A Wealthy Neighbour

Detroit's filing last month for Chapter 9 bankruptcy is yet to be approved by a federal bankruptcy court. But spillover effects are already evident.

Just within the state of Michigan, various government issuers looking to tap the muni bond market are meeting considerable market resistance. Thus, Genesee County, the City of Battle Creek and, just yesterday, Saginaw County, have all delayed multimillion offerings. This is because yields on the deals would have been much higher than planned (which means that offering prices acceptable to markets would be too far below what city and county finance officials deemed necessary). Markets aren't being perverse. It's simply that the potential Michigan offerings were to be limited tax, general obligation (GO) bonds associated with the funding of the respective governments' pension systems. This would not be unusual, under normal market conditions. But Detroit's emergency manager, Kevyn Orr, has changed everything in this segment of the muni bond market; under the Chapter 9 filing, he is proposing to treat GO City of Detroit bonds as unsecured debt. If the court agrees, this would be the first occurrence, in the $3.7 trillion American muni market, some 40 per cent of which is comprised of GO bonds, where such bonds are normally considered secure, even sacrosanct. Not surprisingly, net outflows from muni funds have been considerable over the past several weeks. And issuers who have nonetheless proceeded in the post-Detroit bankruptcy filing environment have been forced to offer up yields that the market hasn't seen, or is likely to see in other markets, for a long time - Puerto Rico's Electric Power Authority, for example, just issued $673 million of 30-year bonds requiring a price level equivalent to a 7.12 per cent yield. Demand was strong.

But in a classic example of how markets discriminate, not all Michigan issuers are being punished. Oakland County, immediately adjacent to the northern boundaries of Detroit, and ranked in the top ten counties in America by income, is planning an issue of $300 million taxable retiree health-care bonds next month. The county, with a triple-A rating, expects to achieve a yield some 0.95% above comparable term Treasurys. America's city, county and state finance officials will be watching closely, fully aware that even triple-A rated government entities like Oakland County may face considerably more expensive financing in the wake of Detroit's misery.