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Detroit bankruptcy ruling a good move

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Staff writer ▼ | December 4, 2013
According to Fitch Ratings, the December 3rd ruling by a federal bankruptcy court judge that the city of Detroit is eligible for Chapter 9 was not a surprise, although the ruling regarding pension obligations provided unexpected clarity to a question that has puzzled many municipal market participants.
Detroit
DetroitAccording to Fitch Ratings, the December 3rd ruling by a federal bankruptcy court judge that the city of Detroit is eligible for Chapter 9 was not a surprise, although the ruling regarding pension obligations provided unexpected clarity to a question that has puzzled many municipal market participants.


The ruling on pensions follows a similar finding by the judge in the Stockton, CA bankruptcy case, who concluded in his August 6th, 2012 opinion that even if post-employment health benefits were a vested right under the CA constitution, they would not be protected in bankruptcy. This reasoning could also be extended to pension benefits, but that remains an open question in California.

The immediate challenge to the ruling on Detroit's eligibility was also not a surprise. Fitch expects challenges to the judge's decision on pensions will follow, and that they will be protracted.

An important question regarding the Detroit case was whether Michigan's constitutional protections for pensions would withstand a bankruptcy filing. If so, Fitch reasoned, the city's ability to adjust an often sizable and growing component of spending in Detroit and elsewhere would be eliminated.

However, although the judge ruled that pensions could be adjusted, Fitch does not believe the ruling grants Detroit's emergency manager unlimited freedom to adjust these obligations. The city must submit a plan of adjustment to the bankruptcy court, which must be deemed 'fair and equitable' by the presiding judge. The emergency manager expects to submit the plan to the court by year-end.

Fitch does not believe that the judge's decision on pensions will lead to a spate of additional bankruptcy filings in Michigan. While many local governments have struggled since the beginning of the last decade's recession, few Fitch-rated entities are even near the kind of distress that led to Detroit's filing.

In addition, while the judge's ruling may lead other financially strained local governments to try to obtain relief through bankruptcy, it may instead provide incentive for employees and retirees to negotiate changes to pension obligations rather than risk the loss of control that accompanies a bankruptcy.

Yesterday's ruling did not specifically address bonded debt, except to say that 'nothing distinguishes pension debts from other debts'. Fitch expects that the city will continue to pay its water and sewer utility debt but not its tax-supported debt.

Michigan Governor Rick Snyder sai that a ruling that Detroit is eligible for bankruptcy has let the city stay on a path toward a "brighter future."

The governor said that Judge Steven Rhodes' ruling affirms his own earlier difficult decision to authorize the bankruptcy filing as the last viable option to restore Detroit. Mr. Snyder says letting the city shed its debt will lead to streetlights working, ambulances responding quickly, and crime and blight shrinking. He also expects jobs and investment to surge in Detroit.


 

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