Detroit’s historic bankruptcy has evolved into a populist fight between retirees and banks, as the city prepares to unveil a critical plan next week to shed some of its $18 billion in debts.
Each side is fighting for its share of Detroit’s limited resources, be it tax revenue or city assets.
Gov. Rick Snyder and Detroit Emergency Manager Kevyn Orr recently have made moves that fueled the fight, as the governor signaled a desire to treat pensioners better than investors of city bond debt. He has pledged $350 million in state assistance for pensioners, while telling Wall Street it will not be getting special treatment.
When Orr took the city into bankruptcy in July, he forged a pact to let two big banks cut in line ahead of pensioners and other creditors. But he abandoned that plan after U.S. Bankruptcy Judge Steven Rhodes twice rejected the settlement as too generous for the banks and a repeat of the city’s bad financial decisions.
In recent weeks, Orr has taken a more aggressive stand against Wall Street financial institutions, including filing suit to invalidate a disastrous 2005 debt deal blamed for plunging Detroit into bankruptcy. The result: an emerging “us versus them” narrative that has rankled the nation’s municipal finance industry.
“When you’ve got one constituency made up of all these pensioners and then you’ve got the Wall Street bigwigs that structured and benefited from the devastation of Detroit, of course it’s going to become ‘us versus them,’ ” said Laura Bartell, a bankruptcy law professor at Wayne State University.
Orr’s debt-cutting reorganization plan, which he said Monday is set to be made public next week, is expected to give retirees a larger percentage of the billions they’re owed over the amount bondholders are likely to recover from the $369 million they lent the city.
Snyder, private foundations and the Detroit Institute of Arts have pledged $820 million toward a fund to bolster pensions and shield the DIA’s assets from being auctioned to satisfy creditors.
The strategy of pitting Main Street versus Wall Street will get its first legal test in court Wednesday, when the city asks Rhodes to dismiss two lawsuits over Detroit’s decision to halt payments on bond debt.
The insurers of city bonds are striking back against Orr’s contention that they’re unsecured creditors, arguing city taxpayers approved taxes dedicated to paying off debts to finance capital improvements to police and fire stations, public lighting facilities, and cultural and economic development initiatives.
In court filings this week, the bond insurance companies contended investors of city bonds hold a property right to certain taxes under state law that cannot be cut in the same way Rhodes has ruled pensions can be reduced.
“The key difference between the pension claims (and all other unsecured claims against the city) and those at issue here is that the bondholders have property interests in the restricted funds created by Michigan law,” wrote Paul Hage, an attorney for National Public Finance Guarantee Corp., which insured $87.4 million in tax unlimited general obligation bonds.
Bondholders vs. retirees
Property rights versus contractual rights are at the heart of Detroit’s efforts to dodge Michigan’s constitutional protection of pensions, which Rhodes deemed a contract that can be torn up in bankruptcy.
Bankruptcy judges in the recent California Chapter 9 cases in Vallejo, Stockton and San Bernardino have “recognized that municipal debtors are constrained by state-law restrictions on the use of certain funds,” Hage wrote.
“These voter-approved taxes cannot be used for any purpose other than payment of debt service on the unlimited tax bonds,” wrote Carol Connor Cohen, attorney for Ambac Assurance Corp., which is on the hook for $146 million in general obligation bonds.
Legal experts say Rhodes’ ruling on whether the city must segregate tax revenues for the purpose of repaying the bond debts could dictate how much money is available to split up among retirees, bondholders and other creditors.
“(Orr’s) going to get smacked on that,” said Chris Herzeca, a private investor and attorney from New York following the issue closely. “Rhodes is going to find that these bonds are secured. Because that’s the law.”
“It’s creative lawyering,” she said. “I think their argument is a loser because the voting of the taxes was to provide money to the city, not the bondholders.”
Detroit skipped a $12.6 million interest payments due Oct. 1 to the holders of unlimited tax and limited tax general obligation bonds. In a court filing last month, a city attorney said the bondholders have no legal right to be paid while the city is in bankruptcy.
“Nothing in these ‘pledges’ grants plaintiff a lien in specified tax revenues,” city attorney Deborah Kovsky-Apap wrote.
For some retirees watching the bankruptcy unfold, they’re hoping for a better spot in the debt-repayment line than the bondholders.
“Some of these people who bought the bonds, they knew they were on shaky ground to start with and if that’s the case, too bad, you lost. You knew that going in,” said Ken Schick, 68, of Maple Grove, Minn., who retired from the city water department in 1997 after 30 years. “We needed the bonds at one time to make the city work, and if they borrowed too much and they lent us too much, too bad.”
Awaiting judge's ruling
Snyder’s recent public statements about giving pensioners a better recovery over bondholders has already earned him scorn from one of the three Wall Street rating agencies.
“The governor’s comment that state funds will not bail out bondholders or Wall Street but are going to Michiganders suggests an ‘us versus them’ orientation to debt repayment that undermines willingness to pay public debt in Michigan,” Fitch Ratings said in a Jan. 27 statement.
If Rhodes determines the bondholders are unsecured creditors like pensioners, the federal bankruptcy code requires their treatment under the plan of adjustment be “fair and equitable.”
But in some cases, there can be discrimination among different classes of unsecured creditors, Bartell said.
Snyder, who has a law degree, appears to understand that distinction.
“That’s what the judge will decide,” Snyder said in a recent interview.