The city of Detroit, Michigan, filed for Chapter 9 bankruptcy on July 18, 2013. It is the largest municipal bankruptcy filing in U.S. history by debt, estimated at $18–20 billion, exceeding Jefferson County, Alabama's $4-billion filing in 2011. Detroit is also the largest city by population in U.S. history to file for Chapter 9 bankruptcy, more than twice as large as Stockton, California, which filed in 2012. Detroit's population had declined from a peak of 1.8 million in 1950 to 700,000 at the time of its bankruptcy.
Detroit's bankruptcy filing followed a declaration of financial emergency in March 2013 that resulted in Kevyn Orr being appointed as "emergency manager" of the city by Michigan Governor Rick Snyder. Orr's subsequent negotiations sought to get creditors to willingly agree to debt restructuring and accept less than initially agreed on Detroit's debt, and were ultimately unsuccessful.
On July 19, 2013, Judge Rosemarie Aquilina of the Thirtieth Judicial Circuit Court of Michigan ruled the bankruptcy filing by Detroit violated Article IX, Section 24, of the Michigan Constitution and ordered Governor Rick Snyder to withdraw the filing immediately. On July 23, an appeals court stayed the circuit court ruling pending future rulings on Michigan Attorney General Bill Schuette's appeal. On July 24, the Bankruptcy Court added its own, federal stay of the state court proceedings. On August 2, the bankruptcy court set a hearing date of October 23, 2013, for trial on any objections to the city's eligibility for Chapter 9 bankruptcy, and March 1, 2014, as the deadline for the city to file a bankruptcy plan. After a nine-day trial on eligibility, the Bankruptcy Court on December 3, 2013, ruled Detroit eligible for Chapter 9 on its $18.5 billion debt. On June 3, 2014 the Michigan Legislature passed a package of bills to help Detroit avoid further bankruptcy proceedings. On the same day, Governor Snyder pledged to sign the package of bills.
After a two-month trial, Judge Steven W. Rhodes confirmed the city's plan of adjustment on November 7, 2014, paving the way for Detroit to exit bankruptcy. Creditors and insurers were expected to absorb losses totaling $7 billion, with creditors receiving between 14 and 75 cents on the dollar.
Background
In April 2012, Detroit Mayor Dave Bing and the nine-member City Council entered into an agreement with Michigan Governor Rick Snyder that allowed for greater fiscal oversight by the state government in exchange for the state's providing Detroit help with its finances. A financial review team was appointed in December 2012 to conduct a 60-day review. The team consisted of Andy Dillon (Treasurer of Michigan), Thomas McTavish (Michigan Chief Financial Officer and Auditor General), Ken Whippel (Korn/Ferry), Darrell Burks (PricewaterhouseCoopers), Ronald Goldsberry (Deloitte Consulting) and Frederick Headen. In February 2013, Snyder announced that the Michigan state government was taking financial control of the city of Detroit, as it viewed that Detroit failed to meet deadlines set by the state government. In accordance with Public Act 72 of 1990, the state government's Local Emergency Financial Assistance Loan Board appointed Kevyn Orr as the emergency financial manager of Detroit following a declaration of financial emergency. As emergency manager, Orr was granted the power to rewrite Detroit's contracts and to liquidate city assets.
A report on the financial health of Detroit was released by Orr in May 2013. The report stated that Detroit is "clearly insolvent on a cash flow basis" and that the city would finish its current fiscal year with a US$162 million cash-flow shortfall. It also stated that the city's budget deficit would reach $386 million in less than two months and that one-third of the city's budget was going toward retiree benefits.
Declining city revenue led to the cash-flow shortfall in Detroit. In 2005, the city's budget was facing a $300 million deficit, sparking fears of potential receivership. In 2013, Detroit’s revenue had fallen over 20% from its 2008 level. Revenue fell due to Detroit’s declining population, which reduced the property and income tax base. Rising foreclosures and unemployment following the Great Recession reduced property values and further reduced the property and income tax base. Additionally, Michigan decreased state revenue sharing with Detroit due to declining population numbers reported in the 2010 census.
City expenses also contributed to the cash-flow shortfall. City operating expenses decreased by 38% between 2008 and 2013 through employee layoffs and reduction of employee healthcare and benefits. At the same time, debt payments, retiree healthcare and pension payments, and most significantly, financial expenses, increased between 2008 and 2013. Financial expenses included certificates of participation to finance $1.6 billion in debt, which required termination payments as a result of the city’s low credit rating.
Contributions of city revenue and expenses to the cash-flow shortfall help explain the immediate causes of Detroit’s bankruptcy filing, but Detroit’s complex history provides greater context for the city’s financial problems. The decline of population and employment opportunities in Detroit had been going on for decades prior to the bankruptcy filing. Detroit’s population declined from 2 million in 1950 to 714,000 in 2010. Jobs followed the population, as over two-thirds of businesses in Detroit closed between 1972 and 2015. Many of these residents and jobs left Detroit for the surrounding suburbs during the process of white flight from the city. White flight occurred in conjunction with federal housing policy and Detroit real estate industry practices in the decades following World War II that excluded black Detroit residents from loan opportunities and confined them to neighborhoods with continually deteriorating housing.
Bankruptcy filing
In June 2013, the government of Detroit stopped making payments on some of its unsecured debts, including pension obligations. In an effort to avoid bankruptcy, Orr sought to persuade some of Detroit's creditors to accept 10% of the amount they are owed. White House Press Secretary Jay Carney said, during a press conference in July, that he knew of no plans by President Obama to bail out the Detroit city government similar to the bailouts in recent years of Detroit-area automakers General Motors and Chrysler. On July 17, just one day before the bankruptcy filing, Detroit's two largest municipal pension funds filed suit in state court to prevent Orr from cutting retiree benefits as part of his efforts to cut the city's budget deficit.
After several months of negotiations, Orr was ultimately unable to come to a deal with Detroit's creditors, unions, and pension boards and therefore filed for Chapter 9 bankruptcy protection in the Eastern District of Michigan U.S. Bankruptcy Court on July 18, 2013. Snyder approved the filing by Orr in a letter attached to the court documents. Some of the named causes for the bankruptcy are the shrinking tax base caused by declining population, program costs for retiree health care and pension, borrowing to cover budget deficits (since 2008), poor record keeping and antiquated computer systems, that 47% of owners had not paid their 2011 property taxes, and government corruption. Two city workers' pension plans had for nearly 25 years been paying out "13th month" checks.
Bankruptcies of cities, towns, villages and counties since the Great Depression are rare (about 60 since 1950, i.e. around 1 per year; special district bankruptcies have been more numerous), and how Detroit will be affected is unclear. Detroit's estimated long-term debt was more than $14 billion and could be between $18 and $20 billion, far exceeding the $4 billion in debt of Jefferson County, Alabama, that had been the largest American municipal bankruptcy filing to date. It is also the largest city by population in U.S. history to file for bankruptcy, with more than double the population of Stockton, California, which filed for bankruptcy in 2012. State officials said that city services will not be affected immediately by the bankruptcy filing. Municipal workers with pensions are not insured by the federal Pension Benefit Guaranty Corporation, since they work for a municipality and not a business, and some also had received pensions in lieu of Social Security benefits.
According to a Detroit area bankruptcy attorney, legal costs for the bankruptcy proceedings could cost Detroit "tens of millions to hundreds of millions of dollars." Orr hopes that Detroit can emerge from bankruptcy by late Summer or Fall in 2014; he says that the process is moving as "expeditiously as possible".
Orr has considered the sale of valuable city assets, but other arrangements or regulations make it difficult to sell some of them. For instance, valuable works at the Detroit Institute of Arts cannot be sold due to private and city agreements, as well as state law; other city assets that could not be sold include the Coleman A. Young International Airport and the Belle Isle Park. Eddie Francis, the mayor of the neighboring city of Windsor, Ontario, has said that his city would consider purchasing Detroit's half of the international Detroit–Windsor Tunnel if it is offered for sale.
Reaction
Yields on bonds issued by the city of Detroit increased on July 18 to record highs, as investors considered the potential effects of the bankruptcy filing. Rates had already escalated when yields jumped from 8.39% in mid-May to 16% in mid-June 2013. The credit rating agency Moody's said that the bankruptcy filing was credit negative for Detroit and that it created an "unprecedented litigation scenario," which could impact services city residents receive, as well as how much bondholders would recover from Detroit.
Business and labor leaders reacted to the filing. Detroit union leaders called Orr's move to declare bankruptcy premature due to ongoing financial negotiations with creditors, unions, and pension boards, but also stated that employees will continue to work in a typical fashion. The only major U.S. automaker headquartered in Detroit itself, General Motors, said it "is proud to call Detroit home and ... (this is) a day that we and others hoped would not come. We believe, however, that today also can mark a clean start for the city."
Politicians have commented on the bankruptcy. Bing said that the people of Detroit "have to make the best of it". Snyder stated that "I know many will see this as a low point in the city’s history," "If so, I think it will also be the foundation of the city’s future—a statement I cannot make in confidence absent giving the city a chance for a fresh start, without burdens of debt it cannot hope to fully pay." President Barack Obama said that he is following the developments and that he is "committed to continuing our strong partnership" with Detroit. Kentucky Senator Rand Paul stated that he will not allow the government to bail out the city, saying "He is bailing them out over my dead body, because we don’t have any money in Washington." Snyder also stated that he did not support a government bail out. "It's not just about putting more money in a situation," he said. "It's about better services to citizens again. It's about accountable government."
Detroit's debts included $369 million in unlimited general obligation bonds, bonds issued with the general backing of taxpayers, described by Florida bond finance director Ben Watkins as "[having] been the gold standard of the municipal-bond market". The offer by Kevyn Orr to settle these for less than 20% face value, and doubts regarding the willingness of Michigan to assume the debts, was predicted to drive up borrowing costs of nearby municipalities. This effect has been seen in regard to localities in Michigan. Three have so far had to postpone new bond offerings or face higher interest rates. However, this concern has not materialized on a wider scale, as investors have actually treated municipal general obligation bonds as safer than before the filing. Recent history from California "has shown that the fallout from a bankruptcy can dissipate quickly" in the bond market. Contributing to this is the fact that Moody's has fewer than 40 of the 7,500 local governments that it rates listed as below investment grade.
Soon after Detroit declared bankruptcy, it was reported that the city would continue with plans for a bond issue to fund a new $444 million arena for the Detroit Red Wings. Repayment of the bonds would be split between taxpayers and developers of the arena. Both Snyder and Orr acknowledged concerns raised about the expense, but stated that continuing the project makes good economic sense even with the context of Detroit's bankruptcy. With the arena, and additional retail, office, residential and hotel space the developer has committed to build as part of the overall project, it is expected to create about 8,000 construction jobs, with work due to start in 2014.
Legal developments
From bankruptcy filing to eligibility ruling
On July 19, 2013, Ingham County Circuit Court Judge Rosemarie Aquilina ruled, using a typed statement with hand-written notes attached, that the bankruptcy filing by Detroit violated the Michigan constitution by impairing pension payments and ordered Snyder to withdraw the filing: Snyder has appealed the motion, and Aquilina indicated she was sending a copy of her ruling to President Obama. While under Article IX, Section 24, of the Michigan Constitution, neither the state nor any of its "political subdivisions" are permitted to default on the accrued financial benefits of their pension plans or retirement systems, federal law may allow bankruptcy judges to renegotiate pensions of municipalities in bankruptcy. Many consider public pension benefits of existing retirees "virtually untouchable"; the clash between state constitutional protections of vested public pension rights and the general ability of the bankruptcy process to modify debt obligations has yet to be fully tested in any Chapter 9 proceeding.