Taking Stock on Stockton. The messy process of exiting municipal bankruptcy is front and center in Stockton, Detroit, and Lansing this week—pivoting around the issue of what constitutes equitable allocation of debt. The twin proceedings as each city moves towards exiting bankruptcy is profoundly different in another sense, however: In Michigan, the Governor and legislature will be acting on a package of 11 bills meant to facilitate the Motor City’s exit from bankruptcy; whereas, in California, the Governor and legislature appear to be on another planet.

U.S. Bankruptcy Judge Christopher Klein, in his courtroom in Stockton is presiding over a multiday hearing pitting investment firm creditor Franklin Templeton—the last holdout—versus the city of over the question whether the California city, which filed for Chapter 9 bankruptcy protection nearly two years ago, may be permitted to virtually eliminate the claims of one creditor while treating others far more favorably–and making no cuts to its pension obligations―in stark contrast to the city’s proposal to reduce its obligation or debt repayment to Franklin Templeton, whose Franklin High Yield Tax-Free Income Fund and Franklin California High Yield Municipal Fund would receive less than a penny on the dollar. The issue will be simple, and yet devilishly complex for the court, as the equity in San Bernardino, Detroit, Stockton, and other severely distressed cities pit state constitutionally protected public pensions versus equity―and where the decisions about the future of these cities and the daunting pension obligations of many state and local governments could have significant repercussions on almost every state and local government because of the potential impact on the $3.7 trillion municipal bond market: decisions in these municipal bankruptcy cases could have a contagion effect by sharply raising the perceived threat to investors, thereby comparably raising the cost of capital finance for all states and local governments. In Stockton, where yesterday’s hearing marked the first of four days over which Judge Klein will seek to determine whether Stockton’s proposed plan of adjustment is feasible and fair, a key element of his decision will hinge upon this signal discrepancy in the treatment of creditors Calpers versus Franklin, with the latter arguing that Stockton’s plan, which proposes providing Franklin only $94,000 to cover its $35.1 million loan, is discriminatory because of  the significant disparities compared to the treatment not only of other bondholders, to whom the city is proposing payment of 52 to 100 percent of their claims, but also to the complete forgiveness, in effect, of the city’s pension liabilities—where the city notes that sundering its relationship with Calpers, the state retirement system, would not only raise state constitutional issues, but also trigger a $1.6 billion termination fee—a hefty amount in a case where the city is seeking to reorganize some $900 million in debt. Yesterday, the city’s attorney, Marc Levinson, told Judge Klein: “For the city, this week is a fight for its life,” testifying that he has sought to clinch a deal with Franklin Templeton, but the company is not budging. Moreover, Mr. Levinson told the court that Stockton’s plan treats Franklin’s debt the same way it proposes to treat retiree health benefits: both were to get about 1 percent.

In a Parallel Universe. Halfway across the country, the Motor City plan of adjustment was proceeding yesterday in both U.S. Bankruptcy Court before Judge Steven Rhodes, but also in the state capitol of Lansing―but with considerably greater intergovernmental issues, what with the U.S. government, Oakland, and Macomb counties filing official objections to Detroit’s proposed plan of adjustment―and bond insurer Syncora notifying the court it intends to call Governor Rick Snyder, State Attorney General Bill Schuette, and former Detroit Mayor Dave Bing to testify during this summer’s trial to determine whether the federal court should approve the Motor City’s plan of adjustment. Macomb County submitted a filing claiming Detroit’s restructuring plan is “not feasible,” and the suburban county claimed that the city’s plan to spin off its water department would raise rates on suburban customers. Neighboring Oakland County accused Detroit emergency manager Kevyn Orr’s restructuring team of “putting the water and sewerage systems at risk” by considering transferring the assets to an outside authority in exchange for lease payments that could help reduce the city’s debt and reinvest in services: “Nothing can be more vital to a thriving commercial 21st- Century metropolis than the providing of clean, safe water and sewerage service in an efficient and sufficient manner…Yet, notwithstanding this essential need, the city appears willing to engage in a game of chance, jeopardizing the DWSD, and thus the region, by putting the DWSD’s operations at risk.” The smelly sewer issues, moreover, drew added objections, when a group of major water and sewer bondholders objected to the city’s plan of adjustment.  But it was not just the Motor City’s neighbors, but also the federal government raising objections: yesterday, attorneys for the federal government raised objections on behalf of both HUD and EPA, noting the U.S. government would oppose the city’s restructuring plan until its objections can be resolved. The attorneys objected to the city’s plan of adjustment because, they claimed, Detroit owes $112 million to HUD and the city has failed to guarantee that it will follow EPA guidelines during its restructuring.

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