To Broke and Back
The story of the Motor City’s return from bankruptcy’s brink
Detroit Resurrected: To Bankruptcy and Back, by Nathan Bomey (W.W. Norton & Co., N.Y. $27.95, 320 pp., April, 2016)
Early in Detroit’s municipal bankruptcy case—the largest in U.S. history—federal bankruptcy court judge Steven Rhodes rejected a settlement that would have paid two banks $165 million. The banks had loaned money in a complex deal to enable Detroit to keep paying bloated municipal pension obligations. It was “too much money,” Rhodes declared. If the city won’t stop making bad deals on its own, the judge said, then the court would force it to stop. It was precisely this type of judicial head-slap that Detroit needed. As Nathan Bomey chronicles in the excellent Detroit Resurrected, 50 years of mismanagement and magical thinking had made the Motor City insolvent, with unfunded retiree pension and health-care liabilities totaling an astounding $9.2 billion—about nine times Detroit’s annual budget.
When Michigan governor Rick Snyder appointed emergency manager Kevyn Orr to run the city and pursue a municipal bankruptcy filing in 2013, Detroit’s retiree liabilities were more than a money problem. The city operated like an alternate universe for government workers, rolling along as if the heady, post-World War II days hadn’t ended. Detroit’s 32,000 municipal retirees were not on Medicare; the city footed their health-care bills. And Detroit continued to provide its workers with defined-benefit pension plans in which workers paid nothing into the system. In mid-2004, things went from bad to worse. The pension funds “had accumulated a shortfall of $1.7 billion after poor investments and mismanagement led to a stunning $852 million decline in value” during the reign of Mayor Kwame Kilpatrick.
The bankruptcy itself was not a certainty. In fact, with the city crumbling around them and public services in crisis, Detroiters protested Orr’s arrival. Citizens, retirees, and union representatives testified in court that Orr hadn’t negotiated in good faith. They argued that reducing the pensions violated the Michigan constitution, and said the bankruptcy should not be allowed. Rhodes, the even-tempered jurist who emerges as the hero of the story, ruled that the bankruptcy should go forward without delay. A team of federal judges mediated fights over a smorgasbord of contracts as Orr sought to rein in a city living far beyond its means. The pensions took center stage. Many of the retirees were poor and couldn’t make do without their city pensions. Detroit’s firefighters and police hadn’t paid into the Social Security system. They faced possible destitution if their pensions were cut.
The whole mess was complicated by Detroit’s pro-labor past and the complex financing put in place to sustain the pensions. Detroit has been a pro-union Democratic city for decades. Successive strong-mayor administrations allowed unions to hold sway, buoyed by a provision in the Michigan constitution that cast doubt on whether pension contracts could be altered, regardless of Detroit’s ability to sustain them. The insanity reached its apogee in November 2004. Kilpatrick found a new way to shove the problem under the rug: a colossal Wall Street loan. Detriot was prohibited by Michigan law from issuing bond debt exceeding 10 percent of Detroit’s assessed value ($1.3 billion). Kilpatrick needed $1.44 billion, so his administration set up “service corporations” (run by Kilpatrick’s appointees) and a trust that the city could use to sell banks certificates of participation, or COPs, instead of bonds.
To make matters worse, the city purchased interest-rate swaps, locking in a 6 percent interest rate on the COPs, which were secured by gambling revenue. That feature later gave the banks the advantageous status of secured creditors in the bankruptcy. The COPs, approved by the city council, were rated AAA in the go-go days before the Great Recession. The companies that insured the bonds weren’t secured creditors and later became fierce opponents of the bankruptcy plan.
By 2013, interest payments on the COPs were choking Detroit. Orr considered selling paintings from the Detroit Institute of Art in order to pay creditors, causing a media firestorm. Reporters aghast at the barbarism of selling art to fund pensions descended on Detroit from as far away as France. A senior judge-mediator came up with a plan dubbed the “grand bargain.” Valued at $816 million, it was comprised of pledges from private foundations, the state, and the Detroit Institute of Art. In exchange for the sort of charity normally thrown at developing nations, no paintings would be sold, and hardship to pensioners would be avoided.
The insurers—whose corporate lives were on the line—fought ferociously against the grand bargain. They said that it favored the pensioners, who were likewise unsecured creditors. They argued that, as creditors in the same class as the pensioners, they should be treated equally. Morality and sentiment, widely invoked in favor of the grand bargain, have no place in court, the insurers said. They wanted to see at least some paintings sold so that they could have a fairer recovery. Under pressure, the insurers settled. The settlement included land-development deals that tied the insurers’ long-term fortunes to Detroit’s. The grand bargain stood. Detroit’s bankruptcy slashed $7 billion in debt from the city’s books.
Detroit Resurrected is a cautionary tale. Even after everything Detroit went through, Orr couldn’t move current workers into defined-contribution retirement plans because of union opposition, a testament to Detroit labor’s ongoing power. One can’t help but wonder whether selling a few paintings might have been so controversial in a city with a culture of free enterprise. The insurers’ aspect of the story, more than any other, gives cause for concern about Detroit’s future. Bomey deserves much credit for bringing it to light so clearly and evenhandedly.
Photo by Justin Mier
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