Inevitable and Needed, But Sufficient?

It appeared inevitable almost from the beginning of Kevyn Orr's appointment in March as the emergency manager of the City of Detroit. Mr. Orr allowed the City to default on a $39.7 million payment due unsecured creditors in June, and he has been carefully telegraphing in recent weeks that a final decision on financial re-structuring overall was imminent. Then, on Monday of this week, there were reports that Mr. Orr was meeting in Detroit with Michigan Governor Rick Snyder. The Governor apparently encouraged Orr to move more quickly in resolving the insolvency, then decided on Wednesday to sign off on the filing.  

Mr. Orr's announcement this afternoon that Detroit is filing for Chapter 9 bankruptcy was therefore not a surprise. With nearly $20 billion in debt and pension liabilities, this is the largest-ever municipal bankruptcy filing in America, easily surpassing the $3.7 billion filing by Jefferson County, Alabama in 2011. Prior to declaring bankruptcy, Detroit's strategy, unveiled last month, was to pay off the majority of what secured creditors such as certain bondholders are owed, while offering pennies on the dollar to unsecured bondholders, unions and pension funds. Union and pension representatives objected strenuously. But this will now likely be the essence of the City's formal proposal to a federal bankruptcy court, and such an approach will no doubt prompt heated debates before the judge as each group of creditors argues its case for why it deserves a bigger portion of what is certainly a very limited amount available for distribution.

While making his announcement, Mr. Orr indicated that his hope is to steer the city through the bankruptcy process in ten to twelve months, and, assuming a relatively smooth process (there are over 100,000 creditors listed in the filing, so this is a big assumption), to spend an additional $1.2 billion to fight crime and blight. But bondholders and other creditors, secured or otherwise, could hold up the city for months if not years in court with delay tactics in a bid to secure more favorable terms. And future borrowing at reasonable rates could be difficult for Detroit. So, as much as this bankruptcy will sooner or later give Detroit a fresh start, it may provide only breathing room, as the tax base, in a city that has shrunk from nearly two million people in 1950 to 700,000 today, remains too small to prevent the beginning of new, and likely expensive, borrowing. In short, bankruptcy may be a necessary but hardly sufficient condition for a sustainable re-building of Detroit.