The Detroit Bankruptcy Case – Municipal Bondholders Take Note

For the past 16 months the city of Detroit has gone through a gut-wrenching series of negotiations to settle the largest bankruptcy in US history. Detroit has a population of 680,000 and a land mass larger than Manhattan, Boston and San Francisco combined.

Two factors weighed on the city’s crisis. First, it suffered a decline in employment and tax revenue from the cutbacks and closures in the auto industry. A second time bomb was that pension funds had calculated their rate of return at 6.75%. With interest rates near zero there was no way they could meet this goal. The created a gaping hole in their pension funds.

The mediations involved a diverse group of players from bondholders holding $4.7 billion in Limited Tax General Obligations to insurance companies that insured these bonds to $18 billion for 32,000 pensions, $7 billion in municipal debt and a city on the verge of total collapse. It had 35,000 broken street- lights and 30% of its buildings were burned out and/or dilapidated. Legal matters such as whether or not mediations for pension reductions were in violation the State of Michigan Constitution had to be settled. An unusual player in the mix was the Detroit Institute of Arts (DIA) that wanted to preserve Detroit’s art heritage.

The architect for creating a “Grand Bargain” was Chief US District Judge Gerald Rosen. Presiding judge was Steven Rhodes. Judge Rhodes’ decision took only 75 seconds, followed by a two- hour speech. His first words were: “Now is time to return democracy to the people.” He went on to say: “This will cause a real hardship and, in some cases it is severe.” “This bankruptcy, however, like most is about shared sacrifice that is necessary because the city is insolvent and desperately needs to fix its future.”

The highlights of the “Grand Bargain” included the following:

Bondholders. Creditors like insurer Syncora Guarantee will get 14 cents of the dollar for their debts.

Retirees. Pensions are cut from 4.5% to 20%. The Cost of Living Adjustment (COLA) was scrapped. There will be higher health costs. Mediations will settle forfeiture of previous payments from the system that are deemed improper.

Lawyers and Experts. The cost will be $150 million.

City of Detroit. Cutting of pensions will erase $7 billion in debt.
$816 million will go into pension funds over the next 20 years.
$1.7 billion was set aside to demolish blighted buildings.

DIA Art was saved. Judge Rhodes said: “To sell the DIA art would be to forfeit Detroit’s future.” “The city made the right decision.”

State of Michigan. The State contributed $195 million in the settlement.

Foundations and Private Donors contributed $466 million.

Review Commission. A nine member Commission was set up to insure that the city follows through on its reconstruction.

State Constitution. The agreement absolves the State of any legal liability to pay Detroit’s pensions under the State Constitution.

Judge Rhodes cautioned Governor Snyder that the State has a “legal and moral obligation to insure municipal employee benefits in Michigan are adequately funded.”

Rhodes added: “This ‘Grand Bargain’ is an ideal model for future municipal debt restructurings.”

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