handled by consultants. The most significant expenditure is for law enforcement (contract with the county sheriff), which will comprise approximately 60 percent of the anticipated Fiscal Year 2012/2013 budget. The sheriff has advised the city on the maximum cut they could absorb in service levels and continue to service the city from an officer safety standpoint. This cut would not be sufficient to cover the gap. Additional cuts in other services are being reviewed but if all services are curtailed, and all other costs eliminated (which can’t legally be done), there will still be a significant budget gap.

Q: Would the worse case scenario for the city be bankruptcy or disincorporation, or could the city absorb a loss of nearly 50 percent of its General Fund?

A:  The city [of Jurupa Valley] cannot absorb this loss. Worst-case scenario would be disincorporation, which would have to go before the voters. Bankruptcy is not really an option because we are so small in consultant staffing, and we have no debt or pension liabilities, etc., there is really nothing to re-organize. Again, law enforcement is the largest expenditure and they cannot be cut sufficiently to make up the gap do to their officer safety requirements.

Q:  What effect, if any, did the past swap of property taxes for VLFs have on Jurupa?

A:  When the 2004 “swap” took place, cities not yet in existence (and future annexations to existing cities) were left out of the funding “swap” formula. In 2006, AB 1602 was signed into law correcting the problem. However, instead of being placed in the “property tax in Lieu of VLF scenario,” as all other cities, the legislation devised a formula to allocate that proportional amount directly out of the VLF account. Thus, all cities and all annexations to existing cities that occurred after 2004 (essentially 2006) are now treated differently than all other cities in the state.

Q:  What efforts, if any, are under way in the Legislature to restore those funds?

A:  The city of Jurupa Valley has had several discussions with various legislators and the governor’s legislative and finance staff, including direct talks with Ana Matosantos, state finance director, on this issue. Also, SB 1566 has been introduced as a bi-partisan bill that will restore the VLF funding to the post-2004 new cities and annexations, beginning in FY 12/13. The authors of the bill are Sens. Gloria Negrete Mcleod and Bill Emmerson, with Sen. Kevin De Leon as a co-author. [Negrete Mcleod and De Leon are Democrats; Emmerson is a Republican.] Additionally, there is bipartisan co-sponsorship in the Assembly. The bill is currently in the Senate Rules Committee awaiting committee assignments. It is unclear at this time if the governor will support this bill.

Q: What is the story that Jurupa needs to get out on this issue?

A: Primarily that this is a matter of being treated fairly and equally with all the other cities in the state. Jurupa Valley understands and is willing to absorb the proportionate loss of the other cities in the state of their VLF funding, which in our case is approximately only $300,000 annually. However, we should not lose the proportionate AB 1602 funding that we have also lost since we do not receive the property tax in lieu of VLF, as all other cities retained. Additionally, this city is made up of a large segment of economically disadvantaged communities that have already enjoyed some significant service increase over what the county was providing, and that is now threatened. Additionally, the whole purpose of SB 89 was to re-direct revenue to law enforcement. However, in our case, and the other three cities mentioned previously, this is having a reverse affect. All four cities have either cut their law enforcement service down to dangerous levels, or are contemplating that for the next fiscal year. The bottom line is that we (and the other three cities and annexations) should not be treated any differently than the other 476 cities in the state.

Correction on March 29,2012: This article originally included Milpitas among the Northern California cities seeking bankruptcy. City manager Tom Wilson told us that the city “has no intention of filing for bankruptcy.” The city council did declare a fiscal emergency. But that was to deal with a $7 million budget problem because the state dissolved the city’s redevelopment agency. The city council soon will be “rescinding the fiscal emergency.” We regret the error.

— John Seiler, Managing Editor

By WAYNE LUSVARDI

Stockton … Hercules … Lincoln … Milpitas.  The list of cities has grown to four in the span of one week.  These are all cities in California recently threatened with budgetary insolvency — where expenses exceed revenues.  All have started to explore filing bankruptcy or drastically reducing their budgets and effectively doing the same, as would happen in a bankruptcy court.

AB 506, by Assemblyman Bob Wieckowski, D-Fremont, became law in 2011 to prevent or delay just such a run of bankruptcy filings.  The California Legislature does not want a run of cities filing bankruptcy because the state budget continues to run a $20 billion annual deficit and is unable to bail out insolvent cities.

AB 506 prohibits a municipal government from filing a federal bankruptcy unless they it either:

1. Undegoes a neutral evaluation conducted by a third party and involving all interested parties, including unions and creditors. This applies to the cities of Stockton, Hercules and Lincoln; or
2. Declares a “fiscal emergency” that threatens the health, safety or well-being or residents without bankruptcy protections. This applies to the city of Milpitas.

The city of Stockton has initiated the mandated neutral evaluation process preparatory to filing bankruptcy.   The city of Milpitas has declared a “fiscal emergency,” preparatory to raising taxes or filing bankruptcy if a tax ballot initiative fails.  The cities of Hercules and Lincoln have drastically reduced their budgets, as they would be forced to do by a bankruptcy judge.   But they are all in the same “fiscal” boat with budget deficits.

The Start of the Great California Muni Bankruptcy Run?

Each city has its own unique story as to how they ended up with an insolvent budget.

Stockton

For Stockton, it was overbuilding of homes during the Mortgage Bubble, reliance on redevelopment projects that now have gone bust and the fast growth in public pension costs.   Retiree pension costs have risen from $8.5 million per year in 2007-08 to $16.8 million in 2010-11, and the proportion of costs may continue to rise.  The median home value has dropped about 65 percent compared to about 33 percent on average in California since 2006 (CityData.com).

In 2011, Stockton had a $3.98 million hole in its operating budget to patch. The sources of that hole were: $2,323,600 in declining property taxes, a $1,047,000 loss of vehicle license fees and $700,000 in fire department overtime.  SB 89 diverted $130 million in vehicle license fees statewide from cities to counties to help pay for prison realignment.

Hercules

For the City of Hercules, located in the north San Francisco Bay, the median home price has plummeted from $650,000 in 2006 to $250,000 in the third quarter of 2011 (CityData.com).  That reflects a whopping 62 percent decline and a decreasing property tax base.  Hercules took a $1.85 million hit to bail out its redevelopment agency when Gov. Jerry Brown ended redevelopment this year. That bailout pushed the city into a $1 million deficit on its budget balance sheet.   Hercules lost $87,107 in vehicle license fee revenues under prison realignment.

Lincoln

For Lincoln, a small community north of Sacramento, it was the debt on a new $16 million library that pushed its budget into a $2 million annual deficit. According to CityData.com, the median home value in Lincoln dropped from $500,000 in 2006 to $250,000 in the third quarter of 2011, a 50 percent decline. Lincoln lost $146,154 in vehicle license fees under prison realignment.

Milpitas

Milpitas, a suburb of San Jose located in the South Bay, was hit with a $39 million cost to bail out its redevelopment agency, which shoved the city budget into a deficit.  Median home values have declined relatively more modestly in Milpitas, from $600,000 in 2006 to $400,00 by the third quarter of 2011, reflecting a 33 percent decline, according to CityData.com.  Milpitas lost $252,859 in vehicle license fees under prison realignment in a city running a $5.2 million budget deficit.

Bankruptcy as ‘Reputational Stain’

The biggest decline in municipal revenues has been in sales taxes, however, for all cities.  If it were not for Proposition 13, property taxes would have declined even further. Prop. 13 has a “circuit breaker” built in to it to prevent a free fall in property taxes. Cities also lost the revenues from vehicle license fees in 2011.

State Treasurer Bill Lockyer was quoted in the Wall Street Journal saying he wants to avoid the “reputational stain” of a wave of municipal bankruptcies because it would make it difficult for the state to raise funds in the bond markets.  Bond underwriter Richard Larkin of Herbert J. Sims Co. said that, as the number of bankruptcies mounts, bond interest rates will rise.  AB 506 may not be enough to push back a tidal wave of bankruptcies and higher bond borrowing costs from happening.

In turn, those higher bond interest rate costs will be added to the debt line item in city, county and state budgets, putting more pressure on other line items in each budget.   Cities are caught in a downward spiral of revenues that local tax initiatives may not be able to entirely fix.  As revenues continue to ratchet downward any, “tax fix” may only be temporary, requiring yet another and another tax fix.  Bankruptcy, or voluntary budget reductions, may be a better way to go because either offers a way to control costs instead of a death spiral that tries endlessly to raise revenues — even as the tax increases themselves drag the city down.