Detroit's interest rate swaps with UBS and Bank of America were supposed to protect the city from rising interest rates. (Brandy Baker / The Detroit News)
Detroit— A federal judge on Thursday said he would not let Detroit continue to make bad financial decisions, rejecting a proposed $165 million settlement with two banks to terminate a troubled pension debt deal.
“The court ... will not participate or perpetuate hasty and imprudent financial decision-making,” U.S. Bankruptcy Judge Steven Rhodes said in making his ruling. “It’s just too much money.”
Rhodes called the deal too generous and urged the negotiators, who had reached a Christmas Eve settlement between Detroit and banks UBS AG and Bank of America’s Merrill Lynch Capital Services, to resume negotiations aimed at terminating a deal that helped trigger the biggest municipal bankruptcy in U.S. history.
“It’s higher than the highest reasonable number. … By any rational analysis, it’s not close,” Rhodes said of the latest proposed settlement.
The settlement would have terminated a deal engineered during ex-Mayor Kwame Kilpatrick’s tenure and blamed for pushing the city into bankruptcy. Rhodes recommended Detroit try for a third time to reach a better deal with the banks.
The judge did, however, allow Detroit to borrow $120 million from London-based investment bank Barclays to pay for computer upgrades and better public safety services.
Instead of paying UBS AG and Merrill Lynch $165 million, Detroit could try to negotiate a less expensive deal and Emergency Manager Kevyn Orr could sue to recover $300 million paid to the banks, the judge said.
Rhodes said a lawsuit could be costly and take a long time, even though he said Detroit was “reasonably likely” to win. He recommended more negotiation but said if the city chooses litigation, “so be it.”
Several groups, including bond insurers, pension funds and banks fought the $165 million settlement and attempts to terminate the Kilpatrick-era debt deal, calling it illegal and too generous.
“(Orr’s) team lost today,” said attorney Robert Gordon, who represents Detroit’s two pension funds. “But I’m not here to gloat about it.”
Gordon said creditors probably will benefit from the ruling if Detroit can negotiate a less expensive settlement, which would free up more money to pay creditors.
The city is facing a March 1 deadline to file a debt-cutting plan that was expected to include the settlement.
Orr said his team will continue working toward a solution but did not signal whether the city would sue the banks.
“We are reviewing today’s decision but we are thankful the court has approved our ability to pursue quality of life financing for the benefit of the city’s 700,000 residents,” Orr said in a statement.
Patrick O’Keefe, a Bloomfield Hills financial turnaround consultant, said that the judge’s ruling was “absolutely” a surprise, given that the city had already complied with his request to negotiate a more favorable deal.
“He asked them to go back to the table and get a better deal, which they did,” O’Keefe said, also noting that the agreement was endorsed by the court-appointed mediator.
“There were those two things going for it,” O’Keefe said. “Still, he (the judge) shot it down.”
O’Keefe added Rhodes’ handling of the matter may have given a “potentially false hope.”
“People are probably wondering why they spent Christmas Eve negotiating,” he said. “I don’t understand the strategy here.”
If Detroit negotiates a less expensive settlement, that would alleviate pressure on a city coping with more than $18 billion in debt, said Matt Fabian, managing director of Municipal Market Advisors, a Concord, Mass.-based bond market research service.
Fabian faulted the city’s bankruptcy firm, Jones Day, for taking a “rapid fire” approach to the settlement.
“In the end, it wasn’t really all that much debt, at least in the context of the city’s overall estate, but it is clearly important for how the remainder of the Chapter 9 will proceed,” Fabian wrote in an email.
The judge’s ruling rejected a settlement brokered by a team of mediators headed by Chief U.S. District Judge Gerald Rosen, who Rhodes appointed to resolve bankruptcy disputes.
Rosen said last month the settlement, while not perfect, was best characterized by the warning “Do not allow the perfect to become the enemy of the good.”
The city wanted to pay UBS AG and Merrill Lynch $165 million to end an interest-rate swaps arrangement tied to $1.44 billion in money borrowed in 2005-06 to prop up Detroit’s pension funds. If it had been approved, Detroit would have paid off the banks from a $285 million loan and spent the balance on city services.
City bankruptcy lawyer Corinne Ball said the settlement would have eliminated Detroit’s most costly obligation and lead to a “cost-effective” loan.
Detroit’s interest rate swaps with UBS and Merrill Lynch were supposed to protect the city from rising interest rates.
But the deal soured for Detroit when prevailing interest rates plummeted in 2008-09, causing the city’s annual interest payments to rise to $50 million.
The settlement was the focus of a dayslong trial in bankruptcy court that featured objections from bond insurers, pension funds, banks and others, who face potentially smaller payouts in the bankruptcy case.
Rhodes halted a trial last month over Orr’s original plan to pay the two banks $230 million after questioning whether the settlement of 75 cents on the dollar was unfair to other creditors.
UBS and Bank of America agreed to a lower payout during Christmas Eve negotiations.
Opponents of big banks trumpeted the judge’s ruling Thursday on social media sites, calling the rejection a setback for Wall Street. Outside federal court, protesters marched in the snow and chanted “Hands off our pensions!”
Retired city worker David Sole, who had fought the settlement, said Thursday he didn’t expect Rhodes’ ruling.
“It just shows … the banks are crooks and shouldn’t be paid,” Sole said. “This was way too much money to give the banks.”