DETROIT BANKRUPTCY: “IT’S NOT TINSEL TOWN; IT’S NOT CHI-TOWN…” HMM….

12/3/13

U.S. Bankruptcy Court Judge Steven Rhodes ruled today that Detroit could indeed file for protection under Chapter 9 of the bankruptcy code.    Since I advised bankruptcy for the state of Illinois in yesterday’s post (SOLVING ILLINOIS’ PENSION MALADY:  WHY, ONE CAN ALWAYS COUNT ON THE WORD OF OUR LEGISLATURE!, 12/2/13), it probably behooves me to make a few comments on the Detroit situation, even though the decision was immediately appealed and may, though probably won’t, be overturned.

First, while the lawyers will have to sort this out, and doubtless arguments will be made to the contrary, it looks like all unsecured creditors, be they bondholders, employee pension funds, contractors, or anybody else, have the same priority in bankruptcy.   Regardless of the law, however, it would seem that some sort of special accommodation has to be made for employee pension claims.   Since the pensioners have no access to social security, their pensions are their only means of livelihood; to deprive them of their pensions would be to throw them out in the street.  We can’t do that.  Judge Rhodes knows that. Everyone knows that.

So while Judge Rhodes said that the court could cut future pension payments, he is not saying, as some people would have you believe, that the courts should, or even could, eliminate those payments.  Some, perhaps all, pensioners will see their payments cut; one suspects none will see them eliminated.  Some clever formula will have to be derived under which the most highly paid pensioners take some cuts, perhaps some big cuts, but those at the bottom take few, if any, cuts.   Even under the plan working its way through the Illinois legislature as I write this, a plan that was, of course, formulated away from the bankruptcy court, the people at the bottom of the pension ladder will be taken care of, as they should be.

Second, an argument is being made, and doubtless will be continued, that any substantial hair cut for bondholders will send a chill throughout the municipal bond market, that all municipal bond issuers will pay higher rates if Detroit bondholders are made to suffer.

I don’t know whether such damage will be done to the muni bond markets if the supposedly big boys who hold Detroit bonds are made to feel some pain.  But I do know whether such damage should be done…of course it shouldn’t!   If a potential investor cannot distinguish between the credit of Detroit and, say, Dallas, s/he has no business owning municipal bonds, plain and simple.  Having to suffer for buying bonds of a lousy credit is part of the normal workings of the market place.  Those who take such risks cannot cry innocence when their big, risky bets don’t work out.   You pays your money, you takes your chances…Capitalism without failure is like Christianity without hell…or any other trite expressions come immediately to mind.   Bondholders took the risk and thought they would be paid to do so.  They were wrong.   They should feel the pain.  That’s capitalism.  And that’s life.

Third, Judge Rhodes determined that Detroit was insolvent before its bankruptcy filing in the summer; that was the major reason that he allowed the bankruptcy to proceed.  By those standards, it looks like neither Illinois nor Chicago is an obvious candidate for bankruptcy because one could argue that neither is insolvent.   Or maybe not.   Contractors who do business with the state are waiting a long, long time to be paid.  Both state and city pension plans are severely underfunded.   And both the city and the state are effectively borrowing to pay operating expenses.  One could conceivably make the argument that both Chicago and Illinois are insolvent, but it would be a stretch.   It will only be a matter of time, however, before the practical, if not legal, bankruptcy of both becomes obvious.  By then, of course, the hole will be much deeper and the pain more intense, but what do the politicians care?

I prescribed bankruptcy for Illinois yesterday.  Last week (“OKLAHOMA VS. ILLINOIS”:  COMMENTS FROM SOMEONE WHO KNOWS SOMETHING ABOUT ILLINOIS POLITICS), I made the case that, contrary to the self-assured but fact denying chest thumpers in these parts, Chicago is Detroit in many ways.   Don’t think that I’m the only one thinking about Chicago and Illinois in the context of bankruptcy and Detroit.   Investors, taxpayers, state officials (in their more candid, perhaps very private, moments), and people who make decisions regarding where to locate businesses do not think a municipal bankruptcy in the Land of Lincoln is such a laughable proposition.

See my two books, The Chairman, A Novel of Big City Politics and The Chairman’s Challenge, A Continuing Novel of Big City Politics, for further illumination on how things work in Chicago and Illinois politics.