Getting Ready for the Checkered Flag in the Motor City

September 16, 2014

Visit the project blog: The Municipal Sustainability Project 

Getting Ready for the Checkered Flag. Detroit’s trial before U.S. Bankruptcy Judge Steven Rhodes resumed yesterday after he refused to grant an extension of the timeout requested by FGIC, with Martha Kopacz, the court-appointed financial expert, asked by the court: “Is it likely that the City of Detroit after (emerging from bankruptcy) will be able to sustainably provide basic city services to the citizens of Detroit and meet the obligations in the plan without the probability of a significant default?” Ms. Kopacz answered in the affirmative.  Judge Rhodes followed up by asking Ms. Kopacz whether she was confident in her conclusions. She testified that she was. Later testimony focused on the financial assumptions the city used to establish how much its two pension systems were underfunded and forecasts for future pension investment returns and liabilities. The trial will resume this morning at 8:30.

The Denouement. Judge Rhodes’ query to Ms. Kopacz will be the question—in the end—that Judge Rhodes, alone, will have to answer. As the pace of the trial has accelerated inside and outside the courtroom, both the allotted time for the trial is elapsing, as is the time for Governor Rick Snyder’s Emergency Manager Kevyn Orr. Mr. Orr’s tenure as emergency manager under Public Act 436 is scheduled to end at the end of the month—at which point the Council can force his departure. It appears that Mr. Orr will transition to what Mayor Mike Duggan last week termed a “bankruptcy adviser” to the Mayor and Council, and governance of the Motor City will revert to self-governance—but governance overseen by a financial oversight board. Detroit’s mayor and a City Council led by President Brenda Jones will have the powers of their respective offices fully restored. But as the wise columnist for the Detroit News, Daniel Howes, asks: “[W]ill their collective posture change and become more resistant to the requirements of a restructuring plan they did not draft?” That is to write that the question burning in Judge Rhodes—who, after all, can only say ‘yes’ or ‘no’ to Mr. Orr’s proposed plan of adjustment—is after Mr. Orr leaves, will the right leaders be in place to administer a plan they did not write—and that no one knows for certain can work?

Less Harried in Harrisburg. Pennsylvania’s House Urban Affairs Committee yesterday unanimously approved legislation to enable the state’s capital city Harrisburg to develop vacant, desolate, underused, or abandoned space under the City Revitalization and Improvement Zone or CRIZ program—a program which authorizes the investment of Pennsylvania tax revenues in designated zones to enable new investment in local economies by redeveloping eligible vacant, blighted, and/or abandoned properties for commercial, hospitality, conference, retail, community, or other mixed-use purposes.. Under the program, eligible municipalities are authorized to create an authority to issue bonds for redevelopment projects, with the bonds repaid using most state and local taxes generated within the CRIZ area during and after construction. Developers are required to supply at least 20 percent of the development cost for the project through private funding. The program, which was created last year, is based on Allentown’s neighborhood improvement zone program, which resulted in more than $500 million in new investment for the city. Under the original legislation, third-class cities with populations above 30,000, except for Harrisburg, which—in the wake of opting not to file for federal bankruptcy protection, went under state receivership, could enroll in the program. Even though Harrisburg successfully exited receivership last March, the committee determined it should be able to participate.

September 15, 2014

Visit the project blog: The Municipal Sustainability Project 

Getting Ready for the Checkered Flag. David Heiman, an attorney for Detroit, this morning, in announcing a settlement with perhaps the bitterest adversary to the Motor City’s proposed plan of adjustment, bond insurer Syncora,  told U.S. Bankruptcy Judge Steven Rhodes that the once “passionate adversaries” had “laid down the swords” and achieved a comprehensive settlement. Among the elements of the deal, through which Syncora will withdraw objections and appeals tied to the city’s plan to shed $7 billion in debt, the bond insurer is expected to receive approximately 14 percent recovery on financing it supplied for the burgeoning pension debt, up from about 10 percent. The agreement involves a transfer of property owned by the city and extension of the Detroit-Windsor Tunnel lease to a Syncora subsidiary and a 30-year lease of a parking garage below Grand Circus Park. Syncora will also receive $6.25 million in settlement credits to be used on eligible properties, including the Joe Louis Arena, other parking assets, and real property located within three miles of the tunnel. Mr. Heiman testified that there are aspects of the agreement that still need to be addressed, including complications related to specific parcels that cannot be conveyed to Syncora, but indicated the sides expected to resolve the outstanding issues by close of business tomorrow. Syncora and the city had agreed to a tentative settlement last Tuesday in which the insurer would get a 20-year extension on its deal to operate the Detroit-Windsor Tunnel, a 30-year lease on a city parking garage and millions in bonds and options to purchase city property. Altogether, the deal is difficult to value, but people familiar with the agreement have estimated Syncora will ultimately collect 20% to 25% of the approximately $200 million it’s owed. Ryan Bennett, an attorney for Syncora, told Judge Rhodes the agreement was a “very complicated and creative” resolution to the firm’s relationship with Detroit—coming in the wake of marathon weekend negotiations. The breakthrough was accompanied by a formal apology by Syncora’s attorney for accusing bankruptcy mediators, especially Chief U.S. Judge Gerald Rosen, of “naked favoritism.” (Please see next item below.)

The abrupt announcements this morning could put the Motor City on the verge of reaching a comprehensive agreement on its bankruptcy exit plan with all its creditors—leaving bond insurer Financial Guaranty Insurance Co. (FGIC), which was previously allied with Syncora, remaining as Detroit’s single greatest obstacle to a successful emergency from insolvency, although several hedge funds and more than 600 individuals are still objecting to the city’s proposed plan of adjustment pending before the court for Judge Rhodes’ approval or disapproval. When the Motor City and Syncora reached their tentative agreement last week, there were apprehensions Syncora would first insist upon concessions from Bank of America and UBS, the two global banks — which had agreed to their own $85 million settlement with Detroit on the swaps agreement which the city had argued was illegal, and which had led to the conviction and imprisonment of former Detroit Mayor Kwame Kilpatrick  — with the banks demanding that Syncora and FGIC cover their losses on the interest-rate transaction brokered by Mayor Kwame Kilpatrick’s administration in 2005. Syncora, which is confronting its own solvency apprehensions, had been seeking a release by the two banks from its obligation to cover those losses. In their own settlement with Detroit, UBS and Bank of America are getting $85 million on interest rate swaps worth $290 million—potentially leaving Syncora on the hook for the remainder. Syncora also had objections related to Mr. Orr’s proposal for additional funds to provide millions more to two retiree health insurance trust funds if Detroit were successful in eliminating $1.4 billion in pension debt that Syncora and Financial Guaranty Insurance Co. insured. Nevertheless, Syncora’s decision to withdraw its objections to the city’s restructuring plan enhances the likelihood that Judge Rhodes would approve Detroit Emergency Manager Kevyn Orr’s proposed plan to eliminate $7 billion of the Motor City’s debts and reinvest $1.4 billion in the city’s future sustainability. At the same time, however, hopes for an agreement with Detroit’s key holdout creditor, FGIC, remain in question—albeit, with the clock clicking down, the pressure on FGIC to come to an agreement with the city or face a significant loss is tightening the screws. With Judge Rhodes making it ever so clear he will not allow Detroit to exit bankruptcy unless he is convinced the city’s proposed plan of adjustment will provide for a sustainable future, FGIC does not want to be the last creditor standing.

Mea Culpa. In addition, this a.m., Syncora issued a formal apology to U.S. Chief Judge Gerald Rosen—filing a four-page apology to Judge Gerald Rosen and mediator Eugene Driker, who the firm had accused of engineering a “fraudulent” plan to rescue Motor City retirees and to preserve city-owned art at the Detroit Institute of Art at the expense of other creditors, writing “We are deeply sorry for the mistake we made and for any unfounded aspersions it may have cast on Chief Judge Rosen and the Drikers.” Judge Rhodes responded that the apology resolved a pending consideration from the judge to sanction the bond insurer over its “scandalous and defamatory” claims against the mediation team.

Detroit & San Bernardino Race to the Last Lap

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September 12, 2014

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Getting Ready for the Checkered Flag. Chief U.S. Judge Gerald Rosen yesterday afternoon ordered Detroit, Syncora, UBS, Merrill Lynch, Ambac, Black Rock, the city’s Official Committee of Retirees, FGIC, and other financial creditors into continued mediation this morning, “continuing day-to-day, as deemed necessary, until released by the mediators,” as the city’s efforts to work out agreements with its key creditors before emergency manager Kevyn Orr’s likely exit on October 1st nears—and the key obstacle to resolution hinging on whether Syncora is able—in these closed door, mediated negotiations—to obtain concessions from other creditors, including Bank of America Corp. and the city’s retirees. Judge Rosen said negotiations will continue every day until a deal is reached or he sends them home. The closed-door negotiations are, theoretically, to go around the clock until Detroit and its outstanding holdout creditors can negotiate an end to the biggest municipal bankruptcy in U.S. history. After the momentous agreement reached Tuesday between the Motor City and Syncora, FGIC is the last and only major creditor opposed to the city’s proposed plan of adjustment pending before the U.S. Bankruptcy Court. Tuesday’s agreement calls for Syncora to get $23.5 million from the $162 million pool of settlement funds. Now Syncora wants banking giants UBS AG and Bank of America to drop their pursuit of a nearly $200 million insurance claim against Syncora tied to Detroit’s troubled pension debt and has indicated its deal with the city hinges on getting the banks, retirees and bondholders to forgo a potentially better recovery of what they’re owed, a likely topic of negotiation in mediation. Syncora is apprehensive that without an agreement by Bank of America’s Merrill Lynch unit and UBS to modify their rights to collect their insurance payments from Syncora on the soured swap deals that put the Motor City’s former mayor in prison, the plan still cannot proceed. Detroit’s representatives take the position that Syncora can still drop its objections to the city’s plan and go ahead with the settlement no matter what UBS, Bank of America and other creditors decide. If Syncora is unsuccessful in obtaining an ok from the banks to forgo the insurance, it will have to choose whether to continue to oppose the city’s proposed plan of adjustment and put its fate in the hands of Judge Steven Rhodes. But, in the complex negotiations being mediated by Judge Rosen, the Judge is pressing to obtain consent from a committee of retired workers and investors who hold tax-backed bonds.

Under Syncora’s settlement, Detroit would give Syncora new debt, renew a lease on a tunnel to Canada that the bond insurer controls, turn over a parking structure and give an affiliate of the company land for development. The fight lasted 14 months. During that time, Syncora fought to liquidate the city’s art collection, tried to block repairs to miles of broken streetlights and leveled a “blistering” personal attack on federal mediators that drew a rebuke from the judge. Under the deal, the city agreed to extend a lease of the Detroit-Windsor tunnel with a Syncora-controlled firm for 20 years. Syncora also gets to lease a city-owned parking lot underneath Grand Circus Park for 30 years, according to a city term sheet released Wednesday. The package of incentives is worth about $70 million, according to a source familiar with the deal. In return, Syncora has pledged to help Detroit fight bond insurer Financial Guaranty Insurance Co., which is still objecting to Detroit’s debt-cutting plan. Syncora and FGIC were two of the biggest opponents in the bankruptcy trial. Both firms claim the city’s debt-cutting plan pays them as little as 6 cents on the dollar for the $1.4 billion in troubled pension debt they insured to help former Mayor Kwame Kilpatrick prop up the city’s pension funds in 2005. FGIC has claims of more than $1.1 billion — three times the size of Syncora’s. The firm’s negotiators walked out of closed-door talks with the city two weeks ago.

Because FGIC is in the same bankruptcy creditor class as Syncora, for Judge Rhodes to approve Detroit’s proposed plan of adjustment—which is being modified to reflect Tuesday’s Syncora deal—he would have to find that the plan proposed equity amongst classes of creditors—i.e., in this instance, FGIC and Syncora. Detroit had been trying to get the entire $1.4 billion in swap debt Syncora and FGIC insured erased from its balance sheet, claiming the debt illegally exceeded the city’s statutory borrowing limits; the deal (see box above) changes that claim. What this all means is that now one of the most serious obstacles to the Motor City’s emergence from the largest municipal bankruptcy in U.S. history is dependent on the unique and gifted Judge Rosen.

Property Disposal. Detroit Emergency Manager Kevyn Orr yesterday notified the City Council he plans to transfer up to 45,000 city-owned properties to the Detroit Land Bank Authority, which auctions off and demolishes vacant, abandoned and foreclosed properties. Mr. Orr’s plan provides the council 10 days to approve or disapprove of the transfer. In addition, Mr. Orr’s proposal includes a provision requiring all tax-foreclosed properties that revert back to the city instead go to the land bank―all part of what his office reports is an effort to “speed up the process to redevelop that land.” If the Detroit City Council rejects the transfer, it has seven days to come up with a proposal that would yield substantially the same financial result, under provisions of Michigan’s Public Act 436 of 2012, the state’s emergency manager law. If the council develops its own version, that version would be reviewed by the state’s three-member Emergency Financial Assistance Loan Board, which would have 30 days to approve one of the proposals.

Progress in San Bernardino. U.S. Bankruptcy Judge Meredith Jury, in an interim ruling yesterday, agreed to the city of San Bernardino’s proposal—as part of its bankruptcy plan of adjustment—to reject the current bargaining agreement between the municipality and its firefighters. The firefighters’ contract is a burden on the city’s finances in at least two ways, Judge Jury found: pension contributions by the city cost too much, and overtime rules are too generous. Should she adhere to her preliminary ruling, San Bernardino would be free to impose pay and benefit cuts, and the city will have the authority to impose a new contract of its own choosing. In its filing with the federal court, the city wrote that part of the reason to reject the existing contract was so it could replace a constant staffing model with minimum staffing, a proposal which would give the city the flexibility and authority to leave some firefighter positions unfilled for a shift if a firefighter does not come to work—a change critical to the city’s efforts to reduce the more than $4 million in overtime it pays firefighters most years. Another expected reason was continuing to make firefighters pay the retirement contributions the city handled until a year ago last January, reducing the employees’ take-home pay by nearly 14 percent. In a separate ruling, Judge Jury rejected the firefighter union’s motion for relief from the stay preventing anyone from suing the city while it is in bankruptcy. Firefighters’ attorneys want to argue in state court that the city had not followed state law in its negotiations. Judge Jury did not rule on separate, pending motions for relief from the stay from the police and fire unions after contracts were imposed on those unions in January of last year; she made clear that she was not agreeing to the specifics of any potential imposition, advising the parties San Bernardino cannot violate “substantive law,” including the city charter provision that prevents cutting public safety salaries—an issue which is on November’s ballot for possible repeal, adding that previous cases have not established how long the imposed contract can be used, advising the parties: “I said it’s interim, but I don’t how long interim is…I think until a new collective bargaining agreement is negotiated or the plan (to exit bankruptcy) is approved.” San Bernardino’s attorneys will submit proposed wording of the order today, giving firefighters’ union attorneys until midweek to object or file an alternative proposal before a hearing on September 19th to finalize the order. Judge Jury made clear she would provide the firefighters’ attorney an opportunity to question a key city witness before making her final ruling, but noted: “It is very unlikely they are going to convince me” that the contract is not a burden on the city’s recovery. Yesterday’s actions come as the Southern California city has either reached agreements with or is in negotiations with almost all its major creditors. After filing for municipal bankruptcy in 2012, San Bernardino had enmeshed in negotiations with unions and its biggest creditor, the California Public Employees’ Retirement System (CalPERS), to which the municipality owes about $143 million, according to court filings.

eBlog
September 10, 2014

Visit the project blog: The Municipal Sustainability Project

An Interrupted Day Five. The fifth day of Detroit’s municipal bankruptcy exit trial began late and was interrupted by two key announcements arising out of the extraordinary efforts of Chief U.S. Judge Gerald Rosen and U.S. Judge Sean Cox, who have been mediating with objecting creditors of the city—in the case of Judge Rosen, holdout creditors Syncora and FGIC, and in the case of Judge Cox, the negotiations with the city’s surrounding counties over the future of the Detroit Water and Sewer District. With the twin resolutions (please see below) announced yesterday overshadowing the testimony before U.S. Bankruptcy Judge Steven Rhodes, the trial is likely to be suspended today and tomorrow. Indeed, the apparent agreements between the city and its most significant holdout creditors could accelerate the denouement. Kevyn Orr’s spokesperson yesterday noted: “Anything that shortens the time that we’re in court, that limits the objectors that we have, is good for the city…We’re not just giving Syncora anything. They’re going to have to make investments.” On the second front, after a year of failed talks, Detroit announced it had reached agreement to spin off its troubled water and sewer department to surrounding communities that would generate a $50 million annual payment to the city, with Mayor Mike Duggan yesterday stating at a press conference with adjacent county elected leaders: “There has been 40 years of conflict between the city and the suburbs…What you have today is a pretty remarkable accomplishment.” The officials made the announcement at the federal courthouse, where the city’s bankruptcy trial is being held, to make the announcement. In addition, Mayor Duggan noted that Gov. Rick Snyder and his top aide Rich Baird, were “very important” to the negotiations. The Mayor’s announcement could not only eliminate critical opposition to the city’s proposed plan of adjustment pending before the federal court, but also generate annual revenue for the city.

Is it a Smoking Pigeon? Yesterday, Detroit Police Chief James Craig, who assumed leadership a year ago, testified he ran into a situation when he assumed command unlike any before, telling the court the city’s police car fleet was “probably the worst” he had ever experienced and describing the police department as one where it “was very clear that morale was at the very bottom…It was also clear that the department lacked leadership and accountability … and the department had no credibility with the community it served.” Combined with Fire Commissioner Edsel Jenkins’ earlier testimony of the Fire Department’s dire need of repairs, technological upgrades and more firefighters—and that arsonists are the most serious challenge to the Motor City’s firefighters—with 70% of fires in Detroit involving vacant structures. When asked why this happens, he told Judge Rhodes: “I know pigeons don’t smoke.” Chief Jenkins testified that the Fire Department is in dire need of better safety equipment, technology upgrades and more firefighters, who spend most of their time chasing fires set by arsonists. The two chiefs’ testimony came as part of the city’s continued efforts to lay before the court the importance of its proposed plan of adjustment provisions for investing about $1.4 billion into critical public improvements—in effect pressing the federal court to agree that using those funds to invest in the city’s future fiscal and economic viability and sustainability instead of paying higher percentages of debts it owes to its creditors is equitable. Under emergency manager Kevyn Orr’s proposed plan of adjustment pending before the federal court, the city would increase funding to the Police Department by $114 million, and to the Fire Department by $82 million. Chief Craig testified the investment would make a key difference, telling the court the importance of funding for new officers, upgraded video cameras in the cruisers, and better portable radios. He wants to hire 234 civilian staff to cover jobs that are held by police officers but should not be in order to free up the officers to work in the field. He testified Detroit’s overall crime rate is down and detectives are now in all 12 neighborhood police stations: police response time is down to 21 minutes, down to nearly a third what it was when he assumed command—but telling the court that a 21-minute response time was still “not adequate.” He testified his goal is to get response times down to five minutes for priority calls.

Breakthrough.
Later yesterday, outside the courtroom—behind closed doors, Detroit reached agreement with one of its biggest opponents and holdout creditors to the city’s bankruptcy filing, insurer Syncora, which claims it is owed hundreds of millions of dollars by Detroit for insuring a swap agreement under the former and now convicted and imprisoned Mayor Kwame Kilpatrick—a deal which the city claims was illegal, and consequently did not propose financing in its proposed plan of adjustment. The proposed deal would require Syncora to drop all of its pending appeals at the 6th U.S. Circuit Court of Appeals, including its attempt to block Detroit from access to crucial monthly casino tax revenue that the two banks held as collateral. With yesterday’s agreement, both the city and Syncora asked Judge Rhodes for an adjournment of the trial until Friday to work out the details, telling the court the agreement could “profoundly alter” Mr. Orr’s proposed plan of adjustment pending before the court. A hearing is set for this morning on that request. It appears that under the tentative agreement, the city would pay Syncora 26 percent of what the company claims it is owed; Detroit would also extend Syncora’s lease on the Detroit-Windsor Tunnel (Ownership of the company that operates the U.S. side of the Detroit-Windsor Tunnel was transferred from an investment company to Syncora in September in exchange for $334 million in swap liability.) by 20 years, to 2040, and give the company a 30-year lease on the Grand Circus Park parking garage. In their filing, the city and Syncora wrote: “If this agreement is finalized within this time period as we expect, it will profoundly alter the course of the proceeding and the litigation plans of the remaining parties.” In addition, under the agreement Syncora would pledge to help counter bond insurer Financial Guaranty Insurance Co. (FGIC), which now looms as the single largest holdout creditor opposing the city’s proposed plan of adjustment. The announcement yesterday—especially in the wake of Syncora’s bitter opposition and severe, personal attacks on Judge Rosen and other federal mediators—an attack that drew a rebuke from U.S. Bankruptcy Judge Steven Rhodes, and in the wake of Syncora adamant opposition and legal challenges to the so-called “grand bargain” put together by Michigan Governor Rick Snyder and bipartisan leaders in Michigan’s legislature; the turnaround was stunning. Moreover, nearly simultaneously, closed door negotiations between Detroit and its surrounding counties resulted in an announcement of an agreement—expected to be formally released today—to spin off the Detroit Water and Sewer Department. The twin breakthroughs yesterday mean the single greatest obstacle to Detroit’s exit from municipal bankruptcy is holdout creditor municipal bond insurer FGIC, with claims of more than $1.1 billion in pension bonds it insured—some three times the claim Syncora had sought. FGIC walked out of closed-door negotiations two weeks ago. Now the insurer risks being the last one on the bridge.

The tentative agreement. Under the tentative agreement, Detroit would permit Syncora share in $120 million of so-called “B notes,” or new Detroit municipal bonds the city is issuing to creditors to be paid over time under its pending plan of adjustment, with Syncora to receive about a 16% of the deal. Detroit would give Syncora the opportunity to operate a city-owned parking garage underneath Grand Circus Park under a 30-year lease deal—the 800 space garage is Detroit’s third-largest municipal garage—in return for which Syncora would have to make $13 million in capital improvements in the garage, after which it would be able to receive 75 percent of the parking revenue, with the remainder going to the city. The deal would also provide Syncora with a $6.25 million coupon that could be used to bid on any available city property — such as the Joe Louis Arena site, once the city’s NHL Red Wings move out after construction of a planned arena north of the Fox and Comerica Park. As part of the proposal, Detroit would issue $21.3 million in parking revenue bonds, with the cash raised going to Syncora. The city would also give the firm $5 million in cash to help settle claims with firms involved in the $1.4 billion pension arrangement which led to the downfall and imprisonment of former Mayor Kilpatrick. Overall, the federally mediated agreement is projected to increase Syncora’s potential recovery by in excess of 400% compared to its current recovery plan of adjustment pending in the federal bankruptcy court—bringing the city’s proposed offer to approximately 26 cents on the dollar—a significant increase. That current plan proposes paying its retirees about 46 cents on the dollar for their $3.1 billion claim; while UBS and Bank of America are projected to receive about $85 million, or 29 cents on the dollar, for their interest rate swap claim against the Motor City.

The Sharing Economy. In the second of the one-two punches that shook up the federal court yesterday, Detroit and its neighboring jurisdictions of Macomb, Oakland and Wayne counties yesterday announced a forty-year agreement to form a regional water authority, the Great Lakes Water Authority, which will provide $50 million annually to help finance system upgrades. Under the agreement, Detroit would retain its ownership, but the pact would provide the counties with a greater stake in the system’s operations over a system that serves nearly 40 percent of the state’s residents. Under the deal involving Detroit and Macomb, Oakland and Wayne counties, the city will lease infrastructure to suburban communities in exchange for the $50 million annual fee and annual $4.5 million payment assistance fund. Motor City Mayor Duggan noted that not only will the agreement help resolve the city’s pending municipal bankruptcy, but also end what he called “forty years of conflict between city and suburbs over water.” The leaders of the counties had opposed Detroit’s proposed plan of adjustment to exit municipal bankruptcy, claiming then plan would extract tens of millions of dollars from their water departments, trigger rate increases, and prevent needed repairs. Mayhap more importantly, the agreement not only removes a critical obstacle to Detroit’s successful exit from municipal bankruptcy, but also addresses the question posed yesterday by Macomb County Executive Mark A. Hackel, who asked: “How do we become more regional? If we want to be competitive with other regions, we can’t be competitive among ourselves.” Mayhap indicative of the importance of the pact, in the wake of its announcement, the market sharply reacted, with Detroit’s 5.75 percent sewer bonds due in 2031 climbing 5 percent to 111.7 cents on the dollar. The new Authority will be run by a six-person board: two appointed by Detroit, one by each of the counties, and one by Governor Rick Snyder. The lease payments would last 40 years and allow the city to issue $500 million to $800 million in bonds to repair its aging, local water system, which has suffered 5,000 water-main breaks in the past three years. “Major decisions, such as rate increases, will require five of the six votes to be approved,” according to the statement. The Detroit water and sewer system consists of more than 3,400 miles of local water mains, 3,000 miles of local sewer pipes, 27,000 fire hydrants and an extensive billing and collection system. Last week, Detroit closed the sale on $1.79 billion in new bonds for the utility. The new bonds are expected over the 21-year life of the bonds to save the city about $11 million a year. The agreement could also facilitate apprehensions with regard to taking on legacy costs and absorbing Detroit’s high rate of unpaid water bills. The city recently triggered a national outcry when it began shutting off service to delinquent customers. Those issues are said to have been resolved, or commitments made to settle them, after the authority is approved.

Ungambling. With casinos dropping like flies and threatening the solvency of Atlantic City, New Jersey Governor Chris Christie this week met behind closed doors with political leaders and casino officials on strategies to build Atlantic City revenue on non-gambling attractions, telling the media the discussions were focused on finding what he called larger short- and long-term solutions to help Atlantic City adjust to gambling on a smaller scale The abrupt summit comes four years into Gov. Christie’s five-year plan to revitalize the city—a plan now that appears to be in tatters. Now the Governor has signed an executive order to permit New Jersey casinos and racetracks to accept sports bets―as long as they do not involve New Jersey college matches. A non-municipal bankruptcy court reorganization could give Carl Icahn two additional hotels in the city, where funds controlled by Mr. Icahn are Trump Entertainment’s largest creditor, according to public filings. In addition, Mr. Icahn controls 68 percent of Las Vegas-based Tropicana Entertainment Inc., which owns the Tropicana in Atlantic City.

The Expensive Challenge of Finding the Right Outcome in Municipal Bankruptcy

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September 9, 2014
Visit the project blog: The Municipal Sustainability Project

Fourth Lap. Detroit continued to cull through its list of twenty-five planned witnesses in the hearings on the city’s bankruptcy plan of adjustment yesterday, with a key—and depressing—focus on the state of the city’s technology and information systems. Beth Niblock, a former information technology chief for the city of Louisville, who was recruited earlier this year by Mayor Mike Duggan, testified that the city’s information technology is “generations behind” current standards, noting, for instance, that employees send emails, but emails that never arrive in the recipient’s inbox. Drawing a devastating image for U.S. Bankruptcy Judge Steven Rhodes of the city’s computers, software, and email system, Ms. Niblock testified the city’s systems are also extremely susceptible to cybersecurity attacks, adding that the system is so out-dated that it hampers the city’s ability to issue paychecks, collect taxes, communicate internally, and dispatch police and firefighters: “It is fundamentally broken or beyond fundamentally broken…In some cases fundamentally broken would be good.” Emergency Manager Kevyn Orr and the city’s legal team has been using this portion of the trial to justify the plan’s proposal not just to obtain the federal court’s approval to eliminate some $7 billion of Detroit’s obligations, but also to approve the plan’s proposal to reinvest more than $1.4 billion in services, including basic information technology. Her testimony followed the carryover of the city’s chief restructuring consultant, Chuck Moore of the firm Conway MacKenzie, who began last Friday explaining to the court ways Mr. Orr’s plan would improve and reshape the city government, testifying that eliminating waste, fraud, and inefficient spending is crucial to ensure that the city’s proposed plan of adjustment is successful. In response to Judge Rhodes’ questions about whether the plan really offers an achievable plan to improve basic services, Mr. Moore testified that the cash budgeted to improve city services over 10 years must be spent responsibly, noting carefully: “Just because the money exists doesn’t mean it can be spent…It has to be justified.”

Is there a Right Balance? Municipal bankruptcy is rare in the U.S., part of the reason that municipal bonds issued by state and local governments are perceived as such a safe bet: the default rate is just 0.23%. Notwithstanding, for those bondholders in that category, part of their struggle in Detroit’s bankruptcy trial is to recover what they might view as a more equitable share of what they are owed. Unlike a non-municipal corporate bankruptcy—where the corporation can simply be extinguished and its assets equitably distributed; the challenge in municipal bankruptcy is infinitely more challenging: how does one put together a plan to adjust that debt in a manner that will not only be accepted by a federal bankruptcy court, but also will stand the test of time by proving that said plan will provide for a sustainable future for that city? In Detroit, the city foundered under unpayable debts—debts estimated at $18 billion or $26,000 per Motor City resident. Kevyn Orr, the city’s state-appointed emergency manager, has proposed a plan of adjustment to the court to eliminate that debt—but also to try and determine the magic amount in that same plan requisite to try and ensure that Detroit can not just eliminate its debt, but actually have a viable future. Fabulous Matt Fabian of Municipal Market Advisors wisely notes that Mr. Orr’s plan—if approved by the federal bankruptcy court—would help Detroit’s balance sheet—but not its income statement. The city, which already taxes itself more than any other city in Michigan, and which—at least under its plan—will invest in 20th century technology to more effectively collect the revenues it is owed; nevertheless faces declining revenues and a continuing likely decline in assessed property values. It will not be competing with other big cities across the country on a level playing field. Revenues from casinos are down, property values are likely to be re-rated (see chart), and future state fiscal assistance would seem uncertain at best. This is the hard test over the next thirty days before U.S. Bankruptcy Judge Steven Rhodes: does this proposed plan by the city put the Motor City’s finances on a viable path for a sustainable future.

The Extraordinary Cost of Municipal Bankruptcy. While Judge Rhodes is struggling to determine whether to approve or disapprove Detroit’s proposed plan to adjust its debts—paying less, in some cases far less, than it owes to its creditors, but struggling to find some resources to invest so that the city can have a sustainable future; the legal and accounting costs are mounting. For instance, Jones Day, the law firm from which Kevyn Orr was drawn, and his colleagues involved in the case has already, according to fee examiner Robert Fishman, submitted bills to Detroit for just over $26 million, according to Mr. Fishman’s most recent report, which was made public yesterday. Mr. Fishman’s supplemental report adds $3 million in fees and nearly $83,000 in expenses billed in March by Jones Day, the former law firm of Detroit’s state-appointed emergency manager, Kevyn Orr. The addition of the March numbers brings Jones Day’s total billing from July of last year to last March to $25.1 million in fees and $1 million in expenses. It also brings the total price tag for all of Detroit’s professional services in the historic case and reported so far by the fee examiner to about $55 million. Nevertheless, Mr. Orr has said he hopes the final cost will not reach the hundreds of millions of dollars. Jefferson County, Alabama (please see below), which was the largest municipal bankruptcy before Detroit sought federal bankruptcy protection, spent only about $25 million on its two-year case. Experts expect that Mr. Fishman’s next quarterly reports will demonstrate a sharp upsurge in costs to Detroit’s taxpayers, because of the heavy workload by the Jones Day team and other consultants both to prepare for and help shepherd the city through the current trial to determine if the federal court will accept the current proposed plan of adjustment—and the trial is projected to last another five weeks.

Slapping at SWAPs. Wall Street bankers, golfing with frequent pit stops for alcoholic beverages, and the sale of exotic financial instruments were a volatile combination that played a key role in plunging Jefferson County, Alabama into what, before Detroit, was the largest bankruptcy in American history. Swaps, or interest-rate transactions between two so-called counterparties in which fixed and floating interest-rate payments are traded—especially when such financial arrangements are undertaken without a sophisticated municipal advisor held to a legal standard of putting the municipality’s best interests ahead of her or his own—were central to what the former Republican Chairman of the House Financial Services Committee described to me as a criminal endeavor. Thus, as in Detroit, both sewers and swaps involved sophisticated financial advisors preying on municipalities in fiscal straits—ending in prison for the former Mayor of Detroit and bankruptcy for his city. In Bermingham, U.S. District Judge Abdul Kallon has rejected motions by two ex-JPMorgan bankers to dismiss the pay-to-play case against them involving Jefferson County, Alabama’s sewer deals and swaps, rejecting several motions by former bankers Charles LeCroy and Douglas MacFaddin, including a request for partial summary judgment based on the contention that the federal court lacked jurisdiction over the interest rate swap transactions. Messieurs LeCroy and MacFaddin had also filed a request with the court seeking permission to file another motion to dismiss the case based on lack of jurisdiction due to the five-year statute of limitation—a request which Judge Kallon also rejected. In addition, Judge Kallon rejected a motion by Mr. LeCroy for partial summary judgment based on the contention that at least one claim by the Securities and Exchange Commission (SEC) against him should be barred because of the statute of limitations. The SEC is seeking declaratory relief, a permanent injunction enjoining the defendants from violating federal securities laws, and disgorgement of profits or proceeds as a result of their conduct. In his decision, Judge Kallon noted: “[Mr.] LeCroy relies primarily on his own self-serving declaration to support this contention, and he has consistently asserted his Fifth Amendment right at his depositions when asked about his work history and securities dealings after he left J.P. Morgan Securities…This court will not allow LeCroy to convert the [Fifth Amendment] privilege from the shield against compulsory self-incrimination which it was intended to be, into a sword.” The SEC filed suit in 2009 claiming that Messieurs MacFaddin and LeCroy violated multiple securities laws as managing directors at JPMorgan; the former bankers agreed with certain Jefferson County Commissioners to pay more than $8.2 million to close friends who either owned or worked at local broker-dealers, but had no official role in selling the county’s sewer bonds in 2002 and 2003, according to the SEC complaint. The payments, undisclosed at the time, were to ensure that JPMorgan won $5 billion in underwriting and interest rate swap transaction business from Jefferson County. Jefferson County exited from municipal bankruptcy last December, but the case is being appealed.

Detroit Begins Week II in Federal Bankruptcy Court

eBlog
September 8, 2014
Visit the project blog: The Municipal Sustainability Project

First Lap. The City of Detroit completed its first week of trial for its bankruptcy plan of adjustment, seeking to convince U.S. Bankruptcy Judge Steven Rhodes it has put together the right plan to eliminate debts, but proposed enough new investment to guarantee a sustainable future. The proposed plan includes cutting $12 billion in debt to about $5 billion and spending $1.7 billion over the next decade on quality-of-life improvements, especially demolition of thousands of abandoned homes. The city proposes spending the $1.4 billion on everything from blight removal to expanded bus service and improved police and firefighting to bring the city’s woeful public services up to an adequate level, a critical part of the overall prescription for keeping Detroit solvent and reversing decades of depopulation and disinvestment trends that laid the city low. On the other side of the ledger, the plan proposes to cut many retirees’ pensions by 4.5 percent. No tax increases are planned. And, the bitterest opponents of the city’s plan provided withering testimony opposing the Motor City’s plan, accusing plan architect Kevyn Orr, the state-appointed emergency manager, of using faulty logic and improper legal standards in creating a plan that favors the city’s retirees over other creditors—and demanding 75 cents on the dollar of what it claims it is owed as its bottom line. Key opponents, however, not only include financial insurers Syncora and Financial Guaranty Insurance Co., but also Detroit’s suburban neighbors, Wayne, Oakland, and Macomb Counties, whose attorneys laid out deep objections to the city’s plan, arguing the parts of the plan dealing with the Detroit Water and Sewerage Department are illegal and unfair.. Perhaps Detroit’s lead attorney best summed up what is at stake: “The purpose is no less than to save the city of Detroit…Detroit won’t recover or survive if this isn’t done.” Feasibility is one of the key tests U.S. Bankruptcy Judge Steven Rhodes must decide the city’s plans meets before he can approve the plan of adjustment—and that is an issue over which he will struggle in the wake of the report of his own expert witness he hired to assess the Motor City’s plan, Martha Kopacz, who, in her report to Judge Rhodes, found Mr. Orr’s plan feasible, but with significant questions about the commitment to following through and from whence the necessary funding would come. Judge Rhodes also has said that it is critical that Mayor Mike Duggan, the City Council, and other city leaders back the plan and its goals and will follow through in implementing it.

People, processes, and structure. Earlier Friday, the city’s chief financial officer, John Hill, returned to the stand to testify that he has been entrusted with the monumental task of rooting out impediments in the execution of Detroit’s debt-cutting plan. In his second day on the stand as Detroit’s first witness in its historic bankruptcy case, Mr. Hill fielded questions from Judge Rhodes about his role and confidence in the plan — and its feasibility. “It’s not going to be easy to implement,” Mr. Hill responded: “If you go into this thinking it will be, I believe you will fail.” Mr. Hill, who is supportive of the city’s debt-cutting plan, says he will oversee policy, processes and ensure accountability to improve the city’s condition. Repairing Detroit’s antiquated processes is a “race against time” to change the “crisis mentality,” he said. “All three of those things are needed in order to move Detroit to a new future…My responsibility is to make this plan real,” he added: “Also, to try to put the city in a place where it would be able to pay something eventually to these creditors. That’s the way I boil it down.”

5-alarm Debt Fire. Clearly, one of the memorable moments came with the testimony last Friday, when restructuring consultant Charles Moore told the federal court how badly the city needs new fire equipment, testifying that one Detroit fire station sets a soda can on top of a fax machine to act as an alarm. When there’s a call, the fax knocks the can to the ground, alerting firefighters. Mr. Moore also spent considerable time ion the stand detailing Mr. Orr’s plan to invest some $1.7 billion to improve city services. For Detroit police, the investment means $16 million in non-lethal Tasers, bulletproof vests and body cameras. The city would spend $91 million on new police cruisers, $59 million on new fire engines and ambulances and $19 million on firefighter coats, helmets, axes, saws, ladders, boots and breathing aides for firefighters.According to Mr. Moore, over the next decade, Detroit wants to spend almost $559 million improving public safety, reducing response times, closing more criminal cases and fixing outdated equipment and vehicles—and during which period, Mr. Moore Testified, Detroit will realize $483 million in additional revenue—testifying he had studied “any and all areas” in which the city could generate additional revenue, including new fees, fee increases, and additional grant dollars. Moore’s testimony, as a key expert behind Detroit’s plans to restructure city government, will be critical to the city making its case that its exit plan is feasible and will ensure a city that can remain solvent and improve the quality of life for residents long accustomed to shoddy public services. The cross examination of Mr. Moore will continue this morning.

Detroit’s Third Day in Trial

eBlog
September 5, 2014
Visit the project blog: The Municipal Sustainability Project

Day 3. Detroit called its first of twenty-five planned witnesses in the hearings on the city’s bankruptcy plan of adjustment yesterday, as part of its strategy in making a case that Detroit’s financial projections for city operations — a revenue and expense ledger for a post-bankruptcy Motor City — is based on sound financial considerations that stand the best chance of keeping the city solvent, even as neighboring jurisdictions and other creditors, including Macomb, Wayne, and Oakland counties and the United Auto Workers oppose the Motor City’s proposed plan, deeming it unfair, illegal, and infeasible, with the neighboring jurisdictions arguing Detroit’s plan of adjustment should be rejected by the federal bankruptcy court, because it would require the Detroit Water and Sewerage Department (DWSD) — which supplies water to metro Detroit jurisdictions — to pay $425 million over nine years to help fund Detroit’s pension liabilities. The counties have argued that the DWSD is already in financial trouble, and, therefore, should not be relied upon to help cover pension debt. Nor, they argue, should suburban water customers have to pay for Detroit’s pension troubles.

A View from the CFO. Detroit’s chief financial officer, John Hill, was the first of 25 witnesses Kevyn Orr’s team expects to put on the witness stand over the next few in its campaign to convince U.S. Bankruptcy Judge Steven Rhodes to approve its plan of adjustment. Mr. Hill testified, with regard to the plan’s proposed blueprint going forward: “We’ll do everything we can to adhere to it…We definitely believe the plan gives us a road map to how we should be operating.” Nevertheless, Mr. Hill warned that the city’s proposed $1.4 billion plan that proposes reinvesting in improving quality of life and city services cannot be accomplished if the federal court rejects the proposal, advising the court that much of the money for reinvestment — all but about $200 million — will be made available only if the city meets ambitious goals set out to cut costs and raise revenues for the city through actions such as improved revenue collections, adding that the city will be navigating a difficult path under both federal bankruptcy and state-imposed financial oversight that could last more than a decade. The newly enacted Financial Review Commission, which could last 13 years or more, would have ultimate say-so over spending and contracts city officials approve. (Mr. Hill is not exactly new to this challenge: he is a veteran of the Federal City Council, where he served as executive director of the federally appointed financial control board that took over budgeting and operations for the District of Columbia (D.C.)’s city government in 1995-2001 when it was confronted with a $700-million deficit.). He testified yesterday that Mr. Orr had asked him to serve to help Detroit reform its abysmal grants management practices that had cost the city millions of dollars in federal money, because Detroit was not meeting requirements, adding that he is also serving as a kind of bridge or transition between the outgoing Emergency Manager—who the Detroit City Council could ask to resign in October)—and Mayor Mike Duggan. He testified that while he technically now reports to Emergency Manager Orr, he has a strong working relationship with Mayor Duggan and would like to remain longer than his two-year contract in order to help implement reforms he has initiated. He told the court he reports regularly with Mayor Duggan, meeting with him at least three times a week to discuss restructuring plans—even, in one of the few humorous asides of the long day in court adding that Mayor Duggan appears to want him to stay in Detroit and regularly cajoles him, asking if he has bought a house in Detroit yet―to which, he testified, his response has been: “I’m a condo downtown person.” In response to the question whether Detroit had done enough to try to raise revenues, (the city’s biggest holdout creditor, Syncora Guaranty has argued that the city should try to raise taxes even though Michigan state law would have to be amended for that to even happen), Mr. Hill responded he was unaware of any new studies on the issue, especially because Detroit “already is at the maximum rates…It’s generally thought the tax rates are pretty high.” Mr. Hill devoted the bulk of his time yesterday in trying to convince Judge Rhodes that the city’s exit strategy is feasible and stands a strong chance of keeping the city solvent—but with a key warning: Detroit’s plan to invest in its ten-year plan for the future sustainability needs funding. In his hours on the witness stand, he especially focused on the key part of the plan: reinvestiing $1.4 billion over 10 years to improve city services and quality of life. He testified that Detroit’s assessments were in poor condition when he arrived: they were old and now the city is using a new method of measuring conditions of property to factor into assessments―street-level and helicopter-shot HD images, which, he told Judge Rhodes, will make for more accurate information and assessments, but also said he arrived to find no centralized control over the money and money that had not been spent, testifying that Detroit’s system is much more costly than other cities: it uses a lot of manual input by low-level city workers—and that Detroit was not closing books on a monthly basis, making getting out monthly and annual financial statements very difficult to put together and audit. Mr. Hill said that henceforth, all financial functions in Detroit would be consolidated under the CFO’s office. Mayor Duggan would like to appoint him to a 4-year term, but needs the state law to change to do that, he added, telling the court his restructuring plan proposes four initiatives: build revenue, cut costs, improve critical services, and improve quality of life.

Regional Complications. While much of the opposition to date has been focused by holdout creditors Syncora and FGIC, yesterday attorneys for Detroit’s neighboring jurisdictions, Wayne, Oakland, and Macomb Counties, trained their fire on Detroit’s proposed plan, focusing on the Motor City’s proposals for how to deal with the city’s water department after bankruptcy, criticizing Detroit’s proposed plan of adjustment for proposing insufficient investment to fix the aging system’s pipes and other infrastructure. Oakland County attorney Jaye Quadrozzi said that, based on the Detroit Water and Sewer District’s (DWSD) current plans, it would take 561 years to replace all the water and sewer lines—adding for the benefit of you readers and the courtroom that 561 years ago, the world was at the end of the Middle Ages and the fall of Constantinople. The neighboring counties have opposed Mr. Orr’s proposed plan to monetize the DWSD, claiming Detroit is seeking to force suburban ratepayers to pay for Detroit’s pension shortfalls for the department’s workforce—which Ms. Quadrozzi illustrated with a chart titled “POA: The Status Quo of Perpetual Decay,” telling the court that Detroit’s pension assumptions are low, at 6.75%, when, she said, in recent years many other plans made 9%-12%, warning that because the proposed interest rate is set so low, that is increasing the amount of unfunded liability of DWSD’s pension obligations—adding that case law would indicate that Detroit’s plan of adjustment must be proven to be able to fund city services at an adequate level, and the plan does not meet that test for the water department—rather, she testified, it substitutes hope for reality. Ms. Quadrozzi also told the court that a municipal bankruptcy trial is not the place to resolve DWSD—a charge which Judge Rhodes countered by responding the DWSD is a department of the city, and the federal bankruptcy court is the place to resolve problems: “That’s what we do here.” Similarly, Max Newman, an attorney for Wayne County, told the court that it was well-known that Detroit’s general pension system paid out excess benefits in so-called good years, undermining its long-term funding, asking how the DWSD could accept a plan in which $428M would be taken out of the system over the next 9 years—summing up by telling Judge Rhodes that the city’s proposed plan of adjustment is not fair, not equitable, not in the best interests of creditors, violates state law, and is not feasible for the DWSD, and should be rejected. Judge Steven Rhodes said he will reveal next Monday how much of a claim he will allow Macomb County to use in voting as a creditor in Detroit’s bankruptcy, relating to the suburban county’s ongoing legal fight to get repaid for what it says were gross overcharges for repairs after a major sewer line collapsed in Sterling Heights in 2004 (the collapse created a giant sinkhole). Contractors were accused of overcharging for work, charging for work not done. Macomb County is also alleging fraud over the repairs―a repair project that involved former and now convicted Detroit Mayor Kwame Kilpatrick.

Backdoor Negotiations. Even as Detroit enters Day 4 of its municipal bankruptcy confirmation trial, holdout creditor Syncora Guarantee and Emergency Manager Kevyn Orr’s office are continuing to negotiate a settlement—in this instance with Syncora seeking to have the bankrupt Motor City pay more than $200 million cash and cede valuable riverfront property, in addition to a share in the Detroit-Windsor Tunnel in return for the corporation’s support of Mr. Orr’s pending plan of adjustment. The Bermuda-based bond insurer is one of the city’s biggest holdouts impeding federal approval of its proposed debt adjustment and recovery plan. The closed-door negotiations with Syncora have intensified since last week—as the clock on the trial continues to tick—even as they continue under supervised mediation by Chief U.S. District Judge Gerald Rosen on the eve of Detroit’s bankruptcy trial. Mediation talks last week included the other most objecting holdout creditor, Financial Guaranty Insurance Co.; however, those negotiations broke down, and the bond insurer’s representatives walked out of talks, according to the Detroit News. Syncora and FGIC appear to be the single greatest obstacles to resolving the city’s pending case before Judge Rhodes, with the firms bitterly opposing the Motor City’s proposed plan which would offer them as little as 6 cents on the dollar for the $1.4 billion in troubled pension debt they insured to help former, convicted Mayor Kwame Kilpatrick prop up the city’s pension funds nearly a decade ago.

A Taxpayer’s Perspective: U.S. Bankruptcy Judge Thomas Bennett, who presided over the municipal bankruptcy case of Jefferson County, Alabama, the largest in U.S. history prior to Detroit’s, commented at the forum “Bankruptcy & Beyond” at the Widener Law School in Harrisburg, Pa., that the federal municipal bankruptcy law, chapter 9, excludes an insolvent jurisdiction’s taxpayers from having any right or role in the adjustment process. Moreover, the law confronts Judge Rhodes in Detroit’s pending case with either approving or rejecting Detroit’s plan of adjustment: the judge cannot order changes or amendments: therefore the following editorial from The Detroit Free Press bears one’s close attention:
Add Judge Steven Rhodes to the list of Detroit-watchers who have serious doubts about the city’s ability to perfect the necessary financial, structural and organizational change to thrive after bankruptcy.
Except, Rhodes’ opinion really matters. If he doesn’t believe the city can better manage its money, upgrade its pencil-and-paper technology, and deliver services more effectively after bankruptcy — well, he doesn’t have to let the city out of bankruptcy court.

There’s good reason for Rhodes’ concerns, and the stretch back decades.

Every mayor since Albert Cobo in the 1950s had a plan to fix the city, and they’ve all said the same thing: Shrink the work force, expand the tax base, streamline city operations, bring revenue in line with expenses. Thanks to the bankruptcy court, Detroit is poised to shed billions in debt. More than a decade of cuts has shrunk the work force. Whether the city can become more functional, whether a new and improved Detroit will attract new residents and businesses — that’s largely up to Mayor Mike Duggan and the Detroit City Council.
A report by Martha Kopacz, an expert hired by Rhodes to evaluate the city’s plan, casts real doubts on the likelihood that Duggan and the council — whom she credits with unprecedented cooperation and focus — can deliver. Kopacz, who conducted hours of interviews and reviewed numerous reports, found that the city’s computer systems were so out-of-date, they imperil the city’s financial recovery and future health.
Without significant upgrades, she wrote, the city’s ability to meet the commitments in its plan of bankruptcy adjustment is “threatened.”
Kopacz made similar conclusions about the city’s work force: While there are many capable, smart, enthusiastic city workers, some employees don’t understand their jobs or the concept of municipal service, she wrote.
That’s got to change. City workers have endured cuts to pay and benefits, difficult working conditions caused by lack of resources, insufficient supplies, and a constant struggle to do more with less. We get it. But in post-bankrupt Detroit, it’s not good enough to punch a clock.

No less important is Kopacz’s message to Detroit’s elected officials. Without the leadership of Duggan and the administration’s current, productive relationship with the council, implementation of the city’s post-bankruptcy plan wouldn’t be possible, she said.

That’s a narrow bridge on which to balance a heavy load. We hope Duggan and the council are paying attention.
This spirit of cooperation between mayor and council — for which Duggan and Council President Brenda Jones deserve much praise — is relatively remarkable in recent Detroit history. Should it prove tenuous, Detroit will be in dire straits: Rhodes has made no bones about the fact that for Detroit’s post-bankruptcy plan to work, elected officials must be committed.

In addition, Kopacz’s report should be getting attention in Lansing, where the steady erosion of state financial support for cities (abrogated slightly by this year’s increase in revenue sharing) helped push Detroit into insolvency. Yes, Lansing came through with important funding as part of the grand bargain to protect city pensioners and the Detroit Institute of Arts, but the commitment to urban areas has to extend much farther into the future.

Lawyers for the city argued in bankruptcy court Wednesday that this set of city leaders gets it. “Detroit has earned this court’s help,” Jones Day attorney Bruce Bennett told Rhodes.

The twin prospects of emergency management and municipal bankruptcy have been looming over this city for a decade. For many, either represented a doomsday scenario, the worst possible outcome for a struggling city.
That’s wrong. Detroit’s worst outcome has always been this: Emergency management and bankruptcy, followed by … nothing. No change in services. No growth. No revival. To endure bankruptcy and emerge stronger is worthwhile. To squander the benefits of the painful process of bankruptcy with continued bungling or missteps would be something else entirely.

Detroit Bankruptcy Trial: Day 2: Let the Battle Begin

             September 4, 2014

Visit the project blog: The Municipal Sustainability Project 

Day 2.  The second day of the historic trial where Judge Rhodes will have to determine whether Detroit’s proposed plan of adjustment is fair, feasible, and in the best interest of creditors will be a task, as this day emphasized, more complex than any previous trial in U.S. history, because, under the city’s proposed plan, the city’s tens of thousands of creditors would get vastly different returns on their claims. Under the proposed plan, current and former employees, as well as investors, will be forced to take less than the $10.4 billion they are owed if Judge Rhodes approves the plan, which proposes to cut $7 billion of the debt. Detroit’s attorney, Bruce Bennett, began the second day of the trial by arguing that a dismissal will lead to higher taxes and a rush to the courthouse by creditors trying to recoup money. “Dismissal followed by increased taxes will only mean the downward spiral will continue or get worse,” Bennett told the judge. “We don’t need to guess about the future or gaze into crystal balls.” Bennett spoke for about three hours over two days. On Tuesday, he argued that Detroit will not survive being kicked out of bankruptcy court. “This is the city’s last, best chance and it’s going to work,” Bennett said early Wednesday. He acknowledged the plan, which includes about $1.4 billion to upgrade public safety and other services, is not perfect. “In the future, things will happen that we haven’t planned for,” Bennett said. “Unexpected things will most certainly happen and other people, not the emergency manager and not necessarily the team that put all this together is going to have to adjust to the future over time,” Bennett continued. “We expect those adjustments. We expect those changes. They are impossible to predict or nail down.” In closing, he paraphrased Gov. Rick Snyder, who authorized the city’s bankruptcy filing in July 2013. The bankruptcy “should not be viewed as the lowest point in the city’s history, but the beginning of the city’s recovery.” “The facts will show that Detroit has earned this court’s help in escaping from its current distressed state,” Bennett told Rhodes. The second day of Detroit’s municipal bankruptcy trial quickly got to the heart of the matter, with holdout creditor Syncora telling the federal court the Motor City had “a million ways” to raise funding to pay off its more than 100,000 creditors; while holdout creditor Syncora’s lawyer testified before Judge Rhodes that Detroit cannot legally justify treating its retirees better than financial creditors―demanding that it be paid 75 percent of what it believes it is owed, rather than pennies on the dollar—or as its attorney, Marc Kieselstein testified: “Something that’s within shouting distance” of Detroit pensioners.” Challenging everything from Detroit’s access to casino tax revenue and its ability to fix the city’s broken streetlights, pushing for the sale of city-owned art and trying to access retirees’ personal financial information; Mr. Kieslstein described Kevyn Orr’s proposed plan of adjustment as “record-breaking, bone-crunching” discrimination. Syncora and fellow bond insurer Financial Guaranty Insurance Co. — which is on the hook for more than $1 billion — claim the city’s debt-cutting plan pays them as little as 6 cents on the dollar for the $1.4 billion in troubled pension debt they insured to help former Mayor Kwame Kilpatrick prop up the city’s pension funds in 2005. Mr. Kieselstein argued that Detroit’s Emergency Manager and key architect of the city’s plan of adjustment pending before the court, Kevyn Orr, improperly considered the “human dimension” of pension cuts when he devised the plan of adjustment: “This plan has epic levels of discrimination…“It didn’t have to be this way.” He added: “This isn’t ‘Back to the Future.’ Mr. Orr is not Marty McFly. He cannot pilot the DeLorean back in time” and change the fact that the city’s plan does not meet the law’s requirement to be in the “best interests” of creditors. The deal should face higher scrutiny, and be rejected, because it causes “unfair discrimination’’ between two groups of unsecured creditors — retirees and bondholders, Mr. Kieselstein said. Detroit does not have any evidence that justifies the disparate treatment, he added.  But Sam Alberts, an attorney for the U.S. government-appointed Official Committee of Retirees, told the court the cuts would be “life-changing” for retirees and that they would otherwise face “drastic” reductions in health care benefits, adding that Detroit’s former work force was also seeing significant, costly changes to its health care benefits and was hardly getting away without pain: “The benefit reductions to these retirees are, by any measurement, life-changing.”

Nevertheless, Mr. Kieselstein further sought to attack the grand bargain, telling the court it would have a “devastating impact” on financial creditors — that it was nothing more than a “fraudulent transfer,” with Syncora’s lead attorney adding that all of the bankrupt city’s creditors could get 75 percent of their debt paid back if the city “maximized the value of the art collection as well as other assets.” The attorney further testified that Detroit “has many options for raising revenue that have not been explored fully enough,” promising this would be “proven during the course of court proceedings.” Those involved with $1.4 billion of certificates the city issued in 2005 could come away with little or nothing, while city workers with pensions would take comparatively smaller losses. “Bankruptcy is, sadly, the land of broken promises,” said Mr. Kieselstein, who said that the city had unfairly and needlessly chosen some creditors over others since it filed for bankruptcy protection in July 2013.

The Fine Art of Municipal Bankruptcy. Holdout creditors also attacked the city’s refusal, in its plan of adjustment, to sell the art from the Detroit Institute of Art—in effect attacking the dynamic heart of the city’s plan for exiting bankruptcy: the so-called grand bargain, with FGIC’s attorney, Alfredo Perez, attacking the city’s claim that it would be take a long time to determine whether art can be sold the world renowned DIA, and telling the court the Institute has limited economic value for the region—prompting Judge Rhodes to ask Mr. Perez: “If the city owned the schools that its children were educated in…would you want those sold or monetized too?”  To which Mr. Perez responded no, telling the court schools are vital to the wellbeing of the people of the city. (DIA attorney Arthur O’Reilly had already, in his opening statement, testified that it is clear the art is held in trust for the public’s benefit and cannot be sold under any circumstances, vowing to fight any future plans to sell art “on an object-by-object basis if necessary.”). Mr. Perez said most of the DIA’s collection was donated to the city without conditions attached — but that even those pieces could probably be sold because bankruptcy allows debtors to slash contracts. But Mr. O’Reilly testified that the grand bargain and the case “is about respecting charitable donations and the people’s right to art and culture.” He testified that about 95 percent of the DIA’s collection of 60,000 pieces was donated or acquired with donated money, warning that a bankruptcy case dismissal would jeopardize the art collection; he vowed to fight “piece by piece” any attempt to liquidate art, telling the court, the façade of the DIA reads: “Dedicated by the people of Detroit to the knowledge and enjoyment of art,” and asking: “What would that mean if that statement was rendered a dead letter?” O’Reilly asked the judge. O’Reilly spoke after the city’s lawyer wrapped up his opening statements in Detroit’s bankruptcy trial Wednesday. Bennett warned about dire results if the city is unable to dump more than $7 billion in debt and free up money for improved services.

Transition Back to Local Elected Leaders. Yesterday, attorneys for Mr. Orr’s team told Judge Rhodes that the proposed plan of adjustment’s $1.4 billion reinvestment plan has critical support from the city’s elected officials, despite some apprehensions about details of the plan—a key point, because Judge Rhodes has emphasized that the city’s elected leaders must be committed to the plan after Mr. Orr is gone—a departure that could happen within weeks. Mayor Mike Duggan and City Council President Brenda Jones are scheduled to testify during the trial that they understand the plan of adjustment and will implement it—albeit, Mr. Orr’s lead attorney in the trial, Bruce Bennett, yesterday acknowledged that some changes will be necessary to accommodate for unforeseen events. He argued that the plan of adjustment will place the city on a path to an economic recovery by restoring services and drastically reducing the city’s crushing debt load: “In the future things will happen that we have not planned for…(and the city) will have to adjust,” adding that the restructuring would prove that Michigan Governor Rick Snyder was correct to authorize the largest municipal bankruptcy in U.S. history.

Scrambling in Scranton. Pennsylvania Auditor General Eugene DePasquale has warned that the City of Scranton could be forced to file for municipal bankruptcy in three to five years, because its pension funds are poised to run out of money. The sobering news, presented at a press conference at City Hall, is contained in an audit Mr. DePasquale’s office conducted of the funds’ condition from January 2011 to January 2013. The municipality’s pension funds face paying out as much as $10.5 million owed to retired police and firefighters because of the $21 million back pay court award to active members—a report the auditor general’s office did not even evaluate in its audit. With a funding ratio of just 16.7 percent, the city’s firefighters fund is in the worst condition of any plan in the state, according to the state auditor—with benefits at risk in as soon as 2½ years. The non-uniform fund isn’t much better, projected to be insolvent in 2.6 years, while the police fund has less than five years. The fiscal dilemma came as Mr. DePasquale is visiting municipalities across the Liberty Bell state to draw attention to the public pension crisis. Pennsylvania sports the greatest number of public pension systems of any of the 50 states—and the auditor’s office is apprehensive that hundreds of other municipalities have severely distressed plans, defined as having a funding ratio (the percent of liabilities covered by assets) of less than 50 percent. In Scranton, according to Mr. DePasquale, he is especially apprehensive about the 16.7 percent funding ratio for the firefighters fund. His audit shows the pension funds’ financial condition steadily deteriorated over the past few years, despite the city’s contributions. Six years ago, Scranton contributed $3.3 million to its three retirement funds; the city’s pension fund’s financial advisor last week announced the contribution for 2015 will be $15.8 million. However, the city could pay $12.3 million because a state law allows Act 47 distressed municipalities to reduce contributions. But, as the Auditor General noted: it’s clear the severely financially distressed city cannot afford to continue making those types of payments, making bankruptcy “a clear possibility within five years.” For its part, the city recently adopted a commuter tax, which is expected to raise $5 million annually for the pension funds. Now Scranton is considering selling its sewer authority to make a one-time payment to the funds. City officials are also talking with unions about possible pension concessions, according to the Mayor. While the Auditor General had praise for the city’s efforts to catch up, he is concerned that more must be done―focusing on reform to the municipal pension system, including: consolidating plans into a statewide system and increasing funding to municipalities with distressed plans, adding: “We don’t see any way this can be fixed by Scranton alone…I believe strongly that a statewide solution is needed.” Even though Gov. Tom Corbett and the Pennsylvania Legislature debated state pension system reform this summer, it has yet to address the pension crisis some municipalities face.

Rolling the Dice. With its economic mainstay—casinos—closing at a record pace, Atlantic City is turning to its homeowners to avoid insolvency and meet bond payments in the wake of some 33% of its casinos to go dark. The city’s $261.4 million budget for 2014, with 14% of revenue dedicated to debt service, includes a 29% increase in property taxes—that is a 29% increase in addition to last year’s 22% increase. Atlantic City Mayor Don Guardian plans for the city to issue $140 million of debt by year-end in order to satisfy tax appeals for casinos, which opened in Atlantic City in 1978 and heretofore have paid about 70 percent of the city’s property tax levies. But with the seemingly endless run of casino closings, the city is both being forced to issue more debt—and to find other revenue sources. Atlantic City homeowners paid an average of $5,273 annually last year, but this year, warns Finance & Revenue Director Michael Stinson, those amounts will likely have to increase as will its borrowing, although the city’s costs of borrowing will be state-supported under the Garden State’s Qualified Bond Act, with payments tied to $20 million in state aid. The program will earn the bonds a credit grade that is one level below New Jersey’s, notwithstanding Moody’s reduction in the city’s credit rating to junk this summer. Revel Casino Hotel, which closed this week, is the third gambling destination to shut this year, after Caesars’ Showboat last week, and the Atlantic Club in January. Trump Plaza is scheduled to close the week after next—meaning some 33% of the city’s casinos will have closed this year—at a cost of not just significant cuts in property tax revenues, but also about 7,300 jobs. In addition, Atlantic City faces payments to casinos that have appealed tax bills after the recession eroded their assessed property values. With a poverty level of approximately 30 percent –and a homeownership rate of 34 percent, about half the state average, according to Census data, the turn of gambling events could have significant repercussions for remaining homeowners. Atlantic City was the No. 2 U.S. gambling destination until 2012, when it was overtaken by Pennsylvania. New Jersey Governor Chris Christie has invited casino representatives, elected officials, and labor leaders to a meeting next Monday in an effort to reverse the adverse momentum—looking to draw up a blueprint based on retail, entertainment, tourism, and other non-casino revenue. The bleak fiscal situation comes just four years after Governor Christies announced a five-year plan to revive the city, including $261 million in tax breaks to the Revel Casino and the creation of a state-run tourism district. There is concern that was a bet that has not paid.