Business Ethos Blog

Detroit Bankruptcy

Dr. David Mielke, Retired Dean, College of Business at Eastern Michigan University


Dr. David Mielke

Enough of kicking the can down the road.  Kevin Orr, emergency financial manager for Detroit, filed Chapter 9 bankruptcy on Thursday July 18th.  It is the nation’s biggest municipal bankruptcy in history.  It is said that this is a result of decades of decline and mismanagement that left the city too poor to pay billions of dollars to bondholders, for retirement benefits and other creditors.   What will happen to those bondholders, retirees and other creditors?  Was this the “Right Thing to do?”  Let’s look at some issues:

1. It is important to note that during this process business will continue as usual for the city and its employees.  Departments will remain open, services will continue, paychecks will be paid, and suppliers paid.

2. The debt of the city is estimated at over $18 billion.  There are over 100,000 creditors.

3.  The obligations include more than $5.7 billion in unfunded health care benefits.  In fact, there has not been any funding provided for these obligations, $3.5 billion in unfunded pension benefits and $5.4 billion in bond debt.  Of the debt, about $12 billion is unsecured—most likely to receive pennies on the dollar.

4. The legacy costs absorb nearly 40 cents or 40% of every budget revenue dollar for the city in 2012.  That figure is expected to rise to 65 cents of every dollar by 2017.  Police and fire services absorb almost 40%.  That leaves about 20% of the billion dollar budget to pay for all other services and obligations.  That $200 million is far less than what is necessary to run the city and meet its obligations.

5. What is the process?  After a federal judge is appointed, there will be a 30-90 day period in which creditors may challenge whether or not Detroit is entitled to bankruptcy protection, is truly insolvent and has no alternative to filing and whether or not the process can move forward.  There is certain to be hearings during this time period.  If the judge agrees that the bankruptcy should proceed, Kevin Orr will then present a plan to settle all claims.  He will negotiate with various parties as part of the development of the plan.  It is hoped that the judge will then approve the plan with a target of next summer or early fall—near the end of Orr’s 18 month appointment.  (He was appointed in March 2013.)  Judge Rhodes, a senior federal judge in southeast Michigan and a bankruptcy specialist, has been appointed.  Orr will potentially have power to “cramdown”, a bankruptcy term referencing the cramming of new loan terms down creditors’  throats, wiping out creditors, modifying pension plans, and paying pennies on the dollar over objections, provided the judge approves.

6. Two Detroit pension plans on behalf of 32,000 active and retired employees have already sued the emergency manager and the governor asking that the court find that a bankruptcy filing would conflict with the state’s constitutional protection of public retirees’ rights saying that the state constitution bars any government from reducing pension benefits.  Orr filed the bankruptcy petition on Thursday, July 18th.  The suits were filed July 17th.  Two similar suits were filed earlier this month.  The judge is scheduled to have a hearing on these lawsuits on Monday July 22nd.  It is possible that the judge could have placed a temporary restraining order on the bankruptcy filing had the state and Orr not moved first.  In fact, the judge did file a restraining order.  However, experts state that once the federal bankruptcy has been filed, it cannot be withdrawn and that the state has no authority to stop the process.

7. The ruling on this pension suit will potentially have a big impact on future court rulings affecting municipal bankruptcies.  Are state employees’ pension protected under state law?

8. Kevin Orr is a bankruptcy specialist.  He was very involved with the Chrysler bankruptcy.  If we look at the results of the GM and Chrysler bankruptcies, we see a model for a fresh start and success.

9. Michigan’s largest city joins Jefferson County, AL. and the California cities of San Bernardino and Stockton in bankruptcy.

Was the bankruptcy filing the “Right Thing to do?”  As was pointed out by the Governor in his news conference, there are 78,000 abandoned homes in Detroit, the average emergency services response time is 58 minutes versus the 11 minute national average, only one-third of the ambulance fleet was in service during the first quarter of 2013, Detroit is already the paying the highest per capita taxes in Michigan and 40% of the city’s streetlights don’t work—-Detroit’s residents deserve better.  The bankruptcy provides an opportunity for a fresh start.  It is the “Right Thing to do.”