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Detroit Files for Bankruptcy

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The "good faith negotiations" analysis is going to be the most interesting issue in the written opinion to me, when it's released.  It seems like the unions put a lot of their eggs in that basket--that the city government did not negotiate with them in good faith before filing.  The bankruptcy judge apparently agreed, but held that good faith negotiations were "impracticable" (in the language of the Bankruptcy Code allowing a chapter 9 filing to proceed if a municipality "is unable to negotiate with creditors because such negotiation is impracticable").

 

While somewhat arcane and fact-intensive, that's one of the things that will matter most because that eligibility requirement is in the Bankruptcy Code itself, meaning it applies nationwide; individual states are free to impose their own restrictions on chapter 9 filings by their municipalities, but those are of course variable from state to state.

 

(Technical digression and professional rant: There are three main ways to clear the final federal eligibility hurdle: consent of a sufficient number of creditors, good faith negotiations with creditors, and impracticability of negotiations with creditors.  There is a fourth, which is even more arcane [if the city reasonably believes that a creditor is about to obtain a "preferential transfer"] but which, if interpreted broadly enough--and current bankruptcy practice often interprets "preferential transfer" extremely broadly--could basically obviate the other three, and I'm surprised it hasn't gotten more attention from within the bankruptcy bar.  Or maybe it has, and maybe some previous judges have put the kibosh on the ridiculously broad potential reading of that provision that would basically make any municipality otherwise eligible for bankruptcy basically able to clear the final hurdle with no difficulty at all.  Basically, any municipality could reasonably believe that someone is about to attempt to receive a preferential transfer the way preferential transfers are currently defined.)

 

But in the Detroit case, the good faith negotiations issue is apparently going to come down to whether good faith negotiations were genuinely impracticable, because the judge actually expressly held that the city did not negotiate in good faith (a "take it or leave it" offer has been defined as not good enough to qualify).  In other words, if the appeals court finds that good faith negotiate was practicable, it won't need to remand for further findings on whether good faith negotiation occurred--it didn't.  (This assumes, once again, that the court won't take the easy but super-technical way out and find that some creditor was about to obtain a preferential transfer, of course.)

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A different kind of slant in this op-ed, which includes some interesting facts not previously discussed......

 

What bled Detroit dry? (It's not pensions)

 

...The largest municipal bankruptcy in our nation's history, the Detroit decision charts a course where Wall Street banks and bondholders are at the front of the payment line while city residents, police officers, firefighters and other public employees are left at the rear, with only pennies.

 

*  *  *  *  *

 

...Despite the blame placed on public pensions, the truth is that Detroit's path to insolvency had little or nothing to do with pensions, which average just $19,000 per year for most employees and $30,000 per year for police and firefighters, who are not eligible to receive Social Security. There were several drivers of Detroit's downward spiral:

 

A depleted tax base: The city's wealthier white population has declined by 1.4 million since the 1950s, leaving behind an almost entirely African-American and much poorer population.....

 

Skyrocketing financial costs: Wall Street banks saddled Detroit with $1.6 billion in loan deals that were highly profitable for Wall Street, but exposed the city to risk it could not afford to take. The banks have already extracted $300 million from Detroit to terminate these interest rate swaps, and are posed to collect another $300 million in additional windfalls.

 

Corporate subsidies and tax loopholes: While public workers were laid off and had salaries cut, Detroit gave away millions of public revenue in tax loopholes and subsidies to big corporations. A wealth of research finds that tax breaks like these are ineffective and it is apparent they have done little to create good jobs for Detroit residents. These tax breaks should be on the table, just like other obligations of the city in resolving the cash-flow crisis.

 

*  *  *  *  *

 

.... In recent years, thousands of public workers were laid off, and the remaining public employees accepted a 10% pay cut, health benefit reductions and a 40% cut in future pension benefits, saving Detroit $160 million.

 

http://www.cnn.com/2013/12/17/opinion/eisenbrey-detroit-pensions/index.html?hpt=hp_t4

 

 

 

 

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I always wonder what purpose authors of articles like that think they're serving.  The article is nonsensical as a guide to restructuring.

 

The author laments that the tax base has dwindled as "the city's wealthier white population has declined by 1.4 million since the 1950s, leaving behind an almost entirely African-American and much poorer population."  We all know that.  That says absolutely nothing about where the losses in the current restructuring should fall.  You cannot force wealthier whites, or their companies, to return to Detroit.  The bankruptcy court cannot command that.  Therefore, this fact, while true, is irrelevant to the task at hand and offers no relief to the legacy cost obligees.

 

The author then proceeds, in a grim irony, to say that "corporate subsidies and tax loopholes" are another "cost" and should be on the table in any restructuring.  He posits the existence (without citing or linking to any of it) of a body of research demonstrating that such tax breaks and subsidies are ineffective.  I think he would find that that research shows that such tax subsidies are less effective than low taxes across the board, because small businesses that can drive economic dynamism are generally not politically influential (or, unfortunately, bureaucratically adept) enough to procure such favors.  Businesses can and do leave for more economically favorable environments--sometimes abroad, but also frequently to Sun Belt municipalities.  The author is basically burying his head in the sand here and saying that Detroit should forego the opportunity to restructure its pension shortfalls here because it can sock it to its few remaining major corporations a little bit more and pray that they all stick around.  This is one of the symptoms of the willful blindness that got Detroit into this mess in the first place.  Detroit's taxes are already absurdly high.  In addition to raising them being a bad idea, the bankruptcy court also cannot compel it, nor can Detroit's creditors with any votes on the restructuring plan.

 

Therefore, the only point on which the author raises a worthwhile point is with respect to the treatment of existing matured and unmatured debts to Wall Street and the rest of the global financial marketplace.  On this point, the author (perhaps on the broken watch theory) touches an issue that is both germane to the task at hand and within the powers of the bankruptcy court to influence (within the dictates of the law, of course, but there is a great deal about the Detroit bankruptcy that involves breaking new ground).  And on this point, the author's blindness is simply that he doesn't seem aware, or chooses to conceal the amount to which the restructuring team in place and the bankruptcy court have been willing to play hardball with the existing bondholders.

 

For example, the emergency manager's team moved, and the court granted the motion, to authorize <a href="http://www.reuters.com/article/2013/12/13/usa-detroit-moodys-idUSL2N0JS0GX20131213">millions in new borrowing for streetlight repair</a>, diverting the revenue from city utility tax revenue that might otherwise have been used to pay existing bondholders rather than new obligations.  (I also appreciate the ironic circularity of taxing utilities in order to pay for lights.)

 

Perhaps the author thinks that the emergency manager's team blinked too quickly in its fight with the swap counterparties, agreeing to a <a href="http://www.bloomberg.com/news/2013-12-17/detroit-seeks-to-pay-ubs-bofa-230-million-to-end-swaps.html">$230 million payment to UBS and BoA</a>, also to be financed by new borrowing, in order to get out of certain swap contracts that might (or might not) have given those creditors the ability to attach the revenue from the casinos, and which were already costing the city $4 million a month, i.e. $48 million per year.  The payment on the new loan will be about $12 million per year.  Granted, that's still more than $0 and the total principal payout is something like 75% on those contracts (if I'm reading other articles correctly that these are the same swap deals), so if you're feeling very aggressive and wish Orr would have fought to lump them in with other unsecured creditors and given them maybe 20 cents on the dollar, that may look like a capitulation.  On the flip side, that position did have its day in court, as other creditors filed objections to the settlement making exactly that argument, and they lost.  The bankruptcy judge didn't hold that the Wall Street banks would have been able to attach the casino revenue, since the swap contracts were so complex that they would have taken a full trial to litigate in their own right, but they could have been able to, and if Detroit lost the casino revenue, it would have been a dramatic loss in the cash flow that Eisebrey acknowledges is the most important thing to the city.  The settlement with the Wall Street banks clears the path for the city to keep the casino revenue and also reduces their cash flow obligation to those banks by 75%.  It's easy for a commentator to say that the people in charge should have fought harder and gotten more, but such people have never actually been in that position.  When the consequences are real, and when you're the one actually making the decisions, you become more risk-averse.  I'm sure there are people at Bank of America and UBS (again, likely those with no direct responsibility for the decisionmaking on the account) saying that the banks rolled over and took a far larger haircut than they needed to as well, and that they were denied the benefit of their bargains.

 

At the very least, Orr has led with the position that he could declare the bondholders to be general unsecured creditors, and that alone has been enough to spook some people.  So far, has settled with financial market creditors rather than litigate that position to conclusion, but so what?  It's seldom productive to play every hand to the river.

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I think you did indeed miss the point of the article.  It is not meant to layout a blueprint for restructuring.  It doesn't offer a time machine to go back and undo what was done.  It is simply a review of things which have passed, and is in reaction to the countless op-eds (many posted right here in this thread) and hard-pushed narratives which seem to focus on just one, singular issue (public employee pensions) as the sole cause of Detroit's financial woes.  It is a warning for other cities which might be booming at the moment about falling into the same traps.  Atlanta, Charlotte, Houston, etc. all should take note of the mistakes Detroit made along the way.

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I think you did indeed miss the point of the article.  It is not meant to layout a blueprint for restructuring ... It is simply a review of things which have passed

 

No.  Read the last two paragraphs:

 

Instead, Detroit's cash flow shortfall must be addressed by fixing the problems that caused it in the first place. Banks must be told that they have profited enough from interest rate swaps that helped create this mess and will receive no more. The state needs to collaborate by increasing available revenues. Corporate tax loopholes must be closed and ineffective subsidies ended.

 

Like other cities, Detroit can work its way back toward a healthy local economy with good jobs, quality public services and a robust tax base. But making that happen depends on honoring the promises made to workers and ensuring that Wall Street and big corporations pay their fair share.

 

How can you read that and say that it's "not meant to lay out a blueprint for restructuring" and is just a backward-looking review of things that have happened?  The author clearly wants to increase taxes and impose greater cuts on Wall Street creditors in order to preserve all pension benefits.  He leads with that (blasting the judge for permitting the bankruptcy to proceed at all, rather than accepting the public unions' arguments that the bankruptcy was forbidden by the Michigan constitution because it would allow for pension cuts), and ends with that.

 

and is in reaction to the countless op-eds (many posted right here in this thread) and hard-pushed narratives which seem to focus on just one, singular issue (public employee pensions) as the sole cause of Detroit's financial woes.  It is a warning for other cities which might be booming at the moment about falling into the same traps.  Atlanta, Charlotte, Houston, etc. all should take note of the mistakes Detroit made along the way.

 

Is it?  If so, it's a very well-disguised warning, considering that he doesn't mention any other cities, whether those which are booming or those which are teetering on the edge of insolvency, including potentially some others right there in Michigan.  I think you're reading what you want to read here.  The article is clearly a call for action, and it is a kind of action that the author either doesn't know or doesn't care is not within the power of the emergency manager or the bankruptcy court.  (I assume that he at least has some inkling that it's outside their power because he phrases his call to action as in part a demand that higher levels of government bail out Detroit with more cash from on high.)

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^Fair enough.  I read it again and honestly probably did take from it what I wanted to - i.e. a more complete picture of the reasons for Detroit's financial woes...... which I still think has some strong value as a forewarning of pitfalls for large municipalities today.

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^Fair enough.  I read it again and honestly probably did take from it what I wanted to - i.e. a more complete picture of the reasons for Detroit's financial woes...... which I still think has some strong value as a forewarning of pitfalls for large municipalities today.

 

One component of said pitfalls is the pension obligations to be sure. 

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^For certain..... particularly for Detroit due to the other three factors identified, none less so probably than the dwindling tax base.  If Detroit's economy was still strong and it's population had not declined, the pension obligations would be much more manageable.

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^Fair enough.  I read it again and honestly probably did take from it what I wanted to - i.e. a more complete picture of the reasons for Detroit's financial woes...... which I still think has some strong value as a forewarning of pitfalls for large municipalities today.

 

One component of said pitfalls is the pension obligations to be sure. 

 

And to the extent that municipalities are financing either general operations or pension funds with complex financial derivatives and similar instruments from Wall Street, those are also a component.  And I have few problems seeing major Wall Street players bear losses on the risks they assume.

 

But as for lessons for other municipalities, I think the article misses some of the deeper lessons, at least as I see them from the vantage of a restructuring professional with at least casual fluency with complex financial instruments.  For example, in this situation, I see a stern reminder in why fiscal discipline even in good times is so important.  Why?  Because that swap contract that Detroit signed was an interest rate swap contract that would have cushioned a lot of hurt for Detroit if interest rates had gone up, but which obligated Detroit to pay significant sums if interest rates went down.  Detroit probably felt it needed a hedge like that because it was already in a bad place when it signed it, and knew that high interest rates could have become absolutely punitive for a city with Detroit's credit rating.  By contrast, a city like Columbus, with a AAA credit rating, has very little need of such swaps.  While no one likes high borrowing costs across the board, the flight-to-safety response of many large debt investors in uncertain times would mean that Columbus could still borrow money at reasonable rates even in a high-rate environment.  Therefore, not only does Columbus enjoy the advantage of the lower rates now, it also enjoys the advantage of (hopefully) not having felt any need to insure itself against higher rates, particularly when the only way to get such "insurance" was through a rate swap agreement that of course would be heavily tilted in favor of the issuing bank, both in terms of ordinary performance terms and default remedy terms.

 

Keep the roof repaired when the sun's shining.  It's a bit late to fix it when it's raining.

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Foundations pledge $330M to save DIA art

 

Detroit— National and local foundations have pledged more than $330 million to a fund to protect city-owned art at the Detroit Institute of Arts from being auctioned off, mediators in Detroit’s bankruptcy announced Monday.

 

A statement from Chief U.S. District Court Judge Gerald Rosen’s team of mediators called the financial commitments “an extraordinary and unprecedented effort” to preserve the art collection and raise money for Detroit’s underfunded pension funds.

 

As first reported by The News in November, Rosen has been attempting to reach a deal with private foundations to speed the city’s exit from bankruptcy by contributing up to $500 million toward a fund to boost the city’s underfunded pension funds and protect the DIA’s works from unsecured creditors seeking to recover more than $11 billion owed by Detroit.

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Kwame Kilpatrick sent to medium-security prison in Oklahoma

Former Mayor Kwame Kilpatrick didn't get his wish and was sent Tuesday to a medium-security prison in Oklahoma after officials didn’t honor his request to serve a 28-year sentence for corruption in Texas near his wife and three sons.

 

Kilpatrick is incarcerated in the El Reno federal prison, about 30 miles west of Oklahoma City, according to the Bureau of Prisons website. He had been temporarily housed at a transfer center in Oklahoma.

 

The transfer comes as Bobby Ferguson, pal and co-defendant in the corruption case, is on trial on federal bid-rigging charges. Ferguson was sentenced to 21 years.

 

Kilpatrick, 43, is scheduled to be released Aug. 1, 2037. He was convicted of 24 charges including racketeering conspiracy in March after being accused of turning City Hall into a criminal enterprise. His 28-year term is tied for the longest public corruption sentence in U.S. history.

 

From The Detroit News: http://www.detroitnews.com/article/20140122/METRO01/301220054#ixzz2rL3RCdVe

 

 

 

 

 

 

 

 

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Bill Shea (who I know from Browns fans sites) breaks a lot of stories Up North...

 

http://www.crainsdetroit.com/mobile/article/20140126/NEWS/301269993

 

"Detroit's new bus chief not only is tasked with quickly mending the Detroit Department of Transportation's well-documented service troubles but also with creating a financial record-keeping system that a damning report says is missing for federal grants."

 

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Perhaps the author thinks that the emergency manager's team blinked too quickly in its fight with the swap counterparties, agreeing to a <a href="http://www.bloomberg.com/news/2013-12-17/detroit-seeks-to-pay-ubs-bofa-230-million-to-end-swaps.html">$230 million payment to UBS and BoA</a>, also to be financed by new borrowing, in order to get out of certain swap contracts that might (or might not) have given those creditors the ability to attach the revenue from the casinos, and which were already costing the city $4 million a month, i.e. $48 million per year.  The payment on the new loan will be about $12 million per year.  Granted, that's still more than $0 and the total principal payout is something like 75% on those contracts (if I'm reading other articles correctly that these are the same swap deals), so if you're feeling very aggressive and wish Orr would have fought to lump them in with other unsecured creditors and given them maybe 20 cents on the dollar, that may look like a capitulation.  On the flip side, that position did have its day in court, as other creditors filed objections to the settlement making exactly that argument, and they lost.  The bankruptcy judge didn't hold that the Wall Street banks would have been able to attach the casino revenue, since the swap contracts were so complex that they would have taken a full trial to litigate in their own right, but they could have been able to, and if Detroit lost the casino revenue, it would have been a dramatic loss in the cash flow that Eisebrey acknowledges is the most important thing to the city.  The settlement with the Wall Street banks clears the path for the city to keep the casino revenue and also reduces their cash flow obligation to those banks by 75%.  It's easy for a commentator to say that the people in charge should have fought harder and gotten more, but such people have never actually been in that position.  When the consequences are real, and when you're the one actually making the decisions, you become more risk-averse.  I'm sure there are people at Bank of America and UBS (again, likely those with no direct responsibility for the decisionmaking on the account) saying that the banks rolled over and took a far larger haircut than they needed to as well, and that they were denied the benefit of their bargains.

 

Quoting myself from December in order to follow up on this point, as the Detroit Free Press reports on a story that I had missed in this:

 

http://www.freep.com/article/20140116/NEWS01/301160104/detroit-bankruptcy-swaps-ruling

 

The bankruptcy judge is actually strong-arming some of the big banks that are counterparties to the swap agreements.  I earlier reported that the $230 million lump-sum payout for an annual obligation of about $50 million looked pretty decent, but the judge actually rejected it.  Turns out that the judge might have been onto something (or some of the other creditors might have been, since the settlement was hotly contested by both the city's pension funds and by a bond insurer that presumably has some kind of derivative interest in these swap agreements, though I still don't know what the latter's role was).  In either event, the arguments against the settlement prevailed a second time even after the proposed settlement figure with UBS and BoA Merrill Lynch was reduced to $165 million.  The bankruptcy judge rejected even that figure as too high.

 

More coverage from Bloomberg here: http://www.bloomberg.com/news/2014-01-16/detroit-loses-bid-to-pay-banks-165-million-to-end-swaps.html

 

http://online.wsj.com/news/articles/SB10001424052702303465004579324880766804684

 

Judge Rhodes' statements in the articles strongly hint that he is prepared to seriously consider arguments that there is some kind of legal vulnerability in the underlying debts themselves, possibly with the grant of the security interest in the casino tax revenue (which is the central legal fact making these debts ostensibly worth considerably more on the dollar than completely unsecured debts).  The WSJ article reports that he expressed doubt that the swap agreements were legal, but he didn't give any specific grounds for that and I'd be curious to know if any of the other creditors put forward arguments to that effect (i.e., so there's an actual argument raised in the record about the legality of the swaps, as I've generally been assuming that they were fine).

 

Either way, it's a pretty explosive ruling.  Bankruptcy judges seldom insert themselves so directly into settlement discussions even with private companies in chapter 11 bankruptcies, and their powers are even more limited in a chapter 9 municipal filing.

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LOL

 

The judge also rejected Detroit’s accompanying proposal to borrow $165 million from London-based Barclays to finance the settlement.

 

He did approve a proposal to borrow $120 million to pay for “quality of life” services — but the money comes with conditions that could make it harder for the city to use the money to improve emergency services, lighting, utilities and to address blight, the most pressing needs, according to Orr.

 

http://www.freep.com/article/20140116/NEWS01/301160104/detroit-bankruptcy-swaps-ruling

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I'm wondering if the bankruptcy judge will come to regret that procedural roadblock he established, wherein the city needs to file a notice with the court of its intent to spend any part of that $120 million and give other creditors a chance to object to it.  It certainly wouldn't be above some other creditor following the squeaky-wheel theory to say "the city should not be spending $_______ for {insert quality-of-life service} when it could be paying its debt to us instead."

 

Maybe the judge will let that happen once or twice and use his rulings on such objections to clarify that such objections are only welcome if the creditors have some other objection to the expenditure than "pay us instead!"  I can see why the judge wanted some procedure in place, since he was concerned about the historically poor financial decision-making of the city and apparently isn't all that impressed with Orr, either, given how far apart they were on what they considered reasonable numbers to buy out UBS and Merrill Lynch.  And there's some logic to a notice-and-objection system because it effectively turns all other creditors into watchdogs for the court.  ("Hey, they just gave a bridge repair contract to Joe Schmoe's Concrete for way above market, and I think Schmoe and the emergency manager are golf buddies.")  But there are so many other creditors in the Detroit case that the odds of there being one who will object to everything just on principle seem pretty high.

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Detroit releases long overdue financial audit for 2012-2013, shows the city was insolvent as of June 2013

 

http://www.freep.com/article/20140728/NEWS01/307280180/Detroit-CAFR-2013

 

The numbers, the city said, paint a picture of a clearly insolvent city with a $130-million general fund deficit as of June 30, 2013. The shortfall came despite attempts by then-Mayor Dave Bing’s administration to rein in expenses, including slashing city payroll by $81 million through wage cuts, furloughs and attrition and reducing benefits costs by more than $13 million, the city said. At the same time, Detroit boosted income tax collections, bringing in $15 million, and received increased state revenue sharing of nearly $10 million.

 

“These efforts and others outlined in the financial statements, although significant, were not sufficient to address the magnitude of the city’s financial deficiencies at the end of fiscal year 2013,” Hill said.

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Dumb move for GM and bad for Detroit. I think Detroit needs Cadillac to carve out a piece of the industrial design market for its own branding....

 

GM CEO: NYC move to ‘accelerate’ Cadillac progress

David Shepardson, The Detroit News 12:51 p.m. EDT September 23, 2014

 

New York — General Motors Co. CEO Mary Barra said the move of the Detroit automaker’s Cadillac brand headquarters to New York will help accelerate progress at the luxury brand.

 

“When you look at how important Cadillac is, we need to have that team dedicated — thinking Cadillac day in and day out,” Barra told reporters after appearing on a panel at the Clinton Global Initiative’s annual meeting here. “When you think about New York, it’s the perfect place to be. It’s where a lot of luxury is defined. It’s trend-setting — so I think it’s going to be very, very positive.

 

Barra said the move will affect “about 100 people that I think are really going to craft the strategy.”

 

READ MORE AT:

http://www.detroitnews.com/story/business/autos/general-motors/2014/09/23/gm-ceo-nyc-move-accelerate-cadillac-progress/16101011/


"Life is 10% what happens to you and 90% how you respond." -- Coach Lou Holtz

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That's not unprecedented. Ford moved Lincoln-Mercury to California in the late 90s. At first it did work as Lincoln's sales exploded but things fell apart once they moved Jaguar, Land Rover and Aston Martin to the same complex. And of course for most of their histories Buick was in Flint, Chevy in Warren and Olds in Lansing. They didn't consolidate until they bought the RenCen and had all that space to fill.

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From bankruptcy, Detroit emerges buoyant

 

Detroit city government was just eight weeks away from running out of cash when Emergency Manager Kevyn Orr, at the direction of Gov. Rick Snyder, took the city into bankruptcy in July 2013.

 

Employees were taking furlough days to stretch the dwindling dollars. The city was buried under a crushing debt of $18.5 billion, with the bulk of it tied to the legacy costs of pensions and retiree health care.

 

There was virtually no revenue stream — half of property owners had stopped paying their taxes and water bills, and collection of the income tax was intermittent. The city had no practical ability to raise taxes, and because of its dismal credit rating, no ability to borrow.

 

It had no marketable assets except for the collections of the Detroit Institute of Arts, so creditors were banging their shopping carts against the museum's doors.

 

Detroit was staring insolvency in the face, and its residents and even some of its leaders had little appreciation for how rapidly financial conditions were deteriorating.

 

With the approval of the plan of adjustment Friday, however, Detroit's debt load is $7 billion lighter. That will free up $140 million to $160 million a year in debt service revenue that can go directly into rebuilding the municipal infrastructure and improving services.

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Heh.  If the debt started at $18.5 billion and the confirmed chapter 9 plan only reduced it by $7 billion, that still means that the city faces $11.5 billion in debt.  Hopefully it restructured enough of its ongoing obligations so that it actually has the cash flow needed to service that debt now, while keeping city functions alive.

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