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Howes: Bankruptcy for DPS threatens cascading risks

Daniel Howes
The Detroit News

All it took was a few texts from Kevyn Orr Wednesday evening to confirm Gov. Rick Snyder’s worst fears.

A Chapter 9 bankruptcy of Detroit Public Schools risked establishing a precedent, the city’s former emergency manager told the governor, that could expose taxpayers to billions of dollars in creditor and pension liabilities — and the possibility that a federal court could order the state to raise taxes to pay them.

The result would be a financial and political cataclysm, the governor told Senate and House Republicans in separate meetings intended to deliver a stern message. Without enough votes to pass the $617 million rescue package for DPS, the administration would be forced to retain bankruptcy counsel in anticipation of filing Chapter 9 on or before June 17, which is next Friday.

In a straightforward manner some lawmakers already have described as sobering, Snyder shared the warnings delivered by Orr, a Washington bankruptcy lawyer. School districts across the state would be tempted to follow DPS’ path in an effort to shed liabilities on their books, effectively dumping them on Michigan taxpayers and creating a civic firestorm that would be difficult to control.

Even without creating the precedent Orr envisioned, the Snyder administration repeatedly told lawmakers the state and DPS could be “on the hook” for between $2 billion and $3.5 billion in liabilities; that the hit could equal a cut of $3,000 in state aid for every public school student; that bankruptcy could hurt the state retirement system because it includes Detroit teachers; that credit ratings of the state, DPS and other school districts could be downgraded.

“Threatening to go in” to Chapter 9 “and establish that precedent — if I were a legislator that would be the worst thing that could happen,” says a source familiar with the high-level exchange conducted by text message. “The general concepts are pretty straightforward.”

Under federal law, states cannot file for bankruptcy. That means states cannot use the process to shield themselves from litigation or to block creditors from seeking redress in the courts, both of which the city of Detroit successfully did in its historic 15-month bankruptcy. Michigan could not do the same.

More precisely, Orr advised the governor that bankruptcy lawyers likely would advance a go-for-broke argument seeking to establish that states could be ordered to raise revenue to pay creditors and satisfy unfunded liabilities. That risk was skirted in Detroit’s bankruptcy because of the “grand bargain” funded by one-time contributions from foundations, the state Legislature and donors to the Detroit Institute of Arts.

“There is no grand bargain here,” Snyder told his staff, a riff he reprised in his meetings with lawmakers.

The clear implication: Don’t expect a bankruptcy of DPS to mirror the comparatively speedy Chapter 9 engineered by Orr, his army of bankruptcy lawyers, Team Snyder, U.S. Bankruptcy Judge Steven Rhodes and his mediation team headed by then-Chief District Judge Gerald Rosen. The process likely would be more fraught, the options limited and assistance harder, if not impossible, to find.

There is scant precedence for school districts filing for bankruptcy, the Snyder administration found. In 1990, according to an administration letter to state Rep. Laura Cox, R-Livonia, the Richmond Unified School District in Northern California filed for bankruptcy because of $42.5 million in debt. The judge ruled the district could not be protected by the court in bankruptcy and ordered the state to provide the district with operating funds.

Most municipal bankruptcies don’t end in largely consensual restructuring plans, as Detroit’s did. Most don’t have a public-private source of capital to help reach settlements, as Detroit did. Most have assets that can be bartered or turned into cash; DPS’ only assets are its students and their minds, not dilapidated buildings in need of repair.

“Because the city’s bankruptcy went as well as it did, people” in the Legislature “didn’t have a negative view of bankruptcy until the governor laid it out for them,” John Walsh, a former state representative and now Snyder’s director of strategy, said in an interview. “They began to realize how negative a bankruptcy would be. It’s a really, really frightening circumstance.”

There is no stash of cash to save lawmakers from a tough vote or to avert bankruptcy, the governor and his team reminded lawmakers. There is no denying the state’s constitutional obligation to educate all Michigan children. There is no rejecting the state’s complicity in accumulating a half-billion dollars in DPS debt during more than a decade of state control.

The city’s bankruptcy was neither easy nor free of confrontation. Memories dim. Chapter 9 was disruptive; it required sacrifice; it challenged labor and the municipal bureaucracy in ways they had never been challenged before; and it cost the city something in the neighborhood of $180 million in fees to shed $7 billion in liabilities, refinance another $3 billion more and renegotiate all of its union contracts.

Few are happy with the result of the DPS rescue package. Democrats and Detroit Mayor Mike Duggan, Senate leadership and the Snyder administration, business leaders and the Coalition for the Future of Detroit Schoolchildren all backed a more expensive Senate version that included a Detroit Education Commission empowered to regulate public and charter schools.

They didn’t get what they wanted — at least not yet. But the bankruptcy alternative would have been worse, especially for the Detroit kids the state is constitutionally bound to educate.


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Follow Daniel Howes on Twitter @DanielHowes_TDN, or catch him at 3 p.m. and 10 p.m. Thursdays on Michigan Radio’s “Stateside,” 91.7 FM.