Detroit is bankrupt—officially. Indeed, as Judge Steven Rhodes of the United States Bankruptcy Court said earlier today, the city “could have and should have filed for bankruptcy long before it did, perhaps even years before.”
Nearly five months after Detroit filed for the largest municipal bankruptcy in U.S. history—a move ferociously challenged by creditors—Rhodes ruled that the city’s plight warrants Chapter 9 protections while it restructures its debt: $18.5 billion at last count. Detroit’s liabilities are a serious obstacle to delivering essential services to city residents (myself among them).
“The message of this bankruptcy is that the city does not have enough money to properly care for its residents,” Rhodes said.
The detailed decision was announced from the bench in downtown Detroit before a blitz of at least 100 reporters from as far away as Brazil, Russia, and Japan, alongside a massive amount of courthouse security, including a bomb squad, U.S. Marshals, and police on foot, horse, and in cars. Strikingly, the decision came the same day as news broke of sales gains across the auto industry, with big increases for all U.S. brands. General Motors and Chrysler, in which Detroiters have a particular stake, moved through bankruptcy themselves in recent years.
At issue in Detroit’s feisty nine-day bankruptcy trial: whether the city meets federal bankruptcy eligibility requirements. Detroit had to prove it was insolvent and that it had legal authorization by the state of Michigan to file. It also had to prove that it negotiated in good faith with its tens of thousands of creditors—from Wall Street bondholders to city pensioners—or that it was “impracticable” to do so.
The city meets all four requirements, according to Rhodes. He did say that Detroit did not negotiate in good faith, giving “little opportunity for creditor input or substantive discussion.” But with so many creditors and the need for expediency, negotiations met the “impracticable” test.
While in many ways Detroit is in unprecedented territory, its problems are echoed around the country in cities that are eyeing today’s decision for the precedent it sets—particularly when it comes to benefits for city retirees.
It’s a red-letter day, then, in Detroit history—and in its future as a financially streamlined city. But the bankruptcy case and its implications are complex. Building on our analysis after the city first filed for Chapter 9, here are the three most important things to know about Detroit’s bankruptcy decision.
1. NEXT STEP: A PLAN
Rhodes’ judgment takes immediate effect, and creditors are likely to begin fighting for whatever scraps they can get from the city at this point. Detroit’s emergency manager, Kevyn Orr, and city lawyers expect to submit a plan of financial re-adjustment by the end of the month. This will include plans to pay off part of its debts to creditors, including bondholders, retirees, and unions. The plan will also address the need to reinvest in city services. According to the Detroit Free Press, it will likely also make proposals about the sale of assets, such as the city’s massive water and sewer department. At this point, Orr said in a press conference today, everything is on the table.
The city has said that it is possible for it to emerge from bankruptcy before the end of 2014.
2. IT’S STILL NOT OVER
There is a chance that the city will face an appeals process instigated by creditors. In particular, according to Reuters, “The city’s largest union has asked Rhodes to allow any appeal to proceed directly to the U.S. 6th Circuit Court of Appeals, bypassing the U.S. District Court in Detroit.” However, the looming specter of ongoing legal battles is not likely to delay the city as it moves forward with its restructuring plan: it can proceed even as appeals are pending. Also, as the Detroit Free Press indicates, “experts say that appeals courts are hesitant to overturn bankruptcy rulings based on the facts.”
City retirees and its two pension funds are among the strongest dissenters to the validity of Detroit’s bankruptcy, contending that the city, under the emergency management of a former bankruptcy lawyer, opted for bankruptcy instead of negotiating with them fairly. They also argue that Michigan’s constitution protects against pension cuts—a point Rhodes disputed in his ruling, as federal Chapter 9 law trumps state law.
Significantly, Rhodes also said that pension debts are equivalent to contractual obligations under the state constitution and cannot be distinguished from other debts: that is, he will allow pensions to be cut in the city’s restructuring plan.
“It has long been understood that bankruptcy law entails the impairment of contracts,” he said, while at the same time emphasizing that “No one should interpret this … to mean that this court necessarily will confirm any plan of adjustment that impairs pensions””
Nonetheless, dissenters suggest that the city should first sell its assets—such as artwork in the extraordinary Detroit Institute of Arts—to pay down debt before cutting contracts and benefits. Last week, the city’s largest creditors asked Rhodes to order an independent evaluation of the DIA’s prized collection, in addition to the appraisal by Christie’s, the auction house, commissioned by the city. Both moves were strenuously objected to by the museum, its peer institutions, and many thousands of supporters in Detroit and beyond. As Philip Kennicott put it in the Washington Post, Detroit is compelling many of us to make a Platonic case for why “the nurturing of the mind and the care of the soul aren’t secondary or tertiary niceties, they are at least equally important to the other basic needs the city meets,” and that makes art an essential civic asset.
The asset-selling argument contrasts with the plan Orr put forward in June, which rather radically prioritized paying city services over paying unsecured creditors, who were offered settlements of about 10 cents on the dollar. There are likely to be common threads between that plan and the post-ruling restructuring plan that the city will put forward this month.
For his part, Rhodes noted today that a one-time infusion of cash by selling the DIA’s assets would not fix things for Detroit in the long-term and, instead, would only delay failure.
3. THIS DECISION IS PIVOTAL FOR CITIES FAR BEYOND DETROIT
While in many ways Detroit is in unprecedented territory, its problems are echoed around the country in cities that are eyeing today’s decision for the precedent it sets—particularly when it comes to benefits for city retirees.
Retiree health care and pensions make up about half of Detroit’s liabilities, according to the city. As Rhodes noted, 39 percent of the city’s revenue was used to service legacy liabilities in 2012. It’s not a unique problem: Illinois, for example, has a $100 billion pension problem. Chicago alone is in a $33 billion trap. Los Angeles, Houston, Phoenix, and Jacksonville, Florida, all have pension funding gaps that are about double their annual revenue.
Judge Rhodes made a point of not deciding on the size of Detroit’s pension liabilities, which is still disputed. Mismanagement and corruption in Detroit’s two pension funds are significantly at fault for the scale of today’s unfunded liabilities, but not singularly, and regardless, the city must deal with them.
Orr has previously suggested, according to a heartbreaking profile in the Detroit News, that annual retiree health costs could be cut by $50 million by moving retirees older than 65 onto Medicare and giving younger ones a $125 monthly stipend for coverage.
Whatever the final deal ends up being, it will face a great deal of scrutiny—and it will be revealed before long. “Time is of the essence,” Orr said in a post-ruling statement, “and we will continue to move forward as quickly and efficiently as possible.”
