When Detroit goes to bankruptcy court

June 21, 2013

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Detroit Emergency Manager Kevyn Orr predicts that the chances of Detroit entering bankruptcy are about 50/50. But if we consider what the major participants, bondholders, public employees and retirees are likely to do, it’s almost 100 percent certain that Mr. Orr will be entering the federal bankruptcy court house on West Fort Street in Detroit.

The bankruptcy case of Stockton, California provides an indication of how willing bond insurers will be to make upfront concessions. In Stockton, they were totally unwilling to give up anything. From the written ruling of the bankruptcy judge in Stockton, Christopher Klein: (page 17)

Bond insurers are the legal grinding stone of the municipal bond market. They don’t give anything away if litigating would gain them some advantage. They have stables of high-powered attorneys to fight their battles.

Orr has a meeting scheduled today with public employee and retiree representatives. Public employees have already taken pay and headcount cuts under Detroit Mayor Dave Bing. It’s unclear how much more wage cutting they can take. Orr seems to have his sights set on retiree pensions and health care benefits. It’s unclear if Orr could adjust or end these benefits outside of bankruptcy. The relevant part of the Michigan Constitution appears to block Orr from making adjustments:

The accrued financial benefits of each pension plan and retirement system of the state and its political subdivisions shall be a contractual obligation thereof and shall not be diminished or impaired thereby. – Section 24, Article IX

This is the state constitution, so legislation cannot override it. It’s more likely it will be the bankruptcy court where these changes will be sought. In the Stockton case, Judge Klein gave his blessing to Stockton to eliminate free retiree healthcare. In the Central Falls, Rhode Island bankruptcy case, retirees had their pensions cut by 50 percent, while bondholders will receive 100 percent repayment.

There are many unknowns about Detroit, but it has always been doubtful that Orr would be able to reach a voluntary agreement with all the parties. The announcement that he has ordered a probe of the city’s pension funds “amid concerns about corruption, spending and management” makes it unlikely that pension fund trustees will be snuggling up to Orr to discuss shared sacrifice.

When Detroit’s government enters 211 West Fort Street, the bankruptcy law will give a lot of power to Orr, who will guide the proceedings. Everyone must be treated equitably.

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