This Class is Unimpaired by the Plan
@tednesi Ted Nesi The Dow is down 4% as I write this. But I’m sure the market will turn around once Central Falls releases its Ch9 plan at 3.
Central Falls, Rhode Island is a down on the heel community that has become the epicenter of the battle to preference municipal bondholders over retired municipal workers in bankruptcy proceedings. This is a tale of the state of Rhode Island turning federal bankruptcy law and pension law upside down.
When an entity becomes insolvent and seeks the protection of a bankruptcy court it throws itself within the processes and rules of the federal bankruptcy court. Cities are not liquidated in a Chapter 9 bankruptcy but outstanding claims against a community are reduced so that the community can pay them all. Traditionally in bankruptcy proceedings pensions are treated similarly to bondholders and other secured creditors.
In a new and surprising move the state of Rhode Island passed General Laws § 45-12-1 and enshrined in law that bonds are secured by a Rhode Island statutory lien on property taxes and general fund revenues. In essence the state created a post-facto super senior preference for bondholders. The state changed the rules after the game was underway.
The stated concern of state officials was that if Central Falls bondholders were “haircut” in bankruptcy court then bond market access for all cities in the state would close or be severely curtailed. In essence the state wanted to ring fence the assets of the bondholders assets against any harm that a bankruptcy proceeding would subject them to.
The state may feel that this is a clever way to protect their credit rating but they just created the mother of all municipal moral hazards. Bondholders now know that they can loan unlimited amounts of money to Rhode Island towns and cities and the state has guaranteed them 100% access to the tax revenues of a community. As a bond investor I’d go whole hog loaning money around Rhode Island because I would know that cities would cut all services and pensions to pay off my bonds. Winning by investing in Rhode Island!
This scenario has played out in the Chapter 9 bankruptcy plan and five year “recovery plan“. When I read through the documents I quickly realized that there was very little “recovery” for the town as funding for the library was eliminated, the community center would be sold off and trash collection outsourced. A dry husk of a community with the reduced level of services would remain. But bondholders will be repaid 100 cents on the dollar.
Those that suffer the most are the Central Falls municipal retirees will have their pensions reduced by up to 55%. These men and women who worked for decades believing in the promises made to them by Central Falls are just plain out of luck because bondholders must receive full repayment or as the Chapter 9 filing says: “This Class is Unimpaired by the Plan”.
Rhode Island officials probably believe they have figured out a clever template to reorder the municipal finances of their state. But longstanding conventions of treating creditors equitably arose for reasons of social fairness and stability. Bending convention to protect one class over another should be well considered. Beware unintended consequences of treating some brutally while preferencing others.