Money's bottom line in Detroit bankruptcy battle

Daniel Howes

Detroit –

You wouldn't know the municipal bankruptcy trial of the century is underway at the federal courthouse downtown.

There were no protesters out front Wednesday. The overflow space in Room 115 essentially is deserted, occupied by a half-dozen media types and a handful of mildly interested observers. The courtroom U.S. Bankruptcy Judge Steven Rhodes is using to hold Detroit's confirmation trial is filled mostly with suits, i.e. lawyers.

But this is a deadly serious proceeding for Detroit and its future, for its encyclopedic art museum and the "grand bargain" designed to protect its collection from creditors and to bolster city pension plans — even if public interest in the protracted, technical proceeding clearly is waning.

Why not? The largest municipal bankruptcy in American history is devolving into a straightforward fight over money, who gets what little is available and whether any side, each represented by the best bankruptcy counsel money can buy, can claim "the rule of law" to their benefit.

What does the public care if precedent is set that affects municipal finance markets, whether public pensions, believed inviolate, can be reduced, whether Detroit is setting a new standard that could be replicated elsewhere? If they're paying attention, it deserves more than a collective yawn.

History is unspooling in Judge Rhodes' courtroom. Here's the poorest major city in the nation, poster child for urban decline and the perils of one-party rule, trying to chart a course out of insolvency, to off-load $7 billion in debt, to lay the foundation for delivering better services and better government — and do it in an election year.

The outcome is not necessarily guaranteed, not if Day 2 in what's scheduled to be roughly a month-long grind is any indication. Lawyers for Syncora Guaranty Inc. and Financial Guarantee Insurance Co., two hold-out creditors pressing the city to sell DIA art to boost their alleged meager recovery, delivered an evidence-backed pounding of the city and its bankruptcy counsel.

They accused the city and its bankruptcy team of ignoring alternatives to raise cash to pay creditors, of failing to do the analysis necessary to show good faith and reach sound conclusions, of pursuing politically expedient resolutions that aim to preserve the DIA and buy peace with unions and the city's pension funds.

"When we look at 'fair and equitable' we see failure on all fronts," said Marc Kieselstein, a partner with Kirkland & Ellis LLP representing Syncora. "We see ring-fencing the art and funneling all of the proceeds to the pension funds. There's nothing fair and equitable about that."

Even worse, he and the attorney representing FGIC said, is evidence the city was "unforgivably lethargic" in seeking and analyzing alternatives to raise cash that could be more equitably distributed to creditors. Trouble is, under Chapter 9, creditors cannot force a city to do any of that.

The city, Kieselstein argued, failed to analyze whether changes in tax policy could raise more revenue to pay creditors. It failed to explore ways to "monetize" the Detroit Institute of Arts' collection before and after reaching the grand bargain.

It failed to challenge claims, advanced by the DIA, of formidable legal obstacles to selling pieces of its collection. And the city accepted as fact, he continued, that most pieces in the DIA collection are protected by gift restrictions, despite policy dating at least to 1941 that gifts and bequests be without restrictions.

How do they know? City officials said as much in pieces of pre-trial depositions replayed in court. An expert with Ernst & Young, retained by the city, confirmed neither he nor his firm was asked to analyze whether tax policy could be tweaked to raise more revenue. Emergency Manager Kevyn Orr confirmed the view that the city can sell art at the DIA, and "it's fair to say we didn't take any steps to monetize the art."

And Rhodes? "You've made some very powerful arguments," the judge told Kieselstein as he posed a question: How many cents on the dollar would his client need to settle?

"Seventy-five cents."

"Where's the city going to get the money to pay your 75 cents on the dollar," the judge asked. Sell art or offer it as collateral to secure loans (that must be repaid, Rhodes reminded); adjust investment return projections for city pension funds; seriously analyze tax policy alternatives ignored in the rush to a confirmation hearing.

We're there, but it's all far from over. Rhodes has made it clear for months that one-time asset sales (read, as Exhibit 1, pieces from the DIA collection) are ineffective tools to repair structural deficits or correct bad management, even if they raise cash to boost recoveries.

The city and its bankruptcy team clearly are banking on the protections of Chapter 9, the alleged evils of holdout creditors and the emotional appeal of the grand bargain to protect pensioners and the city's cultural heritage to propel their restructuring to confirmation.

Still, history-making or not, it's all about the money.

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Daniel Howes' column runs Tuesdays, Thursdays and Fridays.