MuniLand

Inflationumberitis

As the Detroit bankruptcy is prepared to begin in the courtroom of Federal Bankruptcy Judge Steven Rhodes, a lot of debate is taking place in muniland. Many of these arguments are over whether secured bondholders will take haircuts, where the money will come from to pay off the swaps termination fees that are currently being negotiated and whether Detroit Emergency Manager Kevyn Orr has authority to cut the earned pensions of the city’s retirees. Orr has been making the media rounds to bolster his case for why these well-funded pensions should be cut. Of course, the more he cuts retiree benefits, the more he can force cuts on bondholders. Let’s shed a little light on Orr’s pension voodoo. Here is how the Detroit pension funds are represented in the 2012  annual financial report (CAFR) (page 145):

 

We don’t know Detroit’s pension returns for 2012, but it was a good year overall for public pension funds, with an average return of 12.69 percent, according to Wilshire Trust Universe Comparison Service. In 2012, according to the CAFR, Detroit contributed $64 million to the General Retirement System and $50 million to the Police and Fire System (page 146). That is $114 million, or about 10.3 percent of the $1.1 billion of general fund revenues in 2012. The voodoo comes in when Orr projects pension contributions jumping to $285 million in 2017 from $114 million. That is an increase by a factor of about three (June 14 Creditor Proposal page 91):

 

Why is Orr doing this? Does he believe that the pension funds are not adequately counting their future liabilities? I don’t think so. Ken Klee, one of the smartest municipal bankruptcy attorneys in the nation, who lead Orange County, California out of bankruptcy, lead the Jefferson County, Alabama bankruptcy case. Did attorney Klee go after Jefferson County’s pension fund, which was funded at almost the same level as Detroit’s Police Retirement System? I knew the answer was no, but I wanted to confirm with the Birmingham News reporter who covered their bankruptcy trial since the start:

 

Here is Jefferson County’s pension fund (Jefferson County CAFR page 155):

Orr is also trying to make the argument that the pension bonds (COPs) and related swaps are liabilities of the pension funds and retirees. They are not. They are liabilities of the city, just like bonds that were issued to build a bridge or a school. I dare say that Emergency Manager Orr has inflationumberitis.

Who is representing Detroit?

Since Kevyn Orr was appointed Detroit’s emergency manager on March 18, his approach always seemed a little off, especially when bankruptcy is concerned. For a Chapter 9 municipal bankruptcy to work, most of the parties must come to a mutual agreement about what each will sacrifice. Federal bankruptcy judges only have the authority to “cram down” a minority of creditors in a specific class when the majority agrees. Federal bankruptcy judge Steven Rhodes, for example, can’t force all bondholders in a class to take a 50 percent haircut. Absent that power, municipal bankruptcy usually lasts much longer than others, as parties come to an agreement.

This balancing act is no easy task for a bankruptcy leader (city official, receiver, emergency manager or lead attorney). But when Orr laid out his creditor proposal on June 14, his aggressive treatment of retirees and bondholders seemed to me like he was wielding a chainsaw where a paring knife would have been the best tool to begin the work. The law firm Jones Day, the firm Orr left before becoming emergency manager, had been involved in the corporate bankruptcy fight of Chrysler. Orr’s opening punch felt like a move from corporate bankruptcy.

We get a peek into Orr’s thinking through a series of emails between him, while he was still a lawyer at Jones Day, and state officials. The emails were made public by a FOIA request by a Detroit labor activist. A January 31, 2013 email from associate Dan Moss to Orr is a suggestion to “nationalize” Detroit’s bankruptcy issue and provide “cover” for state politicians:

Obama should supercharge manufacturing in broken cities

President Obama’s speech on the economy on Wednesday will be closely watched. My own view is that the president has been consumed with military and surveillance efforts and has lost sight of his role as the nation’s economic leader. His efforts to recharge the economy thus far seem like a re-branding effort. But we need bigger ideas. I hope he has some, a clear schedule and lots of initiative. Charging up the world’s largest economy is no easy task. Reuters Mark Felsenthal and Roberta Rampton tell the story:

Obama has focused much of his energy in the first six months of his second term on an array of domestic and foreign issues. But on Monday, he told a gathering at a downtown Washington hotel that economic issues would now take priority over others, specifically mentioning gun violence and his plan to address climate change.

I’m already sensing a drift in mission. Reducing gun violence and addressing climate change are vital for our nation, but they are rarely thought of as economic issues. And then there is the reality of Congress’ schedule. Congress breaks in August, leaving four weeks of legislative activity before the government funding deadline, according to Reuters.

Has Detroit over-inflated its pension liabilities?

Joshua Pugh, a writer and contributor to the Detroit News Politics Blog, has written about a topic that is a big one among muniland professionals. That is the question of whether Detroit’s Emergency Manager Kevyn Orr inflated pension liabilities to make the city’s debt appear larger, allowing for more aggressive haircuts for bondholders and pension holders. Pugh points out a Bloomberg Businessweek piece on his personal website:

How much does the city owe? Orr says Detroit has nearly $20 billion in debt and long-term obligations. Pension funds and bondholders have said in the past he’s inflating the numbers. Why would Orr do that? Because the more dire the city’s finances seem, the more aggressive he can be in pushing for concessions. Also, to be eligible for bankruptcy protection, the city must prove that it’s insolvent, meaning it has no way to pay its debts.

In 2004 and 2005, Detroit issued two sets of pension obligation bonds (Certificates of Participation) to fully fund the city’s pensions with an additional $1.5 billion. This is why, when I started looking at Detroit about 18 months ago, the pensions were surprisingly well-funded. Those pension bonds have now been lumped with general obligation bond debt, pension shortfalls (unfunded liabilities) and retiree health care as unsecured debt, which Orr intends to haircut.

The fight begins in Detroit

 

As Detroit’s bankruptcy filing this week brings on understandable lamentations about the city’s dwindling population and derelict building, a murky legal challenge is under way. There are many places where state and federal law cross over in municipal bankruptcy proceedings. There are few court rulings about the subject, so it is hard to know which law books to reach for when understanding the ones that will prevail.

The Tenth Amendment, which reserves to the state all powers that are not directly granted to the federal government, is at play when the U.S. Constitution says nothing on a matter. In Detroit’s case, pension rights are enshrined in the Michigan Constitution. It is an unknown if these will be considered a “contract” that Detroit Emergency Manager Kevyn Orr can break or a “constitutional right,” which would be harder to adjust.

Buying bonds in muniland

When I started the Muniland blog in April, 2011, municipal bonds were being affected by a low interest rate environment, making them expensive and offering low yields to investors. Since non-institutional investors usually have to pay big mark-ups to buy them, it didn’t make sense to encourage people to own individual bonds. But the interest rate environment in the next year will be changing, and folks might want to consider good quality municipal bonds as long-term investments. It may start to make more sense that I talk about trading commentaries by muniland professionals.

One of the most-used benchmarks in muniland is the “Municipal-to-Treasury” ratio. Anthony Valeri writing for Learnbonds.com says:

Municipal valuations are at their most attractive levels of the past several years, according to average municipal-to-Treasury yield ratios. Average 10- and 30-year AAA municipal bond yields are 112 percent and 114 percent, respectively, of comparable maturity Treasury yields (using Municipal Market Advisors yield data) as of July 10, 2013. The higher the yield ratio, the more attractive municipal bonds are relative to Treasuries and vice versa. A ratio over 100 percent means that yields on top-rated municipal bonds are exceeding those of comparable Treasuries, and investors get the added tax-benefit to boot.

Bankruptcy in Detroit, and new precedents may be set

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:

Who is the Development Bank of Puerto Rico’s rumored next president?

In the latest sign of Puerto Rico’s perilous financial footing, The Bond Buyer reported that the president of the Government Development Bank of Puerto Rico, Javier Ferrer, announced his resignation on Wednesday.

In this role Ferrer had the leading role overseeing and advising the debt of the Puerto Rico government and public authorities. The bank also lent to the government and authorities.

Puerto Rico Gov. Alejandro García Padilla announced that Joseph Pagan, currently executive vice president of financing at the GDB, will be the interim president.

Muniland spends 12 percent of U.S. GDP, but not on creating jobs

It’s mind-boggling how much of the national economy is held up by state and local governments. From the Federal Reserve Bank of Atlanta:

State and local governments together spend more on directly consumed public goods and services (excluding grants and national defense) than the federal government does, said Tracy Gordon, a fellow at the Brookings Institution. The economic impact of that spending is significant—state and local governments account for approximately $1.8 trillion, or about 12 percent of U.S. gross domestic product, she added.

The Fed chart above shows data for the southeast states, but it mirrors national trends. State and local governments are not increasing employment. What is increasing is the amount of employee wages that is going to benefits. The Bureau of Labor Statistics wrote:

DealBook’s questionable argument on privatization

The New York Times’ DealBook, ran a blog post written by an attorney involved in some of the worst privatization deals in America. The author Kent Rowey is described by DealBook as “a partner in the energy and infrastructure practice at Allen & Overy in New York.” What DealBook fails to disclose is that Rowey was the transaction attorney for the deals he is praising in the piece and using as examples for other cities to follow. Is this anything less than a paid advertorial in The New York Times?

Rowey jumps into the hellfires of muniland with his piece (emphasis mine):

Gaining much needed cash and operating efficiency are prime incentives for municipalities to undertake such transactions [public-private partnerships]. Chicago entered into a concession for 36,000 parking meters a few years ago through a 75-year contract valued at more than $1 billion. Besides streamlining the costs of running the citywide program, the new concession exposed abuses of handicapped parking permits and led to the passage of a law preventing abuses. Today, the Chicago Metered Parking System is considered one of the world’s best.

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