Detroit’s fiscal situation gets hotter

June 11, 2012

Detroit is standing on the precipice of fiscal collapse. The Detroit Free Press reported on Friday:

The city of Detroit will run out of cash a week from today if a lawsuit challenging the validity of a consent agreement is not withdrawn, city officials said this morning.

Jack Martin, the city’s new chief financial officer, said the city will be broke by June 15, but it should be able to make payroll for its employees. He said the city will be operating in a deficit situation if the state withholds payments on a portion of the $80 million in bond money needed to help keep the city afloat.

The battle ultimately could lead to an emergency manager if state officials deem the city to be in violation of the consent agreement that gives the state significant control over Detroit’s finances.

There are a number of forces at play here. The state of Michigan signed a consent agreement with the Detroit City Council last month to share oversight of the broke city’s finances. That agreement was a factor in spurring Bank of America/Merrill Lynch to provide a short-term, $80 million bridge loan to the city. The state agreed to divert state aid payments to Merrill Lynch’s bank trustee if the city was unable to make the payments.

Now there is an attempt to scuttle the consent agreement between the state and Detroit City Council by Krystal Crittendon, the top attorney working for the city. She filed a court complaint against the state of Michigan, its Department of Treasury, and State Treasurer Andy Dillon, claiming that the state was in default on funds owed the city and therefore could not enter into such an agreement. From the Detroit Free Press again:

Crittendon filed a lawsuit last week saying that the consent agreement was “void and unenforceable” because Michigan owes the city $224 million in revenue sharing plus more than $1 million in unpaid water bills, parking tickets and other debts. Under the city charter, Detroit can’t enter into contracts with entities in default to the city, so Crittendon challenged the consent agreement under her authority to investigate violations of the charter.

[Mayor David] Bing said that under the charter, Crittendon has the autonomy to make such legal challenges, and as mayor he lacks any political power to curb her actions. He said the lawsuit has created an even worse financial situation than the city was already in.

Dillion’s deputy returned fire on Crittendon, and the Detroit City Council said the state would withhold payments to the city and place them in escrow for Merrill Lynch. It now looks like the city will have no money by June 15.

It’s a sad state of affairs for Detroit. The city is almost out of funds; its general obligation debt is rated junk, making any further borrowing difficult; various political factions in the city and state are fighting each other; the governor and state treasurer are trying to keep Detroit on as short a leash as possible; and, as I wrote previously, many of the termination triggers on the city’s interest-rate swaps are going off, requiring even more upfront cash or debt to cover these payments.

In a small footnote to an article Friday Bloomberg noted (emphasis mine):

Detroit plans to sell $575 million of debt secured by sewer revenue as soon as next week, data compiled by Bloomberg show. Proceeds will help finance upgrades to the city’s wastewater treatment system, refinance debt and end swap agreements, according to offering documents. The swap termination fees total about $288 million, according to Fitch Ratings.

The sewer system is still able to sell revenue bonds that are rated A- by Fitch Ratings. But the sewer system cannot issue debt to cover cash shortfalls for the general budget.

Detroit bonds have largely not sold off, with the City of Detroit, Michigan Distributable State Aid General Obligation (Limited Tax) Bonds, Series 2010 (maturing 2030) trading Thursday with yields between 3.7 percent and 4.1 percent for small-size retail trades. These bonds are rated AA because they are backed by state aid. The yields are trading significantly over the Thomson Reuters AA 2030 benchmark of 3 percent. The market perceives a lot of risk in Detroit’s debt, as well it should.

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