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Wednesday, January 19, 2011 11:49 PM

Vallejo Bankruptcy Plan Offers Unsecured Creditors 5-20%; JPMorgan CEO Forecasts More Municipal Bankruptcies; Bernanke Will Not Rescue Cities

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Vallejo is using federal bankruptcy laws to stick it to unsecured creditors. Please consider Vallejo Plan Would Give Unsecured Creditors 5 to 20 Cents on the Dollar

Unsecured creditors will receive 5 cents to 20 cents on the dollar for their claims under a reorganization plan Vallejo, Calif., filed Tuesday in federal court.

The plan to exit bankruptcy outlines the reorganization of debt the city owes its largest creditors, Union Bank and National Public Finance Guarantee. It also sets aside a pool of $6 million to pay unsecured creditors about 5% to 20% of their claims over two years, according to court documents filed in U.S. Bankruptcy Court for the Eastern District in Sacramento.

“The city regrets that it cannot pay a higher percentage,” Vallejo officials said in the court filings. “The city lacks the revenues to do so while maintaining an adequate level of municipal services, such as the provision of fire and police protection and the repairing of the city’s streets.”

The formal legal plan is based on a five-year road map City Council members approved at the end of November, tackling $195 million in unfunded city pension obligations, cutting payments for retiree health care, reducing pension benefits for new employees, raising pension contributions for current workers, and creating a rainy-day fund.

Union Bank, the largest creditor, is owed $50 million after holding letters of credit on four series of defaulted COPs. The filing indicates Union Bank will get a new “lease-leaseback” obligation in exchange for canceling the COP series. It will also get $6 million of unspent proceeds from the COPs held under trust agreements.

Union Bank is slated to get 40% less than what it would have received from the original COP scheduled payments, according to the Vallejo filing.

Vallejo’s exit strategy includes restructuring the debt owed to unsecured creditors, many of which are employees and retirees, by creating a $6 million pool of cash that will be paid out over two years. They will still be able to pursue one of the city’s insurance pools to settle the liabilities, according to the documents.

The city received 1,013 proofs of claims. They are comprised of 969 general unsecured claims, 12 unsecured priority claims, and 32 secured claims, according to court documents. The claims totaled $479 million, with $262 million of general unsecured claims, $45 million of unsecured priority claims, and $172 million of secured claims.

Eventually, creditors will vote on the plan and the court will evaluate the voting before any approval is given.
Vallejo's Regrets

Bloomberg has additional details in Vallejo Bankruptcy Plan Would Pay Creditors as Little as 5%
No city or county has used federal bankruptcy laws to force creditors to take less than they are owed, according to Bruce Bennett, the lead lawyer for Orange County, California, when it filed the biggest municipal bankruptcy in the U.S. in 1994.

Vallejo’s plan assumes the city can’t provide essential services, like police and fire protection, while also paying its debts, he said. Should the city succeed, the case “may become an important precedent,” Bennett said in an interview.

The creditors, who include retirees and former employees, would be paid $6 million over two years. The plan must first be voted on by creditors before U.S. Bankruptcy Judge Michael S. McManus decides whether to approve the proposal.

“While the city regrets that it cannot pay a higher percentage, the fact is that the city lacks the revenues to do so while maintaining an adequate level of municipal services such as the provision of fire and police protection and the repairing of the city’s streets,” Vallejo said in the filing.

The onetime U.S. Navy town of about 120,000 on San Francisco Bay sought protection from creditors under Chapter 9 of the U.S. Bankruptcy Code in May 2008 after the recession eroded tax revenue and unions rejected wage cuts. Chapter 9 allows municipalities to reorganize debt rather than liquidate.

The plan doesn’t alter securities tied to designated revenue sources, such as about $175 million in water revenue bonds, and other special tax obligations secured by special revenue of the city’s restricted funds, according to the documents.

Under the plan, Vallejo will restructure into a single transaction about $46 million of certificates of participation held by its biggest creditor, Union Bank NA, a unit of San Francisco-based UnionBanCal Corp., part of Mitsubishi UFJ Financial Group Inc., Japan’s largest publicly traded bank. Leases on city property that backed the original debt will be consolidated into one lease assigned to Union Bank.

The restructuring will decrease the present value of the city’s payments 40 percent by reducing the interest rate and deferring amortization, according to John Knox, a partner at Orrick, Herrington & Sutcliffe LLP, the law firm representing Vallejo that drafted the bankruptcy-exit plan. Union Bank will also keep $6 million of unspent proceeds of the original debt.

Vallejo’s city council in November unanimously approved a five-year budget blueprint that is the basis for the exit plan. The blueprint aimed to pay down $195 million in unfunded pension obligations, trim retiree health-care premiums, curb benefits for new workers and create a reserve fund.
Busting Unions With Bankruptcy

Bloomberg writer Joe Mysak says Busting Unions With Bankruptcy Isn’t Chapter 9 Way
January 6, 2011

There’s nothing easy, or convenient, or cheap, or quick, or even predictable about Chapter 9. Those who talk about municipal bankruptcy as if it is any of those things, and the blogosphere is alive with such opinions right now, don’t know what they are talking about.

Even the lawyers who specialize in it don’t recommend municipal bankruptcy.

“Filing for bankruptcy protection under Chapter 9 should be considered a last resort, to be effected only after every effort has been made to avoid it,” wrote John Knox and Marc Levinson, partners at Orrick, Herrington & Sutcliffe LLP in San Francisco in their 2009 publication, “Municipal Bankruptcy: Avoiding and Using Chapter 9 in Times of Fiscal Stress.” Orrick is counsel to Vallejo, California, which in May 2008 entered bankruptcy and isn’t out yet.

The reason bankruptcy is so rare in the municipal market is because it could blow up the borrowing costs of every government in a state, as well as the state itself.

The bankruptcy judge is there to help the parties negotiate a plan of adjustment, not as some avenging angel intent on gutting the police union.

Full-service municipalities don’t enter Chapter 9 in order to liquidate or to fire the entire department of sanitation. They do so in order to continue as going civic concerns.

So even if a judge rejects some collective-bargaining agreements, the municipality will still be talking to the people who provide police, fire and sanitation services.

Remain Adults

“The best solution,” Spiotto said, “is a negotiated resolution where both sides retain their adult state, recognize what is reasonable, attainable and affordable and recognize what promises can be lived up to and what cannot.”

I like his reference to “adult state.”
The "Adult State"

Hello Joe, what is it do you fail to understand about these simple arguments?

  • If you don't have the money you can't pay
  • Taxpayers are tired of being taxed to death and there is a Mayoral recall right now in Miami over it
  • Public unions refuse to bargain on reduced pension benefits that are bankrupting cities

Judge Rules Vallejo Can Void Union Contracts

Flashback March 17, 2009: In a groundbreaking ruling as well as a rare victory for common sense and the overall good of taxpayers, Bankruptcy Judge Rules Calif. City Can Void Union Contracts.
In the first ruling of its kind, a bankruptcy judge held the city of Vallejo, Calif. has the authority to void its existing union contracts in its effort to reorganize, holding public workers do not enjoy the same protections Congress gave union workers at private companies.

Municipal bankruptcy is so rare that no judge had yet ruled on whether Congressional reforms in the 1990s that required companies to provide worker protections before attempting to dissolve union contracts also applied to public workers' union contracts

"This will have a huge effect nationwide if it is upheld," said Kelly Woodruff, of Farella, Braun & Martel in San Francisco, representing the firefighters and electrical workers unions. Woodruff said the unions would certainly appeal if the city ultimately voids the existing contracts with the two unions. "And I think we have a good chance of success," she said.

"My understanding is that a lot of cities are watching this and particularly this motion," said Woodruff. "If the city of Vallejo succeeds in using bankruptcy to void union contracts I am sure others will follow," she said.

Vallejo attorney Norman C. Hile of Orrick, Herrington & Sutcliffe's Sacramento, Calif. office said, "This is a decision that is somewhat groundbreaking."

"There are a number of other cities and government entities watching it very closely," he said, but declined to speculate on whether others would take the step Vallejo took of seeking bankruptcy protection.

The decision will be particularly important to cities with large unfunded pension liabilities, according to James Spiotto, of Chapman & Cutler in Chicago and a specialist in municipal bankruptcy who helped advise the Senate Judiciary Committee on Chapter 9 reforms.

He said the unfunded pension liabilities for states and cities was $800 billion a few years ago and may be at $1 trillion today. "The question is whether it is an inability to pay or an unwillingness to pay. If municipalities can't provide basic services and still pay labor costs or pensions then that is a real issue," Spiotto said.

McManus held that because Congress did not impose limits on invalidating union contracts under Chapter 9, cities must only meet the requirements under the U.S. Supreme Court's ruling in NLRB v. Bildisco, 456 U.S. 513 (1984), which gives broader discretion to break the contracts in bankruptcy.
I commented on the ruling at the time in Judge Rules Vallejo Can Void Union Contracts.
I am hoping this gets settled in court rather than out of court. In that regard, it's good news that the sides are not talking.

The union wage and pension agreements were absurd; the union refused to give in; and now the union got what it deserved for bankrupting Vallejo, California. This is a victory for Vallejo taxpayers, and actually, taxpayers in general as this is likely to be a precedent setting case.

Expect to see more cities file bankruptcy or threaten to, in order to get major union concession on pension funding. I am tired of sky high taxes for the benefit of the few while most private plans have suffered.

This was a good ruling. A tip of the hat goes to U.S. Bankruptcy Judge Michael McManus.
Vallejo Blew It

My big problem with Vallejo's announcement today is the city had the opportunity to rewrite union contracts and failed to do so. Thus Vallejo failed to fix its structural problem.

However, the key ruling is Vallejo had the right to do so. The next city to file, and I expect we will see new laws in Michigan to allow just that, will not be as lenient on unions as Vallejo was.

The fact of the matter is that more cities would do take this action if their mayors were not 100% owned and beholden to public unions.

The simple fact of the matter is numerous cities in this country are bankrupt. Union contracts and pension obligations are the reason.

CPAs Declare "Houston Is Bankrupt"

The city of Houston is Bankrupt.
Houston, we have a problem. We are bankrupt.

That is the finding of Bob Lemer, CPA, Retired Partner at Ernst & Young; Aubrey M. Farb, CPA, Retired Partner at Grant Thornton; and Tom Roberts, CPA, Retired Partner at Fitts Roberts.
That is from October 2009. Obviously Houston has managed to kick the can down the road. In the end it does not matter. Rule number 1: You cannot pay, what you do not have. Rule number 2: taxpayers have had it.

Cities cannot pay up unless they slash services or raise taxes. If unions refuse to negotiate, and so far they haven't, then cities are going to have no choice.

So they kick the can down the road just as Illinois did.

Illinois Pension Plans are $208 Billion in the Hole

Flash forward to fiscal year 2010 and take a look at Illinois pension liabilities as shown in Interactive Map of Public Pension Plans; How Badly Underfunded are the Plans in Your State?

Illinois pensions alone are $208 billion underfunded using realistic measures. The overall level of funding is 29%, the worst in the nation.

Click on the above link to see how your state fares.

The only problem here is states cannot go bankrupt. Fortunately, Congress is working on that now. However, states can default. And unless we get some "union adults" in the room, that is exactly what Illinois should do.

"No Question You'll See Cities Default"

Earlier today, before I saw the Vallejo plan, I noted a number of Mayors discussing bankruptcy. Please consider LA Mayor Says "No Question You’ll See Some Cities Default"; Mayor Daley Says "I wouldn’t doubt it"; NY Mayor Goes After Public Pensions

The gist of the story is Chicago Mayor Daley and Los Angeles Mayor Antonio Villaraigosa both warn of defaults. However, Mayor Villaraigosa downplays LA's default risk. He is mistaken. Police and firefighters have bankrupted the city. What cannot be paid, won't be paid and it is time for adults to realize that.

For more on LA, please see
L.A. to Shut Down City Departments in Budget Crisis; IBEW Local 18 Head: "How Taxpayers Feel Is Not Relevant"

Mayoral Graft and "Sacrifices" in L.A

L.A. Controller Says City Could Run Out of Cash by May 5

Please read those links. They show how and why LA is broke, how Villaraigosa is in bed with public unions, and why he is incapable of changing anything. Bear in mind, the links are about LA, but they are certainly representative of problems in many other cities.

Miami's Solution

Miami Mayor Carlos Alvarez is about to be kicked out on his ass, along with Commissioner Natacha Seijas. Both deserve it. Please consider Miami-Dade Commissioners set March 15 recall date for Alvarez and Seijas
Thursday's county commission meeting offered plenty of political drama, as the county's leaders set a date for a recall election for the mayor and one of their colleagues.

In the end, the commission voted to set one election for a recall vote for both Mayor Carlos Alvarez and Commissioner Natacha Seijas: March 15.

The inauspicious selection of the ides of March election date -- the day Julius Caesar was killed in the Roman Senate -- quickly echoed through the commission chambers. Seijas added to the Shakespearean atmosphere with her own "Et tu, Brute?" cry of betrayal, warning her colleagues: "Today it's me, tomorrow it might be you." After the vote, she told them: "It could come back to you and haunt you one day."

The recall drives erupted amid a public outcry last fall after commissioners adopted a new budget, proposed by the mayor, that raised the property tax rate while handing pay raises to most county employees.

Miami billionaire businessman Norman Braman took the lead in the campaign to oust the mayor. He hired professional consultants who gathered 95,499 petitions, about 43,000 more than the minimum needed to force a recall election.

Miami Voice, a political action committee headed by Vanessa Brito, is heading the effort to oust Seijas. Brito initially targeted five commissioners, but was able to get the needed signatures only in Seijas' case.
With an adult instead of a union sympathizer as Mayor of Miami, perhaps we will see an action Miami desperately needs: declaration of bankruptcy.

JPMorgan CEO Forecasts More Municipal Bankruptcies

Please consider JPMorgan’s Dimon Forecasts More Municipal Bankruptcies
JPMorgan Chase & Co. Chief Executive Officer Jamie Dimon said he expects more U.S. municipalities to declare bankruptcy and urged caution when investing in the $2.9 trillion public-debt market.

“There have been six or seven municipal bankruptcies already,” Dimon, 54, said yesterday at his company’s annual health-care conference in San Francisco. “I think unfortunately you will see more.”

Cities including Detroit and Harrisburg, Pennsylvania, have raised the prospect of bankruptcy. Still, the number of filings has declined.

“If you are an investor in municipals you should be very, very careful,” Dimon said at the conference.

Edmund “Ted” Kelly, CEO of Liberty Mutual Holding Co., said yesterday that his firm had reduced holdings of municipal debt in Connecticut, California and Illinois.

“The market is being held up to some extent by the belief that the federal government will bail out” state and local issuers, Kelly said in an interview.
Bernanke Will Not Rescue Cities

The first major city to declare bankruptcy will send a massive stir in the municipal bond market.

Fortunately, Bernanke has already stated he cannot and will not come to defense of cities. I believe Bernanke for the simple reason he is beholden to banks and bailouts of banks not bailouts of cities.

Moreover, I doubt a Republican Congress will bail out cities or state either. Legislation is even in the works to allow states to go bankrupt. Given that Illinois is indeed bankrupt, with an adult governor instead of someone in the unions' pocket, bankruptcy is a viable approach and one I recommend.

That said, I do think Meredith Whitney has it wrong about the dollar amount of defaults. Most cities will probably pay off the bondholders and stiff the public unions. Vallejo blew it in that regard, by failing to fix its structural problem.

However, if Oakland, Miami, Newark, and Detroit all file bankruptcy and all stiff the public unions and renegotiate public union contracts, maybe a few adults in the public unions will step up to the plate and negotiate some appropriate haircuts in pension contracts before cities file.

Don't count on it.

Mike "Mish" Shedlock
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