MUNICIPAL FISCAL DISTRESS: CAUSES AND SOLUTIONS By David Unkovic This paper reviews the causes of fiscal distress

, starting with a look at the basic financial factors involved in running a municipality, and then considers some less obvious causes. The paper then reviews possible solutions and approaches in dealing with the distress. CAUSES OF MUNICIPAL FISCAL DISTRESS Municipalities are like any other businesses in that their fiscal stability is driven by (1) revenues, (2) expenses, (3) assets, (4) liabilities and (5) cash flow. Municipalities, like any other businesses, become fiscally distressed when they have some combination of (1) insufficient revenue sources, (2) out of control expenses, (3) insufficient assets, (4) out of control liabilities and (5) insufficient cash flow. The obvious causes of municipal fiscal distress:

There have been numerous studies which outline the obvious causes of municipal fiscal distress. In Pennsylvania, see an excellent report dated November 2010 of the Pennsylvania League of Cities and Municipalities entitled “Core Communities in Crisis Task Force Report” ( For a national perspective, see the National League of Cities’ report, “City Fiscal Conditions in 2012” ( Revenues. Municipalities that face fiscal distress often have a limited ability to increase revenues. If a municipality is a “core community”, which is a center of employment, education, culture, social services, regional government and history, then many of its employers and much of its land may be exempt from taxation. Many municipalities have faced declining tax bases and fewer resources from the federal and state governments since the onset of the Great Recession. The ability of real estate taxes and income taxes to generate more revenue eventually reaches the point of diminishing returns (the Laffer Curve). Poorer municipalities are typically not in a position to tax their way out of their problems. Many of these municipalities have been able to raise more money through fees, but this is not a sufficient source to solve the entire revenue problem. For example, in the City of Harrisburg, Pennsylvania, where I served as the first stateappointed receiver, half of the property is exempt from real estate taxes. The city serves as the state capital and the county seat and is also the regional center for many healthcare, educational and cultural nonprofit corporations. The city has only 49,000 citizens, of whom


approximately one-third have incomes below the poverty level. It is a poor city with a limited ability to raise additional revenues through tax increases. The problem of revenues is even more stark in Detroit, Michigan, where almost half of the property owners do not pay their real estate taxes ( and approximately 44% of the residents are below the poverty level. Expenses. For many municipalities, labor costs constitute a large portion, often 65% to 70%, of their annual budgets. Salaries and benefits, including healthcare costs and pension payments, are often out of control in distressed municipalities. After working over 30 years in the private sector, I went to work for the state government in Pennsylvania in 2011. The thing that struck me the most in going from the private to the public sector is how much public employees focus on their healthcare benefits and their defined benefit pension rights. It has nothing to do with one’s political party or allegiances, or whether one is in the executive, legislative or judicial branch, or whether or not one is in a union; it is a point of common interest among all public employees, which, if pushed too far, is contrary to the interests of the citizens they serve. And it is often pushed too far in distressed municipalities. Pennsylvania has a Municipal Financial Recovery Act (known as Act 47) which is designed to help distressed municipalities. Pennsylvania also has a statute which provides for an arbitration system for labor negotiations for uniformed municipal employees (known as Act 111). One of the main reasons municipalities have chosen to go into Act 47 over the years is to get some control over their labor and benefit costs. For 25 years, from 1987 to 2011, the state courts held that any arbitration award under Act 111 had to be subject to the limits set forth in a municipal recovery plan adopted by a distressed municipality under Act 47. In other words, for a distressed municipality, when it comes to labor costs and benefits, the recovery plan trumps an arbitration award. This precedent was overturned in a Pennsylvania Supreme Court case in 2011 between the City of Scranton and its firefighter union. The court held that the arbitration award trumps the recovery plan. The state legislature has since amended Act 47 to try to balance out these interests, but not in a way which will give distressed municipalities real control over their labor costs. Healthcare, pension and other retirement costs are a matter of intense debate in states and municipalities across the country. The simple fact is that if a municipality cannot control its healthcare, pension and other retirement costs in a meaningful way, it is almost inevitable that it will become distressed at some point.


Assets. Before the Great Recession, most people who thought about municipal finance would focus on revenues and expenses – it was basically a budgeting exercise. But it is becoming more clear, as governments struggle with hard economic times, that assets are also very important to a distressed municipality. Assets are a two edged sword. They can generate significant revenue to run operations such as water service, sewer service and parking. But they also cost significant amounts to acquire, expand and maintain. If the assets are run efficiently, they can provide important services to the citizens; if they are run poorly, they can take a municipality over a fiscal cliff. Harrisburg is an example of a bad result. The city, together with an authority it controls, owns and operates an incinerator plant and regional water and sewer systems. For purposes of this point, let me focus on the sewer system. The system serves the city and six surrounding municipalities. Over the years, the city overcharged city residents and suburban residents for “administrative costs” of the system by a factor of about 7. So, to cover about $1 million of annual administrative costs, the city charged the users about $7 million. The city used the excess $6 million to cover other general fund expenditures of the city. On top of this, the city did not put any significant money into improving or maintaining the sewer system. As a result, many of the brick sewer pipes under the city’s streets which were installed in the 19th century have not been replaced or improved. It is not unusual for a large sinkhole to appear when an old pipe collapses, bringing down a street with it. Not only did its budgetary problems keep Harrisburg from providing for infrastructure costs in its expense budget, the revenue side of the general fund budget was inflated by inappropriate sewer charges which were not used to maintain the sewer assets. When the music stops on this sewer game, you end up with dramatically decreased general fund revenues, increased maintenance expenses, and a seriously defective asset in need of huge capital expenditures. Of course, an asset which has been well maintained can have a positive impact on a municipality’s revenues, or can be sold to generate revenues, or can be the basis of a privatepublic partnership transaction. Liabilities. Pensions and other post-employment benefits (OPEB) can be debilitating liabilities for municipalities, as described above. The other significant liability often facing a distressed municipality is debt. For a municipality with a significant structural deficit (expenses consistently exceeding revenues), the solution often seems to be to enter into transactions with its assets and liabilities. This can take the form of draining the value of the assets, as described above. It can also take the form of continually incurring debt. Sometimes the debt is incurred to avoid having to cover any infrastructure costs in the annual budget. But the worst abuse is when

debt is incurred to generate current revenues; that is, when debt is treated like a credit card that is being run up to pay current expenses. Harrisburg did all of these things. If you are really interested in how debt can destroy a municipality’s finances, read the excellent forensic report dated January 12, 2012 analyzing the debt and swaps incurred by Harrisburg in connection with its incinerator plant: Cash Flow. Municipalities that rely heavily on real estate taxes do not have a steady flow of revenues. Most of this money comes in during a specific period of the year. Municipal expenses, the largest of which is labor costs, tend to be payable on a regular basis throughout the year. Therefore, municipalities need to be concerned about their cash flow. A financially strong municipality can deal with its cash flow challenges by temporarily drawing on its reserves or by taking out a line of credit from a bank. Distressed municipalities tend to have no extra money around and find it difficult or impossible to get a line of credit. This forces the officials of a distressed municipality to constantly worry about “how can I get money right now”. They get desperate. Maybe they improperly overcharge for unrelated services, maybe they deplete assets, maybe they incur lots of debt and use the money for current expenses, maybe they do an interest rate swap for upfront money, and maybe they stretch out their payments to vendors. You know the game is up when, after employing all the tricks with revenues and expenses and assets and liabilities, the municipality is still running out of cash to pay its employees. I got to experience this directly as receiver for Harrisburg. In late February of 2012, I ordered the city officials to stop transferring money from the water and sewer accounts to the general fund of the city. As described above, the city was grossly overcharging for administrative services for its utilities and using the excess to pay regular city expenses. I believed these transfers to be in violation of the law, so I stopped them. Unfortunately, the city’s cash flow in the first quarter of the year depended largely on these utility moneys. The real estate tax revenue does not start to arrive in significant amounts until April. The city had a large debt service payment due on its general obligation bonds on March 15, 2012. Although the city had been in default for some time on its incinerator revenue debt, it had not defaulted on its general obligation bonds. March was also a three payday month. I simply did not have the money to pay both the workers and the bondholders. When things finally come to that point at a distressed municipality, the decision is not hard. If I don’t pay the workers, then there will be no police or fire service and people could be injured or die. If I don’t pay the bondholders, they are paid by the bond insurer, and no one dies. So I paid the workers and reluctantly defaulted on the bonds.

I also believed that the city could get through the end of 2012 on a cash flow basis if it did not pay the general obligation bonds. That in fact turned out to be the case. The not so obvious causes of municipal fiscal distress: If you google the term “municipal distress”, you will come up with reports and articles that discuss the causes of municipal distress that I have discussed above. But because of my direct experience of being in charge for a time of a distressed city, I have given a lot of thought to what really causes the distress. I believe there are other not so obvious factors, which I will discuss in this section. To some people, these factors may seem tenuous, but to me they are as real as the causes I have already discussed. Racial Separateness and Isolation of the Poor. Harrisburg has a majority African-American population. Detroit has a population which is over 80% African-American. Many of the core communities in Pennsylvania and around the country which are financially distressed have significantly more minority citizens than surrounding municipalities. When I was appointed as the state receiver for Harrisburg, I was very sensitive to the fact that I was an unelected official being given power over elected officials of a government, certainly not a very American concept, and that I was also a white man being given power over a majority African-American city with many African-American elected officials. Although the main focus of my legal career has been in public finance, I have also dedicated a significant portion of my career to legal aid for the poor, both as a pro bono lawyer and as a board member of legal aid organizations. My legal aid work has taught me a lot about the way the world works and I learned to appreciate to some extent the challenges faced by minorities and by the poor. When I was appointed as receiver by Judge Kelly of Pennsylvania’s Commonwealth Court, I told him, and he agreed, that I would be guided in what I did by a sincere fiduciary duty to the citizens of Harrisburg and of the Commonwealth. In the first two months, when I was trying to understand the problems and draft a recovery plan, I met with public officials and a whole range of groups, from the Chamber of Commerce on the more conservative side to Occupy Harrisburg on the other edge of the spectrum, and everyone in between. I also held public forums in communities, and I met with any individual citizens who called up and wanted to meet with me. I was disturbed when I would hear or read comments from some people outside the city or from some public officials at other levels of government saying that Harrisburg’s problems were caused by “those people” in the city. The formulation often went as follows: “those people elected who they elected, so they need to live with the consequences”.

I remember one regional chamber of commerce committee meeting I attended. There were about 30 business people in the room, all white. They complained that city officials simply would not listen to their suggestions on the need for business tax rebates to promote economic development in the city. I suggested that maybe they should work harder to include minorities in their committee work, and that maybe there are different economic development initiatives that are important to African-Americans or Latinos. If they did that, maybe they would get a better reception for their ideas with the city government. I am not saying that people are motivated by racism. But our American way of life continues to largely separate African-Americans from equal opportunity and equal education. That separation is easier to maintain thanks to our system of local governments which tend to isolate the poor, including many minorities, in defined political subdivisions where they receive substandard education, substandard services and substandard opportunities. The Finance Industry. The finance industry created the Great Recession through a combination of lethal products, including the securitization of subprime loans and credit default swaps. The public finance subset of the finance industry at the same time was pushing its own set of products. One product was auction rate bonds. Both municipal issuers and investors were sold on a scheme that would give short term rates to the issuer on a long term bond, without the expense or bother of obtaining a liquidity facility. A handful of big financial institutions would maintain a market in the bonds through an auction mechanism, thereby giving the investors the comfort of liquidity. These bonds were often wrapped with a bond insurance policy from a AAA rated bond insurer. Another product was weekly rate put bonds, which offered a short term rate to the issuer. A liquidity provider, often a bank, would be a standby purchaser if the investment banker could not remarket put bonds. These bonds were wrapped by a bank or bond insurer providing credit enhancement. Both of these products could be wrapped by another product – interest rate swaps. An auction rate issue or a variable rate put issue could be transformed into a fixed rate transaction when the issuer enters into a separate contract swapping interest rate obligations with a large financial institution (the counterparty), often an affiliate of the issuer’s investment banker. The counterparty would pay the issuer a LIBOR based rate (say, 67% of One Month LIBOR) which was intended to cover the issuer’s variable rate obligation on the bonds, and the issuer would pay the counterparty an agreed upon fixed rate. Presto! A synthetic fixed rate obligation has been created out of a variable rate obligation. There were also other similar derivative products offered to municipalities such as basis swaps and caps.

Another product, which was particularly attractive to cash strapped municipalities, was “scoop and toss” refundings. The issuer would refund an existing bond issue by “scooping out” the next couple of years of debt service and “tossing” that debt to the back end of the existing debt service schedule. The net result was to exchange a couple of years of immediate debt service relief for much larger payments on the refunding debt over time. Distressed municipalities sometimes did a series of these scoop and toss refundings, thereby creating a mountain of debt a few years down the road. Another frequently used product was “synthetic advance refundings” using swaptions. An issuer who had a fixed rate bond issue could refund it well in advance of the first call date by entering into a swap option contract (i.e. a swaption) with a counterparty. The counterparty had an option on a specified date in the future to require the issuer to issue variable rate refunding bonds, and at that time a variable-to-fixed rate swap would kick in. The issuer would receive the present value “savings” paid up front from the counterparty, and the variable rate bonds and swap were intended to be a wash. The public finance products described above generated significant fees to the large financial institutions and the rating agencies (just like in the subprime mortgage securitization business), as well as to all the local financial institutions, financial advisors and lawyers involved in these transactions. When the Great Recession hit, thanks to the subprime mortgage transactions and credit default swaps, it had a devastating effect on many of the particular products marketed by the public finance industry to municipalities. The auction rate bonds almost immediately went into cardiac arrest. Issuers were stuck with bonds that shot up to a double digit “maximum rate” when the auctions failed. The rapid drop in the credit ratings of most bond insurers caused bondholders to put their variable rate bonds. Issuers who wanted to refund out of their auction or variable rate bonds were finding it very difficult. If the issuers also wrapped those bonds with swaps, they had to pay very high termination fees to get out of the swaps. As time went on during the recession, the municipalities that did scoop and toss refundings began to hit the wall of higher debt service payments. As time continued to go on, the issuers who did synthetic refundings with swaptions were looking at a mismatch between 67% of LIBOR and the tax-exempt variable rates, and the cost of paying a termination fee to get out of the swaptions grew higher and higher as short term rates went lower and lower. I have not seen an estimate of how much these products cost municipal issuers in total, but it has to be in the many, many billions of dollars. Here is one small example from Pennsylvania (all this information was taken solely from the Official Statement for the 2012 refunding bonds):

Exeter Township School District is in Berks County, Pennsylvania. It has annual revenues of about $55 million. In 2003, the school district issued bonds to finance a construction project. The 2003 Bonds had a first call date of November 15, 2013. Two years later, in 2005, the school district entered into a swaption with a large bank. This was a synthetic refunding. Although the 2003 Bonds were not callable until 2013, a swaption was used to give $565,000 of savings to the school district in 2005. The bank paid the school district the $565,000 when the swap documents were executed. Under the swaption, the bank had the ability to require the school district to issue variable rate refunding bonds in 2013, at which time the swap would also kick in, and the bank would pay the school district a rate of 68% of LIBOR plus 30 basis points (which was supposed to cover the variable rate and a liquidity facility on the 2013 bonds) and the school district would pay the bank a fixed rate of 4.96793%. If the school district did not want to go along with this structure, it could terminate the swaption at any time, provided it paid any termination fee then due. The economics of this swaption were undermined by all the risks that came home to roost in the Great Recession. According to the school district's 2010-11 audited financials (footnote 14), the termination fee that the school district would have to pay the bank as of June 30, 2011 was $2,530,778. The school district issued bonds on December 27, 2012 to refund the 2003 Bonds and to terminate the swaption. The termination fee which the school district paid to the bank at closing on December 27, 2012 was $7,338,000 (the termination fee had increased dramatically since June 30, 2011 as interest rates continued to go down). Here is the bottom line: The school district got a "savings" of $565,000 in 2005 through a synthetic refunding using a swaption. The swaption went negative for the school district when the recession hit, and the school district waited (presumably hoping rates would go down at some point) as the termination fee amount grew, and ended up paying $7,338,000 in 2012. This school district is a fairly strong credit. But this scenario was repeated many times over in Pennsylvania for other cities, counties, school districts and authorities, some of whom are distressed municipalities. The point of all this is that municipalities were not treated well by the public finance industry’s supposedly sophisticated products. The great irony is that many of the large financial institutions which marketed these products were bailed out by TARP money from federal taxpayers located in all the municipalities across the country. But when the particular public finance products went bad, there was no bailout of the affected municipalities by the federal government, and no forgiveness by the credit enhancers or swap counterparties; rather, the local taxpayers again have had to step to the plate to pay off the failed debt and swap obligations to these financial institutions.

Politics. Politics is a messy and rough business. All of the causes of municipal fiscal distress described above can become even worse and even more intractable if bad political behavior is included in the mix. The possible permutations of bad politics and their effects are, of course, endless. Final thoughts on the causes of municipal fiscal distress: If you take a small but important city like Harrisburg, which operates under a set of state laws that makes it close to impossible to match revenues and expenses, and which has a population that is largely poor, and you add to it some bad politics and some awful public finance products, and then you have the nation as a whole go into the worst recession since the Great Depression due to a finance industry that was peddling still more awful products, you can understand how Harrisburg has become a fiscally distressed municipality. In the face of that, to blame the citizens of Harrisburg for bringing this upon themselves, and to insist that the solution is for them to tax their way out of the mess, is to ignore fundamental reality. Multiply the Harrisburg story by its permutations in many other struggling municipalities across the country, and you have you have the totality of the municipal fiscal crisis in America. SOLUTIONS TO MUNICIPAL FISCAL DISTRESS We are Americans, and as Americans we can solve anything if we really want to. Here are some proposed solutions to municipal fiscal distress. Look Forward: When facing a disastrous situation, the tendency is to look backwards at the mess and try to figure out how to fix the worst of the problems as soon as possible. But it is just as important in bad times to try to imagine what the future good times should look like. States need to “look forward” and, assuming for the moment that the immediate disaster will be cleaned up, how should municipal governments be operating in normal times? The primary cause of municipal distress is that the system is often rigged under state law so that the revenues/expenses/assets/liabilities/cash flow of certain municipalities simply do not work, and the desperate short term measures then taken by desperate municipal officials make matters worse and worse. The Look Forward process needs to build up from the basics: • What services do you want municipalities to deliver? Some or all of police protection, fire protection, water service, sewer service, trash removal and disposal, roads and bridges, human services, economic development?


• •

At what level of government should each of the services be delivered? At the municipal level? The county level? At some larger regional level? At the state level? What services should be privatized or delivered through a public-private partnership? Should some municipalities be merged with others to better deliver services? What is the cost of each of the services? How will the services be paid for? What taxing powers should be granted? At what level should the taxes be imposed? For services that are organized on a regional basis, how should regional taxes be imposed? Who should own the assets? What rights under state law should municipalities or regional entities have to encumber, sell or privatize specific assets? How much state oversight should there be when municipalities or regional entities make these decisions? What should the rules be for the incurrence of debt by municipalities? How much state oversight should there be regarding the purposes and structuring of municipal debt? How will labor costs, including benefits and pensions, be controlled so that they are affordable by the municipalities?

Municipalities are all creatures of their states. The state governments, with input from all interested parties including municipalities, have an absolute duty to take the lead on developing the vision of how their municipalities can successfully operate in the future. I know this process sounds like pie in the sky given all the interests, political and cultural and economic, that are always wedded to the current way of doing things. But the truth is that we are all part of a brutal, impersonal global economy, and if any individual, business, municipality, state or country wants to survive, it has to constantly think and adapt. Entities that do not constantly think and adapt will be guaranteed to see hard times. The success of municipalities is just a piece of that big international economic puzzle. Some specific suggestions for the regulation of municipal finances by states: Defined benefit plans for public employees have to be eliminated and replaced with reasonable defined contribution plans. Each state should undertake to pass laws to that effect. In developing the laws for the negotiation of public union contracts, states need to provide safeguards to ensure that contracts or arbitration awards do not exceed the municipality’s ability to pay, while providing municipalities with the revenue sources necessary to pay fair wages and benefits.


Large nonprofits need to start paying municipal taxes like every other business. They benefit from municipal services, so they should pay for them. In order for municipalities to have strong credit ratings, states need to enable municipalities to develop and maintain sufficient reserves. Debt statutes should be tightened as necessary to provide sufficient state oversight to control the structure of municipal debt. The use of long term debt proceeds to pay current expenses or to plug holes in current budgets should be eliminated or strictly regulated. The structuring of debt, including refundings, to push large amounts of debt service into future years should be strictly regulated. Municipalities should not be allowed by their state to enter the debt market unless they have up to date audited financial statements and are in compliance with the federal secondary market disclosure requirements. Interest rate swaps are a game of Russian roulette which municipalities have been playing with some of the largest financial institutions in the world. There are many instances in my home state and across the country in which the bullet has gone off and a municipality faces a multi-million dollar disaster. States should pass laws prohibiting municipalities from entering into swaps and other derivatives. If the federal government and its securities agencies do not take the lead in developing appropriate levels of fiduciary responsibility by financial advisors and investment bankers to the municipalities they serve, states should define such fiduciary standards under their laws regulating municipal debt and securities transactions. States need to be sure that the financial firms that are advising their municipalities on securities transactions are acting in the best interest of the municipalities. After I resigned as receiver on March 30, 2012, I focused, in my capacity as a private citizen, on working with some state senators from both parties to try to have hearings held on what happened in the Harrisburg incinerator debt transactions and to develop legislation to try to prevent other municipalities from ending up in the same situation. The Senate Local Government Committee held two days of hearings in October and November 2012. The agendas and transcripts of the hearings can be found at: The senators asked me to testify about what legislation they should consider. My written testimony can be found at: As a result of the hearings, S.B. 292 through 296 were introduced by a bipartisan group of senators, with the prime sponsor being Sen. Mike Folmer (R – Lebanon) (see
11 for bills). Additional legislation is expected to be introduced soon by another bipartisan group of senators. Among other things, the bills call for more active state oversight of the municipal debt issuance process and prohibit municipalities and authorities from entering into any new interest rate swaps. The workout process for a distressed municipality in Pennsylvania: What do you do with a distressed municipality? I will set forth some thoughts on this with a particular emphasis on Pennsylvania and on my experiences with Harrisburg. The state agency which oversees municipalities in Pennsylvania is the Department of Community and Economic Development (DCED). The statute that deals directly with distressed municipalities is the Municipality Financial Recovery Act, commonly referred to as Act 47. DCED has a section that deals with municipalities. The state workers in that section are experienced and hard working. The number of employees in the section has decreased significantly over the years due to state budgetary cutbacks. DCED has an early intervention program in which a municipality can apply for a grant to help fund the development of a financial plan to address its fiscal challenges ( This program has been successful over the years in helping some municipalities from tipping over into real distress. Municipalities suffering from real distress can apply to the secretary of DCED for a formal determination of distress under Act 47. Since the enactment of Act 47 in 1987, twenty-seven municipalities have been declared distressed (13 cities, 12 boroughs and 2 townships) ( The act contains a process for the development and implementation of a recovery plan. DCED appoints a coordinator, which is usually a DCED employee for a smaller municipality and a team of private consultants for a larger municipality. Once the municipality is on its feet again, it can apply to DCED to come out of Act 47 status. Of the 27 municipalities who have gone into Act 47, only 6 have come out (all of them boroughs). Most municipalities who go into Act 47 seem not to want to come out. This is because Act 47 municipalities have extra powers which non-Act 47 municipalities do not, including higher eligibility for state grants and loans, stronger taxing powers which generate more tax revenues, and, at least until 2011, greater ability to control labor costs. The fact that so few municipalities come out of Act 47 reflects that fact that the basic statutory scheme for

the revenues, expenses, assets, liabilities and cash flow for these municipalities simply does not work. This is particularly true for cities. Thus, for cities in Pennsylvania, Act 47 is like the Hotel California. You can check in, but you can’t check out. I feel that Act 47 itself is a pretty good process. The help which DCED gives to distressed municipalities is very good, although DCED could use more money and staff for the program. But under current law, the help DCED gives can never be enough. What really needs to be addressed in Pennsylvania is the basic statutory scheme for the finances of cities and other municipalities. There has been some movement in the state legislature this year to start a Look Forward process to address the needs of Pennsylvania’s cities. Harrisburg, with some thoughts on receivership: Harrisburg was accepted into Act 47 as a distressed municipality in 2010. DCED appointed a team of consultants as coordinator. That team came up with a recovery plan in mid-2011. The plan was rejected by the city council. Pursuant to the Act 47 statute, the mayor then prepared a recovery plan (which was very similar to the original DCED plan). It too was rejected by city council in August. At that point, all the procedures contemplated by Act 47 had been exhausted. This sort of stalemate had never occurred before under Act 47. The state’s only remedy under Act 47 would be to cut off all state moneys to the city, hardly a realistic option. The governor and the legislature then amended Act 47 to add procedures allowing city council 30 days to come up with its own plan, and if the council failed to do so, providing for the appointment of a receiver. City council did not produce a plan, and the governor nominated me to be receiver. My appointment was made by the Commonwealth Court, an intermediate appellate court which handles all matters relating to the state and local governments. That is how Pennsylvania ended up with its first municipal receiver in its 330 year history. I realize that the functions of municipalities vary from state to state. In Pennsylvania a lot of power resides with local municipalities; county government is fairly limited. Pennsylvania has the largest number of local governments of any state except Illinois. Many of the local governments in parts of Pennsylvania are older than the United States. There are certain powers of municipalities that are set forth in the state constitution that the state cannot simply override. So, with a tradition of strong and independent municipalities, it was a big deal putting an unelected receiver over a municipal government. The amendment to Act 47 gave the receiver the power to develop and implement a recovery plan to be approved by the Commonwealth Court. It also gave the receiver the power to issue binding orders on the city’s elected and appointed officials to implement the plan. It did not give the receiver any power over the city’s creditors or any ability to impair existing contracts. The statute prohibited the city from filing for bankruptcy for one year (that was subsequently

extended by another five months). The receiver therefore had to negotiate with creditors without any power over them and without any ability in the foreseeable future to file for bankruptcy. 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. I believe I was chosen as a public finance technocrat who could get this job done, not because of politics. I am not a partisan political person. Once I was nominated in mid-November, I began a close review of the incinerator deals. I also began talking with many people and organizations. I fairly quickly came to a number of unsettling conclusions: (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, and (7) there were very powerful political forces who wanted the DCED plan reconfirmed and the bond creditors taken care of. I am not going to describe all the politics involved and everything that happened. Let me just say that I clearly understood where my fiduciary duty was: with the citizens of Harrisburg and of the Commonwealth. I was not going to let them down. And I believed that there were certain things I could get done before I got immolated by the politics. Those things included: (1) pushing the forensic consultants to finish and issue the forensic report on the incinerator financings as soon as possible (the truth needed to come out for a fair outcome to be possible), (2) 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, (3) hire a team of consultants that were highly qualified and could get the plan implemented, and (4) 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. 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. I did this on the stand in federal court and in a press conference. I wrote to the state Attorney General and the U.S. Attorney asking them to conduct a criminal investigation of the incinerator financings. When I was then told I would be removed, I resigned on March 30, 2012. I did all of this in a way that would not involve any

other state employees or any consultants to the receiver – including hand writing my resignation letter. With my resignation, I lost my statutory immunity, so I kept silent until I testified two months later in Commonwealth Court at the hearing for the approval of the new receiver. I believe that my successor as receiver, Major General William 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 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. General Lynch is the right person to accomplish the difficult workout and bring Harrisburg back to fiscal stability. Here are some general thoughts about receivership: • If a state is at the point of appointing a municipal receiver, it means that the state should, if it has not already done so, begin a Look Forward process to determine how it can establish a viable financial structure in the future for its municipalities generally. Receivership should be a last option. The state should first exhaust options involving technical assistance in which the municipality tries to work through its own problems. The state should think through exactly what branch or branches of government the receiver will be located in and report to. In Harrisburg, the receiver is in the executive branch but reports to the judicial branch. A receiver could also be solely in the executive branch. There are pros and cons to any of these structures. The state should think through the issue of the duty standard for the receiver. Does the receiver have a fiduciary duty to any specific people or entities? To the state government? To the citizens of the municipality? To the creditors? The duty will have a large effect on the nature of the recovery plan. The state should think through how independent the receiver should be. Is the receiver subject to formal orders from another state official, or is the receiver completely independent? There are pros and cons to these options too. The funding of the receiver should be thought through up front. How much funding will the receiver receive? Who controls the release and use of that funding? These go to the heart of the independence issue.

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• • • • •

Who controls the hiring, direction and firing of the consultants being used in the workout process? What staffing is utilized for the receiver’s office? All consultants? Some direct staff combined with consultants? How does the receiver interact with the press and the public? Who will handle communications for the receiver? What should be the qualifications of the receiver? A technocrat? A political person? Both? The relationship between the receiver and the elected and appointed municipal officials is crucial. Even if the relationship is antagonistic, the receiver needs to keep in mind that, at the end of the day, after the receivership is concluded, the municipal officials are going to be running the municipality again. The receiver needs to be as inclusive and patient with them as possible, while still pushing forward on the recovery process. The receiver should as a general matter keep in communication with as many of the interested parties as possible, even those who are antagonistic to the process. There may be exceptions to this at certain times due to ongoing litigation and other issues.

The ultimate solution to municipal fiscal distress: I grew up in Pittsburgh in the 1950’s and 1960’s. I know what a city with a strong manufacturing base looks like and feels like. The ultimate solution for our distressed municipalities and states and country is the rebuilding of a strong manufacturing sector. Our federal government took the lead on rescuing our finance industry from itself, and every American has contributed a lot of his or her wealth and income to that effort. We need an even larger national effort to restore America’s position as the leading manufacturing country in the world. We need to start standing up for our country, our businesses and our people against the Chinese and the international corporations. Then there will be good jobs for our people and strong businesses that will solve the economic challenges of our municipalities. (See Cate Long’s excellent piece at:

David Unkovic, 58, has been a municipal bond lawyer in Pennsylvania for over 30 years. He has served as bond counsel to all sizes of governmental entities, including townships, boroughs, cities, school districts, counties and authorities. He has also represented various financial entities and nonprofit corporations in tax-exempt financings. Mr. Unkovic has experience in the areas of distressed municipalities, bank lending and investment regulations. For most of his career he has worked at private law firms in Philadelphia, but he has also served as chief compliance officer at PFM Asset Management, 16

as chief counsel of the PA Department of Community and Economic Development and as the state appointed receiver for the City of Harrisburg. In the past year, Mr. Unkovic has worked with state senators from both parties on legislation to improve the debt incurrence and related statutes in Pennsylvania. Mr. Unkovic was born in Pittsburgh, and he received his B.A. in political science, summa cum laude, from the University of Pennsylvania, and his J.D. from Harvard Law School. He is a former president of the Pennsylvania Association of Bond Lawyers, and he has devoted a significant portion of his practice to promoting civil legal aid programs for the indigent. His email address is This paper is being presented to The Bond Buyer’s Second Symposium on Distressed Municipalities on March 18 and 19, 2013 in Providence, Rhode Island. Copyright 2013 by David Unkovic.



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