This Class is Unimpaired by the Plan

Ted Nesi @tednesi Ted Nesi  The Dow is down 4% as I write this. But I’m sure the market will turn around once Central Falls releases its Ch9 plan at 3.

Central Falls, Rhode Island is a down on the heel community that has become the epicenter of the battle to preference municipal bondholders  over retired municipal workers in bankruptcy proceedings. This is a tale of the state of Rhode Island turning federal bankruptcy law and pension law upside down.

When an entity becomes insolvent and seeks the protection of a bankruptcy court it throws itself within the processes and rules of the federal bankruptcy court. Cities are not liquidated in a Chapter 9 bankruptcy but outstanding claims against a community are reduced so that the community can pay them all. Traditionally in bankruptcy proceedings pensions are treated similarly to bondholders and other secured creditors.

In a new and surprising move the state of Rhode Island passed General Laws § 45-12-1 and enshrined in  law that bonds are secured by a Rhode Island statutory lien on property taxes and general fund revenues. In essence the state created a post-facto super senior preference for bondholders. The state changed the rules after the game was underway.

The stated concern of state officials was that if Central Falls bondholders were “haircut” in bankruptcy court then bond market access for all cities in the state would close or be severely curtailed. In essence the state wanted to ring fence the assets of the bondholders assets against any harm that a bankruptcy proceeding would subject them to.

The Dummies Guide to the Pension Crisis

Hat tip to Ted Nesi of for pointing out this excellent union sponsored video that discusses the problems for the public pensions of Rhode Island. Although the details are specific to that state the structural problems apply to almost every state because public pensions across America are underfunded. Every state faces problems that are politically or financially difficult. Either taxpayers will be paying more to top pension plans or retirees will be receiving smaller pension payments. Pension reform is a complex topic and I hope we see more educational efforts like this video.

Further: Judge Taft-Carter issues decision in pivotal RI pension case

Desperation costs are steep

Harrisburg, the state capital of Pennsylvania, has narrowly averted filing for Chapter 9 bankruptcy as their independent city Parking Authority has secured a loan to advance future payments to the city for use of city land. Unfortunately the unnamed lender will be charging the Authority 10.75% interest. The costs of desperation are steep. This one-off lease payment from the Parking Authority allows the city to make their September 15th bond payment on their crushing incinerator debt and avoid Chapter 9, but what about the next bond payment in 2012? They don’t seem to have any more assets to borrow against. So they’ve postponed the problem but not solved it. From Bloomberg:

The Parking Authority will borrow to make the payment, and some on the council balked at the interest rate of as much as 10.75 percent on the loan. About a third of the city’s 49,500 residents live below the federal poverty level. The lease covers land under several garages, and the loan costs may reduce the authority’s income, which provides revenue to the city.

Fitch gives USA its stamp of approval

Fitch leaves munis tied to U.S. rating at AAA, S&P downgrades

Fitch Ratings, one of the three major rating agencies and the one considered the most accurate by institutional investors, has affirmed the credit rating of the debt of the United States at AAA. As a follow-on to this action they have also maintained the AAA credit rating of municipal entities tied to U.S. Treasuries.

Going in the opposite direction, Standard & Poor’s downgraded the investment portfolio of the city of Los Angeles to AA+ because it holds 80% of its assets in U.S. Treasuries.  This follows S&P’s recent downgrade of U.S. Treasuries to AA+. The Bond Buyer reports what happened next:

Los Angeles has dropped Standard & Poor’s from rating its $7 billion investment portfolio after the agency downgraded it along with the United States last week.

Bondholders have cut the line

Something doesn’t seem right in Central Falls, the Rhode Island city that declared municipal bankruptcy yesterday. Now that the state receiver has filed Chapter 9, all the town’s dirty laundry has been hung out in public, and, like any bankruptcy, it’s not pretty. Overspending and declining tax revenues doomed this poor town, along with liberal doses of alleged corruption.

Here is what doesn’t seem right in Central Falls. The city is dead broke and those they owe money to are lined up at City Hall to collect. But for some odd reason, the city’s bondholders have pushed ahead of all the others in line to claim full repayment of their debts; those later in line must settle for 50 cents on the dollar. Retired police officers and firemen will have their pensions cut by 50%.

It wasn’t Central Falls’s decision to give preferential treatment to bondholders. Last year legislators in the state capitol passed a law making the claims of bondholders superior to all other claims in bankruptcy. The Rhode Island General Assembly’s action flies in the the face of common bond market practice, which is that bondholders get in line with everyone else and a judge overseeing bankruptcy proceedings gives a fair resolution to all the creditors.

The smallest city in the smallest state

Central Falls, Rhode Island — the smallest city in the smallest state — filed for bankruptcy today after years of decline. It is the fifth U.S. municipality this year to seek protection from the courts under the bankruptcy law. The Governor of Rhode Island stood with city officials as the bankruptcy process commenced. Reuters quoted him as saying in a statement:

“The current situation is dire and it necessitates decisive steps to put the city back on a path to solid financial footing and future prosperity,” Rhode Island Governor Lincoln Chafee said in a statement.

Central Falls’s population peaked in 1930 and has declined ever since; it currently has only 19,000 inhabitants. The town is extremely poor with median household income of $22,628 and per-capita income of $10,825, according to the 2000 Census. Central Falls, like many hidden American towns, is at the end of municipal row.

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