Detroit filed for bankruptcy Thursday afternoon, becoming the nation’s largest public sector bankruptcy. The move could slash pension benefits to city workers and retirees, and leave investors holding the city’s debt with only pennies on the dollar.
Emergency Manager Kevyn Orr, appointed by Michigan Gov. Rick Snyder to oversee the city’s finances, had been holding meetings with various creditors for the last five weeks in an effort to shed debt that the city can no longer afford. But despite the fact that some banks agreed to take reduced payments, Orr sought and received permission from Snyder to file.
Pension funds and retirees who fear deep cuts in promised benefits had filed suits to try to block a filing. Thursday’s filing came before a hearing on the suits that was set for Monday.
Orr already halted payments on about $2 billion in debt last month, saying the city needed to preserve its dwindling supply of cash. His reorganization plan calls for cutting $11.5 billion in unsecured debt — including pensions, health care funds and loans not backed by assets — down to $2 billion. That would mean that investors and retirees would receive an average of just 17% of what they are owed. Specific plans for the cuts are unknown at this time.
Cutting retiree’s pensions in a municipal bankruptcy has never been done before, said Michael Sweet, a California bankruptcy attorney who is an expert in public sector bankruptcies.
“It’s relatively easy to blow off a creditor. It’s much harder when it’s people who are the fabric of your community who you’ll need going forward,” he said. “You need a police force, you need a fire department. You’re saying [to them] you’re not worth what you were previously promised.”
Sweet said case law on whether pensions can be cut this way is very limited, and it could take years for a court fight over pension cuts to work its way to the U.S. Supreme Court. Given the poor state of funding for many public sector pension funds nationwide, “it’s a big enough question, that (the Supreme Court) is where it likely will have to go,” he said.
When employees of a bankrupt business lose their promised pensions, the Pension Benefit Guarantee Corp. steps in and provides a minimal level of benefits to the retirees. But that federal agency doesn’t back pensions in the pubic sector.
Snyder spokeswoman Sara Wurfel said the decision to file for bankruptcy came after careful deliberation.
“This has been a huge problem for decades and it’s come to a crisis point,” she said. “The emergency manager tried to work with all the creditors, including pensioners.”
Retirees and city employees say they can’t accept cuts in their pension benefits.
“How am I supposed to live without my pension?” said David Sole, 65, after a protest in Detroit last month. Sole retired from the city’s water department in January after 22 years.
Investors say the bankruptcy will make it more difficult for cities and towns everywhere to raise the money they need to build bridges, schools and other infrastructure. It will also hurt municipal bonds held by individual investors. There are more than $1 trillion worth of these general obligation bonds issued by local governments that are at risk said Peter Hayes, head of municipal bonds at BlackRock. He said there will be a ripple effect nationwide.
rr said that the city needs to cut debt in order to restore services and lower costs, such as taxes and insurance, that he says have chased businesses and residents out of the city.
Detroit’s population has fallen 28% since 2000. The unemployment rate, while down from a peak of 27.8% in the summer of 2009 — when General Motors (Fortune 500) and Chrysler Group were going through their own bankruptcies — is still at 16.3%, nearly twice Michigan’s statewide average.,
While the auto industry has enjoyed a resurgence with strong car sales and profits, GM, Ford Motor ( , Fortune 500), Chrysler Group and parts manufacturers have been on a hiring binge, most of the industry’s Michigan plants lay outside of city limits.
Article Courtesy of CNN Money
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