Note to the Bloomberg Editorial Board

July 3, 2013

This note applies to all editorial boards that want to write on the insolvency and likely bankruptcy filing of Detroit

In a blistering but lightly researched op-ed, the Bloomberg Editorial Board dove into the battle between Detroit’s creditors.

Detroit is a poverty-stricken, run-down city that has hocked most of its assets, slashed its employee payroll, taken on debt at an astonishing rate and been crippled by a group of banks that sold unsophisticated and possibly corrupt interest rate swaps to public officials.

Although the state-appointed emergency manager, Kevyn Orr, professes to be attempting to develop a “voluntary” restructuring, it’s clear that the city now crawls toward federal bankruptcy court. And what are the city’s liabilities? Here is where the Bloomberg Editorial Board goes way off track:

The budget deficit is nearly $380 million, while long-term liabilities may total more than $17 billion.

Where did Bloomberg get that $17 billion in liabilities number? It happens that the only place that number has ever appeared is in the Emergency Manager’s Proposal for Creditors. It’s possible this number was inflated to create a public narrative that could be shaped by Orr. The number was questioned by Blackrock’s Peter Hayes and James Schwartz:

There is question as to whether the EM’s plan is inflating pension and OPEB liabilities. The unfunded pension liability was adjusted from $650 million reported in 2011 to approximately $3.5 billion—increasing more than five times over two years through unspecified changes to accounting assumptions. This $3.5 billion now represents nearly one-third of the amount Detroit owes to its unsecured creditors, and raises required pension contributions to approximately 100 percent of the city’s $1 billion forecasted budget deficit over the next five years. OPEBs, which were never funded in the past, now have the largest claim at an estimated $5.7 billion.

Somehow, without verification, huge liabilities appear on the city’s balance sheet.

The Proposal for Creditors details the debt liabilities of the city (page 20):

The City has liabilities of approximately $9.4 billion in special revenue bonds, state revolving loans, pension certificates of participation (i.e., POCs), mark-to-market swap liabilities, unlimited and limited tax general obligation bonds and various other funded City debts.

The debt figures represent true valued legal contracts. No one questions the dollar value of the liability. But Bloomberg jumps off from the debt and retiree benefit numbers and says:

Orr is now negotiating a reorganization plan with unions, creditors and bond insurers. If those talks fail, Detroit could become the largest city in U.S. history to file for Chapter 9 bankruptcy protection. The unions should strive to make a deal before that happens, even if it means forcing retirees to take substantial pension and benefit cuts. State taxpayers should recognize that it’s in their best interests to help those retirees out. And Orr must avoid unduly violating bondholders’ trust. The consequences of failure could reach well beyond Detroit.


It sounds deeply unfair to privilege investors over retirees. But because retirees were promised the most — Orr estimates the city has some $3.5 billion in unfunded pension liabilities alone — they will have to give up the most. It’s not an issue of fairness so much as arithmetic.

Before “fairness” is defined, the arithmetic should be right. Orr has proposed to treat retiree benefits and unsecured bondholders as equal. But unions and public pension trustees won’t easily accept major haircuts based on an inflated number. $5 million has already been set aside to cover expected legal costs in the fight.

Detroit pensions are not, on the surface, excessive, outside of a handful of retirees earning over $100,000 per year. The Detroit News reports that, on average, retired police and firefighters receive $30,607 a year, while general retirees get $19,213. The average pension for a general retiree is not much higher than annual average Social Security payment of $14,760.

The city has certain liabilities that cannot undergo haircuts in a bankruptcy filing. These are the city’s $800 million of interest rate swaps associated with pension certificates of participation (POCs),  which were $439 million out of the money as of June 30, 2012 (page 118). Orr has not suggested haircuts for these liabilities, and the banks on the other side of the swaps secured liens on casino revenues some time ago. This is the truly unfair side of Detroit’s insolvency.

Pronouncements by the Emergency Manager need vetting as do the pronouncements of all the parties. Editorial boards beware: there is as much spinning going on here as in any other story. Dig deeper to find the facts.

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