CHICAGO In a ruling outlining his approval of Detroit’s restructuring plan, the federal judge overseeing the Chapter 9 warned that the state of Michigan needs to ensure its cities can pay their pension obligations to avoid other municipal bankruptcies.
U.S. Bankruptcy Judge Steven Rhodes posted the 213-page ruling on the federal court web site on Dec. 31. It follows his verbal approval of the city’s plan of adjustment on Nov. 7. Detroit officially exited the largest municipal bankruptcy in the U.S. on Dec. 10.
The opinion here walks through the reasons why the judge believes the city’s plan of adjustment, which sheds $7 billion of debt and reinvests up to $1.7 billion into the city, meets federal criteria of being negotiated in good faith as well as fair and feasible.
Rhodes takes an additional step of making specific recommendations to the city and the state to help avoid a repeat of Detroit’s bankruptcy. If Michigan fails to follow through with its obligation to its local governments, history may show that the so-called grand bargain at the center of the city’s bankruptcy exit was a “massive mistake,” Rhodes warns.
As part of the grand bargain, Rhodes approved a settlement that allows the state to pay $195 million to Detroit pensioners in exchange for pensioners dropping the right to sue the state to recover the unfunded pension debt that the city cannot pay. That debt could be as high as $3 billion.
In his ruling, Rhodes says that the exchange of $195 million for a $3 billion liability is “reasonable, although perhaps at the lowest end of the range of reasonable settlements.”
But Michigan needs to assure that its local governments in the future are able to adequately fund their pensions, the judge says. A repeat of Detroit’s bankruptcy in the city or elsewhere in Michigan would show that the court’s approval of the grand bargain was a “massive mistake,” the ruling says.
“The court has found that the state contribution of $194.8 million in exchange for a release of liability on the pensioners’ constitutional claims is a reasonable settlement,” Rhodes wrote. “History will judge the correctness of this finding. It will judge that this finding was correct only if what happened here in Detroit never happens again. The state can sustain that finding in history only by fulfilling its constitutional, legal, and moral obligations to assure that the municipalities in this state adequately fund their pension obligations. If the state fails, history will judge that this court’s approval of that settlement was a massive mistake.”
Rhodes also recommends that the unions and retiree associations help protect pensions and the city’s revitalization in part by taking a “longer-term and broader view of the best interests of their members and retirees” with the goal of helping revitalize the city while protecting pensions.
The state and unions won’t be able to hold up their end of the bargain if the city does not report accurate financial information, Rhodes said, recommending the city adopt a series of annual reporting requirements suggested by an independent municipal finance expert hired by the court.
In reviewing his approval of the settlements resolving disputes tied to the city’s unlimited-tax general obligation bonds, Rhodes said the UTGO bond insurers had some strong arguments concerning the voter-approved property tax, and that a court fight would be costly and the result a “coin toss.”
“The UTGO bond insurers were not only motivated to protect their claims in this proceeding but were also highly motivated to avoid any negative precedent that could be used by other municipalities with UTGO bond financing,” Rhodes said. “For this reason, even a favorable outcome for the city in litigation could have had negative consequences for the city. The city may have lost access to the capital markets when it emerges from bankruptcy or it may have been required to pay higher interest rates for bond debt. On balance, the court finds that the city’s chance of success on the merits of the litigation was a coin-toss.”
In an emotional conclusion that echoed his verbal ruling, Rhodes says our society “holds dear the values of a fresh start and of second chances,” a value that is “manifested with brilliant clarity in our bankruptcy laws.”
“The city will have the fresh start that it needs and deserves under our federal bankruptcy laws,” Rhodes wrote. “The court urges the people of the city of Detroit not to forget [their] anger. Their enduring and collective memory of what happened here, and their memory of their anger about it, will be exactly what will prevent this from ever happening again. It must never happen again.”