Bankrupt Cities Using Emergency Financial Managers to Recover

Investment bankers, lawyers tap new business saving cash-strapped towns.

April 27, 2011, 5:04 PM

May 2, 2011 -- A growing number of cities have been saved from bankruptcy by private-sector, for-profit consultants granted sweeping powers to modify, reject, terminate and renegotiate contracts, including union contracts. They can also amend budgets, determine staffing, eliminate departments and remove members of local pension boards, as well as overrule mayors, city councils and other elected officials.

What Old Man Potter tried to do to Bedford Falls in the movie "It's A Wonderful Life" -- get his fingers around every single aspect of municipal life -- they are doing routinely in towns such as Benton Harbor, Mich.

Some of them go by the name of emergency financial managers, or EFMs for short.

Critics have other descriptions, however, including dictators. "Most definitely," Benton Harbor commissioner Dennis Knowles said of last month's appointment of an EFM, though conceding that the city needed help after making a series of bad financial decisions. "But the city now is under a dictatorship. We aren't able to make our own decisions. All we [the commissioners] can do is meet, approve minutes of the meetings, and adjourn. It's a blatant disregard of the democratic process, the voice of the people."

In Michigan, such managers, appointed by the governor, control not just cities -- including Hamtramck and Ecorse outside Detroit -- but Detroit's public school system as well.

The phenomenon isn't limited to Michigan. Indiana is in the process of creating its own version of EFMs. In New York and other states, comparable powers have been granted to receivers and to oversight boards.

The budget of New York State's Nassau County, for example, which suffers from a $176 million deficit, has been put under the control a state-appointed six-member oversight board.

Michigan's emergency managers were created by the Local Government and School District Fiscal Accountability Act, introduced by Republican Gov. Rick Snyder and signed into law March 16.

Terry Stanton, information officer for Michigan's Department of the Treasury, said the intention of the law is simple: to protect the health, welfare and safety of local government. As for charges of "dictatorship," he said, "No one likes to see their authority taken away. But it's important to note that oftentimes it was the elected officials who were the ones unable or unwilling to address financial problem before they got crisis stage."

The act, he said, has information-gathering provisions designed to give towns early warning they are headed for financial trouble. That way, they would never need to call in an emergency manager or to have one assigned to them.

"The goal is never to have to appoint another emergency manager," Stanton said.

But where circumstances require one, the manager's mission is to go in, make necessary budget and staffing changes and then get out as soon as possible, so that the town can be restored to self-governance.

Ron King, special counsel to two big public pension funds in Detroit, fears emergency managers with "czar-like powers" will, in his clients' words, "subvert the will of the people" and "seize control of public pension funds." He has brought a lawsuit challenging the law's constitutionality.

But what King sees as a threat, others see as an opportunity. Investment bankers, lawyers, accountants and professionals skilled in the restructuring of failing companies see the chance to sell their services to emergency managers. Their foray into the public sector comes at a time when corporate restructuring work is waning.

Michael Imber of Grant Thornton LLP, a principal in the corporate advisory and restructuring services group of Grant Thornton LLP, an accounting firm, said, "Many of the same techniques and processes used by private sector turnaround firms can be used by public sector clients to avoid insolvency."

Joyce Parker, the emergency manager of Ecorse, Mich. (population 11,230), gets paid $132,000 a year to run the city. She has hired a law firm and an accounting firm to help her get Ecorse back on a sound financial footing. In place of a controller, she uses the accounting firm Plante & Moran PLC. Their fee? $10,000 a month.

"It might sound like a lot," Parker said, "but basically, it's what I'd have to pay a finance director, with benefits."

She retains the law firm of Miller Canfield Paddock & Stone, PLC, a major Michigan firm, to "assist with opinions on my authority." Such opinions have been required in response to legal challenges brought by unions and by citizens.

Cash-Strapped Cities Get Emergency Financial Managers

Her efforts seem to be succeeding: Parker has balanced Ecorse's budget and eliminated what had been a structural deficit of close to $5 million. The city's cumulative deficit she has reduced from $14.6 million, she says, to $13.5. She hopes by the end of this fiscal year to reduce it another $1.5 million.

Edward Plawecki Jr. sees an opportunity to train more managers.

Plawecki, general counsel for the investment-banking firm Stout Risius Ross, has helped to develop a training course for emergency financial mangers in association with the Turnaround Management Association. The most recent teaching session, held in Lansing, Mich., in mid-April, drew about 350 attendees from states including New York, California, Ohio and Michigan.

Each participant paid $175. "About 100 were private sector turnaround individuals," he said, including lawyers and accountants.

Topics included "Dealing with a Unionized Workforce." The Turnaround Management Association is considering rolling out variations of the class nationwide.

Plawecki said it's difficult to quantify how big an opportunity near-bankrupt cities represent to the private sector. "But it would appear, due to the volume of distressed communities, that there would be significant opportunity for the private sector to expand its expertise into the municipal sector.

"Most of the lessons learned in the private sector are absolutely applicable, allowing for constraints. Constraints would be the state constitution, state statutes, laws, and charter provisions."

Imber of Grant Thornton agreed that turning around a failing city is pretty much akin to turning around a failing company, but with one big difference.

The fundamental difference is what he calls "the transparency element." In a corporate setting, "You come in and work in the board room," he said, meaning out of the glare of public scrutiny and media attention.

But in government, there are transparency laws that require working in the open. "There's nothing wrong with that," he said of the exposure that can invite intense examination. "It's how government is designed to work."

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