The Perils of Municipal Bankruptcy Recovery

November 12, 2014

Visit the project blog: The Municipal Sustainability Project 

The Burden of Recovery. As we noted yesterday, notwithstanding U.S. Bankruptcy Judge Steven Rhodes’ sign-off of Detroit’s plan of adjustment, the road to recovery will be both precipitous and strewn with perils for the unwary. Two key challenges will be how to pay the accrued bills the city owes to its legions of lawyers and consultants the city’s former, state-appointed emergency manager hired to help put together the eight versions of the Motor City’s bankruptcy exodus plan—a cost which may be as steep as $200 million, and how to meet the inverted pyramid costs of its public pension obligations at a time when the ratio of retirees to contributing employees is teetering in the wrong direction. In the case of the burgeoning fees, one of the Motor City’s city attorneys had requested that Judge Rhodes provide the city with more time to review fees charged by the bankruptcy law firm, Jones Day, and other firms providing financial and restructuring advice to the city—a request that did not receive a positive response from the court—but one which reflected apprehensions on the part of Mayor Mike Duggan that those fees could be as steep as $200 million―a level the Mayor is apprehensive could be large enough to jeopardize the city’s ability to meet the very terms of the recovery plan approved by Judge Rhodes last week—and an amount nearly twice as much as had been anticipated. The issue will remain a cloud on the horizon, as Judge Rhodes has ordered confidential mediation over the fees paid to the professional firms contracted for Detroit’s bankruptcy, with negotiations scheduled to begin in early December. Detroit Corporation Counsel Melvin Hollowell yesterday stated: “The mayor made it crystal clear that he was extremely concerned about the millions in cost overruns of the bankruptcy consultants…Every dollar spent on consultants is a dollar that could be spent to hire a police officer. We will work with the court to handle this through mediation in a timely manner.” Indeed, with concerns about the spiraling fees for outside hired guns an issue from the initial decision by the Governor to appoint Kevyn Orr as emergency manager in March 2013 and the state’s unfunded mandate to the city to hire consultants to analyze the Motor City’s finances and operations and, ultimately, to shepherd the city through a 16-month bankruptcy trial, concerns have mounted over how a bankrupt municipality could afford those rising bills even as it was struggling to cut retiree pensions and health care benefits for its own employees and retirees. Robert Fishman, whom the U.S. Bankruptcy Court hired to serve as the court-appointed fee moderator, has not set a date when his final tally for bankruptcy expenses will be completed.

& an Inverted Pyramid. Moreover, even as Mayor Duggan and the Detroit City Council contemplate options for paying the city’s accumulated legal bills, they also confront an unvenly balanced teeter totter: in a retirement system—which like in most other cities, counties, and states across the country is indelicately balanced on a fulcrum with one end a growing number of retirees with the temerity to live longer than had been projected, but, on the other, a smaller number of contributing participants. In the case of the Motor City, notwithstanding the reduced payments to which retirees agreed to as part of the city’s approved plan of debt adjustment, Mayor Duggan and the Council confront an annual tab of over $500 million annually for Detroit’s 32,000 current and future retirees—or, as the ever insightful Mary Walsh Williams of the New York Times notes: “more than twice the city’s annual municipal income-tax receipts in recent years.” Or, as Judge Rhodes in his approval of the Motor City’s plan to exit municipal bankruptcy last Friday afternoon warned, his greatest apprehension for the city “arises from the risks that the city retains relating to pension funding.” Ms. Walsh notes that contributions to the system will “not be nearly enough to cover these payouts, so success depends on strong, consistent investment returns, averaging at least 6.75 percent a year for the next 10 years”―with any shortfalls an issue Mayor Duggan and the Council will have to confront. One can appreciate from Detroit’s own writing on the proverbial wall just how steep a challenge its elected leaders confront:  its general pension fund is scheduled to decline from its current 74% funded level to 65% thirty years—its police and firefighters’ pension obligations are projected to grow over the same period—before, under the city’s approved plan by the court, achieving full funding by 2053—some thirty years after the State of Michigan is scheduled to terminate its contributions, and a score of years after the contributions from the city’s “grand bargain” have finished. (The state’s contribution to the grand bargain is scheduled to continue through 202s, with the foundations and the art museum continuing to contribute until 2033.) Current Motor City employees have already shifted to a hybrid pension plan: they will begin to bear most of the new plan’s investment risk; however, Mayor Duggan and the city council have inherited the responsibility to provide for decades of payments for retirees under the old plan—or, what Judge Rhodes’ independent hired fiscal expert warned could be the “potential to be saddled with an underfunded pension plan…The city must be continually mindful that a root cause of the financial troubles it now experiences is the failure to properly address future pension obligations.” she said in her report. In approving Detroit’s exit plan, Judge Rhodes, last Friday, warned the state that it will have to serve in an unwanted role as a watchdog over Detroit’s handling of its public pension obligations: “History will judge the correctness of this finding.” But the federal judge—who had early on opined that federal municipal bankruptcy law trumped Michigan’s state constitutional protections of pensions, last Friday warned Michigan’s state elected leaders that the state must “assure that the municipalities in this state adequately fund their pension obligation. If the state fails, history will judge that this court’s approval of that settlement was a massive mistake.”

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