11.21.13

Motor City: With U.S. Bankruptcy Judge Steven Rhodes expected to render his decision on Detroit’s eligibility for chapter 9 municipal bankruptcy as early as today or tomorrow, the related costs to the city, its taxpayers, its employees, and its retirees is growing. Moreover, with all sides are gearing up for an anticipated appeal of whatever decision Judge Rhodes makes, the cash register will continue to ring—further depleting critical funds necessary to get the Motor City back on its own wheels. The Emergency Manager’s office yesterday posted an accounting of information about its current bankruptcy related expenditures (see: www.detroitmi.gov/EmergencyManager/RestructuringInitiatives.aspx.Detroit has paid more than $22 million to restructuring firms through Oct. 1st. Those funds, however, denote only a portion of what its costs are likely to run to finance more than a dozen bankruptcy and restructuring consultants—to whom the tab is projected to be in excess of $62 million―even as the Emergency Manager’s office has informed Mayor Bing and the City Council that the state has capped its costs towards the city’s restructuring at $5 million. To finance the large and growing debts related just to the municipal bankruptcy, Detroit is withholding debt payments to pension obligation certificates and outstanding pension bonds—bonds whose repayments are not secured by a dedicated revenue source. Last week Mr. Orr authorized the diversion of $95 million in such payments.

Motor City Swaps, Pensions, & State Unaid. Wallace Turbeville, a senior fellow at the progressive policy group Demos, and a former municipal investment banker at Goldman Sachs, in a report released yesterday, called the Emergency Manager’s estimated $18 billion debt estimate for the city inflated, writing that the real cause of the city’s fiscal emergency ― like in Jefferson County ―to be the result of illegal and unethical interest rate swaps; he also wrote that Mr. Orr’s unfunded pension liability estimate of $3.5 billion is based on “extreme assumptions,” writing: “To say the pension fund kills the city, it’s like if you were stabbed, strangled and blown up, did you die from the strangling?” Turbeville said. ”That’s why I find this whole thing illogical, except for the fact that somebody didn’t like pensions.” The report urges the city to pull back on its proposal to unwind its costly interest-rate swaps. He recommends Detroit should urge Judge Rhodes to rule these swaps were unethical transactions, and that, therefore, they should be declared illegal: “The law recognizes special duties that sophisticated financial institutions owe to special entities like cities in providing complex financial products…A strong case can be made that the banks that sold these swaps may have breached their ethical, and possibly legal, obligations to the city in executing these deals.” The swaps in question hedge a significant amount of the city’s pension certificates, leading Mr. Turbeville to write that, had he been in charge, he would never have entered into such a risky swap transaction with a city that had Detroit’s long-term structural problems, and to note his belief that the city’s pensions have played a relatively minor role in its financial downfall. Rather, Mr. Turbeville writes that the State of Michigan’s actions helped drive Detroit into insolvency. In addition, Mr. Turbeville expresses apprehension that Emergency Manager Orr’s proposal to borrow $350 million to cover the swap termination payment would sharply hurt the city’s cash flow. Instead, he proposes that the state significantly increase its support for the city, beginning with a backstop of the swaps, so that the city would be able to avoid the termination payment: “If everybody were behaving the most rationally, the state would figure out how to keep the swap outstanding…That’s the optimal solution in a properly functioning political environment.”  (The Motor City entered into the swaps in 2005 and 2006 to hedge $800 million of floating rate pension certificates issued to fund its two pension plans. The remaining roughly $750 million of COPs were issued as insured fixed rate debt.) Mr. Turbeville  writes that Michigan should help Detroit by offering emergency funding or a restoration of its state aid cuts, noting that the state has cut $67 million in annual state aid since 2011, with more than a third of the cut accounted for due to the city’s population loss and consequent impact on population-related state funding formulas; but the bulk of the cut came from cuts and changes by the Governor and legislature in Michigan’s revenue sharing policies: “These cuts account for nearly a third of the city’s revenue losses between fiscal year 2011 and fiscal year 2013, coming on the heels of the revenue losses from the Great Recession and tipping the city into the cash flow crisis that it is now experiencing…Furthermore, the legislature placed strict limits on the city’s ability to raise revenue itself to offset these losses.”

Sewer You. Jefferson County’s successful sale of enough of its $1.7 billion in refinanced sewer warrants could open the door for the county to exit to exit chapter 9 municipal bankruptcy as early as December 3rd. Jefferson County’s plan of adjustment, which the court must deem feasible, provides a road map of the county’s future tax and spending decisions; it also is intended to prove to Judge Bennett that the county is not likely to land back in federal bankruptcy court, because the successful sale of the warrants also demonstrates that the plan contains enough financing for the county to pay its projected debts. The plan, as the extremely gifted New York Times writer Mary Walsh William writes, any exit plan approved by U.S. Bankruptcy Judge Bennett will likely set a template for other cities—and likely muddle federalism by leaving Alabama county subject to the federal bankruptcy court for more than four decades. The county’s plan of adjustment could go into effect the week after next on December 3rd, because that is a likely closing date on the sale of the refinanced sewer warrants. In her article, “A Municipal Bankruptcy May Create a Template,” Ms. Williams notes: “The county’s unusual exit plan, which could offer a possible template for other bankrupt municipalities, calls for the court to retain jurisdiction for the life of $1.8 billion in sewer-revenue debt that it sold over the last few days. If the county falters at some point, even decades from now, the bankruptcy court is supposed to have the power to enforce rate increases to produce the cash needed to pay back the $1.8 billion on schedule, with interest.” This is an important backstop for the county, because the implicit court protection makes it possible for the county to sell its bonds—leading Matt Fabian of Municipal Market Advisors to remind us: “Without the assumption of court protection, the financing would have been more difficult, if not impossible,” as well as to note the key role the county could provide for other cities and counties in severe fiscal distress: a new source of financing. But to demonstrate the intractable nature of federalism, Ms. Williams writes: “Moody’s and Fitch said they were concerned that the new debt is to be paid back slowly at first, with accelerating payments in later years that will require sewer rates to rise. The county’s rate schedule, subject to bankruptcy court approval, also includes increases to cover the cost of the remaining work to be done to bring the system into compliance with the Clean Water Act. Moody’s noted in its report that ‘We are not aware of a precedent for a federal court to compel public utility rates of this nature, given the federalism issues involved in this bankruptcy.’”

 

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