Detroit’s bankruptcy plan
A phoenix emerges
Nov 7th 2014, 22:47 BY V.V.B
“THERE is an exciting feeling of a new beginning,” says John Pottow, a bankruptcy expert at the University of Michigan. After years of decline that ended in disaster when Detroit filed for bankruptcy last year, one of America’s biggest cities has been given a new lease of life. Today Steven Rhodes, a bankruptcy judge, approved Detroit’s plan for the adjustment of debts that will allow the city to slash $7 billion of unsecured liabilities off its $18 billion debt mountain.
Detroit has a long history of mismanagement. But the handling of its bankruptcy so far has been a textbook example of efficiency and pragmatism. Much of the credit for getting Detroit back on track in less than 16 months must go to Kevyn Orr, the bankruptcy lawyer appointed by the state of Michigan to sort out the mess. Mr Orr had the powers of a “benevolent dictator”, says Mr Pottow, and he used them well. Under the agreement both pensioners and bond holders will take pain, albeit at varying degrees. The pensions of retirees will be cut by 4.5% and the cost-of-living adjustments (COLA) will go. Retirees from the police force and the fire brigade will have to live with a reduction in COLA from 2.25% to 1%. Health-care benefits will be reduced by 90% for all retirees. Bond holders, such as Syncora, a bond insurer, had to accept a huge haircut. Syncora will get 26 cents on the dollar. Another bond insurer with a claim of $1 billion, Financial Guaranty Insurance, had to accept big losses.
Mr Orr managed to save the art collection of the Detroit Institute of Arts (DIA) from sale in what is referred to as “the grand bargain”. Foundations, private donors and the state of Michigan raised $816m to protect the DIA from the city’s creditors. The funds raised will help to pay public worker’s pensions—and the ownership of the museum was transferred from the municipality to an independent charitable trust.
The exit from chapter 9 (the part of the American bankruptcy code that deals with municipalities) gives Detroit some breathing space. But it’s only a first step on the long way to recovery. The big question is whether Detroit will manage to become an attractive city again where people want to live, invest, work—and pay taxes. At the moment this seems a long way off: roads are in disrepair; more than one-third of city lights don’t work; public schools are failing the pupils who bother to turn up; ambulances break down; thousands of households don’t have water and there are 84,000 blighted and vacant parcels of property. (The city is demolishing 200 houses a week at a cost of, on average, more than $8,000 each.)
The adjustment plan approved by the judge sets aside $1.7 billion over the next nine years for investment in basic services and infrastructure. It is a vast sum for a city that has trimmed investments to a minimum in recent years, but Detroit’s needs are such that this pot could run out in as soon as five years. The city must rebuild its credibility, otherwise no one will lend to Detroit, says James Spiotto, a bankruptcy expert at Chapman Strategic Advisors.
After a judge approves a bankruptcy plan objectors have 14 days to file appeals. Yet appeals are unlikely at this stage as the tough battles with retirees and creditors have all been fought. Many are now optimistic about Detroit’s chances for recovery. “It can be done,” says Mr Spiotto. His colleague, Mr Pottow, compares the city to an alcoholic who has sobered up. The question is whether Detroit will have the strength and support to avoid past temptations of profligacy, mismanagement and corruption.