July 28, 2014
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Is Detroit’s Bankruptcy Contagious? Moody’s, the credit rating service, on Friday wrote that Detroit’s municipal bankruptcy—if approved by the federal bankruptcy court, “could serve as an example other distressed local governments in Michigan might follow,” with the agency’s Vice President, Genevieve Nolan, stating: “The final outcome of this bankruptcy will likely have broader implications for future bankruptcy cases involving distressed local governments in Michigan, potentially setting an important benchmark for the relative position of debt versus pensions.” Moody’s, noting that Michigan has a relatively high number of municipalities in distress compared to other states, and that the resolutions achieved so far in Detroit’s case have created the appearance that retirees have emerged in better shape than the city’s municipal bondholders, reported that: “The settlements reached in this case may guide future negotiations between Michigan local governments and their creditors and pensioners.” Moody’s added that the Motor City, in its confirmation trial set to begin on August 14th, “is now likely to ask the [federal bankruptcy] court to ‘cram down’ the city’s proposed plan of adjustment on creditor classes that rejected the plan. Because not all classes approved the plan, the court will have to conduct additional analysis on the question of whether the plan discriminates against some creditor classes.” The Motor City’s plan proposes different levels of recovery for different classes of its creditors, and, of course, includes a unique “grand bargain’ proposal for its retirees—so that, while some retirees would realize relatively small reductions, and holders of Detroit’s general obligation unlimited tax bonds would realize a 74 percent recovery; the city’s plan proposes far steeper cuts to holders of the city’s certificates of participation and general obligation limited tax bonds: the city proposes recoveries for these creditors varying from zero to 13 percent. No city has filed for federal bankruptcy protection since Detroit filed last year; Moody’s does not take into account that no municipal elected official wants to admit failure and to affirmatively file for federal bankruptcy.
Motor City Monitor. In submitting his fifth, updated plan of adjustment to U.S. Bankruptcy Judge Steven Rhodes on Friday, Detroit Emergency Manager Kevyn Orr proposed that the federal court appoint a long-term finance professional with broad authority, including subpoena power, to monitor whether the post-bankruptcy Motor City abided by the terms of its federally-approved plan of adjustment. Under Mr. Orr’s proposal, such an independent oversight monitor—who would be parallel to the state monitor, would hold that position until the federal bankruptcy court officially terminated Detroit’s municipal bankruptcy. Under Mr. Orr’s proposal, the independent monitor would:
- provide quarterly reports to the federal court with regard to how the post-bankruptcy Motor City Detroit disbursed funds to creditors,
- complied with the approved plan of adjustment agreements on debt reduction, city pension funds, and retiree health care obligations, and
- whether Mayor Duggan and the Council were meeting the terms of the $816-million grand bargain to modify pension cuts and spin off ownership of the Detroit Institute of Arts.
The revision in the updated draft appears to reflect an effort to respond to Judge Rhodes questions to the city’s attorneys with regard to how he could best exercise oversight with regard to how a post-bankruptcy Detroit is compliant with its own, judicially approved plan of adjustment. In its modification, Mr. Orr’s revision recommends that such a monitor be:
- a neutral party, “independent of the city and the state and free of all conflicts;”
- not an elected or appointed official in Michigan, and
- an individual with an accounting or finance background and experience in municipal finance, with preference given to such persons with experience overseeing municipal governments or agencies annual revenues of at least $250 million in addition to experience with complex financial and operational restructuring.
How many Overseers & at What Cost? Mr. Orr, whose appointment expires at the end of September, releasing him to return home to the Washington area to re-acquaint himself with his spouse and children, theoretically would mean the full restoration of the authority of Mayor Mike Duggan and the City Council to oversee and operate the Motor City—albeit under the purview of a new state oversight commission and now, potentially under separate, independent federal court oversight. Mr. Orr’s spokesperson described it this way: “It’s not about governance or oversight of elected officials, but it’s about how can the [federal bankruptcy] court be reassured that the details and the fine points of the plan will be implemented to the satisfaction of the court.” The issue in this complex recovery involves the federal government, the State of Michigan, and Detroit—with both the State and the federal bankruptcy court—having invested extraordinary resources into ensuring the Motor City’s recovery and long-term sustainability—seeking to find a way to ensure the plan is on track in its implementation.
Debt, or Copping a Plea. The incomparable Jim Spiotto, the nation’s godfather of municipal bankruptcy, poses a fundamental question with regard to Detroit’s municipal bankruptcy: The question is whether the repudiation of $1.4 billion is going to help Detroit regain financial credibility or will it sour the municipal markets against Detroit and possibly government debt in general. http://www.muninetguide.com/articles/detroits-bankruptcy-repudiation-of-cops-defies-history-703 . Writing that in the Motor City’s municipal bankruptcy that a key, unresolved issue is whether the $1.4 billion in certificates of participation (COPs) issued by the City of Detroit can be repudiated by Detroit in its Chapter 9 bankruptcy: “There is no dispute that, when issued, the COPs were represented in the market to be valid, binding and enforceable obligations of the City of Detroit. No one from the City or the State of Michigan at the time of issuance or prior to the Chapter 9 filing instituted any legal proceeding to void that debt or to request that the $1.4 billion received by Detroit be returned to investors in order to void the debt obligations.” But, Mr. Spiotto asks, would the repudiation of that debt help the Motor City to return to solvency and sustainability, or, instead, might it risk not only the Motor City’s future access to the credit markets critical to its future, but also adversely affect access by all cities, counties, and states to the nation’s credit markets.
To oversimplify the City of Detroit’s position, it seeks to repudiate the debt because it claims Detroit had “a bad mayor and a bad administration” at the time of issuance and therefore should not be responsible for that debt. As we all know, if a corporation or an individual issues debt in the public market claiming that the debt is a valid, binding and enforceable obligation and then later, when it is inconvenient or difficult to pay, claims it was never authorized to incur the debt, there would be serious consequences. That corporation or individual would be open to a flood of litigation, if not criminal investigation, claiming fraud on the investors.
In a remarkable paragraph, he adds:
Our Founding Fathers, led by Hamilton and Washington, knew that financial credibility was one of the building blocks of a strong nation. Part of the exceptional success of our state and local governments has been their ability to borrow money in the municipal market at a low cost so they can decide, as a state or a city, what the improvements or essential services should be for their constituents. These decisions and the implementation and funding of the decisions can all be done by local action without the need of approval, review and acceptance by some higher government. That ability to make decisions and fund them locally is one of the unique attributes of our government and one that has, in the past, allowed us to create the world’s best infrastructure and the world’s largest economy.
Indeed, he notes that state and local repudiation of debt is not new, but dates back more than two centuries, noting: “By the 1840’s, eight states and one territory defaulted. Those that defaulted then experienced either an inability to borrow additional funds or, if they could obtain financing for needed governmental improvements and services, the imposition of a 32%+ yield. By the late 1840’s, seven of the eight states had renounced their repudiation and resumed payment on the debt in order to obtain market access at a lower cost.”
Consequently, he presciently warns, with regard to the proposed debt repudiation: “[T]he inevitable consequences to Detroit and to the municipal market upon which all states and municipalities rely for funding their long-term capital improvements and sometimes their essential services, cannot be tolerated. If past history is a judge, the difference in the market between, the better credits and the weaker credits may range from 150-200 basis points or more. Given Detroit’s need to reinvest in the city and borrow significant sums to do so in the future, Detroit could possibly pay at least 200 basis points or 2% more a year for future borrowings. Over the normal life of a bond (30-year period), this is 60% more of the principal borrowed that does not go to pay for infrastructure or essential services, public workers’ salaries or pensions, other creditors or tax relief to the taxpayers. While the legal and political correctness of past administrations can be argued, there should be no doubt that good funds were provided by investors, that benefits were received by the City through its use of those good funds to pay down pension obligations and a public benefit was achieved. It strains the notion of fairness and justice if a benefit can be retained but the consideration for it can be repudiated. Repudiation of the COPs may have little public benefit and long-term public pain. Washington and Hamilton warned, and as history has demonstrated, “no pecuniary consideration is more urgent than the regular redemption and discharge of public debt.” The best test of a fair and just result is whether the outcome can be explained to a young child. It is doubtful a third grader would expect that a party could retain the benefits of a transaction without paying the agreed-upon consideration.”
Bridge over Troubled Waters. The Detroit City Council is considering the transfer of 301 city-owned properties to the Michigan Land Bank in exchange for $1.4 million from the Canadian government as part of plans for a proposed $2 billion international commuter bridge, with a special Council session set for this morning. The new bridge, the New International Trade Crossing, is to span the Detroit River between Detroit and Windsor, Ontario, with the bridge’s Detroit footprint on the Motor City’s southwest side. Canada is paying most of the $2 billion project’s cost on both sides of the border and hopes to recoup the money through the imposition of tolls—with a projected opening in 2020.