The media's been in its customary mid-summer doldrums, all made slower by scorching heat and thoughts of vacation. Even CNN is in continuous rerun mode. Then came Detroit's filing for Chapter 9 protection and up came talk of municipal meltdown.
The well-known decline of Detroit and symbiotic relationship to the auto industry has now been sufficiently regurgitated. Arguably-credentialed talking heads wax profound yet non-committal. The New York Times even finds room on its editorial page for a column by investment banker Steven Rattner entitled "We have to Step In and Save Detroit." This makes for great Hamptons beach reading where a few of Steve's pals could remedy the situation by putting back a small percentage of what they've sucked out of Detroit and the American economy. Besides I'm always worried that when guys like Rattner say "we" he means "me."
Chicken Little is alive and well. This hoopla takes me back to when I made a bankruptcy filing for Harrisburg, Pennsylvania. The media frenzy was over the top. Al Jazeera reporters from Los Angeles, NYC and Washington, D.C., converged on my home with the following softball question: "Isn't Harrisburg's filing symptomatic of the failure of the American economic system and the implosion of its cities and towns?" Substitute Detroit for Harrisburg and the long answer remains: "No."
Those of us with any Chapter 9 experience know that all that the filing does is give Detroit time to file a plan with the Court. The process bears no resemblance to corporate bankruptcy whatsoever, thanks to federal recognition of the primacy of state rights when it comes to local finances. As a result, in Chapter 9, there is no estate created for a judge or trustee to administer. There are no formal creditors committees, no voting, and no priorities. The debtor must simply put forth a plan to be accepted or rejected by the Court.
Chapter 9 is an uncharted free-for-all. Moreover, there is no body of current case law to guide us. So let's not mistake guesswork for expertise in extrapolating what happened in Vallejo, Jefferson County, Stockton, or Harrisburg to anywhere else. It all comes down to fundamental fairness, hopefully with an eye towards provision of core services for a citizenry. And that is how it should be.
Now back to my pet peeves:
First, the muni market has not crashed with Detroit's, or others', filings. Ironically, the day that Detroit filed, Central Falls, R.I., a city recently coming out of bankruptcy, was upgraded by the rating agencies. Headlines fade and the markets are forgiving, perhaps too much so. I've long felt that the muni market is bolstered by an insatiable appetite for tax-free investments that will forever ensure Wall Street's ability to market any piece of garbage.
Second, I am irritated by those ever-whining bond insurers. I'd be in the Hamptons too if I had the foresight decades ago to create this scam. It was so simple. Municipal issuers could forget about their own marginal credit and substitute the AAA credit of an insurance company for a price. It was a no brainer as long as premiums cost less than the interest costs of going it alone into the market. For decades bond insurers lived the orgasmic dream of taking in premiums and never paying out. Never mind that borrowing on someone else's credit might have inevitable consequences. Now they cry foul wanting to be paid ahead of everybody else. They say that their contract is a contract. Legally this isn't necessarily the case. Moreover, keep in mind that a bet is always a bet. And they bet wrong.
Third, I am bothered by what I am hearing from a group I have sympathy for: bondholders. Buyers of bonds gone south did not buy them based on digesting an indigestible prospectus. They don't have an indepth understanding of an issuer's finances. They bought them relying on representations of underwriters and bond lawyers and those unfailing rating agencies. Can it be that phrases like: "full faith and credit" and "unlimited taxation pledge" are no longer sacrosanct? Yet, what about similar pledges on senior debt by Detroit's own Chrysler, General Motors, as well as every corporation that ever went bankrupt? The result was cents on the dollar.
American industry has long and routinely used bankruptcy as a practice to shed and reshape erstwhile obligations. This is unfortunately something that municipal bondholders will increasingly have to stomach. Yet, instead of turning their wrath on issuers, they might more profitably obtain redress from the bankers, lawyers and the rating agencies which launched the bad paper to begin with.
Mark D. Schwartz is a Bryn Mawr, Pa., lawyer, originally trained
as a municipal bond counsel who subsequently was a public finance banker.
He represented the City Council of Harrisburg in an attempted Chapter 9 filing.
In addition to his litigation practice Mr. Schwartz is working on a book tentatively
titled Capitol Murder — Harrisburg: The Intersection of Wall and Main Streets.