CHICAGO — Detroit's recovery may well depend on fair treatment of its bondholders, says bankruptcy expert James Spiotto.
For Detroit, which has filed for the largest municipal bankruptcy in the U.S., revival over the long term hinges on the ability to access the capital markets to finance economic development projects that will help grow the city, Spiotto said.
"What Detroit needs is a recovery plan, and that's investment in infrastructure, education, and essential services," said Spiotto, an attorney at Chapman and Cutler LLP and one of five panelists talking about distressed municipalities Thursday at the Women in Public Finance annual conference in downtown Chicago.
"You're going to need to finance that," he said. "Not everything can be a revenue bond."
Detroit emergency manager Kevyn Orr has proposed treating the city's general obligation bonds as unsecured, on par with pensions and retire health care costs. The treatment will spark a court battle as the city moves through the bankruptcy process, and may not be the city's last word on the issue, Spiotto said.
"For some of us, when we look at the Michigan constitution, which says that voter-assisted bonds are guaranteed, what does that phrase mean abut unlimited-tax general obligation bonds?" Spiotto said.
"If there is a specific pledge of tax revenues, can it really be used for other sources?" he said. "I don't think that book is written yet. Many times in bankruptcy, plans are floated but that isn't the final solution."
The cost of "stomping on your GOs" could be a borrowing penalty of 3% or 5%, which adds up over the 30-year life of the bonds, he said.
"That's [money] that isn't going to the workers, isn't giving relief to the taxpayer and everybody else," he said. "Municipalities in distress need more revenue, they need more taxpayers, they need more good jobs, because that's the future."
While Michigan's treatment of GOs as unsecured has rattled the market, Rhode Island took a different approach when Central Falls declared bankruptcy in 2011. The state passed a series of new oversight laws, including one that makes bondholders whole in case of a Chapter 9 filing. That law was designed to protect capital market access of other Rhode Island cities, said panelist Rosemary Booth Gallogly, the state's director of revenue.
When Central Falls declared insolvency, "we thought immediately that that was really a process that could threaten all the other communities in Rhode Island. Our policy discussion was, because Rhode Island is so small, we didn't want one community's actions to have a negative impact on all for the credit markets," Gallogly said.
"The other issue was when the voters approved the bonds it was a full faith and credit pledge, and we really thought it was very important to abide by that," she said.
While making bondholders whole, Central Falls imposed a 55% haircut on retirees.
"We really did have a very long debate on [retirees versus bondholders]," Gallogly said, adding that legislators decided to appropriate $2.6 million in a special fund to bring the haircut up to 75% over the next five years.
Central Falls had 108 retirees, which allowed officials to negotiate with each one individually, Gallogly said.
The perceived battle between retirees and bondholders can often be a false one, Spiotto said.
"I think there's a moral obligation to treat public workers fairly," he said. "The best way to ensure that is to make sure that the municipality can grow and attract taxpayers."
In other comments, the panelists agreed that states play a crucial role in helping distressed local governments. Michigan's law, which had been considered one of the nation's strongest oversight laws, is now looked at more skeptically, panelists said.
"Investors have been very, very comfortable with the process in Michigan, and that's being questioned to a certain extent," said Nancy Feldman, managing director, Wells Fargo.
"From an investor's perspective, if there's somebody besides the investor or the ratings agency looking over your shoulder, you're going to hopefully behave better," she said.
A relatively new Michigan law that awards additional state aid to local governments that accomplish certain tasks, like shifting to a new retirement plan or posting financial information, has been helpful, said Nicolette Bateson, the chief financial officer for the Detroit Water and Sewerage Department.
"It's too early to tell the impact, but part of it is challenging the mindset that's existed," Bateson said.
Early intervention by the state is key as is an effort toward building consensus among local and state officials and creditors, Spiotto said.
"Ultimately, when things get so bad, when everything is the most dismal, everybody comes together, and they solve the problem," he said. "That's not only been the history, but it's the only way you survive."