Detroit: One Year into Municipal Bankruptcy

             July 18, 2014

Visit the project blog: The Municipal Sustainability Project 

Happy Anniversary. Exactly one year ago—this afternoon, the City of Detroit filed for federal bankruptcy protection. Today, it is 27 days away from the commencement of its confirmation trial to exit municipal bankruptcy. The path to reversing more than a quarter century of decline has been marked by a truly remarkable coalition of not just an electronic federal bankruptcy judge, Steven Rhodes, and his U.S. District Court cohort, Gerald Rosen, the crazy Washington, D.C. suburbanite, emergency manager Kevyn Orr, whose spouse told him God only offers us one chance in a lifetime to truly make a difference; but also a broad coalition of leaders in business and philanthropy, city and suburban elected leaders, Governor Rick Snyder, the Michigan Municipal League, and bipartisan leaders of the state legislature—and outsiders like Richard Ravitch, who volunteered his experience, time, and commitment for free. To have been able to meet some of these characters and be able to observe this process—in such vivid contrast with the federal government’s exceptional dysfunction—in ways that seem to be unique in American history, has been transfixing. When the magnificent Jim Spiotto and I sat in the U.S. Senate Judiciary room as Chairman Howell Heflin (D-Ala.) and Ranking Member Strom Thurmond (R-S.C.) reported PL 100-597 on that summer day in 1988, we never, ever anticipated how it would someday be critical to ensuring essential public services to this revered American city. This is not to write that there is not a long way to go, nor that there can be certainty that the city’s plan of adjustment, if confirmed in the pending trial, will enable the citizens of Detroit to have a sustainable fiscal future with service solvency, but rather to celebrate that, as Daniel Howe of the Detroit News yesterday opined, “both sides of the political aisle, are pulling together (and in the same direction) in ways few have ever seen here.

Moody Motown Blues. Moody’s has issued a new report that determines under the Motor City’s current Plan of Adjustment, recovery rates favor the city’s retirees over its municipal bondholders, with the credit rating agency estimating the recovery on the unfunded portion of the city’s pension liabilities could reach 52%, which would likely exceed the recoveries on other unsecured claims. The report notes that recoveries for pensioners are assisted from a number of sources, including dedicated outside funding and some contingent restoration of benefits—especially from the so-called Grand Bargain of more than $816 million from the state and donations to the Detroit Institute of Arts over 20 years, which could provide nearly triple the recovery rate for the city’s bondholders.  Moody’s notes that these funds would be “in return for shielding the city’s art collection from creditors’ claims and for pensioners accepting the plan,” but writes that recoveries on unfunded pension liabilities absent such an unprecedented arrangement, adding that without the grand bargain, pension recoveries could be as low as 18%. In contrast, the recoveries on certificates of participation issued to fund pensions could be nil if U.S. Bankruptcy Judge Steven Rhodes determines the Motor City can repudiate them―a stark contrast to what the credit rating agency writes with regard to pension recoveries as measured by aggregate liabilities (described as that is both funded and unfunded pension claims), where the recovery could be as much as reach 82%, higher than 74% settlement announced for general obligation unlimited tax (GOULT) bonds.

Not the Odor of Verbena.  Judge Rhodes yesterday indicated he will determine on Monday how much of a claim he will permit Detroit’s neighbor, Macomb County, to use in voting as a creditor in Detroit’s bankruptcy. The county’s creditor status relates to Macomb County’s legal contention with Detroit with regard to what the county claims were gross overcharges for repairs after a major sewer line collapsed in Sterling Heights in 2004, creating a giant sinkhole—so giant that seven years later, Macomb County Public Works Commissioner Anthony Marrocco sued former—and now imprisoned―Mayor Kwame Kilpatrick, members of his administration, contractor Bobby Ferguson, and others over the 2004-05 repair project that Commissioner Marrocco claims cost $26 million more than it should have because of fraudulent overbilling. In the wake of the subsequent federal corruption convictions against Messieurs Kilpatrick, Ferguson, and former Detroit Water and Sewerage Department Director Victor Mercado; the suit was subsequently amended to include the City of Detroit. The issue is significant in not only dollar terms―the County is seeking $26 million; the Motor City is offering $1―but also in terms of what Judge Rhodes’ decision could mean for the creditors’ votes: A claim of $26 million would mean Macomb County’s vote would carry much greater weight: the County’s claim is in class 14, a group of unsecured creditors with total claims of about $150 million; and the County has opposed Mr. Orr’s proposed the plan of adjustment based on its apprehensions that the plan shifts responsibilities for water department pensions onto suburban customers. In testimony before Judge Rhodes yesterday, Commissioner Marrocco’s attorney testified: “They breached a contract and they acted in bad faith…The wrongdoers are gone, but their actions cost other people significant amounts of money that need to be recouped and compensated.” The attorney testified that it was clear by the time of the sale that federal investigators were questioning Detroit Water and Sewer Department employees about the drain repair project, but failed to notify Macomb County of potential liabilities. Judge Rhodes responded he will release his estimate on how much the claim will have for voting purposes: if he rules the claim is valid, Macomb County would be subject to the same treatment of other creditors in its class, receiving a pro-rated share of the city’s final approved offer that could be as low as 10 cents on the dollar.

Four Lemons in Atlantic City. While casino revenues have played an important role in Detroit’s bankruptcy, they play a critical role in the New Jersey seacoast city: they constitute 70% of Atlantic City’s property tax base, and are critical to jobs. Atlantic City had a 14.9% unemployment rate in May, one of the highest in the United States; now the closure of four of its twelve casinos will have a significant impact not just on the workforce, but almost certainly on assessed real estate values. Thanks to Atlantic City’s draw, demand for housing skyrocketed throughout the Shore among casino employees and their families, but now the bad spin of the dial means the fiscal pain will radiate well beyond the city’s limits: Jersey Shore towns are now having to support Atlantic City as tax revenue from the casinos dwindles, a trend that began seven years ago, but is now accelerating. Of 23 Atlantic County municipalities, 22 had tax increases from 2012 to 2013, mainly because Atlantic City contributed less revenue to the county budget, according to data from the Atlantic County Board of Taxation last week, with the biggest drop coming from Atlantic City the largest: 17.5 percent. Keith Szendrey, of the county’s taxation board, last March noted that “Everything in Atlantic City lost value, partly because the casinos lost value, and with the jobs they’ve pared, there is less demand for housing and commercial properties in Atlantic City.” The new round of closure mean, according to the Associated Press, that 7,000 casino workers have been told their jobs could disappear within 60 days: more than 1,000 employees who will lose their jobs at Trump Plaza, 1,600 were laid off from the Atlantic Club, 2,100 will be let go when the Showboat shuts down at the end of August, and 3,100 will be on the street if the Revel closes—a grand total of approximately 7,800 workers. As recently as three years ago, the casinos employed a total of 33,000—in a city with a population of less than 40,000. Although not all of the casino workers live within the city limits, one can appreciate the devastating human and fiscal impact on the city and its surrounding municipalities.  For the near future, Atlantic City leaders have reached settlement agreements on tax appeals with the owners of three of the four closing casinos for them to make payments this year and next, but over the long term, Moody’s has already reflected that the closures will erode the city’s primary source of revenue, as well as its long-term sustainability. With a median family income just above 50% of the United States average, the upsurge in unemployment and foregone benefits will impose significant new costs on the county, while further eroding tax revenues. Moody’s rates Atlantic City’s general obligation bonds Baa2 with a negative outlook. Standard & Poor’s rates them A-minus with a stable outlook. The state, through its Local Government Services office, has awarded $13 million in transitional aid to the city—assistance in addition to an already awarded grant of a $7 million essential services grant. But the sharp disruption mean the city is still working on its fiscal year 2014 budget, even though the city’s fiscal year began Jan. 1—a budget which is expected to include large tax increase, with the size dependent upon what the state determines to provide with state aid—a decision expected to be finalized next month.  

Ola Plebiscite. Puerto Rico Gov. Alejandro García Padilla announced the commonwealth will prepare a plebiscite on its status by 2016 to decide the future of the island’s political status, with the Governor reporting his Popular Democratic Party is working on a definition for the enhanced commonwealth status it supports. Governor Padilla has previously said he would support a constitutional assembly to decide the U.S. territory’s status—any decision on which would be subject to Congressional approval. The Obama Administration has pledged $2.5 million to finance a plebiscite, the ballot for which would have to be approved by the U.S. Attorney General Eric Holder before going to voters. The Commonwealth last Puerto Rico held a nonbinding, two-part referendum in November 2012 whose results have been disputed. Nonbinding referendums also were held in 1967, 1993 and 1998. Seeking statehood has never garnered a clear majority. Such a ballot could offer Puerto Rican voters options of statehood, remaining a commonwealth, or becoming an independent nation. Were voters to opt for statehood, it would lose its current ability to sell municipal bonds that are exempt from state income taxes in every state. If Puerto Rico bonds lost their tax-exemption, this would reduce the number of people interested in buying the bonds and force Puerto Rico to offer higher interest rates. At a press conference Wednesday, Gov. Padilla said he supported unspecified changes in the Commonwealth’s current status so that Puerto Rico would have an improved commonwealth status, stating such a plebiscite would occur before his current term ends at the start of 2017.


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