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Judge Rhodes' Ruling on the Detroit Bankruptcy Sets a Terrible Precedent

Today, bankruptcy judge Steven Rhodes ruled that the criteria for the bankruptcy proceeding for the City of Detroit have been met and the legal proceedings will go forward immediately. While at the same time disappointing and expected, there are some important elements in the ruling that could shape the ultimate outcome.

The elephant in the room is that the immediate precipitating event was a dramatic reduction of city revenues, and that the State of Michigan had a pivotal role in that. Objectively, the politicians in control of the statehouse and governor’s office gained control of the city by reducing revenue sharing, but perhaps more importantly, by not working with the city to increase revenues to get past the immediate cash crunch so that long term structural reforms could be put in place. For example, the judge ruled that the emergency manager did not negotiate in good faith with creditors over the summer, but then avoided this critical pre-condition of bankruptcy by saying that negotiation was impracticable. What is left out of this reasoning is why it was impracticable.

The inescapable inference is that the political leaders of the state have used the bankruptcy laws to get leverage to affect their desired policies. In other words, the bankruptcy was “fixed.”

Judge Rhodes ruled that there was support of this in the record, but that it was not sufficient to prove it. For those of us who are persuaded by the fact that something which walks and quacks like a duck is a duck, this means that the state pulled off their plan with sufficient cover to obfuscate what really went on.

This is a terrible precedent and points to a flaw in the bankruptcy law. The right way for a state to solve the financial problems of its cities is to participate in solutions unless there is simply no other way forward. State involvement in the long-term solution is inevitable, but it should be defined by reaching compromises reflecting the local political will. The bankruptcy law simply should not be used as a tool for avoiding this vital democratic principle. Whether the state managed to skate by using the letter of the law, it is simply wrong and it would be serve the interests of urban centers throughout the land if an appellate court would step back and take a broader view.

On more detailed issues, Judge Rhodes ruled that pension obligations to workers could be abrogated as part of the bankruptcy, notwithstanding a state constitutional provision making them inviolable. That is a deeply unfortunate outcome that could visit misery on retirees and current workers alike. But the practical resolution is far from certain. The Judge did point out that the operating budget (which includes salaries) had been slashed so much that further cuts made no sense. Pension and health care benefits have also been cut. If the judge is persuaded by salary cuts, he should also be persuaded by prior benefits cuts. He hopefully will see the relationship between salaries and benefits. The judge stated firmly that he would not approve cuts to benefits unless the whole plan was “fair.” This may be simply cover for a future draconian ruling, but perhaps not.

The judge also explicitly deferred the accuracy of the $3.5 billion unfunded pension liability (and hopefully the equally important plan for funding it over time). This number has been tied by the state-appointed emergency manager to the desire to cut benefits, though punishing retirees is a strange way to address funding shortfalls that were caused by malfeasance but also by the emergency need to conserve cash (as the judge recognized). The position of the emergency manager has to be picked apart recognizing that this was a politically influenced calculation. The city needs to fund its pension obligations, but through a plan that is sensible, reliable and prudent.

If the plan is unworkably harsh because of the size of the obligation and its repayment terms, the emergency manager may have achieved his and his state employer’s immediate goal of restructuring the politics of Detroit and Michigan, but laid the groundwork for more fiscal strife in the city's future.

And the judge also referenced the impenetrable complexity of the financings, including massive derivatives transactions, brought to the City of Detroit by Wall Street under the Kwame Kirkpatrick regime. Just maybe, the judge will take the time to understand these financings and give them the special attention that they deserve. The language he used in court makes clear that he does not understand the financings yet. Creditors deserve some level of fairness and protection in a disastrous situation like this, but the fairness afforded has to be tempered if their hands were not clean at the beginning.

Read an in-depth examination of the City of Detroit's finances and the assumptions behind Emergency Manager Kevyn Orr's bankruptcy filing.