mead cohen berger shevtsova garfinkle michta grygiel blankenhorn
Motor City Meltdown
Detroit Chooses Pensioners over Bondholders in Debt Plan

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.

Features Icon
show comments
  • rheddles

    Bondholders got screwed in Detroit by the President in 2009. I wonder how many of them are ready to suck it up again in the same city. They may be more willing to contest the proposal in front of BK judge than the Chief Magistrate. I wonder how many of the bond holders are non-Detroit pension funds.

  • Andrew Allison

    I’m confused. 38% of the unsecured debt would be repaid, but the pensioners would get 40% and the bondholders 20%?
    If that doesn’t spook the muni market, what will? As an aside, shouldn’t the haircut be the same for all unsecured creditors?

  • Pete

    No surprise here. The parasites have to be accommodated. They are, after all, a big constituency of the Democrat Party

  • free_agent

    You write, “The political pressure to get the best possible deal for pensioners is
    near-irresistible. … 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

    I don’t think there are a lot of people who would argue that putting the pensioners ahead (in part) of the bondholders is fundamentally unjust.

    As for other pension funds, it seems strange to me that pension funds (which should have conservative investments) would buy bonds from a city whose finances are a disaster waiting to happen.

  • BobSykes

    Anyone who holds any state or municipal bonds or bonds from any unionized company or any foreign bonds is an idiot.

  • Fat_Man

    The Bankruptcy Judge made it clear at the outset that any plan would have to be fair and equitable. I do not see how a plan that pays one class of unsecured creditors a higher percentage of its claims than any other will be fair.

    To my mind, this bankruptcy cannot be completed until the pensions are put on a sound basis. At a minimum:

    1. There must be haircuts of pension benefits so that they do not exceed social security and PBGC standards.

    2. disabled and over 65 health care beneficiaries should be transferred to Medicare without penalties, but without benefit enhancements.

    3. other medical plans should be put in the Obamacare exchanges and subsidies should be granted on a need basis for silver level policies.

    4. The plans should be terminated and replacemed with social security and defined contribution plans,

    5. There should be damage payments by the union fiduciaries who fell down on their jobs by failing to ensure proper funding of the plans.

    6. The representative status of the unions that got the plans into this mess should be terminated.

  • Alexander Scipio

    Anyone surprised? This is what Obama did to Chrysler & GM.

© The American Interest LLC 2005-2016 About Us Masthead Submissions Advertise Customer Service