CHICAGO — In a wide-ranging deposition given a day before his surprise resignation, Michigan Treasurer Andy Dillon described Detroit's descent into bankruptcy and the legislation he helped craft to handle a growing number of troubled local governments across the state.

Dillon was deposed, along with Gov. Rick Snyder and top Snyder aide Richard Baird, last week ahead of a series of hearings starting Tuesday that will determine if Detroit is eligible to enter into bankruptcy.

U.S. Bankruptcy Judge Steven Rhodes will hear legal challenges to eligibility this Tuesday and Wednesday, and factual challenges on Oct. 23 and 24. No bondholders or insurers objected to Detroit's eligibility under Chapter 9 of the bankruptcy code.

Dillon announced his resignation Friday. He stepped down after months of bad press surrounding a bitter divorce, a stint in alcohol rehab, and other problems that he said had become a distraction.

Snyder told local reporters last weekend he is working quickly to appoint a new treasurer.

Throughout the three depositions, union attorneys tried to prove that state officials and Orr decided months ago to cut pensions despite constitutional protections, and that they saw Chapter 9 as the best route to do that. They also tried to prove that the city did not negotiate in good faith with unions and retirees.

In his deposition, Dillon, a former Democratic Speaker of the House, said he first turned down the position of treasurer when Snyder, a Republican, offered it to him in the fall of 2010, but later reconsidered because of the challenges facing many of the state's local governments.

It seemed to be "fascinating job and a fascinating time to have it," Dillon said in response to question from Jack Sherwood, the attorney for the American Federation of State, County, and Municipal Employees.

"We understood that there could be a lot of troubled cities and school districts in the queue, so it was on our radar before we started," Dillon said. "We understood that we would be inheriting some financial crises throughout the state and we thought there was more to come."

The Motor City was also on radar as soon as the Snyder administration took office in January 2011. But it took about six months before the state started to focus on the city, Dillon said.

"And then Detroit started to experience, you know, cash crunches" in late 2011, he said. The state hired an Ernst and Young consultant to start examining the city's books.

In the spring of 2012, the state declared the first fiscal emergency in Detroit and entered into a consent agreement with the city. After several months, the city continued to struggle, and officials brought in investment banking firm Miller Buckfire and restructuring firm Conway MacKenzie, among other firms, to try to address the problems.

Dillon said at that point he told the governor that if the city's cash dwindled to the point where it had $50 million or less, the state should launch another financial review.

"It wasn't until December of 2012 where I had a meeting with [Detroit program manager] Chris Andrews ... and the city had gone through, don't hold me to the number, but tens of millions of dollars of cash from September through December where their disposable cash was eroding rapidly and immediately after that meeting I called the governor and said, 'I think they're at the $50 million threshold and I think we have to commence another review immediately,'" the treasurer said.

Union attorneys questioned Dillon closely about discussions surrounding new legislation to broaden the state's power to intervene in troubled local governments. When he first took over, Snyder pushed for a new emergency management law to replace the existing law, which the state thought lacked the key power to cut labor costs, Dillon said.

"What we found, typically for a governmental unit, 75% give or take of your costs are wages and benefits," he said. "We spent a lot of time on this issue about, you know, the constitutionality of can you modify a collectively bargained agreement. But the thought was we had two conflicting constitutional provisions here. One is the prohibition against impairing of contracts and then the other is the duty of the state to provide for the public health, safety, and welfare."

The administration decided that it was constitutional to temporarily modify an agreement until the financial crisis is over, and Public Act 4 was signed into law in March 2011. It sparked controversy from the start and voters overturned it in November 2012. Sherwood asked Dillon how he responds to critics who said the law was dictatorial.

"I think it's just a harsh reality that when you have a, whether it be a school district or a city in the severe financial crisis, that you've got to have someone that can make decisions and oftentimes what you'll find is the governance, more in cities than in many school districts, makes it very difficult to navigate through a financial crisis," Dillon said.

Sherwood asked why the credit markets — specifically credit firms like Moody's Investors Service — believed that Public Act 4 was good for the state.

"Detroit is a good example," Dillon said. "The health of your biggest city has an impact on the health of the state, right, and if you have a city of 700,000 folks that don't have access to public safety, kids can't walk safety to school, there's no lights on, that's going to have a negative impact on the state's economy."

After the repeal, Snyder, Dillon and top lawmakers worked on a new law that was then passed during the lame duck session. Public Act 436 took effect in March 2013, just three days after Orr took office. That law includes the same powers as Public Act 4, but also increases choices for local officials who face a takeover.

Sherwood questioned Dillon about a Bond Buyer article where Dillon said the criticism of the EM law reflects a misunderstanding of the municipal market, and that "Main Street's saying that everyone should share the pain" doesn't allow troubled credits to access the market.

"Oftentimes when a unit gets into financial trouble they can't access the market on their own," Dillon tells Sherwood. "So the way that they can access the market is they'll work with treasury, where we say, 'All right, if you are going to borrow money we will tell the bond money providers that we will intercept the money, make certain that you get paid first.'"

"At what point is it appropriate if ever for the bondholders with intercept agreements or other special collateral arrangements to share the pain?" Sherwood asked.

"A lot of this calls for a legal conclusion," Dillon said. He cited Detroit's agreement with the interest-rate swap counterparties that gave the counterparties a lien on casino revenue as a secured lien and a 2012 private placement with Bank of America Merrill Lynch that had a lien on state aid.

"If the lenders did their job and got the legal requirements that they need to and have the priority, the first right, to that revenue stream, then they're probably protected," he said.

"If they have defects in the legal work or they don't have a contractual right to that revenue stream they probably will be treated like any other creditor," Dillon said.

"By the same token, the holders of the vested pension and retirement benefits have the protection of the constitution," Sherwood said. "Why is that they have to make a sacrifice in the context of a Chapter 9 case but not the bondholders?"

Dillon's attorney objected, and the treasurer said: "Yeah, I mean, I think those are decisions that would be made by a judge at some point."

Dillon said he also had to take "economic realities" into account.

"It's still there in the constitution, but if the unit can't pay the pension they can't pay the pension," he said.

"Why doesn't that logic also apply to the bondholder creditors of the city of Detroit?" Sherwood asked.

"I'm not certain that it doesn't," Dillon responded. "If the unit doesn't have the money to pay their bondholders there's a problem, and I guess that's what Chapter 9 is for or some type of effort to resolve it in a different way."

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