Detroit eligible for nation’s largest municipal bankruptcy filing, federal judge rules

A federal bankruptcy judge granted Detroit unprecedented powers Tuesday to shed billions of dollars in debt, including the ability to slash city employee pensions despite a state constitutional provision protecting them.

In approving the nation’s ­largest-ever municipal filing, Judge Steven Rhodes cleared the way for Detroit’s emergency manager to develop a plan to reorganize the city’s estimated $18 billion in debt. Beyond cutting worker pensions and retiree health benefits, the city could stiff bondholders and sell city assets such as its water and sewer authority and its priceless art collection.

Municipal bankruptcy experts called particular attention to Rhodes’s decision to allow pensions to be put on the chopping block. Some said the move would set a precedent for future municipal bankruptcies. And unions vowed to appeal the decision.

“This is the first opinion of its kind where a bankruptcy court has directly expressed the view that the supremacy of U.S. bankruptcy laws trumps state constitutional protections of public pension holders,” said Mark S. Kaufman, senior partner at McKenna, Long & Aldridge, an Atlanta law firm. “The implications of that decision are significant not only to Detroit but also potentially to other cities gauging their level of fiscal distress and how to deal with it.”

The decision to approve Detroit’s bankruptcy petition capped four months of legal wrangling triggered when the city’s emergency manager, citing overwhelmed city services, mounting debt and dwindling tax revenue, filed for bankruptcy protection in July.

“This once proud and prosperous city can’t pay its debts. It’s insolvent. It’s eligible for bankruptcy,” Rhodes said from the bench. “At the same time, it also has an opportunity for a fresh start.”

Detroit’s efforts to get out from under its mountain of debt still faces determined opposition from a broad range of interests, including city workers, retirees, bondholders and others who stand to be hurt financially if the city does not pay all of its bills.

“The only thing we can do is challenge this ruling legally and question the morality of attacking pensions that have been earned by these workers,” said Lee Saunders, president of the American Federation of State, County and Municipal Employees, which represents many of Detroit’s 9,500 city workers. “Pensions in Detroit average $19,000 a year, and there is a good possibility that they will be reduced. That is dead-ass wrong and morally corrupt.”

City workers and retirees also expressed dismay, saying any cuts would be too much. “I’m very disappointed,” said Rebecca Koller, 45, a Detroit firefighter for the past 14 years. In the past year, she endured a 10 percent pay cut as the city edged toward insolvency. Now she is likely to see her future pension reduced as well. “I do not understand how the city could promise workers something, have them work and do their jobs, and then not provide what was promised and somehow think that is okay.”

Under municipal bankruptcy law, Detroit’s emergency manager, Kevyn D. Orr, will begin exploring ways to pay some of its debt while restoring and improving city services. Although Orr can propose a reorganization plan that pays creditors only a portion of what the city owes them, creditors have a right to contest it. They can also press the city to sell assets or otherwise to look for ways to minimize their financial damage. Given that, bankruptcy negotiations are expected to drag on for months.

Ultimately, a reorganization plan would have to be approved by the bankruptcy judge. And although Orr has said pension cuts are necessary, Rhodes made it clear that he would allow them to go forward only if the overall plan is “fair and equitable.”

That legal standard has never been tested in a municipal bankruptcy, putting the case in uncharted legal territory, said Kaufman, who is lead counsel to a state-appointed receiver overseeing fiscally distressed Harrisburg, Pa. “There have been no legal precedents to guide what fair and equitable is in this context,” he said.

Detroit 2.0: After decades of blight and now bankruptcy filing, entrepreneurs and technologists are trying to breathe new life into Detroit. (The Washington Post)

At a news conference, Orr, a former D.C. bankruptcy lawyer, promised that his team would be “thoughtful, measured and humane” in proposing pension cuts. He also said that selling at least parts of the collection held by the Detroit Institute of Arts remains an option for raising money to pay creditors.

“There’s going to be a lot of pain for a lot of different people. But in the long run, the future will be bright,” the outgoing mayor, Dave Bing (D), said at a news conference after the ruling.

The Motor City’s descent into bankruptcy has been long and painful. Just over half a century ago, the city had more than 1 million residents and represented the hub of blue-collar prosperity.

That was a time when the auto plants were humming, hiring virtually all comers to jobs with good pay and benefits. Now jobs are few, the population is in decline, and Detroit has the highest rate of violent crime among the nation’s big cities. Average police response time is almost an hour, compared with a national average of 11 minutes. Nearly 80,000 buildings are abandoned or seriously blighted, and 40 percent of the city’s streetlights do not work.

The shoddy services accelerated a population decline that began in the 1950s, and the city lost more than a quarter of its residents between 2000 and 2012. Tax revenue and state aid have plummeted as the auto industry hit hard times, hurting Michigan’s fi­nances. The only way for Detroit to recover, many argued, was to shed its debts in bankruptcy and start over financially.

In recent years, the city has benefited from encouraging development in its downtown and midtown neighborhoods, but many of its far-flung residential sections are blighted and largely vacant.

Michigan Gov. Rick Snyder (R), who appointed Orr in March, applauded the judge’s ruling, calling bankruptcy a painful but necessary step.

“Authorizing the emergency manager to seek federal bankruptcy protection was a difficult decision, but it was the last viable option to restore the city and provide Detroit’s 700,000 residents with the public services they need and deserve,” Snyder said in a statement. “We know that Detroit’s comeback is already in motion.”

Michael A. Fletcher is a national economics correspondent, writing about unemployment, state and municipal debt, the evolving job market and the auto industry.
Reid Wilson covers state politics and policy for the Washington Post's GovBeat blog. He's a former editor in chief of The Hotline, the premier tip sheet on campaigns and elections, and he's a complete political junkie.
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