Honest answers to your bankruptcy questions

[douglasm]

Professor Scott makes a valid point that we all tend to get hung up on. How we got here is of little concern, except for history writers. What is to be done about the current issue is the pressing question.

[Locke09]

Professor Scott makes a valid point that we all tend to get hung up on. How we got here is of little concern, except for history writers. What is to be done about the current issue is the pressing question.

You always need to know how you got somewhere. Failure to figure that out is why we tend to repeat the same mistakes and why our "solutions" rarely seem to address the real problem.

That being said, Coleman Young did not leave office with a deficit. If he was corrupt, and with the FBI dogging his every step it was never proven, then it didn't seem to hurt the bottom line much.

As bonds have been paid off in Detroit over the years, mayors have been extraordinarily successful in getting residents to extend existing bonds, and approve new bonds by stating that property taxes would not go up or would only go up a little bit. The state had to approve those bonds. I don't recall the newspapers ever recommending a no vote on a bond. I swear some years it seemed like I was the only person among all the people I knew yelling, "Vote no". I couldn't get people to understand that if property tax revenue was declining, that meant those bond payments would end up eating into the money that should have been used for operations.

Want a lesson from history? Stop voting yes on every bond they propose for building new police stations, new bus stations, new schools, etc., etc. etc.

[mikefmich]

Great thread, great information & thought. Carry on boys & girls!

[Hypestyles]

I wonder how long the lawsuits and counter-suits will delay the processes in bankruptcy court?

[BankruptcyGuy]

I wonder how long the lawsuits and counter-suits will delay the processes in bankruptcy court?

There likely won't be any more lawsuits outside of bankruptcy court. Initiation of a bankruptcy proceeding stays [[puts a hold on) all litigation in any other court.

After a bankruptcy is filed, there will be one benefit of having an EM--they won't need council/mayoral action to make decisions on bankruptcy issues and file pleadings/motions. Only the EM will need to act.

[313WX]

BankruptcyGuy, my understanding is that the bankruptcy judge can order a moratorium on the city's debt owed to creditors during the bankruptcy.

Does that apply to all debts [[unsecured to secured)? And also, what impact would that have to the city in terms of any benefit to its residents?

[Wesley Mouch]

Professor Scott makes a valid point that we all tend to get hung up on. How we got here is of little concern, except for history writers. What is to be done about the current issue is the pressing question.

What is to be done? The answer is NOTHING. Stop fighting and embrace bankruptcy. Anything else is only a power trip. You may hate everyone and everything about this -- but for the city's sake -- get out of the way.

[BankruptcyGuy]

BankruptcyGuy, my understanding is that the bankruptcy judge can order a moratorium on the city's debt owed to creditors during the bankruptcy.

Does that apply to all debts [[unsecured to secured)? And also, what impact would that have to the city in terms of any benefit to its residents?

Let me divide your question into two parts. First, when an entity files for bankruptcy, payments on loans are stopped. There is an exception that likely doesn't apply to Chapter 9 cases, so I'll skip that, but as of now, no payments are being made on any debt. So that happens right away.

Now, going forward, the City files what they call a "plan of adjustment" for debts going forward. They can propose to the court paying certain debts at certain different rates and terms, subject to two basic rules:

1. The absolute priority rule, which says that secured creditors get paid before unsecured creditors [[there are other categories, only one of which is relevant that I'll discuss below); and
2. The plan must treat similarly situated creditors similarly.

So the plan must pay first administrative expenses, which include operating expenses of the City going forward. If the EM says it will take an extra $100 million to run the City properly, it's going to be hard for any creditor to object.

Second will be secured creditors -- that's mostly DWSD debt.

The EM has elected to classify all other creditors, which include bondholders and the unfunded pension liability as one class. Within that class, everyone has to be treated equally. The pensioners will object to the classification, saying they should be treated with higher priority. If they are successful, they will get more. If not, they'll get the same percentage as bondholders.

Is there a plan that would be approved that would pay bondholders nothing? No.

As I indicated, I think the EM will allocate a bunch more money for operating expenses, and if so, and that's approved, city services may improve.

[douglasm]

BankruptcyGuy.....

Would you talk about the difference between secured and unsecured loans? Some people are complaining that pension funds will not be paid out while other bondholders will continue to receive payment.

As I understand it, things like sewer and water bonds are secured in that there is a revenue stream from sewer and water bills to pay for the infrastructure. This is how we financed our sewer system and treatment plant. Pension funds are not secured by a dedicated revenue stream thus are lower down on the totem pole, right?

And a secondary question. Out here, we have an ice arena whose bonds were secured by the anticipated revenue generated by the arena. It didn't make it's projections and came close to failing. Assuming that senerio for sewer and water bonds, what then is their standing.

Thank you for a very informative discussion.

[corktownyuppie]

As I understand it, things like sewer and water bonds are secured in that there is a revenue stream from sewer and water bills to pay for the infrastructure. This is how we financed our sewer system and treatment plant. Pension funds are not secured by a dedicated revenue stream thus are lower down on the totem pole, right?

I'm gonna let the expert chime in about the answer on the pension question. For the sake of clarity, I'd also like to propose that he clarify some terms which are used interchangeably even thought I believe they actually mean different things.

Pension Liability: These are the promises the city made to employees while they were working to fund their retirement until they die.

Pension Fund: These are funds which have already been set aside from the city budget and are, therefore, not subject to other creditors or even a bankruptcy court.

Pension Funding Levels: This number, expressed from 0% to 100%, describes to what extent the funds that are in the plan will be enough to cover the promises [[so far) already made to existing employees and retirees.

Is that right?

So the issue in front of the court is as follows:

- If the funding level of the pension fund is less than 100%
- And knowing that the city is contractually obliged to keep it at 100%
- Then to which level of priority should the pension liability be assigned? In front of General Obligation Bonds? Behind Secured Creditors? At the same level of other unsecured debt?

Etc.

In either case, it should be noted that if the Bankruptcy Court has no ability to seize already existing pension funds for other creditors, then we the public must insist that there is no such threat as "having pensions get wiped away" while acknowledging that pension payments may be limited only to the level of funding which is already in the pension funds.

[Novine]

If the Bankruptcy judge says the city can get out of its future pension obligations for current employees, then those employees very much face the likelihood of having their pensions "wiped away".

[Eber Brock Ward]

If the Bankruptcy judge says the city can get out of its future pension obligations for current employees, then those employees very much face the likelihood of having their pensions "wiped away".

Please respond to this, Novine:

- The pensions are funded at anywhere between 75-95%, for the projected actuarial cost of presently vested pensioners, depending on who you ask and which of the two pensions you are talking about.
- The portion that Orr says is an unsecured debt is the remaining 5-25% of the pension liability.

Do you have a different understanding of this? If so, where does it come from? My understanding of the situation is that the vested pensioners are projected to get, at a minimum, 75-95 cents on the dollar, and that the remaining 5-25 cents is what's at risk.

I'd hardly call someone getting 75-95 cents on the dollars, minimum[[!), as them getting "wiped away."

[Richard]

"Until we filed for Chapter 9, the City of Detroit has not once ever failed to make General Obligation bond payments."


Exactly. The point is that the city's never missed a GO bond payment because there's a defined revenue stream to make those payments. The same is true of water and sewer bond payments. Those payments are made by users inside and outside the city who use the water and sewer systems. The fact that the city has "no money" has no impact on those bond payments.


Orr and Snyder have followed a strategy of disinformation to conflate all of the outstanding liabilities into "$18 billion in debt" knowing that few people are going to bother to unwind the various parts of that to understand the differences between the various liabilities. Why lead people to believe that city taxpayers are on the hook for billions in water and sewer debt when we know that's not the case? Why present pension benefits that may not be due for 20 or 30 years as obligations due today?


Having watched this unfold, this appears to be a deliberate strategy by Orr and Snyder and I think I know why. If you look at the list of liabilities, it's clear who are going to be the biggest losers from bankruptcy. It's going to be the current and retired city employees. When you break out the billions in listed liabilities, the majority those accrue to current and retired city employees. But Orr and Snyder want to convince the public that everyone is going to share the pain. That's why they are making such a big deal of the fact that they are going after the GO bond holders. They've even promised that pension benefits won't be touched for 6 months. But in the end, if allowed to proceed forward, bankruptcy is going to result in massive cuts to the benefits for current and retired city employees.


Quoting Ezra Klein - "The two main groups of creditors arguing they’re entitled to that money are public employees and retirees, and bond holders. The investors are likely to make out better, since more of that debt is secured; the city will continue to pay water and sewer bondholders. Most of the pension debt has no similar backstop."


The first cut will be retiree health care benefits. Those aren't constitutionally protected and will get axed quickly. Presumably, the promise of pension benefits for current employees will be gutted too. But the real goal for Orr and Snyder will be the pension benefits for current retirees. Those are the biggest target but Orr and Snyder realize that this will be the hardest sell. People are likely going to be sympathetic to the plight of retirees seeing their pensions cut after losing health care coverage. That's why Orr and Snyder need to get the general public believing that the pensioners are collateral damage in an effort to take on the bond holders and big banks. By the time it becomes clear that the bondholders and big banks aren't going to take a big hit, and why would they with dedicated revenue to pay off their bonds, only then will people realize that its the employees, current and retired, who are the real targets and the ones who will lose the most in bankruptcy.

GO bonds are 3% of the total and are covered and insured and play the biggest role in future borrowing costs,the bond insurers came to the table,one delayed future payments the other had a workable plan.

The biggest issue is underfunded pensions across the country,a judge cleared a 50% haircut in another case.

If they could separate pension debt from the other then it would probably be a non issue but it all gets lumped.

[Novine]

"Do you have a different understanding of this? If so, where does it come from? My understanding of the situation is that the vested pensioners are projected to get, at a minimum, 75-95 cents on the dollar, and that the remaining 5-25 cents is what's at risk."

My understanding is that bankruptcy would not only wipe out the unfunded portion, it would also close the system and leave the city off the hook for future contributions. If that's the case, the payouts to current retirees, over time, would make it less and less likely that those vested today but who haven't retired, would get much of anything because there would be no new contributions coming into the system. Are the actuarial assumptions based on that scenario? I would bet that they are not.

[Eber Brock Ward]

"Do you have a different understanding of this? If so, where does it come from? My understanding of the situation is that the vested pensioners are projected to get, at a minimum, 75-95 cents on the dollar, and that the remaining 5-25 cents is what's at risk."

My understanding is that bankruptcy would not only wipe out the unfunded portion, it would also close the system and leave the city off the hook for future contributions. If that's the case, the payouts to current retirees, over time, would make it less and less likely that those vested today but who haven't retired, would get much of anything because there would be no new contributions coming into the system. Are the actuarial assumptions based on that scenario? I would bet that they are not.

Actuarial assumptions build in a rate of return going forward.

If one were to apply how I've seen pension funding levels be stated in other jurisdictions, the City could cease to exist today, and not another dime could *ever* go into the pension systems [[other than investment returns), and the vested folks in the system would still be getting 75-95 cents on the dollar.

This accounts for things like life expectancy, expected rate of return on investments, and so on.

Any contributions the city makes going forward from a particular date when funding level is stated would be to make up that 5-25 cents shortfall and to add money for people that have yet to vest.

If we prevent any non-vested person from vesting in the system and shut down the program, then the vested folks will not see less than what the current funding level is.

Does anybody have any information that runs counter to this? I'll gladly be corrected if this is wrong, but, because of this, I just can't buy into the doom and gloom about pension stuff. Not when public safety is awful and streetlights are out, at least.

[Novine]

A closed fund can't invest in the same way that an open fund can because it has to put more and more of its investments into conservative holdings to ensure that it can continue to make payments to retirees. This is why closing pension funds can be a costly proposition for municipalities because contribution levels have to go up to take into account this shift in assets.

"As a closed DB plan ages, fewer contributions due to fewer active members, relative to retiree benefit payments, increases the need for more liquid assets. This creates a need to shift assets to investments that have a more predictable cash flow such as bonds. This generally has a negative impact on the fund and results in lower investment income. This lost investment income needs to be covered by additional contributions. These contributions may come from the employer, the employee or a combination of both."

http://www.calpers.ca.gov/eip-docs/closing-impact.pdf

In Detroit's case, this process would be accelerated if the city was allowed to forego making any future contributions to the pension fund.

[professorscott]

Freep says Judge Rhodes has ruled that he has jurisdiction in the dispute between the pensioners and the City [[which seems to mean that the Ingham County judge does not).

[DetroitPlanner]

Amid the gloom here are some numbers you hipsters will enjoy. Neighborhood people not so much, its more of a verification you're the baby getting tossed out with the bathwater.
http://www.brookings.edu/research/op...y-katz-bradley

[Lowell]

Here is an interesting piece about bankruptcy and debt that was passed along to me today. Is anyone in the US currently doing time for failing to pay their debts?

In today's selection -- is failing to pay a debt a moral failure and criminal matter that should be punished by jail or worse? Or is it instead a contractual matter, the province of civil courts and the risk management practices of lenders? This question has never fully been settled in any society, and individuals have disagreed vehemently on the issue. And since widespread lending to individuals has existed since the very beginnings of civilization in Mesopotamia, this debate is one of the oldest and most central that societies continually face. In fact, some see this question as the very foundation of the world's great religious and philosophical systems, since language and parables regarding debt are found throughout all of them -- including Christianity [[forgive us our debts, as we forgive our debtors), Islam, the Analects of Confucius, and Hinduism and the texts of the Rigveda.

"In the United States, some of our greatest patriots landed in debtor's prison -- including Robert Morris, the Philadelphia merchant who financed major portions of the Revolutionary War, and Henry "Light-Horse" Lee, the Revolutionary War general and father of Robert E. Lee. And so it was that in 1800, American debtors rejoiced as the first American bankruptcy law was enacted that allowed individuals to discharge their debts without the consequence of jail, but their relief was short-lived as it was repealed in 1803. It was not until 1898, after more false starts, that the first truly modern and durable bankruptcy law was enacted. Nevertheless, imprisonment for debt in the U.S. is on the rise again, with private debt levels near all-time highs and more than a third of U.S. states currently allowing imprisonment for non-payment of fines or debt.

"When news reached the New Gaol in New York late in March 1800 that Congress had passed a bankruptcy bill, the debtors imprisoned there gathered 'to celebrate the auspicious event.' They enjoyed 'a rich repast of social conversation, on the prospect of returning to the world, and the bosom of our relatives and friends,' then drank a series of seventeen formal and volunteer toasts: 'The Bankrupt Law, this Godlike act.' 'God forgive those of our creditors, who have reviled us and persecuted us, and spoke all manner of evil against us, for the sake of money.' 'May imprisonment for debt, with its corrupt and destructive consequences, no longer deface God's image.' 'May the pride of every debtor be to pay his just debts, if ever in his power; and shun offers of credit in future as destructive to his life, liberty, and property.' 'May wisdom and justice draw the line between the honest and fraudulent debtor.'

" 'This Godlike act' was the controversial, short-lived Bankruptcy Act of 1800 -- the high-water mark of debtor relief in the eighteenth century. 'Controversial' because it enabled debtors to escape debts they could not repay and, moreover, granted that boon only to commercial debtors whose success had allowed them to amass debts that were beyond the means of less prosperous debtors. 'Short-lived' because it was too ideologically charged to survive the Jeffersonian revolution. The tide of reform quickly receded, but the Act nonetheless marked a transformation in the moral and political economy of eighteenth-century America. Virtually every toast offered in its honor by the debtors imprisoned in New York turned deeply rooted attitudes toward insolvency and bankruptcy on their head. Earlier in the century, bankruptcy relief was not so much controversial as unthinkable. By 1800 debtors and creditors alike desired it.

"Whether a society forgives its debtors and how it bestows or withholds forgiveness are matters of economic and legal consequence. They also go to the heart of what a society values. Consider, for example, Samuel Moody, minister at York, Maine, who in 1715 related to his congregation the scriptural lesson of the widow who approached the prophet Elisha, distressed that 'the Creditor is come to take unto him my two Sons to be bond men.' [A frequent practice in ancient times was to take a debtor's children when loan payments were not made.] When Elisha learned that she had no property left save one pot of oil, he instructed her to gather all the empty vessels she could and fill them from that one pot, which she did. When she returned to Elisha with news of the miracle, he told her, 'Go, sell the oyl, and pay the debt, and live thou and thy children off the rest.'"

Author: Bruce H. Mann
Title: Republic of Debtors
Publisher: Harvard University Press
Date: Copyright 2002 by the President and Fellows of Harvard College
Pages: 1-2

[BankruptcyGuy]

BankruptcyGuy.....

Would you talk about the difference between secured and unsecured loans? Some people are complaining that pension funds will not be paid out while other bondholders will continue to receive payment.

As I understand it, things like sewer and water bonds are secured in that there is a revenue stream from sewer and water bills to pay for the infrastructure. This is how we financed our sewer system and treatment plant. Pension funds are not secured by a dedicated revenue stream thus are lower down on the totem pole, right?

And a secondary question. Out here, we have an ice arena whose bonds were secured by the anticipated revenue generated by the arena. It didn't make it's projections and came close to failing. Assuming that senerio for sewer and water bonds, what then is their standing.

Thank you for a very informative discussion.

You've got it right: secured debt has some collateral [[in this case, cash flow from water customers), while unsecured debt has none. Secured debt gets paid first, even in Chapter 9 proceedings.

Pension obligations are indeed unsecured. The question is: does Section 24 of the Michigan Constitution mean that these obligations are guaranteed by the State?

Your second question is far more complicated. Did those bonds have a recourse party [[guarantor)? If so, collection can be had by that party? That would be rare, however. On the bond deals I've worked on, those types of bonds have been non-recourse. Either the tax dollars are there to pay the bonds, or not. They are much higher risk than even unsecured muni bonds.

[BankruptcyGuy]

I'm gonna let the expert chime in about the answer on the pension question. For the sake of clarity, I'd also like to propose that he clarify some terms which are used interchangeably even thought I believe they actually mean different things.

Pension Liability: These are the promises the city made to employees while they were working to fund their retirement until they die.

Pension Fund: These are funds which have already been set aside from the city budget and are, therefore, not subject to other creditors or even a bankruptcy court.

Pension Funding Levels: This number, expressed from 0% to 100%, describes to what extent the funds that are in the plan will be enough to cover the promises [[so far) already made to existing employees and retirees.

Is that right?

So the issue in front of the court is as follows:

- If the funding level of the pension fund is less than 100%
- And knowing that the city is contractually obliged to keep it at 100%
- Then to which level of priority should the pension liability be assigned? In front of General Obligation Bonds? Behind Secured Creditors? At the same level of other unsecured debt?

Etc.

In either case, it should be noted that if the Bankruptcy Court has no ability to seize already existing pension funds for other creditors, then we the public must insist that there is no such threat as "having pensions get wiped away" while acknowledging that pension payments may be limited only to the level of funding which is already in the pension funds.

I agree that there has been a ton of confusion over what's being discussed. There are two obligations here:

First, there is the City's obligation to pay the Pension Funds [[which are two separate entities [[DGRS and DPFPS), each with something like $3-4B in assets).

Second, there is the Funds' obligations to pay pensioners.

The latter obligation is not impacted. The issue is that if the Funds have more promises than money, they will eventually run out. And when that happens... they look to promise #1.

So what obligations does the City have to the Pension Funds? Those obligations are defined by very complex actuarial tables and very complex accounting. The second sentence of that same Section of the Michigan Constitution requires that all pension obligations be fully funded. It's likely been violated.

In private-sector situations, when a company cancels a pension plan, the assets are paid out to pensioners proportionally to earned benefits. If it's 75% funded, everyone who's earned a pension gets a 25% haircut.

In this situation, there are likely four creditor groups:

1. Retirees [[funded portion);
2. Retirees [[unfunded portion);
3. Current employees [[who may have contributed to the pension and not be vested yet); and
4. Current employees, with respect to some right to have a pension waiting for them in the future.

#1 is not going to be impacted.
#4 is likely to be cancelled by the City, over the objection of the unions that represent them.
#2 is where the possible state guarantee comes into play. Now you can see why everyone's fighting over the size of it. Although in the end, the City can freeze the pension, and eliminate any future requirement to fund the pension.
#3 is also an interesting case. State law probably allows the termination of a pension plan, but I'm not sure exactly what the rules are with respect to that group.

The retirees will take a haircut. How large? That remains to be seen.

[BankruptcyGuy]

Here is an interesting piece about bankruptcy and debt that was passed along to me today. Is anyone in the US currently doing time for failing to pay their debts?

Interesting. The only thing I've heard of is where the Court levies a fine, and then can hold a party in contempt for not paying the fine. That's exceedingly rare.

[BankruptcyGuy]

Freep says Judge Rhodes has ruled that he has jurisdiction in the dispute between the pensioners and the City [[which seems to mean that the Ingham County judge does not).

I'm surprised the Court of Appeals hasn't overruled her order. It has no effect anyway.

[Jimaz]

... Is anyone in the US currently doing time for failing to pay their debts?

I thought that practice was lost to history but apparently it does happen. I found this list of stories at ACLU: Debtors' Prisons.

[corktownyuppie]

In private-sector situations, when a company cancels a pension plan, the assets are paid out to pensioners proportionally to earned benefits. If it's 75% funded, everyone who's earned a pension gets a 25% haircut.

In this situation, there are likely four creditor groups:

1. Retirees [[funded portion);
2. Retirees [[unfunded portion);
3. Current employees [[who may have contributed to the pension and not be vested yet); and
4. Current employees, with respect to some right to have a pension waiting for them in the future.

#1 is not going to be impacted.
#4 is likely to be cancelled by the City, over the objection of the unions that represent them.
#2 is where the possible state guarantee comes into play. Now you can see why everyone's fighting over the size of it. Although in the end, the City can freeze the pension, and eliminate any future requirement to fund the pension.
#3 is also an interesting case. State law probably allows the termination of a pension plan, but I'm not sure exactly what the rules are with respect to that group.

The retirees will take a haircut. How large? That remains to be seen.

Thanks for this commentary...I think it provides a precise way to talk about these issues while trying to keep the inflammatory language to a minimum.

I think Novine makes a very interesting point which I had not considered, which is that funding level of the existing DGRS and DPFPS may considered 80% in an open system [[where new employees are participating in the plan, allowing the actuaries a larger time horizon over which they could spread the risk and aim for higher returns) vs. a closed system [[where new employees are not offered the plan, leaving a smaller window of time and therefore a lower tolerance to investment liquidity risk.)

So after thinking about it for a day, here is where I stand, for what it is worth:

- Detroit simply doesn't have the funds to "fill the gap" in #2 as above. Services are horrible, and if we continue losing population, the debt-to-income ratio of the city will go from 35-40 cents per dollar up to 65+ cents per dollar within 10 years. This is simply unsustainable...sure we could do it...but at some point, people just vacate the city and there's no money left.

- I am suspending judgment on how angry I am about lost pensions until we have better data on both the funding levels and actual haircuts on the pensions. Obviously, I don't want anyone to lose any pension. But a 5% hair cut is very different from a 90% haircut, and I'm sure anyone thinking about this in a problem/solution perspective rather than a "this is bullshit, how can you do this to me" perspective can understand that.

- I have to imagine that the judge will have to take the "haircut" into consideration when deciding whether or not to approve a restructuring, and while I think a 5-10% loss is one which may cause minimal uproar, I think a 60-70% loss would all but compel either the state legislature to pick up the tab or perhaps even be what tips the scales to get a judge to insist on it in order to make the bankruptcy filing constitutional.

- Lastly, if the state picks up the pension tab....I think home rule is over. And, frankly, the rulers of our city seem to be under far too much political pressure to do what's necessary. [[i.e. politicos complaining about corporate sponsorships on police cars?? I mean, yes, I understand the argument. But I kinda with you would get that angry or more about the 1 hour wait time on priority calls, too, right?)