Detroit’s Third Day in Trial

September 5, 2014
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Day 3. Detroit called its first of twenty-five planned witnesses in the hearings on the city’s bankruptcy plan of adjustment yesterday, as part of its strategy in making a case that Detroit’s financial projections for city operations — a revenue and expense ledger for a post-bankruptcy Motor City — is based on sound financial considerations that stand the best chance of keeping the city solvent, even as neighboring jurisdictions and other creditors, including Macomb, Wayne, and Oakland counties and the United Auto Workers oppose the Motor City’s proposed plan, deeming it unfair, illegal, and infeasible, with the neighboring jurisdictions arguing Detroit’s plan of adjustment should be rejected by the federal bankruptcy court, because it would require the Detroit Water and Sewerage Department (DWSD) — which supplies water to metro Detroit jurisdictions — to pay $425 million over nine years to help fund Detroit’s pension liabilities. The counties have argued that the DWSD is already in financial trouble, and, therefore, should not be relied upon to help cover pension debt. Nor, they argue, should suburban water customers have to pay for Detroit’s pension troubles.

A View from the CFO. Detroit’s chief financial officer, John Hill, was the first of 25 witnesses Kevyn Orr’s team expects to put on the witness stand over the next few in its campaign to convince U.S. Bankruptcy Judge Steven Rhodes to approve its plan of adjustment. Mr. Hill testified, with regard to the plan’s proposed blueprint going forward: “We’ll do everything we can to adhere to it…We definitely believe the plan gives us a road map to how we should be operating.” Nevertheless, Mr. Hill warned that the city’s proposed $1.4 billion plan that proposes reinvesting in improving quality of life and city services cannot be accomplished if the federal court rejects the proposal, advising the court that much of the money for reinvestment — all but about $200 million — will be made available only if the city meets ambitious goals set out to cut costs and raise revenues for the city through actions such as improved revenue collections, adding that the city will be navigating a difficult path under both federal bankruptcy and state-imposed financial oversight that could last more than a decade. The newly enacted Financial Review Commission, which could last 13 years or more, would have ultimate say-so over spending and contracts city officials approve. (Mr. Hill is not exactly new to this challenge: he is a veteran of the Federal City Council, where he served as executive director of the federally appointed financial control board that took over budgeting and operations for the District of Columbia (D.C.)’s city government in 1995-2001 when it was confronted with a $700-million deficit.). He testified yesterday that Mr. Orr had asked him to serve to help Detroit reform its abysmal grants management practices that had cost the city millions of dollars in federal money, because Detroit was not meeting requirements, adding that he is also serving as a kind of bridge or transition between the outgoing Emergency Manager—who the Detroit City Council could ask to resign in October)—and Mayor Mike Duggan. He testified that while he technically now reports to Emergency Manager Orr, he has a strong working relationship with Mayor Duggan and would like to remain longer than his two-year contract in order to help implement reforms he has initiated. He told the court he reports regularly with Mayor Duggan, meeting with him at least three times a week to discuss restructuring plans—even, in one of the few humorous asides of the long day in court adding that Mayor Duggan appears to want him to stay in Detroit and regularly cajoles him, asking if he has bought a house in Detroit yet―to which, he testified, his response has been: “I’m a condo downtown person.” In response to the question whether Detroit had done enough to try to raise revenues, (the city’s biggest holdout creditor, Syncora Guaranty has argued that the city should try to raise taxes even though Michigan state law would have to be amended for that to even happen), Mr. Hill responded he was unaware of any new studies on the issue, especially because Detroit “already is at the maximum rates…It’s generally thought the tax rates are pretty high.” Mr. Hill devoted the bulk of his time yesterday in trying to convince Judge Rhodes that the city’s exit strategy is feasible and stands a strong chance of keeping the city solvent—but with a key warning: Detroit’s plan to invest in its ten-year plan for the future sustainability needs funding. In his hours on the witness stand, he especially focused on the key part of the plan: reinvestiing $1.4 billion over 10 years to improve city services and quality of life. He testified that Detroit’s assessments were in poor condition when he arrived: they were old and now the city is using a new method of measuring conditions of property to factor into assessments―street-level and helicopter-shot HD images, which, he told Judge Rhodes, will make for more accurate information and assessments, but also said he arrived to find no centralized control over the money and money that had not been spent, testifying that Detroit’s system is much more costly than other cities: it uses a lot of manual input by low-level city workers—and that Detroit was not closing books on a monthly basis, making getting out monthly and annual financial statements very difficult to put together and audit. Mr. Hill said that henceforth, all financial functions in Detroit would be consolidated under the CFO’s office. Mayor Duggan would like to appoint him to a 4-year term, but needs the state law to change to do that, he added, telling the court his restructuring plan proposes four initiatives: build revenue, cut costs, improve critical services, and improve quality of life.

Regional Complications. While much of the opposition to date has been focused by holdout creditors Syncora and FGIC, yesterday attorneys for Detroit’s neighboring jurisdictions, Wayne, Oakland, and Macomb Counties, trained their fire on Detroit’s proposed plan, focusing on the Motor City’s proposals for how to deal with the city’s water department after bankruptcy, criticizing Detroit’s proposed plan of adjustment for proposing insufficient investment to fix the aging system’s pipes and other infrastructure. Oakland County attorney Jaye Quadrozzi said that, based on the Detroit Water and Sewer District’s (DWSD) current plans, it would take 561 years to replace all the water and sewer lines—adding for the benefit of you readers and the courtroom that 561 years ago, the world was at the end of the Middle Ages and the fall of Constantinople. The neighboring counties have opposed Mr. Orr’s proposed plan to monetize the DWSD, claiming Detroit is seeking to force suburban ratepayers to pay for Detroit’s pension shortfalls for the department’s workforce—which Ms. Quadrozzi illustrated with a chart titled “POA: The Status Quo of Perpetual Decay,” telling the court that Detroit’s pension assumptions are low, at 6.75%, when, she said, in recent years many other plans made 9%-12%, warning that because the proposed interest rate is set so low, that is increasing the amount of unfunded liability of DWSD’s pension obligations—adding that case law would indicate that Detroit’s plan of adjustment must be proven to be able to fund city services at an adequate level, and the plan does not meet that test for the water department—rather, she testified, it substitutes hope for reality. Ms. Quadrozzi also told the court that a municipal bankruptcy trial is not the place to resolve DWSD—a charge which Judge Rhodes countered by responding the DWSD is a department of the city, and the federal bankruptcy court is the place to resolve problems: “That’s what we do here.” Similarly, Max Newman, an attorney for Wayne County, told the court that it was well-known that Detroit’s general pension system paid out excess benefits in so-called good years, undermining its long-term funding, asking how the DWSD could accept a plan in which $428M would be taken out of the system over the next 9 years—summing up by telling Judge Rhodes that the city’s proposed plan of adjustment is not fair, not equitable, not in the best interests of creditors, violates state law, and is not feasible for the DWSD, and should be rejected. Judge Steven Rhodes said he will reveal next Monday how much of a claim he will allow Macomb County to use in voting as a creditor in Detroit’s bankruptcy, relating to the suburban county’s ongoing legal fight to get repaid for what it says were gross overcharges for repairs after a major sewer line collapsed in Sterling Heights in 2004 (the collapse created a giant sinkhole). Contractors were accused of overcharging for work, charging for work not done. Macomb County is also alleging fraud over the repairs―a repair project that involved former and now convicted Detroit Mayor Kwame Kilpatrick.

Backdoor Negotiations. Even as Detroit enters Day 4 of its municipal bankruptcy confirmation trial, holdout creditor Syncora Guarantee and Emergency Manager Kevyn Orr’s office are continuing to negotiate a settlement—in this instance with Syncora seeking to have the bankrupt Motor City pay more than $200 million cash and cede valuable riverfront property, in addition to a share in the Detroit-Windsor Tunnel in return for the corporation’s support of Mr. Orr’s pending plan of adjustment. The Bermuda-based bond insurer is one of the city’s biggest holdouts impeding federal approval of its proposed debt adjustment and recovery plan. The closed-door negotiations with Syncora have intensified since last week—as the clock on the trial continues to tick—even as they continue under supervised mediation by Chief U.S. District Judge Gerald Rosen on the eve of Detroit’s bankruptcy trial. Mediation talks last week included the other most objecting holdout creditor, Financial Guaranty Insurance Co.; however, those negotiations broke down, and the bond insurer’s representatives walked out of talks, according to the Detroit News. Syncora and FGIC appear to be the single greatest obstacles to resolving the city’s pending case before Judge Rhodes, with the firms bitterly opposing the Motor City’s proposed plan which would offer them as little as 6 cents on the dollar for the $1.4 billion in troubled pension debt they insured to help former, convicted Mayor Kwame Kilpatrick prop up the city’s pension funds nearly a decade ago.

A Taxpayer’s Perspective: U.S. Bankruptcy Judge Thomas Bennett, who presided over the municipal bankruptcy case of Jefferson County, Alabama, the largest in U.S. history prior to Detroit’s, commented at the forum “Bankruptcy & Beyond” at the Widener Law School in Harrisburg, Pa., that the federal municipal bankruptcy law, chapter 9, excludes an insolvent jurisdiction’s taxpayers from having any right or role in the adjustment process. Moreover, the law confronts Judge Rhodes in Detroit’s pending case with either approving or rejecting Detroit’s plan of adjustment: the judge cannot order changes or amendments: therefore the following editorial from The Detroit Free Press bears one’s close attention:
Add Judge Steven Rhodes to the list of Detroit-watchers who have serious doubts about the city’s ability to perfect the necessary financial, structural and organizational change to thrive after bankruptcy.
Except, Rhodes’ opinion really matters. If he doesn’t believe the city can better manage its money, upgrade its pencil-and-paper technology, and deliver services more effectively after bankruptcy — well, he doesn’t have to let the city out of bankruptcy court.

There’s good reason for Rhodes’ concerns, and the stretch back decades.

Every mayor since Albert Cobo in the 1950s had a plan to fix the city, and they’ve all said the same thing: Shrink the work force, expand the tax base, streamline city operations, bring revenue in line with expenses. Thanks to the bankruptcy court, Detroit is poised to shed billions in debt. More than a decade of cuts has shrunk the work force. Whether the city can become more functional, whether a new and improved Detroit will attract new residents and businesses — that’s largely up to Mayor Mike Duggan and the Detroit City Council.
A report by Martha Kopacz, an expert hired by Rhodes to evaluate the city’s plan, casts real doubts on the likelihood that Duggan and the council — whom she credits with unprecedented cooperation and focus — can deliver. Kopacz, who conducted hours of interviews and reviewed numerous reports, found that the city’s computer systems were so out-of-date, they imperil the city’s financial recovery and future health.
Without significant upgrades, she wrote, the city’s ability to meet the commitments in its plan of bankruptcy adjustment is “threatened.”
Kopacz made similar conclusions about the city’s work force: While there are many capable, smart, enthusiastic city workers, some employees don’t understand their jobs or the concept of municipal service, she wrote.
That’s got to change. City workers have endured cuts to pay and benefits, difficult working conditions caused by lack of resources, insufficient supplies, and a constant struggle to do more with less. We get it. But in post-bankrupt Detroit, it’s not good enough to punch a clock.

No less important is Kopacz’s message to Detroit’s elected officials. Without the leadership of Duggan and the administration’s current, productive relationship with the council, implementation of the city’s post-bankruptcy plan wouldn’t be possible, she said.

That’s a narrow bridge on which to balance a heavy load. We hope Duggan and the council are paying attention.
This spirit of cooperation between mayor and council — for which Duggan and Council President Brenda Jones deserve much praise — is relatively remarkable in recent Detroit history. Should it prove tenuous, Detroit will be in dire straits: Rhodes has made no bones about the fact that for Detroit’s post-bankruptcy plan to work, elected officials must be committed.

In addition, Kopacz’s report should be getting attention in Lansing, where the steady erosion of state financial support for cities (abrogated slightly by this year’s increase in revenue sharing) helped push Detroit into insolvency. Yes, Lansing came through with important funding as part of the grand bargain to protect city pensioners and the Detroit Institute of Arts, but the commitment to urban areas has to extend much farther into the future.

Lawyers for the city argued in bankruptcy court Wednesday that this set of city leaders gets it. “Detroit has earned this court’s help,” Jones Day attorney Bruce Bennett told Rhodes.

The twin prospects of emergency management and municipal bankruptcy have been looming over this city for a decade. For many, either represented a doomsday scenario, the worst possible outcome for a struggling city.
That’s wrong. Detroit’s worst outcome has always been this: Emergency management and bankruptcy, followed by … nothing. No change in services. No growth. No revival. To endure bankruptcy and emerge stronger is worthwhile. To squander the benefits of the painful process of bankruptcy with continued bungling or missteps would be something else entirely.

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