Detroit Offers Creditors Pennies on the Dollar

Detroit Offers Creditors Pennies on the Dollar
June 18, 2013

Steve Stanek

Steve Stanek (sstanek@heartland.org) is a research fellow at The Heartland Institute and managing... (read full bio)

Less than one month after Detroit emergency manager Kevyn Orr issued a report declaring the city’s finances to be in worse shape than nearly anyone suspected when he assumed the job in March, Detroit has defaulted on a scheduled debt payment of $39.7 million.

The default happened June 14, the same day Orr issued a debt restructuring plan Moody’s Investors Service described in a statement as “unconventional and precedent-setting in the municipal market. It builds a strong case for insolvency, girding the city for a tough fight with creditors of all types.”

Orr proposes giving unsecured creditors $2 billion of limited recourse participation notes to replace $11 billion of unsecured debts. That’s less than one-fifth what creditors are owed but more than Orr says they might receive if the city goes into bankruptcy.

"The substantial reduction offered to unsecured creditors, the extent of the city's financial stress and the complexity of the city's debt add to the uncertainty of many classes of debt ultimately recovering their investment," Moody’s wrote.

Credit Downgrades

One day earlier, Moody’s had downgraded several classes of Detroit debt and had given other city debt a negative outlook.

The two other major credit rating agencies in the United States, Standard & Poor’s and Fitch Ratings, also downgraded some Detroit debt and gave other city debt a negative outlook.

Fitch Ratings, for example, downgraded more than $2 billion of Detroit debt on general obligation bonds and pension obligation certificates of participation. Fitch also put nearly $5 billion of Detroit’s sewer and water revenue bonds on negative watch, indicating those bonds also could be downgraded.

Orr noted in his proposal to creditors the city’s property tax revenues have dropped nearly 20 percent since 2008 and income tax revenues are down 15 percent in that time. Budget deficits and city debt have skyrocketed, and the city is not paying pension contributions when they come due. The city has more than $9 billion of liabilities.

‘Vast Problems’

 “My first reaction [to news of the missed debt payment] was to think the same thing I've thought for a while: you can only kick the can down the road so far. Detroit's problems are vast and have been covered up with short-term fixes. On top of that is an incredible amount of deferred maintenance on city assets,” said James Hohman, assistant director of fiscal policy at the Michigan-based Mackinac Center for Public Policy, who has been closely following developments in Detroit.

Political corruption has been a serious problem in Detroit but does not explain all the city’s problems, he said. On June 10 federal prosecutors filed papers in the U.S. 6th Court of Appeals to keep former Mayor Kwame Kilpatrick in prison as long as 30 years for his conviction on 24 counts of felony crimes, including racketeering, extortion, bribery, and fraud. Prosecutors accused Kilpatrick and others in his administration of turning City Hall into a criminal operation. Kilpatrick was convicted in March and taken directly into custody. He awaits formal sentencing.

Major Mismanagement

“Corruption is only a facet of the problem,” Hohman said. “The broader issue facing Detroit is mismanagement. You generally can't violate your bidding rules without someone blowing the whistle if you're managed properly. Orr's recent restructuring plan lists all sorts of problems in their accounting and financial systems. While those kinds of problems can lead to direct incidents of corruption, they can also lead to bad decisions in general operations.”

Hohman praised Orr’s restructuring plan, saying it is “exactly what it should be. It lists major reforms in nearly every department, finds ways to get better at collecting what the city is due, and gives a plan to equitably pay debts.”

Retiree health insurance benefits are likely to be hit hard, he said. The city estimates it has $5.7 billion of unfunded health insurance obligations. Retiree health insurance benefits have almost no funding, according to Orr’s report.

“These are expensive benefits that few people in the private sector receive,” Hohman said. “And at 65, everyone is eligible for Medicare anyway. It appears that most retirees will get some additional benefits, but not what they'd been receiving.”

Steve Stanek

Steve Stanek (sstanek@heartland.org) is a research fellow at The Heartland Institute and managing... (read full bio)