Detroit Bankruptcy Proposal - No One is Happy - Does that Make a Good Settlement?

The Detroit pensioners are up in arms over the latest proposal submitted on February 20 by emergency manager Kevyn Orr.

Bondholders are also upset. If everyone is upset, does that mean the deal is fair?

Let's investigate the idea starting with Detroit bankruptcy plan includes deep pension cuts

Detroit's plan to emerge from bankruptcy this year largely hinges on significant cuts to city workers' pensions and retiree health benefits — actions vehemently fought by public employee unions — as well as decreased payments to bondholders, according to a blueprint filed Friday to restructure the city's $18-billion debt.

In the plan, which probably will be amended in the weeks ahead, police, firefighters and those departments' retirees will take a 10% cut to their current pension payment. The pensions of all other city employees and retirees will be cut more than three times as much: 34%. Neither group will receive cost of living adjustments in the future.

Unions immediately decried the bankruptcy blueprint.

"The plan is unfair and unacceptable," Al Garrett, president of the Michigan branch of the American Federation of State and Municipal Employees, said in a statement Friday. "Retirees cannot survive these drastic cuts."

Many city employees maintain that pensions are protected under the Michigan Constitution, and that the state must chip in to make sure pensioners are made whole.

"A more than 30% cut combined with the virtual elimination of healthcare is devastating to the people who dedicated a career to Detroit," Jordan Marks, executive director of the National Public Pension Coalition, said in a statement.

Creditors also objected to the plan Friday.

"While we understand that favoring pensioners and discriminating against bondholders and other creditors might be politically popular, we believe this is contrary to bankruptcy law and will result in costly litigation that will hamper the city's emergence from bankruptcy," Steve Spencer, financial advisor to the single largest unsecured creditor in the case, Financial Guaranty Insurance Company, said in a statement.

Detroit Bankruptcy Funding Hinges on Creditor Settlement

Bloomberg reports Detroit Bankruptcy Funding Hinges on Creditor Settlement.

Detroit’s plan to end its $18 billion bankruptcy assumes bondholders offered 20 cents on the dollar will eventually swallow a deal that guarantees police and firefighters collect 90 percent of their pensions.

Within hours of the plan being filed, the creditors that city officials must win over rejected the proposal, even as they continue talking behind closed doors. Unions and bond insurers both registered their displeasure.

“While we understand that favoring pensioners and discriminating against bondholders and other creditors might be politically popular, we believe this is contrary to bankruptcy law and will result in costly litigation that will hamper the city’s emergence from bankruptcy,” Steve Spencer, a financial adviser for bond insurer FGIC Corp., said in an e-mailed statement.

“The proposed plan of adjustment is a gut punch to Detroit city workers and retirees,” the American Federation of State, County and Municipal Employees said in a statement. “Retirees cannot survive these huge cuts to the pensions they earned. The plan is unfair and unacceptable.”

Under the plan, the city’s retired general employees, represented by AFSCME, wouldn’t get as much as police and firefighters. If Rhodes approves the plan as-is, the general workers would be forced to take 66 percent of their current pensions. If the workers voluntarily accept the proposal, they would get 74 percent, and police and firefighters 96 percent, according to the filing.

The city’s emergency financial manager, Kevyn Orr, told reporters yesterday that the $820 million contribution hinges on an “all in” deal.

“We need a settlement from everybody,” he said. The foundations supplying the money are trying to protect the artwork in the city-owned Detroit Institute of Arts.

The proposal filed yesterday doesn’t include any cash for creditors from a potential new source: a Great Lakes Water and Sewer Authority, which would take over responsibilities from the city. Detroit has said it wants to create the authority and then lease its water and sewer operations to it to boost creditor recoveries.

Under the plan, the city would fully repay water and sewer bonds, as well as other debt that’s backed by collateral. 

Money paid from the pension fund to the annuity savings program from 1999 through 2012 would be put back in the fund. Orr didn’t divulge how much the restitution would cost the employees and retirees who may have received the payments, which totaled about $756 million from 1985 through 2007, according to city records.

The plan also places restrictions on the city’s two retirement programs, and leaves open the door to changing their governing boards under a mediated settlement that includes Republican Governor Rick Snyder and the GOP-controlled legislature. The pension board would be required to limit to 6.25 percent their expected returns on investment.

After a vote, creditors can raise further objections at a confirmation hearing. Rhodes will take the votes and the objections into account before deciding whether to confirm the plan. Bankruptcy law permits him to override a “no” vote through a process known as a cram-down.

Impossible

Everyone wants to be made whole. Unfortunately that's impossible. If it were possible, Detroit would not be in a state of bankruptcy in the first place.

Who Pays and By How Much?

If paying off everyone at 100% is impossible (and it clearly is), the critical question is "Who Pays and By How Much?"

That is what the debate is all about, and no one is happy.

Yet, given that it's mathematically impossible for everyone to be happy, the standard argument that "no one is happy, so it's a fair deal" goes straight into the ash can where it belongs.

Unfortunately, in regards to "what is fair" details are lacking. For example, how much of the police and fire pensions are really funded?

The settlement assumes 6.25 percent returns on investment. I suggest that is enormously on the high side.

And what happens to whom if those assumptions are not met? And while other pensioners are whining about 34% cuts, bondholders face an 80% cut.

The plan does overly favor some bondholder interests (see Bank of America and City Official Fraud Enters the Detroit Bankruptcy Equation; Fair Settlement Reviewed Again), but the amounts involved seem tiny compared to the total haircuts required in dollar terms.

Even assuming (as I do) the plan is overly generous to Bank of America/Merill Lynch, it does screw other bondholders.

A rush agreement to accept the first proposal is not a good idea. Thus, I hope Judge Stephen Rhodes sends this proposal back to drawing board citing numerous "fairness" objections.

I do not think either side should get an unfair advantage. Both bondholders and pensioners should suffer.

For further discussion, please consider Controversy in Detroit: What's a Fair Settlement of Bondholder and Pension Obligation Claims?

Meanwhile, I suggest Rhodes is doing a brilliant job. Let's hope it continues.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com