We are receiving many questions regarding the pending financial crisis in Detroit. I thought I would address some of the issues in this week’s blog.

Is Detroit going to file Chapter 9?

I don’t see at this juncture how they can avoid it. Bankruptcy is the result of failed negotiations. At the current pace of rhetoric while I believe generally all parties (city, creditors, bondholders, unions and retirees) understand the city’s financial plight, not everybody wants to share the pain. For example, Bondholders – Many have alternative payment sources or credit enhancements. I am aware of a certain group that received a pledge of State Revenue Sharing dollars. Others have insurance companies and sureties standing behind their obligations. They are not that interested in taking a haircut they don’t need to.

Union Pension Funds and Retirees – There is still some disagreement as to whether the State backs the payments to municipal retirees in Michigan. If that is so, whether the city or the state pays, why do the retirees want to take less if the state supports these obligations.

The Attorney General has issued an opinion that the State doesn’t have to pay such benefits but their client is the State of Michigan, so does that opinion surprise anybody since you can only imagine how unpopular it would be to a Michigan taxpayer in Grand Rapids to be on the hook for a Detroit retiree benefit.

Post-Retirement Healthcare Benefits – It appears this may truly be a naked obligation. Should the unions negotiate, perhaps something less on pension benefits to get something for healthcare? Both pension and healthcare are large unfunded obligations. Do the unions want to roll the dice, win on pension and lose on healthcare? The healthcare issue seems a lot clearer.

Detroit Taxpayer – Is raising taxes really an option for a City that already has a high income tax and property tax? The bondholders who have relied on the taxing authority and power of the City may demand tax increases. This does not seem to be a viable option.
Michigan Taxpayer – Do the Upper Peninsula taxpayers want to be on the hook for Detroit City employee pensions? I think not. Yet, if the unions win this argument then the state is picking up the tab. This scenario seems harsh in the whole state which didn’t get the benefit of the labor and now would have to pay the bills of a mismanaged city who over-promised.

Is Detroit going to file soon?

Kevin Orr must meet the initial threshold of bargaining in good faith. With the short time he has been involved and the current acrimony, this may be the first fight. Can the federal bankruptcy court mandate state and local government? Some argue they can’t, under a separation of the levels of government (federal and state.)

If a filing happens soon, it will be time consuming, expensive and arguably will be named the Lawyers Full Employment Act as a sea of barristers will descend on the courts to fight all kinds of battles. A tsunami will look like a sneeze compared to this tidal wave of litigation.

Can Detroit avoid a bankruptcy?

Probably not. Creditors’ claims need to get sorted as to amount and in what priority in terms of claims to the city’s assets and cash flow. Right now nobody is backing down. Unlike Chapter 11 which corporations use, the creditors can’t force a bankruptcy. So the longer Kevin Orr can hold out by not paying obligations it may force the creditors to make a deal. But he must get the city to be cash flow positive on the day to day operations if he is to elongate the playing field. It would be better for all to avoid the expensive time consuming process of bankruptcy. There appears to be too many divergent views on the creditors standing which may need to be litigated.

I will continue to write on this as issues develop to offer my opinion and observations.