Saving Critical Resources for a new Detroit. U.S. Bankruptcy Judge Steven Rhodes late yesterday agreed to put off the first big brawl in Detroit’s bankruptcy case, where Detroit Emergency Manager Kevyn Orr will try to persuade Judge Rhodes that two Wall Street banks deserve not only to cut in line in front of pensioners and bondholders in the city’s debt payment line, but also to take a disproportionate share. For Mr. Orr, this is a key step in his efforts to not only untangle a complicated debt transaction that has helped precipitate the city’s bankruptcy, but also is a critical step in his plan for resolution. He has proposed to pay UBS AG and Bank of America at least $250 million—the equivalent of between 75 to 82 cents on the dollar—to terminate an interest rate swap arrangement that went bad for the city during the recession. Unsurprisingly, his proposal is opposed by insurers of the debt, who stand to lose millions of dollars, and the city’s retirees, who are owed billions of dollars in promised retirement benefits—benefits to which they believe they are constitutionally guaranteed. Under the proposal by the city, in return for the payment, the banks would drop their claim to about $11 million a month in revenue from the city’s three casinos—in effect, freeing those funds up for Mr. Orr’s efforts to restore essential services in Detroit: he wants to gain immediate access to the casino revenue so that he can start reinvesting in public protection, repair broken streetlights and demolish tens of thousands of abandoned structures throughout the city. In addition, the city would save about $4 million a month in other payments. Investors holding other types of bonds issued by the city oppose the settlement because Mr. Orr has indicated the city might pay them as little as pennies on the dollar for their debt. The settlement has sparked the most opposition in the case yet from bond insurers and pension certificate holders, who have challenged it on several fronts. The two parties have been in talks with the case’s mediator, Judge Gerald Rosen, for two weeks to try to reach an out-of-court settlement.

Motor City Swapping or Swamping? Detroit originally bought swaps to hedge against potential increases in interest rates; but rates fell sharply as the economy entered its worst downturn since the Great Depression. Thus, when major rating agencies, such as Moody’s and Standard & Poor’s dropped Detroit’s credit ratings in early 2009, the city pledged its casino tax revenue as collateral to avoid an immediate payment of up to $400 million to UBS and Bank of America. Emergency Manager Orr has said he has no choice but to pay UBS and Bank of America a majority of what they are owed, because the banks control access to $15 million a month in casino tax revenues through another financial arrangement that helped put off or avoid municipal bankruptcy for Detroit four years ago: In 2006, city leaders agreed to a fixed 6.3% interest rate on $800 million borrowed to pour into the pension funds. As part of the arrangement, the banks proposed or lured the city into what was made to appear to be a “can’t say no” to lucrative advantage: The banks would pay Detroit the difference between variable interest rates and the city’s fixed rate: the arrangement made the actual monthly payment for taxpayers less than 1 percent, according to city records—and it was important to financing part of the $1.44 billion that former Detroit Mayor Kwame Kilpatrick had borrowed in 2005 and 2006 to fund the city’s pension obligations. In addition, it seemed to promise to lower costs for Detroit’s troubled general fund. But, as with the city’s casino industry, city leaders were gambling that variable interest rates would remain high, which would keep the costs to Detroit low. However, the 2008-09 recession and federal monetary policy sent variable interest rates plummeting, causing Detroit’s annual interest payments on the bonds to soar to $50 million this year from an estimated $5 million a year in 2006. Detroit’s situation, moreover, deteriorated in 2009 when Wall Street rating agencies downgraded Detroit’s credit rating to junk status, triggering a default on the swaps and the threat of an immediate $400 million termination payment that could have sent the city into bankruptcy. That threat led to the deal between then interim Motor City Mayor Ken Cockrell with UBS and a Bank of America subsidiary to pledge the city’s $15 million in monthly casino taxes as collateral to keep the swaps arrangement in place — and avoid the potentially lethal termination fee. These swaps are tied to the duration of the pension bonds, which in Detroit’s case expire in 2029 and 2034. In seeking to exit the swaps, consequently, emergency manager Orr’s financial consultants have estimated that the swaps, principal, and other interest payments tied to the $1.44 billion in pension bonds could end up costing Detroit taxpayers more than $2.7 billion by 2034. Ergo, Mr. Orr hopes to pay the termination fee with a new loan of up to $350 million that relies on pledging as collateral the same casino wagering tax revenue that is entangled in this financial industry web of hedges, insurers, and swap counter parties.

Challenging Michigan’s Emergency Law. U.S. Bankruptcy Judge Steven Rhodes yesterday scheduled a hearing for October 2nd to consider the NAACP’s argument that its ongoing challenge to the state’s emergency manager law should be allowed to proceed outside of bankruptcy court. The Michigan and Detroit chapters of the NAACP joined with Donnell White, Thomas Stallworth III, Rashida Tlaib, and Maureen Taylor to file a lawsuit last May as part of an effort to overturn the emergency manager law as unconstitutional, because, they claim, it infringes on voter rights. Their lawsuit, filed in May in the U.S. Eastern District Court of Michigan, was immediately delayed by Detroit’s bankruptcy case—which, from its onset, U.S. Bankruptcy Judge Stephen Rhodes has sought to ensure is on a fast track, and therefore sought to prevent anyone from trying to undermine the city’s bankruptcy through legal proceedings. Nevertheless, the plaintiffs have told Judge Rhodes that their lawsuit should be allowed to proceed, because they are “not seeking any damages, contractual claims or similar related relief that would implicate the city’s finances.” However, Judge Rhodes said in a recent hearing that the removal of emergency manager Kevyn Orr would disrupt the city’s bankruptcy.

Getting out of Chapter 9: San Bernardino & Seeking Citizen Input to Put Together the Plan to Get Out of Bankruptcy. San Bernardino’s Council took one key step towards agreement on a long-term plan to move the city towards its exit from bankruptcy by asking its citizens to weigh in yesterday, asking residents and other members of the public what they think is important for the city to prioritize and consider. Allowing for such input is one reason U.S. Bankruptcy Judge Meredith Jury allowed the city to move forward with the timeline the city is expecting to follow, which includes having an “outline” of its plan by October 15th, which would set the stage for beginning mediation sessions with retired bankruptcy Judge Gregg Zive of Reno, Nev., shortly thereafter. Yesterday’s meeting was technically a continuation of the City Council meeting of Sept. 9, and will begin with a discussion of transferring properties from the Economic Development Corp. as the state controller has ordered. That decision has been repeatedly delayed because of concerns over what encumbrances might be associated with the properties, but staff members have recommended that the transfer be approved today.

Steps Toward Exiting Chapter 9. The Jefferson County Commission took a key step towards exiting its municipal bankruptcy yesterday when it voted 3-2 to approve a multi-year increase in the county’s sewer rate. The rate increase will kick in on November 1st: for residential customers on the county’s sewer system, the boost will translate into a five dollar base charge increase effective, while business owners will see a 3.49% rate increase this fall. Next year, there may be a 7.89% user rate increase across the board. The Jefferson County Commission president stated the increased was the best deal the commission could agree to, albeit admitting the rates are at the outer edge of “reasonable.” Some concern has been expressed that the rate increases this will disproportionately affect the county’s poorest residents and those on fixed incomes. The vote is a key part of the county’s bankruptcy and debt restructuring plan, but that plan could still unravel.

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