The Final Act in Detroit’s Bankruptcy

07 Jun
June 7, 2014

As goats graze (temporarily) in Detroit neighborhoods, an enormous number of objections have been filed to Detroit’s plan for adjusting its debts, and Detroit has responded with a two hundred plus page reply defending the art-for-pensions deal (aka the Grand Bargain) and the plan.

One of Detroit’s main defenses for the dramatically higher payout to pension beneficiaries than to several classes of bondholders (13% or less for bondholders vs. 59% or much more for pensions, depending on how the claims are calculated) is that payments coming from outside sources like the state of Michigan or the foundations that are ponying up $366 million to protect Detroit’s art shouldn’t count for the purposes of the comparison.  I’m surprised that Detroit puts so much weight on this argument, which seems deeply and transparently flawed.  To the extent the payments are for the art, which is an asset of Detroit, they should benefit all of Detroit’s creditors, not just one group of them.

Since I’ve been very critical of the Grand Bargain, at least in its current form, I should note that many of the details of Detroit’s plan strike me as admirable.  Detroit has been careful to minimize the cuts to the most vulnerable pension beneficiaries, for instance, and the city has made adjustments to the claims of pensioners who benefitted from indefensibly generous annuities and gratuitous payments by the pension funds.

One of the most interesting questions now is whether Detroit will attempt to settle with either of the two classes of bonds that have been offered the stingiest payouts under the plan.  If Detroit settled with both classes, the “unfair discrimination” argument would disappear, because it is available only to a class of creditors that votes against the plan.  My prediction, which is of course worth every penny you’re paying to read this post, is that Detroit will try to settle with one group of bondholders—the limited tax general obligation bondholders (LTGOs)—but not the other—the holders of certificates of participation (COPs).  The COP funding was used to plug a hole in Detroit’s pensions, and the bankruptcy judge has hinted that he thinks the funding arrangement was illegal.   This gives Detroit a better defense against an “unfair discrimination” objection with the COPs than with the LTGOs.  It isn’t unfair discrimination to give the COPs a pittance, the reasoning would go, if there’s a plausible argument the COPs aren’t entitled to anything.