Detroit bankruptcy: Governor authorizes filing, declaring 'no viable alternative'

The Detroit bankruptcy filing, which follows a decades-long decline in city finances that led to $18 billion in debt, sets the stage for a showdown with 43 public sector unions facing a drastic cut in pensions.

Detroit filed for bankruptcy Thursday, the largest municipal bankruptcy case in US history. The move followed a state-led intervention to revive the city’s finances, which had been failing for decades.

The historic filing is “recognition [Detroit] hit bottom, and it’s an opportunity to get a roadmap back to restructure itself and become [a city] that has a chance to right-size itself,” says Douglas Bernstein, a managing partner of Plunkett Cooney, a law firm in Bloomfield Hills, Mich. that specializes in bankruptcy law.

“That’s not to say it will be simple and not without pain,” he says, “but it’s recognition that things have to change.”

Among the reasons for the bankruptcy: systemic population loss, including from residential flight; high unemployment; a sharp decline in real estate values; and chronic corruption and mismanagement.

Gov. Rick Snyder authorized the petition, which was filed late Thursday afternoon in US Bankruptcy Court in Detroit. A press conference is scheduled for 10 a.m. EST Friday.

“This was a difficult decision, but clearly the right decision in my view because we have no viable alternative,” Governor Snyder, a Republican, told reporters in a brief teleconference late Thursday. “We have a great city, but a city that’s been going downhill for the last 60 years. This is an opportunity to say enough is enough.”

Snyder described the city’s $18 billion in debt and unfunded liabilities as “unsustainable,” saying that 38 cents of every dollar of city income is going toward debt repayment, legacy costs, and other obligations.

The slow march leading to this decision started in March when Snyder named Kevyn Orr, a restructuring specialist and University of Michigan graduate who represented Chrysler during its 2009 bankruptcy, as the Motor City’s emergency financial manager. Snyder said he received Mr. Orr’s recommendation to file for Chapter 9 bankruptcy on Tuesday.

Over the last few months, Orr negotiated with Detroit’s creditors to try and reduce the city’s debt, $5.7 billion of which is related to health-care costs for retirees. To date, he was only able to win commitments from two parties, Bank of America Corp. and UBS AG. Both banks agreed to accept 75 cents on the dollar, according to a report in the Detroit News.

While Snyder says he expects the restructuring to take place in a year, bankruptcy experts say it will take much longer due to the unprecedented and complex nature of the case.

“Chapter 9 broadly defines municipalities, but you have very few instances where you have had a true city file, which makes proceeding under this chapter somewhat unpredictable. There’s not much in the way of case law that gives guidance. So [the state] must not jump in blindly,” Mr. Bernstein says.

The Chapter 9 filing sets the stage for a legal showdown between the state and the 43 public sector unions operating in the city that say their pensions are protected under the state constitution, even though a federal bankruptcy judge has the authority to slash those benefits and invalidate union contracts.

Two lawsuits are already underway; one filing, representing three retirees and two city workers, is scheduled for a Monday hearing in Ingham County. Another lawsuit, filed by both the General Retirement System and the Police and Fire Retirement System of the City of Detroit, was filed on behalf of more than 32,000 active and retired city workers.

Under Orr’s proposal, current retirees enrolled in the city’s health-care system will be offered a new program that relies mainly on provisions of the US Affordable Care Act, also referred to as Obamacare. Orr also wants to stop payment on unsecured debt to fund safety services; pay creditors, including pension funds, less than 10 cents or less on the dollar; and restructure the city water department into a regional authority.

Besides saying that the state does not have the legal authority to make their pensions vulnerable in bankruptcy court, the unions also complain that the city has been wasting money over many years on high-paid consultants and six-figure salaries for top officials, at the same time that unions have been asked to make concessions.

They say that, under Orr, bargaining sessions have been perfunctory, and that they suspect Snyder’s authorization to force Detroit into bankruptcy was inevitable. 

“I have yet to sit down at a negotiating table with Orr to find out what is going on. He’s not really trying to sit down and bargain with anybody,” says Ed McNeil, of the American Federation of State, County and Municipal Employees Council 25 in Detroit.

“Everybody is getting rich off the city of Detroit, and you want workers to pay for it. If you are so broke, how do you consistently pay money out to vendors and consultants?” Mr. McNeil adds.

Another group likely to feel the pain of bankruptcy is the city’s unsecured creditors, who will receive $2 billion on the $11.5 billion owed. Orr wants to use $1.25 billion for enhanced safety and security measures, such as blight removal, street lighting improvements, and police and fire enhancements.

Bankruptcy also inevitably widens the racial and partisan divides between Detroit, which is ruled by Democrats and has a majority black population, and the rest of Michigan, which leans Republican and is majority white.

“There’s so much partisanship, not to mention racial politics embedded in this decision,” says Vincent Hutchings, a political scientist at the University of Michigan in Ann Arbor.

“[Detroit] is still the biggest city in the state, so improving the fortunes of the city would have positives for the state, but it’s going to be tough,” he says. “Even if we leave aside the underlying racial dynamic, the partisan divide is so sharp. It’s tough for a Democratic city to look favorably upon the actions of a Republican administration.”

Snyder sought Thursday to reassure Detroit residents that, despite the hard news, “tomorrow is a regular day,” and that a positive outcome was possible.

The bankruptcy offers an “investment for better services to citizens, which is clearly something citizen deserve … by resolving the city government issues, hopefully this is the last obstacle for the city of Detroit,” he said.

The psychological toll of living in a city that’s officially bankrupt is significant, but not much different than most residents have been living with for years, says Charles Ballard, an economist with Michigan State in East Lansing.

“So much psychological damage has already been done. It’s widely understood that Detroit is in a severe crisis. Is it that much worse than we already knew? I don’t think so,” says Professor Ballard. “I actually think the upside is substantial. You have a clean slate.”