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Detroit’s Reorganization Plan: The Good, the Bad and the Ugly

Detroit's Emergency Manager, Kevyn Orr, has filed a “plan of adjustment” with the court in the largest municipal bankruptcy in history. It includes some troubling news, some hopeful news and leaves out important items that should be known before a final plan for moving forward is settled.

It is troubling that existing pensioners will see their benefits cut. Retirement benefits are to be cut by 34% for general employees or 10% for police and fire, but it appears that figure can be reduced if the pension trustees, who Orr distrusts deeply, will “go along.” This illustrates that Orr and his boss, Governor Snyder, are more interested in restructuring the role of public employees, a la Wisconsin Governor Scott Walker, than the fiscal effects of pensions.

In principle, the cut to pension benefits is deeply concerning because it is a precedent that puts pensions in all municipalities at risk. The court’s assertion that it has the power to reduce benefits is on appeal and could conceivably be reversed.

If the 34% cut is implemented, a retiree with long service who was promised 2/3 of their final salary would be reduced to less than half of their final salary. This could mean more personal bankruptcies and foreclosures in the city, compounding its structural problems. It will undoubtedly spread misery throughout these families who must suffer for problems not of their making. Importantly, reports also say the plan drastically cuts health benefits. The only hope is that the Affordable Care Act will ease the pain.

The plan also attacks existing labor contracts. The damage to the fiscal health of Detroit did not happen all at once. Since the onset of the Great Recession, the city has repeatedly cut its payroll and operating budget by close to 40%. Public employees have already been “adjusted” severely. They have every right to claim that the plan of adjustment is unfair.

And important issues related to the toxic financial deals entered into by the corrupt Kilpatrick administration, which governed the city for seven years ending in mid-2008, remain unresolved. Orr has sued to void $1.4 billion of debt taken on to fund future city pension obligations, a step he took only after being pushed by the bankruptcy judge. And the plan discloses that he has reached a third agreement to settle the termination of $800 million of derivatives taken on in connection with the Kilpatrick-era pension financing, but the terms of the settlement will only be made public at a later date. The first two settlement deals were rejected by the court out of hand as being far too generous, so the new proposal may well be rejected also.

Without resolution of these huge issues, it is difficult to assess the other matters dealt with in the plan.

The plan to convert the huge regional water and sewerage system into a separate authority that can be more easily influenced by the statehouse is also to be revealed later. This appears to be a shell game, having more to do with politics and ideology than Detroit’s fiscal circumstances. It has received far less attention than it deserves. When it is revealed, we can only hope that the bankruptcy court keeps asking why it is a good idea for the people of Detroit until Orr comes clean. As with the derivatives settlement proposals, Orr's words cannot be taken at face value.

The plan does appear to accommodate the good Samaritan proposal by a number of foundations to provide funds that would preserve Detroit’s art collection rather than auctioning off this public asset at a fire sale. This shamed Michigan Governor Snyder into proposing state funds to assist the city alongside the foundations.

All of this is a journey into uncharted waters. Bankruptcies typically adhere to some simple rules. Unsecured creditors usually share pro rata. But this plan reflects the immense complexity of putting a governmental entity through bankruptcy. Cities are not businesses.