IN SERVICE OF CREDITORS: EMERGENCY FINANCIAL MANAGEMENT AND POISON WATER IN FLINT, MICHIGAN.

Author:Murphy, Austin
 
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  1. INTRODUCTION

    Within the context of the now infamous Flint water crisis in the State of Michigan, this case study supplies an extremely egregious example of the adverse consequences associated with the interests of creditors of a municipality being misaligned with those of the local populace. It demonstrates that a State-appointed administrator assigned the task of resolving a municipal budgetary crisis may positively affect the local fiscal situation even when that emergency financial manager causes a humanitarian catastrophe and adversely impacts the credit of the State and its political subdivisions in the aggregate. The welfare of the people in Flint was clearly incongruous with the interests of those financing the local government, and the appointee managing the City appeared to have only served the latter positively in this case. The events in Flint provide a compelling indication of the urgency in obtaining appropriate funding for the large infrastructure investments needed to provide safe potable water in the U.S., and novel forms of municipal financing that better align the interests of creditors, municipalities, administrators, and the people are suggested for that purpose.

    Murphy (2018) has previously shown that State-appointed managers tasked with improving the financial health of a particular political subdivision can benefit the existing creditors of that particular municipality. However, a common motivation for State intervention in local financial affairs is to enhance the creditworthiness of the local governments statewide (Gao, Lee, and Murphy, 2019). Murphy (2018) found evidence that the fiscal discipline and the associated draconian cuts to municipal services imposed by an emergency financial manager tend to negatively impact the credit of local governments economically intertwined with a State-managed municipality and do not reduce the overall yields on the obligations of the State itself and its other political subdivisions. Thus, one of the purposes of emergency financial management laws, which are intended to enhance the overall credit of the State and its local governments (Spiotto, 2013), does not seem to be fulfilled by that method of resolving municipal fiscal crises. The Flint case provides further evidence on this issue as well as on the risks of very detrimental effects on the welfare of the people in a distressed municipality caused by the incentives existing within the current financial structures for funding local governments.

    This research, which incorporates an event study of individual announcements surrounding the Flint water crisis on the bond returns of the municipality, also presents an especially important perspective on the broad nationwide issues confronting many local governments that involve trade-offs between short-term fiscal responsibilities and the provision of safe municipal water services. The incompatibility of the people with the interests of investors supplying the long-term funding required for the large capital expenditures needed to supply healthy potable water are made especially apparent by this case. An important whistle blower in water crises, namely Virginia Tech Professor Marc Edwards, has stated that the aging lead-based infrastructure currently used in providing municipal water services across the U.S. represents a nationwide crisis, which needs resolution, but which remains largely ignored outside Michigan (Malewitz, 2018) where it has finally begun to represent an important issue in State elections (Egan, 2017).

    The large infrastructure investments needed in the U.S. that are estimated to cost $2 trillion are widely inhibited by fiscal constraints (Wang and Wu, 2018), and changes to institutional structures are urgently needed to resolve the general dilemma of underinvestment and long-term operating inefficiencies caused by municipal debt overhang given existing market incentives (Buccola, 2019). By indicating the critical importance of developing improved methods of funding municipalities and their infrastructure investments, the Flint case leads to some ideas for new forms of financing which could help avoid the humanitarian problems associated with current market solutions to funding municipal investments.

  2. BACKGROUND ON THE WATER CRISIS

    Governments in the U.S. are constitutionally required to serve the people whom they govern and are generally subject to direction and oversight by leaders elected by voters (Harvard Law Review, 2013). Elected government leaders have fixed terms of office, can be subject to recall, impeachment, or removal for cause, and some may have term limits. However, many states allow the State government to appoint emergency financial managers to concentrate on the focused task of addressing the fiscal difficulties of a financially distressed local municipality (Calvert and Maher, 2016). In Michigan, those administrators usurp all the power of the locally elected government and completely run its operation (Longley, 2011), although they remain accountable to the governor and applicable laws.

    The empirical examination of the Flint case here contributes new evidence on the issue of a political subdivision being run without direct oversight by the local people, and it is especially informative on a potentially even more important issue faced by many municipalities. In particular, Flint was confronted with a serious health risk relating to aging infrastructure being used to supply water to the residents, and many other municipalities across the nation have similar problems associated with old lead pipes leaching into tap water. In Michigan alone, there are still many municipalities with traces of lead in the water they supply, and some areas even have amounts in excess of federal limits for municipal water (Fonger, 2017). One major credit rating agency has estimated that a seemingly necessary replacement of the aging lead pipes in the U.S. may cost over a quarter trillion dollars (Dolan, 2018).

    The trade-offs between the fiscal difficulties caused by the need to fund such infrastructure investments and the humanitarian risks associated with delaying the urgently needed repairs may have already adversely affected the health of many residents across the U.S. For instance, the level of lead in the water supply used in Washington, D.C. has been found to be 20-30 times higher than in the Flint case more than a decade after that city's own water crisis was made public (Shaver and Hedgepeth, 2016). In Chicago, over one fifth of the schools have "unacceptable" levels of lead in the drinking fountain water (Leng and Leng, 2017), and nearly a third of the homes there have been reported to have lead content in the tap water that exceeds the maximum decreed by the Food and Drug Administration to be allowed for the bottled water that government agency regulates (Howard, 2018). Many experts believe that no amount of lead in water is safe for human consumption (Fonger, 2018), as is a relevant fact for another third of Chicago homes which are supplied with smaller traces of lead in the tap water that are within federal guidelines (Howard, 2018). The issue regarding the funding of the large infrastructure investments needed for supplying safe water supplies to municipal residents is actually international in scope, with lead found in water pipes of many European homes built before 1970 often exceeding the local standards for safety (Noll, 2013).

  3. THE FLINT CASE

    In 2011, emergency financial management was imposed on the City of Flint by the State of Michigan because of a projected $25 million deficit in that local government's budget (Fox6, 2017). This deficit compared to a net loss of under $2 million in Flint's 2010-2011 fiscal year on revenues of $108 million, of which $46 million came from Federal and State transfers (including through Michigan revenue sharing of sales tax receipts), and which exceeded operating expenses before approximately $3 million in debt service payments (City of Flint, 2011). With high pension health care costs to pay, a loss of some Federal grant money, an eroding tax base, and already "shaky" municipal services, Flint had few opportunities to improve its financial situation after years of laying off employees, outsourcing, and raising City service fees (Carmody, 2013). For instance, Flint residents, who paid higher rates for water than existed in any other municipality in the U.S. (and twice the national average), had charges for water that far exceeded United Nations (UN) guidelines for affordability (Wisely, 2016), and so the City of Flint did not seem to have much room for raising revenues from the provision of its municipal water services.

    To help alleviate this adverse financial situation, the State-appointed manager authorized a switch from purchasing water out of Detroit to sourcing it from the Flint River, whose industrially polluted water was 19 times more corrosive than the water from Detroit (Talty, 2017). Decades earlier, the pollution in the Flint River water was deemed to be unsafe for drinking, but, starting in April 2014, Flint's financial manager began sending this water to homes via aging service lines prone to lead corroding from the pipes (Fox6, 2017). Unlike the Detroit water previously purchased, no anti-corrosive agent was to be used to treat the Flint River water, which invariably exposed the Flint residents to dangerous levels of lead and other toxins (Talty, 2017). Although the cost to add the phosphate additive needed to inhibit lead leaching from water pipes would have been only $150 per day, it would have necessitated an $8 million upgrade of the Flint treatment plant to enable it, and, despite a federal instruction by the Environmental Protection (EPA) to do so, the emergency financial manager decided not to authorize the needed corrosion protection because the City lacked the funds to pay for it (Kaffer, 2016).

    The elected but powerless Flint City Council had...

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