The Might Pension Enigma. Michigan Attorney General Bill Schuette Saturday announced he will intervene in Detroit’s bankruptcy to defend the state’s constitutional protection of pension benefits city retirees and workers have earned, stating the state constitution makes it “crystal clear in stating that pension obligations may not be ‘diminished or impaired.’” Detroit’s Chapter 9 bankruptcy filing claims $3.5 billion in unfunded pension liabilities that Emergency Manager Kevyn Orr has said the city cannot afford to pay. The AG stated he would file for appearance in the municipal bankruptcy case in U.S. Bankruptcy Court in Detroit this morning. The case itself is to sort out the municipality’s plan to address $18.5 billion in debts and liabilities, including $11.5 billion in unsecured claims, mostly from underfunded pensions and unfunded retiree health insurance promises. In his statement, the AG noted: “Equally staggering is the financial uncertainty of pension benefits relied upon by Michigan seniors living on fixed incomes and anticipating a safe and secure retirement after a lifetime of work…Retirees may face a potential financial crisis not of their own making, possibly a result of pension fund mismanagement.” The filing this morning underlines the conflict between Michigan’s constitutional protections versus the federal municipal bankruptcy law. While U.S. Bankruptcy Judge Steven Rhodes last Wednesday halted lawsuits retirees and the city’s pension funds filed against the city, in a ruling from the bench, Judge Rhodes said he has not decided on whether Michigan’s constitution protects earned pension benefits in a federal bankruptcy, but said retirees have raised “very serious questions,” stating: “The court will rule on them in due course with adequate opportunity to be heard.” Detroit’s unfunded health-care burden is larger than its pension deficit; however, the pension problem is much more complex: unlike post-retirement health care benefits, Detroit has put aside specific funds to meet very specific pension promises. While what it has said aside might not be sufficient, nevertheless a promise of $30,000 a year can be made lessened only by breaking a constitutional bound commitment. Moreover, beyond the legal, obligational, federalism, and constitutional issues thought which to be sorted; there are two other profound challenges: 1) economics: if the court agrees to slash retirement benefits of those retirees who live in Detroit, what are the implications for their abilities to pay taxes and fees critical to the city’s economy? And 2) if the cuts were deep—in excess of 50% as in Central Falls—and that is the only source of a family’s income: what happens if it is not enough?

State-Local Balancing. In his statement, Attorney General Schuette stated he would continue to represent Governor Snyder and state agencies in Detroit’s bankruptcy proceedings: the state of Michigan is among Detroit’s estimated 100,000 creditors in the Chapter 9 case. During last week’s arguments, city lawyers argued Detroit would be “irreparably harmed” if retirees were able to block the Chapter 9 filing. City lawyer Heather Lennox argued the city would be “prevented from accessing necessary protections” of a Chapter 9 bankruptcy filing. Judge Rhodes appeared to concur with those apprehensions, stating that lawsuits against the city during bankruptcy “are costly, expensive, and inefficient” and can cause “prejudice” to the debtor, underlying his clear determination to accelerate the municipal bankruptcy process.

What’s it all about, Alfie? Over its course, these proceedings not only will help determine the future for the city of Detroit and its 700,000 citizens, but also will be “profoundly meaningful” for the small number of local governments in the U.S. that are below investment grade and could change their approach to pensions and other long-term liabilities, Moody’s investment services noted in a new report last Friday: “If Detroit is bogged down in years of expensive proceedings and fails to restore solvency or materially restructure its liabilities, other distressed issuers (cities and counties) would be unlikely to emulate Detroit’s approach.” (Moody’s currently only has speculative ratings on 34 local governments.) Nonetheless, how Motown proceeds—and how the federal and state courts make decisions will have significant implications for every state and local leader, because of the implications for state and local credit markets and the sanctity of public pension funds—and the balance between federal power and state constitutions.

Notwithstanding its fiscal distress and bankruptcy, some parts are reviving. Property is so cheap that Detroit still attracts dreamers. Perhaps the most prominent is Dan Gilbert, the chairman of Quicken Loans, a mortgage provider. In 2010 Mr Gilbert moved Quicken’s headquarters from the suburbs to the centre of town. Another of his companies, Rock Ventures, owns or controls over 30 buildings in the area, which locals light-heartedly call “Gilbertville”. Mr Gilbert’s firms have invested around $1 billion in downtown Detroit and employ some 10,000 people there.

The city government barely functions, but other bodies are filling the void. For example, the Detroit Employment Solutions Corporation, a non-profit, has replaced the city’s employment-services department. Pamela Moore, its boss, says it uses 30% less federal funding and has doubled its job placements.

Something is working. Charities and bigwigs have helped raise $140m for a light railway. Quicken Loans has lured 85 other companies into town and brought in 1,000 interns for the summer. Some will stay. Young graduates from the rich but boring nearby suburbs seem to like urban living.

As Detroit hurtled toward bankruptcy, it managed to stay under a statutory debt limit. That may seem unlikely given the mountain of debt sitting on top of the city. But according to Detroit’s most recent annual financial statement, it slid under a state-imposed cap with $75 million to spare (or to borrow.)

How’s that possible? Here’s why.

In 1909, Michigan passed a law limiting the amount of debt a city could legally incur. The cap is set at 10% of the total assessed value of all real property and personal property in a city, with some adjustments. But only a fraction of the debt counts against the state-imposed debt ceiling. Here’s an analogy: It’s as if you had a credit card that capped grocery purchases but allowed you to spend as much as you want on other stuff, like gas and clothes and travel. And when you couldn’t make a payment, you could always use another card for a cash advance. Detroit is spending more than 40% of its revenue on borrowing costs and public-employee retiree benefits, according to the city.  Its emergency managers say the city owes $9 billion to creditors and has racked up billions of dollars more in health-care and pension liabilities.

But all of that was accommodated, thanks to exceptions in the law. Over the years, as lawmakers tinkered with the limit, the loopholes grew bigger. Or, in the words of the city’s official financial statements to potential bond purchasers, “significant exclusions to the debt limitations have been permitted.”

Revenue bonds, including ones for water supply and sewage, don’t fall under the cap. Neither do those risky lease-financing schemes and derivatives deals that allowed Detroit to convert casino dollars into pension payments. Long-term retiree liabilities don’t count either.

So while Detroit’s debt cap in 2012 was calculated at just over $1 billion, only $957 million of its long-term debt counted against the limit, according to the city’s annual financial report released in December. Most of it consisted of general obligation bonds.

“Certainly, [a debt limit] is not a panacea,” David Zin, the chief economist for Michigan’s Senate, told Law Blog.


Moody Blues: “Our negative outlook on the local government sector as a whole, in place now for close to five years, reflects a number of substantial economic and fiscal pressures, including a sluggish economic recovery, constraints in key revenue sources, and mounting spending pressures. In spite of the negative outlook, we anticipate that few issuers will follow Detroit into default or bankruptcy. We don’t expect elevated financial stress to lead to pervasive defaults. We expect defaults to remain rare even among outliers. Most local governments exhibit solid credit fundamentals, notwithstanding the recent period of economic and fiscal stress. In fact many local governments are starting to feel the effects of the housing recovery, and while this recovery varies somewhat from region to region, most local governments have seen property tax and other revenues stabilize and in some cases return to growth. Spending pressures have not completely subsided for many local governments, and it may be several years before most can rebuild reserves spent down during the recession.”

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