In Parallel Universes. Two of the nation’s cities – one in California and one in Michigan – are each in a federal courtroom this week as part of the exceptional process of exiting municipal bankruptcy, trying to obtain federal judicial seals of approval that their respective plans of adjustment constitute equitable allocations of their respective debts amongst their creditors. Each, as Detroit Emergency Manager Kevyn Orr testified yesterday to the Michigan legislature, is at a crossroads. The outcomes, in each case, could have profound implications for every state and local government: A federal decision that California’s public pension system (Calpers) could be impaired, which would mirror U.S. Bankruptcy Judge Steven Rhodes’ decision in Detroit, notwithstanding the state constitutional protections in each of the two states, would have wide-ranging implications for public employee pensions across the nation. U.S. Bankruptcy Judge Christopher Klein yesterday noted that Stockton’s public pension obligations are a “festering sore”—a sore, he added, which “We got to get in there and excise. “Already, further south in southern California, the City of San Bernardino is currently in mediation with Calpers. Nevertheless, as we noted yesterday, the twin proceedings as each city moves towards exiting bankruptcy, are profoundly different in another sense: In Michigan, Detroit devoted much of yesterday in advocating adoption of a package of 11 bills meant to facilitate the Motor City’s exit from bankruptcy; whereas, in California, the Governor, a former Mayor of Oakland, and legislature appear to be on another planet.In addition, as seemingly simple as the issue of insolvency might seem to be, overcoming it via a federal courtroom is devilishly complex, as the equity in San Bernardino, Detroit, Stockton, and other severely distressed cities pitting state constitutionally protected public pensions versus equity―but also 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.
Taking Stock on Stockton. In the Stockton case, U.S. Bankruptcy Judge Christopher Klein yesterday said he will question officials from California Public Employees’ Retirement System (Calpers) to determine whether the nation’s largest pension fund can be forced to take losses in the case along with other creditors. The sharpest challenge to the city’s plan of adjustment has been waged by the investment firm creditor Franklin Templeton—the last holdout—which is strongly challenging whether the Golden State 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 Calpers 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 city is apprehensive that any reduction in its pension payments to Calpers would 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. In his opening, Stockton’s attorney, Marc Levinson, told the court: “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. Robin Respaut, reporting on yesterday’s proceedings for Reuter’s, wrote that this Solomon-like determination of whether Calpers should remain whole while other creditors absorb steep losses is what Judge Klein yesterday likened to a “festering sore,” stating he needed to consider alternatives: “We got to get in there and excise it and figure out what the story is. Maybe Calpers is correct, maybe not.” Stockton has not, in its contested plan of adjustment, sought to apportion any of its debt adjustments or cuts on Calpers, which claims it is protected under the California state constitution. Unsurprisingly, Calpers’ attorney recommended the federal court not consider any plan affecting the city’s public pension obligations than what the city has included in its current plan of adjustment, telling the court: “There is a bit of the cart before the horse here…What we are in jeopardy of is embroiling the city in a messy problem that the city does not want to be embroiled in.” But that drew a rejoinder from Judge Klein, who responded that he would be rubber stamping the city’s proposal if he did not consider the alternatives. Stockton, for its part, has expressed a double apprehension of taking on the state giant: 1) it fears triggering a $1.6 billion termination fee, and 2) “the real and palpable belief that if we take on pensions, we lose employees.” said Stockton attorney Marc Levinson. In yesterday’s second of four days of this week’s hearing, the main focus was trained on the equity claims of Franklin Templeton Investments, which—unlike Calpers—is faced with the city’s plan to pay it less than a penny on the dollar. Its attorneys yesterday pressed their case on the inequity, noting that Stockton is planning to use public facility fees, which Franklin told the court could be used to pay back funds owed on Franklin’s bonds, on other projects instead, as well as to pay its bankruptcy lawyers, adding: “There is room for the city to pay Franklin a heck of a lot more than a penny on the dollar.”
The Capitol Connection? Halfway across the country, Detroit Emergency Manager Kevyn Orr testified before the newly created Detroit Recovery and Michigan’s Future Committee of the legislature in Lansing, urging swift action to approve a package of eleven bills that would provide a $195 million state contribution to the Motor City’s insolvent pension funds, urging the state elected leaders to recognize how critical the funds are to the city’s recovery: “Without this settlement, no mistake about it, we will have to go back to the drawing board.” Yesterday’s hearing, chaired by House Speaker Pro Tem John Walsh (R-Livonia), who is chairing the new committee and sponsor of one of the bills, was the first of three scheduled for this week on the Detroit legislation. The committee hopes to vote on the package early next week. Chairman Walsh advised his colleagues that Detroit was “kind of a pay now or pay later situation,” warning that that by doing nothing, they would push more pensioners onto social welfare programs that would ultimately cost the state: “Detroit is, for better or worse, an inseparable part of this state: It simply cannot be liquidated like a private business and sold away. The citizens will remain. The infrastructure will remain. And we must address it.” One member of the committee, Rep. Earl Poleski, stated: “I just want to understand what the plan is and understand the background of the city of Detroit…All of us want to ensure that Detroit emerges from bankruptcy sooner rather than later, but only in a responsible and reasonable way that protects both the city and the rest of the state.” Orr acknowledged that stakeholders have expressed concerns with various provisions in the package, and state Rep. Thomas Stallworth III (D-Detroit) said that details of the oversight commission and pension reform proposals could prove a sticking point. “I don’t know that there are too many strings attached, but let’s just say the magnitude of the strings is maybe a little bit hard to swallow. There’s a layer of bureaucracy that I think we have to be concerned about.”
Mr. Orr told the special committee members that without the state contribution, which is estimated to total $350 million over 20 years, Detroit’s proposed plan of adjustment—its key to exiting municipal bankruptcy, would likely fail. He testified the proposed portion of the “grand bargain,” which would raise about $820 million for the city’s pensions probably would fall apart—in effect leading to the collapse of the central element of the city’s plan of debt adjustment, and warning that the state could end up spending more over the long run if thousands of Detroit retirees were pushed under the poverty line, so that they would be forced to become dependent upon state assistance. In contrast, he testified, with approval, under the proposed plan, retiree health care costs would drop to $22.6 million in 2018 from $182.1 million annually—but warning that absent swift action, Detroit’s long-term debt is on track to consume as much as 73% of its general fund revenue by 2023. In contrast, he testified, if the proposed plan of adjustment were to be accepted by the federal court, that debt would drop to 11%. Without outside money, pensioners would face much more significant cuts. A general retirement pensioner would see her or his annual income drop from $24,434 to $17,300 under the restructuring plan, he testified. But without the state settlement, that number would drop to $13,000; because of those projections, Mr. Orr told the special committee that pensioners, who received ballots this week and have to turn them in by July 11th, would be unlikely to approve the Motor City’s plan of adjustment without assurances of the state contribution. He added that should the legislature not act, the world famous Detroit Institute of Art’s collection could be vulnerable to a potential fire sale—with the proceeds used to pay off all creditors, instead of focused on those retirees who might fall below federal poverty levels—and adding that the state would risk leaving itself open to future litigation over pension reductions—adding that he personally agrees with U.S. Bankruptcy Judge Steven Rhodes’ December ruling that federal bankruptcy law trumps Michigan’s state constitution—an issue currently on appeal to the 6th U.S. Circuit Court of Appeals.
His testimony yesterday marked the first of three days of hearings on the legislative package unveiled last week which outlined what the state would contribute and defined what Michigan’s role would be in both helping the city to exit bankruptcy and to establish some oversight over its future. The legislation, House Bills 5566-5575, as well as another yet-to-be-introduced bill, would provide for the funding portion through Michigan’s budget stabilization fund ($195 million), which would, in turn, be reimbursed by means of an annual $17.5 million appropriation from tobacco settlement funds. The oversight provisions in the package are modeled after similar oversight boards utilized in New York City and Washington, D.C., with Mr. Orr noting that the proposed provisions were both more and less “robust,” adding that Washington, D.C.’s CFO recently told him that having an independent CFO who does not report to the mayor is crucial for a fiscal recovery. (The Michigan proposed package does not include that provision.)
Among the key provisions in the package:
- The legislation would absolve the state of all legal liability in the bankruptcy case.
- The legislation would require formation of a 7-member oversight commission which would have broad authority to review and approve city contracts, collective bargaining agreements and budgets for at least two decades. The Governor, Treasurer, budget director, House Speaker, Senate and Mayor would appoint oversight commission members, but the Detroit City Council would not have any representation on the panel. The commission could go dormant during periods of prolonged financial health.
- The package would do away with traditional pensions for new city employees, moving them to a 401k-style system without retirement health care benefits. City pensions would be required to establish “investment committees” and restrict out-of-state travel.
- Detroit would be mandated to hire a chief financial officer and would lose an exemption to a law preventing public employers from paying more than 80 percent of medical benefits for their employees.
- Another bill would prohibit renewal of a 10-year operating millage for the DIA, which would transition to a private trust under the bankruptcy plan. The millage, approved by voters in late 2012, generates about $23 million a year from residents in Wayne, Oakland and Macomb counties.