01.06.14

Snowing on Appeals. The Motor City’s trial in the U.S. Bankruptcy Court over the fate of the city of Detroit’s proposed $165 million financial agreement mediated by Chief U.S. District Court Judge Gerald Rosen on Christmas to settle a 2005 financial bet will be delayed amid a bitterly cold snowstorm that is shutting down much of the state today. It is unclear when the trial, which was in the midst of closing arguments when it adjourned Friday, will resume. It is clear that there are growing questions about the role of the federal government, raising the issue of whether the Motor City should be paying anything to the two financial institutions at issue—UBS and Bank of America to settle the disastrous $1.4 billion pension debt interest-rate swaps deal. If anything, the issue was further complicated last Friday when Detroit emergency manager Kevyn Orr testified that he asked the U.S. Securities and Exchange Commission whether it would consider prosecuting the two global banks over the arrangement, nor has there been any information from the SEC. Nevertheless, Mr. Orr testified that even though there were “serious questions” about whether the city has a legal obligation to pay any of the $165 million, because the city might have a “potential fraud claim” against the banks; nevertheless, he told the court the city decided to settle the swaps debt instead of pursuing a legal challenge, calling the chances of success 50-50. U. S. Bankruptcy Judge Steven Rhodes last month questioned Mr. Orr’s decision not to disclose its legal assessment of the $1.4 billion pension obligation certificates of participation deal and related swaps—and in the session Friday, Mr. Orr told the court that the city’s decision in 2009 to pledge its casino tax revenue as collateral on the swaps might have been illegal, because the Michigan Gaming Act may not allow the pledge; that the original 2005 debt swap might have been illegal, because it may have put the city over its legal debt limit, and that Detroit might have a fraud claim against the banks, because of unfair negotiations with the city based upon their access to leveraging “superior” information about future interest rates. (Under the agreement, the swaps provided a steady interest rate of 6% for the city when they were brokered under former Mayor Kwame Kilpatrick’s administration, but when interest rates plummeted, the city was at the wrong end and found itself further indebted with a $50 million annual cost just for what it owed the banks on the swaps, amounting to nearly 5 percent of its annual revenues.  But Mr. Orr testified that any decision to sue the banks was complicated by both a legal opinion approving the deal given to the Detroit City Council, as well as a letter of approval from the Michigan gaming board approving the use of casino tax revenues as collateral. Those complications, Mr. Orr told Judge Rhodes, created the risk that any suit now would not only have an uncertain outcome, but also would take too long and cost too much. Worse, he warned, were the Motor City to lose, the banks could trap Detroit’s casino revenue until the swaps debt was paid off. Even at a the much lower rate reached in the mediation before Judge Rosen, Mr. Orr believes that gaining the additional revenues freed up from that proposed settlement would free up cash flow to reinvest in public safety and blight removal, while also removing restrictions over the use of its vital casino tax revenue.

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