After months of waiting Detroit’s bondholders are finally getting a look at the city’s plan to repay them, and they aren’t thrilled with what they’re seeing. The city will reportedly split creditors into two groups: city employees who were promised benefits from the city, and everyone else. Although everyone is taking a massive haircut in one form or another, city workers will walk away with at least 40 percent of the money they were promised; others will likely get less than 20 percent. In total, only $4.2 billion of the city’s $11 billion in unsecured debt will be repaid. As the WSJ notes, however, the long, drawn-out court process could dramatically change the contours of the plan:
Details of the plan sent to creditors on Wednesday have been kept under wraps as the city and its debtholders continue to talk in closed-door mediation. The city sent its working draft to creditors in the hopes that the plan with a richer payout might spur some of them to settle with the city individually or, in the least, offer their own suggestions toward modifying the overall proposal, according to another person familiar with the matter.So far, the plan which is considered to be a rough draft, doesn’t include any major settlements with the city’s creditors. But it could be more welcome news for unions and pension funds if they agree to settle.
This is bad news for bondholders, but probably also expected news. The political pressure to get the best possible deal for pensioners is near-irresistible. Even with this deal pensions are going to take a massive and painful hit. The irony here is that many of the bondholders are themselves pension funds; Detroit’s pensioners are getting a bit of a break at the expense of many retirees and near-retirees across the country.The news will also be sobering to investors in the municipal debt market. Lending money to cities and states has suddenly become a much riskier proposition. Cities and states are going to have to pay higher interest rates as bondholders will (correctly) reason that they will be sent to the back of the line for repayment should anything go wrong.There is no good way out of a municipal bankruptcy. The failure of a great city creates an ugly, complex mess. It’s too early to tell for sure, but right now it looks as if Detroit’s failure will spread pain across the debt markets for a long time to come.And Detroit is just the tip of the iceberg. The Baby Boom generation wants big pensions, but it hasn’t saved up enough money to pay for them. That inconvenient truth is going to create one problem after another for this country in the decades to come.