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Detroit and the Lose-Lose Battle for Blue


The fallout from Detroit’s bankruptcy filing will be felt far beyond its city limits. John Dizard at the FT explains what’s at stake for the municipal bond market and beyond in a fight that’s likely to find its way to the US Supreme Court.

Dizard’s piece reinforces our impression that this is a lose-lose battle. Federal bankruptcy law is in tension with the Michigan constitution, which guarantees protection of pension and retirement benefits. Should the Supreme Court rule in favor of the unions, the national muni bond market could dry up as investors realize they might be left out to dry in similar future bankruptcies. This could in turn cause several other borderline metropolises to drift dangerously closer to insolvency.

The piece ends with some well-deserved dressing down of both Wall Street analysts and pension fund managers:

Detroit’s broken pension promises were based, in part, on an assumed 8 per cent return on investment, within the range accepted by most US state and municipal sponsors. That is likely to prove a multiple of what it should have been, even if the “risk-free” return on Treasuries were to return to a long-term norm. A 5 or 6 per cent rate of return assumption is aggressive enough. The added phantom returns compound the pension plans’ underfunding by justifying reduced employer contributions or higher benefits.

All the little modeling tricks, illiquidity premiums, and PowerPoint charts used by portfolio managers to lure plan sponsors will come back to haunt them for decades to come. At some level of consciousness, everyone in the business knows this is true. Look forward to explaining to the neighbours they can’t retire when they thought they could because you were complicit in the lie that you could beat the index.

Emphasis ours. Ouch. Read the whole thing here.

[Detroit image courtesy of Shutterstock]

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  • Thirdsyphon

    An amendment to the Michigan State Constitution won’t be binding on a Federal Bankruptcy Court, which can and will dish out lumps to pensioners and bondholders alike in parceling out the limited resources of Detroit. Where the amendment really might come into play, though, is afterwards. Remember, a bankruptcy proceeding will only resolve the claims of the various parties against *Detroit*. Once that’s done, the unions might have a claim to be made whole for the remainder of their pensions against the State of Michigan itself, based on that amendment. The bondholders will not.

  • TheCynical1

    Blue Model liberals love federal supremacy, except when they don’t.

  • Bruce

    What nobody has addressed is how in the world guarantees of public pensions winds up in a Constitution.

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