Bankruptcy in Detroit, and new precedents may be set

By Cate Long
July 18, 2013

The emergency manager of Detroit, Kevyn Orr, with the blessing of the Governor of Michigan Rick Snyder, has gone to the federal courthouse and filed a petition for Chapter 9 municipal bankruptcy. The most important dimension of this filing is that it shields the city from lawsuits that are being filed against it. Already Detroit’s public pension funds and workers have filed state-level lawsuits against Orr and Snyder to halt them from filing for bankruptcy. Undoubtedly a legal judgment was made about the validity of those suits and whether seeking the protection of the federal bankruptcy court was necessary.

It took the municipal market and public by surprise when the filing happened today. The publisher of the Bond Buyer, Mike Stanton, said:

The purpose of Chapter 9 is to provide a financially-distressed municipality protection from its creditors while it develops and negotiates a plan for adjusting its debts. Although similar to other chapters in some respects, Chapter 9 is significantly different in that there is no provision in the law for liquidation of the assets of the municipality and distribution of the proceeds to creditors. Such a liquidation or dissolution would violate the Tenth Amendment to the Constitution and the reservation to the states of sovereignty over their internal affairs. Indeed, due to the severe limitations placed upon the power of the bankruptcy court in Chapter 9 cases, the court generally is not as active in managing a case as it is in corporate reorganizations under Chapter 11. The functions of the court in Chapter 9 cases are limited to approving the petition, confirming a plan of debt adjustment, and ensuring implementation of the plan.

There have been few municipal bankruptcies in the U.S., and none yet the size of Detroit. Prior cases in Central Falls, Rhode Island and Vallejo, California treated bondholders carefully. They still needed to maintain access to the the bond markets for short and long-term funding. But the bankruptcy of Jefferson County, Alabama, where bondholders are taking between 20 and 85 percent haircuts, has changed the rules for municipal bondholders. Now the blood has begun to flow.

Detroit has been in desperate financial shape for nearly 20 years. Corruption, violence, uncollected property taxes, borrowing to fund deficits and flawed city management doomed the city years ago. For two decades, Detroit’s administration should have been shrinking. That process only began under the current mayor Dave Bing.

The process of restructuring liabilities began with the bankruptcy filing today. It may last up to two years and involve a lot of litigation. New precedents about the treatment of bondholders, swaps counterparties, employees and pensioners will likely be developed. Conflicts will arise between the Michigan Constitution and federal bankruptcy law. The fights and protests may be vicious. But in the end, Detroit may be reborn with finances it can sustain and public services that should make the city livable.

 

PHOTO: A vacant, boarded up house is seen in the once thriving Brush Park neighborhood with the downtown Detroit skyline behind it in Detroit, Michigan March 3, 2013. REUTERS/ Rebecca Cook

4 comments

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The long slow decline of our childrens country continues unabated. And everyone in the Congress/Executive/Supreme Court run by citizen Walmart is careful not to buy the bonds of distressed US cities going bankrupt. They prefer the Goldman investments in Communist Military China and Russia for much much better returns.
Who is the traitor? The citizen who blows the whistle and has his passport revoked instantly, or the elected official that votes China most favored trading status?
Enjoying bankruptcy, America?

Posted by UScitizentoo | Report as abusive

Good article. The author is correct, precedents will be set. There were many factors that contributed to the decline of the city; globalization, corruption, over zealous unions, etc., all played a part. That’s why it happened and will happen in other cities and even states. People just want a simple, one line, one problem answer to everything. If it is any more complex than that then it is just swept away by politicians as they watch people bicker over what the source of the problem is. Then it just continues to fester.

Posted by tmc | Report as abusive

For the good of the country, this needs to go through. There has to be an end to the sense that there is no limit to the role of government, and that there is always more money, especially someone else’s money. You are probably better aware than I of the number of foreign countries that have defaulted on their debt. There were consequences for them, one and all.

Posted by ARJTurgot2 | Report as abusive

Is anybody else getting really tired of the fact that it’s always the poor (which includes the so-called middle-class) that have to pay for the financial mistakes of our country’s ruling class? Detroit’s bankruptcy will prove that wealthy creditors will lose little while workers will watch their retirement funds plundered.

Posted by changeling | Report as abusive