Lessons from the Detroit Bankruptcy Example for Community Enhancement Plan

5/8/2014

Hey Folks,
The following are link to a couple articles analyzing the causes of the Detroit Bankruptcy There are lessons here that need to be learned by the people of Coos County before we go forward with the Community Enhancement Plan.....Rob T.

Judge Declares Detroit Bankrupt; Gives OK to Cut Pensions, Burn Creditors

http://www.thenewamerican.com/economy/economics/item/17092-judge-declares-detroit-bankrupt-gives-ok-to-cut-pensions-burn-creditors

Six days after Orr moved to declare bankruptcy, the state of Michigan approved plans for a bond issue to help pay for a new $444-million arena for the Detroit Red Wings hockey team. Taxpayers would be enlisted to pay off those bonds, of course, all in the name of “stimulating” the economy. Governor Snyder said that such a project would be “a huge momentum shift” for economic activity, and that it would tie in nicely with nearby baseball and football stadiums. He said, "It’s something that hopefully will be a tax-base generator. Not the arena as much per se, but all the surrounding development."

Orr himself, who has witnessed first-hand how such spending on “hopeful” projects in the past has driven the city’s finances into the ground, added:

There’s always a debate about does this pan out?

The reality is we are so needy of some economic development, I can’t see how we don’t pursue it because if we don’t, what’s left?

These are the lyrics of the same song sung back in 1997 when Detroit built the 40,000-seat baseball park for the Detroit Tigers (shown). Then Governor John Engler said the new stadium would “symbolize” the city’s renewal.

And in 1999 when the city decided to build Ford Field for the Detroit Lions football team, Chairman William Ford said this would “showcase the city’s turnaround.”

Some lessons have to be learned over and over. Allowing individuals to make financial decisions based on the free market is always the way to simulate an economy. That’s what’s driving Midtown.

On the other hand, politicians making promises that can’t be kept, to be paid for by others, is the lesson that the Detroit bankruptcy is able to teach, but only to those willing to listen.

The Detroit Bankruptcy

http://www.demos.org/publication/detroit-bankruptcy

Legacy Expenses
The city’s “legacy expenses” increased by $62.8 million between FY 2008 and FY 2013. These legacy expenses include the city’s debt service and financial expenses as well estimates of its future liability for healthcare and pension benefits it pays to retirees. A close look at the city’s legacy expenses reveals that this $62.8 million increase was driven heavily by the city’s complex financial deals, not retiree benefits.

The city’s financial expenses increased by $38.5 million between FY 2008 and FY 2013, accounting for more than 60 percent of the total increase in legacy expenses.

The city’s pension contribution expenses remained relatively flat, rising only $2 million during this time. The city’s contribution might have been larger if it had had more money, but increases in the actual contributions it did make did not contribute materially to the cash flow crisis.

The city’s healthcare contribution expenses increased by $24.3 million. This constitutes an increase of 3.25 percent, per year, which is less than the nationwide annual increase in healthcare costs of 4 percent.

The city’s pension contributions in particular did not play a role in pushing it into bankruptcy because they did not contribute materially to the increase in the city’s legacy expenses that added to the cash flow shortfall. While the city’s healthcare contributions did increase, this was largely because of rising healthcare costs nationally, not because the city’s benefits were too generous. In fact, a comparative analysis of Detroit’s retiree benefits shows that its pension and healthcare benefits are in line with those of other comparable cities.

Financial deals.Detroit’s financial expenses have increased significantly, and that is a direct result of the complex financial deals Wall Street banks urged on the city over the last several years, even though its precarious cash flow position meant these deals posed a great threat to the city. The biggest contributing factor to the increase in Detroit’s legacy expenses is a series of complex deals it entered into in 2005 and 2006 to assume $1.6 billion in debt. Instead of issuing plain vanilla general obligation bonds, the city financed the debt using certificates of participation (COPs), which is a financial structure that municipalities often use to get around debt restrictions. Eight hundred million dollars of these COPs carried a variable interest rate, which the city synthetically converted to a fixed rate using interest rate swaps.

These swaps carried hidden risks, and these risks increased after the Federal Reserve drove down interest rates to near zero in response to the financial crisis. The deals included provisions that would allow the banks to terminate the swaps under specified conditions and collect termination payments, which would entitle the banks to immediate payment of all projected future value of the swaps to the bank counterparties. Such conditions included a credit rating downgrade of the city to a level below “investment grade,” appointment of an emergency manager to run the city and failure of the city to make timely payments. Projected future value balloons in low, short-term rate conditions. This is because the difference between the fixed swap payments made by the city and the floating swap payments projected to be paid by the banks increases. Because all of these events have occurred, the banks are now demanding upwards of $250-350 million in swap termination payments.

These swap deals were particularly ill-suited for a city like Detroit, which had been hovering on the edge of a credit rating downgrade for years. Because the risk of a credit downgrade below “investment grade” was so great, the likelihood of a termination was imprudently high. The banks and insurance companies were in a far better position to understand the magnitude of these risks and they had at least an ethical duty to forbear from providing the swaps under such precarious circumstances. The law recognizes special duties that sophisticated financial institutions owe to special entities like cities in providing complex financial products. A strong case can be made that the banks that sold these swaps may have breached their ethical, and possibly legal, obligations to the city in executing these deals.

Comments