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Municipal Markets Unmoved By Detroit Bankruptcy

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Former industrial powerhouse Detroit filed for bankruptcy last Friday, but there is little agreement about what this move signals for other cities struggling with reduced income and mounting debt. The city was struggling to handle $18 billion in debt and obligations, and a deal between Detroit’s emergency manager Kevyn Orr and creditors looked more and more unlikely, causing Michigan governor Rick Snyder to authorize the filing on July 18, David McLaughlin at Bloomberg reports.

Municipal Markets Unmoved By Detroit Bankruptcy

Kevyn Orr’s approach to city creditors

Orr was appointed by Snyder in March of this year after decades of mismanagement and alleged corruption had reduced what used to be America’s fourth largest city and global center of the auto industry into an impoverished city with high crime rates and few opportunities. Orr approached city creditors hoping that everyone would be willing to renegotiate terms so that Detroit’s burden was more realistic. “What did we get for that? We’re getting sued, consistently,” said Orr.

Declaring bankruptcy protects Detroit from future lawsuits or collection attempts until the debt has been restructured. Unlike corporate bankruptcy, municipalities cannot be forced to sell off assets to pay their debts, and creditors are not able to present a counter-proposal. Creditors can still try to force the city out of bankruptcy, but they would have to prove that Detroit is capable of paying its debts.

Before filing bankruptcy, Orr had proposed reducing $11 billion in unsecured debts to $2 billion, shaving pensions, and increasing pension contributions from workers, but there is no guarantee that Orr will pursue the same deal now that he has taken the issue to court.

U.S. Court of Appeals Judge Steven Rhodes will handle the case, but a state judge has ordered Snyder to withdraw the filing, saying that it violates the Michigan constitution. The state is appealing, but even if it loses the case, it’s not clear that the state judiciary has the right to interfere with a federal bankruptcy filing.

Municipal bonds market unfazed by Detroit’s bankruptcy

Snyder said that bondholders will be ‘part of the process, Carter Dougherty at Bloomberg reports. “If you were lending to the city of Detroit in the last few years, didn’t you understand there were major problems and issues?” he said on Face the Nation. “Look at the yields they’re obtaining compared to other bonds.”

There is often an unspoken assumption that governments will not default on their debt, regardless of their credit ratings. This makes government bonds more attractive investments than many other types of debt at the same interest rates, because the actual risk is thought to be lower.

The Detroit bankruptcy is the largest municipal bankruptcy in U.S. history, but it may not be as unique as investors would like.

“We’re not the only city that’s going to struggle,” said Detroit mayor Dave Bing on This Week. “We are the largest, but we absolutely will not be the last. And so we have got to set a benchmark in terms of how to fix our cities and come back.”

So far, investors seem to disagree. “We view Detroit’s default and subsequent bankruptcy as idiosyncratic, and not as a symptom of a wider issue in the municipal market,” said Standard and Poor’s analyst Jane Hudson Ridley. Ten-year yields on municipal bonds were essentially unchanged after the news broke, implying that most traders agree with Ridley’s assessment. But if Detroit bondholders do end up losing their investments during the bankruptcy proceedings, that opinion could change dramatically.

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