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Thursday, July 25, 2013 3:43 AM

General Obligation Bondholders Beware: Detroit Bankruptcy Affirmed, Governor Shielded From Lawsuits; Triumph of Math Over Unions

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As hoped and expected Detroit Bankruptcy Protections Affirmed, Snyder Shielded.

Detroit can enjoy the protections of bankruptcy, including immunity from lawsuits related to the case, a federal judge ruled, extending that shield to Michigan Governor Rick Snyder.

U.S. Bankruptcy Judge Steeven Rhodes in Detroit today blocked lawsuits by public employee groups and pension funds who allegd the state overreached in seeking court protection from creditors. Such claims must be heard in bankruptcy court, Rhodes said. His ruling gives the city the opportunity it said it needs to address $18 billion in debt without disruptions.

Chapter 9 of the U.S. Bankruptcy Code, which covers municipalities, typically prevents creditors from taking actions against the debtor that might interfere with reorganization.

City unions and pension officials claim Snyder, 54, violated Michigan’s constitution by authorizing Orr to file for bankruptcy. Pension funds for retired city workers sued in state court to have the filing declared illegal.

Barring lawsuits against Snyder related to the bankruptcy would be unfair to Michigan’s citizens, said Sharon Levine, an attorney for the American Federation of State, County & Municipal Employees, part of the AFL-CIO.

“We’re taking away very fundamental constitutional rights,” Levine said.

Michael Artz, a lawyer for the American Federation of State, County & Municipal Employees, said outside court after the hearing that while the question of the constitutionality of the Chapter 9 filing should have remained in state court, the union “will fight whatever court we’re in.”
Fights by AFL-CIO Welcome

I welcome these fights by the AFL-CIO. Indeed I hope they spend every cent they have because they are going to lose.

And when they lose, others cities will decide to escape preposterous unions contracts and pension benefits via bankruptcy.

General Obligation Bondholders Beware

Several people emailed me that that bondholders should have nothing to worry about because the bonds are backed by tax revenue.


If that was the case, then there should be little to no difference in interest rates between such bonds. But there is. Just like there is a difference between Greek bonds and German bonds, even though we heard the ECB say for years "we say no to default".

Well guess what? The market was correct, not the ECB.

All bets are off in bankruptcy court because you cannot tax a hollow shell. And what is Detroit but a hollow shell?

Triumph of Math Over Unions

As for pension claims and the Michigan constitution? Same thing: You cannot pay what you do not have. This is the triumph of math and common sense over union greed, arrogance, threats, and coercion. 

Future Rating Impact

The Bond Buyer says Detroit Filing Could Impact Future Rating Analysis
CHICAGO - As Detroit enters into what would be the largest municipal bankruptcy in the U.S., ratings agencies said the outcome may have a negative impact on unlimited-tax general obligation bonds in future credit analysis.

Detroit emergency manager Kevyn Orr’s restructuring plan treats the city’s unlimited-tax general obligation bonds as unsecured, on par with the its lowest-secured debt, such as retiree health care benefits.

The move marks a departure from traditional treatment of ULTGOs, typically considered among the strongest municipal debt.

Orr’s plan, if accepted by a bankruptcy judge, may affect the way Fitch Ratings analyzes ULTGOs in the future, the ratings firm said in a comment released Friday.

Fitch analyst Amy Laskey said in a telephone interview that it’s still uncertain how broad the impact would be if a bankruptcy judge approved Orr’s plan.

“These are issues we’re talking about internally, how broadly that might extend,” Laskey said. “It would certainly make us reexamine the value to credit quality of having that unlimited-tax pledge versus other tax-supported obligations,” she said.

“Our feeling was that with unlimited-tax general obligation bonds you have the pledge to levy property tax without limitation to pay the debt, and that seemed somewhat more secure [than other tax-supported bonds],” said Laskey. “They do give you a little more financial flexibility because you have the ability and the obligation to pay for them, which you don’t have for limited-tax bonds, certificates of participation, or lease revenue bonds.”

If the city moves into Chapter 9, the case could set precedents when it comes to treatment of ULTGOs, she said.
Once again, I cite common sense: you cannot tax a hollow shell. Bondholders took a risk for higher yield, just as did buyers of Greek debt. If there was no risk, yields on Detroit bonds would not have been higher in the first place.

So, pensioners and bondholders both should take it on the chin.

Detroit Will Be In Bankruptcy 'For A Long Time'

Harvey Miller, partner at Weil, Gotshal & Manges, tells Bloomberg Law's Lee Pacchia that Detroit's recently filed Chapter 9 bankruptcy case will not be an easy restructuring. In addition to the profound economic challenges facing the city and the limited ability of a bankruptcy court to force changes on its government, the fundamental tension between bondholders, pensioners and taxpayers could mean Detroit will remain in tangled up in litigation for a long duration of time. "There's going to be a lot of legal fighting in this," he says.

Link if video does not play: Harvey Miller on Detroit Chapter 9

Expect a lot of municipal bond downgrades before too long. Downgrades are coming, deserved, and welcome.

Mike "Mish" Shedlock

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